The Make or Buy Decision It is widely acknowledged in the literature that an internal analysis be carried out prior to any outsourcing decision is made, to decide whether a company should outsource or not. This analysis will help decide whether the function will be kept in-house or if it should be outsourced to an external provider. Rothery and Robertson (1995) state that the make it or buy it decision is fundamental to the whole process of outsourcing. They continue to say that ‘making it’ also assumes ‘doing it’ or ‘servicing it’, as it also applies to the provision of services. McIvor, Humphreys and McAleer (1997) believe the make or buy decision is being given more consideration within organisations because of its strategic implications.
The make or buy decision can often be a major determinant of profitability making a significant contribution to the financial position of a company. With this in mind, they recommend a strategic model for the formulation of an effective make or buy decision, (which is illustrated in FIGURE XX). They have highlighted four stages which they say attempt to overcome some of the problems associated with the make or buy decision. They also state that the partnership sourcing involves greater collaboration, trust, and commitment and information exchange between both parties. Stage 1 – Defining the core activities of the business A core activity is central to the company successfully serving the needs of potential customers in each market.
The activity is perceived by the customers as adding value and therefore being a major determinant of the company’s competitive advantage. Stage 2 – Profiling the appropriate value chain linksMcIvor et al, (1997) note that a key strategic issue in the make or buy decision is whether a company can achieve a sustainable competitive advantage by performing a core activity internally on an on-going basis. However, many companies assume that because the activity has always been performed internally, it should remain that way.
In some cases, however, a closer analysis and benchmarking may reveal that their own capabilities are quite poor in comparison to those of the worlds-best suppliers. Evans and Lindsay (2011) define benchmarking as measuring your performance against the best companies within the sector, finding out how they achieved those performance levels and using the information as a basis for your own company’s targets, strategies and implementation. Therefore, when companies are considering outsourcing, they must rigorously evaluate their own capabilities in relation to their supplier and then make the decision. Jones and Hill (2013) suggest that value chain includes all functions such as production, marketing, information systems and material management and that they all have a role in lowering in lowering the cost structure and increasing the customer’s perceived value. They continue by suggesting the main aim is to distinguish the core activities and maintain control over those, which provide the company with its competitive advantage. Stage 3 – Total cost analysisThis stage involves measuring all the actual and potential costs involved in sourcing the activity internally or externally.
This stage helps identify all the activities and costs associated with the make or buy decision. They have identified two types of costs; 1. Cost estimation of producing the component internally 2. Cost estimation associated with potential suppliers, identified from the previous stages Stage 4 – Analysis of potential suppliers for partnershipThe company may establish a partnership relationship with a supplier in order to exploit their capabilities. Hamel and Prahalad (1994) argue that a company can develop a core competence by learning from partners. McIvor et al, (1997) back this up by stating that effective partnerships require a clear understanding of expectations, open communication and information exchange, mutual trust and common aims for the future. McIvor et al, (1997) highlight the importance of identifying the core and non-core activities of an organisation.
The aim of this process is to maintain control of the core activities with the business, the features which provide the company with their competitive advantage. Non-core activities are activities which can generally be safely outsourced, activities which are important to the smooth running of the business but not a unique element of the overall product. Rothery and Robertson (1995) have illustrated a structured way of evaluating the ‘make it or buy it’ question/decision; 1. Evaluate management time: How much time are management spending on non-core activities? 2. Skills supplement: What skills could be bought to enhance the business?3.
Identify utilities: What internal business is just a utility capable of being out-sourced?4. Cash and capital ratios: Identify the potential for cash and capital flows and their new uses.5.
Products and services: Can these be expanded or should they be reduced?6. How well is the company operating? Carry out a benchmarking exercise.