Make or buy

Another purchasing policy relates to the decision involving, whether to buy a part or component from outside or manufacture in one’s own plant. In some cases, a company may be able to make a required component more economically than it can buy it. On the other hand, historical production policy decisions may at times require a company to make certain parts that it could more effectively from outside suppliers. Deciding whether a part should be purchased or manufactured is known in industry as the make-or-buy decision.

There seem to be mainly two alternatives to the problem of make or buy. Actually, the case is not as simple as this. There is in between stages wherein a company may buy, but takes over some function that is normally performed by the vendor or a company may make, but allow outside suppliers to perform some of the functions involved. Examples vary all the way from control of quality by a purchaser, who puts inspectors in a supplier’s plant to the control of a supplying company through financial investment through management affiliations.

Assuming that only two extremes are available – make-or-buy, there are three types of make or buy problems:

1. making or buying something which it never before procured
2. making something which it is now buying, or
3. buying something which it is now making

Whatever the type, the problem of make-or-buy arises in one of several ways. The development of a new product or the substantial modification of an old one is a typical situation requiring make-or-buy investigations. Secondly, unsatisfactory supplier performance for parts originally purchased is a second situation that gives rise to make or buy investigations. Unsatisfactory vendor performance may show itself in poor service or unreasonable price hike. Thirdly, periods of significant sales growth or sales decline also generate situations that initiate make-or-buy analysis. Reduced sales may result in reduced production activity rendering production capacity and workers idle. When this happens, the management may think of bringing to its own shop, work which was previously performed by outside suppliers. During periods of rising sales, management seeks external assistance in satisfying the production demands made on its limited facilities.

Types of Make-or-Buy Investigations

Make-or-buy problems, when viewed from a broad sense, can be grouped into two general categories. The first category includes parts for which the using firm currently posses the necessary major production potential. With only a small capital outlay for tooling and minor equipment, the firm can make each of these parts. The second category includes parts which the using firm cannot produce in its existing operations, without making a sizeable additional investment in tooling and facilities.

Investigation of problems in the second category extends far beyond the traditional make-or-buy analysis. Any ‘make’ alternative, requiring a significant capital investment becomes a major problem, needing a long time plan and, which should involve top management.

The make or buy problem requiring only a nominal expenditure of funds in the event of ‘make’ decision is the type most commonly encountered by materials and production managers. A decision of this type is important in so far as effective allocation of the firm’s resources is concerned. However, its effect on the firm’s future is far less reaching, than in the case of a decision requiring a major capital investment. Although, the decision requiring a nominal expenditure of funds does not require direct top management participation, it does require coordinated study by several operating departments. Top management’s responsibility is to develop an operating procedure which provides for the poling of information from all departments affected by the decision. In other words, the management should ensure that the decision is made after a careful consideration of all relevant factors.