Everyday, manufacturers are faced with different choices, but the most common of them is choosing between producing an item in-house or buying it. The main driver for this choice is always cost and general profitability. With every choice between these two entities, there’s always some factors to consider. This is why at the strategic and operational level, manufacturers run a make-or-buy analysis to determine their internal cost.
Make-Or-Buy Analysis
In make-or-buy analysis, there’s the cost related and non-cost related factors. For buying a product from suppliers, it seems like a more straight forward plan but there is still a need to know if it would be more profitable or if there would be losses. Here are a few factors that may push a manufacturing company to go for purchasing from suppliers:
• Lack of skills and expertise to produce the product in-house.
• Product is needed in a small volume
• Lack of the right manufacturing facilities
• Manufacturers bias
• Control Consideration
• The part is not that essential in the company’s manufacturing strategy
• Wanting to maintain a multiple-source policy
• The supplier is more specialized and expertised than the manufacturers.
• Cost Consideration (To be discussed later)
Just like buying from suppliers, there are some factors that may push the manufacturers to produce the item in-house.
• Quality control
• Suppliers/ lack of competent unreliable
• Suppliers are not interested in supplying a small quantity.
• Control of transportation, lead time, and warehousing costs.
• Manufacturers bias
• Provision of a backup source for that product.
• Production control in case of decline in sales
• Intention of integrating all production in the company
• To protect product design or proprietary technology.
• Unlimited production capacity
• For continued supply
• Cost considerations
Cost Related Consideration
Running a cost related analysis is very important. This is to know which decision is best to move ahead with. The goal is to run with the plan that would bring the best profit in the long run. While making a cost analysis, it has to be done with care in order to avoid going bankrupt. The biggest mistake most manufacturers make is to disregard the long run in their analysis. A decision that may seem very profitable in the first year may become a big problem in subsequent years. This is called the ‘death spiral’. After running the cost analysis for the first year, it may seem like both options are equally profitable but without a long-run analysis, you could see clearer.
When running a make-or-buy analysis, there are some major factors manufacturers need to get out of the way. This could be done by answering some questions like:
• Is there a bias towards a certain choice?
• Which decision is best for you in the long run?
As we mentioned, there is more to these decisions than just the cost analysis. If manufacturers consider just the internal cost of a decision, the other unchecked factors could be an impending problem. The goal should be to make the best decisions that would favor your general production without leaving any stones unturned.
