In line with global outsourcing becoming more and more utilized to enable more focus on core activities make-or-buy analyses have come of increasing importance. However, it is not always as simple as looking at existing production capacity and decide to keep it in-house if capacity is sufficient and outsource the production if capacity is insufficient.
Make-or-buy typically stretches beyond the purchasing organization and to fully make the decision the analysis must become cross-functional and involve manufacturing or the unit carrying out the activity in question. Nevertheless, the purchasing department is often responsible for conducting the analyses which is favorable to keep it on a high and un-biased level. A make-or-buy decision resulting in buy typically affects different manufacturing units or units carrying out an activity, which could easily lead to a biased analysis if it was done by the units themselves. Ultimately, it will most likely be the purchasers negotiating for better contracts in case the analysis results in a buy decision.
In this blog post I will touch upon an approach for developing a make-or-buy strategy which was used in a recent project delivered to a state-owned company in Sweden. Interestingly, the client does not operate any manufacturing but is supporting its customers with a large variation of service activities meaning the project did not include any analysis of production capacity or similar. The background of the project was a centralization of the organization and the project was initiated by the CEO as an initiative to become ONE company, which included a major synchronization of processes and support activities. At that point an initial analysis had shown large inconsistency between different business areas’ ways of working and their decisions on whether to outsource an activity or keep it in-house. The client had no rules for this kind of decisions and the need for a joint make-or-buy strategy was apparent. From a purchasing perspective they were looking for improvement actions focusing on consolidation of service agreements.
The work began with a classification of all services to have a common ground from which the strategy could be developed. Thereafter service activities were put into a matrix covering the degree of core competence on the Y-axis and the client’s ability to perform the activity relatively to supplier market on the X-axis. The degree of core competence was determined through an analysis of current state and input from the client’s strategy. Further, example of factors deciding the degree of core competence were understanding of systems and how they interact as well as knowledge about customer requirements and demands for the specific activity. The ability to perform relatively to the supplier market was determined based on factors such as understanding of sustainability, business relationship, project management, operations management and innovation capability.
Depending on the positioning of the activities different strategies were suggested. Obviously activities in the bottom left quadrant were recommended to be bought since the suppliers can do it better than the client and the activities were not considered to be core competence. On the contrary, activities which the client could perform better than suppliers and that are core competence should be carried out in-house. For activities in the upper left quadrant that were considered to be core competence but where the supplier market is better the recommendation was to investigate how the ability could be developed in-house. Last, for activities positioned in quadrants inside the dashed line in the figure, the decision should be determined by cost efficiency.
Cost efficiency in this case was a comparison between bought services and own work. For each activity, breaking points in number of hours where own work was no longer cost efficient were identified. An interesting finding in this case was that the work involved with ordering and managing external suppliers led to high breaking points for several activities. In one case, the cost of adding 12 full time employees in-house was equal to the cost of outsourcing the activity due to high internal ordering and supplier management costs.
As mentioned above, answering the make-or-buy question might not be as easy as looking at available capacity, but having a framework for it will most certainly give some guidance to purchasers when answering a complex question.