Make versus Buy
Make versus Buy is a decision process to determine if a product, or part of a product, should be made by the company or by a supplier.
When to Use Make versus Buy
The Make versus Buy decision process is often used to determine if the cost of a product can be lowered by outsourcing all or part of the production. Whenever considering this strategy, the process should be followed.
- Make versus Buy decision is a business decision that should be made in a cross-functional manner. The decision to have a supplier produce all or a portion of a product could be made for several reasons.
- A strategic realignment of the business requires that the product or component be made by a supplier. The business may have shut down a process, or the business may face a requirement for local content in a product to expand the sales within a country. In this case the decision is not whether to “buy” but rather the decision is picking the best supplier.
- There may be a lack of internal capacity and rather than expand the production facility, the business decides to use suppliers to produce the added amount. This is usually a good news story since it implies that sales are doing well and the employees at the plant have plenty of work. Again the decision is to pick the best supplier.
- The part can be procured at a lower total cost than making it in-house. In this case, a careful analysis of cross-functional costs must be done to ensure the best option is selected.
- The analysis should always be done using variable costs, not standard costs. Standard costs have a component of fixed or operational costs that are not eliminated if the part is produced by a supplier. The variable cost is the true measure of cost that is eliminated.
- The recommended Make versus Buy decision process is a seven step process.
- Select the part, assembly or product for outsourcing. This should be a cross-functional decision that includes manufacturing, quality, engineering, purchasing, and finance.
- Prepare a design package that can be presented to potential suppliers. This package should have all necessary drawings, specifications and quality requirements. It normally requires input from engineering, manufacturing, and quality to prepare these documents. This is often the longest step in the process.
- Determine the current variable cost of the product with the in-house manufacturing. This step can be done in parallel with step 2. The costs are normally identified by Finance; however, Quality must also determine the cost of quality for the product.
- Identify potential suppliers. This is usually done by Purchasing, although manufacturing, quality, or engineering may be able to offer valuable input.
- Send a Request for Proposal to the identified suppliers along with the design documentation package. Purchasing normally takes the lead on this step. Engineering and quality must be on standby to answer any technical questions about the design documentation.
- As the quotes are received, conduct the financial analysis. The attached spreadsheet is the one that I use. Note that there will likely be cross-functional support costs either added or subtracted due to outsourcing that must be included.
- Select the best business option. Although this is primarily a financial decision, there can be other business risk conditions that are used in the decision-making process such as experience with the supplier or strategic partner relationship.
- The spreadsheet shown below is the one I use for this type of analysis. It includes the provision for changes to operating costs based upon supporting the new supplier. It also recognizes that first year cost comparison may be skewed by one-time non-recurring costs.
Hints and Tips
- Don’t be surprised to find some of the design documentation may not be up to date. The longer a product is in production, the more that changes were made. Unfortunately, most companies are not rigorous in maintaining their documentation. Some documentation will be current, but often something was overlooked when the changes were approved.
- This is a cross-functional process. Don’t let one department make a unilateral decision.
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