Criteria to Evaluate the Make versus Buy Decision

Criteria to Evaluate the Make versus Buy Decision

Speaker notes

The most suitable criterion in evaluating the make versus buy decision is economic or financial factors. This means taking into consideration the cost savings the company can gain through an outsourcing decision as the most critical element in the decision process. The most important of the financial factors are cost savings and the impact on capital expenditures. If the buy-decision leads to significant cost savings, the company should consider outsourcing (Hwang, Ko & Goan, 2007). A buy decision would be favorable under certain circumstances. For instance, where suppliers have lower costs; where suppliers provide better quality products; where the company needs to make a major investment; and where the company lacks the necessary skills. A make decision would be appropriate where the company has internal cost advantages; where the company is able to deliver quality products; high skill base; and where the company has made significant investment. The make decision will have the company spend $30 per unit; while purchasing will see the company spend $18 per unit. Since the fixed cost is attributable to product line A, the company will be able to eliminate this cost on outsourcing. It is therefore advisable to buy.

Trade-off between Excess capacity and Efficiency

This is a trade-off decision that the firm’s managers would have to make. The firm’s managers would have to evaluate whether there is need to build factories and warehouses with excess capacity. Building factories and warehouses with excess capacity increases flexibility, thus enabling the firm respond effectively to market fluctuations in product demand. If factories and warehouses were built with no provision for excess capacity, they would not be able to handle spikes in demand that may result from various factors. On the other hand, excess capacity costs money and presents idle capacity. The excess capacity does not generate any value for the firm, as it is idle capacity. Increasing the excess capacity leads to decreasing overall efficiency of the operations. In order to make the best decision, it would be necessary to evaluate the average annual demand for products over a period of five years. By comparing this with actual capacity of the factories and warehouse, it would be easy to make a decision.

Trade-off between Optimal Services and Lower Costs

This is a trade-off because the firm managers must make a sacrifice in choosing any of the alternatives, either providing optimal services or seeking to keep costs at a minimum. Supply chain management aims at delivering products in the right time, right place, and right amount (Olson & Swenseth, 2014). This is the efficient frontier in supply chain management. A trade-off occurs between achieving the efficient frontier and keeping costs minimal. As the quality of services improves, there is a consequent increase in costs. This is because improvement in quality of services involves frequent deliveries and higher stock levels, which is expensive. In order to make the best choice, it is important to consider the firm’s strategy. If the firm’s strategy is to achieve market penetration, the firm may strive for optimal services while incurring relatively higher costs. A company that has developed a large customer base may opt for a strategy that promotes its interest and those of the customers. This may involve scaling down the level of services.

Trade-off between Globalization and Transportation Risks

This is a trade-off because with increased globalization of supply chain risks, there are higher transportation risks occasion by political factors, natural disasters, economic factors, and among others. The firm managers must thus forego one of the alternatives. Globalization has played a significant role in improving opportunities for various manufacturers and business organizations (Olson & Swenseth, 2014). This is by enabling the distribution of goods and services to different parts of the world. However, a trade-off exists in that globalization leads to increased transportation costs and risks. In 2010, the eruption of Eyjafjallajokull volcano in Iceland led to the closure of air transportation in various parts of Europe. This significantly affected transportation over the region, especially for firms that relied on air transport (Olson & Swenseth, 2014). The added information that would help in making a decision concerns complexity of the supply chain and ease of access to data. In global supply chains, there could be many parties involved. The ability to identify, quantify, and mitigate risks large depends on the availability of information for decision-making.

Trade-off between Centralization and Decentralization of Activities

This is a trade-off since the firm managers must decide to forego any one of the opportunities emerging from centralization or decentralization of activities. The firm managers have a responsibility of determining where supply chain facilities are to be established. Establishing the supply chain facilities in fewer locations (centralization) would enable the firm to gain benefits in the form of increased economies of scale, for instance, by having fewer workers or machines. On the other hand, establishing the supply chain facilities in multiple locations would be convenient to customers and would enable easier delivery. As such, decentralization would increase the firm responsiveness to customers’ needs. In considering whether to adopt centralization or decentralization, various factors relating to particular locations may come into play. These include cost of establishing new facilities, labor costs, skills requirements, taxation, and infrastructure.

Trade-off between Faster Transport Modes and Slower Modes

There exists a trade-off in the choice of a transport mode. The trade-off exists since supply chains may choose to use one transport mode while incurring the opportunity costs for foregoing the other mode. Faster transportation modes such as air transport are very fast at delivering products to customers (Ivanov, Sokolov, & Dolgui, 2014;2013;). On the other hand, these transportation modes are very expensive and may add significant operational costs in the entire process. Slower transport modes such as ship are cost effective but may fail to deliver the required responsiveness to customer needs. Transportation costs comprise of a significant portion of costs among supply chains. As such, it is important to make the right decision concerning a mode of transport. The additional information needed to make the best choice concerns the nature of goods handled in the supply chain. Various characteristics such as perishability and bulkiness of the goods would significantly influence the choice of the transport mode.

Trade-off between Higher and Lower Pricing

Pricing involves the decision on the amount of money to charge customers for goods delivered. Pricing has significant influences in the level of demand for a product (Olson & Swenseth, 2014). In turn, pricing directly affects the profitability of the firm. There exists a trade-off in pricing because charging higher prices leads to lower demand while charging lower prices leads to lower profit margins for the firm. Charging lower prices can also cause a surge in demand, which the firm may not be able to handle. There is need to establish stable prices for stability to ensue across the supply chain. The additional information that can enable one make the best decision on prices concerns the cost of manufacturing products and the competitive environment. The firm should determine an attractive margin on the cost of products. In addition, it is important to consider the pricing decisions of rivals.

Checklist Item: Quality

Quality is one of the major considerations in the certification process. The vendor should be able to deliver quality products. The quality of the products can be measured as the percent of defects per a certain parts, usually per million parts. The firm should develop a minimum level of quality for which the vendor must meet. The quality checklist may include a number of items including number of defects per certain parts, ISO certificates, CMMI certificates, Microsoft competency certificates, and other quality certifications (Click & Duening, 2005). The ISO certification is the most important in this case. This certification indicates that the vendor complies with all the requirements outlined by the standardization body. Another checklist under quality is the implementation of continuous improvement programs such as lean management, six sigma approach, Toyota production system, and among others. Presence of such quality programs indicates the vendor is keen on quality improvement.

Checklist: Vendor Organizational Structure

The organizational structure is critical in determining how the vendor handles various tasks and responsibilities. The vendor should have a clear organization scheme. There should be a clear definition of the roles and responsibilities of various employees. For instance, there should be clear responsibilities assigned to line managers. The vendor should show evidence of constant interactions with all stakeholders. For instance, there should be evidence of stakeholder meetings. The vendor should have a clear plan on handling various environmental risks. There should be adequate mitigation plans for dealing with any unforeseen events. The mitigation plans should cover the worst-case scenarios that the vendor might face. The vendor should have emergency equipment in site, which relates to identified risks in the environment.  For instance, the vendor should have firefighting equipment and other necessary equipment installed. Lastly, employees should receive adequate training on hazard recognition and mitigation.

Checklist: Performance History

The suitable vendor should be knowledgeable in the specific field of interest. The preferred vendor is one who specializes in providing a limited scale of outsourcing services. It is difficult for a vendor to develop a multifunctional expertise across various fields (Click & Duening, 2005). One of the major reasons is that developing a multifunctional expertise would be expensive to sustain. In addition, it is difficult to transfer the skills and knowledge obtained from one outsourcing function to another in a different field. A vendor who lacks the expertise in a particular field may not be able to handle the challenges involved in the particular field (Click & Duening, 2005). A firm that selects a vendor who lacks the expertise in a particular field risks incurring additional costs. As such, the firm should consider engaging a vendor who has relevant experience in the specific field of practice. The firm may choose to evaluate previous vendor engagements in order to learn more about vendor qualifications.

Pros of Installing Vendor Certification Program

Vendor certification programs provide a recourse if the product fails to meet desired characteristics (“The Open Group”, 2004). The certification program binds a firm to a particular vendor. If the product fails to match to standards, the firm can turn to the vendor for quality improvements. A vendor certification program leads to lower risk and reduced cost of decision-making during component acquisition. By conducting vendor certification, the firm can map vendors that meet the quality thresholds for products. This means it becomes easier to make a choice on a particular vendor (“The Open Group”, 2004). There is also low procurement and acquisition costs due to the shared requirements as established in the standards. Vendor certification programs promote customer satisfaction with the brand. This is because products work as per the outlined standards and there is improved interoperability (“The Open Group”, 2004). Vendor certification programs promote adherence to standards, which has a positive influence on the achievement of the firm vision. There are lower integration costs since the components from various vendors are standard and can fit together.

Cons of Installing Vendor Certification Programs

Both the firm and vendors are likely to incur high certification costs. For instance, testing for conformance for parts may involve huge costs (“The Open Group”, 2004). Vendor certification programs require constant policing or checking to ensure that each certification program’s integrity is maintained. This brings about additional costs. Liability issues are likely to emerge especially where the supply chain is complex (“The Open Group”, 2004). These issues may emerge since it might not be clear on who is to take the blame if products fail to meet set standards. A certification overload may emerge when a vendor has multiple requests from different firms to adhere to different specifications (“The Open Group”, 2004). The vendor could also be a facing a scenario where one has to adhere to competing standards. Another issue concerns innovator dissatisfaction. Innovators design standard products to fit the needs of their customers. Requests for modifications may be expensive and some unrealistic in terms of costs and time.

References

  • Click, R. L., & Duening, T. N. (2005). Business process outsourcing: The competitive advantage. Hoboken, N.J: John Wiley & Sons.
  • Hwang, H. S., Ko, W., & Goan, M. (2007). Web-based multi-attribute analysis model for make-or-buy decisions.Mathematical and Computer Modelling, 46(7), 1081-1090. doi:10.1016/j.mcm.2007.03.021
  • Ivanov, D., Sokolov, B., & Dolgui, A. (2014;2013;). The ripple effect in supply chains: Trade-off ‘efficiency-flexibility-resilience’ in disruption management.International Journal of Production Research, 52(7), 2154-2172. doi:10.1080/00207543.2013.858836
  • Olson, D. L., & Swenseth, S. R. (2014). Trade‐offs in supply chain system risk mitigation. Systems Research and Behavioral Science, 31(4), 565-579. doi:10.1002/sres.2299
  • The Open Group. (2004). Business scenario: certification. Retrieved from http://www.opengroup.org/downloads/BusinessScenario-Cert.pdf

 

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