Page 161 - DMGT525_MATERIALS_MANAGEMENT

Materials Management

Notes 11.3 Make or Buy Decision

When a request for a given material is received from a user department, purchasing routinely
checks to see if the item is being kept in inventory somewhere in the company. Assuming that
it is not in stock, a decision must be made as to how to produce it. This selection process often
begins with the fundamental choice of make or buy.

Notes Management must decide whether a component, service, or finished product should
be produced in the firm’s own facilities or bought from an outside source.
In making the make-or-buy decision, management should strive toward the primary objectives
of obtaining a product of specified quality from a reliable source at the lowest possible total cost
and achieving the best utilization of available resources. Even when a firm has the ability to
make an item itself, a more prudent choice may be to buy from an outside source – for cost
reasons, for example.

Make-or-buy decisions are particularly important in the development of new products, affecting
the economic viability of the offering as well as the ability of the firm to supply its market.
Buying from an outside source can also be a form of risk control when entering a new market.

Example: When the German baby formula company, Alete, decided to introduce a limited
line of commercially prepared baby foods, management did not want to incur the high risk
investment of building a new plant for this purpose until a steady level of demand was assured.
The company formulated the new products, specified their ingredients, and then farmed out
their production to a contract manufacturer. Once sales volume picked up sufficiently,
management brought production in-house.
Another trigger for make-or-buy deliberations could be dissatisfaction with a current supplier’s
performance. Quality and/or delivery may have become erratic and unpredictable over time,
or the price of a part may have been increased to the point where reconsideration is warranted.
This can happen when a supplier gets careless or too comfortable and begin to consider the
buyer’s business captive because of sheer inertia. It is sound purchasing practice to prevent this
attitude from developing by keeping suppliers honest and “hungry for the business” and by
considering alternative courses of action periodically including making the product internally.
The issue of make or buy also presents itself when a firm’s sales volume changes significantly.
When decreased sales leave plant capacity underutilized, a concern for continued employment
will tend to return parts previously bought from outsiders to a firm’s production lines wherever
possible. Conversely, if demand increases markedly, the firm must compensate for inadequate
facilities by supplementing its own production with purchases from outside sources. This may
only be a stopgap measure, however. If the sales increase is judged to be permanent, an expansion
of the firm’s own capacity may be in order.
A variety of factors and considerations affect the make-or-buy decision. A firm that makes a part
preserves its independence and enhances its production skills. Buying the part results in source
dependence without the benefit of capability development. Quality and scheduling control are
also easier to exercise internally than externally. Large quantity needs to favor the make approach,
while low volume demand suggests the buy approach.

On the other hand, higher fixed cost of building and maintaining company-owned capacity
leads to a lack of flexibility. Buying an item from an outside source helps a company to avoid
additional fixed cost and brings with it a higher degree of flexibility because reduced sales
simply translate into fewer purchase orders placed with outside suppliers. A make decision

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