Understanding Make-or-Buy Decisions

Understanding Make-or-Buy Decisions

Let me explain what a make-or-buy decision really is. It's when you, as a business, decide whether to manufacture a product yourself in-house or buy it from an external supplier. You might also hear it called an outsourcing decision. Essentially, you're comparing the costs and benefits of producing something internally against hiring an outside supplier to handle it.

To get this right, you need to look at every angle of acquiring and storing items if you're buying them, versus the full picture of creating them yourself—which could mean buying new equipment and dealing with extra labor costs.

Analyzing the Make-or-Buy Decision Process

When you're thinking about in-house production, account for expenses like purchasing and maintaining new machinery or equipment, plus the cost of raw materials. Don't forget labor costs, including wages and benefits, along with storage, holding costs, and disposing of any leftovers. You also need to check if your business can actually produce at the required levels.

On the buying side, factor in the product's price, shipping, import fees, and sales taxes. Add in storage and labor for handling incoming products. And remember, signing contracts with suppliers can lock in prices for a period—sometimes that's good for you, sometimes not.

In bigger companies, these choices often lean on the expertise of a chief procurement officer.

Factors to Consider When Choosing to Make or Buy

Sometimes a quantitative analysis alone tells you which way is more cost-effective. But other times, you need a qualitative look to address things you can't easily measure.

For instance, you might lean toward buying if you lack in-house expertise, have small volume needs, want multiple sources, or the item isn't key to your strategy or differentiation from competitors. It helps if you can partner with a supplier who's proven reliable for the long term.

On the flip side, making in-house could make sense if you have idle production capacity, better quality control potential, or proprietary technology to protect. Supplier reliability is a big concern, especially for critical operations.

Reassessing Make-or-Buy Decisions: When to Change Course

Situations can arise that force you to rethink buying or making, regardless of what you've done before. This could be a trusted supplier shutting down, shifts in product demand, or new opportunities emerging. At these points, you should reconsider the advantages of each option, going beyond just cost-benefit analysis. Ask if one path leads to savings, new products, or business changes.

Depending on your market position, there are pros and cons to sticking with or switching your strategy.

Related Concepts

Let me define procurement for you: It's how businesses or organizations obtain goods and services on a large scale. It's a strategic process with many decisions, unlike simple purchasing for immediate needs.

Outsourcing means hiring another company to provide what you could do internally, often in countries with lower costs—this is sometimes called offshoring.

Insourcing is the reverse: handling tasks internally that you might outsource, maybe to do them better or build expertise.

Reshoring brings tasks back to your home country from overseas, often due to rising foreign costs or wanting more supply chain control.

The Bottom Line

Make-or-buy decisions are vital for your business, deciding if you manufacture in-house or buy from suppliers. You need to compare costs and benefits carefully, including quantitative and qualitative factors like efficiency, expertise, and reliability. Regularly reassess these as strategies, markets, or suppliers change, so you can shift approaches to optimize operations and stay competitive.