Product-based businesses typically encounter capacity, supply, and market demand issues. These problems result in declining organisational capability, difficulties with suppliers, and diminishing financial capacity.
When any or all of these happen, companies must make strategic decisions between making their products in-house or outsourcing them from other suppliers. To find the most cost-effective approach, they conduct a make-or-buy analysis.
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What’s a Make-or-Buy Decision?
A make-or-buy analysis utilizes cost-benefit to strategically choose between producing items in-house or subcontracting them. It plays an integral part in a company’s strategic planning, helping them stay in business and profitable, especially during market demand uncertainty.
There are factors that this analysis should weigh. Above all, the cost is the top deciding factor. If items are cost-prohibitive, the availability of materials is the next to consider. Expertise in materials matters too. It’s better to seek professional help instead of trying and ultimately failing at manufacturing the products yourself.
Factoring in the costs of resources, including workforce, facilities, and equipment, is also necessary. Should a company decide to manufacture themselves instead of subcontracting them, these resources will require large up-front purchase costs. That being said, fund availability is another factor to take into account.
Financing might not be an issue since there are many available credit products that companies can apply now, regardless of their credit and business history. Even so, there’s a need to do number crunching before moving forward. The last thing these companies want to experience is a death spiral in finances.
Moreover, here are the top advantages of make-or-buy decisions in business:
Companies seek the best options with the most cost advantages and, as much as possible, the fewest downsides. For example, some businesses can save more if they opt for suppliers offering discounts for bulk orders rather than manufacturing the units themselves.
There are instances, however, when making the units in-house is much more cost-efficient for other companies. Raw material availability issues and expensive shipping costs are among the deciding factors in these situations.
Another critical reason is the transition costs. Even if there are cost savings in buying, they aren’t enough to cover procedural, financial, and relational switching costs. That’s why other companies continue to make units in-house.
Overall, companies always choose the most cost-effective way to provide a product or service. Whether making goods in-house or subcontracting production to a third party, make-or-buy decisions are cost decisions that usually lower prices and increase profitability.
Solve Storage and Logistics Issues
As a company grows, storing and managing inventory costs can grow too high. This usually happens if the inventory parts have been stored for a long time or transferred between multiple plants.
To lower this cost, many companies work with third-party (3PL) warehouses and companies. However, these services aren’t always ideal if the components are mainly needed for manufacturing.
With make-or-buy analysis, companies can weigh factors unique to their specific business. It will unlikely make companies deal with the logistics and manufacturing costs. Instead, make-or-buy decisions typically guide them to arrange ongoing shipments from reliable suppliers, which helps companies save more time, effort, and money.
Help in Strategic Planning
When realizing benefits, make-or-buy decisions can help businesses investigate the internal and external environments in which they operate. They’re considered crucial because the results from those decisions can shape a company’s overall strategic manoeuvre.
Specifically, make-or-buy decisions can enable and even improve production that other businesses aren’t otherwise capable of. For example, a new design needs additional raw materials, which are unfamiliar to a manufacturer and can only be imported at high costs. Make-or-buy analysis can help them find a supplier that allows them to produce the product at a cost with acceptable profit margins.
Similarly, businesses can also avoid mistakes resulting from taking on more than what they can handle with the help of make-or-buy decisions. They can help companies find and opt for the most viable alternatives to clients while being aware of their capacities. As a result, unnecessary costly mistakes can be avoided.
Adjust to Meet New Demands
Increasing product demand is another issue that most growing businesses face. While it’s a good problem, it can overtake what companies can produce with their current labour force. This is when make-or-buy decisions usually come in handy.
If there’s no easier method to grow fast enough to meet ongoing demand, businesses can resort to outsourcing the production of certain items. Doing so allows these businesses to pay more attention to the products that need to be made in-house, save more time, avoid delays and costs, and generate higher returns.
Act as A Competitive Advantage Source
A rigorous make-or-buy analysis helps companies gain a competitive advantage. As mentioned earlier, it can help businesses become more cost-efficient. It can also help them be productive by focusing on its core activities and outsourcing the rest. This, in turn, increases the value it delivers to consumers and shareholders and weather market downturns.
The changing markets and related costs are good reasons why considering the make-or-buy decision can help companies big time. While it may not offer cost savings during strong economic times, it’s one of the most viable strategies when financial situations grow more difficult. Nonetheless, it’s important to note that the best decision always depends on current circumstances.