Some companies outsource everything except the function that is responsible for the unique characteristics of the product or service. Other integrate vertically, from the raw material mine to the shop where they sell the finished product. Both ways work, but based on what the decision to go either way is made?
What we know as “make or buy” is in its core a decision whether we should product or service in house or outsource to a supplier.
Let me give you two real-life examples:
The first company has three employees. They are in the wedding gowns industry. Freelance designers create the models and are getting paid a per cent of the sales. Garment producers in China produce gowns based on the orders. There is no stock of finished goods. Sales are, you may guess, trough commission-based agents. Production once finished, is sent directly to the shops. All that these three guys had to do is to coordinate the stakeholders in the process. Besides having a great idea.
Another example is a catering company. They do everything in the house. Cleaning the vegetables. Preparing each dish from scratch. And the final packing into individual portions. Several attempts have been made to replace the raw vegetables, but it always seemed too expensive. A couple of suppliers offered to create spice mixes that will reduce the cooking time. When the math is done, it was costing 3 times the cost of the current process.
Opposite ways, yet both companies are successful. Below you will find links to articles that will explain how in theory options need to be evaluated. And what affects the final choice. But it is not so simple. It is quite easy to calculate the material cost. Add the equipment and workforce. Plus the part of the rent for space. But, there are many intangible factors that we need to look into.
Let me add a bit of practical advice.
If you look only at cost and cash flow, rarely you will get to the decision to outsource. Especially if you are doing it in the house already. You have already space, equipment and knowledge. Why giving profits to someone else? Yet, if it is something new, do not forget to look at the total cost of ownership or TCO. In a future post, I will go into more details on TCO. For now, remember that this includes all cost of having a piece of equipment: acquiring, maintaining, disposing of. If it is a new line, we have to think about the needed space. Then the required investment into the equipment. Also, there are funds tied up in the raw material stocks as well as the finished product. Outsourcing will mean that no large upfront investment is needed. Hence it is easier to do an experiment and see how the market reacts to the new product.
What do we have already in the house? If there is extra space available, the machines could be adjusted for the new product. Since we already have a skilled workforce, there is no reason to outsource. Many companies have fallen into it, and I personally do not like it. Outsourcing only to save a few pennies while laying people off and having space does not make sense to me in the long term. The COVID crisis revealed how vulnerable and dependent on low-cost country suppliers companies got.
Another thing that we need to take very seriously is how strategically important this item is for the final product. No one should outsource something that is the core of the competitive advantage. Especially not to low-cost-countries, very well known for their lack of intellectual right laws.
The next important factor will be the speed. How much time do we need to get all we need and start the production? If we do not have the necessary knowledge, how much time it will take to learn it or hire the right people? And, do we have the time? Does this product solve a bottleneck? We need to take into consideration as well the profit lost.
As you can see, many factors impact his decision. While many of them can be quantified, some are related to difficult to measure. Our job as procurement professionals is to look at all aspects of this possibility. And to give our most unbiased advice