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Make or Buy Decision in the business world*

In classical economics, based on Ronald Coase, the decision on whether to make or buy a product was seen as based on minimising transaction costs. This was centred around the structure of the market and the nature of the transactions.

For example, if there is a large number of competitive suppliers and purchasers can easily access the market without any cost, then it is better to purchase the product.

For businesses, this decision is based in a dynamic environment. That is, usually the initial stages of the products will comprise of few suppliers and difficult transactions. Then, as the market grows, new entrants are attracted and they get more skilled at buying. This will lead to the development of a liquid market. Later, as mergers and acquisitions occur, weaker companies fall while the number of suppliers shrink.

Thereby, when applied in a global level, the make or buy decision is vital. These choices range from fully integrated production to the company that exists by co-ordinating efforts of others in a series of contracts.

Considering on make or buy decisions, from Hill and Hult (2017)’s point of view, make or buy decisions are made at both the strategic and operational levels.

The strategic level make or buy decisions will be focused on the long term. The operational level ones will be focused on the short term. These decisions are also considered as the starting point for operations’influence on global supply chains.

When making these decisions, issues of product success, specialized knowledge and strategic fit should be considered. Yet, the make or buy decision is most often decided based on only two critical factors, being the cost and production capacity.

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In terms of cost, concerns should be on acquiring raw materials, component parts and any other inputs into the process along with the costs of finishing the product.

In terms of production capacity, the concerns should be on whether the firm has the capacity to produce the product at a cost at least not higher than buying from the external supplier.

Understanding that make or buy decisions are complex, when deciding on producing it in house, the firms has to consider the following very carefully.

  • Cost
  • Quality control
  • Presence of proprietary technology
  • Are suppliers limited? If they are, consider the excess capacity available.
  • Can we have control?
  • Will there be continuous supply?
  • Industry drivers
  • Production capacity

On the other hand, when considering a decision of buying, the following should be concerned.

  • Cost
  • Multi source policy
  • Do we lack the expertise?
  • What are the competencies of suppliers?
  • Should we buy in small volumes? If yes, how does our inventory plan work?
  • Brand preferences
  • Is the product and essential or non essential item for the business?
  • Production capacity

Therefore, the decision of whether to make or buy your products are crucial and will affect your value chain greatly.

Stay tuned with Zeeable for more of such updates!!

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