Make or buy

The term Make-or-Buy refers in the economy to the entrepreneurial decision between own production (Make) or the foreign cover (Buy). The make-or-buy decision is particularly important in industrial manufacturing processes.
In principle, the question “Make or Buy?” is relevant for all activities of the company value chain. From a company-strategic perspective, the question is closely linked to the extent of the vertical integration of the company. From an operational point of view, I usually consider the outsourcing of production steps to be an economic consideration.

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What does “Make-or-Buy” mean?

The make-or-buy decision is relevant to companies both in terms of services and products. In the metal and plastic processing industries, the question is usually whether certain intermediate goods are produced or bought by another company.

Typical intermediate goods include, for example, components, assemblies, intermediate products or semi-finished products. But also services such as the construction of components using a CAD software are affected by make-or-buy decisions.

In the strategic orientation of companies, this is referred to as vertical integration of production. It indicates the proportion of in-house versus outsourced manufacturing within a company. The degree of vertical integration is typically measured by production depth, expressed as a percentage representing the share of in-house production.
Production depth [%] = (own production / total manufacturing) * 100 %

How is a make-or-buy decision taken?

In the decision to produce goods or services, it is appropriate to apply standardized business processes. This procedure enables the decision to focus on objective criteria such as economic efficiency.

In this context, the “emergency-invented-here” syndrome is particularly important. This syndrome refers to the dislike of entrepreneurs, goods or services of suppliers, although this is economically advantageous.

The decision-making process is usually based on an analysis involving various operational and strategic factors. In addition to an economic analysis, it is also about assessing risks and evaluating factors such as quality, business objectives and liquidity.

What are the decision criteria?

The main make-or-buy decision criteria will be briefly presented below:

Strategy: The make-or-buy decision is closely linked to the company's strategic orientation. If the company wants to focus on its core business, it is in principle preferable to use a non-recurring goods in areas outside this core business.
Costs: From an economic point of view, the make-or-buy decision requires a complete cost consideration. In doing so, the cost of own-production is compared to the cost of a foreign purchase. It is important to take into account all costs during this consideration. For example, when awarding services to a supplier, the transaction costs must be included, while capital costs and opportunity costs may be incurred in the case of own production. Factors such as the utilisation of our own machine park also play a role here.

Liquidity: With regard to corporate liquidity, it should be borne in mind that own production is often associated with an investment in the expansion of production capacities. In the case of liquidity bottlenecks, a foreign cover can therefore be the better choice.

dependence: The external cover of products or services creates dependencies. Depending on the industry and reliability of the supplying company, these represent a risk to be taken into account in the make-or-buy decision.
Quality assurance: The external supply of services and goods is usually associated with a higher effort for quality assurance for the client.

Time: For time-critical projects or orders, an evaluation of the delivery times is required. Purchase of a finished product is often faster, taking into account delivery times and, under certain circumstances, approval procedures.

What types of make-or-buy decisions are there?

The make-or-buy decision essentially distinguishes between the operational and the strategic design:

Operative Make-or-Buy decision:
The operating perspective is highly cost-oriented and usually takes into account only a limited period of time. In the case of an operational decision, motives such as missing resources in their own production, different costs for self-manufacturing and non-recovery or project periods play a role.

Strategic Make-or-Buy Decision:
The strategic perspective includes long-term effects and corporate objectives. This is about how the company wants to position itself on the market in the future and whether it decides on “Lean Production” (concentration on core business) or on “Economies of Scope” (contributory benefits).

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