Why Make Rather Than Buy?

When choosing between manufacturing a product in-house or purchasing it from an external supplier/outsourcing, the two most important factors to consider are availability of production capacity and cost.  The make or buy decision is one that firms wrestle with more and more today, as there has been a surge towards global outsourcing over the past few decades.

Despite certain benefits of buying a certain part of a product, it can be me more beneficial for a firm to make the product or part in-house, rather than outsource or buy it from a supplier for several reasons.  For example, in terms of cost considerations, it can often be less expensive to make the part, when shipping costs and bargaining power of suppliers are taken into account.  If a firm has excess plant capacity or any existing idle capacity, making a part in-house can help to absorb fixed overhead costs. Quality control is another factor: if your part or product is being manufactured thousands of miles away, you don’t have the same oversight or control over the quality of the part, regardless of specifications or instructions.  Suppliers can also be unreliable, or it may be difficult to find one competent enough to manufacture your product.  If you make the part yourself, you have an increased assurance of continual supply. On the flip side, if you are a small firm, the part or product quantity you need or want may be too small to even interest a supplier, leaving you with making the part as your only option.  Many firms also like to keep all parts under their own supervision in order to protect their designs or proprietary technology.  It is significantly easier for a rival firm to spy if an off-site supplier is making the part or product.

Making a product in-house can evidently be more beneficial from a cost and production standpoint, but pride and labor considerations can also be significant factors.  Firms that have been around for a long time may have a certain degree of pride in doing it their way rather than outsourcing, or management may be reluctant to lay off a significant number of workers in order to shift to a supplier.  Either way, there are certainly benefits to making, rather than buying a certain product or part in the production chain.

 

3 thoughts on “Why Make Rather Than Buy?

  1. Economic benefits might only be realized if the supplied part in question is not labor intensive, or if minimum wage rate gaps are minimized. If production is not labor intensive, making the part in house might absolutely cut down on in house fixed costs, and thus should be taken into consideration. However, if the production process is labor intensive, outsourcing might be an effective way to cut down on labor costs. In the U.S. labor unions push wage rates higher, and the difference between paying a worker domestically versus abroad might outweigh the benefits from lowering average fixed costs, and therefore might be counterproductive to profitability.
    Further, abiding by pollution standards set for manufacturers can be very costly if the part in question produces environmental externalities. In countries without comparably rigorous environmental regulations, manufacturing can be exponentially cheaper as a result of not needing to abide by regulations that are often expensive to abide by.

  2. On the opposite side many companies choose to outsource the production of parts. One reason stems back to the fundamental theory of exchange which basically says that voluntary trade is mutually beneficial. Whoever has the advantage in creating a product is likely better to stick with it. It may make more sense for a company to outsource the making of their parts so that they are able to put their time and resources into what they actually excel in making.

  3. Rather than labor intensive, how about (i) coordination-intenstive or (ii) specific investment intensive (“asset specificity”)? If you need really close coordination, working with another firm can be hard, particularly if the project is more important to you than to your supplier (or the careers of the specific engineers and managers at the supplier). Costs may be secondary. Likewise, if the supplier has to invest specific to you as the customer, they either have to trust you, or you have to finance their investment, or put in a commitment to purchase a minimum quanitity (whether you turn out to need it or not).

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