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Make versus Buy is a decision process to determine if a product, or part of a product, should be made by the company or by a supplier.
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Quick reference
Make versus Buy
Make versus Buy is a decision process to determine if a product, or part of a product, should be made by the company or by a supplier.
When to Use Make versus Buy
The Make versus Buy decision process is often used to determine if the cost of a product can be lowered by outsourcing all or part of the production. Whenever considering this strategy, the process should be followed.
Instructions
- Make versus Buy decision is a business decision that should be made in a cross-functional manner. The decision to have a supplier produce all or a portion of a product could be made for several reasons.
- A strategic realignment of the business requires that the product or component be made by a supplier. The business may have shut down a process, or the business may face a requirement for local content in a product to expand the sales within a country. In this case the decision is not whether to “buy” but rather the decision is picking the best supplier.
- There may be a lack of internal capacity and rather than expand the production facility, the business decides to use suppliers to produce the added amount. This is usually a good news story since it implies that sales are doing well and the employees at the plant have plenty of work. Again the decision is to pick the best supplier.
- The part can be procured at a lower total cost than making it in-house. In this case, a careful analysis of cross-functional costs must be done to ensure the best option is selected.
- The analysis should always be done using variable costs, not standard costs. Standard costs have a component of fixed or operational costs that are not eliminated if the part is produced by a supplier. The variable cost is the true measure of cost that is eliminated.
- The recommended Make versus Buy decision process is a seven step process.
- Select the part, assembly or product for outsourcing. This should be a cross-functional decision that includes manufacturing, quality, engineering, purchasing, and finance.
- Prepare a design package that can be presented to potential suppliers. This package should have all necessary drawings, specifications and quality requirements. It normally requires input from engineering, manufacturing, and quality to prepare these documents. This is often the longest step in the process.
- Determine the current variable cost of the product with the in-house manufacturing. This step can be done in parallel with step 2. The costs are normally identified by Finance; however, Quality must also determine the cost of quality for the product.
- Identify potential suppliers. This is usually done by Purchasing, although manufacturing, quality, or engineering may be able to offer valuable input.
- Send a Request for Proposal to the identified suppliers along with the design documentation package. Purchasing normally takes the lead on this step. Engineering and quality must be on standby to answer any technical questions about the design documentation.
- As the quotes are received, conduct the financial analysis. The attached spreadsheet is the one that I use. Note that there will likely be cross-functional support costs either added or subtracted due to outsourcing that must be included.
- Select the best business option. Although this is primarily a financial decision, there can be other business risk conditions that are used in the decision-making process such as experience with the supplier or strategic partner relationship.
- The spreadsheet shown below is the one I use for this type of analysis. It includes the provision for changes to operating costs based upon supporting the new supplier. It also recognizes that first year cost comparison may be skewed by one-time non-recurring costs.
Hints and Tips
- Don’t be surprised to find some of the design documentation may not be up to date. The longer a product is in production, the more that changes were made. Unfortunately, most companies are not rigorous in maintaining their documentation. Some documentation will be current, but often something was overlooked when the changes were approved.
- This is a cross-functional process. Don’t let one department make a unilateral decision.
- 00:03 Hi, this is Ray Sheen.
- 00:05 I'd like to talk with you about a process that you may find yourselves involved with
- 00:08 from time to time.
- 00:10 A make versus buy decision for products or parts of products.
- 00:14 Let's start with a quick overview of why you might be doing this process.
- 00:21 If a company decides to outsource a part, assembly, or product instead of making it
- 00:24 in one of their own production facilities, it will be for one of these three reasons.
- 00:29 There is a strategic realignment of business processes that requires
- 00:32 the product to be made elsewhere.
- 00:34 You may be shutting down a fabrication in one plant
- 00:36 because permitting costs became too high.
- 00:39 Or you may need to do some manufacturing in a country because of local
- 00:42 content rules.
- 00:43 In this case, you don't need to do an analysis to outsource, but
- 00:47 you may want to do one to decide between potential suppliers.
- 00:51 The second reason is a capacity issue.
- 00:53 The demand for the product is greater than what your internal manufacturing process
- 00:57 can support.
- 00:58 Usually this means sales are better than expected so this is a good problem.
- 01:02 On top of that, in this situation you normally keep your internal production
- 01:05 going so there is no impact to your labor force.
- 01:09 Again the decision here is not should you outsource, but
- 01:11 rather which supplier should you select.
- 01:15 The more difficult decision is when you're considering outsourcing in order to
- 01:18 save money.
- 01:19 In this case it is important to do a careful analysis
- 01:22 in order to make the correct financial decision.
- 01:25 One point I want to emphasize is that this analysis uses the variable cost,
- 01:29 not the standard cost.
- 01:31 You may recall from another module that the standard costs includes a portion of
- 01:34 each plan, fixed and overhead operational costs.
- 01:37 These costs will not go away when outsourcing.
- 01:40 So be certain that you do not include them as part of your analysis.
- 01:44 So let me quickly step you through the process to follow when doing a make
- 01:47 versus buy analysis.
- 01:49 One point I want to make,
- 01:50 and it will be obvious soon, this is a cross- functional process.
- 01:55 This decision should not be made by purchasing or
- 01:57 manufacturing without the input from others in the organization.
- 02:01 First is to identify specifically what part or assembly you are considering for
- 02:05 outsourcing.
- 02:06 This sounds simple, but I've seen organizations argue for
- 02:08 weeks on this point.
- 02:10 Second, prepare a detailed design package with drawings, specifications and
- 02:14 quality standards.
- 02:15 This might include drawings for special tooling or inspection gauges.
- 02:19 If you're doing this analysis as part of a product development project,
- 02:22 you probably have a development of those items already in your project plan.
- 02:26 If you're doing this analysis for a product that has been in production for
- 02:29 several years, you'll need some dedicated engineering work to do this.
- 02:33 At least nine times out of ten, some of the documentation is no longer up to date.
- 02:37 A process changed but the process control document was never updated.
- 02:41 An inspection point or tolerance was changed, but
- 02:43 the drawing was never updated.
- 02:45 Depending upon the complexity of what is being outsourced,
- 02:48 this step could take weeks or months of effort.
- 02:51 Work with your finance people to get the current variable cost for the part.
- 02:54 Be sure to include the cost of quality,
- 02:56 which is a pro-rated amount of scrap or rework cost.
- 03:00 Identify potential suppliers.
- 03:02 Your purchasing or sourcing department should be able to help with this.
- 03:05 Send the design package to the suppliers and request a quote for
- 03:08 the production quantity you are forecasting.
- 03:10 Do an analysis of the cost of setting up with the suppliers and
- 03:14 the variable cost of each option.
- 03:16 I have a spreadsheet that I'll show you which I use for this.
- 03:19 Finally, select the best option for the business.
- 03:22 If you've included all the factors,
- 03:23 the analysis should allow you to make an informed decision.
- 03:27 Here's the spread sheet that I mentioned.
- 03:29 It's easy to construct your own, although we will use this one in the exercise.
- 03:33 Let me highlight a few items.
- 03:34 The analysis is based upon the assumed annual production volume.
- 03:38 If the volume is varying each year, use an average value,
- 03:41 note that the first company column is the cost of producing parts in-house.
- 03:45 And the other columns are the potential suppliers.
- 03:48 If you have more than three suppliers, just add more columns.
- 03:51 The rows of material, labor, overhead, and yield effects come from finance for
- 03:55 the in-house cost.
- 03:57 For the suppliers, it will all be material costs based on their unit quote.
- 04:01 And possibly a yield cost, depending upon how you negotiate the handling of defects.
- 04:06 The next few lines are for
- 04:07 in-house support costs that are eliminated or added.
- 04:11 And any one time non-recurring costs at the supplier.
- 04:14 These are not part of the product part costs.
- 04:16 Examples could be an annual supplier visit as added.
- 04:19 Or the supplier may have a one time tooling charge in their quotation.
- 04:23 The final two sections are the annual cost at each location.
- 04:27 The first section is for the first year that would include the non-recurring
- 04:31 costs, and the second section is for
- 04:33 all the future years that do not include the one time non-recurring costs.
- 04:40 You may only do a make versus buy analysis once a year, but
- 04:43 when it's time to do one, this outline will prove very helpful for you.
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