Hochschule O enburg
Make-or-Buy Decisions
- Advantages and Disadvantages -
Sophie Stöckle
General Business Administration
Prof. Dr. Andreas Klasen
ff
29th of January 2021
Table of Contents
1. Introduction ..................................................................................................3
2. Make-or-buy .................................................................................................4
2.1 Criteria ....................................................................................................4
2.2 Outsourcing Business Processes ...........................................................6
2.3 Advantages of Outsourcing ....................................................................7
2.4 Disadvantages of Outsourcing ...............................................................9
3. Summary and Conclusion ..........................................................................11
References..................................................................................................14
Page 2 of 14
1. Introduction
The term Make-or-Buy can be divided in two parts.
Firstly, the “make” part. This part determines if a company makes the decision to produce
a product or service in-house.
And secondly, the “buy” part which indicates if a company decides to have their products
or services made by an external manufacturer. This can also be described as outsourcing.
According to Dressler (2007), the word outsourcing is an artificial word. It is a combination
of the terms resource, outside and using.
Nowadays, these type of decisions, the make-or-buy decisions, have to be made in every
industry, in every sector as well as in every step of a company’s service processes (Irle,
2011). It is particularly important for the manufacturing sector of a company, but it can also
be a relevant decision to make for business processes such as human resources,
intellectual property and other business functions.
Outsourcing can be divided in two categories: offshoring and nearshoring.
Offshoring means that a company either relocates ‘one or all factories from the home
country to another country’ (Deresky, 2017:p.259) or chooses a supplier in the respective
country. The company usually chooses a country, where the wages are lower than they are
in their home country and is situated further away.
Nearshoring theoretically means the same as offshoring, but in this case, the company
leaves the production or process to a third-party supplier who is either geographically,
culturally or temporally close to the company’s home country (Brandt, 2010).
In their report, Schwarting and Weissbarth (2011) stated that the reason a company
considers to make a make-or-buy decision is the ‘increasing pressure to cut expenses and
improve their return on assets’ (p.5).
In general a company’s objective should be to try to produce the best quality as possible
and be as productive as they could be. That implicates that they decide to outsource a
product or service if they are able to achieve their objective by doing that when the
supplier is able to produce the product or service in the required quality with less expenses
as the production in-house would be.
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2. Make-or-buy
2.1 Criteria
Before a company makes the final make-or-buy decision, it has to assess a number of
criteria.
Firstly, it has to determine what the company requires (Sollish, F. & Semanik, J.,
2012), ‘’objectively assess its core competencies and measure them against world-class
standards’ (Schwarting & Weissbarth, 2011:p.5). By doing this, they are able to see what
they should change to be able to hold up to those standards.
Furthermore, it has to analyze the following factors: product or service, overall costs,
production capacity, financial resources, suppliers, independence, employees, market
development and know-how (Thommen, Achleitner, Gilbert, Hachmeister & Kaiser, 2017).
This analysis helps the company to determine if it is in the company’s best interest to leave
the product or service to a third-party supplier or if it is better to keep it in-house.
Eventually, when the company has made the final decision to outsource a product or
service, it has to select a supplier. It has to evaluate the benefits the supplier brings to the
table.
Schwarting and Weissbarth (2011) summarized the factors a company should take into
consideration in their report as followed:
‘Pivotal indicators such as business strategies, manufacturing and engineering
capabilities, design and innovation skills, labor costs, staff skills, employee training
programs, the ability to scale, capacity utilization, and the social policies of the
potential partner must be assessed’ (p.5f).
According to Krüger and Homp (1997) as cited by Morschett, Schramm-Klein and Zentes
(2015), outsourcing can be put into a matrix called ‘strategic relevance/competence-matrix’
(p.369). As shown in figure 1, there are four quarters indicating what a company should do
with the product or service in question. The company has to evaluate the ‘strategic
relevance’ as well as the ‘strength of competence’ of the product or service they consider
to outsource.
Accordingly, a company should decide to outsource a product or service when both
the ‘’strategic relevance’ and the ‘strength of competence’ are low.
Page 4 of 14
figure 1
Source: Krüger/Homp (1997):p.105 as cited by Morschett, Schramm-Klein and Zentes (2015):p.369
Page 5 of 14
2.2 Outsourcing Business Processes
As opposed to production processes, a company can also decide to outsource business
processes. According to Deresky (2017), the ‘service sector outsourcing industry has
grown signi cantly’ (p.261) over the last years.
Patel and Aran (2005) de ned the Business Process Outsourcing as followed:
‘BPO can […] be defined as the contractual service of transferring one or more
business processes to a third-party provider, where the latter takes over the
management, ongoing support and infrastructure of the entire applications or
processes.’ (p.7)
But there is more to this model of outsourcing, including:
‘entire functions such as supply (moving, storing, making and buying of goods and
services) and demand (customer selection, acquisition, retention, etc.) management,
and some enterprise related areas for example, HR,
nance, IT, and facilities
management and customer related processes such as marketing and
support.’ (Scholl, 2003, as cited by Bhat et al, 2010:p.329f)
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fi
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Page 6 of 14
2.3 Advantages of Outsourcing
There are many economical advantages with regard to outsourcing.
The following figure shows the most important reasons why a company makes the
decision to outsource a product or service.
figure 2
Source: Ernst & Young (2013):p.15 as cited by Morschett, Schramm-Klein & Zentes (2015):p. 367
• Cost advantages: According to Morschett, Schramm-Klein and Zentes, reducing costs
is, with 42 per cent, one of the most important factors why companies consider to
outsource.
First of all, it might be too expensive to produce a product or service in-house
(Rolstadås, Henriksen& O’Sullivan, 2012). Outsourcing on the other hand means that
companies do not have to invest money by building their own production facilities or
capacities (Strache, 1981). They also do not require any capital to stock their products
temporarily (in case of tangible products) as they receive them as they are needed.
All in all, the total costs of outsourcing, including direct costs, overhead-costs and the
supplier’s profit as well as transactional costs, should be lower as they would be with an
in-house production (Irle, 2011).
Page 7 of 14
• improved efficiency: According to Morschett, Schramm-Klein and Zentes’ figure, this is
the second most important reason for outsourcing. Furthermore, they stated that the
company’s performance could improve by a third-party supplier taking on the process in
question as they usually have a ‘better expertise, better qualified personnel’ (p.366) and
are technically better equipped. Like this, the outsourcing company is able to ‘gain
access to external skills and technologies.’ (Dolgui & Roth, 2010:p.99)
Moreover, the outsourced processes usually belong to the core competences of the
providing company which means that they have an extensive know-how and therefore
work more efficient (Bruch, 1998).
• stronger focus on core business: As shown in the figure below, another important
reason is the stronger focus on a company’s core business.
Leaving ‘minor/peripheral or supporting activities’ (Morschett, Schramm-Klein & Zentes,
2015; p. 366) to an external manufacturer, the company can focus its own resources on
the activities that are strategically important for them (Irle, 2011).
Furthermore, the company is relieved of a share of personnel management (Bruch,
1998). They do not have to bother when there are economical fluctuations, many
employees are unable to work due to sickness or when they strike as the supplier is
obligated to the outsourcing company to perform within the agreed time. This means
that those problems do not matter for the outsourcing company.
• higher quality goods or services: By making the make-or-buy decision, the outsourcing
company assumes that the third-party supplier is able to produce the outsourced
product or service on a higher level of quality due to their additional know-how (Bruch,
1998) as well as a better documentation of how to actually execute a certain process
and on making sure the quality is as it is supposed to be (Sollish, F. & Semanik, J.,
2012).
Page 8 of 14
2.4 Disadvantages of Outsourcing
On the other hand, there are disadvantages and risks that come with outsourcing a
product or service. The evaluation of risks and drawbacks is a crucial part for the make-orbuy decision.
The following figure shows the most important risks that can occur when outsourcing a
product or service.
figure 3
Source: Ernst & Young (2013):p.15 as cited by Morschett, Schramm-Klein & Zentes (2015):p. 368
• higher costs in total: Firstly, this is a risk that might occur to a company as there are not
the costs of the production and the product or service itself but also transactional costs.
Transactional costs are ‘hidden costs from difficulties not anticipated or identified early
enough’ (Gelès et al, 2004:p.226).
• loss of knowledge: Secondly, this is a relevant drawback a company has to take into
consideration as well. It is possible for them to lose expertise (Morschett, SchrammKlein & Zentes, 2015) as they might lose ‘control over crucial knowledge and technical
staff’ (Rolstadås, A., Henriksen, B. & O’Sullivan, D., 2012:p.10) due to not carrying out
the process themselves.
Page 9 of 14
• non co-operating supplier: Furthermore, this risk is not to be underestimated by a
company. It is possible for the third-party supplier to behave opportunistically
(Morschett, Schramm-Klein & Zentes, 2015) and not respect their product or service
and the company’s Intellectual Property Rights (Rolstadås, Henriksen & O’Sullivan,
2012) on the outsourced process.
• dependency: According to Morschett, Schramm-Klein and Zentes (2015), a company
could become dependent on the supplier by outsourcing a product or service. As shown
in figure 2, this represents, with 51 per cent, the most important risk. The reason for this
is that there is a shift of power from the outsourcing company to the supplier (Irle, 2011).
Another problem concerning a company’s dependence on their supply is, as Bruch
(1998) investigated, that there is the risk of the supplying company to go bankrupt. This
means that they cannot provide the process in the same form anymore or at all.
• loss of control: Gelès et al. (2004) investigated that keeping a product or service inhouse makes it for a company possible to optimize ‘resources and schedule
monitoring’ (p.225). Therefore, they lose that control by outsourcing a process.
Moreover, assuming a problem during the process occurs, the company is not able to
interfere personally due to the long distance between the supplier’s facilities and the
company’s in the case of offshoring. That means that producing a product or service inhouse, the problem could be solved more quickly or the company should choose a
supplier closer to their facilities (Deresky, 2017).
Page 10 of 14
3. Summary and Conclusion
In conclusion, it must be said that the make-or-buy decision cannot be generalized for all
companies. The benefits and chances as well as the risks and drawbacks have to be
evaluated for each and every company as well as for every product or service individually.
On the one hand, the decision to outsource a product or service comes with a lot of
benefits such as the potential reduction in costs, an increase of efficiency, the fact that a
company can focus on its core activities and the higher-level of quality the company is able
to offer their customers.
One of the benefits I’ve already mentioned is that the outsourcing company does not have
to invest in increasing their capacities with higher demand and, in contrary, do not have to
worry about reducing them with a decrease in demand. This allows conclusions to be
drawn about economic fluctuations.
On the other hand, outsourcing also has disadvantages like higher total costs, the
company’s loss of expertise due to giving a process to a supplier and not making it
themselves, the risk of choosing a non co-operative supplier and the dependency on the
supplier in question for instance.
To reduce the potential risks, a company has to come up with a strategy of how to avoid
them.
The risk of becoming dependent on a supplier, for example, is rather easy to prevent by
selecting not one but multiple suppliers wherever possible. When one of the supplier has
problems with fulfilling their obligations, the outsourcing company is still able to receive the
product or service by one of the other suppliers.
Another way to reduce the risks is not to conclude any permanent contracts with the
supplier. In this manner, the company is able to see how the supplier works and if they
meet their expectations. It also ‘limits the […] long-term financial risk and ensures
accountability from the outsourcers’ (Schwarting & Weissbarth, 2011:p.10).
Furthermore, the company should not pass their core competencies to the outsourcer. A
company’s core activity usually represents their unique selling proposition. They should not
give this into someone else’s hands since the supplier could potentially try to “steal” it and
market it as their own.
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In their paper, Schwarting and Weissbarth summarized the selection process as followed:
‘Crucial to the migration of risk is the supplier selection. It must be based on a clear
understanding of the supplier’s strategy, operations, and cost structure. Choosing the
lowest bid is not sufficient. Only a supplier that has a compatible business strategy
and will maintain an advantaged cost position over time can offer competitive prices
in the long term’ (p.11).
This clearly shows, that a company should not base their decision on the supplier’s pricing
only but also consider the overall picture such as favorable payment and delivery terms,
the suppliers reputation as this could also reflect on the outsourcing company, the
suppliers ability to produce the required capacity and the political stability of the supplier’s
country.
Thinking of the industry as it is now, almost every company makes the decision to
outsource one or several products or services.
Looking at the automotive industry, many companies outsource a large number of
components built into their cars like seats or interior equipment for example.
One common business process that is likely to being outsourced is creating the company’s
balance sheet. Companies hire a tax consultant to do this for them. Small companies even
pass the complete bookkeeping over to an advisor.
Another process is information technology (IT). Many companies do not have the knowhow of how to handle the support of a software and do not want to acquire the knowledge
needed. This is why they hire a supplying company which provides them with a software
including all specifications tailored to the outsourcing company.
In summary, there is no general statement that can be made with regard to the make-orbuy decision. It is very dependent on the company in question and their requirements.
Page 12 of 14
statement of originality
I hereby confirm that I have written the accompanying thesis by myself, without
contributions from any sources other than those cited in the text and acknowledgements.
This applies also to all graphics, drawings, maps and images included in the thesis.
Sophie Stöckle
Page 13 of 14
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