Strategy Planning
Module-2
Outsourcing: Make Versus Buy
How do firms take make-versus-buy decisions?
What is the underlying theoretical logic for make versus buy
decisions?
What are the costs and benefits of outsourcing?
What should be the nature of the relationship with vendor firms?
How can a firm design its sourcing strategy based on a purchase
portfolio matrix?
How has the Internet affected the sourcing decisions of firms?
Nike outlet
• Nike is a virtual corporation. The actual manufacturing is done by Nike
sub-contractors working out of Taiwan, Hong Kong and South Korea.
The actual manufacturing plants are located in Indonesia, China and
Vietnam. The logistics, which involves transportation and storage, is
handled by third-party companies. And the stores that sell the final
products are franchisee outlets. Nike is a virtual corporation that has
outsourced almost all activities. It has retained only two processes in-
house—designing and brand management. In other words, Nike, with
a global presence, offers a truly global product to its customers.
• The decision of a firm to perform its activities internally or get those
activities done from an independent firm is known as the make versus
buy decision.
• This make versus buy issue is strategic in nature and involves the
following key decisions:
I. What activities should be carried out by the firm and what activities
should be outsourced?
II. How to select the entities/partners to carry out outsourced
activities and what should be the nature of the relationship with
those entities?
III. Should the relationship be transactional in nature or should it be a
long-term partnership?
The Strategic Approach
• The supply chain involves a number of firms and encompasses all
activities associated with the transformation of goods from the raw
material stage to the final stage, wherein the goods and services
reach the end customer.
• While studying make versus buy decisions, we analyze from the point
of view of the focal firm or the nodal firm, which is at the strategic
center of the supply chain.
• The firm that provides an identity to the product in terms of brand
(Bharti, HUL, Nike, etc.) has higher stakes in the chain and has been
identified as the main entity of the chain.
• The make versus buy decision evaluates the contribution of each activity.
• Using the value chain framework developed by Michael Porter, we
classify all supply chain activities as primary activities and support
activities.
• Primary activities consist of inbound logistics, operations, outbound
logistics, sales and service.
• Secondary activities involve procurement, technology development,
human resource management and firm infrastructure management.
• The make versus buy decisions look at each of these activities critically
and ask the question:
• Should this activity be done internally or can it be outsourced to an
external party? Once the decision to outsource has been taken, the firm
has to choose among competing suppliers and also decide on the nature
of the relationship it would like to establish with the supplier firm.
B H A R T I A I R T E L : O U T S O U R C I N G O F NETWORK
OPERATIONS
• Network management to Ericsson, Nokia and Siemens.
• IT management to IBM.
• Customer service call centers to Hinduja TMT, Mphasis, IBM Daksh
and Teletech India.
Identifying Core Processes
• The identification of core processes is a crucial decision.
• In these areas they can invest in people, equipment and R&D.
Such a focus will also help the firm in attracting the best talent from
that field.
The Business Process Route
• For any firm, three core and high-level business processes include
customer relationship, product innovation and supply chain
management.
• Customer relationship focuses on acquiring new customers and
building relationships with existing customers.
• Product innovation focuses on developing new products and services,
while supply chain management focuses on fulfilment of customer
orders.
• It is possible to un-bundle the three business processes and a firm can
afford to outsource two of these business processes.
The Product Architecture Route
• In the product architecture approach, the focus is on sub-systems and
components and the make or buy decisions are made at that level.
• In a product, first the sub-systems are classified as strategic and non-
strategic.
• A sub-system is strategic if it involves technologies that change
rapidly, if it requires specialized skills and technologies and if it can
significantly impact the performance of the product on attributes that
are considered important by the customer.
Market Versus Hierarchy
• The make versus buy decision is also known as the market versus hierarchy
decision.
• If a firm decides to make the relevant component in-house, it may not have the
necessary economies of scale and might have to use internal hierarchy for
coordination.
• In the hierarchical form, a firm has greater control over coordination but there
may not be enough motivation for the internal supplier to work on innovations to
reduce cost and improve service over a period of time.
Economies of Scale
• Higher volume allows a firm to spread its fixed cost over a larger
volume of operations.
• Higher volume allows a firm to choose more efficient technologies.
• Pooling of buffer capacities and inventories.
The Make-Versus-Buy Continuum
Two important alternatives:
• Tapered integration, where a firm both makes and buys a given input.
• Collaborative relationship, which could be a formal contractual
relation or a long-term informal relationship, based on trust. In some
cases, it can lead to alliances or joint ventures.
• TOYOTA: IN-SOURCING OF ELECTRONICS PARTS Traditionally, Denso
was the sole supplier for Toyota for all electrical and electronics parts
till 1988. In 1988, Toyota opened its own electronics manufacturing
facility, as it had recognized by the mid-1980s that electronics was
going to play an important part in automobile manufacturing. It is
estimated that, today, about 30 per cent of the total vehicle content is
related to electronics. As the share of electronics in cars is increasing
and as these technologies change at a pace faster than those of
traditional automobile technologies, Toyota identified electronics as a
core and strategic function and decided to master it so that it can
manage its suppliers effectively. They still depend a lot on Denso for
supply, but they have consciously built design and manufacturing
capability within the firm.
• V E N D O R R A T I O N A L I Z A T I O N B Y MARUTI UDYOG LIMITED
Maruti Udyog Limited (MUL) has been the leader of the Indian
automobile industry for about two decades. In the face of increased
competition, MUL is under increased pressure to bring down costs. To
improve its efficiency, MUL started the vendor rationalization
programme in 2002. By 2004, it had managed to slash the number of
vendors from 350 to 220. Maruti found that by lowering the time and
the cost involved in dealing with more vendors, it has successfully
been able to increase the efficiency of the supply chain. Maruti plans
to build a set of technically capable and financially sound vendors
who can match up to its standards on a priority basis. In India, Toyota
works with less than 100 suppliers while Mahindra & Mahindra has
more than 1,000 suppliers.
Impact of the Internet on Sourcing Strategy
• A large number of researchers and practitioners argued that with the advent of
the Internet firms can source from anywhere in the world and that old ideas of
sourcing will not be valid in the virtually connected world.
• E-SOURCING AT MARICO Marico is a market leader in the hair care business. For its
Parachute brand, it procures copra (raw material) worth Rs 3 billion in money value and
equivalent to 600 million coconuts in quantity terms annually. Copra supply has
traditionally been in the unorganized market and most of the producers are illiterate.
Buying copra on this scale required lot of time and effort on the part of Marico. In 2004,
Marico launched an e-sourcing initiative (implemented in stages), which transformed the
buying process gradually from manual to an automated electronic process. Potential
vendors send their quote through SMS and get an electronic confirmation within half an
hour. The payment is also made electronically. Apart from making the process more
efficient, e-sourcing has given Marico much greater control over the buying process.
Conclusions
• Traditionally, firms started with the assumption that everything should be done
internally unless there is a compelling logic for outsourcing an activity. Now, a
large number of firms want to be virtual corporations where they start with the
assumption that activity must be outsourced unless there is a compelling logic that
justifies keeping activities in house.
• Since outsourcing is a strategic decision that cannot be altered in the short run,
firms must look not at the immediate costs but at the long-term supply chain costs
and risks in making this decision.
• Firms can identify core activities from a strategic perspective either through the
business process route or by the product architecture route. When a firm decides
to outsource some core process/sub-systems, it must keep the necessary
architecture knowledge inhouse.
• A firm has to look at the benefits as well as the costs involved in their make
versus buy decisions. If additional costs due to poor economies of scale plus
agency costs of internal control and coordination are less than transaction
costs of market exchange, the firm should opt for make.
• Pure make and pure buy are two extreme ends of the make versus buy
continuum. There are many ways of managing outsourced activities—
tapered integration and collaborative partnerships are two among several
hybrid ways in which outsourced relationships can be managed.
• Not all items are sourced using same the approach. Purchase portfolio matrix
is one popular approach for classifying items into four categories: routine
items, leverage items, strategic items and bottleneck items. Purchase
portfolio classifies items based on the importance of the item in terms value
of purchase and the supply risk associated with the item in the supply
market.
• Firms should try and reconfigure their supply base and use new technologies like
the Internet and e-commerce in implementing sourcing strategies based on the
purchase portfolio matrix.
REVERSE AUCTION
• Unlike a typical auction, the roles of buyers and sellers are reversed in reverse
auction.
• Firms use this approach to identify suppliers willing to supply specific items like
steel or service like freight at the lowest bid price.
• The supplier is under tremendous pressure to reduce the bid and usually ends up
bidding a lower amount than would be bid during normal circumstances.
• Reverse auction must be used for items under the low supply-risk market
category in the purchase portfolio matrix, because for these items there are a
large number of suppliers and there is surplus capacity in the market; hence,
there is enough incentive for suppliers to reduce their bids during reverse
auctions.
5 steps for making your supply chain world
class
• Step 1: Define clear objectives. Start by identifying overarching goals
that will create consumer satisfaction. ...
• Step 2: Gather necessary data. ...
• Step 3: Embrace technology and digitalization. ...
• Step 4: Conduct supply chain network analysis. ...
• Step 5: Refine and continually improve.