Chapter 5 - Make or Buy, Insource & Out

Core competence and differentiation

Insource range -In the middle is "best source" between the Y of contribution to operations and X axis of contribution to strategy.

WHY OUTSOURCE ?

Procurement cost reduction usually grabs the headlines, HOWEVER, it should not be the only, or even the most important reason. There should be STRATEGIC reasons for outsourcing

Examples of Outsourcing

Production Assembly Transportation Warehousing Distribution Sales Payroll Accounting Design Engineering Construction Installation Human Resources Employee Benefits Call Centers Purchasing (ouch!)

Best practices for off shoring

Clear contract terms - no assumptions Ensure project financially viable Know your partner Know the rules, they may be different Search for problems before they come up Do a thorough risk analysis Stay focused Expect competition Watch intellectual property Set realistic time horizons Build cross-cultural teams

A firm's core competence:

- provides access to wide variety of markets - makes significant contribution to perceived customer benefits - is difficult for competitors to imitate - and is not typically outsourced

Make or Buy Decision and Break-Even Analysis

-A tool for computing the cost-effectiveness of sourcing decisions when cost is the most important criterion. -Assumes all costs can be classified as either fixed or variable. -Assumes linear relationships can be established for both the make option and the buy option with the point of intersection representing the breakeven quantity

What is Core Competence?

-Core competencies are the collective learning in an organization, especially how to coordinate diverse production skills and integrate multiple streams of technology.

Purchasing's Role in Outsourcing

-Providing a comprehensive, competitive process -Identifying opportunities for outsourcing -Aiding in selection of supplier sources -Identifying potential relationship issues -Developing and negotiating contracts -Ongoing monitoring and management of the supplier relationship (SRM)

Make or Buy Decision with Marginal Costing Considerations

-Firms facing a continue-to-make or buy decision for a component must evaluate marginal costs of the decision. -The decision to buy will depend on whether the firm can utilize the released machinery capacity profitably or not. -If machinery will become idle, then fixed (sunk) costs become irrelevant and only variable costs should be compared to the buy price in the analysis. -If, on the other hand, machinery does not become idle, but will be used profitably elsewhere, then both variable and fixed costs should be compared to the buy price.

Strategic reasons for outsourcing?

-IMPROVE QUALITY -REDUCE SUPPLIER BASE -"PARTNER" WITH WORLD CLASS PROVIDERS FOR ACCESS TO TECHNOLOGY, PROCESSES, AND MARKETS -IMPROVE PROCESS EFFICIENCY -LOWER TOTAL COST OF OWNERSHIP -IMPROVE CAPITAL AND ASSET MANAGEMENT

Offshoring -

-The transfer of manufacturing processes or services to a foreign country.

Factors to consider when offshoring -

-Legal climate and protection of intellectual property -Local ability to copy manufacturing technology and processes -Control over ingredients, formulations, etc. -Economic and political stability vs. USA -Foreign government investment in necessary infrastructure

Risks of Outsourcing

-Loss of control in your supply chain -Exposure to supplier risks such as: financial, loss of supplier commitment, response time, quality, poor service, cultural issues -Unexpected/unanticipated costs -Difficulty quantifying economics, conversion costs -Supply availability constraints -More attention required by senior management -Possibility of being tied to obsolete technology -Concerns with long-term flexibility and meeting changing requirements -Reduced employee morale / union opposition

Outsourcing: A Popular Trend

-Why do companies outsource? -What usually gets outsourced? -What risks are they accepting?

The Outsourcing Decision

1.)Is the activity strategic? If yes, keep in house if not: 2.)Is the activity critical to the business but not strategic? if yes, keep in house if not: 3.)Create a RFP. Gather supplier bids/proposals 4.) Is the supplier's bid/proposal more desirable than the internal option? if yes, keep in house if not: 5.)Could the internal option achieve similar results? if yes, keep in house, if not: 6.) Negotiate a contract to ensure that expectations are realized?

Reasons to Buy Instead of Make

Lack of managerial or technical production experience Lack of production capacity Customer preference for a particular brand Challenges of maintaining technological leadership for non-core activity Lower cost Enables greater operational flexibility and resource utilization There are more options in potential sources and substitute items Insufficient volume to justify in-house production Forecasts show great demand and/or technological uncertainty Availability of a highly capable supplier nearby May open up markets for firm's products and services Bring a product or service to market faster Superior supply management expertise

Non-Core Competence and Commodity

Outsource range

Reasons to Make Instead of Buy

Quality requirements are exacting / special processing needed Greater assurance of supply Preserve technological secrets Lower cost To take advantage of unused capacity/avoid having idle equipment Maintain control of a core competency Avoid single-source dependency Reduce extended supply chain risk A significant customer requires it Distance from the closest available supplier is excessive Future market potential for the product or service is expanding rapidly Forecasts of future shortages in the market or rising prices Quantities are too small and/or no supplier is interested