Make or Buy Decision
According to a rule of thumb, activities that constitute a company ’s core competence or that are based on a sustainable cost advantage should be performed internally.
Core competencies can be recognized on the basis of two criteria:
First, a decision needs to be made on whether or not a certain product or process is strategically important for the company. Strategically important products or processes are those that embody a proprietary technology or have high customer value. One way of measuring strategic importance is to determine the R & D expenditure on the product concerned.
The second criterion is of an operative nature, namely the extent to which the company's own abilities to produce a particular product are better than those of other existing suppliers. This "operative performance" can be assessed on the basis of three factors: process reliability, service, and product quality. Important indicators in this regard are the number of (internal) complaints or the fault rate for certain products. The criterion of operative performance also measures the extent to which suppliers or production capacities are available in sufficient numbers / quantities.
Competitiveness can be assessed on the basis of these two criteria:
The first criterion involves evaluating the extent to which a process or product currently produced in-house is cost efficient. This can be done by comparing the company's own cost structure with that of alternative sources. In this context, a high degree of "costing honesty ”Is necessary. Especially when it comes to the valuation of activities performed in-house, it frequently happens that cost-effectiveness is rated too optimistically because of a failure to adequately factor in overhead. This criterion also includes assessing the rate of internal capacity utilization and how, in the event of underutilization, in-sourcing can serve as a lever.
Besides cost effectiveness, the second criterion for evaluating competitiveness is the extent to which the cost can be improved upon. This question calls for an objective analysis of profitability. As soon as a gap is found between the in-house cost and the outsourcing possibility, an assessment is made of how the profitability gap can be closed.