Make or Buy Decision

In each instance of defining procurement, we consider an acquisition from outside the organisation (or agency).  Procurement is, effectively realised in the establishment of a legal contract. For this to occur we must therefore have a party to which we are to enter into a contract with, and since you can’t be in a contract with yourself; the organisation must engage an external party.  In simple terms, technically procurement is only termed procurement if we acquire from outside of our organisation.

Prior to the engagement in procurement, the decision should be made as to whether or not procurement is necessary; this can be considered within two dimensions;

  1. Do we actually require the product or service; and
  2. Do we need to acquire it from outside our organisation?

Too often these simple considerations are overlooked and we jump straight into the procurement process.  In this article we are going to concern ourselves with the second point, making the assumption that yes the product/service is required, but questioning whether or not we do need to source it from outside the organisation.

Let’s start with a quick scenario; to provide some context and honestly to make it more interesting.

You work for a small business providing Training and Consultancy, seriously lacking in inspiration today.  You require a company vehicle for staff to meet clients etc.  the need has been established and the decision to acquire a car has been made; thus fulfilling the first criteria, now the second, do you make or buy the car?

The quick answer was the correct one, you buy the car.

How about this: the business requires a website to promote the business online, do you do it yourself (make) or contract it out (buy)?

The difference between these two prospects is one of practicality; apart from the obscure lateral thinkers it would be impractical and improbable that the training business would be able to deliver a motor vehicle, however in the second scenario you started thinking “well maybe we could make the website using our own internal capabilities”.

So whether we are looking for cars or websites, the considerations of whether we make or buy rely on a set of questions;

Do we have the skills, resources and ability?

This is a question of organisational capacity; are we physically able to produce what is required, do we have the staff, equipment, licenses etc.?  This is the first question that should be raised as it may be clear that we need to go outside the organisation.

Can we and Should we increase capability?

If no, can we create or are we likely to be in a position where this is possible, upskilling staff, buying equipment etc.?  This examines future capacity.  The next consideration is one of should we actually increase capacity?

Capacity shouldn’t be increased for the mere sake of doing so or a knee jerk reaction to a potential cost saving, but integrate a degree of strategy.  Whilst we will explore this later, we should ask is this a once of endeavour or are we likely to require the product/service on an ongoing basis?

The other consideration is whether or not it aligns with our current offerings and whether it could transform into a commercial addition.  Whilst it doesn’t make much sense for a small training business to diversify into car production, a training business providing information & technology consultancy may consider including website development to its services.  As such the investment costs borne to provide the initial internal service could be recouped through the commercial provision of the service to future clients.

If the answer to the above are “no” then it would be suggested that procurement should be employed.  If the answer is “yes” further investigation into the make or buy analysis can be undertaken.

Questions to ask

If there is possible capability, the following questions should be asked as they will provide an insight into which method may work best.

  • Will this be a once off requirement?
  • Will it provide any additional benefits- training, upskilling opportunities etc.?
  • Are there any security/confidentiality risks in outsourcing?
  • Is it something we want to do?
  • Do we have the time, space and motivation?
  • Do we need close monitoring/control of the activity?
  • Will quality (well really grade) be affected?
  • Is it risky and can these risks be transferred if we outsource?
  • Are there any life-cycle costs- i.e. maintenance costs from supplier?
  • What do we own if we outsource – intellectual property etc.?

 

Force Field Analysis

A simple and practical method of conducting this is through a force field analysis, devised by Kurt Lewin for the application to change management, it considers the reasons for and reasons against allowing for a rational and weighted decision to be made.

This approach is relatively simple;

Step 1: Create a list of the reasons to make (develop internally)

Step 2: Create a list of the reasons to buy (outsource)

Step 3: Provide a weighing based on the benefit to the agency; i.e. 0 = no benefit, 1 = low, 10 = high.

Step 4: Separately add the respective weightings of each; the reasons to make and the reasons to buy

The one with the greatest total is the optimal approach.

 

So, for our website scenario we could do the following:

Make Force (0-10) Force (0-10) Buy
Ease of future updates 8 5 Technical Expertise
Understanding of business and brand 7 6 Visual appealing
Available staff 9 3 Increased options
Total 24 14

 

In this case we would select to do it internally- make, rather than buy.

 

Taking a cost based approach

This is another evaluation method; however, it relies purely on costs and discounts non-financial benefits.  The inputs would be the variable and fixed costs for both scenarios; make and buy.

  • Variable costs to make
  • Variable costs to buy
  • Fixed cost to make
  • Fixed costs to buy

Let’s continue with the website example;

Make:  Our business has the majority of equipment on hand to develop websites; a computer ($1000) and internet connection ($100), however we will require some additional software at a cost of $1200.  It is estimated that it will take 10 hours to build the website at a cost of $20 per hour- based on the opportunity cost of paying our own staff.

From the above we can estimate our costs to be:

Fixed Costs = $2300 (Computer, internet and software)

Variable Costs= $200 per site

We have gone to the market and determined that if we get the website outsourced we will still need to retain our computer and the internet price will not be affected, we will however save $1200 on the software.  We have also been quoted a price of $1000 per website.

We can identify our costs of procurement to be:

Fixed Costs = $1100 (Computer, internet)

Variable Costs= $1000 per site

So our table looks like this

Make Buy
Direct Costs $2300 $1100
Indirect Costs $200 $1000
Total Costs $2500 $2100

 

In summary, it would be cheaper for us to buy the website than making it.  Yes, I have casually ignored the hours we would need to spend in the procurement process, getting quotes, explaining our needs with the service provider, supplying information, having meetings, coffee etc.  but hopefully it provides sufficient information for you to understand how it works.

Just for fun, if we had to make multiple websites; let’s say 5 would it be financially better making or buying?  Have a go in the comments below.

 

 

 

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