The ‘Make-or-Buy Decision’ Tool for Supply Chain Managers

Kraljic Matrix

APICS CLTD Version 1.1, 2018 Edition, page 2-92

When designing your supply chain you will benefit by understanding the Make-or-Buy Decision concept.

The APICS Dictionary, 15th edition, defines make-or-buy decision as:

‘The act of deciding whether to produce an item internally or buy it from an outside supplier.’

Typically, a make-or-by decision involves a make-or-buy cost analysis defined in the APICS Dictionary, 15th edition as:

‘Comparison of all costs associated with making an item versus the cost of buying the item.’

The make-or-buy concept is important to know for anyone pursuing CSCP and CLTD certification, although the specific definitions are not on the top terms list. CSCP approaches the concept from a strategic perspective; where does supply chain fit in the strategic plan, how should contracts be used, and what are the risks involved. CLTD takes a tactical view; contracting processes, break-even analysis, and sourcing materials.

Fundamentally, make-or-buy considerations will factor in the possible consequences of giving the activity in question to another company, including:

  • Is the activity a core competency?
  • What are the consequences of losing related skills or knowledge?
  • What is the landed cost (total cost of ownership)?

Given the potential large capital investment resulting from these decisions, CLTD goes one-step further to perform a break-even analysis.

The APICS Dictionary, 15th edition, defines break-even analysis as:

‘A study of the number of units, or amounts of time, required to recoup an investment.’

The APICS Dictionary, 15th edition, defines core competency(ies) as:

‘Bundles of skills or knowledge sets enabling a firm to provide the greatest level of value to its customers providing growth in a way it is difficult for competitors to emulate.’

Core competencies are those activities/processes a company should (will) insource assuming all things being equal (i.e. available capacity and skill supply).

The APICS Dictionary, 15th edition, defines insourcing as:

‘Using the firm’s internal resources to provide goods and services.’

A key tool a supply chain manager has is ‘contracting’. If you are using a third-party logistics provider for your warehousing needs, a temp agency for seasonal labor or advanced telephony services for your call center, there are various forms these relationships can take, including outsourcing, and offshoring.

The APICS Dictionary, 15th edition, defines outsourcing and offshoring respectively as:

‘The process of having suppliers provide goods and services previously provided internally.’

Note; Subcontracting is a synonym for outsourcing and a top term to know for anyone pursuing CSCP certification.

and

‘Outsourcing to a company in a different country.’

Note; While offshoring implies something done in a far-away country, across an ocean, the concept can apply to neighboring countries on the same continent (i.e. Mexico, USA and Canada). Often referred to as ‘near-sourcing’ (undefined by APICS).

The CLTD Body of Knowledge further discusses leveraging make-or-buy decisions for raw materials and/or finished goods inventory. When considering materials sourcing options the supply chain manger can use the Kraljic or Purchasing Portfolio Matrix, a method developed by Peter Kraljic in 1983. The matrix is used to create a purchasing portfolio by segmenting items (products or services) into 4 dimensions. The result is supply chain managers can prioritize buying activities based on profit impact and level of risks involved.

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