Outsourcing Production: Make-or-Buy Decisions
Identify the factors that influence a firm’s decision of whether to source supplies from within the company or from foreign suppliers.
International businesses frequently face make-or-buy decisions, decisions about whether they should perform a certain value creation activity themselves or outsource it to another entity.24 Historically, most outsourcing decisions have involved the manufacture of physical products. Most manufacturing firms have done their own final assembly but have had to decide whether to vertically integrate and manufacture their own component parts or outsource the production of such parts, purchasing them from independent suppliers. Such make-or-buy decisions are an important aspect of the strategy of many firms. In the automobile industry, for example, the typical car contains more than 10,000 components, so automobile firms constantly face make-or-buy decisions. Toyota produces less than 30 percent of the value of cars that roll off its assembly lines. The remaining 70 percent, mainly accounted for by component parts and complex subassemblies, comes from independent suppliers. In the athletic shoe industry, the make-or-buy issue has been taken to an extreme with companies such as Nike and Reebok having no involvement in manufacturing; all production has been outsourced, primarily to manufacturers based in low-wage countries.
Whether a firm should make or buy component parts.
In recent years, the outsourcing decision has gone beyond the manufacture of physical products to embrace the production of service activities. For example, many U.S.-based companies, from credit card issuers to computer companies, have outsourced their customer call centers to India. They are “buying” the customer call-center function, while “making” other parts of the product in-house. Similarly, many information technology companies have been outsourcing some parts of the software development process, such as testing computer code written in the United States, to independent providers based in India. Such companies are “making” (writing) most of the code in-house, but “buying,” or outsourcing, part of the production process—testing—to independent companies. India is often the focus of such outsourcing because English is widely spoken there; the nation has a well-educated workforce, particularly in engineering fields; and the pay is much lower than in the United States (a call-center worker in India earns about $200 to $300 a month, about one-tenth of the comparable U.S. wage).25
Nike relies on outsourcing to manufacture its products; however, the company has received worldwide criticism for turning its back on social responsibility for the sake of profit.
Outsourcing decisions pose plenty of problems for purely domestic businesses but even more problems for international businesses. These decisions in the international arena are complicated by the volatility of countries’ political economies, exchange rate movements, changes in relative factor costs, and the like. In this section, we examine the arguments for making products in-house and for buying them, and we consider the trade-offs involved in such a decision. Then we discuss strategic alliances as an alternative to producing all or part of a product within the company.
THE ADVANTAGES OF MAKE
The arguments that support making all or part of a product in-house—vertical integration—are fivefold. In-house production may be associated with lower costs, facilitate investments in highly specialized assets, protect proprietary product technology, enable the firm to accumulate valuable skills and capabilities, and ease the scheduling of adjacent processes.
It may pay a firm to continue manufacturing a product or component part in-house if the firm is more efficient at that production activity than any other enterprise.