Supply Chain Management (SCM) 101: Sourcing and Procurement - Make-or-Buy Decision, Outsourcing, Offshoring, Nearshoring

What This Is

A make-or-buy decision is a critical supply chain management decision that determines whether a company should produce a product or component in-house (make) or purchase it from an external supplier (buy). This decision affects a company's costs, quality, and responsiveness to customer demand. For example, Amazon might decide to make its own packaging materials or buy them from a supplier.

Key Frameworks & Formulas

• Make-or-Buy Matrix: A decision-making tool that considers factors such as production volume, production complexity, and supplier reliability to determine whether to make or buy a product.
• Economic Order Quantity (EOQ): EOQ = ?(2DS/H), where D is demand, S is setup cost, and H is holding cost.
• Safety Stock: Safety Stock = Z ×-× ?L, where Z is the Z-score,-is standard deviation, and L is lead time.
• Total Cost of Ownership (TCO): TCO = (Purchasing Cost + Holding Cost + Opportunity Cost) / (Production Volume).
• Fisher's Model: A framework for evaluating the make-or-buy decision based on factors such as production volume, production complexity, and supplier reliability.
• Supply Chain Operations Reference (SCOR) Model: A framework for evaluating supply chain performance based on factors such as delivery, quality, and cost.
• Break-Even Analysis: A method for determining the point at which the cost of producing a product in-house equals the cost of buying it from a supplier.
• Payback Period: The time it takes for the cost savings from buying a product to equal the cost of producing it in-house.

Step-by-Step Application

1. Conduct a Cost-Benefit Analysis: Calculate the total cost of ownership (TCO) for both make and buy options.
2. Evaluate Supplier Reliability: Assess the supplier's ability to meet demand, quality, and delivery requirements.
3. Consider Production Complexity: Evaluate the complexity of the production process and whether it can be outsourced.
4. Analyze Lead Time and Inventory Levels: Evaluate the impact of lead time and inventory levels on the make-or-buy decision.
5. Develop a Make-or-Buy Strategy: Based on the analysis, develop a make-or-buy strategy that aligns with the company's goals and objectives.

Common Mistakes

• Mistake: Failing to consider all costs associated with producing a product in-house.
• Correction: Conduct a thorough cost-benefit analysis to ensure all costs are accounted for.
• Mistake: Assuming that buying a product from a supplier will always be cheaper.
• Correction: Evaluate the total cost of ownership (TCO) for both make and buy options to ensure the most cost-effective decision.
• Mistake: Failing to consider the impact of lead time and inventory levels on the make-or-buy decision.
• Correction: Analyze lead time and inventory levels to ensure they align with the company's goals and objectives.

Exam / Certification Tips

• Be prepared to apply formulas and frameworks: Make sure to memorize key formulas and frameworks, such as EOQ and SCOR.
• Understand the differences between make and buy: Be able to explain the key differences between make and buy, including costs, quality, and responsiveness.
• Consider the impact of lead time and inventory levels: Be prepared to analyze the impact of lead time and inventory levels on the make-or-buy decision.
• Develop a make-or-buy strategy: Be able to develop a make-or-buy strategy that aligns with the company's goals and objectives.

Quick Practice Problem

A company is considering whether to make or buy a component that has a production cost of $10 and a holding cost of $5 per unit. The demand is 100 units per month, and the lead time is 5 days. What is the reorder point?

Answer: Reorder point = Demand × Lead Time = 100 units/month × 5 days = 500 units.

Last-Minute Cram Sheet

• Make-or-Buy Matrix: A decision-making tool that considers factors such as production volume, production complexity, and supplier reliability.
• EOQ = ?(2DS/H): A formula for calculating the economic order quantity.
• Safety Stock = Z ×-× ?L: A formula for calculating safety stock.
• TCO = (Purchasing Cost + Holding Cost + Opportunity Cost) / (Production Volume): A formula for calculating the total cost of ownership.
• Fisher's Model: A framework for evaluating the make-or-buy decision based on factors such as production volume, production complexity, and supplier reliability.
• SCOR Model: A framework for evaluating supply chain performance based on factors such as delivery, quality, and cost.
• Break-Even Analysis: A method for determining the point at which the cost of producing a product in-house equals the cost of buying it from a supplier.
• Payback Period: The time it takes for the cost savings from buying a product to equal the cost of producing it in-house.
• Make-or-Buy Decision is not just about cost: Consider factors such as quality, responsiveness, and supplier reliability when making a make-or-buy decision.
• EOQ is not always the optimal order quantity: Consider factors such as lead time and inventory levels when calculating the optimal order quantity.