/ 2012

Strategic Make or Buy Decision Methodology for Achieving

Competitive Advantage

Kiwon Lee*, Euiho Suh**, Daegeun Hong***

Department of Industrial and Management Engineering

Pohang University of Science and Technology (POSTECH)
77 Cheongam-ro, Nam-gu, Pohang, Gyungbuk, Korea, 790-784
w0hya@postech.ac.kr*, ehsuh@postech.ac.kr**, dghong@postech.ac.kr***

Abstract ing. This helps companies to be more flexible in re-

Make or Buy decision is becoming increasingly im-
portant as firms are globalized with branch plants
around the world. In most cases, the decision making
mainly depends on the cost analysis in terms that how
we can make the products cheaper. However, for
gaining companys future compatibility, it is needed
to consider not only cost aspect but also technology
aspect and product operation ability from a company
view. In this sense, previous researches mentioned
importance and factors of the technological and oper-
ational aspect theoretically, but they are insufficient
to apply the Make or Buy decision process in practice.
Therefore, this paper describes a systematic method-
ology for Make or Buy decision to achieve compa-
nys competitive advantage. The proposed methodol-
ogy consists of three perspectives: technological,
financial, and operational perspective. A case study of
Company A, home appliance manufacturer, is per-
formed to prove the effectiveness of the proposed
methodology.
Keywords: Make or Buy Decision, Quality Function
Deployment, Patent Portfolio Analysis, Total Cost
Analysis, Optimal Production
1. Introduction
Recently, companies strategically use external
resources not only to reduce their expenditures but
also to maximize their manufacturing efficiency. Uti-
lizing external resources is called to be an outsourc-
sponding to the global competition environment.
Strategic sourcing, that is, Make or Buy is becoming
the main issue of the business in order to achieve
competitive advantage [7, 19].
Make or Buy decision is the act of making a
strategic choice between producing an item internally
(in-house) or buying it externally (from an outside
supplier) [5]. However, previous studies on Make or
Buy mainly discussed the production cost to gain
competitive price of companies [16]. In most cases,
the decision making mainly depends on the cost anal-
ysis in terms that how we can make the products
cheaper. When the Make or Buy is only analyzed
from the production cost perspective, companies of-
ten fall into the trap of a short-term profit instead of
core competence.
In this sense, Welch and Nayak [19] suggested a
Make or Buy decision model considering financial
and technological aspects at the same time. Sislian
and Satir [16] also developed a model of Make or
Buy decision including finance analysis and produc-
tion analysis. Previous researchers mentioned im-
portance and factors of the technological and opera-
tional aspect theoretically, but they are insufficient to
apply the Make or Buy decision process in practice.
For gaining companys future compatibility, it is
needed to consider not only cost aspect but also tech-
nology aspect and product operation ability from a
company view [14].
Therefore, this paper describes a systematic
methodology for Make or Buy decision to achieve

000380
/ 2012
companys competitive advantage. The proposed
methodology consists of three perspectives: techno-
logical, financial, and operational perspective. In
technological perspective, Make or Buy decision of
the product is evaluated through QFD and patent
portfolio analysis. In financial perspective, Make or
Buy decision of the product is evaluated by Total
Cost of manufacturing. In operational perspective,
optimal production is considered in Make or Buy
decision. Based on the results of three perspectives,
guidelines of the Make or Buy decision are developed.
2. Literature review
2.1. General concept of Make or Buy decision
Product manufacturing process is generally di-
vided into two types in terms of who produces prod-
ucts or items: Make and Buy [17, 18]. Make is a
manufacturing type that a company produces items or
components of the product by using its own in-house
capabilities or functions. Make originally meant the
activity for manufacturing something inside of the
firm. On the other hand, buy is a manufacturing type
that a company entrusts some of its internal activities
to outside suppliers [5]. Nowadays, firms tend to out-
source their functions and activities for the purpose of
cost reduction, concentration to core competency or
mass production, and action for demand fluctuation
[10]. Outsourcing activity has been used for keeping
competitive advantage of the firm in flexible supply
of products.
Make or Buy decision indicates a strategic
choice between internally possessing fundamental
functions or services for producing products and pur-
chasing functions or items from external providers
[5]. Past Make or Buy choice was a traditional simple
question in business management [3], but as previous
product and service market has been shifted to the
global market, Make or Buy decision making process
is becoming an important issue for not only achieving
firms competitive advantage but surviving in fierce
competition on global environment [7, 9, 17, 19].
With the importance of Make or Buy decision
making, researches on the factors to consider in Make
or Buy decision are conducted in many ways. Welch
and Nayak [19] emphasized the technological aspect
for firms competitive advantages through importance
and maturity of process technology. Maclvor et al.
000381
[10] developed conceptual Make or Buy decision
making framework based on firms core capability
and cost factors. Winer et al. [20] interpreted Make or
Buy issue through cost, necessity of using firms
overproduction, stability of procurement, and degree
of expertise process technology. Sislian and Satir [16]
suggest technological position, demand fluctuation,
manufacturing capability, process maturity, and out-
sourcing risk as factors for evaluating Make or Buy
decision.
When concluding Make or Buy decision, vari-
ous perspectives and factors for evaluating Make or
Buy have to be considered [14]. As the previous re-
searches indicated, major factors to consider in Make
or Buy decision are largely discussed in three per-
spectives; technological, financial, and operational
perspective. Therefore, in order to support Make or
Buy decision effectively and elaborately, methodolo-
gy for Make or Buy decision through integrated and
balanced approach with technological, financial, and
operational perspectives is needed.
2.2. Make or Buy decision making in financial per-
spective
Companies traditionally regarded manufacturing
cost as the most important factor in Make or Buy
decision making [2]. For this reason, initial Make or
Buy decisions were dealt with economic approach
mainly based on the Transaction Cost Theory, which
is accounting for the actual cost of outsourcing pro-
duction of products or services including transaction
costs, contracting costs, coordination costs, and
search costs [11, 12, 15]. Although the economic ap-
proaches are analyzed based on the long-term goal
for gaining firms competitiveness in a broad per-
spective, many of previous researches approaches
mainly focused on the problem solving in short-term
view.
Besides, a firms Make or Buy decision in fi-
nancial perspective are analyzed by calculating man-
ufacturing cost in terms of the cost per each item unit
supplied in general. Unit cost concept has an ad-
vantage to simply expect product cost with produc-
tion quantity, but it also has a disadvantage to distrib-
ute indirect cost in manufacturing product or items.
That is, fixed costs which are required in manufactur-
ing and cant follow the detail breakdowns of the
total expenditure directly are not able to allocate their
/ 2012
costs into the unit cost exactly. Due to the limitation
of distribution of indirect cost, a firm can take wrong
decision of buy, despite it has a surplus asset or capa-
bility. In this sense, Burt et al. [1] insisted that all
manufacturing related costs be included in Make or
Buy decision when considering financial perspective.
A distinctive feature of manufacturing products
or items compared to buy them is the investment of
facilities or infrastructure for making them. If a firm
decides to make products or items, deservedly it has
to invest money to construct a factory or set up facili-
ties for making products or items. Short-term manu-
facturing cost analysis cant fully reflect the effect of
investment, so it leads not to compare benefits be-
tween Make and Buy. Therefore, it is necessary to
consider investment cost and to conduct financial
analysis in terms of long-term and total cost view.
2.3. Make or Buy decision making in the Technologi-
cal and Productive perspectives
In technological perspective, a company should
decide Make for components and all functions related
to the technologies that will be the core technologies
for the future companys competitiveness based on
the importance of manufacturing technology, tech-
nologys maturity, and manufacturing capability [8].
Probert [13] presented the optimal outsourcing strate-
gic selection introduced the 3 by 3 matrix of a tech-
nological competitiveness and technological im-
portance for the defining the company's core technol-
ogies. Welch and Nayak [19] also introduced the 3 by
9 matrix for the classification of the company's tech-
nologies in the manufacturing strategic perspective.
Make or Buy decisions are made by the reflecting the
technologies to 3 by 9 matrix in terms of the technical
competitive advantage, technology maturity and
technical importance.
In the productive perspective, a company needs
to find the optimal Make points for boosting the effi-
ciency of production to the maximum considered the
manufacturing capacity of a company [4]. Sislian and
Satir [16] presented the methodology of Make or Buy
decision making in the form of flowchart for strategic
outsourcing. Make or Buy decisions are made by the
volatility of demand and productive capacity of part-
ners, targets for outsourcing in flowchart.
Thus, the technological competitiveness, techno-
logical maturity and technological importance are
considered for the technological perspective and the
000382
volatility of demand and productive capacity are re-
flected for the productive perspective in the previous
researches about Make or Buy decision making.
However, there are the limitations for previous re-
searches that only qualitative approaches are applied
for decision making. Making sophisticated decision
making process is needed when qualitative and quan-
titative approaches for decision making are balanced.
Now days, In order to achieve the company's
competitive advantages by improving a company's
future competitiveness and maximizing the manage-
rial flexibility and efficiency in the global unlimited
competition environments, not only financial ap-
proach but also technological and productive ap-
proaches are needed for Make or Buy decision mak-
ing [10, 13]. If the approaches of decision making are
overly weighted toward one side, the decision making
would be interrupted by the distortion of information.
A company should conduct the decision making in
the synthetic perspectives based on the balanced vi-
sion because Make or Buy decision making is not for
the short-term responses, but for long-term planning
of the future strategy for companys management
policy. In other words, a new methodology which can
practically imply the companys conditions consid-
ered financial, technological and productive aspects
is needed for the Make or Buy decision making.
3. Methodology
The suggested methodology for Make or Buy
decision is shown in Figure 1. There are four stages:
technological perspective, financial perspective, op-
erational perspective, and guidelines of decision mak-
ing.
Figure. 1. Make or Buy Decision Research
Framework
/ 2012

3.1. Step1: technological perspective
3.1.1. Analysis of Technology Importance
QFD offers casual connection between custom-
ers requirements and engineering characteristics.
The customer requirements are considered to be input
parameters; whereas the items or processes are con-
sidered as output parameters. This application high-
lights the consideration of different processes and
items to see which are best suited to each diverse
company. By using QFD in this study, a company
needs to consider the actual customer requirements
and then, match the best suited processes or items.
So in this study, the typical QFD processes used
in various applications are customized to select key
processes and items. The proposed application of 1st
QFD is to examine the choices of item importance
against the requirements of a product. In 2nd QFD,
the choice of process importance against the key
items selected in the 1st QFD is analyzed. Figure 2
represents the elements of HOQ for this application.
Item
Item 1 Item 2 Item 3 Item n
C.R.
C.R. 1
represents the trend of patent moves caused by the
general patenting activity [6].
Maturity of technology is interpreted based on
this general patenting activity, and the stages are clas-
sified into four stages according to the patent portfo-
lio. Growth period is that the technology is intro-
duced, so it increases both application and applicant
in this period. Development period is the technology
is on the rapid growth of R&D, and also it increases
both application and applicant rapidly. Maturity peri-
od is that the technology is on the stable stage, and
trend shows stagnant or decrease in application and
applicant. Finally, Decline period is the technology is
decrease in application and applicant due to introduc-
tion of alternative technology. In this study, technolo-
gy maturity stage is classified only into
growth/development period or maturity/decline peri-
od in larger concept of maturity.
Tech.
Tech. 1 Tech. 2 Tech. 3 Tech. k
Key Item

C.R. 2 Item 1

C.R. 3 Item 3
:
: Item n

C.R. m Technology
Importance
Item
Importance

Key Item Key Process

Item 1
Item 3
Tech. 1 Figure 3. Patent Portfolio-Based Technology
Item n
Tech. 3
Maturity Analysis
Figure. 2. 1st and 2nd QFD: C.R.-Item and
Item-Process Relationship Analysis
3.1.3. Matrix of Technology Strategy

3.1.2. Analysis of Technology Maturity

Rising Key Saturated Key
High
The basic concept of patent portfolio as a type of Technology Technology

the patent analysis is the tool for analyzing the stages Technology
Importance

of development of a particular technology based on Low

Non-Key Non-Key
Technology Technology
the patterns in patenting activity [21]. A general mod-
el for patenting activity can be established to under- Growth/Development Maturity/Decline
Period Period
stand maturity of the technology through the number Technology
Maturity
of patent applicants and patent applications. Technol-
ogy maturity of each process technology is carried Figure 4. Matrix of Technology Strategy
out through the patent portfolio.
As plotting the bubbles on the patent portfolio A matrix of technology strategy consists of two
which consists of two axes, the number of patent ap- axes: technology importance and technology maturity.
plicants and patent applications, technology maturity It can assist the Make or Buy decision-making as
is defined. Bubble sizes represent the number of ap- shown in Figure 4. In this matrix, when a process
plications, calculating the ratio of the number of ap- technology is high in the technology importance and
plications in particular period per total number of is located on growth/development period in the tech-
applications and the number of applicants in particu- nology maturity view, it is basically decided Make.
lar period per total number of applicants. Figure 3 The other cases are concluded with Buy. However,

000383
/ 2012
when a process technology is high in the technology
importance, even if it is located on maturity/decline
period in the technology maturity, financial analysis
will be additionally performed in the next step.
3.2. Step2: Financial perspective
Processes assigned to Make in the matrix of
technology strategy are conducted with total cost
analysis and manufacturing cost analysis. This study
is premised on the assumption that a company makes
a production planning based on demanding forecast-
ing of a product.
3.2.1. Manufacturing Cost Analysis
The manufacturing cost is meant the cost of pro-
ducing a product or item in a company during a spe-
cific period. In Make case, the manufacturing cost is
added all the primary cost, for example, material cost,
labor expenses, capital expenditures, etc. In Buy case,
the manufacturing cost is calculated the cost of pur-
chasing a product or item externally. Figuring out
Make cost and Buy cost during a specific period
through the manufacturing cost analysis assists the
Make or Buy decision-making as shown in Figure 5.
In this figure, Make or Buy section is decided by the
primary cost characteristics such as fixed cost and
variable cost, and a number of production planning.
3.2.2. Total Cost Analysis
In this study, Total cost is meant that the total
amount spent on a particular cost, including the price
of the investment itself, plus commissions, fees, other
transaction costs, and taxes. In other words, it in-
cludes the sum of fixed costs, variable costs, and
semi-variable costs during a specific period. Make or
Buy decision-making is performed by using invest-
ment economic feasibility with calculated total costs
of Make and Buy.
3.3. Step3: Operational Perspective
Figure 5. Total Costs of Make and Buy According to
Production Quantity
000384
In using Make mixed with Buy condition, the
optimum production of Make and Buy is calculated at
a specific production planning. In the Figure 5, the
Make decision can reduce total cost by buying some
items at the point of additional investments by the
increase of production.
3.4. Step4: Guidelines of Decision Making
Make or Buy decision of processes and items is
suggested based on the analysis of three perspectives:
technology, finance and operation. Guidelines of de-
cision making on make or buy is presented in 3 by 3
matrix form, Make or Buy Decision Support Matrix
(Figure 6). This guideline framework can support
users to decide Make or Buy effectively. It consists of
technological guidelines axis (rising key technology,
saturated key technology, non-key technology) and
financial and operational guidelines combined con-
cept of two perspectives (advantageous for make, buy,
and mixing make and buy).
Figure 6. Make or Buy Decision Support Matrix
4. Case Study
Company A is global company which is setting
up local corporations in various countries and pro-
ducing home appliances. Company A has made stra-
tegic use of item sourcing from foreign corporations
and partner companies in local area in order to reduce
manufacturing cost and investment risk, and enhance
flexibility of in-house production line. However,
Company A performed assembly and inspection pro-
cess, relatively non-value-added works, it didnt have
core process in-house for growth, and worried about
the situation that Company As capability itself has
been declined. Thus, in order to procure its competi-
tiveness in the future and the world, Company A is
planning to reorganize the current Make or Buy for-
mation of each process by establishing the standards
/ 2012
of the optimum production through the Make or Buy
decision methodology in this paper.
4.1. Step1: Technological perspective in Company A
4.1.1. Analysis of Technology Importance
In the analysis of technology importance of
Company A case, customer requirements of As air
conditioner are derived and items for consisting of
the air conditioner are listed. Based on the customer
requirements the items, key items are selected
through the QFD. In this case study, items which can
be purchased from the outside easily and are under 1%
of the cumulative cost in the air conditioner such as
sticky tape, bolt, nut, etc. is filtered out of this analy-
sis. Furthermore, 2nd QFD is skipped because of the
intuitive relationship between key items and their
process.
After analyzing technology importance in Com-
pany A case through QFD, three manufacturing pro-
cesses (A, B, C) of eight (A, B, C, D, E, F, G, H) are
concluded into key processes. Due to the security
policy of the Company A, name of the manufacturing
processes is concealed but named it process A to H.
One of the key processes in this case is SMT (Surface
Mount Technology), process A. SMT is a technology
for constructing electronic circuits in which the com-
ponents are mounted directly onto the surface of
printed circuit boards. This paper introduces the case
focused only on the SMT, process A.
4.1.2. Analysis of Technology Maturity
In the analysis of technology maturity of Com-
pany A case, technology maturity of the eight pro-
cesses is analyzed through the patent portfolio. First
of all, draft of searching formula and keywords for
finding SMT related patents are prepared based on
the specifications of the SMT. After that, the search-
ing formula and keywords are refined by the technol-
ogy specialist in the field of Company A, and final
searching formula is derived. WIPS, the patent in-
formation database, is used in this analysis and time
period for classifying application year of the patents
is set into 5-year.
Figure 7 represents the result of the patent port-
folio by analyzing based on the number of patent
applications and applicants from the Korean, Japa-
nese, USA, and Europe patents. Patent portfolio of
SMT shows that both trends of the number of patent
applications and applicants are increasing in the Fig-
000385
ure 7. Thus, technology maturity of SMT is conclud-
ed that process A (SMT) is on the
growth/development period.
Figure 7. Patent Portfolio of Process A (SMT)
4.2. Step2: Technological perspective in Company A
Analysis in financial perspective is simulated by
Microsoft Excel application. Excel-based manufac-
turing cost simulation program is developed in order
to support Make or Buy decision to decision makers
easily in practical. Besides, due to the security policy
of the Company A, the result of analysis in financial
perspective in this paper is shown to virtual cost data
and quantity not actual data.
In manufacturing cost analysis of process A
(SMT), total cost for making the items manufactured
through SMT, virtually named SMTpart1, SMTpart2,
and SMTpart3, is analyzed. The simulation program
calculates and represents the total cost both making
SMTpart1, SMTpart2, and SMTpart3 and buying in
determined production quantity.
First of all to calculate manufacturing cost anal-
ysis in the simulation program, planned production
quantity of the items for 10 years is entered into the
program. The number of planned production quantity
for each item is determined by demand estimation of
air conditioner. After that, value of manufacturing
cost factors for making or buying items is entered
into the program, when the items make or buy for the
number of planned production quantity. Then simula-
tion program calculate the one-year total cost of mak-
ing or buying all SMTpart1, SMTpart2, and SMT-
part3 in make and buy cases.
Material cost (variable cost), labor cost (semi-
variable cost), facility investment cost (semi-variable
cost), building construction cost (fixed cost), and land
rent fee (fixed cost) are set as a manufacturing cost
factor when making. SMTpart1, SMTpart2, and
SMTpart3. Purchase cost (variable cost) and shipping
cost (variable cost) are set as a manufacturing cost
/ 2012

factor when buying. results of the three perspectives: technological, finan-

The total amount of each Make and Buy cost is
calculated by the simulation program, and also it
shows the total cost corresponding to production
quantity of Make or Buy in a graph form as shown in
Figure 8. As the capacity of the SMT facility is input
to 500,000 in Make case and facility reinvestment
occurs, there is jumping point of total cost on the
500,000 quantity in total cost-production quantity
graph.
cial, and operational. In this SMT example, basically
taking Make strategy and mixed Make and Buy for
some years is concluded through the analysis of tech-
nological, financial, and operational perspective. Also
a Make or Buy decision making flowchart is pro-
posed as following Figure 9. It can support decision
makers to decide Make or Buy of manufacturing pro-
cesses including SMT.
In this case study, Company A wants to build
Make or Buy guideline process in flowchart format in
order to apply the methodology easier. Therefore,
Make or Buy Decision Making Flowchart is present-
ed as following Figure 9.

Figure 8. Total Cost of Make and Buy Corresponding

to Production Quantity

4.3. Step3: Operational perspective in Company A

In the analysis in operational perspective, opti-
mum production quantity is founded through mixing
Make and Buy case in order to increase production
performance. It is applied on the excel-based simula-
tion program connected with the result of analysis in
financial perspective. In using Make mixed with Buy
of SMT items, optimum production quantity is result-
ed from taking better choice by comparing Make and
Buy total cost in total cost-production quantity graph.
In this SMT example, capacity of SMT facility
Figure 9. Make or Buy Decision Making Flowchart
is 500,000, and the number of planned production
quantity in 2016 and 2017 is 600,000. For making
5. Conclusion
600,000 items in 2016 and 2017, it needs to reinvest
additional facility in 2016 because one facility can
In this study, Make or Buy decision making
produce only 500,000 in this case. It means that addi-
methodology is proposed via technological, financial,
tional facility is built only for making 100,000 items.
and operational perspectives. To begin with, in tech-
As you see on the Figure 8, it is more beneficial that
nological perspective, a matrix of technology strategy
only Company A make 500,000 items and buy the
is developed based on the technology importance and
other 100,000 items from the outside in 2016 and
maturity, and it enables decision makers to help mak-
2017. Applying this concept into whole 10 years,
ing decisions in technological perspective. Secondly,
total cost of manufacturing SMT items is reduced.
in financial perspective, through the manufacturing
cost analysis and total cost analysis, Make or Buy
4.4. Step4: Guidelines of decision making in
decisions are supported. Thirdly, in operational per-
Company A
spective, optimum production quantity through mix-
Make or Buy decision making guideline in
ing Make and Buy is reflected on the decision. Final-
Company A is suggested covered previous analysis
ly, Make or Buy decision making guideline consider-

000386
/ 2012
ing three perspectives is proposed.
In order to confirm the implementation of the
methodology in practical, case study of Company A
is conducted. Defining key processes and items, Ana-
lyzing total cost of manufacturing cost, and optimiz-
ing production capability is conducted for helping
Make or Buy decision in constructing new foreign
corporation. Company A is on the pilot test to this
Make or Buy decision support methodology in air
conditioner case, and it is planning to be extend to all
business in Company A.
Proposed methodology in this study supple-
ments the previous studys limitation of the qualita-
tive approaches through QFD and the patent analysis
which is quantitative approach in technological per-
spective. Through the total cost analysis in financial
perspective, short- and long-term cost and investment
analysis is conducted. It also approaches the Make or
Buy issue to not on dichotomy but mixed Make and
Buy in operational perspective. Based on the meth-
odology, firms can get competitive advantages in the
rapidly changing circumstances by defining key pro-
cesses and make standard to improve production ef-
fectiveness.
The study assumed that there no interrelation-
ship among manufacturing processes. The Make or
Buy guideline of particular process can be reversed
due to dependency to another process. This condition
can be considered in the further research by optimiza-
tion method such as integer programming.
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