To Make or Buy for Your Project?

When managing projects, you are faced with a ton of decisions. These include critical make or buy decisions during procurement management.

Is it better to produce certain project deliverables internally or outsource them to vendors?

Determining the right answer to this question requires an effective make or buy analysis to evaluate the costs, benefits, risks, and strategic factors.

In this post we look at make or buy analysis in project management, how to use it to make decisions, as well as tips for mastering the concept for the PMP exam.

Make or Buy Analysis Definition

Make or buy analysis is a structured technique used to evaluate whether to produce an item or service internally or outsource it to an external supplier by weighing the costs and benefits of the two alternatives.

The analysis aims to determine if an organization or individual should make the product or service using its facilities, labor, equipment, etc. or buy it from an outside vendor.

The goal is to select the option that optimizes project objectives like cost, schedule, quality, risk mitigation, resource utilization, and alignment to core competencies.

As a project manager, conducting a make or buy analysis is key, especially during procurement activities in the project planning phase.

It informs make or buy decisions on whether to acquire each procurement item or service from the open market or provide it in-house using organizational assets.

Importance of Make or Buy Analysis in Project Management

Make or buy analysis in project management provides key insights that impact:

• Project Scope: It greatly influences the project scope by determining how much work will be handled internally by your team versus externally by vendors. This impacts resource needs and coordination efforts.
• Costs: It provides vital data to compare the total cost differences between making or buying, including both direct and indirect costs like materials, labor, transportation, overhead, and economies of scale.
• Schedule: The decision will likely compress or extend the schedule based on factors like production lead times and shipping logistics. This needs to be incorporated into the schedule.
• Risks: It assesses risks such as supplier reliability, adequacy of specifications communication, and degree of quality control, which can be mitigated upfront.
• Resources: The analysis evaluates if you have sufficient internal skills, capacity, and capabilities to make the item with acceptable quality standards. Resource constraints may dictate buying.
• Core competencies: Core competencies should be considered if certain production abilities are organizational strengths that would be advantageous to leverage.
• Quality: For some items, quality control may be easier to manage internally vs through vendors. This needs weighting in the criteria.
• Strategic Goals: Outsourcing production may enable focusing internal resources on core capabilities that align with strategic goals vs making commoditized items.

Without this vital analysis, you risk sub-optimal procurement decisions that impact timelines, cost, risk, resources, and overall project success.

Make or Buy Analysis Formula

The make or buy analysis formula involves comparing the total costs of making the product or service internally versus buying it from an external supplier.

The key steps are:

• Identify all direct costs such as materials, labor, and allocated overhead for internal production.
• Identify all indirect costs like facilities, equipment, and management oversight.
• Estimate the purchase price from suppliers, including delivery and other fees.
• Account for any opportunity costs from making vs buying.
• Calculate the total cost for each option.
• Compare the total costs and select the lower-cost option.

The formula can be expressed as:

Total Make Cost = Direct Costs + Indirect Costs
Total Buy Cost = Purchase Price + Opportunity Costs

Make or Buy Decision Factors

While make or buy analysis provides vital data, the decision requires weighing several key qualitative factors. Factors you need to consider include:

1. Cost Factors

Will production costs be lower internally versus outsourcing? Consider direct costs like labor and materials as well as overheads.

Then, analyze the total cost of ownership, not just the purchase price. Include ancillary costs like transportation, inventory, inspection, and coordination.

Also, does internal production provide lower overall costs considering all labor, material, equipment, facilities, transportation, and overhead expenses? Keep in mind that outsourcing may have higher per unit costs but no fixed overhead.

Analyze the total cost of ownership over the full lifecycle, not just the upfront purchase price. Then account for ancillary costs like inspection, inventory, coordination, customization, and consumables.

2. Quality Factors

Does internal production allow better quality control than external sourcing? Do vendors possess specialized expertise or equipment to deliver higher quality?

While internal production allows closer control over quality management during the full manufacturing process versus a vendor’s black-box approach, suppliers may have specialized expertise or equipment to deliver higher quality.

3. Capacity Factors

Does sufficient capacity exist internally in terms of labor, facilities, and equipment for internal production? Will outsourcing free up internal resources for core operations vs. ancillary production?

Resource constraints like available labor hours, facilities square footage, and equipment units may dictate outsourcing even if internal costs are lower.

On the other hand, retaining production may allow faster adaptation to changing requirements.

4. Time Factors

Will making the item internally accelerate or delay the schedule compared to outsourcing lead times? How critical is the delivery timeframe?

Internal lead times must be compared to supplier production and delivery timeframes as outsourcing may expedite delivery but reduce flexibility for short-notice changes.

5. Risk Factors

What risks arise from reliance on external vendors like supply delays or quality issues? Does internal production introduce risks from resource constraints, technical issues, or other factors?

Over-reliance on a single or a few vendors creates risks like delivery delays, quality issues, communication gaps, and geographic concentration.

However technical challenges, resource issues, or incompetence risks can arise with internal production.

6. Strategic Factors

Does internal production better leverage organizational core competencies? Does outsourcing enable a greater focus on competitive differentiators?

Internal production better leverages existing capabilities like technical expertise or specialized equipment while outsourcing simplifies resource management to focus on core differentiators.

Make or Buy Decision Advantages and Disadvantages

Whether you decide to produce an item or service in-house or it is outsourced, there are potential pros and cons to either approach.

Advantages of a Make Decision

1. Greater Control Over Production

Making items internally rather than outsourcing gives an organization much greater control over the entire production process, with tight control enabling optimizing operations for maximum efficiency.

This includes closely managing activities like quality assurance, scheduling, resource allocation, capacity scaling, and process improvements.

2. Develops Operational Efficiencies

Internal production allows companies to develop skilled and experienced workforces specialized in their processes, as well as optimize equipment utilization, and streamline workflows to minimize waste.

Also, dedicating workforces and machines to routine production creates efficiencies.

3. Leverages Existing Assets

Producing internally enables leveraging investments already made in facilities, equipment, and worker training. Making use of these existing assets improves their return on investment.

4. Adapts to Changing Requirements

With internal production, organizations can pivot more quickly to modify outputs based on changing requirements. Whereas outsourced production has less flexibility to adapt.

Disadvantages of Make Decision

1. Higher Fixed Costs

Making products requires significant fixed overhead costs including production facilities, heavy equipment, management supervision, and routine maintenance expenses which you’d avoid if you outsource.

2. Limits Economies of Scale

Unless the production volumes are extremely high, in-house production limits the economies of scale that external suppliers can provide through specialization and higher volumes, and the per unit cost is often higher.

3. Ties Up Resources

While outsourcing frees up organizational resources to handle other tasks, dedicated production resources cannot be deployed to other higher-value projects, representing an opportunity cost.

4. Inflexible Capacity

It is difficult to scale internal capacity up and down with changing demand. Excess or insufficient capacity both have costs. Suppliers handle these fluctuating volumes more fluidly.

Advantages of a Buy Decision

1. Specialized Expertise

Vendors are typically focused on a product or process and often develop very specialized expertise that an internal team may not be able to match cost-effectively. Their depth of knowledge can lead to quality and efficiency benefits.

2. No Fixed Overhead Costs

Outsourcing converts fixed costs into variable costs, only paying for the volume produced. It also provides access to economies of scale from the supplier’s larger production across customers.

3. Focus on Core Competencies

Buying from vendors allows the focus of internal resources on an organization’s true core competencies rather than distracting the production of ancillary inputs.

4. Access to Innovation

Suppliers at the cutting edge often have access to the latest technologies, methods, and innovations that an internal team may take time to develop. Buying can provide access to leading-edge advances.

Disadvantages of Buy Decision

1. Less Control Over Suppliers

Buying from external vendors provides less oversight and control compared to internal production. This can lead to issues meeting specifications, quality norms, and delivery timelines.

2. Higher Risk Exposure

Outsourcing creates risks such as lack of supply, geopolitical factors impacting operations, financial instability of vendors, and reliance on a limited supplier base whereas internally managed risks can be lower.

3. Potential Loss of Capabilities

Over-reliance on outsourcing can cause erosion of internal capabilities over time. This loss of competencies can be difficult to rebuild later if needed.

4. Intellectual Property Leakage

Critical organizational knowledge transferred to vendors during procurement processes creates potential IP leakage risks versus keeping production in-house.

Make or Buy Analysis Example

Let’s walk through an example of a make or buy analysis for a software development project.

The project team must decide whether to build the server hardware internally or outsource it to an OEM supplier.

First, the project manager gathers data on internal production costs. These include:

• Direct material costs: $250 per server for components
• Direct labor costs: $100 per server for assembly technicians (at a fully loaded rate)
• Variable manufacturing overhead: $150 per server including utilities, consumables, etc.
• Fixed manufacturing overhead: $5 million per year including equipment maintenance, supervision, and rent

The total estimated manufacturing cost is $500 per server.

Annual production volume is estimated at 10,000 servers, leading to a total internal cost of $5 million + ($500 x 10,000 units) = $10 million.

External supplier quotes range from $600 – $800 per completed server unit including delivery.

Assuming the chosen OEM’s quote is $700 per server, the total outsourcing cost at 10,000 units is therefore $7 million.

Despite higher per-unit costs, in this case, outsourcing provides a lower total cost by leveraging the supplier’s economies of scale and avoiding major fixed overhead expenses.

This example demonstrates using the make or buy formula to quantify the cost trade-offs.

However, the final decision also depends on strategic factors like maintaining internal capabilities and risks associated with supplier dependence, and the best decision balances both financial and qualitative factors.

Challenges of Make or Buy Analysis in Project Management

While a make or buy analysis in project management is a valuable technique, conducting it effectively has several challenges:

• Obtaining accurate cost data on internal production and supplier pricing can be difficult, especially with uncertainty in product volumes, efficiency variances, and indirect costs.
• Forecasting production variables like volumes, quality, scrap rates, and utilization add uncertainty to cost projections.
• Quantifying soft factors like flexibility, risk, quality, and alignment to strategy is largely subjective. Over-reliance on quantifiable financials risks suboptimal decisions.
• Make or buy criteria often conflict, requiring tradeoff judgments between cost, time, risk, control, etc. Disagreements can arise on weightings.
• Analysis paralysis is possible by chasing perfect information, robust models, or consensus. It’s important to strive for appropriate analysis depth within schedule constraints.
• Oversimplification also occurs from glossing over complex interdependencies in procurement economics and logistics.

As a project manager, you need to apply your leadership capability to drive an efficient yet sufficiently thorough make or buy analysis process.

Leverage your team’s expertise while mitigating potential biases and keep challenging assumptions to avoid suboptimal make or buy decisions.

Make or Buy Analysis PMP Exam Tips

Procurement management and planning is a part of the PMP exam content outline, and this knowledge area requires knowledge of make or buy analysis.

While it is highly unlike that you will be required to do any calculations on make or buy analysis or decisions in your PMP exam, it’s important to master the concept.

When procurement management questions arise, remember these tips:

• Know the make or buy analysis inputs, evaluation criteria, and outputs. Be able to walk through the decision process.
• Recognize how it fits into the Plan Procurements process and impacts the project management plan.
• Study the make or buy formula to analyze direct and indirect costs. But also consider strategic qualitative factors.
• Understand challenges like obtaining accurate data and quantifying soft factors. Analysis paralysis and oversimplification are common pitfalls.
• Sunk costs are not a factor to consider when doing make or buy analysis.
• Review examples of make or buy scenarios and decisions focused on cost-benefit tradeoffs.

Conclusion

Make or buy decisions are a critical part of project management that compares internal production to external sourcing.

By conducting a structured make or buy analysis using the simple cost formula and evaluating strategic factors, you gain key insights to optimize procurement choices.

Frequently Asked Questions