The afterlife of a make versus buy decision
Our client had done a detailed assessment for a major make versus buy decision, but then the market conditions changed considerably and it became unclear what the best thing to do would be. nVentic quantified the complex options to drive the company towards the optimum business scenario.
Context
A major manufacturer was suffering from a lack of sourcing options for a major component. The majority of world supply was coming from China and prices had risen considerably in line with underlying commodities, although the main element of price was the conversion cost. Following a thorough make versus buy exercise, our client decided to insource production, leaving them much less exposed to their suppliers. This was supported by a robust business case. Investment was made into machinery and expertise to bring production inhouse.
However, before in-house production even started, market prices of the underlying commodities dropped by a high double-digit percentage. Buying the component suddenly became very competitive. Because controlling were, correctly, including depreciation in the internal costs, it became more expensive to use components produced in-house to those bought on the market. This created a vicious circle where low utilisation of inhouse assets made it more expensive to use them, driving lower utilisation.
As a significant investment had been made, our client was reluctant to write it off. On the other hand, it made little sense to incur further cost unnecessarily simply because of a decision made in the past. Opinions on the best way forward differed. nVentic was asked to produce a quantitative comparison of the different options to help our client reach consensus on the way forward.
A major manufacturer was suffering from a lack of sourcing options for a major component. The majority of world supply was coming from China and prices had risen considerably in line with underlying commodities, although the main element of price was the conversion cost. Following a thorough make versus buy exercise, our client decided to insource production, leaving them much less exposed to their suppliers. This was supported by a robust business case. Investment was made into machinery and expertise to bring production inhouse.
However, before in-house production even started, market prices of the underlying commodities dropped by a high double-digit percentage. Buying the component suddenly became very competitive. Because controlling were, correctly, including depreciation in the internal costs, it became more expensive to use components produced in-house to those bought on the market. This created a vicious circle where low utilisation of inhouse assets made it more expensive to use them, driving lower utilisation.
As a significant investment had been made, our client was reluctant to write it off. On the other hand, it made little sense to incur further cost unnecessarily simply because of a decision made in the past. Opinions on the best way forward differed. nVentic was asked to produce a quantitative comparison of the different options to help our client reach consensus on the way forward.
Approach
nVentic started by taking the original make versus buy exercise and baselining the actual and potential future operational realities. We then collected all of the data required to make as accurate a comparison of the options as possible.
A number of high-level scenarios were considered: Keeping the insourced capability as it was, moving the insourced capability to a lower-cost location within the group, and selling off the machinery and outsourcing production entirely.
Furthermore, the analysis was broken down to a granular level, to ascertain whether certain component sub-classes should be insourced whilst others were outsourced. And a number of new elements were also considered, such as currency fluctuations, new offers on the market, cost of poor quality (COPQ), and increased asset utilisation.
Qualitative aspects were also considered, such as R&D opportunities, quality enhancement opportunities and the likely development of the external supply market.
For each option considered, costs were compiled and validated with Finance. The major cost elements considered were: materials, taxes, labour, overheads, depreciation, freight and quality.
nVentic started by taking the original make versus buy exercise and baselining the actual and potential future operational realities. We then collected all of the data required to make as accurate a comparison of the options as possible.
A number of high-level scenarios were considered: Keeping the insourced capability as it was, moving the insourced capability to a lower-cost location within the group, and selling off the machinery and outsourcing production entirely.
Furthermore, the analysis was broken down to a granular level, to ascertain whether certain component sub-classes should be insourced whilst others were outsourced. And a number of new elements were also considered, such as currency fluctuations, new offers on the market, cost of poor quality (COPQ), and increased asset utilisation.
Qualitative aspects were also considered, such as R&D opportunities, quality enhancement opportunities and the likely development of the external supply market.
For each option considered, costs were compiled and validated with Finance. The major cost elements considered were: materials, taxes, labour, overheads, depreciation, freight and quality.
Results
The detailed analysis showed that for around 50% of the components in scope, in-house production was in fact less costly than external purchases. Furthermore, for almost all of the other 50% of components, in-house production was less costly than external purchases if depreciation was excluded. This effect was only magnified if utilisation could be significantly increased and the cost of poor quality reduced.
A key breakthrough was making the whole organisation realize that once the machinery was bought, the acquisition cost could not be avoided by not using it!
Moving the machinery to other locations was found to deliver even clearer financial benefits, but was less desirable from a R&D perspective. It was considered that the opportunity to drive innovation in this component had a significant value in itself, but would only become realistic if utilisation were increased.
Finally, since this component was a significant one to this client, maintaining in-house capability was worthwhile both from a strategic and risk perspective.
The detailed analysis showed that for around 50% of the components in scope, in-house production was in fact less costly than external purchases. Furthermore, for almost all of the other 50% of components, in-house production was less costly than external purchases if depreciation was excluded. This effect was only magnified if utilisation could be significantly increased and the cost of poor quality reduced.
A key breakthrough was making the whole organisation realize that once the machinery was bought, the acquisition cost could not be avoided by not using it!
Moving the machinery to other locations was found to deliver even clearer financial benefits, but was less desirable from a R&D perspective. It was considered that the opportunity to drive innovation in this component had a significant value in itself, but would only become realistic if utilisation were increased.
Finally, since this component was a significant one to this client, maintaining in-house capability was worthwhile both from a strategic and risk perspective.
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