Make or Buy?

The firm must decide whether to make its own production materials or buy them from outside sources. This is the make-or-buy decision. The quantity of items needed is one consideration. If a part is used in only one of many products, buying the part may be more cost-effective than making it. Buying standard items, such as screws, bolts, rivets, and nails, is usually cheaper and easier than producing them internally. Purchasing larger components from another manufacturer can be cost-effective as well. When items are purchased from an outside source instead of being made internally, it is called outsourcing. Harley-Davidson, for example, purchases its tires, brake systems, and other motorcycle components from manufacturers that make them to Harley’s specifications. However, if a product has special design features that need to be kept secret to protect a competitive advantage, a firm may decide to produce all parts internally.

In deciding whether to make or buy, a firm must also consider whether outside sources can provide the high-quality supplies it needs in a reliable manner. Having to shut down production because vital parts aren’t delivered on time can be a costly disaster. Just as bad are inferior parts or materials, which can damage a firm’s reputation for producing high-quality goods. Therefore, firms that buy some or all of their production materials from outside sources should make building strong relationships with quality suppliers a priority.

Inventory Management: Not Just Parts

A firm’s inventory is the supply of goods it holds for use in production or for sale to customers. Deciding how much inventory to keep on hand is one of the biggest challenges facing operations managers. On the one hand, with large inventories, the firm can meet most production and customer demands. Buying in large quantities can also allow a company to take advantage of quantity discounts. On the other hand, large inventories can tie up the firm’s money, are expensive to store, and can become obsolete.

Inventory management involves deciding how much of each type of inventory to keep on hand and the ordering, receiving, storing, and tracking of it. The goal of inventory management is to keep down the costs of ordering and holding inventories while maintaining enough on hand for production and sales. Good inventory management enhances product quality, makes operations more efficient, and increases profits. Poor inventory management can result in dissatisfied customers, financial difficulties, and even bankruptcy.

One way to determine the best inventory levels is to look at three costs: holding inventory, frequent reordering, and not keeping enough inventory on hand. Managers must measure all three costs and try to minimize them.

To control inventory levels, managers often track the use of certain inventory items. Most companies keep a perpetual inventory, a continuously updated list of inventory levels, orders, sales, and receipts, for all major items. Today, companies mostly use computers to track inventory levels, calculate order quantities, and issue purchase orders at the right times.

Computerized Resource Planning

Many manufacturing companies have adopted computerized systems to control the flow of resources and inventory. Materials requirement planning (MRP) is one such system. MRP uses a master schedule to ensure that the materials, labor, and equipment needed for production are at the right places in the right amounts at the right times. The schedule is based on forecasts of demand for the company’s products. It says exactly what will be manufactured during the next few weeks or months and when the work will take place. Sophisticated computer programs coordinate all the elements of MRP. The computer comes up with materials requirements by comparing production needs to the materials the company already has on hand. Orders are placed so items will be on hand when they are needed for production. MRP helps ensure a smooth flow of finished products.

Manufacturing resource planning II (MRPII) was developed in the late 1980s to expand on MRP. It uses a complex computerized system to integrate data from many departments, including finance, marketing, accounting, engineering, and manufacturing. MRPII can generate a production plan for the firm, as well as management reports, forecasts, and financial statements. The system lets managers make more accurate forecasts and assess the impact of production plans on profitability. If one department’s plans change, the effects of these changes on other departments are transmitted throughout the company.

Whereas MRP and MRPII systems are focused internally, enterprise resource planning (ERP) systems go a step further and incorporate information about the firm’s suppliers and customers into the flow of data. ERP unites all of a firm’s major departments into a single software program. For instance, production can call up sales information and know immediately how many units must be produced to meet customer orders. By providing information about the availability of resources, including both the human resources and materials needed for production, the system allows for better cost control and eliminates production delays. The system automatically notes any changes, such as the closure of a plant for maintenance and repairs on a certain date or a supplier’s inability to meet a delivery date, so that all functions adjust accordingly. Both large and small organizations use ERP to improve operations.

Keeping the Goods Flowing: Supply-Chain Management

In the past, the relationship between purchasers and suppliers was often competitive and antagonistic. Businesses used many suppliers and switched among them frequently. During contract negotiations, each side would try to get better terms at the expense of the other. Communication between purchasers and suppliers was often limited to purchase orders and billing statements.

Today, however, many firms are moving toward a new concept in supplier relationships. The emphasis is increasingly on developing a strong supply chain. The supply chain can be thought of as the entire sequence of securing inputs, producing goods, and delivering goods to customers. If any links in this process are weak, chances are customers—the end point of the supply chain—will end up dissatisfied.

Effective supply-chain strategies reduce costs. For example, integration of the shipper and customer’s supply chains allows companies to automate more processes and save time. Technology also improves supply-chain efficiency by tracking goods through the various supply-chain stages and helping with logistics. With better information about production and inventory, companies can order and receive goods at the optimal point to keep inventory holding costs low.

Companies also need contingency plans for supply-chain disruptions. Is there an alternative source of supply if a blizzard closes the airport so that cargo planes can’t land or a drought causes crop failures in the Midwest? By thinking ahead, companies can avert major losses. The length and distance involved in a supply line is also a consideration. Importing parts from or outsourcing manufacturing to Asia creates a long supply chain for a manufacturer in Europe or the United States. Perhaps there are closer suppliers or manufacturers who can meet a company’s needs at a lower overall cost. Companies should also reevaluate outsourcing decisions periodically.

Strategies for Supply-Chain Management

Ensuring a strong supply chain requires that firms implement supply-chain management strategies. Supply-chain management focuses on smoothing transitions along the supply chain, with the ultimate goal of satisfying customers with quality products and services. A critical element of effective supply-chain management is to develop tight bonds with suppliers. This may mean reducing the number of suppliers used and asking them to offer more services or better prices in return for an ongoing relationship.

Exhibit 10.8 Managing an efficient supply chain is critical for businesses, especially when the product being delivered is a bouquet of fresh-cut flowers. To ensure that only the freshest, most colorful floral arrangement arrives for that special someone, online floral delivery acts as a national website that serves customers through reputable local florists that deliver the same day. The site uses a web service that draws in customers through search, combined with coordinated carrier scheduling and a review of local florist quality that allows delivery of flowers fresher than the competition. What strategies help businesses create and maintain an effective supply chain? (Credit: Brood_wich/ Flickr/ Attribution-2.0 Generic (CC BY 2.0))

General Motors plans to pare the number of its suppliers to give larger, longer-term contracts to a strategically selected group to be based in a new supplier park near its Texas-based SUV plant. GM is one of several manufacturing firms reconsidering far-flung suppliers in their supply chain. Global parts networks have long been seen as critical to cutting costs, but more companies are concluding they’re a risky bet due to political shifts, protectionist measures, and natural disasters. The automaker says its new move was planned before President Donald Trump criticized GM’s Mexican imports, and the new supplier park will trim logistics expenses and bring other gains from proximity of parts to the assembly plant.^[1]

Instead of being viewed as “outsiders” in the production process, many suppliers play an important role in supporting the operations of their customers. They are expected to meet high quality standards, offer suggestions that can help reduce production costs, and even contribute to the design of new products.

Effective supply chain management depends on strong communications with suppliers. Technology, particularly the internet, is providing new ways to do this. E-procurement, the process of purchasing supplies and materials online, is booming. Many manufacturing firms use the internet to keep key suppliers informed about their requirements. Intel, for example, has set up a special website for its suppliers and potential suppliers. Would-be suppliers can visit the site to get information about doing business with Intel; once they are approved, they can access a secure area to make bids on Intel’s current and future resource needs.

The internet also streamlines purchasing by providing firms with quick access to a huge database of information about the products and services of hundreds of potential suppliers. Many large companies now participate in reverse auctions online, which can slash procurement costs. In a reverse auction, the manufacturer posts its specifications for the materials it requires. Potential suppliers then bid against each other to get the job. However, there are risks with reverse auctions. It can be difficult to establish and build ongoing relationships with specific suppliers using reverse auctions because the job ultimately goes to the lowest bidder. Therefore, reverse auctions may not be an effective procurement process for critical production materials. Other types of corporations can use these auctions as well. The U.S. Army utilizes reverse auctions to leverage technology to fight the reality and perception that it is inefficient in its procurement practices. The General Services Administration found that government agencies had 31 suppliers that were charging between $9.76 and $48.77 for the same hammer.^[2] In 2005 the U.S. Army began to partner with FedBid, Inc., the largest commercial marketplace for reverse auctions, for a variety of products, from paper to computers to helicopters. Costs dropped by $388 million according to independent government cost estimates over the past decade.^[3]

Another communications tool is electronic data interchange (EDI), in which two trading partners exchange information electronically. EDI can be conducted via a linked computer system or over the internet. The advantages of exchanging information with suppliers electronically include speed, accuracy, and lowered communication costs. EDI plays a critical role in Ford Motor Company’s efforts to produce and distribute vehicles worldwide. With the emergence of blockchain technology, there is the potential to automate these types of processes to cover multiple transactions with a variety of participating organizations.^[4]

Summary of Learning Outcomes