SUPPLY CHAIN DESIGN THE MAKE-BUY DECISION PROCESS IN THE AGE OF TEMPORARY ADVANTAGE.

Abstract Number: 002-0419Title of the Paper: SUPPLY CHAIN DESIGN: THE MAKE-BUY DECISION PROCESS IN THE AGE OF TEMPORARY ADVANTAGE.. SUPPLY CHAIN DESIGN: THE MAKE-BUY DECISION PROCESS IN

Abstract Number: 002-0419

Title of the Paper: SUPPLY CHAIN DESIGN: THE MAKE-BUY DECISION PROCESS

IN THE AGE OF TEMPORARY ADVANTAGE.

Name of the Conference: Second World Conference on POM and 15th Annual POM Conference, Cancun, Mexico, April 30 - May 3, 2004

Name: Mauro Sampaio

Institution: EAESP/FGV - Operation and Logistics Department

Address: Av 9 de Julho 2029 10 andar, ZIPCode 01313-902, Brazil

SUPPLY CHAIN DESIGN: THE MAKE-BUY DECISION PROCESS IN THE AGE OF

TEMPORARY ADVANTAGE.

ABSTRACT

In the last years, we have noted cyclical movements in the supply chain architecture concerningsome production sectors Once we have the sector integrated vertically, made up by largedominant companies, once the same sector is disintegrated horizontally, made up by a crowd ofcompanies acting in market niches In this highly competitive environment, the domain ofessential competences, with larger added value, is decisive for any organization survival Thisarticle intends to facilitate the understanding of the subject, analyzing the evolution of traditionaldecision models – make-buy - and evaluating their adaptation to the economy sectors in highevolutionary speed

The truck and bus manufacturing plant of Volkswagen in Resende-RJ is a classicexample A true nonsense business – a Car Manufacturer that does not perform any assembly

activity The suppliers perform the entire work that would be traditionally incumbent exclusivelyupon the car manufacturer Volkswagen undertakes new competences, now being responsible forthe design, coordination, and quality control The American car assembler, Ford Motor Company,second larger world automobile company, will also transfer the production of vehicles to itssuppliers, in its future factory in Camaçari-BA There is seemingly a tendency that the new unitswork less and less with the production of their own automobiles They see each other as futuremarketing and sales organizations, developing new products and controlling the whole supplychain

This movement toward searching new competences does not occur in the local scope.Large global companies are also trying to develop new competences, as for instance, we have:

“New Times reported the formation of a joint venture between a Toyota subsidiary and Texas Instruments, in building a US$1.5-billion semiconductors’ factory, for producing memory chips for electronic automotive components The article described the first movements of Toyota entering the telecommunications and software sector and used the word “intriguing” twice to express its perplexity with relation to Toyota’s strategy” (Pollack, apud Fine, 1998:176)

What would be the reasons for this new strategic positioning? How to explain this franticsearch for new competences even being so distant to upstream or downstream from its traditionalbusiness? What will be the impact concerning outsourcing decisions over supply chain?

Many studies treating this subject “what to make, what to buy”, as an example, Hamel andPrahalad (1990, 1994), Quinn and Himer (1994, 1999), Venkatesan (1992) among others,concentrate on evaluating advantages and obstacles regarding process outsourcing for a specificentity They are models that guide an organization to select and develop internally onlycompetences with higher value added to customers, thus aiming at conquering a sustainable

competitive advantage Nevertheless, will these prescriptive models still be appropriate in ahighly competitive environment?

Increasing competitiveness, competition has been ceasing to be among companies to takeplace among supply chains (Vollmann and Cordon, 1996), as shows Figure 1 An isolatedcompany no longer survives, as it needs to be integrated with its customers and suppliers It isuseless that a manufacturer adopts the best practices, if its suppliers are expensive and/or theirdistribution channels are inefficient taking care of customers’ expectations

Figure 1: Competition Among Supply Chains

Manufacturers Dealers Retailers Consumers Suppliers

Source: Adapted from VOLLMANN and CORDON, 1996

In this new competitive context there is little understanding regarding outsourcing impactover an outsourcing decision concerning supply chain and/or industry This work intends tocontribute for the debate on this theme, filling out this literature gap

Summarizing, the article will aim at answering the following research question: To whatextent are the classic decision models “What to Make, What to Buy” appropriate in a dynamicand complex environment?

To reach such goal, the article is structured in nine parts, including this introductory part.The second part reviews classic outsourcing models Some problems found are clarified in thethird part The fourth reviews some models of organizational change The fifth submits adynamic model The sixth makes a critical analysis concerning submitted models The seventhclassifies such models The eighth submits final considerations The last part reports limitationsregarding work and gaps

Make-buy decision process Models

Modeling the make-buy decision process is a great relevance theme between academicsand executives A representative volume of work has dealt with the matter, such as publicationsin: Harvard Business Review, Sloan Management Review, and European Journal of Purchasing

& Supply Management, among others

According to Gutward (1995), available classic models regarding the make-buy decisionprocess can be classified in:

 Economical Analysis

 Transaction Cost Analysis

 Strategic Analysis

 Multidimensional Analysis

The simplest way, and maybe, the oldest one to approach this subject, is the Economical

Analysis The methodology consists of comparing production cost for a certain component with

purchase cost in the market Textbooks on accounting submit such analysis in the context ofrelevant costing However, the final decision cannot be that simple, it should include otherconsiderations besides product cost

The economist Coase (1937) developed a fertile theory on vertical integration, the

Transaction Cost Theory, which takes into account several other important factors The

transaction cost, improved later by Williamson (1991), studies how partners are risk-protected intheir trade relationships Those risks refer to the possibility that the elements accorded betweenthe parties do not take place Risk minimization implies reducing transaction costs, representing

an efficiency element in competition among companies

In the decades of 80 and 90, authors as Porter (1985) Hamel and Prahalad (1990, 1994) Quinnand Himer (1994, 1999) and Venkatesan (1992) proposed other models, considering StrategicSchool principles Porter (85) focuses the selection of strategic positions on the business seekingthe conquest of maintainable competitive advantages Now, the authors Hamel and Prahaladbelieve that competitive advantage derives from capacities deeply rooted that are behind theproducts of a company (Mintzberg, Ahlstrand, and Lampel, 2000: 163) This approach consists offocusing the efforts and investments of the organization on a small group of capacities, referred

to as essential competences In order to identify it, we suggest classifying organization capacitiespursuant two criteria: strategic importance and relative competence in the market, according toFigure 2 With respect to strategic importance, the company’s competence analysis is carried out,asking if the activity will be able to or not to differentiate it with relation to competitors, in otherwords, to increase its value noted by the customer The analysis of relative competence is carriedout comparing the company’s capacity and the capacity of other competitors with regard to costs,quality, and processes

Figure 2: Make or Buy Decision

The core competence concept is simple and intuitive: “A collective learning of theorganization unique group of capacities that allows the company to create great products”(Hamel and Prahalad 1990:82), but to select it is an arduous and controversial task Quinn andHimer (1994:45-47) suggest seven points for identifying core organization competences:

 Focus on knowledge and abilities, not in products or functions: Products are easily

copied or replaced The traditional functions, as production, engineering, marketing orfinances are no more core competences as they were in the past The competences need to

be abilities that cross these functions, involving activities as of service or product project,technological creation, customer services or logistics, which are much more based onknowledge

 Develop long run competences: the challenge is to build and to dominate abilities in

areas that customers will value in the future

 Limit the number of competences: The company should develop two or three abilities

critical to its business Each demands an intense investment of time and resources thatshould not be diluted with the development of secondary capacities

 Choose the best sources: effective strategies should choose the available spaces in the

market where there are imperfections and/or knowledge gaps, in which investments inintellectual resources can be leveraged

 Dominate the knowledge area: A company only gets to increase its profitability in areas

of activities where its performance is more effective than any other competitor does

 Focus on customer's needs: At least one core competence should be directly related to

customer care and customer service Through the regressive analysis of its value chain, acompany can identify the activities capable of providing at the customer, largereffectiveness, and lesser cost

 To align organizational systems: The maintenance of competences cannot depend on

some gifted “stars”, whose absence in the company may generate serious problems andeven destroy its success When a strategy depends strongly on creativity, dedication,initiative, and excellent professionals' attraction, the core competences should be alignedwith the company’s systems, which include their values, organizational structure, andmanagement system There are cases where this people development system becomes thecore organization competence

Other authors (Londasle, 1999; Anderson, Probert and Jones, Gregory mentioned byGutwald, 1995) elaborated another category for outsourcing models referred to asmultidimensional that considers other factors as: Allocating expenses, innovation skill, humanfactors, employees' experiences, technological maturity, costs, among others

That brief bibliographical revision demonstrates that a lot has been written on the theme, fromfinancial models, to even complex multidimensional models These are different models that try

to persuade the organization to develop some few competences However, one can also associatecritics to each of the submitted perspectives, according to Table 1, generating the followingquestions: To what extent those classic models appropriate in different productive sectors are?Would many companies that apply those methodologies be taking the risk of losing essentialcapacities for their future?

Table 1: The classic Make-Buy models and their main critics

Analysis

Transaction Cost Analysis

Strategic Analysis

Multidimensional Analysis

Specific

Critics

Ignores the existence of hidden costs, such

as transaction cost

He/she ignores thepresence of Opportunist Suppliers

Disregards intangible and strategic assets

in economic equations

Considers that supply chains are built for cost reduction

Does not preserve the knowledge of

an outsourcing activity

Assumes that current competences will

be the same as future

competences

The presuppositions are the same as those of the previous models The critics are diluted, but they remain

General

Critics

STATIC MARKET VISION They consider that the companies look for eternal sustainable competitiveadvantages (an exclusive and valuable market position)

Source: elaborated by the authors

Submitted Problems

Following the classic models, several business administration consultants recommended,during the last decade, the exhausting and indiscriminate outsourcing practice Starting byoutlying activities and migrating gradually to capacities close to the core organization

competence Meeting request, business leaders distributed production and engineering activities,among others, to external contracted parties, in an implacable effort to reduce their costs

Elapsing some years, several failure cases appeared in the business literature Somecompanies almost lost the essential capacities for its business future As example, we have theclassic IBM case study that practically gave the leashes of computer industry to Microsoft andIntel (Chesbrough and Teece, 1996)

English studies on the subject “outsourcing strategy” (PA Consulting Group, 1996)indicated that only 5% of the interviewed administrators were satisfied with the accomplishedresults, most of them considered the financial return simply mediocre Venkatesan (1992)reported in his academic research that he did not understand why American companies dedicatedtheir scarce resources to develop and produce commodities that do not add value to the endcustomer

In short, some organizations end up adopting structures integrated vertically when theycould build much more efficient modular supply networks, and others look for developingsuppliers in competences that should never be abandoned This denotes that executives domanage to clearly distinguish essential competences from outlying competences In addition, theclassic models, especially developed with such goal, seem to drive to mistaken decisions

Understanding the organizational change

To help the discussion it is interesting firstly to understand the process of OrganizationalTransformation itself, both in the organizational dimension and in the supply chain dimension, inother words, to understand: (a) why do organizations change and how do organizations change(b) why do supply chains change and how do supply chains change

In early years, when we did not speak about large mergers and scope of uncertainties wasmore controllable one believed that the change followed a prescriptive process of seismicvariation: you unfreeze, change, and freeze again In the new competitive context, so complexand dynamic, the organizations seem more in punctuated balance, a slightly manageable chaoticstate

“A satisfactory metaphor to understand the change process is the simple fall of a drop of water

in a lake; when the entire surface spreads a wide movement of circular waves We only have the control of the process to the moment of the drop, later it is non-lineal pure physics In that context, the key is to understand the studied phenomenon: To be drop is to promote the change,

to be a wave is to be changed All the phenomena like to think that they are drops, but this is not always possible” (Caldas in Caldas and Wood: 1999)

The “Make-Buy Decision Process” can be understood as a water drop pertaining to theorganizational transformation process The executives control the process to the moment thedecision is made up, later a complex dependence occurs and is spread in time

“The decisions on the provisioning determine, partly, the location of the seed and its subsequent growth – if the competence will develop into a full competence When the seed begins to germinate, the company that planted it is not always capable to control its development” Fine: 1998:163).

Why do organizations change and how do organizations change?

Among the academics that study organizational transformation, the authors Tushman andRomanelli (1985) are one of the major references They propose that the organization lives a longperiod of stability, referred to as convergence, which is punctuated by short periods of radical

changes, referred to as reorientation The types of change vary according to the period or context

in which the organization is found (Figure 3)

Convergence is a long period characterized by incremental changes and adaptations Theeffective concern is with efficiency (make the things right) and alignment with strategicguidance In this period, executives want the continuous improvement of already developedcompetences

Reorientation is a short period characterized by radical strategic changes, redistribution ofpower, structures, and systems The effective concern is the effectiveness (make the right things)and a new strategic alignment In this period, the executives want to develop new competencesand to focus in making different things

Some recent news published in the business media exemplify such organizational changes

in reorientation periods:

Source: Adapted from Tushman and Romanelly (1985)

Figure 3: Punctuated Balance Thesis

“The Brazilian Xerox, traditional manufacturer of copying machines, after almost two decades

of fierce Japanese competition, is reorienting its business It wants to unlink its image from the copying machines and to be recognized as a solution provider in the area of corporate services The goal is to transform Xerox into a digital company in the next years This is not a simple change, it means mass dismissals and closing up branches To enter the digital world, Xerox tries to reinvent itself (Maira da Costa: Exame 05/05/1999)

“Dupont, an American multinational company, was born in 1802 starting from a gunpowder factory in the state of Delaware, in the United States Along the century, it was responsible for some achievements of the world petrochemical industry In 1926, it introduced the impermeable cellophane, in 1931 it created the rubber neoprene, in 1938, the Teflon, and in the sixties, the Lycra However, in the last years it left chemistry aside chemistry and started to invest heavily in biology and biotechnology, looking for the focus on meeting the great world lacks, concerning both nutrition and health The company decided to change when it was at the peak of success; it decided to invest exclusively in the so-called “Life Sciences” (Luís Nassif: Estado de São Paulo 05/01/2000)

Why do supply chains change and how do supply chains change?

In Clockspeed, Charles Fine (1998) is based on a decade of research in Sloan SchoolManagement to introduce the concept of evolutionary speed, essential for understanding thedynamics of a supply chain According to the author, each productive sector has its ownevolutionary life cycle (clockspeed) measured by the speed in which new products processes andorganizational structures (table 2) are being introduced The computer microprocessor industryhas a high evolutionary speed when compared with the automobile industry or with the

manufacturers of commercial aircrafts A personal computer has less than six-month service life,while an automobile has a service life of four to six years.

Table 2: Mensuration of evolutionary speed – sector sample

OrganizationHigh

Medium Bicycle Automobiles 4-6 years4-6 years 20-25 years10-15 years 5-10 years4-6 years

Pharmaceutical Products 7-15 years 5-10 years 10-20 yearsLow

Commercial aircrafts 10-20 years 20-30 years 5-30 years

Source: Fine (1998: 238)

The main verification consequence of this phenomenon is keeping apart the concept ofcompetitive sustainable advantage, proposed by Michael Porter (1996) The faster the sector’sevolutionary speed becomes, the more temporary the competitive advantage becomes According

to Fine (1998), the company needs to learn to concentrate directly in two groups of priorities: 1)explore the current capacities and competitive advantages and 2) build new capacities in aconscious and deliberate way for the unavoidable moment in which the old ones no longerconstitute a competitive advantage source The organization needs to have the ability to develop aseries of temporary competences

Through examining historical evolution, mutation, survival, and extinction of entities indifferent markets, Fine presents the double helix sectorial model, an infinite double cycle, whichexplains changes in supply chains This model consists of a cyclical movement betweenvertically integrated sectors, made up of horizontally disintegrated gigantic companies andsectors, made up by a crowd of innovators, each looking for an own niche, in the wide spaceresulting from the previous extinction of giants (Fine, 1998)