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

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 de Julho 2029 10 andar, E-mail: ZIPCode 01313-902, Brazil msampaio@fgvsp.br Phone: (5511) 3281 7776 Fax: (5511) 3262 3682 Name: Luiz Carlos Di Serio Institution: EAESP/FGV - Operation and Logistics Department Address: Av de Julho 2029 10 andar, E-mail: ZIPCode 01313-902, Brazil ldiserio@fgvsp.br Phone: (5511) 3281 7776 Fax: (5511) 3262 3682 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 concerning some production sectors Once we have the sector integrated vertically, made up by large dominant companies, once the same sector is disintegrated horizontally, made up by a crowd of companies acting in market niches In this highly competitive environment, the domain of essential competences, with larger added value, is decisive for any organization survival This article intends to facilitate the understanding of the subject, analyzing the evolution of traditional decision models – make-buy - and evaluating their adaptation to the economy sectors in high evolutionary speed Key-Words Supply Chain Design, Supply Chain Management, Make-Buy Decision Process, and Outsourcing Strategy Introduction In the last years, supply chain architecture has undergone important changes Some organizations are rethinking their borders, changing their competences and/or modifying the relationship form with their suppliers and dealers, giving to such evolution the characteristic and connotation of a true revolution The truck and bus manufacturing plant of Volkswagen in Resende-RJ is a classic example 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 exclusively upon the car manufacturer Volkswagen undertakes new competences, now being responsible for the 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 its suppliers, in its future factory in Camaỗari-BA There is seemingly a tendency that the new units work less and less with the production of their own automobiles They see each other as future marketing and sales organizations, developing new products and controlling the whole supply chain 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 frantic search for new competences even being so distant to upstream or downstream from its traditional business? 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 and Prahalad (1990, 1994), Quinn and Himer (1994, 1999), Venkatesan (1992) among others, concentrate on evaluating advantages and obstacles regarding process outsourcing for a specific entity They are models that guide an organization to select and develop internally only competences with higher value added to customers, thus aiming at conquering a sustainable competitive advantage Nevertheless, will these prescriptive models still be appropriate in a highly competitive environment? Increasing competitiveness, competition has been ceasing to be among companies to take place among supply chains (Vollmann and Cordon, 1996), as shows Figure An isolated company no longer survives, as it needs to be integrated with its customers and suppliers It is useless that a manufacturer adopts the best practices, if its suppliers are expensive and/or their distribution channels are inefficient taking care of customers’ expectations Figure 1: Competition Among Supply Chains Suppliers Manufacturers Dealers Retailers Consumers Source: Adapted from VOLLMANN and CORDON, 1996 In this new competitive context there is little understanding regarding outsourcing impact over an outsourcing decision concerning supply chain and/or industry This work intends to contribute for the debate on this theme, filling out this literature gap Summarizing, the article will aim at answering the following research question: To what extent are the classic decision models “What to Make, What to Buy” appropriate in a dynamic and 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 the third part The fourth reviews some models of organizational change The fifth submits a dynamic model The sixth makes a critical analysis concerning submitted models The seventh classifies such models The eighth submits final considerations The last part reports limitations regarding work and gaps Make-buy decision process Models Modeling the make-buy decision process is a great relevance theme between academics and executives A representative volume of work has dealt with the matter, such as publications in: 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 decision process 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 of relevant costing However, the final decision cannot be that simple, it should include other considerations 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 in their trade relationships Those risks refer to the possibility that the elements accorded between the parties 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) Quinn and Himer (1994, 1999) and Venkatesan (1992) proposed other models, considering Strategic School principles Porter (85) focuses the selection of strategic positions on the business seeking the conquest of maintainable competitive advantages Now, the authors Hamel and Prahalad believe that competitive advantage derives from capacities deeply rooted that are behind the products of a company (Mintzberg, Ahlstrand, and Lampel, 2000: 163) This approach consists of focusing 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 capacities pursuant two criteria: strategic importance and relative competence in the market, according to Figure 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 other words, to increase its value noted by the customer The analysis of relative competence is carried out 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 the organization 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 and Himer (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 or finances 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 on knowledge • 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 that should 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 in intellectual 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, a company can identify the activities capable of providing at the customer, larger effectiveness, 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 and even destroy its success When a strategy depends strongly on creativity, dedication, initiative, and excellent professionals' attraction, the core competences should be aligned with the company’s systems, which include their values, organizational structure, and management system There are cases where this people development system becomes the core organization competence Other authors (Londasle, 1999; Anderson, Probert and Jones, Gregory mentioned by Gutwald, 1995) elaborated another category for outsourcing models referred to as multidimensional that considers other factors as: Allocating expenses, innovation skill, human factors, employees' experiences, technological maturity, costs, among others That brief bibliographical revision demonstrates that a lot has been written on the theme, from financial 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 associate critics to each of the submitted perspectives, according to Table 1, generating the following questions: 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 essential capacities for their future? Table 1: The classic Make-Buy models and their main critics Models Origin Focus Specific Critics Economical Analysis Transaction Cost Analysis Finances Economy Cost Transaction Ignores the Disregards existence of intangible and hidden costs, such strategic assets as transaction cost in economic equations He/she ignores the presence of Considers that Opportunist supply chains Suppliers are built for cost reduction Strategic Analysis Multidimensional Analysis Administration Strategy Does not preserve the knowledge of an outsourcing activity Transdisciplinary Plural The presuppositions are the same as those of the previous models Assumes that current competences will The critics are be the same as diluted, but they future remain competences STATIC MARKET VISION General They consider that the companies look for eternal sustainable competitive Critics advantages (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 by outlying 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 Some companies almost lost the essential capacities for its business future As example, we have the classic IBM case study that practically gave the leashes of computer industry to Microsoft and Intel (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 accomplished results, most of them considered the financial return simply mediocre Venkatesan (1992) reported in his academic research that he did not understand why American companies dedicated their scarce resources to develop and produce commodities that not add value to the end customer In short, some organizations end up adopting structures integrated vertically when they could build much more efficient modular supply networks, and others look for developing suppliers in competences that should never be abandoned This denotes that executives manage to clearly distinguish essential competences from outlying competences In addition, the classic 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 Organizational Transformation itself, both in the organizational dimension and in the supply chain dimension, in other words, to understand: (a) why organizations change and how organizations change (b) why supply chains change and how supply chains change 10 Table 2: Mensuration of evolutionary speed – sector sample Evolutionary speed Sector Product technology Computers < months High Toys < year Semiconductor 1-2 years Bicycle 4-6 years Medium Automobiles 4-6 years Pharmaceutical Products 7-15 years Commercial aircrafts 10-20 years Low Petrochemical 10-20 years Electricity 100 years Source: Fine (1998: 238) Product technology 2-4 years 5-15 years 3-10 years 20-25 years 10-15 years 5-10 years 20-30 years 20-40 years 50-75 years Organization 2-4 years 5-15 years 2-3 years 5-10 years 4-6 years 10-20 years 5-30 years 20-40 years 20-30 years The main verification consequence of this phenomenon is keeping apart the concept of competitive sustainable advantage, proposed by Michael Porter (1996) The faster the sector’s evolutionary 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 a conscious and deliberate way for the unavoidable moment in which the old ones no longer constitute a competitive advantage source The organization needs to have the ability to develop a series of temporary competences Through examining historical evolution, mutation, survival, and extinction of entities in different markets, Fine presents the double helix sectorial model, an infinite double cycle, which explains changes in supply chains This model consists of a cyclical movement between vertically integrated sectors, made up of horizontally disintegrated gigantic companies and sectors, made up by a crowd of innovators, each looking for an own niche, in the wide space resulting from the previous extinction of giants (Fine, 1998) 14 According to the author, when the sectors’ structure is vertical and the product architecture is full, as is the case of IBM in the eighties, the forces that act toward the horizontal and modular configuration are: • The implacable entrance of niche competitors, that hope to conquer different sectorial segments • The challenge to maintain the position ahead of the competition in the several dimensions of technology and markets • The bureaucratic and organizational inflexibility that are usually settled in large and suitable companies On the other hand, when the sector has a horizontal structure, as it is the case of the entertainment market in the year 2000, another group of forces impels it toward vertical integration and integrated product architecture Such forces include: • The technical progresses in a subsystem, capable of transforming it in scarce goods of the chain and that grant market power to its holder • The market power in a subsystem, which encourages bundling with other subsystems, in such a way to increase control and to add more value • The market power in a subsystem, which stimulates the integration of engineering with other subsystems, in such way to develop integrated patented solutions Figure illustrates the double helix model, an important tool for business diagnosis Before designing its supply chain, the company should identify the future business tendency and 15 try to anticipate abrupt market movements The business secret consists of always choosing the right core competence Figura 4: Double Helix Model Source: Fine (1998: 58) Systemic vision of change The submitted models, concerning the punctuated balance of Tushuman and Romanelli and Double Helix of Charles Fine, have different analysis perspectives The first approaches the process of changes in isolated organizations, identifying long convergence periods punctuated by short reorientation periods The second model approaches the dynamics of supply network, which moves among vertically integrated sectors and horizontally disintegrated sectors However, this article presupposes that both models, each one under its respective perspective, illustrates the same phenomenon - “the competence development process dynamics”, 16 according to Figure The convergence and reorientation periods arise from supply chain dynamics itself Reorientation periods correspond to the inversion times of the Double Helix curve, which are: • Moments when it is necessary to abandon known and dominated traditional competences, and to develop new abilities, the whole sector is probably dissolving or; • Times when it is necessary to increase the number of competences, maintaining the already developed previous ones, the whole sector is being disintegrated vertically Convergence periods correspond to the development of already settled competences Figura 5: Double Helix Model and Punctuated Balance model Source: Adapted by the authors from Tushman / Romanelli and Fine 17 Continuous Evolution Market In dynamic markets the best strategy for a company does not necessarily consist of making an effort for a condition of stability, as the positioning strategy proposed by Porter (1996), but in learning to move with fluency and safety in turbulent times, even having to assign to an external supplier a considered competence until such essential date Instead of pursuing the essential capacities as something unchangeable, it is necessary to face its duration consequently arising from the sector’s evolutionary speed or the relevant technology Fine (1998) submits two important tools to aid in the Make-Buy Process decision making in continuous evolution markets: Model based on engineering concepts: The outsourcing process can occur in different phases of a development and manufacturing process (Figure 6) When competent suppliers exist, the importance of designing and/or producing such subsystems internally is diluted Even so, Fine (1998) recommends preserving knowledge architecture: technical memory of outsourcing capacity and permanent control of its performance Toyota is a reference in such development process and capacity use, although it has several outsourcing capacities, the company preserves the technological leadership of all capacities that it considers critical in its supply chain 18 Figure 6: Framewor for “Make-Buy” Decision Process based on engineering concepts Source: Fine (1996) Matrix for: “Make-Buy” decision analysis: It illustrates the way in which the product’s architecture and the outsourcing strategies interact (Figure 7) When a product has a modular architecture, in other words, it has interchangeable components, it is usually possible to unfold it in outsourcing subsystems and modules However, that is not always the best strategic alternative See the case of IBM, in the beginning of the decade of 80, it outsourced the main components of its personal computer: Operating system for Microsoft and microprocessor for Intel, triggering a drastic power change in that market segment The whole sector moved from a vertical integrated structure to a horizontal modular structure When the product’s architecture is integrated, that is, when one same component executes more than one function, the outsourcing challenge is higher, 19 because it is necessary to maintain an intense communication and interaction process among the several subsystems’ development teams Figura 7: Matrix for: “ Make-Buy” decision analysis Source: Fine (1998:173) Such matrix makes it possible to classify all subsystem components of a certain product, according to the degree of strategic importance and outsourcing possibility, considering the evolutionary speed of their respective components Critical Analysis of Make-Buy Decision Process Models The classic Make-Buy decision process models are frequently used in different markets Business leaders are encouraged to subcontract everything possible, from manufacturing activities, engineering and even administrative activities, under the presupposition that the bureaucracy is bad and flexibility is good (Chesbrough and Teece, 1996) However, such 20 arbitrary practice may be disastrous, taking the organization to lose capacities that are essential for its future The own alternatives suggested: to make, to develop internally or to buy, to develop externally, not take into account the complexity of relationships noted in practice and disrespect the natural dynamics of supply networks The concept of integrated versus modular supply chains proposed by Fine (1998) seems to provide a much more fertile and profitable referential for the subjects regarding the supply chain project This is not a simple semantic change, old paradigms and administrative practices can be insufficient to work with that new configuration, “”It is impossible to judge ideas of a new paradigm analyzing under the prism of an old paradigm” (Csillag, J M quoted by Corbett, 1997: p.3) This article suggests that the classic models are inadequate in high evolutionary speed markets, for not considering the dynamics of supply chains itself Nevertheless, the problem can be still even wider: (a) the evolutionary speed of many sectors should increase progressively in the next years; (b) In a close future, network strategies should be feasible; (c) competition increasingly fierce A lot of management policies and practices now effective lose sense in this new hyper-competitive environment This question is maybe only the tip of a true iceberg Classifying Make-Buy Decision Process Models The authors Van de Ven and Poole (1989) consider that interaction among different perspectives takes to a better understanding of organizational life, any individual perspective invariably will entail in a partial vision for the studied phenomenon Make-Buy Decision Process models can also follow such principle, the use of a single model can take to erroneous and visionary decision making A classification proposed for Make21 Buy Decision Process models described in this article can be accomplished considering two fundamental dimensions (Figure 8): • Evolutionary speed of market: Considers the evolutionary cycle of a certain sector, which can be measured by the speed with which it introduces new products, processes, and organizational structures Evolutionary speed affects decision process and supply chain architecture, varying from low to high-speed • Involved Criteria: The models can approach or not strategic business aspects Some models emphasize the exclusive reduction of costs, others consider that the organization should develop competences for higher added value, regardless of the investments required to achieve it Figure 8: Classification of Make-Buy Models 22 According to the classification of Make-buy decision process models, only the model of Fine (1998) would be recommended for evolutionary high-speed sectors such as personal computers, semiconductors, toys, shoes and cosmetics, because it considers market’s dynamics The models based on economic and financial concepts would be suitable for low evolutionary speed sectors, as some agricultural and mineral extraction sectors that compete in costs Strategic models may be used by evolutionary low-speed and competitive sectors in differentiation The combination of different perspectives could be used in average evolutionary speed sectors That classification of make-buy decision process models also brings an alert to entrepreneurs: It is dangerous to think exclusively of costs in high evolutionary speed sectors Final Considerations This article /aimed at answering the following research question: To what extent are the classic decision models “What to Make, What to Buy” appropriate in a dynamic and complex environment? For answering such question, the article analyzed the classical Make-Buy Decision Process models: Economical analysis, transaction cost analysis, strategic analysis, and multidimensional analysis Such models seemingly consist of multifaceted perspectives arising from different schools of knowledge: Financial management, economy, business strategy, among others; however, they neither seem to illustrate all complexity regarding the studied phenomenon, nor the approach seems to be broad enough for systemic inferences To enrich the discussion under different perspectives, the article tried to understand the process of organizational transformation itself, both the organizational dimension and the supply chain dimension It briefly reviewed the Punctuated Balance Model of Tushuman shortly & 23 Romanelli and the Double Helix Model of Charles Fine The dimension and analysis points of view were compared and analyzed The article presupposes that the submitted models approach the same phenomenon according to different perspectives The first one studies organizational transformation under the organization’s optics, identifying convergence and reorientation periods The second studies the dynamics for supply networks under the optics of the sector’s historical evolution, identifying the cyclical formation of integrated vertical structures and horizontal modular structures As no classical model considered the possibility for a supply network dynamics in the temporary dimension, the article submits a new perspective describing the dynamic model proposed by Fine (1998) As contribution, the article classifies the Make-Buy Decision Process models submitted in two dimensions: Evolutionary speed of sector and involved criteria In short, the article’s main conclusions can be synthesized, as follows: The classical Make-Buy decision process models are inadequate in continuous evolution markets The Make-Buy dichotomy itself seems inadequate when competition stops being among companies to take place among productive chains The concept of integrated versus modular supply chains proposed by Fine (1998) seems to provide a much more fertile and profitable referential for the subjects regarding supply chain project The maintainable competitive advantage is a concept arising from low evolutionary speed markets The temporary advantage is the predominant concept in high evolutionary speed markets The faster is the evolutionary speed of a sector, the less the competitive advantage lasts The business secret consists of always choosing the right core competence It is dangerous to think exclusively of costs in the high evolutionary speed markets 24 Limitations and Directions for Future Researches This article was based on personal observation and academic speculation; it aimed at integrating the knowledge concerning the following knowledge areas: Supply Network Management and Organizational Transformation The main work’s limitation is the lack of an exploratory or quantitative study on the studied phenomenon Even so, many research - guidelines are open from this academic article, involving both theoretical and empiric aspects If the supply chain project is the most important competence of an organization, as this article defended, it seems obvious that a deeper and more compressive investigation regarding the subject becomes necessary Just like genetic scientists that study the fruit flies for achieving new “insights” on the evolutionary trail of animals and human beings (Fine, 1998), studying the dynamics of highspeed sectors, such as Internet, personal computers and entertainment sectors can provide new perceptions on how options in the supply chain project may affect the organization’s performance The study may also provide true lessons for the other sectors, such as automobile, and commercial aviation, among others To such an extent, the recommended future research could be: Elaborate a more comprehensive model for supply chain project This model may consist of two parts: First part to determine solid criteria for the Make-Buy Decision Process The second part, to set up the more appropriate relationship type between supply network components Elaborate a more comprehensive model for specifying the core competences of an organization, even temporarily, considering factors, such as: Supply network dynamics, competitiveness model, customer requirements, and inducers of evolutionary speed for products, processes, and organization 25 Empiric study to discover, in different sectors, how Brazilian companies decide which competences are core and which are outlying, both for product and infrastructure Studying the evolutionary life cycle (CLOCKSPEED) of industry sectors, seeking to validate the Double Helix model in a developing country like Brazil 26 Bibliographical References CALDAS, M.P e WOOD JR., T Transformaỗóo e a realidade organizacional: uma perspectiva Brasileira Editora Atlas, 1999 CHESBROUGH, H.W.; TEECE D.J “When is virtual virtuous? 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