The benefits of vertical integration for a company that involves the company owning virtually every aspect of their entire supply chain can be very effective. Apple, Inc. is currently probably the best example of a vertically integrated company. However, even Apple, as successful as they are, outsources or partners with many other companies in a number of key areas. Few companies in any sector can duplicate Apple’s success in vertical integration. The reason is simple; other companies that specialize in a particular area most often can provide goods and services faster, better, and cheaper. With their dedication to their focused activities, they generally can drive far higher volumes which makes them more efficient and allows them to spread their fixed costs over a larger base. One all too common example is a startup company spending time on building a web site when there are hundreds of companies that focus on this particular activity and can probably do it better and faster.
Unfortunately, many organizations within a company fall into the trap of believing that we can do it better ourselves. The best example of this mindset is development organizations that insist on developing certain aspects of a product in-house rather than outsourcing or integrating commercial, off-the-shelf (COTS) hardware or software products. However, this notion appears in many other organizations as well. For example, a direct channel sales organization is often reluctant to engage an indirect channel, or a marketing organization is reluctant to outsource public relations, web design, SEO, or other activities to firms that specialize in those areas. Financial, manufacturing, purchasing, information technology, and customer service organizations can easily follow the same rationalization. The article in this series “The Could Versus Should Trap” describes this phenomenon.
To be fair, there may be valid reasons for individual organizations to take on new challenges or extend their current operations to address the new requirements. However, that decision must be made objectively with the costs, timing, and risks carefully considered. A particular organization may have difficulty in reaching an objective “make or buy” decision. Historically, strategy groups have drawn a line for their activities and have left the tactical decisions on how to implement their strategies up to the various operational groups. Unfortunately, if implementations do not proceed as planned, the blame is assigned to the lack of execution within the various operational elements. This approach may help strategy groups rationalize the failure, but it does not help the company. Instead, strategy groups should challenge every operational group or function to carefully make “match versus build” decisions. The process is remarkably simple. It consists of asking two questions.
- Who besides our internal resources could provide these goods and services that could meet our needs?
- As we weigh the in-source versus outsource alternatives, are we truly examining all of the actual costs and the opportunity costs in terms of dollars, time, and risk to arrive at an objective decision?
The key consideration in the second question is the focus on the opportunity costs. That is, if the task is performed in-house, what other tasks will be postponed or neglected? Many startups and smaller companies fall into the “We’ll do it ourselves to save money” trap. In most cases, they do not realize that their time is a far more precious resource than the actual dollars they are trying to save by not outsourcing. Some common examples include:
- Internally developing and managing the company’s web site.
- Developing custom hardware versus off-the-shelf hardware.
- Stocking, configuring, and shipping products versus using a large logistics supplier.
- Processing payroll, benefits, and other human resource related activities.
- Performing all finance related functions in-house.
- Developing custom CRM, sales, and other support systems versus using readily available online services.
In the last few years, the shared resource or fractional specialist business model has grown significantly making the outsourcing of these activities to specialists commonplace. Capabilities have moved well past contract manufacturing to include part-time or fractional CFOs, H/R departments, product design houses, and even fractional CEOs.
To change an organization’s mindset regarding the build or buy question, strategy organizations should begin the dialogue by asking what external resources could perform this function. Only if the function involves the company competence which should never be outsourced or if no outside alternative truly exists, should internal resources be applied. Invariably, this will not be a popular approach within the organization but needs to be followed to help ensure the optimum use of resources. Match your needs with those who are best suited to meet them.