Make it or buy it? This strategic decision remains notoriously difficult for businesses. Sustained value creation requires the constant expansion and modification of a firm, and many of the assets and activities connected to its corporate theory belong to others. So to compose the value that your theory reveals demands you make sound decisions about when to acquire, configure, and own these assets (make) versus when to contract for their outputs (buy).
Vocal advocates, both in and out of a firm, will argue for both paths. Open innovation gurus and outsourcing firms preach the near-universal virtue of outsourcing. Many voices within firms call for integration. All too often, our own intuition regarding make or buy decisions is terribly misguided.
We integrate only to discover we should have outsourced and outsource only to discover we should have integrated. We see great value in keeping control of our assets and processes through integration, convinced we can outperform our suppliers, only to discover our internal efforts are high-cost or low quality.
We see integration as an opportunity to capture suppliers’ profits, only to discover that its price tag far exceeds its value. On the other hand, when we resist the temptation to integrate, we find that we have become massively dependent on a unique asset we don’t possess and now pay dearly to access.
The wrong decisions can generate lost value of historically disastrous proportions. For example, 40 years ago, the Saturday Evening Post‘s demise was labeled “the greatest corporate disaster in American history.” At its peak, the Post captured 30 percent of all magazine advertising in the United States. It’s failure’s proximate cause was a set of disastrous integration decisions.
The CEO of the parent company, Curtis Publishing was enamored of the control afforded by vertical integration, and he pursued it with a passion. He authorized the construction of a massive, state-of-the-art printing facility. He purchased three large paper mills to feed the presses. He acquired 262,000 acres of timberland to feed the mills. The firm also forward-integrated into circulation.
The result was catastrophic. Internal assets quickly atrophied in cost performance or quality, and the publisher collapsed.
How do you avoid making a similar mistake? Assuming that a theory revealed a clear idea of the assets and activities you want to combine and configure, doing this effectively requires decisions about what types of incentives are required for the people and organizations involved.
Fundamentally, you must choose between two competing incentive systems, each with distinct advantages and disadvantages in the behaviors they motivate. Naturally, the best-case scenario is you can successfully minimize the inherent trade-offs in choosing one or the other and instead enjoy the “best of both worlds.” But these trade-offs do exist and this difficult choice between outsourcing and integrating remains. Understanding the precise nature of the trade-offs inherent in each is critical for anyone who wishes to create and capture the value envisioned in their theory.
We must also remember that make or buy decisions are not mere items on a checklist — once done, we never revisit. Instead, these decisions need frequent review and recognition that a decision to switch is not a signal of failure. Rather, it reflects the passage of time and a growing imbalance in the advantages and disadvantages of the original choice.
This excerpt comes from Beyond Competitive Advantage. Published June 14, 2016, by Harvard Business Review, enter your email below to download the first chapter.