ECONOMICS OF INDUSTRY Companies of firms in the same industry are bound to fall along the same vertical chain, this is the chain wherein some bit of value is being added to the product at each step. Vertical integration means the firm has complete control over its inputs, production and outputs along the value chain. The different firms only differ in terms as in how many links are present in their vertical chain. Adopting vertical integration for a firms means reduction of transportation costs as common ownership means closer geographical areas, the supply chain is more coordinated, barriers to entry are there making it hard for new firms to enter the market, core competency is expanded and access to uneasy distribution channels is gained.

I think it can be in a firms interest to outsource its components from competitors rather than producing in-house because (Make Vs Buy Decision) this way the firms can gain economies of scale which is a good amount of saving in costs gained by the increased level of production (the firm being a supplier) whereas in-house production doesn’t gain much economies of scale as the demand would be little. The firm becomes obedient and efficient as they must follow the rules and efficiency as is in the entire market. Buying from the market improves flexibility but some disadvantages of the buy decision are the search costs, incomplete contracting which is transaction costs- under the contracts between parties only certain remedies are covered in case of unknown or unforeseen changes. That contract automatically becomes invalid, they must look into other measures resulting into additional contracting costs. For example, suppose a computer manufacturing firm has to deliver 50 computers to a retailer and they have a contract between themselves but the company is not sure whether they should install Windows in the computers or not as the producer probably would try and cut costs, this wasn’t clearly put in the contract therefore results as being vague. At times one of the parties from the market is more well-informed then the others which gives them undue advantage.

The costs associated with the buy decision is the dependency on certain suppliers or distributors holds the risk of compromising on the vertical supply chain when the firm is unable to carry out the supply activity, private information of the firm can be leaked out to upcoming or existing competitors, the transaction costs increases between the firms. Basically meaning that the firm loses much control over the actions taken. Major advantages of outsourcing is that the firm can plan their budget completely as there is so little risk and they usually have a set price to buy at; the costs are comparatively lower than in-house production but the prices can highly vary; training, technology and even product expiration or out-of-date costs are all absorbed by the vendors in between, there is a set standard for the products they produce as quality is certain. In-house production also holds some advantages and disadvantages, like independence within the firm related to deadlines, less capital spent on logistics instead spent on employee enhancement and training, shorter communication runs and the opportunity to gain market suppliers and firms know-how basically larger expertise, need of direct control over product, untrustworthy suppliers, the want to expand in manufacturing area, and volume too small for supplier to produce are some of the advantages whereas some disadvantages would be that specialized knowledge is needed, a lot of preplanning has to be done related to budgeting, resource planning, warehousing etc. Agency and influence costs come along with in-house production, agency costs are when the ideas, information possessed or motive aren’t the same of the principal and agent, the basic slacking of an employee leading to deterioration of a firm and influence costs are influential activities which take place within a firm, large firms are more likely to suffer these costs.
For example if we look at a firm which needs to produce 20 units of its product in 10 regular periods, they can either purchase it at 200 per unit or end up spending thousands on machinery and production equipment and produce at 18 per unit, its clear they incur more expenses producing in-house; to produce in-house is long term planning and action whereas the price at which a firm purchases a product is the final price they pay in total for that product.
Some firms may not have a strong management to handle the production department, their experience in that area is not sufficient enough or past performances were poor.

Also related to the Make Vs Buy decision is core competency is whether the firm is better and out performs the rivals. Before a firm can even decide whether to make or buy they must identify their own set of skills and what would be more beneficial for them.

Now after analysing all the above factors it does seem that in-house production is cheaper but the quality they can purchase their products from their suppliers can be of their choice and better. Also the firm would want to maintain good supplier relationships and to purchase products from them would keep it healthy and initiated. No business organization should take the hassle of making something on their own when they can buy it from outside at a cheaper price. A firm should just always remember to follow a proper process while making the Make or Buy decision and decide whats best for the company as a whole.

Some examples of firms in the Make or Buy Decision are:

IBM literally produce all their components and softwares components for their mainframe computers, whereas Dell Computers outsources all of its hardware and software components and direct sale is made to their end users through mediums like websites.
The sports company Reebok only outsources and buys all their products from market suppliers making them fully dependent, they own no production houses themselves.
Hermès the International Watch Company recently decided to get its watch cases from SWISS watch case-maker. "We wanted to secure our future supply of strategic components," says Luc Perramond, chief executive of La Montre Hermès, Hermès's watchmaking division.

REFERENCES

http://faculty.babson.edu/gwin/indstudy/ (as accessed on 12/2/2013)

http://web.missouri.edu/~kleinp/papers/KI140-17-433-464--KLEIN-x.pdf (as accessed on 12/2/2013)

http://www.atkearney.com/documents/10192/71569ecf-c266-484b-91a8-3385885d5e4e (as accessed on 12/2/2013)

Anderson, Erin. 1985. “The Salesperson as Outside Agent or Employee: A Transaction Cost Analysis,” Marketing Science 4, pp. 234–54

M. F. Corbett: ˝The Outsourcing Revolution: Why it makes sense and how to do it right˝, Dearborn Trade Publishing, Chicago, 2004

M. J. Power, K. Desouza, C. Bonifazi: “The Outsourcing Handbook: How to Implement a Successful Outsourcing Process”, Kogan Page Limited, London, 2006