How to Make Design vs Buy Decisions

By Michael Chase. This page is available under the Creative Commons Attribution License

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Your product performs its function better than any other. You’ve invested heavily in your differentiating technology and hired the brightest PhDs to stay one step ahead of the competition. Premium pricing and commanding market share have been your reward.

Before your system goes out the door, it gets married up with third-party data packages, accessories, controllers, vacuum pumps, vision systems, etc., to create the whole product that customers buy. By leveraging all this third-party content, you’ve been able to out-innovate the competition on the things that matter most and hold your position as the market leader.

But this strategy has come at a price.

Passing all that third-party content through your P&L has made it impossible to achieve the high gross margins that management expects.

What should you do?

Gross Margin vs. R&D Needs

Management expects high gross margins from capital equipment companies. This expectation is rooted in the assumption that it takes a lot of R&D to create these complex machines. Staying competitive means a lot of money must flow from gross margin to R&D and still leave a healthy profit on the bottom line.

But for each third-party component in your system, the R&D comes from your supplier. You don’t need margin dollars to fund R&D for these components. The trade-off, however, is that cost of goods for this third-party content is often higher than if you designed manufactured it yourself. See the figure below.

Chart showing relationships between R&D expense, gross margin, and 3rd party content
Chart showing relationships between R&D expense, gross margin, and 3rd party content

The Design Vs. Buy Decision

So, the question becomes when should you design a component yourself, and when should you source it from a third party? Before making this trade-off decision, you must define the specific subset of your market’s buying criteria on which you intend to compete. This subset represents your competitive strategy and will guide your design versus buy decisions.

Choose design if:

  • A component directly contributes to the differentiation that enables your competitive strategy, or
  • A component is not readily available from third parties.

For all other components, seek third-party suppliers. A make-versus-buy-decision made this way produces a lean R&D organization capable of rapid innovation that will keep you ahead of the competition.

What About Gross Margin Expectations?

Making design-verses-buy decisions with the method described above optimizes your business for competitiveness. Doing so puts you on a path to the leading market share and profitability management wants. To secure management’s support, you’ll need to explain

  • Your make-versus-buy decisions,
  • How your approach will lead to higher growth, profit, and market share than those who have chosen a different path, and
  • What they should be looking for as evidence that your strategy is working.

If your strategy indeed generates sustainable competitive advantage, top-line growth, and bottom-line profit, it will resonate with your management.