The Make-or-Buy Question in Mature Industries

The make-or-buy question has confounded many executives. To wit, when should a company rely on itself to manufacture or provide certain parts, products or services, and when should it instead purchase them from outside sources? This issue of vertical integration has long been the topic of considerable debate, especially for mature markets like automotive, which leads to a second, related question: How can companies stay competitive when their industry is moving offshore to regions of cheaper labor?

Both subjects were recently investigated by Filipe Santos, assistant professor of entrepreneurship at INSEAD in Paris, Ana Abrunhosa of the faculty of economics at the Universidade de Coimbra and Inês Costa with the Center for Innovation, Technology and Policy Research IN+ at the Instituto Superior Técnico in Lisbon. The researchers studied developments in the Portuguese footwear industry during the 15-year period from 1990 to 2005. That global market has been undergoing dramatic changes. On the supply side, manufacturing has been shifting away from developed regions, such as the United States and southern Europe, and toward emerging economies, including China, India and Eastern Europe. Meanwhile, on the demand side, consumers have been increasingly thinking of shoes as a lifestyle purchase instead of a basic item of consumption. (Details of the study are contained in How to Compete in Mature Industries? Boundary Architecture as a Mechanism for Strategic Renewal, which was a finalist for best paper award at the 2006 Strategic Management Society Conference.)

To study how organizations were dealing with those changes, the researchers conducted in-depth case studies of three companies — Basilius, J. Sampaio & Irmão and Investvar — that were roughly comparable in 1995 in terms of size and business activities but then experienced radically different performance trajectories. Basilius had established an excellent strategic position in 1995 but was performing weakly 10 years later. In contrast, J. Sampaio & Irmão was positioned weakly in 1995 but was performing strongly 10 years later. And Investvar was included in the study as an example of an extreme success — a company with a similar starting position in 1995 but considered by industry experts as the best performer from 1995 to 2004.

For the three companies, the researchers looked at the interconnected set of business activities that created value for each organization. That system included not just general processes such as product design, marketing and distribution, but also industry-specific activities such as the cutting and stitching of leather pieces and the production of soles. For each of those activities, the researchers investigated whether the three companies performed it in-house, subcontracted it or did a combination of both, and they also charted any changes in those decisions over time.

Conventional wisdom holds that companies should stick to what they know during tough times, but this study found otherwise. In fact, only Basilius (the low-performing company) followed that approach. J. Sampaio & Irmão and Investvar (the high-performing companies) employed a different strategy. First, instead of concentrating on their core competencies, they entered new activities both upstream and downstream of their current operations. Second, instead of trying to protect their core activities from external pressures, they opened them up to outside markets. Third, instead of trying to couple their internal activities tightly to improve operational efficiencies, they made those business units more modular and autonomous. In summary, both J. Sampaio & Irmão and Investvar increased the scope, permeability and modularity of their value-creating activities.

The researchers assert that those three variables — scope, permeability and modularity — are the crucial factors for success. By judiciously adjusting them over time, a business can remain competitive even as its industry matures. In particular, the researchers argue that greater scope, permeability and modularity enable companies to spot and respond to business opportunities more quickly. J. Sampaio & Irmão, for example, was able to exploit a market niche by becoming a supplier of sample shoe collections for retail chains. Such benefits, the researchers contend, outweigh the coordination costs involved in managing an increased number of activities.

But the results are hardly definitive. For one thing, the study investigated just three companies in a market that has become increasingly fragmented because of varying, specialized customer needs. As the researchers acknowledge, industries that have a more homogenous demand certainly could have starkly different dynamics. And the study did not prove causality, just correlation — that scope, permeability and modularity appear to be tied to high performance. Nevertheless, the research is intriguing because it does suggest that retrenching might not always be the wisest course of action in a mature market. In fact, doing just the opposite could help an organization better withstand the ever-increasing global competitive pressures of an industry that’s moving offshore.

For more information about this research, contact Filipe Santos at Filipe. santos@insead.edu.