a firm must decide whether to make a component parts in-house or to contract it

Question

a firm must decide whether to make a component parts in-house or to contract it out to an independent supplier. Manufacturing the part requires a nonrecoverable investment in specialized assets. The most efficient suppliers are located in countries with currencies that many foreign exchange analyst expect to appreciate substantially over the next decade. What are the pros and cons of (a) manufacturing the component in-house and (b) outsourcing manufacturing to an independent supplier? Which option would you recommend? Why?

Explanation / Answer

Manufacturing in-house would reduce the risk of currency appreciation and rising costs from independent suppliers. Specialized asset investment would make firm dependent on specific suppliers, however, technological know-how would be protected, and improved scheduling would be available.  Out-sourcing would be beneficial if the product using the component fails in the market because the supplier will bear the cost of the non-recoverable investment, and flexibility in case a better component can be designed or bought would be preserved.  Outsourcing would also lower organizational and coordination costs. Based on what we know, manufacturing in house may be slightly preferred, but other information could tip the decision the other way.

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