Collaboration, competition and strategic costing: knowing when to start learning

Alnoor Bhimani,Mthuli Ncube,Mohamed Azzim Gulamhussen,Pascal Frantz

doi:10.1504/ijaape.2008.020842

Abstract

Many companies confronted with 'make or buy' decisions adopt the mid-way option of engaging in collaborative relationships (CRs) with suppliers rather than in internal production or the purchasing of parts through a process of competitive bidding. Engaging in CRs requires evaluations of when to enter such relationships and when to abandon them. Traditional incremental cost analysis does not readily allow such analysis for the establishment of supplier networks and relationships. This paper develops a real options-based model that focuses on the cost implications of learning curves and timing concerns. It provides an optimal timing valuation approach to establishing/abandoning a CR that incorporates differential learning rate payoffs and that assesses the contingencies embedded in a CR. A standard illustration of the application of the model is provided.

Highlights

The “make-or-buy” option for a firm requiring subcomponents or input material has been extensively discussed in the management accounting literature with particular reference to incremental costing approaches as a decision aid
The costs and benefits accruing to a firm producing required parts or subcomponents internally are weighed against the financial and managerial consequences of outsourcing via competitive bidding (CB) by suppliers of the products (Callioni et al, 2005; Dekker, 2004; Groot and Merchant, 2000; Meer-Kooistra, 1994; Quinn and Hilmer, 1994; Speklé, 2001;Vining and Globerman, 1999)
In this paper we extend the real options approach to take into account the time implications of learning rate cost effects in strategic supplier switch decisions

Summary

INTRODUCTION

The “make-or-buy” option for a firm requiring subcomponents or input material has been extensively discussed in the management accounting literature with particular reference to incremental costing approaches as a decision aid. Prevalent in many facets of managerial decision-making, a real options approach has not been considered in assessing make or buy decisions with learning cost or timing issues as strategic factors in the management accounting literature. It provides an approach to the evaluation of the costs and benefits of the contingencies embedded in CRs. Some scholars have suggested that cost related timing issues affecting managerial decisions should be considered using a real options frame of reference (Amran and Kulatilaka, 1998; Copeland and Tufano, 2004; Datta, 2006; Dixit and Pindyck,1994; Luehrman, 1998a;1998b; Trigeorgis, 1996). In this paper we extend the real options approach to take into account the time implications of learning rate cost effects in strategic supplier switch decisions. We conclude with a discussion of the contributions and limitations of our analysis and comment on research possibilities for applying our approach to other CR related issues connected to cost management

MAKE OR BUY OPTIONS IN MODERN ENTERPRISES

TIMING OPTIONS TO ADOPTING COLLABORATIVE RELATIONSHIPS

THE OPTIMAL TIMING FOR CR ENTRY: A NUMERICAL EXAMPLE

THE DECISION TO ABANDON A COLLABORATIVE RELATIONSHIP

Findings

CONCLUSION