Companies should have a set of strategies to follow when they produce their products and services. According to Besanko (2013, p127), the production of any good or service requires a range of activities in a vertical chain .The firm must look at its production process which is said to follow from upstream suppliers of raw inputs to downstream manufacturers, distributors and retailers. 'Make' or 'buy' is a fundamental decision to be made by firms in the quest to be more profitable and efficient in the delivery of their products and services. There are benefits for companies that choose the 'buy' option. Firstly, market firms are often able to achieve economics of scale and learning economics in production of input that are unreachable to firms that choose to make the input themselves. Market firms have other advantages: while a division within a hierarchical firm may hide its inefficiencies behind complex monitoring and reward systems, independent firms must survive the discipline of market competition. This encourages productive efficiency and innovation. Another reason is that vertically integrated firms can try to replicate market incentives but may encounter problems associated with motivation (agency cost) and internal lobbying for resources (influence costs).
Agency costs are due to slacking by employees and the administrative effort to deter slacking. Managers and workers who knowingly do not act in the best interests of their firm are shirking. As an example of agency cost, consider this: each branch of company x has a revenue target separate from the other branches, so branch performance is not measured by coordination with other branches. This leads to providing a technical resource from one branch to another with a cost that is sometimes more than it would be if the resource came from the market. Moreover, each branch overprices its free resources for fear of being locked into long term projects with other branches, which results in low utilization of existing resources, thus favoring outsourcing.
