To make or buy the supply chain?

From the July-August 2025 edition of Supply Chain Management Review.

July-August 2025

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All companies are engaged in outsourcing. They outsource production or service operations, and when they do, they typically rely on their first-tier suppliers to select and manage second-tier suppliers and beyond—what we call deep-tier suppliers. However, cost pressure, high-profile supply disruptions, quality failures, and sustainability scandals caused by deep-tier suppliers have raised concerns about delegating sourcing decisions to the first-tier suppliers.

For example, a Toyota first-tier supplier worked with a semiconductor supplier called Renesas. In 2021, there was a fire at this second-tier supplier. This unfortunate incident amid the global chip shortage forced Toyota to cut production by 40%. The question of whether Toyota should have been more involved in selecting this second-tier supplier arises. Similarly, H&M faced public backlash recently when reports linked its second- and third-tier cotton suppliers in Xinjiang, China, to forced labor. It posed reputational and financial risk for H&M.

Such incidents point out the importance of visibility and control over deep-tier suppliers. However, it is neither practical nor feasible for companies to manage all upstream suppliers directly. This raises a critical question: How should companies strategically approach the selection and management of deep-tier suppliers? Many firms tend to react only after supply chain problems happen, often by creating direct relationships with deep-tier suppliers that caused the problem or pressuring first-tier suppliers to switch their suppliers. But these reactive measures are often arbitrary and devoid of a systematic approach.

In our Journal of Supply Chain Management article published in April 2024, we introduced a practical, structured decision-making framework to guide companies on when and how to approach the selection and management of deep tier suppliers. The key insight behind our framework is that decisions regarding the selection and management of second-tier suppliers and beyond (i.e., deep-tier suppliers) mirror the classic make-or-buy decision, but at the supply chain level. When a company delegates the sourcing decision involving subcomponents or sub-services to its first-tier supplier, it is effectively “buying” this first-tier supplier’s supply chain. This buying company relies on the first-tier supplier to select and manage the suppliers that lie further upstream. In contrast, when a company takes an active role in selecting or managing certain deep-tier suppliers, it is “making,” at least in part, the supply chain by directly shaping supplier choices and oversight. Building on this make-or-buy analogy, we identify three strategic approaches that companies can adopt to govern multi-tier supplier networks: supply-chain buy, supply-chain make, and hybrid approaches.

Supply-chain buy

In the supply-chain buy model, a buying company outsources production or service operations to its first-tier suppliers and delegates the selection and management of second-tier suppliers and beyond. The buying company considers this first-tier supplier a one-stop shop. It follows a hands-off strategy, where the first-tier supplier is responsible for managing the suppliers that lie beyond the buying company’s purview. A well-known example is how global retail brands partner with supply chain management firms like Li & Fung. Li & Fung coordinates sourcing, logistics, and supplier relationships across a vast network of over 15,000 suppliers in 60 countries, allowing brands to concentrate on design, branding, and customer engagement rather than upstream supply chain management.

Supply-chain make

Under the supply-chain make approach, the buyer continues to outsource production or service operations to its first-tier suppliers but retains the right to directly control the selection, contracting, and management of some second-tier suppliers and beyond. The buying company is now looking deeper into the supply chain beyond its first-tier supplier. This strategy follows a more hands-on approach, where some deep-tier supplier selection and management decision-making remains centralized in the buying company. Honda and Toyota employ a supply-chain make practice known as directed sourcing, where the company directly contracts with some second- and third-tier suppliers and mandates that the first-tier suppliers work with these designated deep-tier suppliers. Another notable example is Apple’s supply chain strategy. While Apple contracts manufacturers like Foxconn for final assembly, it holds on to most of the sourcing decisions at the component level. Apple actively manages relationships with over 180 component suppliers worldwide, ensuring strict compliance with quality, sustainability, and labor standards.

Hybrid approaches

Hybrid approaches distribute responsibility of supply-chain make or buy decisions across the buyer, its first-tier suppliers, and some external stakeholders. The intent is to collaboratively select, manage, and monitor deep-tier suppliers. Companies employing hybrid approaches often implement strategies such as the following.

• Approved vendor lists: Buyers and suppliers share a pre-approved list of deep-tier suppliers to ensure compliance and reliability.
• Collaboration with deep-tier suppliers: Buyers and deep-tier suppliers strategically collaborate to improve coordination, quality standards, and operational efficiency.
• Joint supplier training and risk assessments: Buyers and first-tier suppliers collaborate with non-governmental organizations and monitoring agencies to ensure sustainability, ethical sourcing, and compliance with labor regulations.

An example of a hybrid approach comes from IKEA’s sustainability initiative in its cotton textile supply chain. IKEA conducts training and workshops with both first-tier suppliers (cutting and stitching) and deep-tier suppliers (dyeing, weaving, ginning, and farming) to improve social and environmental outcomes. By working across several supply chain tiers, IKEA strengthens supplier capabilities while reinforcing resilience and sustainability commitments. Table 1 summarizes the three approaches to supply-chain make or buy.

Having introduced the three approaches to supply chain make-or-buy decisions, we now present a practical decision-making framework to help companies evaluate the options across supply-chain make, supply-chain buy, or hybrid approaches. The insights are taken from two influential theories from economics and management: transaction cost economics and the capabilities view. We adapt them to the complexities of multi-tier supply chains.

Transaction cost economics, recognized with Nobel Prizes in Economic Sciences in 1991 (Ronald Coase) and 2009 (Oliver Williamson), explains how firms decide between in-house production and outsourcing by assessing transaction costs—the costs associated with managing external exchanges. These include costs for gathering information, negotiating contracts, monitoring suppliers, and managing risks associated with outsourcing. The higher the complexity and uncertainty of an exchange, the greater the costs. If outsourcing reduces overall costs and improves efficiency, companies often choose external providers. However, when managing suppliers becomes costly and risky, keeping operations in-house may be the better option. Many firms also adopt hybrid approaches, collaborating with suppliers while maintaining partial control through long-term partnership or joint ownership.

Outsourcing decisions also depend on a company’s core strengths—some firms outsource activities in which they lack expertise, while others retain certain processes in-house to safeguard their competitive advantage. The capabilities view emphasizes the importance of aligning outsourcing decisions with a company’s key competencies. Even if outsourcing incurs higher transaction costs, a firm may still choose this option if the required capabilities for in-house management do not align with its existing expertise. Conversely, if outsourcing appears cost-effective but the activity in question strengthens the company’s core competencies, it may be strategically beneficial to keep it in-house. Ultimately, the decision between outsourcing and internal management requires a careful balance between transaction costs and company capabilities to enhance efficiency and maintain competitiveness in supply chain operations.

In the context of the supply-chain make or buy decision-making, sourcing capability becomes the most prominent capability. Sourcing capability is a company’s ability to find, evaluate, and work with suppliers effectively. Think of it like a chef selecting ingredients for cooking in a restaurant—it is not just about picking the cheapest option but also about ensuring quality, reliability, and good relationships with suppliers. A company with strong sourcing capability has skilled purchasing managers, clear processes for selecting and working with suppliers, and good communication between different departments. These abilities help the company avoid risks like suppliers delivering poor-quality products or failing to meet deadlines. Over time, businesses develop these capabilities through experience, technical knowledge, and strong supplier partnerships.

One critical risk in managing multi-tier supply chains is opportunism from the first-tier supplier. When a company delegates sourcing decisions to a first-tier supplier, it assumes that the supplier will act in its best interest when selecting and managing deep-tier suppliers. However, if performance evaluation is difficult or information is not fully transparent, the first-tier supplier may take advantage of its position. This could include cutting costs by choosing lower-quality suppliers, misrepresenting costs to increase margins, or neglecting proper oversight of deep-tier suppliers. Such opportunistic behavior can lead to quality issues, compliance failures, and reputational risks for the buying firm. Understanding when and how to mitigate this risk is essential for making informed supply chain governance decisions.

Integrating these premises of transaction cost economics and the capabilities view and extending them into the context of multi-tier supply chain management, we offer the decision-making framework seen in Figure 1.

 

Consider a supply-chain make approach if:

Your company has invested in specialized assets linked to some deep-tier suppliers.

Buyers sometimes invest in specialized assets—such as production equipment and know-how—when working with deep-tier suppliers, especially for key components. These investments develop through direct collaboration, engineering programs, and prior experience. For example, Apple worked with Catcher Technology, a second-tier supplier, to develop the MacBook’s aluminum body. Instead of sourcing from Foxconn, which also had aluminum casing production capabilities, Apple remained committed to Catcher due to its prior investments in the supplier’s capabilities. This ensured access but also created dependency, leading Apple to manage this second-tier supplier more closely. When a company has made significant investments in a deep-tier supplier, allowing a first-tier supplier to control sourcing decisions poses a risk—the first-tier supplier might replace the specialized supplier. Therefore, companies should consider supply-chain make to mitigate such risk.

Your company has stronger sourcing capabilities than your first-tier supplier, and the first-tier supplier struggles to assess and manage deep-tier supplier performance.

Evaluating a supplier’s performance can be complex. While buyers can analyze quality data and conduct inspections, some issues may surface only after further use or processing. Identifying the root cause of defects can be difficult, and suppliers may shift the blame. Moreover, factors like environmental and social compliance are often hard to measure. When deep-tier supplier performance is difficult to track, the risk of hidden quality issues, cost-cutting, or non-compliance increases. If your first-tier supplier struggles to assess certain deep-tier suppliers, but your company has the expertise to do so more effectively, it is best to take direct control. In such cases, a supply-chain make approach ensures greater oversight and reduces risks. For example, Boeing’s first-tier supplier, Vought, was making the rear-end fuselage model for its 787 Dreamliner. Vought struggled to manage the deep-tier suppliers that were making components for the module. The problem became aggravated to a point where Boeing had to take a drastic measure by acquiring the Vought operation that was making this module.

There is a risk of opportunism from the first-tier supplier.

The first-tier supplier may exploit its position as the broker between your company and deep-tier suppliers by hiding costs, selecting lower-quality suppliers, or neglecting supplier management. When you suspect this type of behavior from your first-tier supplier, you should first assess your sourcing capability and seriously consider managing deep-tier suppliers directly. For instance, Keyboardio discovered its first-tier supplier had secretly sourced keycaps from a deep-tier supplier using inferior materials, only realizing the issue after months of disputes over quality. In such cases, closer oversight of deep-tier suppliers helps prevent hidden risks and ensures product integrity. If your company has stronger sourcing capabilities than the first-tier supplier and there is a risk of the first-tier supplier acting in its own interest against your company’s, supply-chain make approaches can help maintain quality and transparency.

Consider a supply-chain buy approach if:

The first-tier supplier has the capability to assess deep-tier supplier performance, and the risk of opportunism from this supplier is low.

If the final product’s quality can readily be assessed, any issues with subcomponents should be traced back to the first-tier supplier, thereby making it accountable for its sourcing decisions. In such cases, the risk of opportunism is low, and your company can comfortably delegate sourcing to the first-tier supplier. For example, when Google partnered with Flex to develop Chromecast, it relied on Flex’s sourcing and manufacturing expertise without concerns about supplier mismanagement. Because Chromecast is a relatively simple product, Google had no difficulty assessing Flex’s performance and did not need direct control over deep-tier suppliers.

Your first-tier supplier has strong sourcing capabilities, and you can rely on them to manage deep-tier suppliers without risk of opportunism.

When a first-tier supplier has strong sourcing capabilities and can be trusted to manage deep-tier suppliers effectively, delegating sourcing decisions can streamline operations and reduce administrative burdens. A well-established first-tier supplier often has expertise in their particular industry, closer relationships with upstream suppliers, and better negotiation power, allowing it to secure higher-quality components at competitive prices. Your company’s direct involvement in deep-tier supplier selection and management may be comparatively inefficient and may even be disruptive. In such cases, a supply-chain buy approach enables your company to focus on core competencies while benefiting from the first-tier supplier’s expertise in supplier selection and management.

Consider hybrid approaches if:

Your first-tier supplier has strong sourcing capabilities, but you do not have confidence that they will manage deep-tier suppliers without risk of opportunism.

If you deem your first-tier supplier’s sourcing capability to be good, maybe even better than your own, taking full control of indirect transactions may not be the best option. The supplier may be better equipped to manage deep-tier suppliers, negotiate favorable terms, and ensure smooth operations. However, completely handing over these decisions can create challenges, especially when there is uncertainty about the first-tier supplier’s transparency or trustworthiness. A hybrid approach can help strike a balance. By working closely with both the first-tier and deep-tier suppliers, your company can benefit from the first-tier supplier’s expertise while selectively maintaining oversight to reduce the risk of hidden quality issues or cost-cutting. This collaborative approach allows your company to retain strategic influence without taking on the full burden of managing deep-tier suppliers.

 

Conclusion

In navigating the complexities of supply chain make-or-buy decisions, companies must carefully balance cost efficiency, risk management, and strategic sourcing capabilities. While a hands-off supply-chain buy approach may offer cost savings and operational simplicity, it can also expose firms to potential supply disruptions, quality failures, and reputational risks. In contrast, a supply-chain make strategy may provide greater control. Still, it demands more investment in supplier oversight. Hybrid approaches may offer a middle ground, enabling firms to collaborate with first-tier and deep-tier suppliers while maintaining flexibility. Ultimately, there is no one-size-fits-all solution. Each company must assess its transaction costs, sourcing capabilities, and strategic priorities to determine the most suitable governance approach. By applying our decision-making framework, as shown in Figure 1, companies can move beyond reactive multi-tier supply chain management and adopt a proactive, structured strategy to enhance resilience, sustainability, and long-term competitiveness. 

About the authors

Sangho Chae is an associate professor of operations management at the University of Warwick Business School. His research focuses on supply network structures and their implications for innovation, supply chain resilience, and corporate misconduct. He can be reached at [email protected].

Thomas Y. Choi is professor of supply chain management at Arizona State University’s W. P. Carey School of Business. He is co-director of Complex Adaptive Supply Networks Research Accelerator (CASN-RA). His most recent book is The Nature of Supply Networks (Oxford University Press, 2023).

Glenn Hoetker is the MBS Foundation Chair of Sustainability and Business at Melbourne Business School, University of Melbourne. His work focused on interfirm coordination and uncertainly, especially in the context of sustainability.

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