Make or Buy

The make or buy decision is essentially the choice between making a product in-house or outsourcing and buying in. This page looks at both financial and non-financial considerations.

Financial perspective

A product should be made in-house if the relevant cost of making the product in-house is less than the cost of buying the product externally. A key concern is whether or not spare capacity exists within the firm making the decision.

Spare capacity exists

Unless stated otherwise, it should be assumed that there is spare capacity. The relevant cost of making the product in-house is the variable cost of internal manufacture, plus any fixed costs directly related to that product.

No spare capacity exists

If no spare capacity exists, the relevant cost of making the product in-house is the variable cost of internal manufacture, plus any fixed costs directly related to that product, plus the opportunity cost of internal manufacture (e.g. lost contribution from another product).

Other issues to consider

In addition to the relative cost of buying externally compared to making in-house, management must consider a number of other issues before a final decision is made.

• Reliability of external supplier: can the outside company be relied upon to meet the requirements in terms of:
  • quantity required
  • quality required
  • delivering on time
  • price stability
• Specialist skills: the external supplier may possess some specialist skills that are not available in-house. An alternative perspective is that out-sourcing may result in the loss of in-house skills and competences. 
• Alternative use of resource: outsourcing will free up resources which may be used in another part of the business.
• Social: will outsourcing result in a reduction of the workforce? Redundancy costs should be considered.
• Legal: will outsourcing affect contractual obligations with suppliers or employees?
• Confidentiality: is there a risk of loss of confidentiality, especially if the external supplier performs similar work for rival companies.
• Customer reaction: do customers attach importance to the products being made in-house?

Rating :	Ratings & Comments  (Click the stars to rate the page)

Tags:	make v buy;outsourcing;relevant costs