Make or Buy Decision MeaningA Make or Buy Decision is a decision made to either manufacture a product/ service in house or buy it from outside suppliers (outsourcing) based on cost-benefit analysis. A complete or accept decision can be made using quantitative or qualitative research and most of the time, the results of quantitative analysis (cost-benefit analysis) are enough to decide on whether to make the product in-house or buy (outsource) from outside suppliers. Show
How Does Make or Buy Decision Work?The decision applies to both goods and services. Businesses compare the cost and benefits of producing the goods or services within the company and the cost and benefits of getting an outside supplier to supply the goods and services into consideration. The value here must include all the fees associated with manufacturing (including material, labor, cost of machinery and space), storing, moving, taxes, etc. and the corresponding benefits must include benefits in terms of increased margins (for in-house production) or low capital requirement (for outsourcing). You are free to use this image on your website, templates, etc., Please provide us with an attribution
linkArticle Link to be Hyperlinked Analysis for Make or Buy DecisionLet’s discuss the analysis of make or buy decisions.
Examples of Make or Buy DecisionLest discuss examples of make or buy decisions for better understanding. Make or Buy Decision Example #1As stated earlier, there may be some factors at play that may influence a company’s company’s decision to make an item in the house or outsourcing it. Under such circumstances, two factors are to be considered:
Assume a company is deciding between manufacturing a part in-house that costs $26 per unit, including direct cost, fixed overheads, and variable overheads, as given in the table below.
The same part is available in the market at $23 per unit, including the cost of buying, shipping, and warehousing, as shown in the table below.
Should the Firm Make or Buy the part? AnalysisIf surplus capacity available will remain idle if the component is bought, out of pocket expensesOut-of-pocket expenses are the expenses that an employee pays out of their own pocket and then gets reimbursed from their employer. Transportation, meals, and lodging expenses are common examples.read more will be $23 per unit, $1 more than the variable and direct cost of making component which is $22 ($15 + $7). Hence it is economical to make it. However, if the Firm is utilizing or can utilize the capacity in making some other part which contributes to say $4 per unit in profits, the effective cost of buying the component will be $19 ($23 less $4 contribution from other products). In that case, it would be economical to buy the Component at $23 per unit from outside. The relevant calculation for making decision may be as follows:
Make or Buy Decision Example #2The smartphone giant Apple Inc. outsources the manufacturing of all its devices to China because manufacturing is not its core competencyThe core competencies in business refer to its resources and unique fundamental capabilities that distinguish it from market competitors. It is an essential component of marketing strategy leading to brand recognition and business growth. The concept serves to be useful for companies focusing on multiple product lines and operating more than one business unit at a time. read more. It is also significantly cheaper to assemble the tools in China due to substantially lower costs. Apple designs its produces in its office in the United States; the products are then manufactured in China and shipped back to the United States and other countries for sales. Factors Considered for Make or Buy DecisionThe following are the major factors considered while deciding to make the good or service in-house.
The following are the major factors considered while deciding to buy the good or service from the outside supplier.
Advantages of Make or Buy DecisionSome of the advantages of making or buy decisions are as follows:
ConclusionThe make or buy decision should be taken with utmost care keeping the long-term and short-term benefits into consideration. There are pros and cons to both make and purchase; however, generally, businesses tend to outsource function where they do not have a core competency or when the cost of procuring the components or services from outside suppliers is significantly cheaper. Recommended ArticlesThis has been a guide to what is make or buy decision and its meaning. Here we discuss how does make or buy decision works along with its factors and examples. You can more about finance from the following articles –
Which of the following should be ignored when making decisions multiple choice avoidable costs differential costs incremental costs sunk costs?The correct answer is B.
Relevant costs include variable costs and the avoidable portion of the fixed costs. Sunk costs are costs already incurred in the past and will not affect the current decisions. Thus, this type of cost is usually ignored when deciding among alternatives.
Which of the following should be ignored when making a decision?Sunk costs should be ignored in making decisions because they have no influence on future costs and benefits.
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