Make-or-Buy decision (also called the outsourcing decision) is a judgment made by management whether to make a component internally or buy it from the market. While making the decision, both qualitative and quantitate factors must be considered.
Examples of the qualitative factors in make-or-buy decision are: control over quality of the component, reliability of suppliers, impact of the decision on suppliers and customers, etc.
The quantitative factors are actually the incremental costs resulting from making or buying the component. For example: incremental production cost per unit, purchase cost per unit, production capacity available to manufacture the component, etc.
The following example illustrates the numerical part of a simple make-or-buy decision.
The estimated costs of producing 6,000 units of a component are:
|Applied Variable Factory Overhead||9||54,000|
|Applied Fixed Factory Overhead||12||72,000|
|$1.5 per direct labor dollar|
The same component can be purchased from market at a price of $29 per unit. If the component is purchased from market, 25% of the fixed factory overhead will be saved.
Should the component be purchased from the market?
|Relevant Fixed Overhead||3||18,000|
|Total Relevant Costs||$30||$29||$180,000||$174,000|
|Difference in Favor of Buying||$1||$6,000|
Written by Irfanullah Jan and last revised on