Make-or-Buy Decision Explained How to Make Outsourcing Decisions

Make-or-Buy Decision Explained: How to Make Outsourcing Decisions

What Is a Make-or-Buy Decision?

A make-or-buy decision is choosing between manufacturing a product in-house or purchasing it from an external supplier.

Also referred to as outsourcing, a make-or-buy decision compares the costs and benefits of producing a necessary good or service internally to hiring an outside supplier.

To compare costs accurately, a company must consider all aspects of acquisition and storage versus creating the items in-house, which may require the purchase of new equipment and storage costs.

Key Takeaways

– A make-or-buy decision is choosing between manufacturing a product in-house or purchasing it from an external supplier.

– Make-or-buy decisions, like outsourcing decisions, compare the costs and advantages of producing in-house versus buying.

– Factors that tilt a company towards making or buying include labor costs, expertise, storage costs, supplier contracts, and volume.

– Companies use quantitative analysis to determine the most cost-efficient method.

Understanding a Make-or-Buy Decision

For in-house production, a business must include expenses related to purchasing and maintaining production equipment and production materials. Costs to make the product include labor wages and benefits, storage requirements, holding costs, and disposal of remnants or byproducts.

Buy costs from an outside source include the price of the good, shipping, importing fees, sales tax charges, storage expenses, and labor costs for receiving and inventory. It also includes signing contracts with suppliers.

The most important factors to consider in a make-or-buy decision are production costs and the ability to meet requirements.

Choosing Make or Buy

Quantitative analysis can determine the cost-effectiveness of each approach. Qualitative analysis addresses concerns that cannot be measured.

Factors influencing buying include lack of expertise, small volume requirements, multiple sourcing, and non-critical items.

Additional consideration is given if a firm has a successful history with a supplier and desires a long-term relationship.

Factors favoring in-house production include idle capacity, quality control, proprietary technology, and concerns about supplier reliability.

Why Choose?

Certain events, such as a trusted supplier closing or changes in demand, may prompt a company to consider making or buying. Management must consider beyond cost-benefit analysis and potential outcomes like economies of scale, new product lines, or business restructuring.

Depending on the business and market position, there are advantages and disadvantages to staying on the same path or exploring new directions.