Make-Or-Buy Decision

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What is a 'Make-Or-Buy Decision'

A make-or-buy decision is the act of choosing between manufacturing a product in-house or purchasing it from an external supplier. In a make-or-buy decision, the most important factors to consider are part of quantitative analysis, such as the associated costs of production and whether the business has the capacity to produce at required levels.

BREAKING DOWN 'Make-Or-Buy Decision'

Also referred to as the outsourcing decision, the make-or-buy decision compares the costs and benefits associated with producing a necessary good or service internally to the costs and benefits involved in hiring an outside supplier for the resources in question. To compare costs accurately, all aspects regarding the acquisition and storage of the items must be considered.

Make Costs

In regards to in-house production, a business must include expenses related to the purchase and maintenance of any production equipment as well as the cost of production materials. Further costs can include the additional labor required to produce the items, storage requirements within the facility or if additional storage space must be purchased, and the proper disposal of any remnants or byproducts from the production process.

Buy Costs

Costs relating to purchasing the products from an outside source must include the price of the good itself, any shipping or importing fees, and applicable sales tax charges. Additionally, the expenses relating to the storage of the incoming product and labor costs associated with receiving the products into inventory must be factored into the decision.

Decision-Making Points

The results of the quantitative analysis may be sufficient to make a determination based on the approach that is more cost-effective. At times, qualitative analysis addresses any concerns that cannot be measured specifically.

Factors that may influence a firm's decision to buy a part rather than produce it internally include a lack of in-house expertise, small volume requirements, a desire for multiple sourcing and the fact that the item may not be critical to the firm's strategy. Additional consideration may be given if the firm has the opportunity to work with a company that has previously provided outsourced services successfully in the past and can sustain a long-term relationship.

Similarly, factors that may tilt a firm towards making an item in-house include existing idle production capacity, better quality control or proprietary technology that needs to be protected. Concerns regarding the reliability of the supplier may also be considered, especially if the product in question is critical to normal business operations. The firm should also consider whether the supplier can offer a long-term arrangement, if that is desired.