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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 can 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, a company must consider all aspects regarding the acquisition and storage of the items must.

Make and Buy Costs

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

Buy costs related 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 company must factor in the expenses relating to the storage of the incoming product and labor costs associated with receiving the products into inventory.

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 a company cannot measure 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. A company may give additional consideration if the firm has the opportunity to work with a company that has previously provided outsourced services successfully and can sustain a long-term relationship.

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

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