Concept of Make or Buy Decisions
A make-or-buy decision is an act of choosing between manufacturing a product in-house or purchasing it from an external supplier. A firm may be manufacturing a product by itself. It may receive an offer from an outside supplier to supply that product. Similarly, a firm may be buying a product from outside., it may be considering manufacturing that product in the firm itself. The majority of the make or buy decisions are made on the basis of price. For example, if an organization needs a certain type of software but does not have the IT resources necessary to build it in-house, then it makes sense for the business to look outside of the business to purchase this software.
Such a problem of make or buy be faced by companies which manufacture the goods assembling various sort of components parts like Television, Motor car, Watch, Computer, etc. manufacturing companies. The outcome of this analysis should be a decision that maximizes the long-term financial outcome for a company. Make-or-buy decisions are not short-run in nature but fall into the small-scale tactical decision category. The decision to make or buy may be motivated by cost leadership and/or differentiation strategies. Making instead of buying or buying instead of making may be one way of reducing the cost of producing the main product. Alternatively, choosing to make or buy may be a way of increasing the quality of the component and thus increasing the overall quality of the product.
A company has to take make or buy decision when it has to face the following choices:
- Buy a certain part or sub-assemblies from outside suppliers, or
- Use available capacity to produce the item within the factory.
Cost analysis for make or buy is necessary. The decision in such case will be made by comparing the price being paid to outsides and all additional costs that will have to incur for manufacturing the product. This type of make or buy decision should be made only after a proper analysis that compares manufacturing costs with purchasing costs and assess the best use of the available facilities. Consideration of a ‘Make’ option automatically implies that the company has the available capacity for that purpose or has considered the cost of obtaining the necessary capacity in the decision analysis.
The following situations demand the evaluation of make or buy decisions:
- When the organization introduces new products.
- The fluctuating demand for the company’s products.
- When the organization carries out value analysis or cost reduction programs.
- Deteriorating quality and delivery commitment of the supplier if presently the item is bought.
- The scarcity of funds for investment in additional plant and equipment.
Relevant Information Regarding Make Or Buy Decisions Are As Follows:
- Incremental production cost for each unit
- The unit cost of purchasing from an outside supplier
- Number of available suppliers
- Quantity of production capacity available to manufacture components
- Opportunity costs of using facilities for production rather than for other purposes
- Quality for space available for storage
- Costs associated with carrying inventory
- Increase in throughput generated by buying components.