Make or buy decision

Make or buy decision is a choice whether to purchase spare parts and production materials from external parties or produce them internally. This decision often arises in planning the manufacturing process.

The company compares the costs of making it relevant to the purchase price before making a decision. If there is no spare capacity for production, then they need to calculate the opportunity cost of manufacture. Examples of expenses that are relevant in the decision context are direct labor, direct material, and variable overhead.

Factors that influence decisions

Several factors influence the decision to make or buy. They include the level of difficulty and complexity in manufacturing, quality of goods, profit factors, available resources, economies of scale, and capacity to produce. Other factors are related to security, especially privacy and intellectual property.

Regarding profits, in general, companies compare purchasing prices with estimated marginal production costs. When the marginal cost of production is higher than the purchase price, then obviously the option of buying goods from an external party is a better choice.

Advantages and disadvantages

Some large companies try to produce every component in a product. That is because it gives them full control over every aspect of operations, including the quality of the final output.

Conversely, some companies prefer to buy from outside suppliers. That way, the company can focus on core competencies. Also, purchases from external parties are often cheaper because of their economies of scale and specialization.