5.6.5 (HL)—Make or buy decisions

A make-or-buy decision compares producing an input internally with purchasing it, using relevant costs, capacity, quality, control, reliability and strategic dependence.

Avoidable variable and fixed costs matter; allocated overhead that remains after outsourcing should not drive the decision. Supplier risk and opportunity cost can outweigh a lower quoted price.

Compare relevant total cost at the required volume, then include capacity released, quality, lead time and dependency.

Buying a component saves $2 per unit but uses a supplier with long lead times; if internal capacity could make a higher-margin product, the opportunity cost changes the answer.

The lowest purchase price is not automatically the lowest total or strategic cost.

Calculate only relevant costs at the required output. Cost to make (CTM) = avoidable fixed costs of internal production + variable cost per unit × quantity. Cost to buy (CTB) = supplier price per unit × quantity + relevant ordering, transport, inspection or contract costs. For 5,000 units, avoidable make fixed costs of $8,000 and variable cost of$6 give CTM = $8,000 + 5,000 ×$6 = $38,000. A supplier price of$7 plus $1,000 delivery gives CTB = 5,000 ×$7 + $1,000 =$36,000, a $2,000 cost advantage to buy. The final judgment must also weigh quality, control, reliability, capacity released, intellectual property and supplier dependence; allocated fixed overhead that remains under both choices is not a saving.