Cost to buy vs. cost to make

The "Make vs. Buy" decision is a fundamental business choice between producing a product or service internally (making it) or purchasing it from an external supplier (buying it). This decision is critical for companies needing specific components, finished goods, or services to operate or sell.

The decision is primarily based on comparing the total relevant costs of each option over the long term. You analyze and quantify all costs associated with *making* the item internally versus all costs associated with *buying* the item externally. The financially optimal choice is usually the one with the lower total relevant cost.

Relevant costs for the "Make" option typically include:

• **Direct Material Costs:** Raw materials needed.
• **Direct Labor Costs:** Wages for workers directly involved in production.
• **Variable Manufacturing Overhead:** Costs that vary with production volume (e.g., utilities, supplies used in production).
• **Incremental Fixed Manufacturing Overhead:** Any *additional* fixed costs incurred specifically because you decide to make the item (e.g., hiring a new supervisor, needing additional factory space). *Avoid allocating existing fixed costs unless they specifically increase due to this decision.*
• **Opportunity Costs:** The potential benefit lost by using resources (like factory space or skilled labor) for making this item instead of for their next best alternative use.

Relevant costs for the "Buy" option typically include:

• **Purchase Price:** The price charged by the external supplier per unit.
• **Ordering Costs:** Costs associated with placing and receiving orders (e.g., administrative costs, inspection costs).
• **Transportation/Shipping Costs:** Costs to get the item from the supplier to your location.
• **Receiving and Handling Costs:** Costs related to receiving, inspecting, and storing the purchased item.
• **Any other costs directly attributable to outsourcing** compared to making it.

Yes, while cost is a major factor, other strategic and operational considerations are important:

• **Quality Control:** Can you maintain required quality levels by buying vs. making?
• **Capacity Availability:** Do you have the existing capacity (equipment, labor) to make the item?
• **Expertise & Technology:** Do you have the necessary know-how and technology?
• **Supplier Reliability:** Is the supplier reliable in terms of delivery time and quality?
• **Confidentiality/Proprietary Information:** Does making it protect sensitive intellectual property?
• **Strategic Importance:** Is making the item core to your business strategy or a source of competitive advantage?
• **Flexibility & Speed:** Which option offers greater flexibility to scale production up or down?

A comprehensive decision considers both quantitative (cost) and qualitative factors.