Download Make and Buy Decisions-Engineering Economics-Lecture Slides and more Slides Microeconomics in PDF only on Docsity!
Make and Buy Decisions
Determination of whether it is more advantageous to make a particular item in house or to buy it from a supplier.
The choice involves both qualitative (such as quality control) and quantitative (such as the relative cost) factors.
The buy side of the decision also is referred to as outsourcing.
Make-or-buy decisions usually arise when a firm that has developed a product or part—or significantly modified a product or part—is having trouble with current suppliers, or has diminishing capacity or changing demand.
Issues like government regulation, competing firms, and market trends all have a strategic impact on the make-or- buy decision.
Cost considerations (less expensive to make the part)
Desire to integrate plant operations
Productive use of excess capacity to help absorb fixed overhead.
Need to exert direct control over production and/or better quality Design secrecy is required to protect proprietary technology
Unreliable suppliers or No competent suppliers
Desire to maintain a stable workforce (in periods of declining sales) Quantity too small to interest a supplier
Control of lead time, transportation, and warehousing costs
Greater assurance of continual supply
Provision of a second source Political, social or environmental reasons (union pressure)
Emotion (e.g., pride)
Criteria for Make
Lack of expertise
Suppliers' research and specialized know-how exceeds that
of the buyer
cost considerations (less expensive to buy the item)
Small-volume requirements
Limited production facilities or insufficient capacity
Desire to maintain a multiple-source policy
Indirect managerial control considerations
Procurement and inventory considerations
Brand preference
Item not essential to the firm's strategy
Criteria for buy
Cost considerations for the "buy" analysis
Purchase price of the part
Transportation costs
Receiving and inspection costs
Incremental purchasing costs
Any follow-on costs related to quality or service
Simple Cost Analysis
Quantitative factors deal with cost. The quantitative effects of the make-or-buy decision are best seen through the Relevant Cost Approach.
For example, assume a firm has prepared the following cost estimates for the manufacture of a subassembly component based on an annual production of 8000 units:
The supplier has offered the subassembly at a price of $ each. Two-thirds of fixed factory overhead, which represents executive salaries, rent, depreciation, and taxes, continue regardless of the decision. Should the company buy or make?
Simple Cost Analysis
Manufacturing model
Economic Analysis
2
2 0 c (1 / )
C D Q C r k
0 2 2
( ) 2
c
DC Q TC DP C k r Q k
An item has yearly demand of 2000 units. The different costs in respect of make and buy are as follows. Determine the best option.
Economic Analysis
Buy Make P = Item cost/unit 8.00 5. C 0 = Procurement cost/order cost 120 C 0 = Set up cost (for making) 60 Cc = Annual carrying cost 1.60 1. K = Production rate 8000 units
Break Even Analysis
Break-even point (BEP) is the point at which cost or
expenses and revenue are equal: there is no net loss or gain. The main objective of break-even analysis is to find the cut-off production volume from where a firm will make profit.
cos / cos /
FC BEP Selling t unit Variable t unit
FC
BEP X
P V
Make or Buy Decision
A manufacturer of TV buys TV cabinet at Rs. 500 each.
In case the company makes it within the factory,
the fixed cost is Rs.400, 000/-
variable cost is Rs. 300 per cabinet.
Should the manufacturer make or buy the cabinet if the
demand is 1,500 TV cabinets?
