Make or Buy Decisions-Engineering Economics-Lecture Slides, Slides of Microeconomics

Download Make or Buy Decisions-Engineering Economics-Lecture Slides and more Slides Microeconomics in PDF only on Docsity!

Module No. 14

Make or Buy Decisions

Engineering

Economics

Introduction

 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.

Elements of the "make" analysis

 Incremental inventory-carrying costs

 Direct labor costs

 Incremental factory overhead costs

 Delivered purchased material costs

 Incremental managerial costs

 Any follow-on costs stemming from quality.

 Incremental purchasing costs

 Incremental capital costs

 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

 Types of analysis followed in make or buy decision are as

follows:  Simple cost analysis  Economic cost analysis  Break even analysis

Approaches for make or Buy Decisions

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:

Economic Analysis

 The following inventory models are considered to illustrate this concept.  Purchase model  Manufacturing model

 A basic problem for businesses and manufacturers is, when ordering supplies, to determine what quantity of a given item to order. The formula for Purchase model (EOQ) and TC for each model are given as:

1

2 0

c

C D Q C



0 1

DC Q C c

TC DP

Q

 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

   

Break Even Analysis

 In economics & Business the break-even point (BEP) is the point at which cost or expenses and revenue are equal: there is no loss or gain

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

  

 There are three alternatives available to meet the demand

of a particular product. The details are as follows:

Make or Buy Decision

Cost Manufacturing by using process A

Manufacturing by using process A

Buy

FC/yr 5,00,000 6,00,

VC/unit 175 150

Pur. price 125

 The annual demand of a product is 8,000. should the company make the product using process A or process B or buy it?