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Make or Buy Analysis

the act of making a strategic choice


between producing an item internally
(in-house) or buying it externally (from
an outside supplier).
Other Jargons

Vertical Integration
a measure of how much of the supply chain is
owned and operated by the manufacturer.

Outsourcing
a practice used by different companies to reduce
costs by transferring portions of work to suppliers
rather than completing it internally.
Other Jargons

Backward Integration
a business strategy that involves the purchase
of, or merger with, suppliers up the supply chain.

Forward Integration
a business strategy whereby business
activities are expanded to include control of the direct
distribution or supply of a company’s products.
Advantages of Make or Buy
Analysis
•Saving Money
•Staying Flexible

•Quality Control

•Scaling for Volume


Insourcing vs Outsourcing
Problem
Two recent college graduates,
Mary and Sue, have decided to open a
bagel shop. Their first decision is
whether they should make the bagels
on-site or buy the bagels from a local
bakery. They do some checking and
learn the following:
Insourcing vs Outsourcing
• If they buy from the local bakery, they
will need new airtight containers in
which to store the bagels delivered from
the bakery. The fixed cost for buying and
maintaining these containers is $1000
annually.
• The bakery has agreed to sell the bagels
to Mary and Sue for $0.40 each.
Insourcing vs Outsourcing
• If they make the bagels in-house, they
will need a small kitchen with a fixed
cost of $15,000 annually and a variable
cost per bagel of $0.15.
• They believe they will sell 60,000 bagels
in the first year of operation.
Insourcing vs Outsourcing
Requirements:
a. Should Mary and Sue make or buy the
bagels?
b.If Mary and Sue are uncertain as to the
demand for bagels next year, what is the
indifference point between making or
buying the bagels?
Insourcing vs Outsourcing
Solution:
a. TC Buy  FCBuy  (VC Buy x Q)
TC Buy  $1000  ($0.40 X 60000)

TCBuy  $25000
Insourcing vs Outsourcing

TC Make  FCMake  (VC Make x Q)


TC Make  $15000  ($0.15 X 60000)
TCMake  $24000
Insourcing vs Outsourcing

Based on the computations above, we


could obviously see that Mary and Sue
must choose to make the bagels if they want
to incur lesser cost since making or
producing the bagels are cheaper than
buying them.
Insourcing vs Outsourcing
Solution:
b.
FCMake  (VC Make x Q)  FCBuy  (VC Buy x Q)

$15000  ($0.15 x Q)  $1000  ($0.40 x Q)


$15000 - $1000  $0.15  $0.40 Q
Insourcing vs Outsourcing

$14000 $0.25Q
 .
$0.25 $0.25
56000  Q
Insourcing vs Outsourcing
The quantity to which Mary and
Sue would get the same profit is 56000
bagels. So if Mary and Sue wanted to
buy bagels and earn more profit, they
must buy a quantity lower that 56000
but if they wanted to make bagels and
make more profit, they must produce a
quantity higher than 56000.
Other Factors to Consider