Definition: The make or buy decision analysis is an evaluation of manufacturing something in-house versus buying that product from another seller. In other words, it is when a business weighs the pros and cons of making or doing something within the business using company resources or outsourcing that part of production or business function to an outside party.
What Does Make or Buy Decision Mean?
What is the definition of make-or-buy decision? The make vs buy decision traditionally relates to parts in a manufacturing process. If an organization finds that they can make one or more of the manufacturing inputs that they use in house, then the organization should evaluate the cost and compare it to the cost of purchasing those inputs elsewhere.
However, a company also has to make this decision as it relates to building software or carrying out business functions. For example, if an organization needs a certain type of software but does not have the IT resources necessary to build it in-house, then it makes sense for the business to look outside of the business to purchase this software.
There are pros and cons to each of the alternatives, and they depend on the amount and type of resources that the firm holds. Things that business should think about other than cost include: cost of ownership, legal considerations, and how often modifications will need to be made to the product.
Let’s look at an example:
Example
Organization QRS manufactures high quality cases for musical instruments. The COO is currently in the process of deciding if the foam inserts should be manufactured in-house or bought from an external manufacturer.
The cost of manufacturing these inserts in-house consists of:
- Direct labor: $200,000
- Direct materials: $240,000
- Overhead: $100,000
The cost of purchasing these inserts externally is $500,000. What should the COO choose?
The total cost of making these items in-house is $540,000. The COO should purchase the inserts externally.
Summary Definition
Define Make or Buy Decision: Make-or-Buy Decision means an analysis by management on whether the company should produce a product or part or purchase it from a vendor.
