Make-or-Buy Decision

A strategic decision to choose between producing a product by the company or purchasing it from an external supplier, that is outsourcing.

Author: Chhavi Gupta
Chhavi Gupta
Chhavi Gupta
Hi, I am Chhavi Gupta. Education- MBA (2024- Pursuing), Bcom (Hons) 2021, and did my schooling from Presentation Convent Sr. Sec. School in the commerce stream. Skills- MS office, Canva, Power BI(learning), Financial statement Analysis, Time management, Critical thinking, Problem solving, Communication, Leadership. Experience- I am still a university student and a fresher. I don't hold any work experience as of now. But I have completed my summer internship at Paytm as a finance intern and during my Graduation done a Data Entry internship. Currently I am a Financial Analyst Intern at WSO. Thank you.
Reviewed By: Rohan Arora
Rohan Arora
Rohan Arora
Investment Banking | Private Equity

Mr. Arora is an experienced private equity investment professional, with experience working across multiple markets. Rohan has a focus in particular on consumer and business services transactions and operational growth. Rohan has also worked at Evercore, where he also spent time in private equity advisory.

Rohan holds a BA (Hons., Scholar) in Economics and Management from Oxford University.

Last Updated:February 8, 2024

What Is a Make-or-Buy Decision?

A make-or-buy decision is a decision to choose between producing a product by the company or purchasing it from an external supplier, that is, outsourcing. The decision is based on cost and benefit analysis.

The cost and benefit of producing a product is compared with that of purchasing the product from outside suppliers. All the necessary costs and benefits should be considered. 

The benefits of having control and management over the quality, protection of intellectual property rights, cost savings, innovation, customization, core competencies, expertise, demand of the product, etc., should also be considered before making any decision.

The cost of purchasing the product and its storage cost versus the manufacturing cost of the product, including labor, raw material, new equipment, etc., should be considered.

Key Takeaways

  • A make-or-buy decision is deciding between whether to manufacture a product by the company itself or buy it from outside suppliers. The decision is based on a cost-and-benefit analysis. 
  • Other than cost, other major factors like competition, technology, number of suppliers, core competency, etc should also be considered.
  • The decision depends from company to company because each company's business environment is unique.
  • A company should choose between the two wisely only after analyzing all the costs, benefits, and other factors.

Understanding Make-or-Buy Decisions

Managers must decide whether to produce a product or purchase it from outside. 

While thinking of producing or manufacturing, various costs like raw material, labor, manufacturing, waste disposal costs resulting from the production process, etc., should be included.

If considering buying the product from outside, various costs like supplier cost, product price, sales tax, shipping, warehouse, inventory cost, etc., should all be considered. 

Make-or-buy decisions are important as they affect the financial performance of the company. Such a decision may impact the operations of a business. The main driving force for the decision is the production cost and quality of the product.

The decision is based on the core competency of a business. Businesses generally tend to outsource when they don’t have the core competency or outsourcing is cheaper.

Factors affecting Make-or-Buy decision

There are different factors affecting both making and buying decisions. The following factors are to be considered before making any decision: 

Make Decision

Stated below are some of the important factors to be considered while deciding to produce the goods themselves:

  • If the company identifies that purchasing the product is more expensive than manufacturing it, it will avoid purchasing it and instead manufacture it. Choosing the cheapest option.
  • When outsourcing, the business might lose control and management over its product.
  • Sometimes businesses fear losing intellectual property and avoiding purchasing from outside 
  • Not all suppliers are reliable and credible.
  • Companies can lose control over the quality of the product if it's purchased from outside.
  • Lack of suppliers for the product in the market.
  • The company has a core competency to manufacture the product, and then it would produce the product in-house rather than purchasing it from external sources.

Buy Decision

The following are the major factors considered for buying or outsourcing a product:

  • If buying the product from a supplier is cheaper than producing it in-house.  Then, the company would choose to buy it.
  • The company may lack the expertise or does not have a core competency to manufacture the product. Thus, the company would opt for outsourcing or buying from outside suppliers.
  • When goods are not required in a large number of volumes, businesses decide to purchase them from external sources rather than make them. This is because they do not want to invest their time, money, and energy in such small volumes.

Make-or-Buy Decision Criteria

Setting up a consistent make-or-buy approach that applies to every company is impossible. Every company has a different business environment, dynamics, threats, opportunities, core competencies, competitions, industries, etc. 

In short, if a company is significantly affected by one factor, then the other company doesn't need to be affected by the same factor. Companies assess outsourcing to see if present overhead expenses may be reduced to get access to new resources.

Cost is only one side of the coin; other factors specific to individual organizations should also be considered. 

The core competencies, efficiency, technology, competition, current financial position, etc., all these factors also play a significant role in deciding whether to make or buy the product.

For instance, a manager may analyze the R&D, production, designing, assembling, and marketing costs in the manufacturing of a product. Competition analysis, financial analysis, and technological capabilities should be analyzed for outsourcing decisions.

Choosing Make-or-Buy

Sometimes, cost analysis is insufficient to decide whether to make or buy the product. Factors other than cost also come into play in navigating the decision. These factors may differ from company to company and their significance to each firm.

For choosing a make decision the cost of manufacturing the product should be low compared to purchasing it from the external supplier. 

This cost should include all the costs of R&D, marketing, designing, etc. Also, other forces like loss of intellectual property, quality control, management, over-reliance on suppliers or very few suppliers available in the market, expertise, etc., are relevant.

A company may be influenced to buy a product because the company finds it cheaper to outsource or buy it from outside suppliers rather than manufacture it in-house. Other drivers, like low volume, demand, lack of expertise, etc., are relevant to the decision.

Therefore, a business has to analyze every factor carefully before deciding. A wrong decision may impact the company financially and its reputation and image in the market and in front of its customers.

Benefits of a Make-or-Buy Decision

Some of the advantages are:

  • It includes selecting the most efficient choice for manufacturing or purchasing a product.
  • The company uses the choice with the lowest cost, making it lucrative for the corporation.
  • The business also earns a competitive advantage. If the company decides to manufacture the product in-house, it can efficiently utilize its core competencies and have a competitive edge over others. It would increase the company's reputation, financial health, and brand image.

Drawbacks of a Make-or-Buy Decision

Apart from the advantages, some disadvantages include:

  • One negative is the potential for significant losses if the corporation makes a poor decision. If the company decides to manufacture the product but lacks the necessary competence, it will lose capital and resources, leading to an increase in expenses and damage its reputation in the market.
  • If the corporation chooses to outsource or buy from suppliers, it loses control over the product's quality.

Researched and Authored by Jason Luu | LinkedIn

Reviewed and Edited by Sakshi Uradi | LinkedIn

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