Make or buy: compare the costs that actually change

A make-or-buy analysis compares producing a component or service internally with purchasing an equivalent result. Start with the same specification, usable quantity, delivery requirement, and review period. Then identify the costs and revenues that change. An internal unit cost that includes allocated overhead may be useful for reporting but can mislead a sourcing decision if those overhead costs will continue after outsourcing.

ACCA's relevant-cost guidance focuses on future cash flows changed by a decision, including opportunity costs where applicable. Its cash-flow guidance distinguishes those amounts from sunk and continuing commitments. Apply that discipline to the actual operating choices. Finance needs evidence from production, procurement, and the people who control the resources being discussed.

List materials, variable labor where genuinely variable, consumables, utilities, supervision, maintenance, and other production costs. Ask what will stop, by how much, and when if the work moves outside. A supervisor's allocated salary will not disappear if the person continues managing other work. A dedicated external contract may be avoidable only after a notice period or termination payment.

Record the action required to realize each saving. If management intends to redeploy staff, identify the new work and any additional benefit rather than treating their existing salary as a cash reduction. If equipment can be sold, support the proceeds and timing. If it will remain idle, keep the ongoing ownership cost visible in the company forecast.

Add freight, inspection, minimum orders, setup, tooling, inventory holdings, expected losses supported by evidence, and any internal work retained. Identify who owns materials, intellectual property, and rejected units. Compare payment terms with the internal production cycle. Paying a supplier before delivery can increase the cash requirement even when the quoted unit price is lower.

Review the supplier's capacity and the company's ability to recover if supply stops. A second source, retained internal capability, or buffer inventory can have a real cost. Include the supported cost of the chosen protection in the comparison. Avoid assigning an arbitrary probability or failure cost just to make the preferred option win.

Budget the transition separately from the steady operating year. Trial batches, supplier qualification, duplicated production, and staff training may require spending before any internal cost stops. Give the transition a completion condition so that a temporary overlap does not quietly become a permanent additional cost.

Assume a hypothetical annual requirement of 30,000 usable units. Internal variable cost is $8 per unit and $40,000 of fixed cost would be avoided by outsourcing. The relevant internal cost is $280,000. A supplier charges $11 per unit, and retained incoming inspection costs $10,000, giving a purchasing cost of $340,000 before other differences.

Assume another $60,000 of allocated company overhead continues under both choices. It does not change the $60,000 cost advantage of internal production in this simplified comparison. The figures are illustrative; actual labor behavior, quality, payment timing, tax, and volume assumptions must be established before a decision.

Now suppose outsourcing would free a constrained resource for another product that could generate $90,000 of additional contribution after its incremental costs. Under that further hypothetical assumption, the $60,000 purchasing disadvantage is offset by the $90,000 opportunity, leaving a $30,000 economic benefit. The result depends on the new demand and the actual bottleneck being released.

Test whether another constraint will prevent the extra output, whether customers will buy it, and whether the contribution already appears elsewhere in the forecast. Spare capacity with no supported alternative use does not create the same opportunity benefit. Keep a base case without the opportunity and a separate case with the evidence-supported alternative.

Present the cost comparison, cash timing, supplier obligations, quality requirements, and assumptions that change the preferred option. Define a trial or acceptance process where useful, with actual product specifications and a way to measure defects and delivery. Identify what remains in-house and who will own supplier performance after the change.

Retain the original calculation and compare actual delivered cost, usable units, working capital, and realized savings after implementation. If allocated costs remain, report them honestly rather than moving them to other products and calling the outsourcing saving complete. The company should be able to identify the payments, capacity, and operating responsibilities that actually changed.