Outsourcing
Decide which activities to keep in-house or place with suppliers, weighing relevant costs and capabilities alongside quality, capacity and delivery.
Compare equivalent acceptable parts over the same period
Compare equivalent acceptable parts over the same period
Outsourcing means arranging for an outside supplier to carry out work for the business rather than doing it internally. The work may be making a component or providing a service. A make-or-buy comparison is one application of that broader decision.
A core competence is a capability central to what the business does particularly well. Outsourcing may free resources to focus on those strengths, but it also makes the business depend on suppliers for the work they perform. Compare costs alongside capacity, quality, delivery and capabilities worth retaining. See OpenStax: Outsourcing and core strengths.
Make means produce internally; buy means purchase from a supplier. Define quantity, specifications and delivery date before comparing options. Use Manufacturing Cost and Volume for an initial cost comparison.
Include avoidable setup, tooling, material and processing for make; purchase price, freight, incoming checks and expected rework for buy. Compare costs that change with the decision. Shared rent that remains after outsourcing is not automatically a cash saving.
Start here: decide which future costs change between the two routes, then compare their totals. A relevant cost changes with the choice. An avoidable cost is removed by choosing the other route; a sunk cost has already been incurred and cannot be recovered. Fixed, direct and allocated describe costs, but those labels alone do not establish relevance.
Why the cost boundary matters
Reassigning unchanged overhead does not create a saving. Additional fixed spending can be relevant, and a benefit sacrificed by using a resource is an opportunity cost. See ACCA: Relevant costs and OpenStax: Relevant information for decision-making.
Worked case: which costs change for 100 parts?; Practice
Worked case: which costs change for 100 parts?
This original hypothetical order needs 100 acceptable brackets delivered within one month. All amounts below are illustrative dollars, not supplier prices or facts about a particular shop. For the numeric comparison, assume both routes supply the same specification and acceptable quantity by that deadline.
Making needs a new $300 setup and $9 per acceptable part ($6 material plus $3 additional processing). Buying needs a $10 per-part quote, a separate $0.50 incoming check per part, and $100 freight for the order. The quote excludes those checks and freight. These are future payments incurred only for their respective routes.
The $600 shared rent for the month is paid unchanged either way. A $200 study was paid for last month and is irrecoverable. Assume spare internal capacity, no displaced work or alternative income, and no other route-dependent costs or credits. These are case assumptions; spare time alone does not establish that opportunity cost is zero in a real decision.
Predict before reading the totals: does making's lower per-part charge outweigh its new setup at this quantity? Which two amounts should be excluded from the relevant-cost totals?
| Cost and treatment | Make | Buy |
|---|---|---|
| New setup: avoidable if buying | $300 | $0 |
| Material + additional processing: $9 × 100 | $900 | $0 |
| Supplier quote: $10 × 100 | $0 | $1,000 |
| Separate incoming checks: $0.50 × 100 | $0 | $50 |
| Freight: once per order | $0 | $100 |
| Shared rent: $600 either way, excluded | — | — |
| Past study: $200 irrecoverable, excluded | — | — |
| Total relevant cost | $1,200 | $1,150 |
Here “—” means excluded from this comparison, not a zero expense. Make = $300 + $900 = $1,200; buy = $1,000 + $50 + $100 = $1,150. Buying is $50 lower under the stated assumptions. The new setup matters even though it is fixed for this order: buying avoids it. Adding the unchanged rent to both sides would leave the $50 difference unchanged; adding it only to make would invent a saving.
For a quantity sensitivity check, use the existing Manufacturing Cost and Volume explorer with A as make ($300 setup, $9/part) and B as buy ($100 order freight, $10.50/part). Identify relevant costs first; the explorer cannot decide which costs belong. Do not add freight or checks again after including them in those inputs.
Practice: include the avoidable setup Practice: count buying charges once
A cheaper quote can still be the wrong choice; Practice
A cheaper quote can still be the wrong choice
| Factor | Question |
|---|---|
| Capacity | Is machine and staff time available? What other useful work would be displaced? |
| Quality | Can each route meet the specification consistently, and how will it be verified? |
| Lead time | Can the route deliver when needed, including queues and transport? |
| Core competence | Is this capability central to what the organization does well and needs to retain? |
| Risk | What happens if demand changes, a supplier fails or the design changes? |
Standard parts often favor buying; distinctive capabilities may favor making. Neither is a rule based on volume alone.
The worked case establishes a conditional cost difference. It does not verify a supplier's quality, available capacity or delivery promise. Before committing, obtain evidence that each route can meet the requirement. If making displaces another useful job, include the benefit given up; if buying adds rework, expediting or other costs, revise the ledger. See OpenStax: Make or buy a component for avoidable fixed costs and the qualitative checks alongside the numeric analysis.
Check assumptions before committing resources; Checklist; Practice
Check assumptions before committing resources
- Define matching requirements, quantity and timing.
- List relevant costs and identify charges already included in rates.
- Check capacity, quality evidence, lead time and supplier dependence.
- Repeat the comparison at lower and higher plausible demand.
- Record what would change the decision.
Review Design for Manufacturing before treating a costly design as fixed.