Generally, four important issues merit attention in all purchasing decisions, quality, quantity, cost and service. These basic issues, as they affect the make-or-buy decision, would be elaborated to give a proper perspective.
Compare the quality of the purchased item and the quality that the company could have achieved had it made it on its own. If there is no possibility of a very wide variation, quality considerations do not weigh in making a make-or-buy decision.
Absence of quality desired or in the market may indicate a situation where suppliers have not enough it worthwhile to make it considering the meager, non-recurring demand for it. So economic viability of producing the desired item should also be considered by the manufacturer who takes a ‘make’ decision.
If the specifications of the engineering department regarding quality are more fastidious than necessary for the proper operation, or expected life for commercial standards of the item, there is room for relaxation in the specifications so that the purchase of the item as available from outside becomes possible. However, this is a matter of expert review involving value analysis.
Unpatented designs or processes are generally not entrusted with outsiders to protect business interests by preventing others copying them for a prolonged period of time.
Buying from outside have several reasons:
1. To take advantage of specialized activity of the buyer.
2. To take advantage quality resulting from patterns or production methods that the supplier controls.
3. To introduce flexibility with respect to quality of the part being purchased.
Quality and quantity considerations differ with reference to one important issue – Quality is fairly specifiable whereas it is not so with quantity. Quantity is always in a state of flux and it is related with time element. The correct quantity under given condition at a given time may not be valid at another time under changed circumstances. How much to buy – quantity is a variable whereas, what to buy – assortment – is not.
Considering upon the basis of quantity, the make decision is taken when the supplies are likely to be too small to interest an outsider. However, it should be considered whether the order can be made large enough to interest outsiders or a corresponding large inventory can be maintained to meet production needs. It is also seen if sundry small use items can be ordered with common specifications.
Cost has relevance in make-or-buy decisions when all other factors are equal, or else reasonable cost estimates of the variations should be included to make up for any inequality.
The estimation of the cost accurately becomes difficult when overhead costs are to be allocated on an item that is made in the plant from the Materials and on the machines being used for other items. If the item is such as stands out in a class by itself, the overheads are easy to allocate.
A plant with excess capacity can increase production by merely adding incremental costs that are variable in nature. A plant working at capacity, however, can give additional output only by increasing its capacity, thereby adding incremental costs of both fixed and variable nature. BEC (break-even-chart) would make the point clear.
A firm raises its output from 100 to 110% incurring thereby incremental costs of Rs 30 (Rs 120 to Rs 150 per unit) as a result of increase in fixed and variable costs. However, the same firm could have raised its output from 70 to 80% and incurred incremental costs of only Rs 8 per unit (Rs 91 to Rs 98) since the latter output range keeps fixed costs constant and increases merely direct costs.
When the plant works below capacity, the cost of making should be determined by dividing the estimated volume into the increased variable costs. The purchase decision then would be taken for the item if its unit purchase cost equals or is less than the unit increase in variable costs. At any higher price, the decision is in favor of making, because it would be contributing something towards overhead costs.
The plant operating at capacity presents a different situation. The options now open are to expand the facilities or go in for an outside purchase. In such a situation it is right on the part of the company to purchase from outside at any price less than the unit total costs making the item. If the requirement is meager, the buyer may even be justified in paying an enhanced price rather than committing funds to expansion of facilities that may be left partly utilized and partly unutilized.