Tool

to document and explain the hypotheses with objective elements and to be able to compare them

MAKE or BUY?

Choice planned in a broader strategic and organizational development horizon, or suffered?

BREAK-EVEN

What is the Quantity that makes the choice indifferent?

In a manufacturing company (but the same principles can also be applied in a service company) deciding whether to produce or turn to an external supplier is not an easy choice.

To simplify, we can think of a company that sells and markets a machine with a product development, industrialization and production structure.

Beyond a series of raw materials and components, which for obvious reasons of economy of scale or skills not present cannot be the subject of the evaluation (for example for small metal parts or hydraulic components) there may be some categories on which to concentrate the analyses.

Decisions can depend on different aspects, such as, for example:

  • quantities needed in a certain period;
  • the necessary skills;
  • the level of investments made or to be made;
  • production or procurement times;
  • transport costs;
  • the availability of alternatives;
  • belonging to a group of elements recognized as a distinctive critical factor;
  • the market context;
  • the need for flexibility;
  • the hypotheses of change of some variables (both internal and external) in the medium and long term.

The list shown is certainly not exhaustive, but it is useful for understanding that there are no mathematical formulas that can give a certain answer, decreeing the best decision to make.

A company that wants to be proactive and not be subjected to external conditions, it is useful to periodically start discussion processes that can help make investment and divestment decisions.

Every decision, especially if it has a strong impact on modifying the organizational structure, should be taken by activating subjects (internal, external) who can make a contribution, also supplementing the analyzes with objective elements.

The “Make or Buy” model

The model is in the series of “MAKE of BUY” and the break-even point is displayed through the BREAK-EVEN diagram.

Input

The first part of the template (sheet ‘Analysis’) allows you to enter the variables:

  • description of the item, component or semi-finished product;
  • period of time to which the analysis refers, year, quarter or month;
  • quantity;
  • production costs (from bill of materials) such as – for example – raw materials, direct labour;
  • variable production costs for the expected quantity;
  • part of the absorbed or eliminated fixed production costs;
  • total price in the case of purchase from an external supplier.

Calculations

In the section relating to the calculations, the costs in the two hypotheses are compared, evaluating the different trends as the quantities vary.

In the final part the draw quantity is highlighted.

Break-even diagram

In the example shown, you can see the variation in cost trends as the purchase price varies for 50,000 units:

Price = 8 Quantity = 15.150

Price = 7 Quantity = 26.700

That is, the more the purchase price is reduced, the smaller the gap separating the alternatives.

Model Limits

The model has limits dictated by some hypotheses which may not necessarily correspond to reality.

For example, the diagram expects the cost trend to be linear, but in reality, as volumes change, it could have a curvilinear or stepped trend. It should therefore be kept in mind that the differences highlighted must lead to significant deviations to justify a structural change.