Make Or Buy

Include only costs that change between producing internally and purchasing externally. Relevant amounts may include avoidable variable costs, avoidable fixed costs, the supplier’s price, and any opportunity cost from using internal resources. Allocated or unavoidable costs should not drive the decision when they remain unchanged under both alternatives, because they do not affect the incremental economic result.

Capacity determines whether internal production displaces another valuable use of resources. If unused capacity exists, the analysis generally emphasizes avoidable production costs versus the supplier price. When capacity is scarce, managers must also include the opportunity cost of the output or activity that could have used that capacity. This can make purchasing externally more attractive even when internal costs appear lower.

Financial comparisons may not capture quality, supplier reliability, or the degree of operational control. A lower quoted price could be less attractive if purchased output creates quality concerns or supply uncertainty. Conversely, outsourcing may be reasonable when an external supplier can provide dependable performance. These factors supplement relevant-cost analysis rather than replacing the cost comparison.

An allocated fixed cost may appear attached to internally produced output even though the cost will continue after production stops. Removing that amount from the analysis can create an overstated benefit from buying externally. Managers should separate avoidable fixed costs from unavoidable allocations, then compare only the amounts that differ between the internal and external alternatives.

First, identify the internal and external alternatives and establish the decision period. Next, list costs that change under each option, including avoidable variable and fixed costs, the supplier price, and opportunity costs tied to capacity. Compare the resulting amounts, then assess quality, reliability, and control before selecting the alternative that best supports the decision.

For a short-term sourcing choice, managers can compare the supplier’s price with the internal costs that would actually be avoided. Existing fixed commitments may remain relevant to operations but should not be treated as savings unless the decision removes them. The result helps evaluate whether purchasing frees capacity, reduces incremental spending, or creates a better use for scarce resources.

The approach can support decisions about products, services, outsourcing, and the allocation of limited production capacity. By distinguishing costs that change from costs that remain, accounting information helps managers evaluate operational efficiency and broader cost-management strategies. Including qualitative considerations also gives decision makers a more complete basis for judging supplier relationships and internal control over activities.