The Make or Buy Decision

I have been asked this question a fair amount of times so I am going to write about it in this blog. The make or buy decision can be a complicated one but in the kaizen/kaikaku life we make it much simpler.
One of the key decisions a company will face (strategically and at the operations level) is what to make in house and what to purchase (buy).
Factors to consider in a make or buy decision include cost, time, capacity utilization, control of production/quality, design secrecy, supplier reliability and technical expertise, volume, and workforce stability.
I think its best to use a concrete, real life, example of a business I worked with in the past.
 Original Data:  Produce 10,000 units
  Cost Factors:    Raw Materials $9,000
                           Direct Labor   $12,000
         Variable factory overhead $5,000
           Fixed factory overhead   $24,000
    Total Cost to Make:    $50,000
Now it is best to break this figure down into price per unit for comparison purposes.
        $50,000/10,000 = $5.00 a unit
The price to purchase is $4.50 a unit
The question is should you buy it or purchase it?
On its face the answer is easy. Purchase it for a saving of $.50 a unit! But hold on!! There are some factors you need to consider.
1. You only avoid 80% of the variable factory overhead costs.
2. You only avoid 10% of the fixed factory overhead costs.  
So now what?
Solution:
Total Cost to make:                        $50,000
Less cost avoided:
                                Raw Material $9,000
                                Direct Labor  $12,000
 Variable Overhead (5,000*.80) = $4,000
 Fixed Overhead (24,000*0.10) = $2,400
Total Avoided Cost:                =$27,400
Cost Not Avoided:                    = $22,600
Plus Cost to Purchase                = $45,000
Total Cost To Purchase        =  $67,600         
   Compare this to the cost to make at $50,000
So, the increase in cost to purchase would be 17,600! or 67500/10000 = $6.75/unit!

The winner is Make it!!! If you don't you will lose $1.75 per unit!

The major thing in the make or buy decision is what are the avoided costs? However, if a company has
poor vendor relationships or trying to keep product secrecy, than the decision becomes much more qualitative.

Computing the numbers is a good baseline for the decision but it should never be based on numbers alone. Time to customer, quality controls, supplier reliability, and workforce stability can all nullify the $1.75 savings.
To illustrate this point, remember the true saying that it costs 5-10 times more to acquire a customer than to keep one; therefore, customer satisfaction will always be the x factor!

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Baka Yoke, One Piece Flow - Sore Dewa Mata!