The Make Or Buy Procurement Decision

PurchTips - Edition #88 November 15, 2005

By Charles Dominick, C.P.M., SPSM

How Do You Know When To Outsource?

Are we outsourcing enough? What functions can we move to China? Are we doing business with India yet?

It is likely that a procurement manager somewhere is being asked these questions right now. Executives have noticed their peers increasingly relying on outsourcing.

While outsourcing may seem new, it really is just a new focus on the classic make or buy procurement decision. You need to ensure that such decisions are made intelligently and not just based on the outsourcing trend.

When dealing with a make vs. buy decision, there are four numbers you need to know:

1. Your volume
2. The fixed costs associated with making (e.g., the tooling that must be bought)
3. The per-unit direct costs of making
4. The per-unit landed cost from a supplier

So, you plug these numbers into a couple of formulas:

CTB = V * LC    and    CTM = FC + (PUDC * V)

Where,

CTB = Cost To Buy

V = Volume

LC = Supplier's Per Unit Landed Cost

CTM = Cost To Make

FC = Fixed Costs (of making)

PUDC = Per Unit Direct Cost (of making)

If CTM exceeds CTB, then it is more financially desirable to buy. If CTB exceeds CTM, the opposite is true. Practice by using the Excel template at http://www.NextLevelPurchasing.com/make.xls .

Make/buy decisions aren’t just about numbers, though.

Questions you absolutely must consider include:

• Is this the organization’s core competency?
• Could we be harmed by disclosing proprietary information?
• What will be the impact on quality or delivery?
• What additional risks would we be facing?
• How irreversible is the decision?

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