Make or Buy Decisions

Learning Outcomes

  • Create a report outlining the data to support a make or buy decision

Ok, so back in Module 11: Relevant Revenues and Costs we talked about the make or buy decision. This decision has several components. Hupana could make their awesome soles of the shoes they sell, or they can continue to buy them from the supplier they currently use. The supplier charges $5.00 per pair and is a great vendor! They deliver on time, and have excellent customer service! Hupana needs to look at the costs and make a decision.

Hupana Make or Buy Decisions Relevant Costs
Make Buy
Direct Materials ($2.50 per sole x 2000 soles) $5,000.00
Direct Labor (.1hr/hole at $20/hour) $4,000.00
Variable Overhead (.1hr/sole at $3/hour x 2000 soles) $600.00
Depreciation of Equipment (not relevant)
Allocation of fixed overhead (not relevant)
Cost of buying $10,000.00
Total Cost $9,600.00 $10,000.00
Difference in favor of making $400

At first glance, it looks like bringing the making of the soles in house would save Hupana money! The total costs to make them, is less than continuing to buy them. Remember the fixed overhead happens whether we make or buy the soles, thus that is not a relevant expense. Also, if you think back to the budget for Hupana, they already had the equipment purchased, so that is a sunk cost (a cost we can’t recoup no matter which decision we make), so again, it isn’t relevant to this decision.

There are other things  to think about though. Is Hupana missing another opportunity, such as adding a product line, by manufacturing in house? What about a potential learning curve to make them? The numbers don’t always tell the entire story, so management will need to look at all of the options before making this decision.

Practice Questions