CIMA BA2 Syllabus D. DECISION MAKING - Make or Buy - Notes ^{3 / 4}

If Spare production capacity is available

So here we have spare room to MAKE more products, therefore...

• Production resources may be idle (if the component is purchased from outside)

• Fixed costs are irrelevant (because we won't need any extra fixed costs)

• So just consider the variable costs of MAKING compared to the purchase cost of BUYING

Decision

1. Buy

   If buying price < the variable costs of making

2. Make

   If buying price > variable costs of making

No spare capacity available?

So we need to buy more space or stop making something to create space

• Stopping making something to create capacity causes lost contribution

• So compare the contribution lost + extra costs of MAKING to the purchase price of BUYING

Decision

1. Buy

   if relevant costs of making > Purchase price

2. Make

   if relevant costs of making < Purchase price

For Example, if we can make something for $100 and buy it for $120, then obviously we should make it.

However, if we bought it in, we would free up our staff and then the staff could make an item with a contribution of $50, so this now becomes a relevant cost.

So the relevant costs are:

Making cost $100 + $50 (Contribution lost because we did not have enough space to make the other product) = $150 
Buying cost $120

Therefore, now we should buy it.

Always look at relevant costs when considering making or buying

Illustration - Make

Product A has:

Variable cost $5
General Fixed cost allocated to it $4 
Total cost $9 

We can purchase this externally from a supplier for $8

Should we make or buy?

Solution

The relevant cost of Product A is only the variable cost of $4, therefore this compared with the external price of $8 is cheaper, and therefore it should be made.

Illustration - Buy

Product A has:

Variable cost $5
Specific fixed cost for product A $4 
Total cost $9 

We can purchase this externally from a supplier for $8

Should we make or buy?

Solution

The relevant cost of Product A is now $9 as the fixed cost is specific to product A, therefore this compared with the external price of $8 is more expensive, and therefore it should be bought from the supplier.

Non Financial Considerations of Making or Buying

1. Do not buy in your strengths. 

   Use your own strengths, for example, Apple does not get anyone else to make their phones, because that it was they are good at.

2. Quality or Reliability need to be considered if we are buying, if they are not up to the mark, better to make it even if it is more expensive to do so.

Illustration

Craft Ltd makes four components A, B, C, and D and the associated annual costs are as follows:

SOLUTION

Therefore only buy in component A as this is the only one which makes a saving if bought in