Question 39.1: Make or Buy Cost Comparison Suppose that the quoted price fo...
Make or Buy Cost Comparison
Suppose that the quoted price for a certain component from a vendor is $8.00 per unit for 1,000 units. The same part made in the home factory would cost $9.00. The cost breakdown on the make alternative is as follows:
Unit material cost per unit = $2.25 per unit
Direct labor = $2.00 per unit
Labor overhead at 150% = $ 3.00 per unit
Equipment fixed cost = $ 1.75 per unit
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Total = $9.00 per unit
Should the component be bought or made?
The vendor ’ s quote seems to favor a buy decision, but consider the possible effect on
the factory if the component is purchased. The equipment fixed cost is an allocated cost based on an earlier investment (Section 1.5.2).
If it turns out that the equipment is rendered idle by the decision to buy the part, then one might argue that the fixed cost of $1.75 continues even if the equipment is not in use.
Similarly, the overhead cost of $3.00 consists of factory floor space, indirect labor, and other costs that will also continue even if the part is bought.
By this reasoning, the decision to purchase might cost the company as much as $8.00 + $1.75 + $3.00 = $12.75 per piece if it results in idle time on the machine that would have been used to make the part.
On the other hand, if the machine can be used to produce other components for which the internal prices are less than the external quotes, then a buy decision makes good economic sense.