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Make-or-buy decision

Make-or-buy decision compares the costs a business can avoid by stopping in-house production against the purchase price from an external supplier.

Also known asoutsourcing decision

ByHoang TruongUpdated

FrameworkRelevant costing

See it move

Loading infographic...

The infographic is a two-column comparison table contrasting the make and buy options. The "Make (in-house)" column lists avoidable costs: variable cost €30 plus avoidable fixed cost €8, totalling €38 per unit. The "Buy (supplier)" column shows a purchase price of €40, making in-house production the cheaper option by €2 per unit. A note clarifies that unavoidable fixed overhead of €10 is excluded from the analysis because it persists regardless of the decision and is therefore irrelevant to the choice.

Where it fits
SubjectCost AccountingAdvancedTopicRelevant Costs & Decision-MakingAdvanced

The formula

LaTeX
Avoidable cost=VC+Avoidable FC per unit\text{Avoidable cost} = VC + \text{Avoidable FC per unit}

Variables

Variable manufacturing cost per unit ()
Fixed overhead per unit that genuinely disappears if in-house production stops ()

Allocated fixed overhead that persists regardless of the decision is excluded from the comparison.

LaTeX
Net advantage to make=PbuyAvoidable cost per unit\text{Net advantage to make} = P_{\text{buy}} - \text{Avoidable cost per unit}

Variables

External supplier's quoted purchase price per unit ()

Positive result → continue making internally; negative result → outsource to the external supplier.

Check yourself

PracticeCORE

Castellan GmbH currently makes a component in-house at €55 per unit, comprising €28 variable cost and €27 allocated fixed overhead. Of the fixed overhead, €19 per unit is unavoidable (a dedicated machine lease) and €8 per unit would disappear if production stopped. An outside supplier quotes €38 per unit. What is the correct decision?

Select an answer to check your understanding.