Page 323 - DMGT501_OPERATIONS_MANAGEMENT

Unit 14: Purchasing

14.2.4 Evaluating the Make or Buy Decision Notes

In the build-up of a product or service, there are some parts that the organization will create
internally, some parts, it may have no option but to purchase from outside, the other remaining
parts can be either made internally or purchased from suppliers. To decide whether a service or
good should be provided from inside the organization or it is to be purchased from suppliers,
management must ask the following questions:
1. Who has the technical capabilities to provide the good or service?
2. Who can deliver a quality product?

3. Who can make timely deliveries?
4. What costs are associated with each alternative?
A make or buy decision should be viewed as an investment decision. Very often, new equipment
or balancing equipment is required to manufacture the part in-house. Figure 14.2 provides a
framework of how such costs can be treated. Management should consider internal sources for
services or goods and evaluate these sources to the external sources with the same after thorough
analysis. One should be careful that there are no hidden costs when evaluating alternatives.
Internal sources should perform at the same high level expected from external suppliers.
The real cost of a purchased product is not the unit price, but the lowest final cost, which is the
lowest total cost to the buying firm. The lowest total cost includes the purchase price, transportation
and receiving costs, costs to rework defective products, and costs for special processing that
would not be necessary if another supplier were used. The lowest-final-cost objective relies on
the system view of the firm.

Figure 14.2: Investment for Make or Buy Decision

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