Assessing the Make option

1. Assessing the Make option

Welcome to the final chapter of this case study. We are finally ready to incorporate the make side of the decision.

2. Internal cost estimates

Just like with the buy option, it is important to calculate the full cost of production when considering the make option. In the Buy option, our data were quotes from suppliers. In the Make option, we will use internal estimates. Internal estimates are similar to quotes because they have the expected unit cost and enough information to calculate upfront investments. Unlike quotes from external suppliers, internal estimates are not binding offers. If the cost of production changes, your company still has to absorb those costs.

3. Internal estimate data - Cost per Unit

Internal Estimates include unit costs - which are comprised of raw materials, energy costs, and labor costs. These are costs that increase for every additional unit we produce.

4. Internal estimate data - equipment data

Internal Estimates also include data about the equipment used to manufacture the parts. Depending on our existing machine capacity and production demand, we may or may not need to invest in new manufacturing equipment. The internal estimates include the equipment model number, the manufacturing capacity of each machine, the existing available capacity, and the cost of an additional piece of equipment. Note that the capacity for each machine is different for each part. If production demand exceeds existing capacity, we need to include the cost of new equipment in the full cost for the Make option.

5. Incremental equipment costs

For the Make versus Buy decision, we should only consider the incremental costs of our decision. Incremental costs are new costs introduced by our make-or-buy decision, not sunk costs that exist before the decision. If we already have a piece of manufacturing equipment, its cost should not be considered incremental to the Make versus Buy decision.

6. Pizza example

Like with most things in life, incremental costs are easier to understand with pizza. Let’s return to the question of whether to buy pizza or make it on your own. Let’s assume you already own one oven. To make one pizza, you need to buy dough, cheese, and sauce. These costs should be included in your full cost. You already have an oven, so that is a sunk cost and should not be included.

7. Pizza party example

Now let’s imagine you want to have a party serving ten pizzas for friends. Your full cost now includes ten pizzas worth of dough, cheese, and sauce, but your single oven might not be able to make ten pizzas quickly enough. You may also need to buy or rent another oven to meet the demand. The cost of this second oven is an incremental cost and should be included in the full cost of the Make option. You may need to hire someone to help make ten pizzas, or your friends can help out.

8. Other types of incremental make costs

While our incremental costs in this course focus on equipment investments, incremental costs can also include other costs such as facilities and hiring new salaried employees. If the current staff and facilities can handle the new production requirements, there is no need to include their cost in the full incremental cost for the make decision.

9. Calculating investment required

The full cost for the make option is similar to the buy option. The full cost is the extended cost plus any incremental investment cost. In this course, we can calculate our required investment cost by looking at our existing capacity versus the expected production volume. If the expected production volume exceeds the current capacity, we must include the incremental investment cost in our full cost calculation.

10. Equipment needed formula

To calculate the number of machines required to purchase, we subtract our existing capacity from our production volume, then divide the remaining volume by the equipment capacity of a new machine.

11. Equipment needed formula

Note that we have to round up to the nearest whole machine because we cannot purchase half of a piece of equipment. We can use the DAX ROUNDUP() function to round to the next whole number.

12. Let's practice!

Let's use this to calculate our make full cost and finish up our make versus buy tool!

Create Your Free Account

By continuing, you accept our Terms of Use, our Privacy Policy and that your data is stored in the USA.