Direct answer
A make-or-buy analysis compares the future costs and consequences that change between internal production and external supply; allocated costs that remain either way are not automatically savings.
What this calculation tells you
Make-or-buy analysis structures a sourcing decision rather than merely comparing a quoted price with a fully allocated internal cost. It distinguishes avoidable cash flows from sunk or continuing commitments.
The cheapest modeled option can be unacceptable when it creates single-source exposure, intellectual-property risk, poor quality or slow response.
Where it is used
Manufacturing
Compare component production with supplier quotes and capacity alternatives.
Professional services
Evaluate internal staff, contractors and specialist providers.
Technology
Compare owned infrastructure or development with external services.
Hospitality and retail
Assess in-house preparation, logistics or support against vendors.
When this guide helps
- A supplier quote is below allocated internal cost.
- Internal equipment has no alternative use.
- Outsourcing requires inspection and freight.
- Demand uncertainty favors a flexible external arrangement.
Remove costs that do not change
Allocated rent, depreciation or management cost may remain after outsourcing. Include only avoidable amounts in the financial difference while showing the full reporting impact separately.
Value capacity honestly
Freed capacity has opportunity value only when a feasible alternative use exists. Bottleneck relief can be valuable even if total facility cost remains.
Add supplier and transition economics
Include freight, duty, tooling, minimums, inspection, defects, inventory, contract management, switching and termination costs over the decision horizon.
Keep nonfinancial constraints explicit
Quality, resilience, control, knowledge, labor, compliance, confidentiality and strategic flexibility require documented assessment beyond the calculator.
- Use future cash flows.
- State volume scenarios.
- Model transition time.
Worked case: 10,000 units
Make variable cost is 8/unit plus 20,000 avoidable fixed cost; supplier price is 11/unit.
Make=100,000; buy=110,000.
Making is 10,000 lower under entered avoidable costs.
Unavoidable allocated overhead should not be counted as savings.
Reproduce this worked caseOpen Project Profitability Calculator
Worked case: 5,000 units
Use the same costs at half volume.
Make=8x5,000+20,000=60,000; buy=55,000.
Buying is 5,000 lower at this volume.
Capacity value, quality, lead time and supplier risk still need separate evidence.
Reproduce this worked caseOpen Project Profitability Calculator
make-or-buy analysis: compare assumptions, not just answers
The simple cost crossover is 20,000/(11-8)=6,667 units. Treat nonfinancial constraints and alternative use of capacity explicitly.
| Scenario | Key input | Decision output |
|---|---|---|
| 10,000 | Make 100 thousand; buy 110 thousand | Make lower by 10 thousand |
| 5,000 | Make 60 thousand; buy 55 thousand | Buy lower by 5 thousand |
make-or-buy analysis: calculation checklist
- Avoidable costs only
- Same specification/quality
- Volume and horizon matched
- Capacity opportunity included
- Supplier risk separate
Practical questions
Frequently asked questions
Should fixed overhead be included?
Only the portion that changes because of the decision is relevant to the incremental comparison; continuing overhead remains visible elsewhere.
Is the lowest supplier quote the buy cost?
No. Landed, quality, inventory, administration and risk-related costs may also change.
How should idle capacity be valued?
Use an evidenced alternative contribution or cost avoidance, not an assumed opportunity that cannot be realized.
Further reading
Authoritative sources
Use these primary and professional resources to check definitions, conventions, or requirements that may extend beyond this guide.