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7/29/2019 Engineerin Economics Chapter (Eng. Eco) 014
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By
Muhammad Shahid Iqbal
Module No. 14
Make or Buy Decisions
Engineering
Economics
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Introduction
Determination of whether it is more advantageous to makea particular item in house or to buy it from a supplier.
The choice involves both qualitative (such as qualitycontrol) and quantitative (such as the relative cost) factors.
The buy side of the decision also is referred to asoutsourcing.
Make-or-buy decisions usually arise when a firm that hasdeveloped a product or partor significantly modified a
product or part
is having trouble with current suppliers, orhas diminishing capacity or changing demand.
Issues like government regulation, competing firms, andmarket trends all have a strategic impact on the make-or-
buy decision.
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Cost considerations (less expensive to make the part)
Desire to integrate plant operations
Productive use of excess capacity to help absorb fixed overhead.
Need to exert direct control over production and/or better quality
Design secrecy is required to protect proprietary technology Unreliable suppliers or No competent suppliers
Desire to maintain a stable workforce (in periods of declining sales)
Quantity too small to interest a supplier
Control of lead time, transportation, and warehousing costs
Greater assurance of continual supply
Provision of a second source
Political, social or environmental reasons (union pressure)
Emotion (e.g., pride)
Criteria for Make
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Elements of the "make" analysis
Incremental inventory-carrying costs
Direct labor costs
Incremental factory overhead costs
Delivered purchased material costs
Incremental managerial costs
Any follow-on costs stemming from quality.
Incremental purchasing costs
Incremental capital costs
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Lack of expertise
Suppliers' research and specialized know-how exceeds that
of the buyer
cost considerations (less expensive to buy the item) Small-volume requirements
Limited production facilities or insufficient capacity
Desire to maintain a multiple-source policy
Indirect managerial control considerations Procurement and inventory considerations
Brand preference
Item not essential to the firm's strategy
Criteria for buy
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Cost considerations for the "buy" analysis
Purchase price of the part
Transportation costs
Receiving and inspection costs
Incremental purchasing costs Any follow-on costs related to quality or service
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Types of analysis followed in make or buy decision are as
follows:
Simple cost analysis
Economic cost analysis
Break even analysis
Approaches for make or Buy Decisions
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Simple Cost Analysis
Quantitative factors deal with cost. The quantitative effects of
the make-or-buy decision are best seen through the Relevant
Cost Approach.
For example, assume a firm has prepared the following cost
estimates for the manufacture of a subassembly componentbased on an annual production of 8000 units:
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The supplier has offered the subassembly at a price of $16
each. Two-thirds of fixed factory overhead, which represents
executive salaries, rent, depreciation, and taxes, continue
regardless of the decision. Should the company buy or make?
Simple Cost Analysis
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Economic Analysis
The following inventory models are considered to illustrate this
concept.
Purchase model
Manufacturing model
A basic problem for businesses and manufacturers is, when
ordering supplies, to determine what quantity of a given item to
order. The formula for Purchase model (EOQ) and TC for each
model are given as:
1
02
c
C DQ
C
0 1
1 2
cDC Q CTC DP
Q
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Manufacturing model
Economic Analysis
2
02
(1 / )c
C DQ
C r k
0 2
2
( )2
c
DC QTC DP C k r
Q k
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Break Even Analysis
In economics & Business the break-even point (BEP) is the point at
which cost or expenses and revenue are equal: there is no loss or gain
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Break Even Analysis
Break-even point (BEP) is the point at which cost or
expenses and revenue are equal: there is no net loss or
gain. The main objective of break-even analysis is to find
the cut-off production volume from where a firm will
make profit.
cos / cos /
FCBEP
Selling t unit Variable t unit
FCBEP X
P V
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