Make or Buy Decisions: Meaning, Factors, & Examples for UGC NET

A make or buy decision is a strategic choice regarding whether to produce a product or service in-house ("make") or purchase it from an outside supplier ("buy"). It will involve a thorough cost-benefit analysis of several criteria including cost, resources, strategic implications, and possible risks. Companies regularly require different products and services for operations. It can be raw materials for production. Services may consist of marketing or web development. The company can complete these tasks by hiring people or in-house. But there's the option to complete these tasks or get goods externally. That's where the make or buy decision happens. Companies can decide with make or buy decision factors to understand what will be beneficial. In the end, the costs and subsequent profits are prioritized.

Make or buy decision analysis should be on your list for the UGC NET Commerce exam. It covers important commerce topics. The make or buy decision exam questions are often present in this exam. 

In this article, we will cover what do you mean by make or buy decision. Also, find details to define make or buy decision, make or buy decision example problems, and make or buy decision advantages and disadvantages.

In this article, learners will know the following topics:-

• What is Make or Buy Decision?
• How do Make or Buy Decisions Work?
• Types of Make or Buy Decisions
• Flowchart of the Make or Buy Decision Process
• Analysis for Make or Buy Decision
• Make or Buy Decision Criteria Framework
• Make or Buy Decision Example
• Factors Considered for Make or Buy Decision
• Advantages of Make or Buy Decision
• Disadvantages of Make or Buy Decision

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What is Make or Buy Decision?

Companies have a choice when there's a need for products or services. They can either manufacture themselves or hire someone else. This decision of whether to make a product or service in-house or buy from an external supplier helps explain make or buy decision.

• The factors affecting make or buy decision includes quantitative analysis. It means that the company evaluates what is better with cost analysis.
• The benefits of manufacturing in-house are compared with buying from outside. The make or buy decision meaning includes all production costs.
• Services required by a company can also be outsourced. There might be specialized firms offering better value than completing the production in-house.

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Fig: make or buy decisions

Example 

Understand what is make or buy decision with example by reading below.

• Suppose a clothing company wants to venture into the online space. It requires a website for this task.
• The make or buy decision company example is to build the website by hiring employees or using an IT services firm.
• Completing the task will require interviewing employees, hiring costs, and benefits. Also, it will take more time unless the company hires a team. But, the benefit will lead to better privacy and security. The company can build a team for website maintenance as well.
• Outsourcing this task to an IT company may complete the task quickly. There will be more professionals with the firm. But, the company's privacy will be at the hands of another firm.
• This example of make or buy decision requires the company to analyze the costs of this service and future expenses. The affordable method will be viable if the company wants to lower production costs.

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The make or buy decision in marginal costing may only focus on the involved costs. But, companies can also include the qualitative factor. Either way, the make or buy decision works by adding up every involved cost in both options.

• The company must include every production expense if it decides to make the product. It includes raw materials, transfer pricing costs, labor, machinery, storage costs, overheads, transportation, and taxes. These costs should total up to arrive at the capital the company needs.
• The buying decision must analyze capital requirements, time factors, storage, transportation, and quality checking costs. The benefits involved with in-house production are higher margins. The company won't have any profit, leading to lower costs. Buying from someone else will always include a profit margin for that firm.
• Outsourcing will require a lower requirement. The company doesn't have to set up a production unit. But, these costs should be compared with various sellers to determine the most affordable option.

The make or buy decision works after analysis of these different factors by the company management.

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Types of Make or Buy Decisions

No make or buy decision is ever identical for every situation. Adaptable to the necessity of the business, the type of urgency, and the strategic surrounding context, they also differ somewhat in form. The enterprise would, therefore, encounter some major types of decisions classified as follows:

Strategic Make or Buy Decisions

Such long-term decisions coincide with core mission or capabilities of the company.

• For example, a tech company reaches a decision to make security software in-house always to safeguard proprietary information.
• Generally relates to critical components or services impacting the competitive advantage of the company.
• Used when: Competitive positioning or IP is in question.

Tactical Make or Buy Decisions

This type takes short- to medium- term decisions that usually depend on immediate capacities, costs, or availability of resources.

• For example, a company may outsource manufacturing temporarily because there are equipment maintenance problems or labor shortages.
• Such decisions are reversible and usually taken to tackle supply chain fluctuations or sudden demand increases.
• Used when: Temporary or stop-gap decisions are made.

Single-Time Make or Buy Decisions

These are one-off or non-recurring decisions.

• For example, a company conducting a one-time marketing campaign could choose to outsource the creative work.
• Such decisions are usually project-specific and do not influence the long-term production strategy.
• Used when: Handling one-off requirements or short-term projects.

Recurring Make or Buy Decisions

These are decisions that recur after intervals-perhaps monthly, quarterly, or yearly.

• A retail chain could, for instance, decide every quarter on whether to make its in-store signage in-house or outsource it to someone else.
• Reassessments occur regularly to match internal costs against market price trends or vendor performances.
• Used when: Costs or vendor conditions change periodically.

Capacity-Based Make or Buy Decisions

This arises whenever a company reaches or surpasses what its production capacity can handle.

• If internal resources cannot keep up with the load, the business can buy externally until expanding its capacity.
• It mostly relates to facility limitations, labor shortages, or seasonal peaks.
• Used when: Internal capacity cannot meet demand.

Outsourcing Core vs Non-Core Activities

Certain organizations distinguish core activities (they make) from non-core (they buy).

• For example, an auto manufacturer may make engines but purchase tires from suppliers.
• This raises concentration on the core competencies and efficiency in other areas.
• Used when: Differentiation between strategic and supporting functions.

Flowchart of the Make or Buy Decision Process

The flowchart outlines key steps—identifying needs, evaluating capacity, comparing costs, and making a final decision. It simplifies complex decision-making into a visual and structured process.

Fig: make or buy decisions

• Identify need: Establish whether or not a product or service is necessary to meet operational or strategic objectives.
• Assess Internal Capabilities: Check if your company has the resources- labor, time, infrastructure-to make it internally.
• Estimate Internal and External Costs: Compare the cost of in-house production vs purchasing. Include all direct and indirect costs.
• Evaluate Qualitative Factors: Factors such as quality, lead time, control, confidentiality, and scalability play a key role.
• Make the Decision: Choose the most viable option considering both cost and qualitative outcomes.
• Implement the Decision: Start internal production or finalize the procurement deal, based on the chosen route.

Analysis for Make or Buy Decision 

The make or buy decision requires detailed analysis by the company. The following details are present in the make or buy decision analysis.

Quantitative Analysis 

The company should follow the below-mentioned measures for quantitative analysis.

• The primary analysis factor is the costs. The company must determine and estimate its cost to make the product or service. It must include setting up production units, machinery, leases, labor, raw material, etc. These primary costs help them understand the average production charges.
• Buying requires checking logistic costs, warehousing, transportation, and company charges.
• Quantitative analysis requires checking and comparing these costs to arrive at the make or buy decision.

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Qualitative Analysis 

The company should follow the below-mentioned measures for qualitative analysis.

• The company should also check if it can handle production. The decision becomes simpler if it doesn't have the resources.
• If the company is already incurring fixed costs, it will benefit from in-house production.
• Other qualitative measures include privacy and security for the company.

Make or Buy Decision Criteria Framework

Not only is the cost parameter attached to the make or buy decision, but also a spectrum of strategic, financial, operational, and qualitative factors will define them. Companies create a Make or Buy Decision Framework to assess both possibilities against each other. This exercise enables objective decision-making based on evidence rather than intuition. Below is a comparative decision table that serves as guidelines for this process.

 Make or Buy Decision Matrix (Table Format)

How to Use This Table for Decision-Making?

1. Assign weightage to each criterion based on the company’s goals.
2. Score both Make and Buy options on a scale (e.g., 1 to 5) under each factor.
3. Multiply the score by weight, and total both columns.
4. The higher total score indicates the preferred option.

This model is widely used in cost accounting, operations management, and strategic planning, making it highly relevant for UGC NET Commerce preparation.

Make or Buy Decision Example 

Let’s consider the following make or buy decision example problems: 

Suppose a toy company wants to decide whether to make products by itself in India or outsource to China. The company's specialization is design. The manufacturing charges per unit come out to be ₹100 in India. It includes variable, fixed, and all other costs.

The per unit cost in China is ₹80. This cost includes all logistics, production, and storage costs. Clearly, the company will make a higher profit by outsourcing production. The products will be shipped back to India for sale. The make or buy decision will be simple if the company only wants to lower production costs.

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Factors Considered for Make or Buy Decision 

Companies assess cost, production capacity, manpower, fixed costs, and supplier availability. These factors help determine whether internal production or outsourcing offers better value and feasibility. Find below the factors influencing the make or buy decision.

Production Volume

A higher production volume will be beneficial when the company manufactures the product. It will lead to economies of scale and lower costs. If only a few units are needed, buying will be beneficial.

Cost Analysis 

The make or buy decision has the primary cost factor. If it is cheaper to make the products, including all production charges like labor, transportation, raw material, overheads, etc., the company should make them. If it results in lower buying costs, the company should outsource.

Production Capacity 

If the company already has the production capacity, it is better to make the products. The fixed costs will still incur. That's why the production capacity should be utilized for making the products.

Manpower Availability 

The company shall analyze manpower availability for the make or buy decision. If there is an easy availability of skilled people, it may be favorable to make the goods. The opposite will require buying decision by the company.

Security And Privacy 

If the company deals in private data, it is better to manage in-house production. It will help avoid any risks and keep the company data safe.

Fixed Costs 

If the company has lower fixed costs for production, it is better to make the products. The company should buy if the costs are higher.

Availability Of Sellers

The company should have access to competent sellers with high-quality goods for buying decisions. If there are no sellers, the company can only make the products.

Quality Concerns

The company should check the product qualities before outsourcing to a seller. It will be better to manufacture goods if the quality is not up to company standards.

These are some of the factors influencing make or buy decision.

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Advantages of Make or Buy Decision

This decision helps optimize cost, improve focus on core activities, and enhance resource use. It enables strategic planning and increases operational efficiency. Read below to learn the advantages of the make or buy decisions.

• Efficient model: The make or buy decision helps choose the most effective model. It helps weigh the pros and cons of making and buying.
• Business strategies: The company can base the strategies based on make or buy decisions. 
• Better decision-making: The company's analysis on make or buy decisions helps make better decisions. These factors affect the company's growth.
• Lower costs: The company can choose the most affordable option through the make or buy decision.
• Focus on core competency: The company can focus on core competencies by outsourcing services to different firms.

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Disadvantages of Make or Buy Decision 

Potential drawbacks include loss of control, quality risks, and dependency on third parties. Wrong choices can lead to higher long-term costs and reduced flexibility. Read below to learn some of the limitations of the make or buy decision.

• Cost Considerations: In-House Costs: Making a product or providing a service internally may involve high initial setup costs, including equipment, labor, and training expenses. These costs can impact the overall profitability of the venture. Outsourcing Costs: While outsourcing may initially appear cost-effective, there could be hidden or unforeseen costs, such as transportation, quality control, and communication expenses. Over time, outsourcing costs may increase.
• Quality Control Issues: In-House Control: When a company makes a product internally, it has greater control over the production process and quality standards. Outsourcing may lead to challenges in maintaining consistent quality, especially if the external supplier has different quality standards.
• Dependency on Suppliers: Reliance on Suppliers: Relying on external suppliers introduces a level of dependency. Any issues with the supplier, such as disruptions in the supply chain, financial instability, or changes in their business operations, can directly impact the buyer's ability to meet its own obligations.
• Loss of Core Competencies: Internal Expertise: Outsourcing may result in a loss of internal skills and competencies. If a company chooses to outsource a critical component, it may lose the expertise needed to innovate or adapt to changes in the market.
• Confidentiality and Security Risks: Data and Information Security: Outsourcing may involve sharing sensitive information with external partners. This poses potential risks to data security and confidentiality, especially if the external party does not have robust security measures in place.
• Communication Challenges: Communication Barriers: Working with external suppliers can lead to communication challenges due to differences in time zones, languages, and cultural nuances. Miscommunications may result in delays, errors, or misunderstandings.
• Flexibility and Adaptability: Limited Flexibility: Outsourcing agreements may involve long-term contracts, limiting a company's flexibility to adapt to changing market conditions. If market demands shift, the company may be constrained by contractual commitments.
• Loss of Control: Control over Processes: Making a product internally allows for greater control over production processes, timelines, and customization. Outsourcing can result in a loss of direct control, making it challenging to respond quickly to changes or unexpected challenges.

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Conclusion 

The make or buy decision is a strategic choice that organizations must carefully evaluate, taking into account a range of factors to determine whether to produce goods or services internally or outsource them from external suppliers. While there are advantages to both approaches, the decision involves inherent trade-offs, and each option comes with its own set of challenges. Organizations need to conduct thorough analyses of their capabilities, market conditions, and long-term objectives to make informed decisions that align with their strategic goals. Flexibility and adaptability are key considerations, as businesses must be prepared to adjust their strategies based on changing internal and external factors. 

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