Fixed Investment
Financial calculations determine the production volume at which the cost of internal manufacturing equals the cost of purchasing from an external supplier. Calculating the make or buy break even requires a detailed comparison of fixed costs and variable costs for both options. This point serves as a decision threshold for companies considering investment in new assembly equipment.
Variable Cost
The price per unit for raw materials and labor typically decreases as volume increases due to economies of scale. Purchasing from a third party includes a profit margin and shipping fees that are added to the unit cost. When internal variable costs are lower than the purchase price, the make option becomes more attractive at high volumes.
Decision Analysis
The break even volume is found by dividing the difference in fixed costs by the difference in unit variable costs. Below this volume, buying from an external source is more economical. Above this volume, the higher fixed investment is justified by the lower marginal cost of production.
Resource Allocation
Internal production involves high upfront costs for machinery, floor space, and specialized staff. These expenses remain constant regardless of how many units are produced. A supplier spreads their own fixed costs across many customers which often results in a lower entry price for low volumes.
Selecting the make option provides more control over the production schedule.
