Business decision making is not an easy road. Ironically, perhaps unfortunately, it is a road taken way too often by both intrapreneurs and entrepreneurs with significantly threatening outcomes. It is easier to take instruction than to be the one to determine the pathways to outcomes, hence it is good to have some fore knowledge of how to take those decisions.

Asides the fear of the rebound/boomerang of decisions, the fear of being able to handle decision outcomes is significant. With the current market situation, how businesses decide to either ‘make’ or ‘buy’ a component of a product/service, or an entire product/service is significant for both process and product costs including profitability and liquidity.

This article focuses on both quantitative and qualitative considerations that business managers should assess before taking a “make or buy” decision.

What is a Make or Buy Decision?

In basic terms, a “make or buy” decision puts businesses on an uneven pedestal, much like a pendulum – wherever you swing has costs and potential benefits which can be predetermined, but actual impact is known only after the decision has been made. Few examples include the decision to ‘make’ or ‘buy’ ready-made spices, napkins, engine spares, oils, chips. For services, it might be a decision to outsource a business, HR, accounting, or other processes.

For accounting purposes, it might appear easy to determine the cost of ‘buy’ decisions – product or service cost plus any incidental costs, that’s all. But for decision making, it is not that easy especially when you have to compare with a ‘make’ option. This becomes complex, because you have to imagine alternative forgone (opportunity cost, remember this from elementary Economics?) – school no be scam o. An understanding of how opportunity cost works is important in business decision making.

To ensure that we can apply a critical and analytical approach to our business decisions with respect to “make or buy” decisions, below is a fictitious example. The highlighted lessons can be applied to most scenarios even very complex decision situations.

MTY Ltd. is opening a new plant in Ikeja, Lagos State that would produce 500,000 units of brake discs monthly. Two suppliers of a significant component used to produce brake discs submitted a quote of ₦760.00 and ₦710.00 per unit including freight and insurance. MTY Ltd. has the capacity to produce 700,000 units of this component in their Ota, Ogun State factory, which has become out of use for over a year. The associated cost of producing one unit of the component in their Ota factory includes Materials – ₦90.00, Labour – ₦250.00, Overheads – ₦350.00. Transportation from Ota to Ikeja is currently challenged due to the state of the road. The choice to produce at the Ota factory comes with commitments to labour and environmental laws, while excess production can be sold at the open market.

3 Decision Scenarios from the Example Above

1. Buy from the cheaper supplier

This looks like the best solution especially if management is looking at minimising cost. Some drawbacks to consider on this decision include quality assurance. How can MTY Ltd. verify the quality of the component as well as alignment with their brake discs specification? Would using the component require additional production cost?

If MTY Ltd.’s customers are aware that a significant component of their brake discs is outsourced, would it influence their purchase decisions and how?

In this era of sustainability, to what extent does the supplier align with the SDGs in their production? Does the supplier comply with government regulations and industry standards?

2. Buy from the more expensive supplier

There is the bandwagon effect of higher stakes – “because it is expensive, it has to be good”. This is not always true. Management would like to justify the extra cash. Why are we paying more when we can get it for less? The other questions about compliance and customer perception are relevant here as well.

3. Produce at the Ota factory

This is the make decision scenario. The quantitative cost of the component is what a Performance Manager (Cost/Management Accountant) is trained to compute based on certain principles and assumptions, which I will not highlight due to space constraints, but I will give a simplified outlook.

Materials: ₦90.00 + Labour: ₦250.00 + Overheads: ₦350.00 = ₦690.00

At a glance, this looks cheaper than both ‘buy’ decision scenarios, but considering the full situation, it might not necessarily be cheaper. Transport cost from Ota to Ikeja is not included in the computation. Labour and Environmental compliance cost for maintaining the factory is not included in the computation as well as the fact that the factory has been out of use for some time which might require some repairs or upgrade.

On the flip side, producing at the factory gives more assurance of quality except management deliberately desires to produce low quality components. The prospect of selling excess capacity at market price is also significant. Asides taking a part of the component’s market share, there is brand visibility that production can confer.

Conclusively, there is no straight forward answer to any “make or buy” decision scenario. Availability of credit options can become an appealing and compelling consideration for ‘buy’ decisions, while quality assurance and the need for brand visibility can drive ‘make’ decisions.

Businesses are advised to consult professionals before taking a “make or buy” decision as they are trained to identify areas of advantage and leverage.