Question

You have two alternatives to consider to produce a part. The first alternative requires an initial investment of $50,000, production costs are $30 per part and they can be sold for $50. The second alternative is that you can buy the part externally for $40 and they still sell for $50.

a. Make and explain your recommendation for these two alternatives showing your calculations and the graph you would show to management.

b. What are two make-buy issues of which management should be aware?

Answer 1

I Would suggest to for the first option as it would be a great advantage to have the production capacity at your disposal and as the graph/calculation suggests it would only take only 2500 sales to break even for the first scenario.

Even though the second option doesn’t require procurement and outsources the whole production it takes a toll on the profit margin which will eventually take a toll on the company’s top line once the initial days are over.

Below table clearly indicates that after 2500 sales it the first option clearly shows a much better profitability due to enhanced capabilities in production and profit margin

SALES NUMBER	PROFIT AMOUNT FOR CASE 1	PROFIT AMOUNT FOR CASE 2	PROFIT IN 1ST CASE	PROFIT IN CASE 2
1000	$20,000.00	$10,000.00	-$30,000.00	$10,000.00
2500	$50,000.00	$25,000.00	$0.00	$25,000.00
5000	$100,000.00	$50,000.00	$50,000.00	$50,000.00
7500	$150,000.00	$75,000.00	$100,000.00	$75,000.00
10000	$200,000.00	$100,000.00	$150,000.00	$100,000.00
20000	$400,000.00	$200,000.00	$350,000.00	$200,000.00
30000	$600,000.00	$300,000.00	$550,000.00	$300,000.00

Biggest make buy issues that the management should be aware about are

Ability of the supplier to give continuous service and our bargaining power over them. If an outsourced model is chosen and the supplier somehow fails to deliver or gets attracted to the competitor it will be a disaster.

Quality of procured raw materials if the production based model is chosen. If the quality is poor and the replacement costs or repair costs are too high it will diminish the benefit of having a good profit margin. Similarly if the quality is impeccable and deprecation is very little then it can be used for prolonged profitable time. Even scrap value would be an add on in that case.