Make or buy

What it means

Make or buy is the decision whether a company should provide a component, service or activity itself or buy it from an external supplier. It applies to making parts, but also to support functions such as accounting, IT, logistics, cleaning or marketing.

The decision has a quantitative side: comparing the cost of doing it in-house with the supplier’s price. In-house costs must include everything the activity really costs, the total cost including people, space, equipment and management, while separating costs that would remain after outsourcing from those that would disappear.

The qualitative side matters just as much: whether the activity is core and sets the company apart from competitors, what know-how would be lost, how dependent the company would become on the supplier, and quality and flexibility. Companies usually keep core activities and more often buy support ones, which is the essence of outsourcing.

How it works in practice

When comparing costs we recommend distinguishing the short and long run. In the short run, when the company has spare capacity, comparing the supplier’s price with the marginal cost of in-house production is enough. In the long run, investment, equipment renewal and the wages of people who could otherwise do something else must be included.

The decision also involves opportunity cost: management time and capacity devoted to in-house production could have gone into growing the core business. Buying from a subcontractor frees up resources but increases dependence.

There are tax and accounting consequences too. In-house production means assets, inventory, employees and payroll obligations; buying services means invoices and possibly the reverse charge for services from abroad. For changes such as insourcing a previously bought activity, we prepare an estimate of the effect on results and cash flow.

What to watch out for

The most common mistake is comparing the supplier’s price only with the direct costs of in-house production, forgetting overheads, management and risk. The in-house option then looks cheaper than it is. Conversely, when buying, the costs of selecting the supplier, checking quality and managing the contract are forgotten.

The second risk is irreversibility. Once an activity is outsourced, the company loses people and know-how, and bringing it back is expensive. For core activities we therefore recommend a gradual transition, clear contract terms and a plan in case the supplier fails to perform.