Engineerin Economics Chapter (Eng. Eco) 014

7/29/2019 Engineerin Economics Chapter (Eng. Eco) 014

1/13

By

Muhammad Shahid Iqbal

Module No. 14

Make or Buy Decisions

Engineering

Economics


2/13

Introduction

Determination of whether it is more advantageous to makea particular item in house or to buy it from a supplier.

The choice involves both qualitative (such as qualitycontrol) and quantitative (such as the relative cost) factors.

The buy side of the decision also is referred to asoutsourcing.

Make-or-buy decisions usually arise when a firm that hasdeveloped a product or partor significantly modified a

product or part

is having trouble with current suppliers, orhas diminishing capacity or changing demand.

Issues like government regulation, competing firms, andmarket trends all have a strategic impact on the make-or-

buy decision.


3/13

Cost considerations (less expensive to make the part)

Desire to integrate plant operations

Productive use of excess capacity to help absorb fixed overhead.

Need to exert direct control over production and/or better quality

Design secrecy is required to protect proprietary technology Unreliable suppliers or No competent suppliers

Desire to maintain a stable workforce (in periods of declining sales)

Quantity too small to interest a supplier

Control of lead time, transportation, and warehousing costs

Greater assurance of continual supply

Provision of a second source

Political, social or environmental reasons (union pressure)

Emotion (e.g., pride)

Criteria for Make


4/13

Elements of the "make" analysis

Incremental inventory-carrying costs

Direct labor costs

Incremental factory overhead costs

Delivered purchased material costs

Incremental managerial costs

Any follow-on costs stemming from quality.

Incremental purchasing costs

Incremental capital costs


5/13

Lack of expertise

Suppliers' research and specialized know-how exceeds that

of the buyer

cost considerations (less expensive to buy the item) Small-volume requirements

Limited production facilities or insufficient capacity

Desire to maintain a multiple-source policy

Indirect managerial control considerations Procurement and inventory considerations

Brand preference

Item not essential to the firm's strategy

Criteria for buy


6/13

Cost considerations for the "buy" analysis

Purchase price of the part

Transportation costs

Receiving and inspection costs

Incremental purchasing costs Any follow-on costs related to quality or service


7/13

Types of analysis followed in make or buy decision are as

follows:

Simple cost analysis

Economic cost analysis

Break even analysis

Approaches for make or Buy Decisions


8/13

Simple Cost Analysis

Quantitative factors deal with cost. The quantitative effects of

the make-or-buy decision are best seen through the Relevant

Cost Approach.

For example, assume a firm has prepared the following cost

estimates for the manufacture of a subassembly componentbased on an annual production of 8000 units:


9/13

The supplier has offered the subassembly at a price of $16

each. Two-thirds of fixed factory overhead, which represents

executive salaries, rent, depreciation, and taxes, continue

regardless of the decision. Should the company buy or make?

Simple Cost Analysis


10/13

Economic Analysis

The following inventory models are considered to illustrate this

concept.

Purchase model

Manufacturing model

A basic problem for businesses and manufacturers is, when

ordering supplies, to determine what quantity of a given item to

order. The formula for Purchase model (EOQ) and TC for each

model are given as:

1

02

c

C DQ

C

0 1

1 2

cDC Q CTC DP

Q


11/13

Manufacturing model

Economic Analysis

2

02

(1 / )c

C DQ

C r k

0 2

2

( )2

c

DC QTC DP C k r

Q k


12/13

Break Even Analysis

In economics & Business the break-even point (BEP) is the point at

which cost or expenses and revenue are equal: there is no loss or gain


13/13

Break Even Analysis

Break-even point (BEP) is the point at which cost or

expenses and revenue are equal: there is no net loss or

gain. The main objective of break-even analysis is to find

the cut-off production volume from where a firm will

make profit.

cos / cos /

FCBEP

Selling t unit Variable t unit

FCBEP X

P V

Engineerin Economics Chapter (Eng. Eco) 014

Documents

Transcript of Engineerin Economics Chapter (Eng. Eco) 014