9.2: Make or buy a component part

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A manufacturing company may have the capacity and ability to make one of the parts that goes into the manufacture of its products. It may also have the alternative of purchasing the same part from an external supplier. Assuming equal quality and availability, the lower-cost option will be selected.

Example

Compu Company manufactures laptop computers and now will sell them complete with a carrying case. The company is currently operating below full capacity and has the ability to manufacture the cases. The company may usedifferential analysis to determine if it should make or buy the cases.

For this differential analysis, only costs need to be considered. The selling price per unit would not be affected by the decision, and no other factors impact revenue.

The following are the costs of producing one carrying case in house.

Direct materials	$22.40
Direct labor	14.00
Fixed factory overhead	5.60

Rather than manufacturing the carrying cases, the company can purchase them from an outside vendor for $34.20 each, plus a transportation cost of $3.70 per case.

The following differential analysis compares the manufacturing costs per unit with the costs related to purchasing the carrying case. Note that the factory overhead is fixed and would be incurred under either alternative, so it is not listed.

Differential Analysis
	Make	Buy	Difference
Costs:
Purchase price		$34.20
Inbound shipping charge		3.70
Direct materials	$22.40
Direct labor	14.00
Total cost per case	$36.40	$37.90	$1.50

The cost of making the carrying case is $1.50 less than purchasing it. Compu Company should manufacture the cases.