Make-or-Buy Decision: A Practical Guide

A make-or-buy decision determines whether a company should produce a good or service internally (make) or obtain it from an external supplier (buy). This choice affects costs, capacity, quality, intellectual property, and strategic flexibility. Making the right decision requires combining quantitative cost analysis with qualitative judgment about risk, capability, and long-term goals.

Key takeaways

• Compare all relevant costs of making versus buying, including hidden and ongoing expenses.
• Consider qualitative factors such as expertise, core competency, supplier reliability, and strategic importance.
• Reassess decisions when market conditions, demand, or supplier capability change.
• Alternatives include outsourcing, insourcing, and reshoring — each has trade-offs.

What the decision involves

A thorough make-or-buy analysis compares:
* Direct production costs: raw materials, energy, machine depreciation, maintenance.
* Labor costs: wages, benefits, training, overtime.
* Overhead and facility costs: space, utilities, insurance.
* Inventory and holding costs: storage, obsolescence, waste disposal.
* One-time capital costs: new equipment, tooling, implementation.
Versus buying:
* Purchase price and volume discounts.
* Shipping, customs, taxes, and import fees.
* Supplier management costs: contracting, quality audits, logistics.
* Potential contractual lock-ins or price volatility.

Quantitative analysis often gives a clear signal, but qualitative factors can override purely numeric results.

How to analyze the decision

1. Define the scope: specify the product or service, required quality, and volume.
2. Identify all cost components for both options (include one-time and recurring costs).
3. Calculate cost per unit under realistic volumes and sensitivity ranges.
4. Assess capacity and timing: can you scale production to meet demand?
5. Evaluate non-cost factors: quality control, IP protection, lead time, supplier risk.
6. Consider strategic fit: does producing internally support core competencies or competitive advantage?
7. Run scenario analyses (e.g., demand spikes, supplier failure, cost inflation).
8. Make a decision and document assumptions for future reassessment.

Factors that favor buying

• Low production volumes that don’t justify capital investment.
• Lack of in-house expertise or prohibitive training time.
• Opportunity to use specialized suppliers with superior technology or scale.
• Desire to diversify risk through multiple suppliers.
• The item is non-core to the company’s competitive differentiation.
• Attractive, reliable long-term supplier relationships.

Factors that favor making

• Existing idle capacity that can be used efficiently.
• Need for strict quality control or customization.
• Protection of proprietary technology or intellectual property.
• Supplier unreliability or geopolitical risk.
• Long-term cost advantage after amortizing capital investments.
• Strategic intent to build internal capabilities.

When to reassess a past decision

Reevaluate your make-or-buy choices when:
* A supplier becomes unreliable or exits the market.
* Demand rises or falls significantly, changing unit economics.
* New technology or process improvements alter production costs.
* Regulatory, tariff, or geopolitical changes affect supply chains.
* Strategic priorities shift (e.g., move to vertical integration or focus on core offerings).

Reassessment should be periodic and also triggered by material events. Maintain contingency plans for supplier failure and scalability needs.

Related concepts

• Procurement: strategic sourcing and contract management of goods and services.
• Outsourcing: contracting an outside firm to perform functions previously done internally (often to reduce cost or access expertise).
• Insourcing: bringing previously outsourced tasks back in-house to improve control or quality.
• Reshoring: relocating previously offshore operations back to the company’s home country for supply-chain control, quality, or cost reasons.

Practical checklist before deciding

• Have you included all direct and indirect costs?
• Have you tested sensitivity to volume and price changes?
• Is supplier reliability and continuity assured?
• Does the decision protect or expose critical IP?
• Does it align with long-term strategic objectives?
• Are you prepared to switch course if conditions change?

Bottom line

A disciplined make-or-buy decision balances hard cost calculations with strategic and operational considerations. Use comprehensive cost modeling, account for qualitative risks, and build regular reassessment into planning. The best choice is the one that delivers the required quality and capacity while supporting the company’s strategic goals and flexibility.