Evaluating Production Decisions: Cost to Buy (CTB) vs. Cost to Make (CTM)
- As an owner of a coffee shop you'd need to decide whether to bake your own pastries or buy it from a supplier.
- This decision hinges on comparing the Cost to Buy (CTB) and the Cost to Make (CTM).
- By understanding these costs, you can make informed choices that impact profitability, quality, and operational flexibility.
Cost to Buy (CTB): What Does It Include?
Cost to Buy (CTB)
The total expense incurred when purchasing goods or services from an external supplier.
Components of CTB
- Supplier Costs: The price paid to the supplier for the product or service.
- Transportation Costs: Expenses related to shipping, handling, and delivery.
- Quality Control Costs: Inspections, testing, and potential rework if the purchased goods don’t meet standards.
A coffee shop buying pastries from a supplier would include the cost per pastry, delivery fees, and any expenses related to checking the pastry's quality.
Advantages of Buying
- Simplicity: Reduces the complexity of operations.
- Focus: Allows the business to concentrate on core activities.
- Scalability: Easier to adjust supply based on demand.
Disadvantages of Buying
- Less Control: Limited influence over quality and production timelines.
- Dependency: Reliance on suppliers can lead to disruptions.
- Potentially Higher Costs: Suppliers may charge a premium for their services.
When calculating CTB, don’t forget to factor in hidden costs like delays or quality issues that might arise from relying on external suppliers into your answer.
Cost to Make (CTM): What Does It Include?
Cost to Make (CTM)
The total expense incurred when producing goods or services internally.
Components of CTM
- Raw Materials: The cost of inputs required for production.
- Labor Costs: Wages for employees involved in the production process.
- Equipment and Maintenance: Depreciation, repairs, and operational costs of machinery.
- Overheads: Utilities, rent, and other indirect costs associated with production.
So if you decide to bake your own pastries for your coffee shop, your CTM would include flour, yeast, the salaries of pastry chefs, oven maintenance, and electricity.
Advantages of Making
- Quality Control: Greater oversight of the production process.
- Customization: Ability to tailor products to specific customer needs.
- Long-Term Savings: Potentially lower costs once initial investments are covered.
Disadvantages of Making
- Higher Initial Investment: Equipment and setup costs can be substantial.
- Complexity: Managing production requires expertise and resources.
- Capacity Limitations: Scaling up production may require significant additional investment.
When calculating CTM, consider both fixed and variable costs to get a complete picture of the expenses involved.
Comparing CTB and CTM: Key Considerations
1. Profitability
- Objective: Minimize costs while maintaining quality.
- Approach: Compare CTB and CTM to determine the most cost-effective option.
If CTB is \$3 per unit and CTM is \$2.50 per unit, making the product internally may be more profitable.
2. Flexibility
- Buying: Offers flexibility to scale up or down quickly.
- Making: Provides control but may require time and investment to adjust production capacity.
3. Quality Control
- Buying: Relies on supplier standards.
- Making: Allows for direct oversight and customization.
- Don’t assume that lower CTM always means higher profitability.
- Consider hidden costs like equipment maintenance or unexpected downtime.
Practical Steps for Decision-Making
- Calculate CTB and CTM: Include all relevant costs, both direct and indirect.
- Evaluate Strategic Goals: Consider long-term objectives such as quality, scalability, and brand reputation.
- Conduct a Break-Even Analysis: Determine the point at which the cost of making equals the cost of buying.
- Assess Risks: Consider potential disruptions, such as supplier reliability or equipment failures.
A tech company deciding whether to manufacture its own components or outsource production might conduct a break-even analysis to determine how many units it needs to produce internally to justify the investment.
Zara’s Production Strategy
- Zara, a global fashion retailer, exemplifies the make vs. buy decision.
- The company produces 50% of its items in-house, allowing it to maintain quality control and respond quickly to fashion trends.
- However, it outsources basic items to reduce costs and focus on its core competency: fast fashion.
- Can you think of a situation where a business might choose to buy even if the cost to make is lower?
- Why might this be the case?
