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Comparison · Pricing & Margin

Make vs. Buy Costs: Compare What Actually Changes

Compare internal production with outsourcing using avoidable costs, supplier delivery charges, and the opportunity cost of constrained capacity.

By PriceAndProfit Editorial Updated

A make-versus-buy comparison should include the costs that differ between making a component and purchasing it. A full accounting cost is useful context, but some assigned costs remain after outsourcing. Conversely, a supplier quote may omit freight, inspection, coordination, or transition work. Put both alternatives on the same delivered-quality and quantity basis before deciding which has the lower relevant cost.

Worked calculation

Relevant make cost = avoidable internal costs + opportunity cost of displaced work; relevant buy cost = supplier price + additional purchasing and delivery costs

Suppose 1,000 components can be made with $6 of materials, $4 of direct labor, and $2 of variable overhead per unit. An additional $3 per unit of allocated fixed overhead brings reported cost to $15. Assume only $1,000 of the $3,000 fixed overhead total would disappear if production stopped. Relevant making cost is therefore $12,000 of variable costs plus $1,000 of avoidable fixed cost, or $13,000 for the order.

A supplier offers the components for $12.50 each and charges $800 for the shipment. Buying costs $13,300 before other differences. Although $12.50 looks lower than the $15 full unit cost, buying is $300 more expensive than the $13,000 avoidable making cost under these assumptions. The remaining $2,000 of fixed overhead continues either way and should not be credited as a saving from outsourcing.

Hypothetical worked example
Alternative for 1,000 unitsRelevant cost without displaced workWith $2,000 displaced contribution
Make $13,000 $15,000
Buy $13,300 $13,300

Decision checks and limits

Capacity can reverse the comparison. If making these components prevents a different job that would contribute $2,000, the relevant economic cost of making includes that forgone contribution. It becomes $15,000, making the $13,300 purchase alternative better by $1,700 in this scenario. The opportunity cost is relevant only if the alternative work is feasible and would actually be displaced. Idle capacity does not automatically have a market value equal to a hoped-for future order.

Check quality tolerances, delivery reliability, rework responsibility, and minimum order quantities before treating the alternatives as interchangeable. A new supplier may require a one-time qualification cost, while internal production may require additional equipment beyond the current capacity range. Show one-time and recurring costs separately and state the evaluation period. The arithmetic identifies the lower modeled cost; it does not replace a supplier-quality assessment or establish that labor and fixed costs can be eliminated when management has no practical way to do so.

Make internally

  • Relevant costs: Materials, labor, overhead, and fixed commitments that the production decision changes.
  • Capacity question: Whether the work uses otherwise idle resources or displaces another contribution.

Buy externally

  • Relevant costs: Supplier charges plus changed receiving, inspection, delivery, and coordination costs.
  • Capacity question: Whether released internal resources can be removed or used productively elsewhere.
Bottom line

Choose the measure or structure that matches the stated decision, then reconcile the dollars using the same period and cost scope.

Apply the calculation

  1. Test avoidability

    Identify the specific payment or resource commitment that disappears under each option and when it can actually change.

  2. Complete the supplier cost

    Include freight, inspection, transition work, and any changed inventory requirement on the same quantity basis.

  3. Evaluate constrained resources

    Add a supported opportunity cost only when internal production displaces a feasible alternative contribution.

Method references: OpenStax: Relevant information for decisions. Accessed October 22, 2026. All dollar figures are hypothetical worked examples.

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