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Managerial Accounting: Make or Buy Case

ABC Ltd is considering whether to expand in-house manufacturing or outsource production of valves to meet growing demand. An analysis showed that outsourcing would be less expensive than expanding facilities. Other factors like flexibility, risk reduction, and supplier knowledge should also be considered in the make-or-buy decision. Based on the cost analysis and other important factors, ABC Ltd should outsource valve production.

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jessica laran
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438 views3 pages

Managerial Accounting: Make or Buy Case

ABC Ltd is considering whether to expand in-house manufacturing or outsource production of valves to meet growing demand. An analysis showed that outsourcing would be less expensive than expanding facilities. Other factors like flexibility, risk reduction, and supplier knowledge should also be considered in the make-or-buy decision. Based on the cost analysis and other important factors, ABC Ltd should outsource valve production.

Uploaded by

jessica laran
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Managerial Accounting

MAKE OR BUY CASE

Introduction:
ABC Ltd. is a manufacturing company engaged in the manufacturing of
valves. The Management is skeptical whether to purchase valves from other
suppliers or manufacture on their own, to be ale to sustain the current
demand of the said product.

Background information:
ABC Ltd started their business initially with sales of 10,000 valves per
month and now they have grown the volume to about 50,000 valves per
month. They have been buying all the raw material for the valve and were
doing all the manufacturing in house. Now they have established themselves
in the market and are planning to expand and produce different varieties of
valves. They have their plant in the main city and the total area of the plant is
50,000 sq. ft. Now if they want to expand and continue doing all the activities
of manufacturing of all the varieties in house, they would need another
50,000 sq.ft. of the area. In the recent times, the land prices in the area have
more than doubled in the last 3 years and still land is available with great
difficulty. Mr. Mohan is the production head of ABC Ltd. and has been
successful with the production and the level is continuously increasing. But in
recent times, he is facing the problem of quality complaints which have gone
up from average 0.2 % in previous 2 years to 0.5 % this year. Also, he is
finding that there is a high level of dissatisfaction among the workers
regarding workload as well as salary levels. The workers are regularly
complaining about the over work.

Alternatives:
Two alternatives are being considered, whether to expand the business
using in house manufacturing or to buy from outsource. The marketing
manager has expressed very bullish prospect about the company’s growth
and said that the company should take advantage of growing economy and
established brand image of the company and definitely go for expansion. The
finance manger also expressed that this will result in economy of scale for the
products and will further increase the profitability of the products.

The Marketing manager asked the Production manager about the


option of outsourcing. Mr. Mohan is skeptical about the outsourcing option as
he felt that the outside agency will always charge more as he will try to make
his profit as well and also is worried about the possible problems of deliveries.
Mr. Naresh, the Purchase manager said that since the suppliers would also be
interested in doing the business, they would not like to delay as with delay
they also incur loss. The Finance manager said that we can look at cost
comparison for buying against in house manufacturing.

Solution:
The table below gives the comparison of in house and outsourcing cost

Recommendations:

After a thorough analysis considering the comparison between


manufacturing and procurement costs, it is very clear that we should go for
buying the product from outside. Even if the cost would have been same for
both manufacturing in house as well as cost for procurement, we would have
still gone for purchasing the product from the supplier. In case cost is higher
for procurement little bit as compared to manufacturing in house, it is better
still to go for buying from outside as it gives better flexibility and risk is less
even if the forecast is wrong and the ultimate demand turns out to be lower
than forecast demand.
_____

Questions -

1. Based on this data, is it economical for ABC Ltd.to go for buying


the product from market or manufacturing in house.

Considering the costs as per table above it is very clear that we should
go for buying the product from outside.
2. What other factors should ABC Ltd. look at for making this
decision?

Generally, whether we should go for in house manufacturing or


outsourcing, we have to consider following factors. The following factors
generally influence make-or-buy decisions:
a. Relative economics
b. In-house capacity currently available
c. The need for control or secrecy
d. Advantages of access to supplier knowledge and skill
e. An opportunity to maintenance a robust supplier
f. The relative risks involved
g. Capital investment versus expense for tax purposes
h. Degree of scope definition available
i. Affects uncertainty and risk
j. Overall degree of technical, cost and schedule risk
k. Type or complexity of the requirements
l. Confidentiality of the process
m. What will be the contractor's entire responsibility?
n. Urgency of the deliverable
o. Contractors' capacity to perform
p. And/or extent of subcontracting
q. How long have we got for execution?
r. Affects the pace of the work
s. Extent of price competition
t. Contractors' accounting systems

Careful evaluation of these factors is required to arrive at final decision.

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