Make or buy a part: 4 checks before you switch supplier

• Compare only the costs that change if you switch.
• Work out the totals for both options at the volume you need.
• Test a sample against your written quality requirements.
• Get the price terms and conditions for changes in writing.

Each check follows from a worked make-or-buy case in OpenStax's managerial accounting textbook , which uses a manufacturer called Thermal and a supplier called Plato Plastics.

This post is written for owners and managers who have to decide whether a part or component should be made in-house or bought from an outside supplier. The advice is practical rather than technical, so you can use it with your own accounts and your own supplier quotes.

A supplier's offer is easy to compare because it comes as one number for each unit. Your own cost can also be one number for each unit, so the two sit side by side and the answer seems obvious. That is a fair place to start, but the case shows why it is only a start.

The case begins with an offer. Plato Plastics "has approached Thermal and offered to produce the 120,000 lids Thermal will require for current production levels of the T6 carrier, at a unit price of $1.75 each." The chapter then notes how the offer looks: "Initially, the $1.75 presented by Plato seems like a much better price than the $2.19 that it would cost Thermal to produce the lids."

That first reaction is the one to test. A lower unit price is a reason to look closer, not a reason to switch on the spot.

Compare the costs that would actually change if you switched. Do not compare the supplier's price with your full unit cost without asking which parts of that cost would still be there after the switch. Costs that stay the same whether you make the part or buy it do not help you choose between the two options.

A practical test is to ask, for each cost on your list, what would happen to it if you bought the part tomorrow. If the answer is that the cost would stop, it belongs on the internal side. If it would continue, it does not change the choice and can be set aside.

The chapter frames its comparison the same way. It finds that "when the relevant costs are compared between the two alternatives, it is more cost effective for Thermal to produce the 120,000 units of the T6 lid internally than to purchase it from Plato." The lower sticker price did not settle the question.

For your own comparison, list the costs that would stop if you buy the part, the costs that would start, and the costs that would continue either way. Then compare only the first two groups with the price you are offered.

Work out the totals at the volume you actually need, and compare both options as totals. The case uses 120,000 lids. At $1.75 each, buying the 120,000 lids comes to $210,000.

The chapter gives two comparisons, and they point in opposite directions. In the first, the chapter says: "By producing the T6 lid internally, Thermal can save $8,400 ($210,000 − $201,600)." Here making the lid in-house is the cheaper choice.

In the second, the purchase cost is still $210,000, but the internal figure is higher. The chapter says: "In this scenario, it is more cost effective for Thermal to buy the T6 lid from Plato, as Thermal would save $6,000 ($216,000 − $210,000)."

The purchase price did not change between the two comparisons. The internal side did, and that was enough to reverse the answer. The practical lesson is to build your own internal figures from your own records, not to reuse another company's numbers. Make sure the internal figures match the same volume as the offer.

Suppose buying 10 parts costs $80, while the internal costs that would stop if you bought them total $70. Making the parts costs $10 less. These figures are illustrative; the cost difference still needs to be weighed against quality, delivery, and switching costs.

A part has to meet your quality requirements before a lower price counts for anything. The case asks this directly: "Will the T6 lid made by Plato meet the quality requirements of Thermal?" Ask it before you spend time on the cost figures, because a cheaper part that fails your requirements does not save you anything worth counting.

Make the question practical. Write down the requirements the part must meet, such as dimensions, materials, and tolerances, and ask the supplier to show how it will meet each one. Get samples and test them against the requirements you wrote down. Agree on what happens when a delivery falls short, and who pays for the rework or replacement. Decide who checks incoming parts, and how often.

Hold your own part to the same standard too. The outside part is being compared with what you make now, so if your current output has gaps, the comparison should show them as well. Otherwise the switch may be judged against a standard your own process does not meet.

Ask directly, because a low price only helps if it stays low. The case asks the question that matters here: "Will Plato continue to produce the T6 lid at the $1.75 price, or is this a teaser rate to obtain the business, with the plan for the rate to go up in the future?"

You cannot tell from the offer alone which one you are getting, so ask the supplier directly and put the answer in writing. Ask how and when the price can change, and what notice you would get.

For related quote checks, see supplier price changes .

Think about the other side too. If you have stopped making the part, bringing production back may take time, equipment, and people. Price increases then leave you with fewer choices. Factor that into the decision now, not after the first increase.

Buying a part changes how you use in-house capacity. If your own team and equipment are making the part today, a switch may leave that capacity idle, or it may free it for other work. The comparison should say which, because the answer changes what the switch is worth.

Think about the people and skills too. Staff who know how to make a part are an asset that does not appear on a unit price. If you buy the part, decide what happens to that knowledge, whether the team can be redeployed, and what it would take to rebuild the skill if you later decide to make the part again.

Consider control too. When an outside supplier makes the part, you rely on its schedule, its capacity, and its response when something goes wrong. Write down what you would need to know to judge those things, and ask for it before you sign, not after the first late delivery.

1. Fix the part and the volume. Write down the part, the number of units you need, and the period the comparison covers.
2. List your internal costs. Include every cost that would stop if you bought the part, such as materials, labor, and equipment running costs.
3. Set the purchase price against the same volume. Use the quoted unit price multiplied by the units you need, so both sides cover the same work.
4. Remove costs that stay the same. Take out any cost that appears on both sides, since it does not help choose between them.
5. Total both options. Compare the totals for the full volume, not just the unit figures, and write down the difference.
6. Test the result. Change the internal cost, the volume, and the price one at a time, and check whether the answer changes. The chapter's two comparisons show how a change on the internal side can reverse the answer.

A volume mismatch is harder to spot. A quote for one order size can look sound next to an internal cost worked out for another, and the totals will then compare work that is not the same. Keep both sides on the same units and the same period.

Check whether the supplier can keep up before you commit, because a price is only useful if the supplier can deliver the volume at the quality you need. Ask for evidence rather than relying on the sales conversation alone.

Useful evidence includes the supplier's record of meeting delivery dates, its capacity for the volume you need, and the stability of its own business. Ask for references from other customers, and ask how the supplier handles a shortfall in its own supply. These answers add to what a single quote tells you.

Also consider what happens if the supplier fails. If you have stopped making the part, a supplier that closes or stops producing it leaves you with no internal source. Keep a plan for that case, even if you hope never to use it.

Check the supplier's reach too. Find out where it makes the part, how it ships, and whether one site or one event could stop supply. Those details show how much a single problem would cost you.

The cost of switching belongs in the plan as its own line, separate from the unit price. Depending on the part, these can include setting up the supplier, moving stock, changing documents, and training staff who will receive and check the parts.

Then add the time it takes. A switch can leave a gap while the new supplier ramps up, and you may need stock on hand to cover it. Put a value on that gap, or at least a range, so the decision reflects it.

If you move the other way, bringing a part back in-house, the same logic applies in reverse. Equipment, space, and trained people may need to be found or rebuilt before production starts.

Negotiate with your own numbers in hand, not with the supplier's first quote alone. Knowing your relevant costs shows where an offer stands against your other option, and which terms are worth pressing for.

Put the agreed terms in writing, including the price, the quality requirements, the delivery schedule, and any conditions on price changes, so that you can review the decision against them later.

When the totals are close, let the other checks decide. A small difference in cost can be outweighed by quality risk, delivery risk, or the cost of switching, and none of those show up in a single unit price.

Be honest about the uncertainty in each figure. An internal cost that rests on an estimate deserves a different weight from a supplier's written quote, and the comparison should show that difference rather than hide it.

If the decision is still close after the checks, it is reasonable to choose the option that you can reverse more easily, and to set a review point after the switch.

Involve production, purchasing, and quality staff before you decide, because each sees a different part of the switch. Production knows how the part is used, purchasing knows the supplier terms, and quality knows the tests the part has to pass.

Ask each group what they need to see before they can support the decision, and record their answers next to the numbers. A decision that the people affected have reviewed is easier to explain afterwards.

Write down the decision, the numbers behind it, and the conditions that would change it. A short record helps when the price changes, when the supplier has a problem, or when someone asks why the part was switched.

Include the volume, the relevant costs, the quality checks, and the price terms, along with the date you made the decision. Note which figures are estimates and which come from a written quote, so that anyone reviewing the decision can see how much weight each figure can carry.

Keep the record with the quotes, the internal cost workings, and the notes from the quality tests, so the numbers can be traced back to their source. For a related way to organise part costs, see parts pricing spreadsheet fields .

Check the result against the numbers you used to decide. If the costs, volume, or prices differ from what you assumed, find out why and decide whether the switch should stay.

Set a review point in advance, such as the end of the first agreed period, and put it in the calendar when the decision is made. Setting the date in advance means the review does not depend on a problem to start it.

Use the review to test the assumptions, not only the bill. A switch that looks right on paper can still need adjustment, and a clear record makes that adjustment easier to discuss.

Choose a part you already make or buy.

Related guides: Parts inventory valuation: 5 inputs for each part's cost · Service call cost: 5 expenses to add before you quote · After-hours fees: 4 inputs to set before quoting .

Is the lower unit price always the cheaper choice?

No: the costs that change determine the cost comparison. In the OpenStax case, the same purchase total leads to different decisions when the internal costs change.

What if the totals are close?

Compare quality, delivery, switching costs, and how easily you could reverse the decision. Record the uncertainties alongside the totals before choosing.