How to approach it
- Rebuild variable cost per component and per assembled unit for next year (apply each inflation rate to the right cost).
- Work out labour hours per component unit and per finished product, including assembly.
- Option 1 (make): output is limited by labour hours.
- Option 2 (buy): the freed hours let you make more finished units; compute the new output (check any demand limit).
- Compare total contribution (or profit) under each option, then add non-financial factors.
Key rules to apply
- Under a binding constraint, outsourcing is worth it if the contribution earned from the freed resource exceeds the extra cost of buying.
- Fixed overheads that continue either way are not relevant.
- Non-financial factors: supplier reliability and quality, loss of know-how, confidentiality, effect on staff, dependency.
Common mistakes
Drawn from the examiners' comments for this sitting (summarised in our words) and from typical errors on this topic.
- Including fixed overheads in the variable cost of making (examiners' point).
- Using the same sales volume in both options, ignoring the extra units the freed hours allow.
- Forgetting assembly hours or the number of components per finished unit.
- Listing financial factors in the non-financial part.
Similar question with worked solution
Written by us with our own numbers; it tests the same skills as Q8 without copying it.
Original practice question
Buying in to release labour
Product P sells for Rs 2,500 and needs 3 units of component K plus assembly. Making one K costs Rs 310 variable (incl. 1 labour hour). Assembly needs 2 labour hours and Rs 650 of other variable cost per P. A supplier offers K at Rs 330. Labour is limited to 50,000 hours; demand for P is 14,000 units. Labour is paid only for hours worked; fixed costs are unchanged.
Required: Should the company make or buy K?
Worked solution
| Make K | Buy K | |
|---|---|---|
| Hours per P | 3 + 2 = 5 | 2 |
| Units of P possible | 50,000 ÷ 5 = 10,000 | min(25,000, 14,000) = 14,000 |
| Variable cost per P | 3 × 310 + 650 = 1,580 | 3 × 330 + 650 = 1,640 |
| Contribution per P | 920 | 860 |
| Total contribution | Rs 9.20m | Rs 12.04m |
Answer: Buy: contribution rises by Rs 2.84m because the freed hours make 4,000 more units, despite the higher unit cost.