Cloth diapering is an emerging trends in baby care products nowadays. My wife has been involved in this business retail for 5 years. As the holder of a particular brand, she received a discount of up to 40% of each type of goods. With an average turnover of US$5,000 to resale 500 units per month she thought if by selling her own brand will earn greater profits. The costs of making 10,000 units per year are known as the following: the variable cost (cv) of $2 per unit, the fixed cost (CF) of $10,000 per year. There are known producers who offer for tolling at $4 per-unit cost with the minimum order volume of 1000 units. It is now came for her to choose whether making it or outsourcing it.
Development of alternatives
When it comes to making decision, the lower the breakeven point the less likely that a loss will occur. When it comes to outsourcing decision, the cost to buy and the cost to make are compared to see which is the higher value losses and the less costly solution.
Development of prospective outcomes
When the price is independent of demand and is greater than the variable cost per unit (cv), a single breakeven point result. Using the equation:
Total revenue = total cost (breakeven point)
pD’= CF + cvD’
D’ = CF / (p – cv) (1)
To make the same amount of product that have been sold in retail , we calculate the cost to make and the cost to buy.
Cost to Make (CTM) = Fixed costs + (Per-unit direct cost x volume) (2)
Cost to Buy (CTB) = Volume x Per-unit cost when buying (3)
Selection of the acceptable criteria.
- If the Cost to Buy is less than the Cost to Make, consider to outsourced it
- If the Cost to Buy is higher than the Cost to Make, consider the breakeven point before to make it.
Analysis and comparison of alternatives.
Using Equation (1),
D’ = $10,000 / ($10 – $2) = 1,250 units or only 13% of total capacity.
The demand in which breakeven point is at the amount of 1,250 units or only 13% of total capacity. This result can be considered as one consideration to make.
Using the sale amount in a year, we use equation (2) and (3) to see the cost to make and the cost to buy, following:
CTM = $10,000 + ($2 x 6,000) = $22,000 per year
CTB = 6,000 x $4 = $24,000 per year
At the volume of 6,000 units per year, the cost to make is less cost than the cost to buy. Supported by the lower breakeven point which the less likely that a loss will occur, this result leads to consider to make as the preferred option.
Selection of the preferred alternative
Base on the analysis that the cost to make is less than the cost to buy and the breakeven point is lower to show that the business will earn more profit, my wife is recommended to consider improving her business in making her own cloth diaper brand rather than to buy or keep her previous role as retailer.
Performance monitoring and postevaluation of results
The recommendation is concluded on the simple economic analysis only. To get more comprehensive recommendation on this preferred options, she has to continue with the investment analysis and also consider the nonmonetary attributes as the most important value of being a housewife and a mother for her children.
The Make or Buy Decision. (n.d.). Retrieved October 7, 2013, from http://www.tutorialspoint.com/management_concepts/the_make_or_buy_decision.htm
Outsourcing: the make-or-buy decision. (n.d.). Retrieved October 7, 2013, from worldacademyonline.com/article/26/380/outsourcing__the_make-or-buy_decision.html
Prioritization: making best use of your time and resources. (n.d.). Retrieved October 7, 2013, from http://www.mindtools.com/community/pages/article/newHTE_92.php
Sullivan, W. G., Wicks, E. M., & Koelling, C. P. (2012). Chapter 2 / Cost concepts and design economics. In Engineering economy (15th ed., pp. 31-38). Boston, MA: Prentice Hall.