Make-or-buy decision
In one sentenceChoosing between making a part or providing a service in-house and buying it from an external supplier, by comparing relevant costs only.
Simply put
Compare the supplier's price with the cost you will actually save if you stop making it, not with the full unit cost in the books.
Fixed costs that remain in both cases, such as rent, do not enter the comparison. Also consider quality and dependence on the supplier.
Worked example
A factory makes 1,000 parts a month with a variable cost of 18 SAR each, plus 6 SAR of allocated fixed costs that will not disappear, and a supplier offers to sell them for 22 SAR.
Relevant manufacturing cost18 × 1,000 = 18,000 SAR
Purchase cost22 × 1,000 = 22,000 SAR
Full unit cost in the books (misleading here)18 + 6 = 24 SAR
Continuing to manufacture saves22,000 − 18,000 = 4,000 SAR per month
Formula: Purchase price − costs that will disappear if manufacturing stops
Don't confuse it with
Unit costThe full unit cost includes fixed costs that do not disappear, so comparing it with the supplier's price may lead you to the wrong decision.