Model Answer
0 min readIntroduction
The ‘make or buy’ decision is a classic problem in managerial accounting, determining whether a company should produce a component internally or purchase it from an external supplier. In the context of a company considering manufacturing brakes, a thorough analysis of all relevant costs and benefits is crucial. This decision impacts not only the financial bottom line but also strategic considerations like control over quality, supply chain resilience, and focus on core competencies. A comprehensive evaluation, considering both quantitative and qualitative factors, is essential to determine if manufacturing brakes in-house would be profitable.
Cost Analysis: Manufacturing vs. Outsourcing
To determine profitability, we need to compare the total cost of manufacturing brakes in-house with the cost of outsourcing them. This involves analyzing both fixed and variable costs.
Manufacturing Costs (In-House)
- Fixed Costs: These costs remain constant regardless of production volume.
- Factory Setup/Expansion: Cost of building or modifying a facility.
- Machinery & Equipment: Purchase and installation of brake manufacturing equipment.
- Tooling Costs: Costs associated with molds, dies, and other specialized tools.
- Research & Development: Costs related to designing and refining the brake manufacturing process.
- Depreciation: Depreciation of machinery and equipment.
- Variable Costs: These costs vary directly with production volume.
- Raw Materials: Cost of steel, rubber, friction materials, and other components.
- Direct Labor: Wages and benefits of workers directly involved in brake manufacturing.
- Utilities: Electricity, water, and other utilities consumed during production.
- Maintenance: Costs of maintaining machinery and equipment.
- Quality Control: Costs associated with inspecting and testing brakes.
Outsourcing Costs (Buying)
- Purchase Price: The price per brake unit from the supplier.
- Transportation Costs: Costs of shipping brakes from the supplier to the company’s facility.
- Inspection Costs: Costs of inspecting incoming brakes to ensure quality.
- Inventory Holding Costs: Costs of storing brakes in inventory.
- Potential for Supplier Dependence: Risk of price increases or supply disruptions.
Quantitative Analysis: Break-Even Point
A break-even analysis can help determine the production volume at which manufacturing in-house becomes more cost-effective than outsourcing. The formula is:
Break-Even Point (Units) = Fixed Costs / (Selling Price per Unit – Variable Cost per Unit)
If the company anticipates producing brakes above the break-even point, manufacturing in-house may be more profitable. However, this analysis needs to be refined with accurate cost estimations.
Qualitative Factors
Beyond the quantitative analysis, several qualitative factors should be considered:
- Quality Control: Manufacturing in-house allows for greater control over quality.
- Supply Chain Resilience: Internal production reduces reliance on external suppliers, mitigating supply chain risks.
- Intellectual Property: Manufacturing in-house protects proprietary technology and designs.
- Core Competencies: If brake manufacturing aligns with the company’s core competencies, it may be a strategic advantage.
- Capacity Utilization: If the company has underutilized capacity, manufacturing brakes can improve overall efficiency.
- Flexibility: Internal production allows for greater flexibility in responding to changing customer demands.
Risk Assessment
Manufacturing brakes involves several risks:
- Technological Obsolescence: Brake technology is constantly evolving, requiring ongoing investment in R&D.
- Market Demand Fluctuations: Changes in automotive sales or brake technology could impact demand.
- Labor Relations: Potential for labor disputes or skill shortages.
- Regulatory Compliance: Compliance with safety and environmental regulations.
Comparative Table
| Factor | Manufacturing (In-House) | Outsourcing (Buying) |
|---|---|---|
| Fixed Costs | High (Factory, Equipment) | Low |
| Variable Costs | Potentially Lower at Scale | Higher per Unit |
| Quality Control | High Control | Dependent on Supplier |
| Supply Chain Risk | Low | High |
| Flexibility | High | Low |
Conclusion
Determining whether it is profitable to manufacture brakes requires a detailed cost-benefit analysis considering both quantitative and qualitative factors. While in-house manufacturing offers greater control and potential long-term cost savings at scale, it necessitates significant upfront investment and carries inherent risks. A thorough break-even analysis, coupled with a careful assessment of the company’s core competencies and risk tolerance, is crucial. Ultimately, the decision should align with the company’s overall strategic objectives and long-term profitability goals.
Answer Length
This is a comprehensive model answer for learning purposes and may exceed the word limit. In the exam, always adhere to the prescribed word count.