Make or Buy Decision sample essay
Taiwanese smart phone maker HTC Corporation is considering outsourcing manufacturing to other companies to improve its efficiency. Before building its own brand, HTC concentrated on manufacturing low-end smart phones for companies like Apple. However, in recent years, HTC has been under pressure from shareholders to reduce costs because of loss net operating income for the third quarter of 2013. Now, HTC wants to change its strategy; they want to concentrate on the research and development of high-end smart phones and outsource some of their low-end smart phone production to increase their sufficiency and lower the costs.
In the smart phone industry, in order to improve efficiency, it is important for the phone makers to build more commoditized products and universally outsource some products to manufacturers who can produce cheaper products. However, just as the Yuanta Securities analyst Dennis Chan says, there are many factors that effect whether to make the decision to outsource. HTC definitely needs to consider many factors to decide whether they will continue making products or outsourcing (Dou, 2013). Problem Identification
The case above is talking about how HTC suffers from a new situation about whether to continue producing smart phones or outsource them to other manufacturing companies. Actually it is a “make or buy decision” problem in accounting. Make or buy decision is a decision to carry out manufacturing a product in-house or purchasing it from an outside supplier. As every company comes under increasing pressure to reduce costs and increase their return on assets, it shows an increased importance to managers whether to keep the activities, even the key parts, in-house or outsource them (Gambino, 1980). Outsourcing is an important part in make-or-buy decision making.
For HTC, if the production cost is much higher than outsourcing the low-end smart phone to other companies, or it doesn’t have sufficient production capacity to produce it internally, outsourcing seems a better choice for the company. However, in the business world, it is not easy to determine whether a make-or-buy decision is good for the company; there are many factors to consider. The following part will describe the factors which have an effect on make-or-buy decisions. Accounting Method Explanation—Make-or-Buy Decision
Make-or-buy decisions occur in business when a company needs to decide whether to produce goods internally or to purchase them externally. This typically is an issue when a company has the capacity to manufacture products or they can purchase the products on the market. When analyzing a make-or-buy business decision, it is necessary for managers to look at several factors. The analysis must examine thoroughly all of the costs related to manufacturing the products as well as all the costs related to purchasing the product. 1. Quantitative factors and Qualitative factors.
The make-or-buy decision involves both quantitative analysis and qualitative analysis. Quantitative factors can be calculated and compared; subjective judgment and multiple opinions are required when we want to examine some quantitative factors. Also, we need to consider various factors from all angles when the make-or-buy decision is used, because some of the factors involved can be quantified with certainty, while other factors cannot. Quantitative factors include things such as the availability of production facilities, production capacity, and all of the resources needed. Variable and fixed costs are also important factors when analyzing the make-or-buy decision. Similarly, quantitative costs also include the price of the product in the marketplace.
The comparison between the production cost and purchasing cost is one of the most important processes in analyzing the make or buy decision. Qualitative factors are more difficult to measure than quantitative factors and more subjective judgment needs to be taken into consideration. For example, the reputation and reliability of the suppliers, the possibility and the likelihood of changing or reversing the decision in the future, and the long-run outlook regarding production or purchasing the product are all typical qualitative factors. In the HTC outsourcing case, identifying and picking up the quantitative and qualitative factors is the first step. First, for the quantitative part, the variable and fixed costs of producing the smart phones must be taken into consideration. Usually, variable costs include direct materials, direct labor, and variable overhead. Also, we need to collect the data about the salary paid for workers and supervisors, depreciation of the equipment, and the allocated general overhead.
The purchasing price of smart phones which the supplier offered is another required factor when comparing production cost. Secondly, for the quantitative part, HTC needs to do a lot of research to know whether their supplier has a good reputation and reliability, and analysis the benefits and costs if they choose to purchase the smart phones from the supplier instead of producing them. 2. The analysis must also separate relevant costs from irrelevant costs and look only at the relevant costs. When making the make-or-buy decision, it is necessary to distinguish between relevant and irrelevant costs. Relevant costs for making the product are all the costs that could be avoided by purchasing the product. An avoidable cost can be eliminated in whole or partially through choosing one alternative over another. In the HTC case, by choosing to purchase smart phones from another supplier, the cost of manufacturing the phones can be avoided.
In reality, opportunity cost is very common when considering the relevant costs. Opportunity cost is the potential benefit that is given up when one alternative is selected over another. Take the HTC case for example; if the smart phone manufacturing facilities are idle, and the company accepts to outsource the smart phone, the opportunity cost is zero and it means there is no impact on the cost related to the opportunity cost. However, if the company decides to use the facility to produce another kind of product, the opportunity cost incurred. According to the different situations, it may change the manager’s decision. Irrelevant costs are the costs that will be incurred no matter whether the product is manufactured internally or purchased externally. There are two kinds of categories of irrelevant costs when we make the make-or-buy decision.
The first one is suck cost, which is always incurred during the operation process and cannot be avoided regardless of what decision the manager makes. In the HTC case, the manufacturing facilities have been purchased; no matter if the smart phone is made or purchased from a supplier, the costs of the manufacturing facilities (fixed cost) have been incurred. Another irrelevant cost is future cost which has no impact on the alternatives. Following the HTC case, the company needs to promote the smart phone through advertisement in order to gain big sales. If the company is going to allocate the same ad fee to the promotion regardless of producing them or purchasing them, the future cost is an irrelevant cost when making the decision.
The analysis must also consider the availability of the product and the quality of the product under each of the two scenarios. Other factors—such as the availability of the product and the quality of the product under different alternatives—are also important for an manager to make the make or buy decision. Following the HTC example, if the company chooses to produce the smart phone internally regardless of their deficiency in production capability, it can lead to poor quality products or low efficiency in production. In a long-run perspective, the company may not make a good decision. In order to get more accurate information about the products and the suppliers who can offer suitable prices and high quality products, the company needs to do research. This includes internal research and collecting business data from outside professional research companies which can provide more accurate information.
Dou, E. (2013). HTC May Give In to Lure of Outsourcing. The Wall Street Journal. Retrieved from http://blogs.wsj.com/digits/2013/10/23/htc-may-give-in-to-lure -of-outsourcing/?KEYWORDS=htc+
Gambino, A. (1980). The make-or-buy decision. New York, N.Y.: National Association of Accountants.
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