Performance Management · Limiting factors

Make or Buy Decisions with a Limiting Factor

Updated 11 October 2026 · Fact-checked

When internal capacity is scarce, you cannot make everything. For each component, work out the extra variable cost of buying (buy price minus variable cost of making), divide by the scarce resource saved per unit, and rank. Make the components with the highest extra cost per scarce unit first. Buy the rest.

Understand Limiting Factors with Make-or-Buy Decisions

A normal make-or-buy decision compares the relevant cost of making with the buying price. If making is cheaper, you make. This works only when you can make as many units as you like.

A limiting factor changes this. If machine hours, labour hours or materials are short, you cannot make every component in-house. Some must be bought, even if making each one is cheaper per unit. The question becomes: which components should we buy so that the extra cost is as small as possible?

The key figure is the extra variable cost of buying. This is the buy price minus the relevant (usually variable) cost of making. It is what you pay extra each time you buy instead of make. Making a unit saves that extra cost. It also uses up some of the scarce resource.

So the best use of the scarce resource is where it saves the most extra cost per unit of resource. Divide the extra cost per unit by the scarce resource used per unit. Rank from highest to lowest. Make in that order until the resource runs out. Buy whatever is left.

This is the same logic as contribution per scarce unit in a product-mix question. The difference is the measure. In product mix you rank by contribution per scarce unit. In make-or-buy you rank by extra cost of buying per scarce unit.

Key rules to remember

Extra variable cost of buying per unit: Buy price per unit − Relevant variable cost of making per unit; Use relevant costs only. Ignore absorbed fixed overheads unless they are avoidable if you buy.
Extra cost per unit of scarce resource: Extra cost of buying per unit ÷ Scarce resource used per unit made; This is the ranking figure. Use the same scarce resource for every component.
Ranking rule: Make first the component with the highest extra cost per scarce unit; buy first the lowest; Making saves the most money where this figure is highest.
Total cost of the plan: Variable cost of units made + Buy price × units bought; Check by starting from the cost of making everything and adding the extra cost of the units bought.

How to solve Limiting Factors with Make-or-Buy Decisions questions

Use this method for any make-or-buy question where a resource is scarce. Do the steps in order and keep your workings in a small table.

1Check which resource is scarce and how many units of it are available. Note the number of units of each component required.
2For each component, find the relevant variable cost of making. Leave out fixed costs unless the question says they can be avoided.
3Calculate the extra cost of buying per unit: buy price minus variable cost of making. If this is zero or negative, buy it. It does not need the scarce resource.
4Divide each extra cost by the scarce resource used per unit made.
5Rank the components. Highest extra cost per scarce unit is ranked first (make first).
6Work down the ranking. Allocate the scarce resource to make as many units as possible, up to the demand for each. The last component may be made only in part.
7Buy all remaining units. Calculate the cost of the plan, or the extra cost compared with making everything, as the question asks.
8Add any non-financial points if asked: supplier reliability, quality, control and spare capacity.

Quickest way: Rank by extra cost per scarce hour

When to use it: Use this in Section A or B objective questions where you only need the quantity to make, the quantity to buy, or the extra cost.

Write three numbers for each component: extra cost of buying, scarce hours per unit, and extra cost per hour.
Circle the order, highest extra cost per hour first.
Subtract hours used by each component from the total available. Stop when the next component needs more than is left.
Divide the leftover hours by hours per unit to find the part-made quantity.
Extra cost of the plan = units bought × extra cost per unit. You do not need the full cost unless asked.

Common mistakes in Limiting Factors with Make-or-Buy Decisions

Ranking by the extra cost per unit instead of per scarce hour.
Students stop after the buy-minus-make step because it looks like the answer.
Fix: Always divide by the scarce resource used per unit. A small extra cost on a component that uses many hours can still be the best one to buy.
Making the components with the lowest extra cost per hour first.
Students confuse this with ranking by cost, where low is better.
Fix: Make first where buying hurts the most. Highest extra cost per scarce unit means make first. The lowest-ranked components are bought.
Including absorbed fixed overheads in the cost of making.
The question gives a full absorption cost per unit, and students use it.
Fix: Use relevant costs only. Fixed overheads count only if they would be avoided by buying.
Ignoring components that are cheaper to buy than to make.
Students apply the ranking to everything.
Fix: If the buy price is below the variable cost of making, buy it. It does not compete for the scarce resource, so take it out first.
Making a part-quantity of the wrong component or rounding badly.
Students forget that only the marginal component in the ranking is split between making and buying.
Fix: Allocate hours in rank order. Only the last component made may be made in part. Convert the leftover hours into whole units.
Using the wrong scarce resource or ignoring that supply is limited.
Students overlook a second constraint, such as a supplier limit.
Fix: Reread the question for all constraints. If the supplier has a cap, or there is more than one scarce resource, the simple ranking does not apply and you may need other methods.

Worked examples

Example 1

A company needs 1,000 units of component A, 2,000 of B and 1,500 of C. Machine hours available are 6,000. Variable cost of making: A ₹40, B ₹30, C ₹55. Buy price: A ₹52, B ₹39, C ₹70. Machine hours per unit: A 2, B 1, C 3. Decide how many of each to make and buy, and find the extra cost of the plan compared with making everything.

Show the solution

Hours needed to make all: A 2,000 + B 2,000 + C 4,500 = 8,500. This is more than 6,000, so there is a limiting factor.
Extra cost of buying per unit: A 52 − 40 = ₹12. B 39 − 30 = ₹9. C 70 − 55 = ₹15.
Extra cost per machine hour: A 12 ÷ 2 = ₹6. B 9 ÷ 1 = ₹9. C 15 ÷ 3 = ₹5.
Ranking, make first the highest: B (₹9), A (₹6), C (₹5).
Allocate hours. B: 2,000 units × 1 = 2,000 hours, leaving 4,000. A: 1,000 × 2 = 2,000 hours, leaving 2,000. C: 2,000 ÷ 3 = 666 full units, using 1,998 hours.
Make 666 units of C using 1,998 hours, and buy the other 834 units of C (1,500 − 666).
Extra cost of buying: 834 × ₹15 = ₹12,510.
Check the cost of making everything: A 40,000 + B 60,000 + C 82,500 = ₹1,82,500. Add ₹12,510 to get a plan cost of ₹1,95,010.

Answer: Make all 2,000 B and all 1,000 A. Make 666 units of C and buy 834 units of C. The extra cost compared with making everything is ₹12,510, giving a total variable cost of ₹1,95,010. The 2 spare hours remain unused because a whole unit of C needs 3.

Example 2

A firm needs 800 units of X and 600 units of Y. Labour hours available are 3,000. X: variable cost of making ₹90, buy price ₹105, 3 labour hours per unit. Y: variable cost of making ₹60, buy price ₹72, 2 labour hours per unit. The variable costs of ₹90 and ₹60 exclude fixed overheads. Fixed overheads of ₹20 per labour hour are absorbed in addition to these variable costs. These fixed overheads are unavoidable: they are incurred whether the components are made or bought. Find what to make, what to buy and the extra cost of buying.

Show the solution

Hours to make all: X 800 × 3 = 2,400. Y 600 × 2 = 1,200. Total 3,600, which is above 3,000, so there is a limiting factor.
The ₹90 and ₹60 are variable costs and do not include the absorbed fixed overhead. The ₹20 per hour fixed overhead is a distractor. It is unavoidable whether you make or buy, so it is not a relevant cost. Ignore it.
Extra cost of buying: X 105 − 90 = ₹15. Y 72 − 60 = ₹12.
Extra cost per labour hour: X 15 ÷ 3 = ₹5. Y 12 ÷ 2 = ₹6.
Rank: Y (₹6) first, then X (₹5).
Make all Y: 600 × 2 = 1,200 hours. Hours left: 3,000 − 1,200 = 1,800.
Make X with the remaining hours: 1,800 ÷ 3 = 600 units. Buy the other 200 units of X.
Extra cost of buying: 200 × ₹15 = ₹3,000.

Answer: Make 600 units of Y and 600 units of X. Buy 200 units of X. The extra cost compared with making everything is ₹3,000.

Exam tips

Check first whether the buy price is below the variable cost of making. Those components are bought outright and need no ranking.
In objective questions, check that hours used add up to the hours available. This catches most arithmetic slips.
In a constructed-response question, lay out a table with extra cost, hours per unit, extra cost per hour and rank. Markers can then award method marks even if one number is wrong.
Add a short non-financial comment when asked: supplier reliability, quality, confidentiality and loss of control. Keep it to one line each.
Read the question for avoidable fixed costs or supplier limits. Either can change the answer.

Practice questions from Limiting factors

Limiting Factors with Make-or-Buy Decisions in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Limiting Factors with Make-or-Buy Decisions: frequently asked questions

What is the difference between make or buy with and without a limiting factor?

Without a limiting factor, you compare the relevant cost of making each unit with the buy price, and make if it is cheaper. With a limiting factor, you cannot make everything, so you rank components by the extra cost of buying per unit of scarce resource. You make in rank order and buy the rest.

How do I rank make or buy with a scarce resource?

Calculate the extra variable cost of buying per unit, then divide by the scarce resource used per unit made. Rank from highest to lowest. Make the highest first because each scarce hour saves the most money there.

Why do we use extra cost of buying, not contribution?

The demand for the component is fixed, and it has to be supplied either way. So the decision only changes cost, not revenue. The aim is to minimise the extra cost of buying in, which is why you rank by that figure.

What if the supplier can only provide a limited number of units?

Then buying is also constrained and the simple ranking may not give a feasible plan. You may have to make some units even though they rank low. Read the question for any supplier cap before you start.