Performance Management · Relevant cost analysis
Make or Buy and Outsourcing Decisions in ACCA PM
Updated 11 October 2026 · Fact-checked
A make-or-buy decision compares the relevant cost of producing something in-house with the price of buying it from a supplier. Include only future, avoidable cash flows. Choose the cheaper option, then check qualitative factors. If a resource is scarce, rank products by the extra cost of buying per unit of scarce resource saved.
Understand Make-or-Buy and Outsourcing Decisions
A make-or-buy decision asks whether a business should produce a product or component itself or buy it from an outside supplier. Outsourcing is the same idea applied to a service or activity, such as payroll, IT support or distribution.
The cost comparison uses relevant costs. These are future cash flows that change because of the decision. For making, they usually include direct materials, direct labour that would otherwise be avoided, variable overheads and any fixed costs that would be saved if you stopped making. For buying, the relevant cost is the purchase price plus any extra costs such as delivery or inspection.
Ignore sunk costs and general fixed overheads that continue whichever option you choose. Absorbed fixed overhead is a common trap: it is only relevant if the cash cost actually goes away when you buy. Opportunity costs count. If buying frees up space, machines or labour that can earn money elsewhere, that benefit reduces the net cost of buying.
The maths is only half the answer. Qualitative factors can override a small cost saving: quality, reliability of supply, loss of control, confidentiality, supplier power, the effect on staff, and whether the company can restart production later.
If capacity is limited, the question changes. You cannot make everything, so you must decide which items to make and which to buy. You do this by comparing the extra cost of buying with the amount of scarce resource each unit uses.
Key rules to remember
- Relevant cost of making
- Relevant cost of making = variable costs avoided + avoidable fixed costs + opportunity costs
- Use cash costs only. Leave out sunk costs and fixed overheads that continue anyway.
- Basic decision rule
- Make if relevant cost of making < relevant cost of buying
- With no limiting factor, choose the lower relevant cost, then review qualitative factors.
- Extra cost of buying per unit
- Extra cost of buying per unit = buying price per unit − relevant variable cost of making per unit
- Use this figure when a resource is limited. It is the saving you lose by buying.
- Ranking with a limiting factor
- Ranking measure = (buying price − variable cost of making) ÷ units of scarce resource per unit
- Make the items with the highest measure first. Buy those with the lowest.
- Total cost with limiting factor
- Total cost = cost of items made + cost of items bought
- Check that the total scarce resource used does not exceed the amount available.
How to solve Make-or-Buy and Outsourcing Decisions questions
Use this method for any make-or-buy or outsourcing question, with or without a scarce resource.
- 1Read the requirement. Note the volume needed, any limit on a resource, and whether the question asks for a calculation, a recommendation or both.
- 2List every cost of making. Mark each as relevant (future, cash, avoidable) or not (sunk, apportioned, unavoidable).
- 3Check for opportunity costs, such as spare capacity that could be rented out or labour that could be redeployed.
- 4Work out the relevant cost per unit of making and compare it with the buying price. Convert to totals if fixed costs are avoidable.
- 5If a resource is limited, calculate the extra cost of buying per unit, divide by the scarce resource per unit, and rank. Make in rank order until the resource runs out.
- 6Calculate the total cost of the final plan and, if useful, the saving against buying everything.
- 7Add the qualitative factors: quality, supplier reliability, control, confidentiality, flexibility, staff and long-term risks.
- 8State a clear recommendation with the financial figure and one or two key non-financial points.
Quickest way: Extra cost per unit of scarce resource
When to use it: Use when the question gives several products or components, a limited resource and an option to buy some of them.
- For each item write buy price minus relevant variable make cost.
- Divide by the scarce resource used per unit (for example machine hours).
- Rank from highest to lowest. Highest means making is most valuable per hour.
- Allocate the scarce resource to the top-ranked items first, up to their required volume.
- Buy the rest. Calculate total cost once and check the resource total equals the limit.
Common mistakes in Make-or-Buy and Outsourcing Decisions
Including absorbed fixed overhead as a cost of making.
The question gives a full absorption cost per unit and students use it as it stands.
Fix: Include fixed costs only if they are avoidable by buying. Use the stated saving, not the absorbed rate.
Ranking by the buying price or by the make cost per hour.
Students copy the contribution-per-hour method without adjusting it for the buy option.
Fix: Rank by the extra cost of buying per unit of scarce resource. This shows how much you save by using each hour on making.
Making the lowest-ranked items first.
Students confuse which items to buy with which to make.
Fix: Highest extra buying cost per hour means make first. Buy the lowest-ranked items.
Ignoring qualitative factors or listing them without relating them to the case.
Students focus on the numbers and run out of time.
Fix: Write two or three specific points tied to the scenario, such as quality control or supplier dependence, then give a recommendation.
Forgetting opportunity costs when capacity is freed up.
The question mentions a use for spare space or labour in a single line.
Fix: Underline any alternative use of resources and deduct the benefit from the net cost of buying, or add it to the cost of making.
Treating existing labour as a relevant cost when it will be paid anyway.
Labour is usually variable, so students assume it is always avoidable.
Fix: Ask whether the pay stops if production stops. If staff are retained and have no other use, the cost is not relevant.
Worked examples
Example 1
Delta Co needs 10,000 units of component X a year. A supplier offers X at $14 per unit. Delta's cost per unit to make X is: materials $5, direct labour $4, variable overhead $2 and absorbed fixed overhead $3. Direct labour is variable. If Delta stops making X, specific fixed costs of $10,000 a year would be saved. The other absorbed fixed overhead continues. Should Delta make or buy?
Show the solution
- Relevant variable cost of making per unit = $5 + $4 + $2 = $11. The $3 absorbed fixed overhead is not relevant, because only $10,000 of fixed cost is avoidable.
- Relevant cost of making = 10,000 × $11 = $110,000, plus avoidable fixed costs of $10,000 = $120,000.
- Cost of buying = 10,000 × $14 = $140,000.
- Making is cheaper by $140,000 − $120,000 = $20,000.
- Qualitative factors: making keeps control of quality and supply. Buying frees management time and removes the risk of production problems, but creates dependence on the supplier and may reveal designs.
Answer: Delta should make X. It saves $20,000 a year compared with buying ($120,000 against $140,000), subject to supplier reliability and quality checks.
Example 2
Echo Co makes products A and B and can also buy them. Machine hours are limited to 6,000. Demand is 2,000 units of A and 1,500 units of B. A uses 2 machine hours per unit, variable make cost $20, buy price $26. B uses 3 machine hours per unit, variable make cost $30, buy price $42. Fixed costs are unaffected by the decision. Find the cheapest plan and its total cost.
Show the solution
- Hours needed to make everything = (2,000 × 2) + (1,500 × 3) = 4,000 + 4,500 = 8,500. Only 6,000 are available, so some items must be bought.
- Extra cost of buying per unit: A = $26 − $20 = $6. B = $42 − $30 = $12.
- Per machine hour: A = $6 ÷ 2 = $3. B = $12 ÷ 3 = $4.
- B ranks first, so make B first. Make 1,500 units of B using 1,500 × 3 = 4,500 hours.
- Hours left = 6,000 − 4,500 = 1,500. Make 1,500 ÷ 2 = 750 units of A. Buy the other 2,000 − 750 = 1,250 units of A.
- Costs: B made 1,500 × $30 = $45,000. A made 750 × $20 = $15,000. A bought 1,250 × $26 = $32,500. Total = $92,500.
- Check: buying everything costs (2,000 × $26) + (1,500 × $42) = $52,000 + $63,000 = $115,000. The saving is $22,500, which equals (1,500 × $12) + (750 × $6) = $18,000 + $4,500.
Answer: Make all 1,500 units of B and 750 units of A, and buy 1,250 units of A. The total cost is $92,500, which is $22,500 less than buying everything.
Exam tips
- In objective test questions, check whether the figure given is a full absorption cost. If so, remove the fixed part unless the question says it is avoidable.
- In a limiting factor question, write the ranking measure as a short table in your working. Method marks are given for the correct ranking even if arithmetic slips.
- In constructed response questions, show relevant and irrelevant costs clearly and say why fixed costs are excluded. Examiners reward the reasoning.
- Always finish with a recommendation. A calculation without advice loses marks, so include at least two qualitative points linked to the scenario.
- Objective test answers are marked all or nothing, so check the units in the final figure: per unit, per year or total.
Practice questions from Relevant cost analysis
- Ridge Co makes component Z internally at a variable cost of $14 per unit and allocates fixed overheads of $6 per unit, of which only 40% wou…
- Cobalt Co is considering stopping Product P, which has sales of $90,000, variable costs of $60,000, directly attributable avoidable fixed co…
- Zeta Co is considering a special order that needs 400 kg of Material X. Zeta holds 500 kg of X in inventory, bought for $6 per kg. X is regu…
- Which of the following is a relevant cost for a decision on whether to accept a special order?
- Dalton Co is pricing a one-off contract. Which of the following overhead items is relevant to the decision?
Make-or-Buy and Outsourcing Decisions in other exams
The same ground in other exams, if you are preparing for more than one or want another angle on it.
Make-or-Buy and Outsourcing Decisions: frequently asked questions
How do I solve a make or buy question with a limiting factor?
Work out the extra cost of buying each item (buy price minus variable make cost). Divide it by the scarce resource used per unit. Make items with the highest figure first until the resource runs out, and buy the rest.
Which costs are relevant in a make or buy decision?
Relevant costs are future cash flows that differ between making and buying. These include avoidable variable costs, avoidable fixed costs and opportunity costs. Sunk costs and fixed overheads that continue either way are not relevant.
What qualitative factors should I mention for make or buy in ACCA PM?
Mention quality, reliability and security of supply, control over production, confidentiality, supplier power and price rises, effect on employees, and flexibility to restart production. Link each point to the scenario rather than listing them in general terms.
Is outsourcing different from make or buy?
The decision logic is the same: compare relevant costs and review non-financial factors. Outsourcing usually refers to services or whole activities, so factors such as service-level agreements, loss of expertise and redundancy costs become important.