Most companies do not carry out each step from sourcing raw materials to producing the final product. Different companies usually process products through a number of steps on the value chain. For example, oil is often extracted, shipped, and refined into gasoline, petroleum, jet fuels and asphalt. Instead of being fully refined, hydrocarbon raw materials can be obtained from the cracking process used in refining oil, and chemically processed to make hydrocarbon monomers used as the building blocks of plastics. These monomers are then shipped to a polymerization plant where there are normally processed into pellet-like plastics, which are shipped to be molded into final products.
It doesn’t necessarily make sense for a yogurt company to also extract its own oil and make its own plastic containers the yogurt is shipped in. For example, Nestle can order plastic containers from China for $0.02/piece. It can also buy the plastic pellets and make the yogurt containers itself. To do so, it would have to lease factory space, equipment and workers.
Variable Costs
Plastic Pellets/Shipping $0.004/piece
Fixed Costs
Labor $300,000
Factory Lease $100,000
Equipment $25,000
Total Fixed Cost $425,000
At what quantity does it make sense for Nestle to make, rather than buy, the plastic containers?
To cover fixed costs:
425,000 / # units = fixed cost per unit
Total cost per unit to make = fixed cost per unit + variable cost per unit
= 425,000 / # units + 0.004
Total cost per unit to buy = 0.02
It makes sense to buy up until the point that total cost per unit to buy = total cost per unit to make.
425,000/# units + 0.014 = 0.02
425,000/# units = 0.02 – 0.004
# units = 425,000 / (0.02 – 0.004)
= 26,562,500
Therefore, Nestle should make its own plastic yogurt containers if it needs more than 26,562,500 units/year.
Make or Buy Decisions
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