Resource planning and constraints - Make or buy outsourcing ...

Learning Outcomes

After reading this article, you should be able to evaluate resource planning decisions involving internal production versus outsourcing. You will understand the criteria for make or buy analysis, identify qualitative and quantitative factors in outsourcing, and assess capacity constraints. By the end, you should be able to apply these principles to ACCA-style scenarios, recommend options, and analyse the impact on organisational performance.

ACCA Advanced Performance Management (APM) Syllabus

For ACCA Advanced Performance Management (APM), you are required to understand how resource allocation and constraints affect management decisions. This includes the ability to evaluate strategic resource planning, assess outsourcing choices, and apply quantitative techniques. In particular, revision should focus on:

• Appraising make or buy decisions using financial and non-financial criteria
• Assessing the impact of outsourcing on performance and resource allocation
• Evaluating capacity constraints and their management in operational planning
• Applying relevant costing principles to short-term and strategic resource constraints

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which of the following is a relevant cost for a make or buy decision?
   1. Historic unit manufacturing cost
   2. Future avoidable variable cost
   3. Apportioned head office overheads
   4. Sunk research and development costs

2. If outsourced supply is cheaper than internal cost but production capacity can be used for a more profitable product, what key concept must be considered?

3. State two qualitative factors to consider when evaluating whether to outsource a business process.

4. True or False? Committed fixed costs are always relevant to a make or buy analysis.

5. Briefly explain how capacity constraints might affect the outsourcing decision in a multi-product environment.

Introduction

Efficient resource planning ensures that an organisation can meet demand while managing costs and risks. Organisations frequently confront the decision to manufacture products or services internally, or to outsource them to external suppliers. Correctly analysing make or buy options is fundamental to controlling costs and aligning resource use with the company's objectives, especially when resources are limited.

This article explores how to evaluate make or buy decisions, including the financial and qualitative considerations of outsourcing. It also explains how capacity constraints influence resource planning, and how to apply relevant costing to optimise business decisions.

Key Term: make or buy decision
A management decision process comparing internal production costs and benefits against those of acquiring goods or services from an outside supplier.

Key Term: outsourcing
The act of contracting out the production of goods, services, or business processes to an external provider, rather than carrying them out internally.

Key Term: capacity constraint
Any bottleneck that limits an organisation’s ability to produce output, often due to limited resources such as time, labour, equipment, or materials.

Key Term: relevant cost
A future cash flow that will change as a direct result of a specific decision.

MAKE OR BUY DECISIONS

Organisations must frequently determine whether to continue producing goods or services using internal resources or purchase them externally. The decision hinges on both cost and non-cost considerations.

Relevant Costs in Make or Buy Analysis

The correct approach is to compare only relevant costs and benefits. This usually includes:

• Variable production costs directly avoided by outsourcing
• Any direct fixed costs saved by not producing in-house
• Purchase price from the supplier
• Additional transport or quality costs, if relevant

Costs that do not change as a result of the decision (such as apportioned fixed overheads or historic costs) are not relevant.

Key Term: sunk cost
Expenditure that has already been incurred and cannot be recovered; it is not relevant to future decisions.

Qualitative Factors

Not all important factors can be quantified. Additional considerations often include:

• Reliability and quality of external suppliers
• Loss of internal know-how or control
• Effects on workforce morale and job security
• Flexibility in responding to changes in demand
• Impact on intellectual property or confidentiality

Worked Example 1.1

A company produces component Alpha at a variable cost of $12 per unit and incurs $15,000 of avoidable annual machine maintenance if production continues. An external supplier offers Alpha at $13 per unit. Annual demand is 6,000 units. If Alpha is not made, machinery will sit idle with no alternative use.

Should the company make or buy Alpha?

Answer:
The relevant in-house cost per year is ($12 × 6,000) + $15,000 = $87,000. Buying cost = $13 × 6,000 = $78,000. Buying externally will save $9,000 per year, so the company should buy Alpha.

Worked Example 1.2

Component Beta can be made internally at a variable cost of $7 per unit, but the equipment could instead make Product Gamma, generating an extra contribution of $10,000 per year. Outsourcing Beta costs $8 per unit for 5,000 units per year.

Should Beta be made or bought, considering opportunity cost?

Answer:
In-house cost: $7 × 5,000 = $35,000. Opportunity cost from lost Gamma: $10,000. Total relevant in-house cost: $45,000. Buying cost: $8 × 5,000 = $40,000. Buying Beta externally saves $5,000 after considering opportunity costs, so the company should outsource.

Exam Warning

In many scenarios, the limiting factor is not only the direct cost but the best alternative use of capacity. Be sure to include any lost contribution as an opportunity cost. Students often overlook this in exam questions and fail to recommend the financially optimal option.

OUTSOURCING: COSTS, RISKS, AND BENEFITS

Outsourcing extends beyond simple cost savings—it can impact organisational flexibility, risk exposure, and long-term capabilities.

Common benefits:

• Reduction or avoidance of fixed costs
• Focus on core activities
• Access to specialist skills or technology

Common risks:

• Loss of process control
• Dependency on external suppliers
• Potential supply chain disruptions
• Quality inconsistency

Key Term: opportunity cost
The benefit foregone by choosing one alternative over another.

CAPACITY CONSTRAINTS AND DECISION MAKING

Capacity limits the volume of output over a period. A capacity constraint can be production hours, skilled labour, or machine availability. If all requirements cannot be met in-house, resources must be allocated to the most profitable products, and outsourcing may be used to satisfy remaining demand.

When Capacity is the Constraint

• Prioritise internal production for items with highest contribution per unit of the limiting resource
• Outsource products or components that deliver a lower contribution per limiting factor
• Consider overall profitability, not just unit costs

Worked Example 1.3

FastPro Ltd manufactures two products (A and B) on one machine. Machine time is limited to 3,000 hours per month. Product A generates a contribution of $20 per unit and takes 2 hours to produce. Product B earns $10 per unit and takes 1 hour. An external supplier can provide A at a $2 lower contribution per unit.

Which product should FastPro prioritise, and how should outsourcing be considered?

Answer:
Contribution per machine hour:

• A: $20 ÷ 2 = $10/hour
• B: $10 ÷ 1 = $10/hour

Both products yield equal contribution per bottleneck hour. If further demand for A exists beyond internal capacity, outsource A for the excess but only if net contribution from the supplier is greater than alternative use.

QUALITATIVE AND STRATEGIC FACTORS IN RESOURCE DECISIONS

Beyond immediate financial impact, consider how decisions align with organisational strategy:

• Will outsourcing affect the company’s reputation or compliance?
• Does external supply expose the firm to geopolitical risks?
• How will knowledge or process loss affect future competitiveness?

Summary

Resource planning involves more than just calculation. Effective make or buy and outsourcing decisions require a thorough review of both quantitative and qualitative factors, including opportunity costs and capacity limitations. The best answer is seldom the lowest direct cost—it is the option which creates the most value for the organisation while considering relevant risks and strategic objectives.

Key Point Checklist

This article has covered the following key knowledge points:

• Identify all relevant costs and benefits for make or buy decisions
• Incorporate opportunity costs and avoidable costs in analysis
• Evaluate qualitative impacts, such as quality, flexibility, and risk
• Assess the effect of capacity constraints on decision making
• Apply limiting factor and opportunity cost analysis where internal resources are scarce
• Recommend outsourcing only when it improves overall organisational value

Key Terms and Concepts

• make or buy decision
• outsourcing
• capacity constraint
• relevant cost
• sunk cost
• opportunity cost