Cost to buy (CTB)

Cost to Buy (CTB)

This topic is assessed in IBDP Business Management at Higher Level (HL) only.

When a business needs a component, sub-assembly, or service, it faces a fundamental choice: produce it internally or purchase it from an external supplier. This is the make-or-buy decision. Making an informed choice requires calculating the true total cost of each option — not merely the apparent purchase price or the estimated production cost, but all the costs attributable to each route. Cost to buy (CTB) is the total cost of sourcing a component or service from an external supplier, and it is the subject of this section. The cost to make (CTM) and the comparison between the two are examined in the cost to make section.

Components of CTB

CTB comprises more than the quoted purchase price. A rigorous make-or-buy analysis must include all costs associated with the buying option:

  • Purchase price: the price per unit quoted by the supplier, multiplied by the quantity required. This is the most visible component but not the only one.
  • Delivery and inbound logistics costs: the cost of transporting goods from the supplier to the business's facility — freight charges, import duties, customs clearance, and insurance in transit. For international suppliers, these can be substantial and must be calculated on a per-unit basis at the relevant order quantity.
  • Ordering and administrative costs: the cost of the procurement process itself — raising purchase orders, supplier qualification and audit, invoice processing, and supplier relationship management. For complex or regulated components, the administrative burden of supplier management can be significant.
  • Inventory holding costs: if the bought component must be held in stock before use (particularly under a just-in-case inventory approach), the cost of financing, storing, and insuring that inventory is attributable to the buying option. Under a just-in-time arrangement with a reliable local supplier, holding costs may be minimal.
  • Quality inspection and incoming goods costs: if bought-in components require incoming inspection before use — particularly if supplier quality cannot be fully relied upon — the cost of that inspection is part of the buying cost.
  • Supplier risk premium: this is rarely quantified explicitly but represents the implicit cost of supply chain risk — the probability and financial consequence of supplier failure, delivery delay, or quality failure that must be absorbed or mitigated through buffer stock, dual-sourcing, or contractual protections.
\[ \text{CTB} = (\text{Purchase price per unit} \times \text{Quantity}) + \text{Delivery costs} + \text{Ordering costs} + \text{Holding costs} \]

This formula is not provided on the IB Business Management formulae sheet — apply it from understanding. The specific cost components included will vary by context; always include all costs stated in the question.

Worked Example — Meridian Logistics Ltd

Meridian requires 6,000 precision housings per month for its cargo sensor unit. It is evaluating whether to buy these from a specialist supplier or manufacture them internally. The supplier quotes £4.80 per unit. Additional buying costs per month are: delivery from the supplier's facility £480; ordering and administration £220; incoming inspection (the supplier has variable quality) £360; inventory holding cost (2 weeks' buffer stock required) £580.

\[ \text{CTB (monthly)} = (£4.80 \times 6{,}000) + £480 + £220 + £360 + £580 \] \[ = £28{,}800 + £1{,}640 = £30{,}440 \] \[ \text{CTB per unit} = \frac{£30{,}440}{6{,}000} = £5.07 \]

The true cost of buying the housing is £5.07 per unit — 5.6% above the quoted purchase price of £4.80. A naive comparison using only the purchase price would understate the buying cost and potentially lead to an incorrect make-or-buy decision. This CTB of £5.07 will be compared against the CTM in the cost to make section to determine the financially optimal choice.

 Key Takeaways

  • CTB = (purchase price per unit × quantity) + delivery costs + ordering costs + holding costs + any other attributable buying costs.
  • The purchase price is only one component of CTB — delivery, administration, inspection, and holding costs can add materially to the true buying cost per unit.
  • CTB must be calculated at the relevant volume — bulk discounts may reduce purchase price but require larger inventory, increasing holding costs.
  • Supplier risk is a real but hard-to-quantify component of CTB — disruption costs can be significant and should be considered qualitatively even when not included in the numerical calculation.
  • CTB is only meaningful in comparison with CTM — it is one half of the make-or-buy analysis examined in the cost to make section.