Cost to make (CTM)

Cost to Make (CTM)

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

The second half of the make-or-buy analysis is the cost to make (CTM) — the total cost to the business of producing a component or service internally rather than purchasing it from an external supplier. Like CTB, CTM must include all costs attributable to the internal production option — not only the direct material and labour costs, but also the fixed cost of the capacity committed to making the component. Comparing CTM with CTB (examined in the cost to buy section) provides the financial basis for the make-or-buy decision.

Components of CTM

  • Direct material cost: the cost of raw materials and components consumed in producing the item internally.
  • Direct labour cost: the cost of the workforce time directly attributable to producing the item — at the relevant wage rate and hours required per unit.
  • Variable overhead: variable costs of production beyond direct materials and labour — energy consumption, tooling, consumables — that vary with output volume.
  • Fixed cost allocation: the share of fixed production costs (machinery depreciation, factory space, supervisory salaries) attributable to producing this component. This is the most complex component — it requires a decision about which fixed costs are genuinely avoidable if the item is outsourced (and therefore relevant to the decision) versus which fixed costs will be incurred regardless (and therefore irrelevant to the make-or-buy comparison).
\[ \text{CTM} = (\text{Variable cost per unit} \times \text{Quantity}) + \text{Attributable fixed costs} \]

This formula is not provided on the IB Business Management formulae sheet — apply it from understanding.

The make-or-buy decision

Once CTB and CTM are calculated on a comparable basis (same quantity, same time period), the financial comparison is:

  • If CTM < CTB: making internally is cheaper — financial logic favours making, subject to qualitative considerations.
  • If CTB < CTM: buying externally is cheaper — financial logic favours buying, subject to qualitative considerations.

However, the financial comparison is only one input to the make-or-buy decision. Qualitative factors that may override the financial result include: the strategic importance of maintaining internal capability; quality control considerations; the risk of supplier dependency (particularly for components critical to the product's performance); intellectual property and confidentiality; and the flexibility implications of each option — internal production can be adjusted immediately; an outsourced component is subject to the supplier's lead times and minimum order constraints.

Avoidable versus unavoidable fixed costs

The most important analytical distinction in CTM is between avoidable fixed costs (those that will genuinely be eliminated if the item is outsourced — the relevant costs for the decision) and unavoidable fixed costs (those that will continue regardless of whether the item is made or bought — irrelevant to the decision). If the machinery used to make the component can be sold or redeployed productively if outsourcing is chosen, its depreciation is avoidable. If the factory space used cannot be sublet or redeployed, the associated rent is unavoidable and should be excluded from the CTM comparison — it will be incurred whether the component is made or bought.

Worked Example — Meridian Logistics Ltd: make-or-buy comparison

Continuing from the cost to buy section: Meridian requires 6,000 precision housings per month. The CTB was calculated at £30,440 per month (£5.07 per unit). The production team has costed internal manufacture:

Direct materials per unit: £1.80. Direct labour per unit: £0.95. Variable overhead per unit: £0.35. Monthly avoidable fixed costs (dedicated tooling depreciation, attributable supervision): £9,600.

\[ \text{Total variable cost} = (£1.80 + £0.95 + £0.35) \times 6{,}000 = £3.10 \times 6{,}000 = £18{,}600 \] \[ \text{CTM} = £18{,}600 + £9{,}600 = £28{,}200 \] \[ \text{CTM per unit} = \frac{£28{,}200}{6{,}000} = £4.70 \]

Comparison:

\[ \text{CTB per unit: } £5.07 \qquad \text{CTM per unit: } £4.70 \] \[ \text{Saving from making: } £5.07 - £4.70 = £0.37 \text{ per unit} \] \[ \text{Monthly saving from making: } £0.37 \times 6{,}000 = £2{,}220 \] \[ \text{Annual saving from making: } £2{,}220 \times 12 = £26{,}640 \]

On financial grounds, making the housings internally is preferable — CTM (£4.70) is lower than CTB (£5.07) by £0.37 per unit. However, Meridian's management must also consider: does internal housing production occupy capacity that could generate a higher contribution if used for something else? If the production machinery used for housings could instead assemble 300 additional tracking units per month at a contribution of £85 each, the opportunity cost of making housings (£300 × 85 = £25,500 per month) would substantially outweigh the £2,220 monthly saving — making buying preferable despite the higher direct cost.

 Key Takeaways

  • CTM = (variable cost per unit × quantity) + attributable avoidable fixed costs — not on the formula sheet.
  • Only avoidable fixed costs are relevant to the CTM calculation — unavoidable fixed costs will be incurred regardless and do not affect the make-or-buy decision.
  • If CTM < CTB, making is cheaper; if CTB < CTM, buying is cheaper — but qualitative factors (strategic capability, quality, supplier risk, opportunity cost) may override the financial result.
  • Opportunity cost is a critical qualitative input: if internal capacity used for making has a higher-value alternative use, the financial advantage of making may be outweighed by the foregone contribution.
  • The make-or-buy decision is not permanent — it should be reviewed whenever costs change, supply chain conditions shift, or internal capacity changes.