How to Conduct a Make-or-Buy Analysis for a New Subassembly

A new subassembly can look deceptively simple. A welded frame, wiring harness, machined housing, or populated control panel may contain only a few major components, yet its cost and risk depend on engineering time, supplier capability, transport, quality control, working capital and future demand. The right decision is rarely based on the quoted unit price alone.

A make-or-buy analysis compares the full business case for producing a component internally with the case for purchasing it from an external manufacturer. It should account for avoidable costs, capacity constraints, strategic value, intellectual property, supply continuity and the practical realities of operating in Australia.

The most useful analysis is built before a sourcing preference has formed. Treat the exercise as a structured decision rather than a justification for an existing opinion. A clear model allows operations, engineering, finance, procurement and sales to test the same assumptions and understand the trade-offs.

Define The Subassembly And Decision Boundary

Start by describing exactly what is being compared. Specify the design revision, annual volume, expected product life, required delivery frequency, quality standard, packaging, testing and any customer-specific requirements. Identify whether the decision concerns complete manufacture, partial outsourcing, or a hybrid arrangement in which critical work remains internal.

The decision boundary is important. If the company makes the subassembly, include direct labour, materials, consumables, inspection, rework, maintenance, supervision and production support. If it buys the item, include supplier tooling, freight, customs, insurance, incoming inspection, inventory, expediting, payment terms and supplier management.

A precise boundary also prevents double counting. For example, factory rent may remain payable whether the line runs or sits idle, so it is not necessarily an avoidable cost. By contrast, a new test fixture, additional technician or outsourced certification may exist only under one option and should be included.

Separate Relevant Costs From Accounting Costs

The central financial question is not “Which option has the lower standard cost?” It is “Which costs will change if this decision is made?” Fixed overhead allocations can make internal production appear expensive even when much of that expense will remain after outsourcing. At the same time, unused internal capacity has an opportunity cost if it could support a profitable product.

Build a variable cost model for each option. For internal production, calculate labour minutes, machine time, scrap, yield loss, tooling wear and inspection effort. For external supply, calculate the supplier price plus freight, port charges, GST treatment, customs duties where applicable, packaging, buffer stock and the cost of managing quality issues.

Use total cost of ownership rather than purchase price. An overseas quotation may be attractive before adding ocean freight through Port Botany, currency movements, minimum order quantities and several weeks of inventory. An Australian supplier in Adelaide, Newcastle or regional Victoria may carry a higher quoted price but provide shorter replenishment times and faster engineering changes.

Test Capacity, Capability And Investment

Determine whether the internal operation has the people, equipment and floor space to produce the subassembly at the required rate. A line that appears to have spare hours may already depend on overtime, weekend shifts or a bottleneck shared with another product. Include setup time, planned maintenance, changeovers and realistic first-pass yield.

Then identify the capital required. New CNC fixtures, crimping equipment, environmental test chambers, extraction systems or software may alter the economics significantly. Spread one-off investment over an agreed planning horizon, but also test what happens if demand is half the forecast or the programme ends early.

The external option needs a capability assessment of its own. Review process controls, certifications, technical staff, capacity loading, subcontractors and business continuity arrangements. A supplier that can build 500 units in a trial month may not be able to sustain 5,000 units annually without adding equipment or relying on unapproved subcontracting.

Quantify Quality And Supply Risk

Quality costs are often hidden until production starts. Estimate the probability and impact of scrap, field failures, warranty claims, line stoppages, inspection, returns and corrective action. For a safety-related or regulated subassembly, a low-probability failure can outweigh a substantial unit-cost saving.

Assess supply risk across materials, geography and logistics. Identify sole-source components, long-lead semiconductors, imported metals and specialist coatings. Consider whether a supplier’s business is exposed to shipping disruption, energy prices, labour shortages or a single major customer.

The Australian market adds distance and concentration risk. A business in Perth may face a different freight and replenishment profile from one in Melbourne, while remote sites can make an urgent replacement costly. Consider dual sourcing, local safety stock and approved substitute materials before awarding the work. A manufacturing perspective can help connect these operational details with wider reshoring and industrial competitiveness issues.

Account For Labour, Compliance And Knowledge

Internal production gives the company greater control over process knowledge, training and engineering feedback. It can also create recruitment and retention pressure, particularly where skilled welders, electricians, machinists or automation technicians are scarce. Model realistic wages, leave, training, supervision and overtime rather than relying on a historic labour rate.

For Australian operations, labour assumptions should reflect the Fair Work Act 2009, applicable modern awards, enterprise agreements, penalty rates and health and safety obligations. A supplier’s lower price may reflect a different employment structure, but the buyer still needs confidence that work is performed lawfully and ethically. Depending on the supply chain, review obligations under Australia’s Modern Slavery Act 2018 as well.

Protect drawings, software, process recipes and customer data through appropriate agreements and access controls. Clarify who owns tooling, test data, design improvements and production fixtures. The cheapest supplier is a poor choice if the company loses control of a differentiating process or cannot recover its tooling when the relationship ends.

Model Scenarios Rather Than One Forecast

Create a base case, downside case and upside case for volume, labour, material prices, exchange rates, freight and yield. For an imported subassembly, test currency depreciation and shipping delays. For internal manufacture, test wage growth, recruitment delays, equipment downtime and a slower production ramp.

Calculate break-even volume and timing. A make option may require a large upfront investment but become attractive at a stable high volume. A buy option may be preferable during market entry, when demand is uncertain or when a specialist supplier already has the required process qualification.

Use discounted cash flow where the decision involves meaningful investment. Compare net present value, payback period and cash conversion effects, including inventory and payment terms. Sensitivity analysis should show which assumptions drive the decision, rather than presenting a false impression of precision.

Compare Strategic Value And Customer Impact

Cost is only one decision criterion. Internal production may support faster design changes, local technical employment, customer audits and a stronger “Australian-made” proposition. For some buyers, local content, repairability and supply transparency have commercial value that should be documented rather than treated as a vague preference.

Buying can provide access to specialist equipment, established process expertise and scalable capacity. It may also allow the company to focus on system integration, product development and customer relationships. Those advantages matter when the subassembly is common across the industry and does not create a defensible market position.

Use a weighted decision matrix alongside the financial model. Score cost, quality, delivery, flexibility, strategic importance, compliance, resilience and implementation risk. Set minimum requirements first: a supplier that fails a safety, traceability or capacity requirement should not win through a favourable price score.

Establish Decision Controls And Review Points

Before approval, document assumptions, data sources, ownership and unresolved risks. Ask finance to validate cost treatment, engineering to confirm specifications, operations to verify capacity, procurement to test supplier evidence and legal or compliance staff to review contractual obligations.

Treat the decision as a controlled experiment when uncertainty is high. A limited production trial, supplier audit or temporary dual-source arrangement can produce better evidence than a lengthy argument over estimates. Set a review date after the first quarter of production and compare actual results with the approved model.

A sound make-or-buy decision leaves a traceable record of why the chosen option was preferred and what would change that choice. It also protects the business from quietly accepting costs that were omitted during the initial comparison.

Begin by issuing a one-page specification for the subassembly, including annual volume, quality requirements, delivery location and required date, then use it to collect internal cost data and comparable supplier quotations.