Make or Buy with a Constrained Resource
Ridgeway Components makes three products. Per-unit data: Product A sells for £60, variable cost £36, uses 3 machine hours. Product B sells for £45, variable cost £22, uses 1.5 machine hours. Product C sells for £80, variable cost £58, uses 4 machine hours. Fixed costs are £120,000 per year and are unavoidable. Machine capacity is limited to 30,000 hours per year. Current demand is A 2,000 units, B 6,000 units, C 1,500 units. An external supplier has offered to supply all of Product C at £63 per unit, which would free the machine hours currently used by C.
1. Determine the optimal production plan and calculate the maximum contribution achievable.
Read the worked answer
Contribution per unit and per machine hour:
- A: £60 − £36 = £24; £24 / 3 h = £8.00 per hour
- B: £45 − £22 = £23; £23 / 1.5 h = £15.33 per hour
- C: £80 − £58 = £22; £22 / 4 h = £5.50 per hour
Rank: B first, then A, then C.
Hours needed for full demand: A 6,000 h; B 9,000 h; C 6,000 h = 21,000 h - this is within the 30,000 h capacity. So there is no binding constraint and the optimal plan is to meet all demand.
Contribution:
- A: 2,000 × £24 = £48,000
- B: 6,000 × £23 = £138,000
- C: 1,500 × £22 = £33,000
- Total = £219,000; less fixed costs £120,000 = profit £99,000.
(If capacity were tighter, the ranking above would drive the plan - but check the arithmetic before assuming a constraint binds.)
2. Evaluate the supplier's offer for Product C, including relevant costs, and state a recommendation.
Read the worked answer
Relevant cost comparison per unit of C:
- Buy price: £63.00
- Make variable cost: £58.00
- Saving per unit if bought: £5.00
But the machine hours released (4 h per unit) have an opportunity cost only if they can be used profitably. Since capacity is not binding (21,000 h used of 30,000 h), the released hours have no alternative contribution - the opportunity cost is nil.
Therefore: buying C saves £5 × 1,500 = £7,500 in variable cost with no lost contribution, so on purely financial grounds accept the offer.
Qualitative factors to weigh:
- Loss of control over quality and delivery reliability.
- Supplier dependency and future price risk once in-house capability is lost.
- Redundancy or idle labour costs (not given - must be checked; if labour is unavoidable, the saving shrinks).
- Fixed costs are stated as unavoidable, so they are irrelevant to the decision.
Recommendation: accept subject to satisfactory quality/delivery terms and confirmation that no unavoidable step-fixed costs are tied to C's production.