Make it ourselves or buy it ready-made: which costs really matter for the decision?
The bread a restaurant bakes itself costs 3 383 soum at full cost, while ready-made bread costs 3 200 soum. So is buying cheaper? No: tandoor depreciation and the share of rent remain whatever the decision. If only the costs that differ are counted, baking it ourselves saves 900 thousand soum a month. But if the freed-up space can earn income, the answer changes again.
The "Yashil hovli" restaurant uses about 200 loaves of bread a day, 6 000 a month. At present it bakes the bread in its own tandoor. A neighbouring bakery has offered to deliver ready-made bread every day at 3 200 soum a loaf. The accountant worked out the full cost: bread baked in-house costs 3 383 soum. The director Sardor is ready to shut down the tandoor. There is no need to rush.
Key rules
- In such a decision only differential costs are counted: costs that appear or disappear depending on the choice
- Costs that do not change whatever the decision (the allocated share of building rent, depreciation of equipment already bought) do not affect the decision. They are included in the full cost, so the full cost may give the wrong answer to this question
- Differential costs of in-house production: raw materials, an extra worker, energy for the tandoor. When buying: price per loaf × volume
- Add the opportunity (alternative) cost: if the tandoor stops, can the freed-up space or the worker's time bring in other income? If so, that income is a hidden cost of in-house production
- The answer depends on volume: the fixed costs of in-house production (the worker, energy) are spread over more loaves at a large volume. At a small volume buying may be cheaper
- Factors beyond the figures: control over quality and taste, what happens if the supplier is late, what to do if he raises the price, the risk of losing your own baker
Example: bread, 6 000 loaves a month
Amounts hypothetical, compiled by the author, in soum, per month.
| Cost | If we bake ourselves | Does it affect the decision? |
|---|---|---|
| Raw materials for the bread (6 000 × 1 800) | 10 800 000 | Yes |
| Baker's wages (hired only for the bread) | 6 000 000 | Yes |
| Extra energy for the tandoor | 1 500 000 | Yes |
| Tandoor depreciation | 800 000 | No: the tandoor has already been bought |
| Allocated share of the restaurant's rent | 1 200 000 | No: the rent is paid anyway |
| Full cost | 20 300 000 (3 383 per loaf) | |
| Differential costs only | 18 300 000 (3 050 per loaf) | |
| Buying ready-made bread (6 000 × 3 200) | 19 200 000 |
At full cost, buying looks 1 100 000 soum cheaper. At differential costs, however, baking ourselves is 900 000 soum cheaper: 19 200 000 − 18 300 000. Even if the tandoor is shut down, depreciation and the rent share do not disappear; they are now simply "hung" on other costs.
If the volume changes:
| Loaves per month | In-house (differential) | Buying | Benefit of baking ourselves |
|---|---|---|---|
| 4 000 | 14 700 000 | 12 800 000 | −1 900 000 |
| 5 000 | 16 500 000 | 16 000 000 | −500 000 |
| 6 000 | 18 300 000 | 19 200 000 | 900 000 |
| 8 000 | 21 900 000 | 25 600 000 | 3 700 000 |
Break-even volume: 7 500 000 : (3 200 − 1 800) ≈ 5 357 loaves. Above that, baking ourselves is cheaper.
Opportunity cost: if the space where the tandoor stands could be turned into a summer terrace earning an extra 1 500 000 soum a month, the true cost of in-house production becomes 18 300 000 + 1 500 000 = 19 800 000, and buying comes out 600 000 soum better. In this case the break-even volume rises to (7 500 000 + 1 500 000) : 1 400 ≈ 6 429 loaves.
Test yourself
5 questions on this topic: pick an option or reveal the answer.
A hypothetical dairy workshop made 400 cheeses in a month: total cost was 12,000,000 soums, of which fixed cost was 4,000,000 soums. What is the average total cost (ATC) per cheese?
In a hypothetical district the working-age population is 20 000 people: 11 400 are employed, 600 are unemployed (looking for work and ready to work), and the rest are not in the labour force. What is the economic activity rate of the population (labour force / working-age population)?
In a hypothetical country in one year: household consumption spending 500, investment 150, government purchases 200, exports 120, imports 170 (bln units). What is GDP by the expenditure approach?
Which of the following bakery costs is a fixed cost in the short run (does not depend on the number of loaves baked)?
In a sewing workshop, the total cost of sewing 100 shirts is 5 000 000 soums, and of 101 shirts 5 040 000 soums. What is the marginal cost of the 101st shirt?
Answered: 0 / 50 of 5 correct
All tests →See also
Sources
- Fundamentals of management accounting and economics (general concepts) · the "make or buy" decision, costs relevant to the decision (differential costs), allocated fixed costs, opportunity (alternative) cost; general knowledge
- Example, company name, prices, volume and calculations · compiled by the author, hypothetical; taxes are not taken into account