Avoid the "dead load" in make vs. buy decisions
In the civil engineering world there is a concept called “dead load”. The Merriam-Webster Dictionary defines dead load as, “a constant load in a structure (such as a bridge, building, or machine) that is due to the weight of the members, the supported structure, and permanent attachments or accessories.” So what does the intrinsic weight of a structure have to do with make vs. buy decisions?
Dead load is weight that cannot be removed from a structure. We cannot “lighten the load” since it is intrinsic to the facility. When faced with a make vs. buy decision, we must determine our cost dead load; the cost that cannot be removed from our operations.
Rather than doing a quick analysis of inventory valuation cost vs. vendor selling price, a proper make vs. buy analysis will recalculate production cost and purchase cost.
Production costs for a part should include only those costs that would be eliminated (or directed to new production) if production of the part were eliminated. Material costs would most likely be eliminated in every production scenario. Direct labor costs may or may not be included. The question to ask with labor costs is, “Would a person be eliminated or could their production time be redirected to other needed products?” Variable overhead cost would be similarly analyzed. Expendable tooling and supplies may be eliminated, but some allocated expenses such as utilities (machine power draw, heat/cooling, lights) may require adjustments. Fixed overhead expenses would rarely be included since expenses for building and machinery (depreciation, insurance) would not often be eliminated.
Landed cost should be used in the analysis for the purchased cost. Landed cost would include the vendor selling price, freight, and any special handling costs such as kiting or breaking down containers/packages after receipt.
In a make vs. buy decision it is critical to remember that not all inventory valuation costs will be eliminated if production of a part ceases. The dead load costs are those costs that remain even if we stop making the part. Every cost should be evaluated by questioning if it will be eliminated when production ceases.
A make vs. buy analysis which considers only production costs that will be eliminated vs. the landed cost of a purchase product will provide management with an appropriate guide for real cost savings.
RSM’s management consulting practice has resources that can address issues in supply chain, operations, inventory management, and accounting. You can be in control of your costs even in the most challenging environments.