The make-or-buy question comes up in most businesses more often than it is formally analysed. Should we build this component ourselves or source it from a supplier? Should we deliver this service with our own team or use a specialist subcontractor? Should we manage this function internally or outsource it?
The instinctive answer often wins. Some organisations have a strong make preference: keeping capabilities in-house, maintaining control, protecting know-how. Others have a strong buy preference: focus on core competency, outsource the rest, keep fixed costs low. Neither instinct is inherently right. Both can lead to expensive decisions when applied without the numbers.
This article provides the financial framework for making these decisions with the right data, including the hidden costs that most organisations underestimate when they compare internal versus external options.
The Basic Framework
The financial comparison between making and buying has two components: the total cost of each option, and the strategic value or risk associated with each option.
The cost comparison is the starting point and the most straightforward part. The strategic value comparison is harder to quantify but often equally important. The framework below addresses both.
Total cost of making:
Direct production costs (materials, direct labour, energy for production) Variable overhead allocated to the activity (quality control, tooling, production planning) Incremental fixed costs (additional equipment, additional headcount beyond current capacity) Management time to oversee the activity (often underestimated) Cost of quality failures and their downstream impact Opportunity cost of capacity used for this activity versus alternatives
Total cost of buying:
Purchase price from external supplier Freight, logistics, and customs (for imported materials or services) Quality inspection and incoming goods verification Management time to manage the supplier relationship Risk premium for supply chain disruption (if the supplier is a single source) Transition costs if the arrangement needs to change
The comparison requires calculating both totals on a per-unit or per-period basis and making sure the comparison is between equivalent outcomes, not just equivalent prices.
The Hidden Costs That Change the Calculation
The most common mistake in make-or-buy analysis is comparing the external supplier’s quoted price against the direct internal cost, without including the full internal cost or the full external cost. Both are systematically underestimated in different ways.
Internal cost underestimation:
Management overhead is almost always excluded. Producing something internally requires management attention: planning, scheduling, quality oversight, vendor management for the raw materials going in. The cost of that attention, measured in management time multiplied by the loaded cost per hour of management, is real and often significant.
Quality failure costs are excluded or underestimated. Internal production has failure rates. Those failures have costs: rework, scrap, customer service if they reach the market, and the management time to investigate and resolve them. External suppliers also have failure rates, but the comparison should include the failure costs for both sides, not just one.
Capacity opportunity cost is excluded. If internal production uses machine time or floor space that could be used for the company’s core product, the margin foregone on the displaced core activity is a real cost of the make decision.
Capital costs are excluded. Internal production often requires equipment, tooling, or inventory investment. The cost of capital tied up in those assets belongs in the total cost of making.
External cost underestimation:
Transition costs are excluded. Moving production or a service from internal to external, or the reverse, involves setup costs, dual-run periods, testing, and qualification time. These are one-time but real costs that belong in the comparison if a change is being evaluated.
Supplier management costs are excluded. A single external supplier relationship requires management time: performance reviews, order management, quality escalations, contract negotiations. This is less time than full internal management of the activity, but it is not zero.
Supply chain risk costs are excluded. A sole-source supplier creates concentration risk. If that supplier has a quality problem, a capacity issue, or a business disruption, the cost to the buying company can be substantial. The make-or-buy comparison should include a risk-weighted cost for this exposure, particularly for components or services that are critical to the company’s own delivery capability.
Swiss Context: Labour Cost Asymmetry
In Switzerland, the make-versus-buy calculus has a specific feature that affects most service outsourcing decisions: the labour cost differential between Swiss internal resources and external providers (particularly those delivering services from lower-cost locations) can be very large.
A Swiss company considering outsourcing a process to an external provider in Central Europe, Eastern Europe, or beyond can expect to face a Swiss fully loaded labour cost of CHF 110K to CHF 140K per FTE annually (including all social charges: AHV, IV, ALV, BVG, SUVA, and overhead), compared to an external provider cost that may be 30 to 50 percent of that figure for equivalent work.
However, the non-labour costs of the external arrangement, particularly the management overhead to run the relationship and the quality and communication friction of working across time zones and cultures, often absorb a significant portion of that saving. A straightforward labour cost comparison will overstate the net benefit of outsourcing.
The more honest comparison applies a management overhead multiplier to the external cost and adjusts for realistic quality and communication friction. For services with clear, codifiable outputs and low communication intensity (data processing, standard reporting, routine testing), the outsourcing economics are usually strong. For services requiring significant judgment, frequent interaction, and cultural alignment (customer-facing roles, complex operational decisions, creative work), the case for outsourcing is weaker and requires much more careful cost modelling.
Beyond the Numbers: When Strategy Trumps Cost
Some make-or-buy decisions should not be made on cost alone, because the strategic value of keeping the capability internal outweighs any cost saving from outsourcing.
Core competency activities are the most obvious case. If a manufacturer’s competitive advantage rests on a proprietary process or precision capability, outsourcing that process to a supplier who may eventually serve competitors undermines the competitive position, regardless of the short-term cost saving.
Regulatory and compliance-sensitive activities may be retained internally for accountability reasons, even if external providers are cheaper. An activity where a failure creates personal liability for directors or regulatory penalties for the company carries a risk premium that the external provider’s price may not include.
Knowledge and data sensitivity is increasingly relevant. Activities that require sharing proprietary customer data, strategic plans, or intellectual property with an external provider may carry confidentiality risks that are not fully visible in the cost comparison.
The financial framework should include a structured assessment of these strategic factors alongside the cost analysis. The output should be a clear recommendation supported by both the cost numbers and the strategic risk assessment, not just the number that is most convenient.
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Alessandro Ratzenberger is a fractional CFO and business controller based in Zurich, with 15 years of operational finance experience at Dufry Group and Bomi (UPS Group).
