Assignment task:
Frank's Driving Appurtenances-A Make-or-Buy Decision
Frank Ziegler is a car buff. From his early childhood days Frank loved to tinker with cars. As he grew older, Frank's interest in cars evolved into how to enhance the comfort, convenience, and enjoyment of driving. Frank always had an entrepreneurial spirit, so he decided to open his own business, Frank's Driving Appurtenances.
Frank investigated the industry of car accouterments. He discovered that, like himself, many people enjoyed adding accessories to their car that expressed their unique personalities. He had designed many unique items for himself and his friends such as cup holders, objects to hang from the mirror, as well as things to adorn the outside of the vehicle. Frank believes that there is an enormous market for these items.
Mr. Ziegler was confident in his skill to design, manufacture, and sell unique accessories. His research showed that there were many suppliers for the type of items Frank made for himself and his friends. Consequently, he didn't have to make things himself; he could purchase and then resell them. Therefore, Frank believed his first step in creating Frank's Driving Appurtenances was to make-or-buy breakeven analysis. Although his primary motivation was to share his own creations, Frank was a realist. He knew that initially the best approach was to ascertain which method, make or buy, was the best financial decision. If buying and reselling was more financially sound, he could later move to making the items himself once his reputation for quality and individuality was established.
Mr. Ziegler had to calculate the costs for both options. Frank had to determine what his fixed cost would be if he made the items. He would need additional tools and machinery and a place to work. His garage would not be sufficient space to make the volume of items he thought he needed.
As Frank evaluated the buy option, he discovered that one element of the variable cost was shipping. Most of the suppliers who sold the types of items Frank wanted were in foreign markets. Although their base price for the items varied slightly, the shipping cost added to the base cost was somewhat volatile.
As Frank prepared to calculate the make-or-buy break-even point, he understood that the one critical piece of data was the volume of sales. How much did Frank think he could sell? An inaccurate estimate of sales could result in the wrong break-even point and potential failure.
Discussion Questions:
Q1. What is the purpose for using the break-even analysis?
Q2. What are the two types of cost Frank must consider when doing the break-even analysis?
Q3. Generally speaking, which type of cost is higher for the make option and which type of cost is higher for the buy option? Why?