Make or buy decisions

Q: Which in house costs are relevant?

Variable costs that stop. Materials, piece work labour, power used by the process, consumables. These are almost always relevant. Fixed costs that can be avoided. A machine lease that can be ended, a supervisor who would no longer be needed, a dedicated software licence. ACCA states that additional fixed costs caused by a decision are relevant, and the same logic applies to fixed costs a decision removes. Labour, depending on what happens to the staff. If employees would be redeployed to other paid work or kept on with nothing to do, their pay is not saved and is not relevant. If they would leave, or temporary staff would no longer be hired, the saving is relevant. Opportunity costs. If the space, machines or people released could earn contribution elsewhere, that contribution is a benefit of buying in. Not relevant, according to ACCA: reapportioned fixed costs whose total stays the same, depreciation and book values, and sunk or committed costs. A full cost per unit taken from the costing system usually includes a share of factory or office overheads that will carry on whatever is decided, so comparing it with a supplier's price is the most common error. The difference between full and marginal cost figures is explained in absorption vs marginal costing.

Q: How do you compare when there is spare capacity?

Illustration only. An engineering business makes 10,000 brackets a year. Its costing system shows a full cost of £10 a unit: materials £4, direct labour £3, variable overhead £1 and absorbed fixed overhead £2. A supplier offers to make them for £9 a unit. ItemMake (relevant)Buy Materials (£4 × 10,000)£40,000 Direct labour, staff leave if work stops (£3 × 10,000)£30,000 Variable overhead (£1 × 10,000)£10,000 Absorbed fixed overheadNot relevant Supplier price (£9 × 10,000)£90,000 Total£80,000£90,000 The full cost report suggests buying saves £10,000; the relevant cost comparison shows buying would cost £10,000 more, because the £20,000 of absorbed overhead does not disappear. If buying in would also let the business end a £15,000 a year lease on the bracket press, the make figure becomes £95,000 and buying is £5,000 cheaper. If the direct labour is salaried staff who would be kept on for other work, that £30,000 is not saved, the make figure falls to £50,000 and making is clearly cheaper.

Q: Which non financial factors should you weigh?

Quality and control. Can the supplier meet the specification consistently, and how quickly can problems be fixed? Reliability and dependence. What happens if the supplier fails, raises prices or prioritises bigger customers? Are there alternatives? Confidentiality and data. Outsourcing processes that handle personal or client data brings data protection obligations and security checks. Skills and knowledge. Work once outsourced can be hard to bring back if the in house expertise has gone. Flexibility. Buying in turns a fixed cost into a variable one, which helps when volumes are uncertain. ACCA's article on budgeting techniques gives an example of an organisation weighing in house provision against outsourcing an entire catering activity as two mutually exclusive options, and notes that simple cost benefit analysis struggles to capture effects such as reputation. The same applies here: write down the qualitative factors next to the figures.

A make or buy decision compares the costs that would actually change if work were moved out of house with the price an outside supplier charges. Only future costs that the decision avoids count; apportioned overheads, depreciation and money already spent do not. Where capacity is short, the contribution that freed capacity could earn belongs in the comparison, and quality, control and staff transfer rules can outweigh a small saving.

Tax investigation insurance from £108.75 a year (£9.06 a month).Pays up to £100,000 of your accountant's fees if HMRC opens an enquiry. No excess. Buy online in a few minutes.

See my price in 2 questions How the cover works Accountant? Offer cover to your clients or call 01795 841 310

What is a make or buy decision?

It is any choice between producing something with the business’s own people and equipment and buying it from someone else. For a manufacturer it might be a component; for a service business it might be payroll, IT support, bookkeeping, cleaning or delivery. The same question arises in reverse when a business considers bringing outsourced work back in house.

The financial part of the decision is a relevant cost comparison. ACCA’s technical article on relevant costs defines a relevant cost as one where the decision causes a change in cash flow, whether extra payments, reduced payments, extra revenue or lost revenue, and suggests a simple test: would the amounts on the bank statement change? The general rules are covered in relevant costs for decisions; this page applies them to the make or buy question.

Which in house costs are relevant?

Variable costs that stop. Materials, piece work labour, power used by the process, consumables. These are almost always relevant.
Fixed costs that can be avoided. A machine lease that can be ended, a supervisor who would no longer be needed, a dedicated software licence. ACCA states that additional fixed costs caused by a decision are relevant, and the same logic applies to fixed costs a decision removes.
Labour, depending on what happens to the staff. If employees would be redeployed to other paid work or kept on with nothing to do, their pay is not saved and is not relevant. If they would leave, or temporary staff would no longer be hired, the saving is relevant.
Opportunity costs. If the space, machines or people released could earn contribution elsewhere, that contribution is a benefit of buying in.

Not relevant, according to ACCA: reapportioned fixed costs whose total stays the same, depreciation and book values, and sunk or committed costs. A full cost per unit taken from the costing system usually includes a share of factory or office overheads that will carry on whatever is decided, so comparing it with a supplier’s price is the most common error. The difference between full and marginal cost figures is explained in absorption vs marginal costing.

Worried about an HMRC check? Tax investigation insurance pays your accountant’s fees if HMRC opens an enquiry or compliance check. Solar Protect cover pays up to £100,000 with no excess. It never pays tax, interest or penalties.

From £108.75 a year (£9.06 a month) for individuals, £117.57 for sole traders and £207.50 for companies and partnerships, including IPT and the £20 admin fee.

See my price in 2 questions or call 01795 841 310.

★★★★★ Rated 4.9 out of 5 on Trustpilot from over 160 reviews

How do you compare when there is spare capacity?

Illustration only. An engineering business makes 10,000 brackets a year. Its costing system shows a full cost of £10 a unit: materials £4, direct labour £3, variable overhead £1 and absorbed fixed overhead £2. A supplier offers to make them for £9 a unit.

Item	Make (relevant)	Buy
Materials (£4 × 10,000)	£40,000
Direct labour, staff leave if work stops (£3 × 10,000)	£30,000
Variable overhead (£1 × 10,000)	£10,000
Absorbed fixed overhead	Not relevant
Supplier price (£9 × 10,000)		£90,000
Total	£80,000	£90,000

The full cost report suggests buying saves £10,000; the relevant cost comparison shows buying would cost £10,000 more, because the £20,000 of absorbed overhead does not disappear. If buying in would also let the business end a £15,000 a year lease on the bracket press, the make figure becomes £95,000 and buying is £5,000 cheaper. If the direct labour is salaried staff who would be kept on for other work, that £30,000 is not saved, the make figure falls to £50,000 and making is clearly cheaper.

What changes when capacity is limited?

When the business is working at full capacity, buying in part of the work can free a bottleneck. The benefit is then the extra contribution earned on the output that the freed capacity allows, not just the cost difference. ACCA’s make or buy example shows this: a product needs two operations on the same fully used machine. Buying in components for the first operation raises material cost from $12 to $15 a unit, but freeing the machine allows output to rise by 50%. On 1,000 units, extra revenue is $15,000 and extra cost is $10,500, so buying in is worthwhile even though each bought in unit costs more. Machine running costs are ignored because the machine stays fully used either way. Ranking products by contribution per unit of a scarce resource is covered in contribution margin.

What UK tax and employment points affect the figures?

Employer costs of an in house team

If making in house means hiring, the relevant cost is more than salary. For 2026 to 2027, GOV.UK shows employer Class 1 National Insurance at 15% on earnings above the secondary threshold of £5,000 a year, so a new employee on £30,000 adds £3,750 of employer National Insurance before pension contributions. GOV.UK also shows the Employment Allowance for 2026 to 2027 as up to £10,500 off an eligible employer’s annual liability; it only reduces the extra cost if the business has not already used it in full. See Employment Allowance explained.

VAT on the supplier’s invoice

An outside supplier who is VAT registered will usually charge VAT at the standard rate of 20%. A fully taxable business recovers it, so the comparison is on net prices. HMRC’s Notice 706 explains that a business making exempt supplies cannot in principle recover VAT relating to them, so for a partly exempt or exempt business, such as many financial and property businesses, irrecoverable VAT is part of the cost of buying in, while an in house team’s pay carries no VAT. The calculation is covered in VAT partial exemption.

Buying from individuals

Where the work is bought from an individual contractor working through their own company, the off payroll working rules may apply and can shift tax costs and responsibilities onto the client; see IR35 and the off payroll rules.

Staff transfers under TUPE

GOV.UK explains that a service provision change, where a service provided in house is awarded to a contractor, is one of the two types of transfer protected by TUPE. Where TUPE applies, the employees’ jobs usually transfer to the new employer with their terms and conditions and continuity of employment. It does not cover contracts for the supply of goods for the business’s own use or for a single event or short term task. A supplier taking on transferring staff will price that into its quote, and the expected redundancy savings in a make or buy appraisal may not arise. Specialist employment advice is usually needed.

Which non financial factors should you weigh?

Quality and control. Can the supplier meet the specification consistently, and how quickly can problems be fixed?
Reliability and dependence. What happens if the supplier fails, raises prices or prioritises bigger customers? Are there alternatives?
Confidentiality and data. Outsourcing processes that handle personal or client data brings data protection obligations and security checks.
Skills and knowledge. Work once outsourced can be hard to bring back if the in house expertise has gone.
Flexibility. Buying in turns a fixed cost into a variable one, which helps when volumes are uncertain.

ACCA’s article on budgeting techniques gives an example of an organisation weighing in house provision against outsourcing an entire catering activity as two mutually exclusive options, and notes that simple cost benefit analysis struggles to capture effects such as reputation. The same applies here: write down the qualitative factors next to the figures.

What mistakes come up most often?

Comparing the supplier’s price with a full absorption cost that includes overheads which will not go away.
Assuming staff costs are saved when the people will be kept on.
Ignoring the contribution that freed capacity could earn, or the contribution lost if in house capacity sits idle.
Leaving out set up costs of switching, contract exit fees, supplier management time and irrecoverable VAT.
Counting depreciation on existing equipment as a saving.
Deciding on cost alone without testing what happens if the supplier’s price rises at renewal.

Solar Protect provides tax investigation insurance for businesses and fee protection schemes for accountancy practices. Read how our cover works or get a quote.

Related Accountapedia entries

Sources

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.