Make It or Buy It? Part 2: Opportunity Costs

There is also availability to consider.

We make one part in-house simply because the only other supplier has a 6 to 18 month lead time.

The OP is covering one topic at a time. Last Issue it was Manufacturing Overhead, this issue its Opportunity Cost. Perhaps in another issue or two we'll get to Lead Times.

A lead time of a year and a half? That's a long wait. Does this buy make Oak cabinets, and only plants an acorn AFTER there's an order for a Davenport?

It might as well be grown.

The joke we have in our company is that the process to make these is so difficult that by the time that supplier gets someone trained well enough to do that job it is time for them to retire. So, they have to start the training program over again.

Ohh, I like that one, I may have to steal borrow that joke for around here.

I find some of your logic wanting. You base cost savings on a welder that has no work and what his potential work could be. Until you provide this potential wor.k Your not saving anything. Why not have him do other work. Whether he is over qualified or paid for it. He is still producing. Not standing around.

Our are you saying send the welder home and let the lower paid employee do the gaskets? You don't keep employees like that.

The author is just using that as an example.

Here is an example of an opportunity cost that can be overlooked. Our shop has a shop labor rate of $45/hr, however we only pay our workers $14/hr at best. Average rate for fabrication/welding shops is $65/hr, however we sell machines. We need two rails for a conveyor, for example. All of our machinery requires everything being done individually by hand. So no two parts are the same and often times results in rework.

Now, I farm it out to a shop with a laser. Older lasers are about $120/hr, Fiber Optic Laser is about $220/hr. However, the Fiber Optic Laser cuts so much faster than the older lasers, that it is actually cheaper lasering with the fiber optic laser.

Doing parts in ones and twos is expensive, because of the set up costs, so you reduce the price by having them make several at once, which works, if it is a part that you know will be used again later on. You spread those set up costs over several parts.

If the parts are delivered and are wrong, you can reject them and the vendor has to redo them, the rework cost is on them. Opportunity Cost, TIME, delaying the completion of a machine, waiting on it to come back corrected, can make that machine late. Some of our contracts have us back charged if our machine is delivered late. We can have the vendor share in those costs for being late, however if you do that too much, they'll start "NO QUOTING" your jobs. So it might be cheaper to just fix it ourselves.

Let's say I ask a shop in another State, on the opposite side of the continent, that has really good prices. I get excited, oh boy, and order from them. They get the job done in good timely manner and delivered on time and everything is correct. I overlooked the shipping costs. The shipping costs puts the price over what they would have cost to make locally. Have to factor in a minimum order, that would make the order cost effective.

Big opportunity cost. Inventory. We fabricate our own machinery parts, much of it from sheet metal. People taking fairly large remnants and just shearing them down into small pieces and throwing them into scraps because remnants just get in they way. We are constantly having to do inventory adjustments on sheet metal.

Inventory, the accountants bane, but the fabricators dream. Your point of inventorying "standard" parts is well used by myself. I have few customers with lots of repeat business and on every new order, there are parts that are the same. Figuring out an "economic order quantity" and forecasting sales are key to knowing which "standard" parts should be inventoried.

In a custom shop like yours this is likely a little more difficult.

Thank you for your comments. With regard to ozzb's questions, I don't think there are answers that apply to all companies under all conditions. For example, let's assume that 1) the welder is typically welding, 2) the shop's need for gasket fabrication is small, and 3) the rubber cutting isn't a rush job. Under these circumstances, having the idle welder cut the gaskets makes sense. If we modify these variables, however, at what point do the opportunity costs (and the job costs) become unacceptable? If the $35/hr welder has only done welding half of the time for the last year, and spends the rest of his time doing $20/hr gasket fabrication, are the opportunity costs now so large that it's time to shake up the shop? I realize that's probably more of a question for the accountants than the engineers, but I'd like to get your take on where the "pain point" might be.

Yes, each company will have different cost structures, and different ways of costing their products. If you specialize, then opportunity costs will likely be very important because you may have a lot of competition, and your pricing structure will likely be based on specific costs/tasks for each product, especially if you have long term contracts.

As a custom fabricator, a "blended" shop rate taking into account both fixed and variable costs along with all other overheads creates a shop charge rate. This has to take into account all the different pay rates for each position/task. With the pay scales as they are today, one is actually selling man(person)hours, not really a specific product. Your cost of materials will vary over time, but relatively speaking remain somewhat constant.

Having any idle worker is never a good thing, so keeping them busy is important. And,,, if the employee is deemed to be a "good" one, you will try to keep them even if they are doing the work of a lower paid position, but only as long as they cannot be utilized in their own position. This has one good side effect in that your higher paid people actually get trained in lower paying jobs(just because they get paid more doesn't mean they can actually do the lower paying job), making them more flexible when times get financially difficult or sales drop off.

As to who is the question for? Even engineers should be aware of or know what the costs really are . After all, it is always about the bottom line and getting a perspective other than the accountants will shed some other type of light on the financial picture. And it won't hurt the engineers to know.

Thank you for answering my question about finding the "pain point" for opportunity costs. One of the things I enjoy about blogging here - and why I've been doing this for several years now - is that I continue to learn from the community. Several members have shared some very detailed examples, and I appreciate the time it took to document them.
With regard to adreasler's comment about Lead Times, I think this is a topic I'll explore in a future blog entry. If the dialog we've had so far is any indication, the "Make It or Buy It?" series of entries is worth continuing.