The “Theory of Constraints” and the Make‐or‐Buy Decision

Abstract

The standard cost approach and the “theory of constraints” (TOC) manufacturing philosophy are compared as bases for the make‐or‐buy decision. The authors argue that many current make‐or‐buy decisions are made improperly and that capacity‐sensitive decision procedures are needed. The standard cost method , a make‐or‐buy decision method based on the standard cost system, is illustrated and compared with the contribution per constraint minute (CPCM) and maximum permissible component price (MPCP) methods, which are based on the TOC philosophy. The CPCM method is used to compare alternatives when the prices of purchased parts are known. The MPCP method provides the buyer with an upper bound purchase price, which could be used when negotiating with a potential supplier. The standard cost method, when strictly applied, ignores the revenue component of the decision and does not consistently yield the most profitable decision. The CPCM and MPCP methods are offered as procedures that consistently choose the more profitable decision.