 Outsourcing, or sometimes called make or buy decisions, occur when companies try and figure out the best use of available resources. When making these types of decisions, there are often three areas that require consideration. How do variable costs compare to outsourced costs? Are any of the fixed costs avoidable if the product is outsourced? And how can freed up capacity be used? Assume the following costs accompany incur to produce 10,000 headphones. Based on the data provided, the average cost is $27 per headphone set. What if an outside vendor could produce the headphones for $24 per set? Should we do it? Initially, we might think it's great because it saves us $3 per set, but remember there are three things we need to consider when performing this kind of analysis. We start by comparing the variable costs of manufacturing the headphones to the purchase price of buying them. In this case, the variable cost to manufacture them is $20,000 less than to purchase them. We would require a purchase price of $2 per set less based on this information. What if buying the headphones rather than making them meant we could reduce plant supervision and avoid $10,000 of fixed costs? Although that improves the decision to buy the headphones. We would still be $10,000 better off by making them ourselves. Okay, what if the additional space and capacity meant that we could produce and sell more earbuds? We would need to consider the additional contribution margin of the earbuds. In this example, the additional $50,000 of contribution from the earbuds more than offsets the additional $10,000 of cost of buying the headphones. So we would be $40,000 better off by buying the headphones and producing more earbuds with the additional space. Each example you see will be a little bit different. Remember to focus on the incremental changes and the following considerations. Again, are outsourced costs less than variable costs? Are any fixed costs avoidable if outsourced? Would freed capacity generate additional contribution margin?