Make or Buy? Not as Simple as It Sounds

We are often faced with a decision whether to design, develop and deliver a course in-house or pay an outside party. This is a classic “make or buy” problem which turns out to be more complicated than most think. Since some critical costs are often omitted in the calculation of the make option, many practitioners are choosing the make option when the buy option is actually less expensive. Of course, there are other reasons than the cost for developing a course internally, but we will only focus on cost for this article.

I’ll begin with an example. Suppose I want to develop and deliver a two-hour course which will take 100 hours of staff time to design, develop, and deliver. The labor cost for the 100 hours is $30 per hour for a total of $3,000. Assume the instructor travel expense is $1,500 and materials are an additional $500. We will assume there is no room rental charge and no other direct expenses. Furthermore, suppose I have a vendor willing to deliver the same course for $7,500. Based on cost alone, which option should I choose?

At first glance, the answer appears obvious. The internal cost comes to $5,000, and if I choose this option, I save $2,500. Is that the correct decision though? Maybe not. First, the $30 per hour may represent only salary neglecting benefits like the employer-paid portion of FICA, health care, pension, unemployment, and other costs associated directly with the employee’s salary. These are called “related costs” and typically are about 25 percent of the hourly rate for management employees. Adding these in, we have a labor and related rate of $37.50 per hour and a labor and related cost of $3,750. You may be thinking that even with the additional $750, the decision still favors the make option, but we’re not finished.

We also need to add the burden rate and here is where it gets complicated. The burden rate takes two things into account. First and the more obvious of the two, burden accounts for the overhead required to support the department. This includes office rental space, utilities, computers, copy machines, office supplies, telephone, etc. as well as items like travel for conferences and education, subscriptions, fees, and consulting not directly related to a course. We include as overhead only those costs not directly associated with or attributable to projects.

This cost needs to be spread across all of the hours attributable to direct work. Typically, an employee works around 70 percent of their 2080 annual hours (52 weeks x 40 hours per week). The rest is spent on holiday, vacation, sick time, staff meetings, performance reviews, general planning, training and development, managing others, etc. So, we divide the total overhead burden for the department by the sum of the attributable hours, not the sum of all hours. This is often close to the average hourly rate, so for this example let’s say it’s $25.

But, we’re still not finished adding internal costs. The second component to burden is the cost of the non-attributable hours discussed above. In other words, what are the labor and related cost of the 30 percent of total hours employees do not spend directly working on task? Employees still need to be paid 40 hours per week even though they are not working on task for all of these hours. This money has to come from somewhere. Those of you who are consultants understand this well. You have to generate enough revenue to cover your time when you’re not on a billable project. This becomes an important part of burden and is not a small number. We divide this additional burden by the number of attributable hours to get the second component of the burden rate. Let’s say this come to $15 per hour.

In this example, the two components of burden add up to $40 per hour, which is more than the labor rate and not unusual. Now, our fully-burdened labor and related rate is $30 + $7.50 + $25 + 15 = $77.50 per hour, which is more than double the labor-only rate of $30 per hour. This pushes the make option to $7,750 for labor plus travel ($1,500) and supplies ($500) for a total cost of $9,750. It turns out that the less expensive option is to buy rather than make.

As you can see, there is more to the calculation than at first glance. Are you making these calculations in your organization? Do you know your total burden cost and the number of attributable hours? Many don’t and consequently think they are saving their organization money by developing and delivering courses using internal staff when it would be more cost-efficient to hire out.

Attend the Make or Buy Session at the CTR Annual Conference

I’ll be covering make or buy in more detail during the CTR Annual Conference on November 3. Click here to learn more and to register. Hope to see you there!