Make-or-Buy Analysis: Financial Techniques for Procurement Decisions

PMBOK v8 Definition

Make-or-buy analysis uses financial techniques—including payback period, return on investment (ROI), internal rate of return (IRR), discounted cash flow, net present value (NPV), and cost-benefit analysis—to decide whether to include something as part of the project or purchase it externally. Factors to consider include the organization’s current resource allocation, skills and abilities, need for specialized expertise, desire to avoid expanding permanent employment obligations, and need for independent expertise.

Why It Matters for the Exam

This concept appears frequently in PMI exam questions about procurement management and business value decisions. You will see it in situational questions where you must determine whether to build a capability internally or buy from a vendor, and in questions linking financial metrics to project selection and value delivery.

Key Points to Remember (for the exam)

• Primary Purpose: Decide whether to develop internally or purchase externally—not just cost comparison, but strategic factors too
• Financial Techniques Used: Payback period, ROI, IRR, discounted cash flow, NPV, cost-benefit analysis (any of these can be used)
• Non-Financial Factors: Current resource allocation, organizational skills and abilities, need for specialized expertise, desire to avoid permanent employees, need for independent expertise
• Common Confusion: Make-or-buy is NOT the same as lease-or-buy; make-or-buy focuses on internal development versus external purchase of project components
• Output: The decision itself becomes an input to procurement documents and source selection criteria
• Value Connection: Links directly to Finance Performance Domain outcomes—NPV, ROI, IRR are metrics for checking value maximization
• Timing: Performed during planning, but may be revisited when changes occur

Typical PMI Exam Example

Your project requires a specialized software module. Your team has expertise in similar modules but is fully allocated to critical path activities. A vendor offers the module with a 6-month warranty. Using make-or-buy analysis, you compare NPV of internal development versus vendor purchase, considering resource constraints and the need for independent expertise. Question: Which factor most strongly supports buying? Answer: The desire to avoid expanding permanent employment obligations and resource allocation constraints.

PMI Exam Traps

• Trap: Thinking make-or-buy only considers cost → Reality: It also considers resource allocation, skills, expertise needs, and employment obligations
• Trap: Confusing payback period with NPV → Reality: Payback period measures time to recover investment; NPV measures total value over time
• Trap: Assuming make-or-buy is a one-time decision → Reality: It can be revisited when project conditions change
• Trap: Believing ROI is the only financial technique used → Reality: Multiple techniques (IRR, NPV, payback, discounted cash flow, cost-benefit) are equally valid

Important PMI Connections

Quick Review Questions

1. Which three financial techniques are explicitly listed in PMBOK v8 as usable in make-or-buy analysis?
2. A project manager must decide whether to build a component internally. The team has the skills but is currently over-allocated. What non-financial factor should be considered?
3. How does make-or-buy analysis connect to the Finance Performance Domain outcomes?
4. What is the difference between using payback period versus NPV in a make-or-buy decision?
5. When should a project manager revisit a make-or-buy decision during the project lifecycle?

PMBOK v8 Reference

Section 2.4.1 - Key Concepts (Finance Performance Domain) and Section on Make-or-Buy Analysis (Procurement Domain)