QS Study

Opportunity cost is an economics term that refers to the value of what you have to give up in order for choosing something else. Another consideration in a make or buy decisions is whether the firm has alternative uses for its facilities if it should decide to buy the product from an outside supplier. It the company makes the part internally, rather than buying it, and then they have to use their production facilities. The benefit that could be derived from the best use of that funny is quality, thus the opportunity cost of buying would be losing quality. Opportunity Cost enters into your decision-making criteria when you have several options to consider, including spending the money on several choices of investment. For example, I own a storage space in a shopping mall. I can open a store using that space but I would then need to invest in the furniture, displays etc. Alternatively, I could just rent out space to a potential seller and get rental revenue. It refers to the value forgone in order to make one particular investment instead of another.

My decision would depend on how much money I would estimate to profit from selling my products (after my investments) compared to how much money I would earn from renting the space. There might be another possibility, I could rent half of the space & use the other half to sell my stuff (changing my opportunity cost). If it can use the facilities to earn additional revenue, it may be better to buy on the outside rather than a loss this revenue, loss revenue represents an opportunity cost, that is, the segment margin foregone when one alternative is chosen over another.