McConkie Company has decided to pursue a cost leadership strategy. This decision is prompted, in part, by increased competition from foreign firms. McConkie’s management is confident that costs can be reduced by more efficient management of the firm’s operational activities. Improving operational activity efficiency, however, often requires some strategic changes in organizational activities. McConkie currently uses a very traditional manufacturing approach. Plants are organized along departmental lines. Management follows a typical pyramid structure. Labor is specialized and located in departments. Quality management follows a conventional acceptable quality level approach. (Batches of products are accepted if the number of defective units is below some predetermined level.) Materials are purchased from a large number of suppliers, and sizable inventories of materials, work in process, and finished goods are maintained, The company produces many different products that use a variety of different parts, many of which are purchased from suppliers.

Required:
Given this brief description of the firm and its setting, for each of the following operational activities and their associated drivers, suggest some strategic changes in organizational activities (and drivers) that might reduce the cost of performing the indicated operational activity. Explain your reasoning.

Meldrum Company manufactures medical equipment. Meldrum produces all the components necessary for the production of one of its products except for one. This component is purchased from two local suppliers: Wood Machining and Gardner, Inc. Wood sells the component for $192 per unit, while Gardner sells the same component for $172. Because of the lower price, Meldrum purchases 80 percent of its components from Gardner. Meldrum purchases the remaining 20 percent from Wood to ensure an alternative source. The total annual demand is 1,500,000 components.
Wood’s sales manager is pushing Meldrum to purchase more of its units, arguing that its component is of much higher quality and so should prove to be less costly than Gardner’s lower-quality component. Wood has sufficient capacity to supply all the components needed and is asking for a long-term contract. With a five-year contract for 1,200,000 or more units, Wood will sell the component for $180 per unit with a con- -
tractual provision for an annual product-specific inflationary adjustment. Meldrum’s purchasing manager is intrigued by the offer and wonders if the higher-quality component actually does cost less than the lower-quality Gardner component. To help assess the cost effect of the two components, the following data were collected for qualityrelated activities and suppliers:

Required:
1. Calculate the cost per component for each supplier, taking into consideration the costs of the quality-related activities and using the current prices and sales volume.
Given this information, what do you think the purchasing manager ought to do?
Explain.

2. Suppose the Quality Control Department estimates that the company loses $6,750,000 in sales per year because of the reputation effect of defective units attributable to failed components. What information would you like to have to assign this cost to each supplier? Suppose that you had to assign the cost of lost sales to each supplier using one of the drivers already listed. Which would you choose? Using this driver, calculate the change in the cost of the Gardner component attributable to lost sales.

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Operational Activity Inspecting products Moving materials Reworking products Setting up equipment Purchasing parts Storing goods and materials Expediting orders Warranty work Operational Cost Driver Number of inspection hours Distance moved Number of defective units Setup time Number of different parts Days in inventory Number of late orders Number of bad units sold