Case 11-2: McMichael Inc.

Art Flynn, packaging buyer for McMichael Inc. (MI), was working on an import substitution project involving a local minority supplier. He was concerned, however, that his efforts would be fruitless because his original proposal had been flatly rejected by the plant manager as too expensive.

McMichael Inc., a medium-sized company, had over the years specialized in prescription skin-care products, a market niche in which it had developed an excellent reputation. About three years ago, after extensive testing, MI had introduced a new facial cream in a special package that allowed for precise measurement of the quantity dispersed. The container, manufactured by a French firm for a different application, was fairly expensive at an FOB MI's factory cost of $0.36. What concerned Art Flynn even more, however, were the quality and delivery problems encountered. Communications with the manufacturer were difficult, and Art had the impression the manufacturer did not seem to care much about MI's business, which, as Art knew, was only a small proportion of their total volume produced.

With the cooperation of MI's marketing, engineering, production, and quality control personnel, Art had found a local minority supplier who appeared capable of meeting MI's requirements. This custom molding firm, OSA Inc., was owned by Bert Wood, a bright engineer, who had purchased the firm several years earlier when the previous owner wished to retire. OSA Inc. had its own tool and die manufacturing operation as well as its own molding shop. It depended heavily on automotive contracts, a situation Bert Wood wished to correct by acquiring more nonautomotive business. In conjunction with MI's engineers, Bert Wood had worked out a mold design for the cream dispenser and included several suggestions for minor improvements. The cost of the mold was $56,000, an investment Bert Wood was in no position to make and that MI would have to absorb upfront. Bert Wood quoted a unit price of $0.27 based on purchase quantities of 30,000 units at a time and an annual volume estimated at 300,000 units. Bert Wood had submitted a cost breakdown of this quote as follows:

Resin 16 Labor 3 Overhead* 8 27

*Overhead breakdown: Power 1 Depreciation 1 Interest 3 Space, insurance, light and heat, taxes, supervision 3

When Art submitted this quote along with the request for a $56,000 mold investment up front, the plant manager and treasurer both turned it down, arguing that the 24-month payback on the mold was far too long and that the company had better investment opportunities with a 12-month payback.

Art was disappointed because he had hoped this project would assist in helping him meet his savings target for the year. When he talked the idea over with his manager, Louise Moffat, she suggested he give it another try. She said, "I am sure that if you can get the mold payback down to 15 months, you will get a warmer reception. There are not that many deals around this company that pay for themselves in one year." She also suggested that Art talk to marketing to see if some other products could use the same packaging, and to the production scheduling group to check if different production quantities could be ordered.

When Art talked to the marketing people, he found out that the package was ideal for another product to be introduced shortly and with an annual demand estimated at 100,000 units. Marketing had been uneasy about using the French package because of the difficulties encountered with it and assured Art that if he could get a reliable domestic source, this option would be highly attractive.

The scheduling group, for a number of years, had used a modified MRP system. When Art discussed the new package idea with them, they told him that if the new product and the older one were to be packaged in the same package, a total package requirement of about 40,000 units would make sense and that the master production schedule could easily be adjusted to run the two products in conjunction.

Art also discussed the situation with the resin supplier, who indicated that his quote to Bert Wood had been based on the lot size of 30,000 packages, but that a 40,000 unit lot would fall into a new price bracket 5 percent lower than the originally quoted price.

Art wondered just what effect all of this new information would have on his original proposal. He knew that Bert Wood had been adamant about his $0.27 quote. Bert Wood had said, "I know I am classified as a minority supplier. But I don't want to hide behind that fact. I want no special favors from any of my customers. Nor am I in a position to make special gifts to anyone else. I have had to borrow at what I consider to be ridiculously high-interest rates to buy this company. Now I have to make it pay off. My $0.27 price is as low as I can go, as far as I can see."

Reference- Purchasing and Supply Management (fifteenth edition) by Johnson Flynn

IMMEDIATE ISSUE

Can the import substitution project be structured to meet MI's return on investment expectations?

BASIC ISSUES

1. Preparation of the feasibility study
2. Cost analysis and savings calculation
3. Minority sourcing
4. Purchasing research
5. Supplier switching
6. Remuneration of supply managers

STUDENT ASSIGNMENT

1. If you were in the position of Art Flynn, what would be your analysis of the import substitution project?
2. What action would you take and why?

POSSIBLE DISCUSSION QUESTIONS:

1. Why is Art Flynn interested in working on this project? Explain
2. Does the minority supplier issue have a bearing on this case? Why ...Why Not?
3. What is the quantitative analysis in this situation?
4. Is it possible to meet MI's 15-month payback target? Explain

Note: Please read above mentioned case and give proper answer of all questions.