Electric Motor Outsourcing Decision CASE

Joan Riley is the supply manager for Foxcroft Corporation, which is a division of a large U.S. industrial power equipment manufacturer located in northern Virginia. Joan is the responsible for all Foxcroft purchases. Her largest dollar expenditures are for electrical components and other mechanical assemblies. Ms. Riley reports to Andrew Moore, the Division Manager at Foxcroft. Andrew has assigned Joan the responsibility leading a team charged with analyzing whether Foxcroft should outsource or internally manufacture a motor assembly. Recently, a Chinese supplier, who produces motors for several Fortune 500 companies, has submitted a very competitive quote. However, there has been a strong bias against outsourcing the motor within the company, particularly since there is a strong union presence in many of the facilities. This assembly controls a key function on a new line of power equipment. As an initial step, Joan's team is responsible for gathering the required information to guide the firm's decision process. Foxcroft's marketing group estimates that volumes for the motor assembly are: Year 11,500 units, Year 22,700 units, and Year 34,000 units. The Chinese supplier of electric motors has quoted a price of $150 per unit, FOB shipping point, with 10% price decreases per year for years 2 and 3. Ms. Riley assumes these price decreases are due to productivity improvements from higher volumes, the positive effects of learning at the supplier, and greater operating efficiencies. The supplier is not responsible for shipping and handling costs. Joan estimates they will be $11.00 per unit for all years. If the new line of industrial power equipment that these motors become part of is successful, it is estimated that the life cycle will be seven years. There is one motor per unit of equipment. The volume of the equipment is forecasted to reach a peak of 5,000 units per year in Year 4 with 20% reductions per year in volume as the product reaches the end of its product life cycle. It is estimated that the product will be completely phased out at the end of year 7.

The industrial engineering department has provided Joan's team with the following per unit cost estimates for internally manufacturing and assembling the motors during year 1 of a three-year planning cycle:

Direct labor $18.75

Cost of receiving components $1.25

Direct materials 36.250

Indirect labor 5.500

Factory supplies 3.135

Transfer price profit 18.750

In addition, initial tooling and line modification costs in Year 1 would total approximately $25,000. Fringe benefits for direct labor are 50% of direct labor rates, variable burden is assigned at 100% of direct labor rates, and fixed overhead is 250% of direct labor rates. Fringe benefits on indirect labor are assigned at 50% of indirect labor rates. Depreciation expense and engineering/design costs over the next three years are $20,000 and $80,000, respectively, to be spread evenly across the first three years of total volume. In years 2 and 3, Joan's buyer has a goal to achieve a 4% annual decrease in material costs. However, the new union contract provides for a 3% rise in direct and indirect labor rates. Joan assumes that this contract will increase the per-unit direct and indirect labor costs by 3%. Finally, Mr. Vincent in accounting also claims that because the Foxcroft unit is manufactured by their division and sold through another internal business unit, a 5% "transfer" price should be added to the final cost of production.

Questions

1. Andrew has asked Joan and her team to solve a three-year insource or outsource analysis on a per-unit total cost analysis basis. Joan needs to be sure to include all quantitative costs.

2. Further he has asked the team to solve a seven-year make-or-buy analysis that looks at the total cost of each sourcing alternative.