Garland Chocolates Shanti Suppiah, director of operations at the Garland Chocolates plant in Durham, North Carolina, was preparing for a team meeting scheduled for Monday, March 18, to decide what to do about declining margins for the Edgeworth Toffee brand. Options were to invest in new equipment or outsource manufacturing and packing. It was Wednesday, March 12, and Shanti needed to prepare her analysis and develop a recommendation prior to the meeting. Garland Chocolates Headquartered in London, UK, Garland Chocolates (Garland) was a leading global food manufacturer with annual revenues of $3 billion. The company pro- duced a wide range of chocolate and confectionary products, under more than 65 brands. It operated more than 50 plants globally, including eight plants in the United States. Garland's products were among the leading brands in the industry, and the Durham plant manufac- tured 20 product lines that were distributed to retail customers in North America, including grocery store chains, boutique candy shops, and convenience stores. Garland's brands were managed by Cross-functional teams with representatives from sales and marketing, operations, finance, engineering, purchasing, and distribution. Each team was governed by corporate goals for growth, profitability, and brand management, but was given significant autonomy to make strategic and tactical decisions in order to achieve their business performance objectives (BPOS). The competitive nature of the industry placed an upper limit on prices, so margins were determined by production and supply chain efficiencies. Consequently, cost control and continuous improvement were high priorities. The company's enterprise resource planning (ERP) system generated weekly BPO reports for team members. The Edgeworth Toffee Brand Production of Edgeworth Toffee was a two-step process: manufacturing and packing. The product was manufactured in two formats. The first format was a fixed-size, retail-ready pack, which contained a half-pound of toffee. The second format was a 10-pound bulk package that was placed in stores so that customers could select the amount of toffee they wanted and self-pack the product. Production of the fixed-size format was approximately 2,500 cases a year, compared to approximately 3,000 cases a year of the bulk format. Both formats sold for $145 per case. There were two dedicated packing lines for Edgeworth Toffee, one for each format. How- ever, the packing lines had long outlived their useful lives, and efficiencies had declined in recent years (see Tables 1 and 2). The efficiency is defined by the ideal labor hours for a certain item divided by the actual number of hours worked. There was one manufacturing line for Edgeworth Toffee. The Manufacturing and Packing Line Replacement Options The accounting de- partment set standard costs for each product line annually. Table 1 provides the standard costs for Edgeworth Toffee, and Table 2 shows actual operating performance data for the manufacturing and packing lines. As shown in Table 2, the packing line was operating at Table 1: Operating Standard Costs for Edgeworth Toffee % 100 17 20 Selling price Raw material Packaging material Labor-manufacturing Labor-packing Overhead Total cost Margin $ per case $145.00 24.65 29.00 13.05 7.25 21.75 95.70 49.30 s 15 Table 2: Manufacturing and Packing Line Performance Statistics 76 Measure Manufacturing efficiency Manufacturing scrap rate Packing efficiency Packing scrap rate Standard (%) Actual (%) 80 1.5 48 1.2 9.6 1.2 48% efficiency, and the scrap rate was nearly 10 percent. Annual maintenance costs on each packing line were approximately $9,000 per year. Annual maintenance costs on the manufacturing line were $10,000 per year. Working with lan Haase, purchasing manager at the Durham plant and a member of the Edgeworth Toffee team, Shanti obtained an estimate of $140,000 for the cost of replacing the two packing lines for Edgeworth Toffee, including installation. It was expected that the new equipment would be able to achieve the BPO efficiency and scrap tate targets. It was also expected that the new equipment would properly function in the next 10 years with the annual maintenance costs of $2,000 per year per packing line. Shanti also felt that it was time to examine replacement of the manufacturing line. The manufacturing and packing lines had originally been installed together more than 20 years earlier. The current maintenance costs on the manufacturing line were $9,000 per year. Although efficiency of the manufacturing line was close to the target of 80%, it was also showing signs of deterioration. The efficiency rate had declined to 76%, compared to more than 90% five years prior, and it had become increasingly more difficult to find replacement parts. A new manufacturing line would cost approximately $600,000 installed. It was expected that the new manufacturing line would properly function in the next 10 years with the annual maintenance costs of $1,000 per year. Outsourcing In addition to investigating options to replace the existing manufacturing and packing lines, Shanti had also looked into outsourcing. A preliminary review indicated that there would be substantial coordination costs if only packing was outsourced; there- fore, outsourcing manufacturing and packing was investigated. Ian and Shanti selected two contract manufacturers to submit proposals, Martin Contract Manufacturing (Martin) and Dasari Inc. Bids were requested from both. In order to make sure the supplier were well informed about the manufacturing and packing processes, both were invited to tour the Durham plant, and they were provided with detailed information and related data regarding the operation of the lines. Following a review of the proposals submitted by the suppliers, Ian and Shanti decided that Martin has the best bid. Martin quoted a cost of $68.00 per case for manufacturing and packing. The supplier would be responsible for raw material and packaging material costs. In addition, Garland would pay $35,000 in tooling costs every year. The Team Meeting As Shanti looked at the information on her laptop that had been collected regarding manufacturing and packing of Edgeworth Toffee, she knew that some- thing had to be done to address the declining margins of the brand as a result of increased production costs. Investing in new equipment seemed like an obvious solution; however, the capital investment would be significant and her proposal would need to exceed the company's 10 percent cost of capital rate to get approval by finance. While reviewing the proposal by Martin, Shanti felt that some of the overhead costs at the Durham plant could be eliminated if production of Edgeworth Toffee was outsourced. The estimate provided by the accounting department was that overhead costs allocated to Edgeworth Toffee could be reduced by 30% if production was outsourced. Historically, the company's strategy had been to control production of its products to ensure quality and delivery performance. Garland had an excellent reputation with its customers. However, if the case to outsource could be made successfully to the team on Monday, Shanti felt that senior management would approve the proposal. This was an important decision and she wanted to make a clear recommendation at the meeting on Monday, supported by a thorough analysis of all possible options. 1. Consider the case where Shanti replaces all of the manufacturing and packing lines. The Durham factory will be able to achieve all of the the standard costs and standard efficiencies. Under this assumption, fill out the following table. Assume that a total of 5,500 cases of Edgeworth Toffee product are sold a year. Round your response to two decimal places. Calculation based on the standard costs (When manufacturing and packing lines are replaced) Annual sales Annual raw material cost Annual packaging material cost Annual labor cost for manufacturing Annual labor cost for packing Annual cost incurred by scrap after manufacturing Annual cost incurred by scrap after packing Annual overhead Annual total cost 2. Consider the case where Shanti replaces only the packing lines. The Durham factory will be able to achieve the standard costs and standard efficiencies for the packing lines only. Under this assumption, fill out the following table. Assume that a total of 5,500 cases of Edgeworth Toffee product are sold a year. Round your response to two decimal places. Calculation when only packing lines are replaced Annual sales Annual raw material cost Annual packaging material cost Annual labor cost for manufacturing Annual labor cost for packing Annual cost incurred by scrap after manufacturing Annual cost incurred by scrap after packing Annual overhead Annual total cost 3. Consider the case where Shanti outsources production of all of the Edgeworth Toffee products. Under this assumption, fill out the following table. Assume that a total of 5,500 cases of Edgeworth Toffee product are sold a year. Round your response to two decimal places. Calculation when production is outsourced Annual sales per case Annual manufacturing and packing cost Annual overhead Annual total cost 4. Suppose Shanti is considering three options: purchasing new packing and manufac- turing lines, purchasing new packing lines only, or outsourcing production to Martin. Compute the total cost that will incur in the next 10 years considering the previous three questions, the installment costs, and the maintenance costs of new equipment. Assume that the annual sales of the toffee products will be 5,500 in the next 10 years. Assume that the risk-free interest rate is 0%. Round your response to two decimal places. For "other costs", use the annual total cost" obtained from Questions 1 2 and 3. Option 1: Purchasing new packing and manufacturing lines: Installment of new packing lines Maintenance of packing lines Installment of new manufacturing line Maintenance of manufacturing line Other costs Total Option 2: Purchasing new packing lines only: Installment of new packing lines Maintenance of packing lines Maintenance of old manufacturing line | Other costs Total Option 3: Outsourcing to Martin Tooling cost Other costs Total 1