MakeVersusBuyCase

ABC Ltd. is a manufacturing company engaged in the manufacturing of valves. They have been in thebusinessforthe last3yearsandhavebeenmanufacturingonlyonetypeofvalve.Theystartedtheirbusinessinitially with sales of 10,000 valves per month and now they have increased the volume to about 50,000valves per month. They have been buying all the raw material for the valve and were doing all themanufacturinginhouse.Nowtheyhaveestablishedthemselvesinthemarketandareplanningtoexpandand produce different varieties of valves. They have their plant in the main city and the total area of theplant is 50,000 sq. ft. Now if ABC expands its operations and continues with its manufacturing activitiesin-house, it will need another 50,000 sq. ft. of land area to do so. In recent times, however, landpricesintheareahavemorethandoubled.Landisstillavailablebut withgreatdifficulty.

Mr. Mohan, the production head of ABC Ltd., has been successful with the production of valves and hasseen the production levels continuously increasing. He has, however, been facing the problem of qualitycomplaints which have gone up from an average of 0.2 % in the previous 2 years to 0.5 % this year. Also,he is finding that there is a high level of dissatisfaction among the workers regarding their workload aswellastheirsalarylevels.Theworkersregularlycomplainaboutoverwork.Mr.Mohanhasalsofound that the workers have been spending a lot of time on tea breaks, lunch breaks and even in betweentheproductioncycleswhentheyspendalotoftimetalkingtoeachother.Duetoinsufficientworkersandstaff, he is unable to take strict action and the workers are taking advantage of this situation. Forcompletingtheworkanddeliveringtheproductsonatimelybasis,hemustemployworkersonovertimeand his overtime cost has also increased 3 times. Mr. Mohan is concerned about the new expansion planofthemanagementandisworriedaboutwherethenewworkerswouldcomefromasheisalreadyfindinga shortage of workers for the existing job. He has requested that management not expand immediatelybutratherimproveandconsolidatethe existing setup. Hehassenthisrequestto Mr. S.Kumar,Director

- Operations.

Mr.Kumarhasgonethrough attherequestofMr.Mohanandcalledameetingofallthedepartmentheadsand explained the situation to all concerned. Mr. Johnson, the Marketing Manager, has expressed verybullish prospects for the company's growth and said that the company should take advantage ofthe growing economy and ABC's established brand image and definitely go for expansion. Mr. Olek, theFinanceManager,hasalsoexpressedsupportforMr.Johnson'spositionandindicatesthatexpansionwillresultinan economyofscale fortheproductsandwillfurtherincreasetheprofitabilityofthecompany.Mr.Mohan again highlighted his problems regarding the availability of manpower as well as productioncontrols and the effects on quality and productivity. Mr. Johnson then asked Mr. Mohan if outsourcingthe productionof thenewvalveswould be thebetteroption.

Mr.Mohanisveryskepticalabouttheoutsourcingoptionashefeelsthatoutsideagenciesalwayschargemore,therebycuttinginto hisownprofitability.He alsoworriesaboutthe possibleproblems withdeliveries. Mr. Kumar asked Mr. Chen, who is the Purchase Manager, about his views. Mr. Chenindicatedthatsincesuppliersarealsointerestedindoingbusinessitwasnotverylikelythatdelayswould

be a great source of concern as this would mean that they too would incur losses. Mr. Olek, the FinanceManager,saidthat hewilllook atthe cost comparisonforbuyingversusin-housemanufacturing.

After listening to all the views, Mr. Kumar told Mr. Mohan to work out the cost of production for futuresales as per the forecast given by the Marketing department. He also told Mr. Chen, the PurchasingManager, to collect the details of the future requirements to get the purchase cost details for a fewcomponentsofthevalves.

Mr.MohanandMr.Chenhavecollectedtheirdataandtheyhavepresentedthedatainthemeetingcalledby Mr. Kumar to review the plan. First the marketing head, Mr. Smith, presented his market forecast andthenMr.Mohanpresentedhis reportandexplainedthedetailsas follows.

• Onesupervisorwithmonthly salaryof$5,000 withexpectedincreaseof10%peryear.
• Directwagesofworkeras $4perunit.Witha 10 %reductioninthe secondyear,nochangein the3^rdyear and anincreaseof10%everysubsequentyear.
• Materialcostof$14perunit withanincreaseof 10%everyyear.
• Powerandfuelcostof$2 perunitwithan increaseof10% every year.
• Indirect laboris50%ofdirect labor.
• They will have to buy a new machine with a cost of $500,000. With usable life of 5 yearsMr.Chenexplainedhis details as follows:
• Componentpricefromsupplierat$20forthefirst2yearswithanincreaseof10%everysubsequent year.
• Transportationcosts$2perunitforthefirstyearwithan increaseof$0.20everysubsequentyear.
• Inventorycost (storage cost)as5% peryearofthe component price.

Mr.Smiththengavethesalesforecastfornext5 yearsasfollows:

Year	1	2	3	4	5
Salesquantity	300,000	500,000	700,000	900,000	1,000,000

Questions

1. Give5reasonswhy ABC Ltd.managementshouldoutsourceitsmanufacturing(buy).(5marks)
2. Give5reasonswhyABC Ltd. managementshouldcontinue in-housemanufacturing(make).(5marks)
3. Takingalltheinformationgivenabove,developtwotablesthatcanbeusedtocomparethecostof manufacturingin-houseversus the costof procurement.(30marks)
4. IsiteconomicalforABCLtd.tobuytheproductfromthemarketortomanufacture itin-house?Why? (5marks)
5. Arethere anyotherfactorsforconsideration for ABC Ltd?What?(5marks)