Rams Ramachandran is considering the wisdom of reducing the number of suppliers his firm uses. Currently, Rams uses 25 suppliers to purchase goods worth $2,500,000 per year. To manage the orders and coordinate with suppliers, Rams employs one manager and two clerical staff. The manager earns $65,000 per year and each clerical staff person earns $35,000 per year. (As VP, Rams earns $175,000 annually.) Reducing the number of suppliers from 25 to 6 would allow Rams' firm to free up one of the clerical staff. While the manager would supervise fewer people, she also would interact more with each supplier; thus, her workload would not change appreciably.

Rams bargains aggressively with suppliers, and, with 25 suppliers, he was anticipating a 3% savings in purchase costs next year. With only six suppliers, however, each supplier would have greater bargaining power, eliminating Rams' ability to reduce the prices paid for goods. Finally, Rams believes that better coordination with fewer suppliers would increase service quality (e.g., a lower risk of stock outs and other problems), and he estimates the cost savings at $100,000 per year.

Required:

a. Classify the following costs as to their relevance and controllability for Rams' decision: (1) Cost of goods purchased; (2) Clerical staff salaries; (3) Manager's salary; (4) Service quality cost savings; and (5) Rams' salary. (note the status quo for Rams is using 25 suppliers)

b. Should Rams use 25 or 6 suppliers?

(Note: In our first session, we discussed the principle of relevance, but I did not elaborate on the notion of controllability. Please refer to Pages 47-49 ofthe book for a discussion of this intuitive notion, which helps greatly in understanding decision horizon (i.e., short-term decisions versus long-term decisions) affects cost structure. Note also that all relevant costs are, by definition, controllable, but all controllable costs are not necessarily relevant.)