Wellington Chemicals Division

This case is set in 1965 in a division of a major UK-based

chemicals firm when the exchange rate was $2.80/, inflation was about 4% per

year, and a chemical worker was paid about 3,000 per year. The issue is_make versus buy

for packaging containers. The container is technologically advanced and is an

important element of the value of the end product to the customer.

The

Wellington Chemicals Division manufactures and sells a range of "hard to

hold" chemical products throughout Great Britain. Since these products

require careful packing and storing, the company has always promoted the

special properties of the containers it uses. In fact, a major element of

Wellington's marketing strategy is its container. The containers are large

steel drums with a unique, patented, spray-on lining made from a specialty

chemical known as GHL. Each drum weighs about 260 pounds and holds about 500

gallons which is about 1.25 tons. The firm operates a department especially to

maintain its containers in good condition and to make new ones to replace those

that are past repair. Wellington is making 3,000 new containers each year and

repairing 4,000 used containers, There are 12,000 containers in circulation (an

average 4 year life) and containers average 3 round trips per year. Thus, on

average, each container is used 12 times and repaired 1.33 times during its

life.

Mr.

Walsh, the division general manager, has for some time suspected that the firm

might save money, and get equally good service, by buying its containers from an

outside source. After careful inquiries, he approached a firm specializing in

container production, Packages, Ltd., and asked for a quotation. At the same

time, he asked Mr. Dyer, his chief accountant, to provide him with an up-

to-date statement of the cost of operating the container department (see

below).

Within

a few days, the quotation from Packages, Ltd. came in. The firm was prepared to

supply all the new containers required (3,000 per year) for 125,000 per year,

the contract to run for a guaranteed term of five years and thereafter to be

renewable from year to year. If the required number of containers increased,

the contract price would be increased proportionally. Additionally, Packages

Ltd. would undertake to carry out purely maintenance work on containers, short

of replacement, for a sum of 37,500 per year, on the same contract terms.

Walsh estimated that Packages, Ltd. would make a 15% profit margin (before

taxes) on each of the contracts. They would only accept the maintenance work if

they were also manufacturing the new containers.

Materials (mostly steel and GHL) E 70,000 Labor Foreman 5,000 Workers 45,000 Department Overheads Manager's Salary E 8,000 Allocated space costs on Container Dept. Facility 4.500 Depreciation of Drum Machinery 15,000 Maintenance of Drum Machinery 3.600 Other Expenses 15.750 46.850 166,850 Allocated Share of Administrative Overheads 22,500 Total Cost of Department for One Year E 189.350