The case explains the major buying decisions and the role of purchasing department in taking crucial decisions where major costs are involved. The case explains that Donley Brothers have to make decision between manufacturing which shows 12% defect rate and buying finished castings from other suppliers. As a matter of fact, all defects are the part of the prices paid or incurred. 12% additional costs are borne by Donley Brothers in this scenario. Thus, supplier machines its own manufactured casting with its sole responsibility of any defects in the good.
Dealing with the defects internally is costing too much for the company which amounts to be $ 312 per casting. Right now, the management of Donley Brothers is thinking to outsource its purchasing by approaching major suppliers of casting in the market. Akron Foundry, one of the suppliers has shown interest to supply castings though having the concern of huge investment of approximately $140,000 in average. The supplier was ready to invest and deliver 150 units of casting per month with a tag price of $ 1,000 on the contract basis of 3 years as a sole provider of goods.
The management is stuck in taking a decision of producing the castings on their own which shows usage of 90% of the total capacity or outsource the manufacturing to Akron Foundry which will benefit them in Dollar terms or not.
Donley Brothers are facing problems in their manufacturing of castings where defect rate is as high as 12%. This is causing them major losses. Also the repair cost is on the peak side and amounts around $312 per casting to repair it for final selling. This is getting far beyond the financial affordability for the management and certain decisions are to be made to outsource complete manufacturing to reduce the burden of defects.
Akron Foundry has shown its interest to provide Donley Brothers with manufactured casting at the rate of $ 1,000 per casting provided it should be the sole outsourced manufacturers for Donley Brother for the next three years. Right now the management is considering exercising the outsourcing option or not.
At the moment, Donley Brothers are facing losses in terms of having 12% defect rate in their production line. There have been huge costs associated with fixing the defect rates. The marketing department is also not happy with the said situation as customers have a genuine complaint of Donley Brother not being able to provide goods at time. Thus, the management wants to get rid of the situation by eliminating the defect or outsource the production for finished casting which would enable them eliminate defects as, if in case some defect is there, it would be complete responsibility of the contracted supplier.
Cost is dependent on: Labor Cost, Raw Material Cost and Over head expenses
1,140 raw castings are needed for producing 1,000 finished castings
So, total costs involved:
Raw Castings $600 x 1140 = $ 684,000
Labor $156 x 1140 = $ 177840
Overhead $156 x 1140 = $ 177840
Total $ 1,039,680
Now purchasing finished castings from the supplier, the cost is:
= 1000 (units) x $ 1000 = $ 1,000,000
Total Difference = $ 1,039,680 - $ 1,000,000 = $ 39,680
So, $ 39,680 could be saved by Donley Brothers if they opt for outsourcing the production of finished castings.
Since the Contract states that Akron will be the sole supplier for 3 years this would increase the bargaining power of Akron and thus it can be a potential danger for Donley Brothers as it is also stated that $1000 per finished casting is for the first years only and the price for the 2nd
year are subject to inflation and other factors. With Akron being the sole supplier he can change higher in coming years which can turn the benefits into loss.
Akron Foundry increases its selling price by 10% in the following time
New Price by Akron: $ 1000 + (0.10 x $1000) = $ 1,100
Total Cost: $ 1,100 x 1000 = 1100000
Akron Foundry increases its selling price by 20% in the following time
New Price by Akron: $ 1000 + (0.20 x $1000) = $ 1,200
Total Cost: $ 1,200 x 1000 = 1200000
So, it is clear that if Akron increases the cost by 10%, the total cost exceeds even if Donley opts for in house manufacturing. Also making Akron the sole distributor has many potential flaws, which are discussed as under:
- If there are some financial or managerial problems in Akron, it will directly suffer Donley Brothers and they will incur more losses in the case mentioned.
- If Akron provides the same goods to some of the direct competitor of Donley Brothers, it will create many problems for Donley.
- If quality falls at Akron, Donley would suffer in the end.
- By contracting Akron, Donley might put its previous industrial relations of many suppliers at risk which might not work for Donley Brothers in future.
There are numerous potential threats to Donley Brothers going concern by solely relying on Akron Foundry as their sole supplier of castings. First, the company would get ‘land-locked’ metaphorically. The company will not be having any choice if something goes wrong with any of the stake holder. For example if Akron Foundry fails to perform and satisfy the industrial demands of Donley Brothers, the direct negative impact will be on Donley Brothers.
Also, the terms and conditions Akron Foundry wants to have in the contract with Donley Brothers seem to be little tough for Donley Brothers management. There is a high risk associated with the deal. In industrial relations, a manufacturing company should not be relying on a single supplier, but should be having alternative modes of sourcing. In this case, this is a potential flaw. Akron Foundry as a sole supply for Donley is very vulnerable for their management.
Make-or-buy decisions are one of the most crucial and delicate decision to be taken by any company. Company like Donley Brothers and the current crash in system is very complicated. There are numerous problems associated and trade-offs are to be done in reaching for a final decision. As a matter of fact, they said decision is purely higher level management decision in which Chief Executive Officer and Head of Departments (HODs) of all functional areas sit together and takes decision on strategic grounds.
In numerous companies which have decentralized organizational hierarchy, the said decisions are made on lower level than CEOs and HODs. This is because, such decisions on such companies are taken as the sole responsibility of the concerning line manager, who takes the decision on the call of staff manager after having in depth analysis of financials and marketing, etc. So, the decision for make - or - buy decision varies due to organizational structures and also the nature of company/business.
Following are some suggestions for improving the current situation of Donley Brothers production and overall system. Firstly, there should be proper quality control and standards which are to be applicable for each and every step of the production. ISO certification and implementation of Total Quality Management (TQM) and Management by Objectives (MBO) should be utilized which will foster continuous improvement in the system. Also, SMART and KAIZEN techniques to minimize wastage and eliminating non-value generating steps should be utilized for effective results and reduced errors in production line. Second, there should be proper hiring of production engineer and systems engineer who will definitely eliminate the problems present in the production system. Technical expertise will also be injected in the production system which will eventually help Donley Brothers to reduce the defects. Third, the company should not only be focusing on outsourcing terms with a single supplier. Industrial relations should be based on multi-stakeholders involved which in fact enable the company to hedge against the risk. Fourth, the company should also utilize their existing capacity for manufacturing rather than outsourcing completely. This will also help them to improve their internal capabilities for the long run; and as suggested by the production capacity of being 90%, the company should not stop their production at all. Fifth, there should be technological innovation introduced in the system, so that the current production system could be made efficient in the future.
- Following are some recommendations which would help Donley Brothers improve their efficiency and also will help to take an appropriate decision:
- Having a proper inspection team, which on technical grounds make it possible to find the defects beforehand.
- Using technology and state-of-the art machinery which would also increase their efficiency and reduce defects
- Quality standards should be improved
- It is not a novel idea to completely outsource the production for finished casting. The production is being done at 90% capacity. Therefore a combination of buying and producing should be used by Donley Brothers.