DS1 has a contribution of $145 per machine hour, DS2 can contribute $120 and DS3 has $280 contribution per machine hour. According to this, GNK can rank the product from highest profit to the lowest at DS3, DS1 and DS2.
- The machine capacity is only $8700 hours per annum. Under this constrain, GNK cannot produce all three products to the demand level. Without outsourcing, there are only 2700 machine hour left after produce 800 units of DS3 and 600 units of DS1. This can only produce 300 units of DS2 and 400 units shorter than the demand of 700 units.
- Without outsource production, GNK can control the production quality and design, but the company will loss a direct $432,000 contribution, and loss of customer and corporation reputation in the long run.
- As a local general engineering firm could supply DS1 at an acceptable price, I recommended applying outsourcing to free the machine capacity to produce more DS2 in the short run. In the long run, GNK could purchase a new machine to increase the capacity.
GNK Ltd.’s production director has pointed out that the machine capacity is only 8,700 hours per annum and cannot be increased during the year for which the budget is being prepared. Under this machine capacity, the company cannot make all the products to the demand level.
This report will show the optimal production plan under this constrain, discuss the advantage and disadvantage of outsourcing and the influence on business without outsourcing.
The contribution per machine hour shows DS2 has the highest contribution per unit, with the 9 machine hours per unit, make it the lowest contribution per machine unit. On contrary, DS3 has the lowest contribution per unit, while it only use 3 hours to assemble, this give DS3 the highest contribution per machine hour. DS1 lies in between DS2 and DS3, it has $870 contribution per unit, as 5 machine hours used, it contribute $145 for one machine hour.
As the production plan shows, GNK could produce 800 units of DS3 and 600 units of DS1, but it can only produce 300 units of DS2. Without outsourcing, there is a total contribution of $1,518,000. After less the fixed costs, the company will have the maximum $48,000 profit under this production plan.
Factors effect on business without outsourcing
Some managers concern the outsourcing will affect the company’s reputation, while there are some other factors that company should be concern without outsourcing. In the first place, GNK will loss customers in both short and long term. In the short run, the 400 units of DS2 customers cannot meet their demand; they will have to go to other companies and they may not come back even GNK increase the capacity in the future. In the second place, the company may also loss the DS1 and DS3 customers. Shopping habits determine most people would like to buy what they need in one place. Some customer may need all three products, as the short of DS2 they may switch to other companies who can offer all three models. Moreover, as the shortage of DS2 will cause the customer unsatisfied, company will also loss customer goodwill and corporation reputation. Additionally, there will be a direct $432,000 loss of contribution. If the company accept DS1 outsourcing, it will free the machine capacity to produce DS2 and the gain from extra sell will direct contribute to the company’s profit.
Pros and cons of outsourcing of DS1
As we can tell from the effects on business without outsourcing, there are some advantages of outsourcing DS1 to a general engineering firm with an acceptable price. Firstly, this will free the machine capacity. As other company will provide some of DS1, GNK does not need to produce all the 600 units of DS1. Then there will be some machine hour left to make DS2 to meet the whole demand quantity of 700 units. Secondly, as all the demand is been meet, the company can protect their customer goodwill and company reputation. Future more, outsourcing will increase the company’s profit by $432,000. Last but not least, outsourcing can also frees managers’ time to focus on more important issues and make the company accelerates the benefits of process reengineering.
On the other hand, there are certainly some issues with the outsourcing. One important consideration in outsourcing is the quality of the outsourced product. It is easier to control the product’s quality internally than is made by another firm. As other manager’s concern, if other firm’s DS1 is not as the same quality as GNK’s, it does will affect the company’s reputation. Furthermore, company has to awarded of the reliability of the outsource provider. Make sure the outside provider could meet the company’s whole year schedule and provide the DS1 on time as customer demand. A comprehensive market research of the engineering firm could help GNK to overcome the problems. From the market research, we could know the outsource supplier’s market share and their reputation. This kind of information will help us to estimate the stability of the firm. A product research can make sure the outsource firm can supply the similar quality product.
As the limit machine capacity, there are 400 units of DS2 short of supply. This will cause GNK loss of customers in both short term and long term. I recommended accepting the outsourcing option in the short run. In the long run, GNK could consider purchasing another machine to increase the capacity.