Mary Harp

Narkon/Lancaster
BA234 Fundamentals of Supply Chain Management
15 March, 2017

Insourcing/Outsourcing: The FlexCon Piston Decision

Outsourcing and insourcing are methods of dispersing work among different departments or
companies for strategic reasons. Insourcing is typically done solely from within a company
while outsourcing uses companies not affiliated to perform a specific task or tasks.

Insourcing makes sense when a business requirement is only temporary or where no significant
investment is involved. Insourcing may help build a team of skilled people though it may take
more time than outsourcing.

Outsourcing is a clear winner when businesses need to cut costs while still requiring expert
personnel. Companies of all sizes use outsourcing to let go of managing non-core functions
while saving a lot of money in the process.

1. Perform a quantitative insourcing/outsourcing analysis using the data provided. What

qualitative issues might affect your final decision? Identify any costs or issues that are not
part of your analysis that might affect your decision. What is your recommendation
regarding what Flex Con should do with its family of pistons? Support your arguments
with evidence gathered during your analysis.

FlexCon is very dependent upon its suppliers for critical and subassemblies and this is a major
component in the performance and cost of finished products. Their customers do not consider
commodity-like components of any importance.

While considering whether to insource or outsource, the company provided information to all its
managers and employees on six key trends that could influence their decision.

A) There is a need to use their production services more efficiently.

B) Whether to focus their investment into a process or technology.

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C) The need to look at what the company excels at and evaluate the ones they dont have
expertise in.

D) Whether fixed costs and assets are relevant on suppliers.

E) Having the tools to forecast and compare different sourcing possibilities.

The cost for insourcing in comparison to outsourcing is relatively high and the decision on what
is most important requires an analysis. Does the company want to jeopardize quality and should
they invest in developing new products or leave it to the supplier?

FlexCon should continue to insource rather than outsource as their reputation for quality
products could be put on the line and damage to their reputation. All costs should be considered
when doing an analysis on whether to insource or outsource.

With the completion of my analysis and data as provided in Appendixes 1, 2 and 3, it is apparent
that FlexCons net outsourcing savings would be approximately $ 18,000 in Year One but they
would have a considerable loss in Year Two and that would be around $ 124,000. Even though
the total insourcing costs are a little higher than outsourcing, the savings would not be realistic
for the company.

Other hidden costs that can have a negative effect on savings for outsourcing would be job
eliminations which can influence morale, loyalty and productivity among the employees who
remain.

2. Assume your group decided to outsource the pistons to the external supplier. Identify a
plan that would enable FlexCon to carry out this recommendation. Be as thorough as
possible.

FlexCon needs to look at all the costs as well as hidden cost before deciding to outsource. Will
they have the budget to accommodate any extra costs and can they make a profit without giving
up quality and long term customers. Are they willing to put their reputation on the line?

When outsourcing the pistons would lower production, there would still be a risk of quality.
Also, finding the right supplier with the capital to invest in producing more than their average
output could also be an issue.

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Some of the steps when planning for outsourcing should include the company looking at
previous contracts which will help identify new projects and provide valuable insight. The next
step will be to set and define specific goals such as to reduce overall corporate costs by a certain
percentage or focus on efficiency. The company should gather a group of employees that can
provide feedback, expertise, and assumptions from a variety of areas of expertise. Next is to
identify the project or projects and develop a set of criteria such as previous decisions, expertise
in an area, quality control and concerns, and where the costs stand in comparison to the
competitor. There is a need to assign a total outsourcing value to the project and make sure to
communicate to all staff so as there will not be any misinformation that could possibly create
rumors and discord within the organization.

Steps for outsourcing should include completing a cost/quality analysis of outsourced services
vs, insourced, identifying the cultural and human impact of change (both positive and negative),
deciding to test the market for cost and quality improvements, deciding which services you want
to explore, creating a scope of works and requests for proposals, analyzing entire quality and cost
benefit to the business and improving existing operations or engaging with outsourcing
company.

3. Discuss the primary reasons when and why insourcing/outsourcing decisions occur.

Decisions on whether to insource or outsource can come from whether there is more competition
for a company than in the past, issues with on-time delivery, technology and a variety of issues.
Does a company feel like they are achieving a reasonable profit, are they losing profits, are parts
becoming more expensive: these are other issues that can have companies analyzing the
production process?

To be able to survive and be profitable in current globalization era, companies tend to use
outsourcing. Companies consider outsourcing to empower business focus, mitigate risks, build
sustainable competitive advantage, extend technical capabilities and free resources for core
business purposes. Outsourcing is the process of transferring the responsibility for a specific
business function. Companies can provide better client service, produce a better product, do a
better job efficiently by outsourcing their non-core business function.

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Companies will allocate their resources within the value chain to those activities that give them a
comparative advantage. When companies outsource their activities to produce their products and
services, they usually move towards a business strategy which helps in maintaining their
competitive advantage.

Some challenges when outsourcing that companies are faced with include managing the
partnership and handling staff transition and morale. Lack of communication with a supplier and
on-site visits could prove whether the company is benefiting from outsourcing and whether
producing or insourcing will be an advantage to the company.

4. A major challenge with an insourcing/outsourcing analysis involves gathering reliable

data. Discuss the various groups that should be involved when conducting an
insourcing/outsourcing analysis such as the one presented in this case. What information
can each of these groups provide?

FlexCon management composed a team of a process engineer, cost analyst, a quality engineer, a
procurement specialist, a supervisor and a machine cell employee to conduct the outsourcing
analysis.

They should decide what kind of impact that project will have on your business. Some
disadvantages of outsourcing would be loss of managerial control, hidden costs, threat to security
and confidentiality, quality problems, bad publicity and ill-will.

5. Discuss the major issues associated with an insourcing/outsourcing analysis and

decision.

Factors that should be considered when making outsourcing decisions are long-term productivity
and cost projections, physical and data security, long term business and employment stability,
political agenda and cultural differences and business continuity capability. Outsourcing enables
companies to leverage the global market place, to choose the work they want to do, and where
they want to do the work to ensure the greatest profit.

There are many important criteria when making supplier decision. The most frequently are
quality, delivery performance history, price and location. The analysis must identify all internal
and external costs and benefits to make an effective and reasonable decision.

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Quantifiable criteria are costs, increased cover of fixed costs, investments and revenues.

The Following data and tables were used in the cost analysis for FlexCon:

Appendix 1 Year 1 Inventory Carrying Charges Outsourcing Option

Beginning Ending Average Inventory Carrying
Inventory Inventory Inventory Costs

January 30,000 0 15,000 $ 2,100

February 30,000 0 15,000 $ 2,100
March 30,000 0 15,000 $ 2,100
April 27,000 0 13,500 $ 1,890
May 25,000 0 12,500 $ 1,750
June 25,000 0 12,500 $ 1,750
July 23,000 0 11,500 $ 1,610
August 21,000 0 10,500 $ 1,470
September 22,000 0 11,000 $ 1,540
October 23,000 0 11,500 $ 1,610
November 23,000 0 11,500 $ 1,610
December 21,000 0 10,500 $ 1,470

Total Inventory Carrying Costs $ 21,000

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Appendix 2 Year 2 Inventory Carrying Charges Outsourcing Option

Beginning Ending Average Inventory

Inventory Inventory Inventory Carrying Costs

January 34,000 0 17,000 $ 2,380

February 34,000 0 17,000 $ 2,380
March 34,000 0 17,000 $ 2,380
April 31,000 0 15,500 $ 2,170
May 28,000 0 14,000 $ 1,960
June 28,000 0 14,000 $ 1,960
July 27,000 0 13,500 $ 1,890
August 25,000 0 12,500 $ 1,750
September 25,000 0 12,500 $ 1,750
October 27,000 0 13,500 $ 1,890
November 27,000 0 13,500 $ 1,890
December 25,000 0 12,500 $ 1,750

Total Inventory Carrying Costs $ 24,150

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Appendix 3 Insourcing/Outsourcing Cost Factors Worksheet

Insourcing Costs Per Unit Year 1 Year 2 Outsourcing Cost Per Unit Year 1 Year 2

Direct Materials $ 4.29 $ 4.29 Purchase Cost $ 12.20 $ 12.20

Semi Finished $ 0.78 $ 0.78
Other

Direct Labor $ 2.36 $ 2.43 Transportation $ 0.10 $ 0.10

Indirect Labor $ 0.73 $ 0.65 New Tooling $ 0.50 $ 0.43

Factory Overhead and Administrative $ 4.31 $ 3.86 Administrative Support $ 0.09 $ 0.08

Preventive Maintenance $ 0.15 $ 0.14 Inventory Carrying $ 0.07 $ 0.07

Machine Repair $ 0.13 $ 0.13 Safety Stock $ 0.18 $ 0.18

Ordering $ 0.06 $ 0.05 Quality Related Costs $ 0.38 $ 0.38

Depreciation $ 0.50 $ 0.43 Ordering $ 0.06 $ 0.05

Inventory Carrying $ 0.06 $ 0.06 Other Costs

Inbound Transportation $ 0.12 $ 0.12 Total Outsourcing Costs per Unit $ 13.58 $ 13.49

Consumable Tooling $ 0.19 $ 0.19 Total Savings (1) $ 30,000 $ (124,200)

Other Costs Less: Taxes on Savings (40%) $ 12,000

Total Insourcing Cost per Unit $ 13.68 $ 13.13 Net Outsourcing Savings $ 18,000

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Exhibit 1 Key Factors Supporting Insourcing/Outsourcing Decisions

Factors Support Insourcing

1. Cost considerations favor the buyer

2. A need or desire to integrate internal plant operations
3. Excess plant capacity is available that can absorb fixed overhead
4. A need exists to exert direct control over production and quality
5. Produict design secrecy is an important issue
6. A lack of reliable suppliers characterizes the supply market
7. Firm desires to maintain a stable workforce in a declining market
8. Item or service is directly part of a firm's core competency, or links directly to the strategic plans of the organization
9. Item or technology behind making the item is strategic to the firm. The item adds to the qualities customers consider important.
10. Union or other restrictions discourage or even prohibit outsourcing.
11. Outsourcing may create or encourage a new competitor.

Factors Support Outsourcing

1. Cost considerations favor the supplier

2. Supplier has specialized research and know-how, which creates differentials in cost and quality.
3. Buying firm lacks the technical ability to build an item.
4. Buyer has small volume requirements.
5. Buying firm has capacity constraints while the seller does not.
6. Buyer does not want to add permanent workers.
7. Future volume requirements are uncertain - buyer wants to transfer risk to the supplier.
8. Item or service is routine and available from many competitive sources.
9. Short cycle time requirements discourage new investment by the buyer - using existing supplier assets is logical.
10. Adding capacity at the buyer requires high capital start-up costs.
11. Process technology is mature with minimal likelihood of providing a future competitve advantage to the purchaser.

Exhibit 2 Aggregated Two-Year Piston Demand

Year 1 Expected Demand Year 2 Expected Demand

January 30,000 34,000

February 30,000 34,000
March 30,000 34,000
April 27,000 31,000
May 25,000 28,000
June 25,000 28,000
July 23,000 27,000
August 21,000 25,000
September 22,000 25,000
October 23,000 27,000
November 23,000 27,000
December 21,000 25,000

Total 300,000 345,000

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Exhibit 3 Total Factory Overhead and Administrative Costs

Previous Year Expense/Cost

Administrative staff 1,200,000

Staff engineeering 900,000
Taxes 120,000
Utilities 1,500,000
Insurance 500,000
Plant Maintenance 800,000

Total 5,020,000

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Insourcing Costs

3 Work Cells produced 288,369 Pistons

Direct Materials

Uses Semi-finished steel alloy 50 lb / 1.1 = 45.45 piston yield per block
Shipped in 50# blocks 288,367/45.45 = 6,345
$ 195.00 per block 6,345 x $ 195 = $ 1,237,275 Total Direct Material Cost
Each piston = 1.1 lb. semifinished raw material 1,237,275/288,369 = 4.29 Year 1 and Year 2
Includes scrap and waste Additional Direct Materials Cost = 225,000/288,329 = .78
Spent $ 225,000 base for Yr 1/Yr 2 misc direct material requirements

Direct Work Cell Labor

27,000 hours last year 472,500 x 1.40 = 661,500 Total Compensation

Payroll - Direct Labor = $ 472,500 with overtime pay 661,500/288,369 = $ 2.30 Direct Labor per unit
Average Direct Labor rate = $ 17.00 per hour ($472,000/27,000 total hrs = $ 17.50 per hr)
Add 40% to direct labor costs for benefits 2.30 x 1.03 = 2.36 2.37 x 1.03 = 2.44

Indirect Work Cell Labor

Assigns Supervisor, Material Handler, Engineer to the three work cells

Supervisor Wages = $ 52,000 Total of Salaries = $ 152,000
Material Handler Wages - $ 37,000 $ 152,000 x 1.03 x 1.40 = 219,184 Year 1
Engineer Wages - $ 63,000 219,184/300,000 = 0.73
Add 40% to direct labor costs for benefits 152,000 x 1.03 x 1.03 x 1.40 = 225,759 225,759/345,000 = 0.65 Year 2
Salaries to increase 3% each year

Factory Overhead and Administrative Costs

Divided factory in to 6 zones 5,020,000 x .25 = 1,255,000

Piston Work Cells - 25% Factory Floor Space 1,255,000 x 1.03 = 1,292,650
28% Total Direct Labor Hours 1,292,650/300,000 = 4.31
23% Plant Volume 255,000 x 1.03 x 1.03 = 1,331,429
Will allocate 25% of Factory Overhead and Administrative costs to work cells
Expects a 3% cost each year 1,331,429/345,000 = 3.86

Preventive Maintenance Costs

Spent $ 40,250 on 18 machines and expects an increase of 10% in each of the two years
Yr 1 = 40,250 x 1.10 = 44,275 44,275/300,000 = 0.15
Yr 2 = 44,275 x 1.10 = 48,702 48,702 /345,000 = 0.14

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Machine Repair Costs

18 work cell machines - 5 - 7 years old 37,000 x 1.08 = 39,960 39,960/300,000 = .13
Total unplanned repair expenses - $ 37,000 37,000 x 1.08 x 1.12 = 44,755
Increase by 8% in Year 1 44,755/345,000 = .13
Increase by 12% in Year 2

Ordering Costs

Incurs ordering costs for direct materials Yr 1 = 1,500 x 12 = 18,000 18,000/300,000 = 0.06
Monthly cost - $ 1,500 in direct and transaction related costs YR 2 = 1,500 x 12 = 18,000 18,000/345,000 = 0.05

Semifinished Raw Material Inventory Carrying Costs

Maintains one month of semifinished raw material inventory

Carrying charge is 18% annually
300,000 x 1.1 lbs = 330,000 330,000/12 = 27,500 lbs Avg Monthly 3.90 x .18 = .70
27,500 x .70 = 19,250 Total Inventory Carrying Costs 19,250/300,000 = 0.06 Yr 1
345,000 x 1.1 = 379,500 379,500/12 = 31,625
31,625 x .70 = 22,137 22,137/345,000 = 0.06 Yr 2

Inbound Transportation

Receives a monthly shipment 31,500/288,369 = 0.109 = 0.11 + .01 = 0.12 Both Years
Transportation cost for the orevious year - $ 31,500
Resulted in 288,369 pistons produced
Costs for other direct materials - $ 0.01 per unit in Years 1 and 2

Consumable Tooling Costs

Estimates additional tooling expenses of $ 56,000 in year 1 56,000/300,000 = .186 = .19

Estimates additional tooling expenses of $ 65,000 in year 2 65,000/345,000 = .188 = .19

Depreciation

Cost per year - $ 150,000

Yr 1 = 150,000/300,000 = 0.50
Yr 2 = 150,000/345,000 = 0.43

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Outsourcing Costs

Unit Price

Average price of $ 12.20 per piston.

Terms - 2/10, net 30
Supplier will maintain negotiated price for the two years

Safety Stock Requirements 300,000/12 = 25,000 Avg stock units per month
Monthly carrying charge = 12.20 x .18 x 25,000 = 54,900 54,900/300,000-0.18

If decision to outsource, will hold one month average demand

Inventory Carrying charges = 18% annually Yr 2 = 345,000/12 = 28,750
12.20 x .18 x 28,750 = 63,135 63,135/345,000 = 0.18

Administrative Support Costs

Commitment of 1/3 buyer's total time to supporting commercial issues 54,000 x 1.40 = 75,600
Buyer's salary = $ 54,000 with 40% fringe benefits 75,600 x 1.03 = 77,868 77,868 x .333 = 25,930
Compensation to increase 3% each year 25,930/300,000 = .086 = .09
25,930/345,000 = .075 = .08

Ordering Costs

Will order monthly - or 12 material releases a year 1500 x 12 = 18,000 18,000/300,000 = .06
Supplier to deliver one month inventory at the beginning of each month
Cost to release and receive an order - $ 1,500 per order 18,000/345,000 = 0.5

Quality Related Costs

Estimates supplier defect level will be 1,500 ppm

Each supplier defect will cost an average of $ 250 in nonconformance costs

1,500/1,000,000 = .0015 .0015 x 300,000 = 450 450 x 250 = 112,500 112,500/300,000 = 0.38 Yr 1
.0015 x 345,000 = 517.50 517.50 x 250 = 129,375 129,375/345,000 = 0.375 = 0.38 Yr 2

Inventory Carrying Charges

Will use Average Inventory Method

Average # of units In inventory each month: ((Beginning Inventory at the Start of each month + Ending Inventory
at the End of Each Month)/2) x Carrying Cost Per Month

Ending inventory is zero including safety stock

Carrying charge applied to inventory on an annual basis - 14% of the unit value of the inventory
12.20 x .14 = 1.708 = 1.71
1.71/12 = .14 21,000/300,000 = 0.07 Yr 1 Yr 2 = 24,150/345,000 = 0.07

Consult Appendixes 1 and 2 in calculation of monthly carrying charges associated with holding inventory.
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Transportation Charges

Suppliers ship goods FOB shipping point

Company assumes all transportation-related costs.

Transportation charges for pistons will average $ 1,200 per truckload

14 truckloads in Year 1 2,100 x 14 = 29,400 29,400/300,000 = 0.098 = .10

16 Truckloads in Year 2 2,100 x 16 = 33,600 33,600/345,000 = 0.0973 = .10

Tooling Charges

Per supplier - new charges would be $ 300,000

Depreciation of tooling charge over 2 years is $ 150,000 a year
300,000/2 = 150,000 150,000/300,000 = .50
300,000/2 = 150,000 150,000/345,000 = .43

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