All Cases For Purchasing and Supply Chain Management 8th Edition By Robert B. Handfield, Larry C. Gi

Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 1: Avion Inc.

Instructor Manual Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 1: Avion Inc.

TABLE OF CONTENTS Case 1 Avion Inc. .................................................... 2 ASSIGNMENT ......................................................... 3 Case One Instructor Notes ............................................ 4

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 1: Avion Inc.

CASE 1 AVION INC. Susan Dey and Bill Mifflin, supply managers at Avion Inc., sat across from each other and reviewed a troubling performance report concerning a key supplier, Foster Technologies. The report detailed the deteriorating performance of Foster Technologies in the areas of material quality and on-time delivery.

Susan:

Bill:

Susan: Bill:

Susan: Bill:

Susan: Bill:

Susan: Bill:

Susan:

I don’t believe what I am seeing. This supplier was clearly a star when we performed our supplier visits before awarding the contract for the new Amrod product line.

I’m not pleased. I was on the team that performed the audit and site visit. Foster’s management was so smooth—they indicated they could meet all our requirements. I feel like this supplier has misled us.

Didn’t you look at their processes and quality systems?

We did, and everything checked out fine. But now every other shipment has issues, and the delays are hurting our ability to get our product to our customers. What really struck us about this supplier was how innovative they were. Really, their biggest drawback was simply their size- they lacked some depth at key manufacturing engineering positions. Maybe that’s why they are having problems. It could be that someone has left the company.

We are going to have to address these problems quickly.

I have a recommendation on how to move forward based on these problems. We should begin immediately to look for another supplier. I never was a fan of these single-source contracts.

They leave us open to too much risk.

But won’t that take a long time?

Yes. We’ll have to conduct another supplier search with team visits. New tooling could really cost us, too. This could take months.

Has anyone talked with the supplier about these problems?

Kevin went over personally today and talked with the production manager. He didn’t have much time to explain, but he indicated on the phone that Foster’s production manager said we should accept responsibility for a good number of the problems that are occurring!

Why should we? I think they are just trying to shift the blame for their poor performance.

At this point, Kevin O’Donnell, another procurement manager, entered the room.

Bill:

Kevin, glad you’re here. We were just discussing how Foster is trying to blame us for their problems. I think we should dump them fast!

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 1: Avion Inc.

Kevin:

Susan: Kevin:

Bill: Kevin:

Bill:

Susan: Kevin:

Bill:

Kevin:

Susan:

Yeah, well, you might not like what I’m going to say. I think Foster’s production manager is correct. I think I would be frustrated with us, too!

What are you talking about?

I spent a good part of the day over at Foster and learned some interesting things. For example, do either of you remember what we told Foster the monthly volume requirements for the product would be?

I remember exactly. The volumes were projected to be 2,500 units a month. So, what’s the problem?

We need to talk with our production group more often. The monthly volumes are now over 4,000 units a month! And not only that, but our production group also now wants material within 10 days of a material release rather than two weeks. We have also been changing the final material release quantities right up to the last minute before delivery.

Uh oh. I remember on our site visit that the most their production system could handle was 3,500 units a month. And a two-week lead time was about as low as they could go.

But why didn’t they inform us that these changes were causing problems? They still have some explaining to do.

Apparently, they tried. What did your team tell this supplier about communicating with us after you finished negotiating the contract?

We said that any operational problems or issues must go through our materials group. They were the members of the team responsible for evaluating and selecting the supplier and then negotiating the agreement.

Foster’s production manager produced an electronic log detailing seven emails and two formal letters outlining the impact of our production and scheduling changes on their operation. He also called us several times with no response.

Each of these inquiries received little attention on the part of our supply management group. I’m not sure how fond Foster is of us as a customer. I think they are anxious for this contract to wind down so they can dump us!

What do we do now?

ASSIGNMENT 1. What initially appears to be the problem? What were the gaps in communication that occurred?

2. How easy or difficult will it be to switch suppliers? Explain why?

3. What do you think is the root cause of this problem?

4. What does it mean to be a customer of choice? Why does a buying firm want to be perceived by a supplier as a customer of choice?

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 1: Avion Inc.

Provide specific examples of what a firm must do to be a customer of choice.

5. Explain the role of supplier performance management in managing supply chain activities.

6. What can you learn about managing a single-source contract from this case?

7. Develop an action plan for Avion that addresses the issues presented in this case. Be prepared to fully explain your recommendations.

CASE ONE INSTRUCTOR NOTES This very integrative case should stress some key points clearly to the student:  

 





Communication with suppliers is perhaps even more critical after contracts are signed Changes in volumes and other requirements can alter the assumptions in the original negotiation and cause significant problems Buyers and sellers need to be proactive as demand and markets change Supplier switching costs are often very high, making the quality of the initial supplier evaluation and selection decision critical A natural tendency exists with many buyers to blame suppliers at the first sign of a problem, even when the buyer contributes to or even causes the problem Being a good customer entails certain responsibilities, such as treating the supplier ethically, communicating frequently, and working together to prevent or solve problems

Question 1: Students should identify the different parts of the value chain involved in this situation. Look for the identification of specific departments or groups along with their responsibilities.

Question 2: Stress that what initially appears to be the problem (i.e., the supplier) may not be the root problem. Furthermore, the initial reaction was to blame the supplier without collecting the required facts.

Students should probe to identify the root cause, which is really a lack of communication on the part of the buyer and changing demand and delivery conditions. It is possible that the buyer has

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 1: Avion Inc.

a poor forecasting system that created the initial demand figures.

Question 3: Students should discuss the various costs, activities, and time associated with supplier switching decisions. In this case, switching would be a difficult activity.

Question 4: Root cause is the cause that, once corrected will eliminate the problem.

Question 5: Suppliers enjoy working with buyers who are good customers, just as buyers like to work with good suppliers. Some ways that a buyer can be a good customer include:      

Pays invoices promptly Treat the supplier ethically Share information early and often Work together to pursue new opportunities and solve problems (rather than blame) Respect the supplier’s need to earn a fair profit Do not switch suppliers frequently to chase better prices

Question 6: Frequent performance measurements can indicate when performance is trending downward or upward. Measurement can also indicate in what area performance is deteriorating (or improving).

Measurement helps when investigating the root causes of problems.

Question 7: Students should understand that suppliers have lead times with their suppliers, and that changes can cause higher costs, production schedule disruptions, and quality problems. At some point, schedules should be frozen or locked in with minimal changes.

Question 8: Reducing lead-time reduces uncertainty and variability. It is generally much easier to forecast for a short time horizon than a longer horizon.

The instructor should look for creativity and the quality of ideas with this question. If this is a class discussion question, then the instructor should ask the students for suggestions to

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 1: Avion Inc.

reduce the lead times for purchased materials and components. The instructor could create a table, such as the following: Why the Action or Activity

Action or Activity to Reduce Material Ordering Leadtimes          

         

Question 9: Students should present at least four good reasons to single source a contract. Possible reasons include:      

Combine volumes with a single supplier for greater leverage Avoid additional negotiations Minimize supplier management and transaction costs To pursue a closer relationship with a single supplier, perhaps even an alliance Few qualified suppliers exist Switching costs may be low, reducing the risk of single sourcing

Question 10: The instructor should look for a plan that (1) clearly defines specific actions that will be taken and (2) works collaboratively with the supplier to address the issues presented in the case.

Some students will argue for a second supplier to alleviate the capacity problems. [return to top]

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 2: Sourcing Chinese Wire Harnesses in a Tariff-Driven World

Instructor Manual Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 2: Sourcing Chinese Wire Harnesses in a Tariff-Driven World

TABLE OF CONTENTS Case 2 Sourcing Chinese Wire Harnesses in a Tariff-Driven World ...... 8 Quote 1 .............................................................. 8 Quote 2 .............................................................. 8 ASSIGNMENT ........................................................ 10 Case 2 Instructor Notes ............................................. 10

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 2: Sourcing Chinese Wire Harnesses in a Tariff-Driven World

CASE 2 SOURCING CHINESE WIRE HARNESSES IN A TARIFFDRIVEN WORLD Sheila Austin, a buyer at Autolink, a Detroit-based producer of subassemblies for the automotive market, has sent out requests for quotations for a wiring harness to four prospective suppliers. Only two of the four suppliers indicated an interest in quoting the business: Original Wire (Auburn Hills, Michigan) and Happy Lucky Assemblies (HLA) of Guangdong Province, China. The estimated demand for the harnesses is 5,000 units a month. Both suppliers will incur some costs to retool for this harness. The harnesses will be prepackaged in 24 × 12 × 6-inch cartons. Each packaged unit weighs approximately 10 pounds.

QUOTE 1 The first quote received is from Original Wire. Auburn Hills is about 20 miles from Autolink’s corporate headquarters, so the quote was delivered in person. When Sheila went down to the lobby, she was greeted by the sales agent and an engineering representative. After the quote was handed over, the sales agent noted that the engineering representative would be happy to work closely with Autolink in developing the unit and would also be interested in future business that might involve finding ways to reduce costs. The sales agent also noted that they were hungry for business, as they were losing a lot of customers to companies from China. The quote included unit price, tooling, and packaging. The quoted unit price does not include shipping costs. Original Wire requires no special warehousing of inventory, and daily deliveries from its manufacturing site directly to Autolink’s assembly operations are possible.

Original Wire Quote:

   

Unit price = $30 Packing costs = $0.75 per unit Tooling = $6,000 one-time fixed charge Freight cost = $5.20 per hundred pounds

QUOTE 2 The second quote received is from HLA of Guangdong Province, China.

The supplier must pack the harnesses in a container and ship via inland transportation to the port of Shanghai in China, have the shipment transferred to a container ship, ship the material to Seattle, and then have the material transported inland to Detroit. The

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 2: Sourcing Chinese Wire Harnesses in a Tariff-Driven World

quoted unit price does not include international shipping costs, which the buyer will assume.

HLA Quote:

  

Unit price = $19.50 Shipping lead-time = Eight weeks Tooling = $3,000

In addition to the supplier’s quote, Sheila must consider additional costs and information before preparing a comparison of the Chinese supplier’s quotation:

      

   

Each monthly shipment requires three 40-foot containers.

Packing costs for containerization = $2 per unit.

Cost of inland transportation to port of export = $200 per container.

Freight forwarder’s fee = $100 per shipment (letter of credit, documentation, etc.).

Cost of ocean transport = $4,000 per container. This has risen significantly in recent years due to a shortage of ocean freight capacity.

Marine insurance = $0.50 per $100 of shipment.

U.S. port handling charges = $1,200 per container. This fee has also risen considerably this year, due to increased security.

Ports have also been complaining that the charges may increase in the future.

Customs duty = 5% of unit cost.

Customs broker fees per shipment = $300.

Transportation from Seattle to Detroit = $18.60 per hundred pounds.

Need to warehouse at least four weeks of inventory in Detroit at a warehousing cost of $1.00 per cubic foot per month, to compensate for lead-time uncertainty.

Sheila must also figure out the costs associated with committing corporate capital for holding inventory. She has spoken to some accountants, who typically use a corporate cost of capital rate of 15 percent.

 

Brokerage fees for hedging currency = $400 per shipment



At least two five-day visits per year to travel to China to meet with the supplier and provide updates on performance and shipping = $20,000 per year (estimated)

Additional administrative time due to international shipping = 4 hours per shipment × $25 per hour (estimated)

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 2: Sourcing Chinese Wire Harnesses in a Tariff-Driven World

The global sourcing costs must be absorbed by Sheila, as the supplier does not assume any of the additional estimated costs and will invoice Sheila later or build the costs into a revised unit price. Sheila feels that the U.S. supplier is probably less expensive, even though it quoted a higher price. Sheila also knows that wire harnesses are a standard technology and are unlikely to change during the next three years. There is also a lot of ―hall talk‖ among the engineers on her floor about next-generation automotive electronics, which will reduce much of the need for wire harnesses. Many harnesses will be replaced by electronic components that are smaller, lighter, and more reliable.

The recent presidential election has generated increased media discussion about the new president imposing 100% tariffs on Chinese imports, but the exact nature of these are uncertain and changes weekly. She is unsure about how to calculate the total costs for each option, and she is even more unsure about how to factor these other variables into the decision.

ASSIGNMENT 1. Calculate the total cost per unit if purchased from Original Wire.

2. Calculate the total cost per unit if purchased from HLA. 3. What qualitative issues, in addition to cost, must Sheila evaluate?

4. Based on the total cost per unit evaluation and qualitative issues, which supplier should Sheila recommend?

5. Discuss the impact of recent tariffs on global sourcing decisions and how those, along with political relationships between the two nations, affected your final sourcing decision.

CASE 2 INSTRUCTOR NOTES This case involves an outsourcing decision in China and challenges student to consider three major issues: 1) the decision of offshoring versus domestic sourcing; 2) US -China political relationship; and 3) the impact of tariffs on sourcing decisions. Student decisions will be affected by the macro factors of politics and tariffs. Both can change, but the threat may be enough for students to discuss other alternatives.

On the one hand, a Chinese supplier, has bid a low price for the business, but this incurs substantial transportation, lead-time, and inventory costs. Students will compare the Chinese price to a domestic quote from a supplier located in Auburn Hills, Michigan. The purchase involves a wiring harness, and entails some complex calculations, in terms of converting pounds, square foot, and unit costs. While the cost calculations produce what is apparently a relatively straightforward decision, students should be encouraged to consider

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 2: Sourcing Chinese Wire Harnesses in a Tariff-Driven World

other elements in the case that could influence the decision (especially country relationships, tariffs and the automotive industry). Some of these other considerations include the cost of:       

Design changes Tariffs or the threat of tariffs particularly on Chinese goods Supplier integration in new product development On-going cost savings sharing agreements On-site technical support Alignment of cultures Other joint improvement initiatives

Questions: 1. Calculate the total cost per unit of purchasing from Original Wire.

The total cost calculations for purchasing from Original is shown in the attached spreadsheet and is $31.10. This includes unit price, packing, tooling, and freight. No special warehousing of inventory is required. This assumes that daily shipments will be made, and no inventory buffers will be held on-site at Autolink.

2. Calculate the total cost per unit of purchasing from HLA. The total cost for purchasing from HLA is $29.42 and represents savings of $1.68 over the Original quote. This is equivalent to a savings of approximately 5.39%. (Note that if you look at the price per unit without considering total cost, the HLA quote is about 35% less expensive than the Original quote.)

3. What qualitative issues, in addition to cost, must Sheila evaluate?

In addition to the cost differentials, Sheila should consider other elements that may influence the sourcing decision. 



If currency rates are rising or descending, this may influence the decision one way or the other. In this case, a different type of hedging contract may be used (see the Global Sourcing chapter for further details).

The purchaser should also consider elements such as quality and technology. If one supplier clearly has better quality, then this may affect the total cost of ownership associated with using a given supplier. If a supplier is also developing new technology that could result in innovative products, they should be considered for early supplier involvement and perhaps become part of a platform team.

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 2: Sourcing Chinese Wire Harnesses in a Tariff-Driven World







This is very difficult to do when a visit to a Chinese supplier only takes place twice a year. However, if Original Wire is eager to support the business relationship with an on-site engineer or technical person, which they seemed willing to do, then the likelihood of joint continuous improvement is likely to increase.

The purchaser should also consider escalation. How long is each price firm? Is it possible that one supplier is trying to get their ―foot in the door‖, and then increase prices after engineering changes are introduced?

What happens if volumes change? Is there any provision for future savings? What measures are in place for future cost savings sharing agreements, through practices such as value analysis and quality improvement?

Given that this is in the automotive industry, the plant is probably producing on a just-in-time basis. What is the delivery record of each supplier? Can they deliver to a very tight delivery window? Is the domestic supplier therefore better to use, since they can ship in less leadtime, or is the Chinese supplier willing to ship to a local warehouse for delivery and agree to pay the cost for storage?

4. Based on the total cost per unit evaluation and qualitative issues, which supplier should Sheila recommend?

Based on the ―rule of thumb‖ discussed in the Global Sourcing chapter, the cost savings are well below the 15% savings rule that justifies going global. The rule states that savings should be at least 15% for an overseas source over a domestic source, to justify the ―additional hidden costs‖ associated with using the global source. Given that this figure is not met, tariff threats and recent deterioration in the US-China relationship, students should probably remain with the domestic source.

5. Discuss the impact of recent tariffs on global sourcing decisions and how those, along with political relationships between the two nations, affected your final sourcing decision.

Based on recent tariff proposals and a deterioration in USChina relationships, it is obvious that global outsourcing decisions need to consider more than unit price. This makes global sourcing decisions more complicated than domestic purchasing. However, as companies compete in an increasingly global marketplace, they will continue to scour the world for global suppliers and make decisions based on total cost and highest value added, not just price alone. Tariffs and country relations will also change. However, tariffs certainly must be

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 2: Sourcing Chinese Wire Harnesses in a Tariff-Driven World

added to total costs (note the current tariffs in this case on this item from China were 5%), and the proposed 100% tariff would make Chinese sourcing of this item noncompetitive.

Sensing this, will Original Wire use this as an opportunity to raise its prices? Thus, political relationships between countries need to be considered and will likely impact the tariff levels.

Although China has been our second or third largest trading partner for years, the recent tariff wars could change this equation. This case provides some interesting opportunities for discussing when NOT to source from China. For example, the term friend sourcing has entered our vocabulary, making sourcing in countries such as India and Vietnam potential landing spots for such sourcing decisions.

Product-wise, while this is a standard technology, there is a good chance that the technology roadmap for this product is about to take a dramatic shift. Autolink may wish to align itself with a supplier who is on the cusp of this new technology, and who is local. There should be further discussions with the suppliers to learn what is happening in this area, with opportunities to discuss joint future research and development streams if required.

Wiring Harness Example Original Wire Quote

Per unit

Annual cost (60,000 units)

Unit cost

$30.00

$1,800,000

Packing cost

$0.75

$45,000

Tooling ($6000/60000)

$0.10

$6,000

Freight ($2.50 / 10)

$0.25

$15,000

TOTAL COST

$31.10

$1,866,000

Happy Lucky Assembly Quote

Per unit

Annual cost (60,000units)

Unit cost

$19.50

$1,170,000

Packing cost

$2.00

$120,000

Inland transport (3 cont.  $200  12 months) / 60000

$0.12

$7,200

Freight forward fee ($100 /

$0.02

$1,200

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Subtotal

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 3: Managing Supplier Quality: Integrated Devices

shipment  12) / 60000 Ocean transport ($4000 / cont.)

$2.40

$144,000

Marine Insurance ((5000 units  21.5)/100)  $.50

$0.11

$6,600

US. Port Handling ($1200 / cont.)

$0.72

$43,200

Customs Duty (5%  $19.5)

$0.98

$58,500

Customs broker fees ($150)

$0.03

$1,800

US Transport ($18.6 cwt / 10 units)

$1.86

$111,600

Warehouse Cost (($1.00 / unit)/month)/2

$0.50

$30,000

Cost of capital ($28.24  (15%/6))

$0.71

$42,353

Cost of hedging ($400/5000)

$0.08

$4,800

Administrative time (4X$25)/5000

$0.02

$1,200

Travel ($20000)

$0.33

$20,000

Tooling ($3000)

$0.05

$3,000

TOTAL COST

$29.42

$1,765,453

Savings - HLA Quote

$1.68

$100,547.50

$28.24

5.39% [return to top]

Instructor Manual Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 3: Managing Supplier Quality: Integrated Devices

TABLE OF CONTENTS Case 3 Managing Supplier Quality: Integrated Devices ................ 16 ASSIGNMENT ........................................................ 17

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 3: Managing Supplier Quality: Integrated Devices

Case 3 Instructors Notes ............................................ 19

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 3: Managing Supplier Quality: Integrated Devices

CASE 3 MANAGING SUPPLIER QUALITY: INTEGRATED DEVICES Bill Edwards is a quality engineer assigned to the Injected Molding Commodity Team at Integrated Devices. The commodity team is responsible for evaluating, selecting, and negotiating agreements with plastic-injected molding suppliers to be used throughout Integrated Devices. The team is also responsible for improving service quality and the material that Integrated Devices receives from its suppliers.

Bill’s role after supplier selection involves working directly with suppliers that require training or technical assistance concerning quality control and quality improvement.

The company spends about 70 percent of each sales dollar on purchased goods and services, so suppliers have a major impact on product quality.

Bill just received a call concerning a recurring manufacturing problem at Integrated Devices’ Plant No. 3. The buyer said their plant is experiencing some quality variability problems with a key plasticinjected molding component supplied by Trexler Plastics. The component is sometimes too short or too long to fit properly with other components within the finished product. On occasion, the bracket snaps, causing end-product failure. Although the unit cost of the plastic-injected molding component is only $1.55, these quality issues (length variability and snapping) are creating production problems that far exceed the component’s purchase price.

The local buyer announced he was having difficulty resolving the problem and asked for support from the corporate commodity team. The buyer said, ―You corporate guys selected this supplier that we must use. The least you can do is to help us out of the problem your selected supplier is causing.‖ The buyer’s comment surprised Bill, although Bill would soon come to understand that local plant personnel resented not being able to select their own suppliers.

After investigating the problem during a tension-filled meeting with the plant personnel, Bill determined he would have to visit the supplier directly. He would work with Trexler’s process engineers to address the manufacturing variability caused by the nonconforming component. Bill went back and reviewed his team’s actions when selecting a single supplier to provide an entire family of plasticinjected moldings.

Trexler had quoted the lowest price of all competing suppliers and had provided samples that passed Integrated Devices’ engineering tests.

Upon his arrival at the supplier, Bill learned that Trexler did not have a dedicated process engineer. One engineer, Steve Smith, was

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 3: Managing Supplier Quality: Integrated Devices

responsible for plant layout, process, quality, and industrial engineering. This individual, who was hired only two months previously, was still becoming familiar with Trexler’s procedures.

When Bill asked to review the supplier’s quality control procedures, Steve had to ask several people before he could locate Trexler’s procedures manual.

Bill decided that his first step should be to understand the process responsible for producing the defective component. At an afternoon meeting, Bill asked Steve for actual output data from Trexler’s process. Steve explained they did not collect data for process capability studies or for statistical control charting of continuous production. However, he did say that sometimes ―things don’t seem to be operating well‖ with the equipment that produces the component.

Trexler uses an inspector to examine every finished item to determine if it should be shipped to the customer.

After explaining the basics of process capability to Steve, Bill asked him to collect data from the process that produced the bracket component. Bill requested that Steve take exact measurements periodically from the process so they could draw statistical conclusions. Bill said he would return in three days to examine the data.

Upon his return three days later, Steve shared with Bill the details of the data collection effort (see Exhibit 1).

Exhibit 1 Process Output Data Part #03217666 4.01 4.02 4.00 4.04 4.02 4.07 4.00 3.96 3.94 4.05 3.98 3.97 3.99 3.96 4.00 3.98 3.99 3.94 3.99 4.02 4.04 Component: #03217666

3.99 3.95 3.98 4.03 4.00 3.93 4.00

3.98 3.98 3.99 4.07 4.01 4.00 3.96

4.00 4.01 4.02 4.04 4.02 4.02 3.97

4.00 4.03 4.01 4.02 4.02 4.00 4.00

4.03 4.00 4.00 4.01 4.01 3.97 4.01

Description: Bracket Design specification: 4 ± 0.06 inches Once Bill calculated a preliminary process capability from this data and examined the training and quality control procedures at Trexler, he realized he had some serious work ahead of him.

ASSIGNMENT 1. Calculate the Cp and Cpk of the process that produces the component purchased by Integrated Devices. Remember—process

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 3: Managing Supplier Quality: Integrated Devices

capability = (specification width) divided by six times the standard deviation of the sample. Can the process at Trexler satisfy design requirements? Assume the Cp = Cpk meaning there is no penalty for offcentering. Is the target Cpk ≥ 1.33 in this sample? This level (1.33 or greater) is considered a good process capability, indicating that the process is well within specification limits and has a low probability of producing defects.

2. Why is it important to prove that a process is proven capable before developing statistical control limits (i.e., SPC charts)?

3. Is Integrated Devices being reactive or proactive when it comes to managing supplier quality? Why? 4. Discuss the possible advantages of negotiating quality requirements directly into supplier contracts.

5. What is the risk of relying on product samples when selecting suppliers? What is the risk of relying too heavily on unit cost when making the selection decision?

6. Why was it so important for Bill to work with Plant No. 3 personnel before visiting Trexler?

7. The local buyer at Integrated Devices did not seem pleased that a corporate team selected the supplier that the local plants must use. Why do firms use corporate commodity teams to select suppliers? How can firms get support from plant personnel for companywide suppliers?

8. Is quality a major emphasis at this supplier? Why or why not?

9. What are the possible effects if Trexler’s inspector approves components for shipment that should be rejected due to nonconformance (Type II error)? What are the possible effects if Trexler’s inspector rejects components for shipment that are in conformance with specifications (Type I error)? How can we control error of measurement?

10.

When evaluating supplier quality, why is it important to focus on the process that produces the material or service rather than on the material or service itself? What did Integrated Devices rely on?

11.

Discuss the likelihood that Bill will resolve the problem(s) with this component.

12.

If Integrated Devices decides to continue using Trexler as a supplier, what must both companies do to begin improving Trexler’s component quality?

Design a supplier quality management process for Integrated Devices that focuses on the prevention of supplier defects. (Hint: Activities performed during supplier evaluation and selection should be part of this process. Process capability analysis may also be

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 3: Managing Supplier Quality: Integrated Devices

CASE 3 INSTRUCTORS NOTES This case examines many issues relating to supplier quality management. A key point of this case is that even simple, relatively inexpensive items can cause non-conformances disproportionate to the value of the item. In this case, an inexpensive molding bracket can cause the failure of the finished product and disrupt production schedules Assignment: 1. Calculate the Cp and Cpk of the process that produces the component purchased by Integrated Devices. Can the process at Trexler Plastics satisfy the design requirement? What should be the target Cpk level?

Discussion: This first requires calculation of the process capability, or Cp: Cp = Specification width -------------------Process width (or 6 x the sample standard deviation) = +/-.06 = .12 specification width -----------------------------------.1602 (6 x .0267) Note: .0267 is the standard deviation of the sample, which is calculated from the sample data provided in the case = .7491 Because the observations in Exhibit 1 average to 4.000, no need exists to calculate Ak  which is the penalty for offcentering. If off centering occurs, then we would use the following formula: K = (Design center - grand mean) ---------------------------(Specification width/2) Then, calculate Cpk using the following formula: Cpk = (1-k)(Cp) This process, with a Cp of .7491, is not capable at a level that will prevent quality defects from occurring. Generally

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 3: Managing Supplier Quality: Integrated Devices

acceptable minimum Cpk levels are 1.33. However, in many industries, the required minimum is now 2.0 or higher.

2. Why is it important to prove that a process is proven capable before developing statistical control limits (SPC charts)?

Discussion: It may be inaccurate to chart a process that is first shown to be incapable. A process that is not capable has too much variability or inconsistency in its output. When developing statistical process control limits, we do not consider or take into account specification targets (i.e., the range that design engineers say is acceptable when producing an item).

The formulas for developing upper and lower control limits rely heavily, however, on a value called average R (range) in the calculation. (See Part B of this case for formulas). R is the variability within a sample identified from measures of actual output and is formally defined as the difference between the highest and lowest measured output within a sample. Greater within sample variability means greater inconsistency in output, with a higher value of R. Average R is a key component when calculating upper and lower control limits. Let us examine this numerically: Assume a component has a specification of 10 +/- .02 inches.

This means the design engineers have concluded that this component must lie between 9.98 and 10.02 inches whenever it is produced. Next, a firm actually produces and measures this component. The grand mean (which becomes the process center in the SPC calculation) is 10 inches, which also happens to be the design center target. Average R is calculated to be .06.

Now, this firm wants to develop statistical process control upper and lower control limits. (Assume that each time a sample was taken from production the sample size was 5 units, which is important when we get the A2 value required for the X bar equation.)

X bar = Process grand mean +/ (A2)(Average R) Upper control limit = 10 + (.58)(.06) = 10.0348 Lower control limit = 10  (.58)(.06) = 9.9652 Recall that the design specification width for this item is 9.9810.02. The control limits are actually wider than the design target! This means that a process operating outside the design specification is considered in control! The control limits must always be within the specification limits, or the chart is meaningless. The high process variability or inconsistency, reflected in the higher value for average R,

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 3: Managing Supplier Quality: Integrated Devices

distorted the calculation of the upper and lower statistical control limits. This illustrates why firms should never develop statistical control levels without first demonstrating that a process is highly capable (through the Cpk calculation).

3. Is Integrated Devices being reactive or proactive when it comes to managing supplier quality? Why? Discussion: As it relates to the situation presented in this case, Integrated Devices is being reactive. This is a reoccurring situation that is just now commanding Bill’s attention. The company did not perform a pre-selection site visit or examine Trexler Plastics processes before awarding the purchase contract. Furthermore, it appears that the primary decision criteria were based on price and the samples, since Integrated Devices personnel assumed quality to be a non-issue. Even when Bill visited Trexler Plastics, he focused on measurements relating to a single performance attribute only. However, the bracket also snaps on occasion, which indicates that more than one problem may be affecting this item. (Note to instructor: This is an important but not a very obvious issue.) Also, Trexler Plastics supplies an entire family of plastic injected moldings. Is the problem affecting other items too? Bill is being reactive by focusing on a specific bracket and not taking a broader view by focusing on Trexler Plastics overall capability.

4. Discuss the possible advantages of negotiating quality requirements directly into supplier contracts.

Discussion: There are several advantages of negotiating quality requirements directly into supplier contracts. First, specifying quality requirements sends a clear message to the supplier about the importance of quality. If the supplier does not know its quality levels, this might provide the incentive to develop quality measurement systems. Discussing these requirements during contract negotiations underlies the importance of this issue. Second, firms often present their quality requirements in terms of continuously improving quality levels or targets that are quantified within a contract. The contract may even provide incentives to achieve quality performance targets. Third, communicating quality requirements through the negotiating process allows the supplier to understand clearly the purchaser’s requirements (and vice versa). Often, understanding each other’s requirements takes us half the way toward satisfying those

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 3: Managing Supplier Quality: Integrated Devices

requirements. Perhaps the two parties can begin to work jointly to understand each party’s requirements and begin to accelerate the rate of quality improvement.

5. What is the risk of relying on product samples when selecting suppliers? What is the risk of relying too heavily on unit cost when making the selection decision?

Discussion: A risk associated with relying on samples is that a buyer gains minimal insight into the process that produced the sample. Relying on samples directs our attention on the product rather than the process. Furthermore, what supplier would send a buyer a defective sample? It is possible that Trexler Plastics had to produce five parts just to get two acceptable samples. We have no way of knowing for sure.

Integrated Devices also has no way of knowing if the same process used to produce the low-volume samples will be the process used to produce high volume quantities.

Relying strictly on unit cost when making sourcing decisions can also be risky. Here, the low-price producer may not necessarily be the low-cost producer due to the increased costs associated with poor quality. Unfortunately, unit price is the most visible piece of data collected within purchasing.

Therefore, most buyers are measured on their ability to get a lower unit price rather than a lower total cost. Most firms lack the sophisticated systems required to track the total cost of doing business with a supplier. Without total cost data, it becomes difficult to justify selecting a higher price supplier, even though that supplier may be a lower total cost supplier.

6. Why was it so important for Bill to work with Plant No. 3 personnel before visiting Trexler?

Discussion: When pursuing total quality management, facts predominate.

Bill needed additional data before visiting Trexler Plastics.

He must be able to communicate objectively with Trexler Plastics using data and facts. For example, Bill needs to determine the severity of the problem. What are the requirements of plant No. 3 (customer requirements)? What exactly is the nature of the defects? How often does the problem occur? Did Integrated Devices properly specify the part to Trexler Plastics? Are the production processes at Integrated Devices performing correctly? Could the problem really be the fault of Integrated Devices rather than the supplier? Also, Trexler Plastics provides a family of parts.

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 3: Managing Supplier Quality: Integrated Devices

Are any problems being experienced with these other parts?

Bill must begin his search for identifying the root cause of the production variability problems.

7. The local buyer at Integrated Devices did not seem pleased that a corporate team selected the supplier that the local plants must use. Why do firms use corporate commodity teams to select suppliers? How can firms get support from plant personnel for company-wide suppliers?

Discussion: Firms use commodity teams to select suppliers because no one individual can possibly be trained in all the areas that teams examine when visiting suppliers. Furthermore, executive management hopes that teams, by working together, will make better decisions than individuals acting alone. Company-wide commodity contracts are established to try and achieve lower cost, consistent performance, and higher quality across all buying units or centers.

The issue of buy-in from local buyers for the use of companywide suppliers is critical. Some firms address this issue by having local buyers participate on the teams that select the company-wide suppliers. It is hoped that these local buyers will buy into the selection decision, since they were part of the process. Other firms measure the extent to which local buyers use approved company suppliers. Measurement often motivates individuals to behave in certain ways desired by the company. Others may offer incentives to use company-wide suppliers or suppliers that were not selected at the local level.

8. Is quality a major emphasis at this supplier? Why or why not?

Discussion: Quality does not seem to be a major emphasis at Trexler Plastics. There are several indications of this: (1) No measurements are in place to measure product quality or the cost of poor quality consistently. (2) All quality control systems rely on inspection rather than prevention. Quality is the responsibility of inspectors rather than all employees.

(3) Trexler Plastics has no dedicated quality or process engineer or process proving systems. The individual responsible for quality is inexperienced and is responsible for many tasks. This indicates that quality is just another assignment to this individual, probably with no increased importance.

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 3: Managing Supplier Quality: Integrated Devices

9. What are the possible effects if Trexler’s inspector approves components for shipment that should have been rejected due to nonconformance (Type II error)? What are the possible effects if Trexler’s inspector rejects components for shipment that are actually in conformance with specifications (Type I error)? How can we control errors of measurement?

Discussion: If Trexler’s inspector approves components for shipment that should have been rejected due to nonconformance, this is called a Type II error. This type of error means that defective material could be making its way into Integrated Devices final product. Some of this material may be detected through inspection or testing at Integrated Devices before it is used in production. However, it is possible that some of the material may not be identified as defective until the end customer uses the product. Some possible effects of Type II errors include:             

Increased inspection costs at Integrated Devices Production delays as defective material is sent back to Trexler Plastics Increased inventory requirements to compensate for poor Trexler Plastics quality Increased handling and shipping Rework costs Production downtime Delivery delays to Integrated Devices customers Potential liability and lawsuits due to defective end products Loss of customer goodwill and future sales Increased final product costs Overtime costs to produce replacement material Expediting and follow-up costs Premium transportation costs (to replace defective material)

If Trexler Plastics inspector rejects components for shipment that actually conform to design specifications, this is called a Type I error. This error results in searching for causes of nonconformance that do not exist. The material produced conformed to the design specification - the inspector made an error. This type of error also creates additional costs as Trexler Plastics ceases production in an attempt to solve a problem that does not actually exist. This can also delay shipments to Trexler Plastics customers, which can affect their customers’ production schedules and customer service.

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 3: Managing Supplier Quality: Integrated Devices

Trexler Plastics may also scrap or destroy conforming material.

10. When evaluating supplier quality, why is it important to focus on the process that produces the material or service rather than on the material or service itself? What did Integrated Devices rely on?

Discussion: Purchasers do not buy products or services per se - they buy the supplier’s capability that produces those goods or services. The good or service is merely an output or end result of the supplier’s process. The process, whether it is the supplier’s product design process, supply management process, or the production process, should be the buyer’s central focus whenever possible. Capable and well-managed processes should produce goods and services that meet the buyer’s requirements.

Integrated Devices clearly relied on product samples during the source selection process. For many routine items, this is not an uncommon practice. Unfortunately, relying on samples provides minimal insight into the supplier’s actual capabilities, quality performance, or cost structure.

11. Discuss the likelihood that Bill will resolve the problem(s) with this component.

Bill focused on a single dimension of the process—length. In reality, the process seems to be causing several problems. The case clearly states that breakage is a problem, also. Bill and or Trexler Plastics are not addressing this issue.

At a broader level, Trexler Plastics is a long way from being a quality-aware company. The company requires structural changes, commitment of leadership, and possibly qualityrelated investment before it can begin the journey toward total quality.

12. If Integrated Devices decides to continue using Trexler Plastics as a supplier, what must the companies do to begin improving Trexler Plastics component quality?

Discussion: Trexler Plastics must make a stronger commitment to customer quality and service. This may require implementing total quality management training, group problem solving, development of quality measurement systems, a focus on prevention rather than inspection, or any other activity that improves product quality. Integrated Devices may have to

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 3: Managing Supplier Quality: Integrated Devices

provide technical support that Trexler Plastics clearly lacks.

Integrated Devices could conclude that Trexler Plastics is not a viable longer-term supply source and begin to search for a more qualified supplier. Companies that produce items that are easily purchased from many different companies face significant risk if they have poor quality. The cost of switching suppliers may be low, making that an attractive option for purchasers. If Integrated Devices keeps Trexler Plastics, then the search for the causes of variability must begin.

13. Design a supplier quality management process for Integrated Devices that focuses on the prevention of supplier defects.

(Hint: Activities performed during supplier evaluation and selection should be part of this process. Process capability analysis may also be part of your supplier quality management process.)

Discussion: 





  

      

Perform pre-selection site visits that focus on supplier quality management before making final supplier selection decisions Require suppliers to provide evidence of quality defect prevention, measurement systems, process proving, and continuous improvement Improve quality measurement systems at Integrated Devices to provide immediate visibility to quality problems with immediate feedback to feedback Develop total cost of ownership systems so sourcing decisions do not have to be based solely on unit price Meet with suppliers to convey Integrated Devices quality requirements and expectations Meet periodically with suppliers to review supplier quality performance and discuss ways to work jointly to improve future performance Involve supplier in product and process design discussions when appropriate Provide training in quality control techniques or provide other supplier development assistance if required Supplier evaluation and selection relates to the following principles of TQM: Quality at the source Prevention rather than detection of defects Relying on objective rather that subjective analysis Focusing on process rather than product

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 4: Porto Case

Instructor Manual Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 4: Porto Case

TABLE OF CONTENTS Case 4: Porto Case .................................................. 28 Buyer’s Information - Porto ......................................... 29 Seller’s Information - Technutronics ................................ 32

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 4: Porto Case

CASE 4: PORTO CASE The instructor’s manual contains information for the buyer and seller.

Buyers and sellers must each have their own set of information before they can plan for and conduct the negotiation. Please copy this information and make it available to the students. Do not allow the buyer to see the seller’s information and vice versa. The students will decide how much information they share during the negotiation.

A reasonable amount of time to allocate for this simulation is 30 minutes for individual planning and 45-60 minutes for the actual negotiation. This negotiation can be an individual or team effort. The larger the negotiating team, the more time the participants may require to plan for and carry out the negotiation.

Do not tell the participants they must reach an agreement. An inability to agree, also known as a deadlock, does not mean failure.

It simply means that the parties were unable to agree or their personal positions on a negotiation had no common area of overlap. A deadlock is often better than reaching a bad agreement.

Before the negotiation begins, the instructor may ask the buyer and seller to list their goals from this negotiation. Furthermore, ask the participants to identify the range over which they expect to negotiate each major issue. For example, the buyer will have a range over which he or she would like to purchase the component. The seller will also have a relevant range over which he or she is willing to sell the component. Developing a range is important for two reasons. When each party has developed a range for an issue (versus a fixed point), this increases the probability that the buyer and seller will have an overlap in their positions and will reach an agreement. Second, a range suggests a willingness to be flexible. Flexibility is important to successful negotiations.

When the authors of this text conduct purchase negotiation simulation, they collect the pre-negotiation data from the buyers and sellers and use this as a basis for analysis after the negotiations are completed.

For example, if a buyer and seller fail to agree on the purchase of the component, often the two parties had no overlap in their positions. A post hoc review of the negotiation is a perfect time to ask the participants what they expected from the negotiation, who was flexible, what were the main issues, who opened with the first offer or concession, why the parties did or did not reach an agreement, and so on. The information that the buyer and seller consider before they commence negotiations provides a basis for after-the-fact discussion.

(Instructor - See the questions that each party must complete before beginning the negotiation. These questions appear at the end of the buyer and seller information packet.)

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 4: Porto Case

Remember that a negotiation has no right or wrong answer. A successful negotiation is one where each party is eventually satisfied. Parties negotiated based on their skill and personal objectives.

BUYER’S INFORMATION - PORTO Gerald Stecklen, a buyer for Porto, is responsible for developing a negotiating plan and strategy for the purchase of a component (called New Prod) for a newly designed product. After evaluating the quotations submitted by potential suppliers, he has decided to pursue purchase negotiations with Technutronics.

New Prod was designed and developed by Porto engineers for a product currently under development. Prototypes of the component were produced by a small, specialized firm without production volume capacity.

Gerald knew the high-tech industry had between five and eight potentially qualified suppliers who were familiar with the complex manufacturing process required to produce New Prod. Supplier capacity was available since the industry was just recovering from a period of underutilization.

Seven suppliers received a request for quotation. The RFQ included a 12-month delivery schedule for 200,000 units plus a possible follow-on order for up to 200,000 units. The quotes also included payment terms and shipping (F.O.B. point) information (Exhibit 1B).

Five of the seven suppliers receiving RFQ’s responded. (Exhibit 2B).

Technutronics had the lowest quoted price at $5.90 per unit. Tyler Manufacturing was very close except for a high unit cost of transportation. Both companies were acceptable suppliers and Gerald decided to pursue negotiations with Technutronics. He understands the lowest quoted price does not always mean the lowest total cost. For that reason, Gerald knows that issues besides price will have to be discussed with Technutronics. The requests for quotation were intended to reduce the list of suppliers before commencing negotiations.

Gerald requested a cost estimate for New Prod from his staff analyst to help him formulate his negotiating plan. The analysis (Exhibit 3B) provides a ―should‖ cost of $4.10 per unit excluding tooling and transportation. This cost included learning curve effects. He believed that production times for this component should decrease as volumes increased due to learning. Based on discussions with internal engineers, Gerald estimated that production of this component should demonstrate an 85%-90% learning rate.* He was not sure, however, that this rate applied specifically to Porto since he has not visited the Technutronics facility.

Quality control measures were a vital concern for Gerald. All products were subject to strict quality guidelines and New Prod was no

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 4: Porto Case

exception. Technutronics, Tyler Manufacturing, and Space Metals each have a record of solid performance ratings for quality and delivery.

With this information, Gerald now sat down and planned his negotiating strategy. * This means that as production volumes double from a previous level, direct labor requirements should decrease 10-15% on average.

Exhibit 1B Expected New Prod Delivery Schedule Month Quantity December 20,000 January 20,000 February 25,000 March 15,000 April 15,000 May 15,000 June 10,000 July 10,000 August 15,000 September 20,000 October 20,000 November 15,000 Total 200,000 Payment terms: Net 25 Transportation Terms: Sellers Plant, Freight Collect Using Location: Detroit, Michigan Exhibit 2B Quotation Summary Supplier

Unit Price

Tooling Costs

Bauer Manufacturing Metal Modes Tyler Manufacturing Avicraft, Inc. Technutronics Aerobotics, Inc. Space Metals

No quote $6.10 $5.95 No quote $5.90 $6.25 $6.40

--------$30,000 $40,000 --------$40,000 $45,000 $50,000

Estimated Transportation Cost Per Unit -------$0.08 $.016 -------$0.06 $0.08 $0.09

Exhibit 3B Buyer’s “Should” Cost Estimate (For 200,000 units)

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 4: Porto Case

Total Cost

Unit Cost

0.3525 lbs./unit x $5.648/lb. $398,215

$1.991

Material:

Direct Engineering Labor: 1500 hours x $11.50/hr.

$17,250

$0.0863

$20,700

$.01035

$33,150

$0.1658

$33,150 x 250%

$82,875

$0.4144

SUB TOTAL

$552,190

Engineering Overhead: $17,250 x 120% Direct Manufacturing Labor: 3900 hours x $8.50/hr.

Manufacturing Overhead:

General and Administrative Costs: $552,190 x 35%

$193,265

SUB TOTAL

$745,455

Profit: $745,455 x 10%

$74,545

$0.3727

TOTAL

$820,000

$4.10

Estimated Tooling Charges:

$0.9663

$25,000

In addition to specific requests by the instructor: 1. Given the unit price, tooling costs, and estimated transportation charges presented in Exhibit 2B, calculate the cost per unit for each supplier (using 200,000 units). What are some possible reasons why two suppliers did not provide quotations to Porto?

2. Prepare to negotiate a contract with Technutronics. Identify the key issues and the range of your position on those issues.

Remember that price is not the only variable subject to negotiation.

3. What do you think will be the most important issue(s) to the seller?

4. What do you believe is the lowest price that Technutronics is willing to accept? What is the highest price for New Prod you are willing to pay? (This defines your negotiating range on the price issue).

5. Conduct the negotiation with the seller. You may share as little or as much information with the seller during the negotiation as

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 4: Porto Case

you desire. Be sure to record any agreement you reach in the form of a contract.

SELLER’S INFORMATION - TECHNUTRONICS Brad Tennant, Sales Manager for Technutronics, was developing a strategy for a negotiation session to be held with Gerald Stecklen, a buyer at Porto Corporation. Mr. Stecklen requested the meeting to discuss the quotation submitted by Technutronics for New Prod, a newly designed component.

Brad’s company submitted the quotation for New Prod in response to a request for quotation of 200,000 units plus a possible follow-on order of up to 200,000 units (Exhibit 1S). Working with the Engineering and Manufacturing staffs, Brad developed an estimate of manufacturing and tooling costs (Exhibit 2S).

The process required to produce the component was unique and somewhat complex. Therefore, quality control requirements for the part were quite involved. Furthermore, if material or equipment problems occurred, an additional $0.60 to $0.70 per unit would be required to produce the part at a level that satisfied the buyer’s requirements.

Additional tooling might also be required beyond the quoted tooling charge of $40,000. However, Brad wanted to keep tooling charges to a minimum.

The Porto business would be beneficial to Technutronics since they were operating at 75% capacity. Porto was also a long-time customer.

The contract would amount to approximately $1,000,000 plus a possible addition of $1,000,000 if the additional 200,000 units were realized.

Estimated direct costs to produce the component were $2.71 (raw material + direct engineering + direct labor) of the $4.68 total cost to produce. Brad wanted to establish a per unit selling price that would cover all direct costs and significantly contribute to fixed costs and profit. Furthermore, he needed to consider the quality cost contingencies.

After some discussion by the management committee and a review of estimated costs for the part, a quotation was agreed upon. The quality cost contingencies were included and the possible tooling cost increases ignored ($4.68 + $ 0.70). A profit percentage of 10% was added ($0.54). Brad and his controller decided to quote $5.90 per unit plus $40,000 for tooling. Brad felt this bid to be competitive with other firms.

The manufacturing manager informed Brad he would make additional effort to develop statistical process control methods to highlight quality problems. Brad realized that the use of statistical methods could help reduce direct costs over time if Technutronics was

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 4: Porto Case

successful in identifying and eliminating the sources of variability within the process. In addition, there were learning curve considerations for New Prod. However, Brad did not include any estimation of learning effects in the bid. Typically, items such as New Prod have a 90% learning curve.

Brad’s task was to develop his negotiation strategy and plan. He knew the contract was important to Technutronics, but they could not sustain a loss. He also knew that Porto did not possess the manufacturing capabilities for the part. The company had no option but to subcontract the component. Brad also knew that other suppliers were anxious for this business.

Exhibit 1B Expected New Prod Delivery Schedule Month December January February March April May June July August September October November Total

Quantity 20,000 20,000 25,000 15,000 15,000 15,000 10,000 10,000 15,000 20,000 20,000 15,000 200,000

Payment terms: Net 25 Transportation Terms: Sellers Plant, Freight Collect Using Location: Detroit, Michigan Exhibit 2S Sellers Estimated Cost (For 200,000 Units) Total Cost

Unit Cost

$497,000

$2.488

Raw Material: (0.4405 lbs./unit x $5.648/lb.)

Direct Engineering Labor: Electrical Engineer $17.50/hr. x 80 hrs.

$ 1,400

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Micro Associate Engineer $11.25/hr x 1200 hrs.

$13,500

Micro Technician $10.50/hr. X 600 hrs.

$ 6,300

Engineering Overhead: $21,000 x 125%

$21,200

$0.016

$26,500

$0.1325

$42,167

$0.2108

$105,418

$0.5272

Direct Manufacturing Labor: Machine Shop $10.65/hr. x 1080 hrs.

$11,502

Mechanical Assembly $6.00/hr. x 2940 hrs.

$17,640

Assembly Supervisor $11.55/hr. x 500 hours

$5,775

Production Manager $14.50/hr. x 500 hours

$7,250

Manufacturing Overhead: $42,167 x 250% SUBTOTAL

$692,885

General and Administrative Costs: $692,885 x 35%

$242,510

$1.2126

TOTAL

$935,395

$4.678

In addition to specific requests by the instructor: 1. Prepare to negotiate a contract with Porto. Identify the key issues and the range of your position on those issues. Remember that price is not the only variable subject to negotiation.

2. What do you think will be the most important issue(s) to the buyer?

3. What do you believe is the highest price that Porto is willing to pay for New Prod? What is the lowest price you are willing to sell New Prod? (This defines your negotiating range on the price issue).

4. Conduct the negotiation with the buyer. You may share as little or as much information with the seller during the negotiation as you desire. Be sure to record any agreement you reach in the form of a contract. [return to top]

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 5: Purchasing Ethics

Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 5: Purchasing Ethics

TABLE OF CONTENTS Case 5 Purchasing Ethics ............................................ 36 Scenario 1 .......................................................... 36 ASSIGNMENT ........................................................ 36 Scenario 2 .......................................................... 36 ASSIGNMENT ........................................................ 37 Scenario 3 .......................................................... 37 ASSIGNMENT ........................................................ 38 Scenario 4 .......................................................... 38 ASSIGNMENT ........................................................ 39 Case 5 Instructors Notes ............................................ 39 Scenario 1 Discussion ............................................... 40 Scenario 2 Discussion ............................................... 41 Scenario 3 Discussion ............................................... 43 Scenario 4 Discussion ............................................... 44

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 5: Purchasing Ethics

CASE 5 PURCHASING ETHICS SCENARIO 1 Bryan Janz was just arriving back from lunch when his cell phone rang.

It was his wife, Nina, calling from home. Nina told Bryan that FedEx had just delivered a package addressed to her. The package contained a beautiful clock now sitting over the fireplace. In fact, Nina said, ―The clock looks absolutely beautiful on our living room fireplace.‖ Thinking the clock was from a family member, Bryan asked who sent the present. She said she did not recognize the name—the clock was from Mr. James McEnroe. Bryan immediately told Nina that she had to repack the clock because it was from a supplier who had been trying to win business from Bryan’s company. They definitely could not accept the clock. Nina was very upset and responded that the clock was perfect for the room and, besides, the clock came to their home, not to Bryan’s office. Because of Nina’s attachment to the clock, Bryan was unsure about what to do.

ASSIGNMENT 1. What should Bryan do about the clock?

2. What does the Institute of Supply Management's code of ethics say about accepting supplier favors and gifts?

3. Why do you think the supplier sent the clock to Bryan’s home and addressed it to his wife?

4. Does the mere act of sending the clock to Bryan mean that Mr. McEnroe is an unethical salesperson?

SCENARIO 2 Lisa Jennings thought that at long last, her company, Assurance Technologies, was about to win a major contract from Sealgood Instruments. Sealgood, a maker of precision measuring instruments, was sourcing a large contract for component subassemblies. The contract that Assurance Technologies was bidding on was worth at least $2.5 million annually, a significant amount given Assurance’s annual sale of $30 million. Her team had spent hundreds of hours preparing the quotation and felt they could meet Sealgood’s requirements in quality, cost, delivery, part standardization, and simplification. In fact, Lisa had never been more confident about a quote meeting the demanding requirements of a potential customer.

Troy Smyrna, the buyer at Sealgood Instruments responsible for awarding this contract, called Lisa and asked to meet with her at his office to discuss the specifics of the contract. When she arrived, Lisa soon realized that the conversation was not going exactly as she

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 5: Purchasing Ethics

had expected. Troy informed Lisa that Assurance Technologies had indeed prepared a solid quotation for the contract. However, when he visited Assurance’s facility earlier on a prequalifying visit, he was disturbed to see a significant amount of a competitor’s product being used by Assurance. Troy explained his uneasiness with releasing part plans and designs to a company that was clearly involved with a competitor. When Lisa asked what Assurance could do to minimize his uneasiness, Troy replied that he would be more comfortable if Assurance no longer used the competitor’s equipment and used Sealgood’s equipment instead. Lisa responded that this would mean replacing several hundred thousand dollars’ worth of equipment.

Unfazed, Troy simply asked her whether she wanted the business. Lisa responded that she needed some time to think and that she would get back to Troy in a day or so.

ASSIGNMENT 1. The buyer at Sealgood Instruments, Troy Smyrna, is practicing a certain type of unethical behavior. What is the term for this behavior? Why is it considered unethical?

2. What should Lisa do in this situation? Formulate a response.

SCENARIO 3 Ben Gibson, the purchasing manager at Coastal Products, was reviewing purchasing expenditures for packaging materials with Jeff Joyner. Ben was particularly disturbed about the amount spent on corrugated boxes purchased from Southeastern Corrugated. Ben said, ―I don’t like the salesman from that company. He comes around here acting like he owns the place. He loves to tell us about his fancy car, house, and vacations. It seems to me he must be making too much money off us!‖ Jeff responded that he heard Southeastern Corrugated was going to ask for a price increase to cover the rising costs of raw material paper stock. Jeff further stated that Southeastern would probably ask for more than what was justified simply from rising paper stock costs.

After the meeting, Ben decided he had heard enough. After all, he prided himself on being an action-oriented person. There was no way he was going to allow that salesman to keep taking advantage of Southeastern. Ben called Jeff and told him it was time to rebid the corrugated contract before Southeastern came in with a price increase request. Who did Jeff know that might be interested in the business?

Jeff replied that he had several companies in mind to include in the bidding process. These companies would surely come in at a lower price, partly because they use lower-grade boxes that would probably work well enough in Southeastern’s process. Jeff also explained that these suppliers were not serious contenders for the business. Their purpose was to create competition with the bids. Ben told Jeff to make

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 5: Purchasing Ethics

sure that Southeastern understood these new suppliers were bidding on the contract. He also said to make sure that the suppliers knew that price was going to be the determining factor in this quote, since he considered corrugated boxes to be a standard industry item.

ASSIGNMENT 1. Is Ben Gibson acting legally? Is he acting ethically? Why or why not?

2. What should Southeastern Corrugated do when it receives the request for quotation from Coastal Products?

SCENARIO 4 Sharon Gillespie, a new buyer at Visionex Inc., was reviewing quotations for a tooling contract submitted by four suppliers. She was evaluating the quotes based on price, target quality levels, and delivery lead-time promises. As she was working, her manager, Dave Cox, entered her office. He asked how everything was progressing and if she needed any help. She mentioned she was reviewing quotations from suppliers for a tooling contract. Dave asked who the interested suppliers were and if she had decided. Sharon indicated that one supplier, Apex, appeared to fit exactly the requirements Visionex had specified in the proposal. Dave told her to keep up the good work.

Later that day, Dave visited Sharon’s office again. He stated that he had done some research on the suppliers and felt that another supplier, Micron, appeared to have the best track record with Visionex. He pointed out that Sharon’s first choice was a new supplier to Visionex, and there was some risk involved with that choice. Ben indicated that it would please him greatly if she selected Micron for the contract.

The next day, Sharon was having lunch with another buyer, Mark Smith.

She mentioned the conversation with Dave and said she honestly felt that Apex was the best choice. When Mark asked Sharon who Dave preferred, she answered Micron. At that point, Mark rolled his eyes and shook his head. Sharon asked what the body language was all about.

Mark replied, ―Look, I know you’re new, but you should know this. I heard last week that Dave’s brother-in-law is a new owner of Micron. I was wondering how soon it would be before he started steering business to that company. He is not the straightest character.‖ Sharon was shocked. After a few moments, she announced that her original choice was still the best selection. At that point, Mark reminded Sharon that she was replacing a terminated buyer who did not go along with one of Dave’s previous preferred suppliers.

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 5: Purchasing Ethics

ASSIGNMENT 1. What does the Institute of Supply Management's code of ethics say about financial conflicts of interest?

2. Sourcing decisions that affect a buyer’s ethical perspective usually involve the: 1) the U.S. business cultural environment; 2) industry environment; 3) organizational environment; and 4) personal environment. Analyze this scenario using these four variables.

3. What should Sharon do in this situation?

CASE 5 INSTRUCTORS NOTES The four ethics scenarios in this case highlight various moral and ethical dilemmas that buyers may encounter. Ethics play an important role within the purchasing profession. This is due partly to purchasing’s authority to control and award large dollar contracts.

The temptation for ethical abuses by the buyer or seller, unfortunately, is always present.

Ethics are the set of principles guiding our behavior. In a business setting, ethical behavior is the use of recognized social principles involving justice and fairness throughout our business relationships.

Ethics have their basis in the field of philosophy, and identify common principles associated with appropriate versus inappropriate actions, moral duty, and obligation. Purchasing professionals have an ethical responsibility to many groups:     

To the firm for which they work To fellow purchasing professionals To employees To customers and shareholders To the community and others in society

When confronting a situation or considering a behavior that may involve ethical issues, several general criteria should govern our judgment and actions: 

   

Would this behavior or action be acceptable to people and other purchasing professionals whom I respect? (This assumes the purchasing professional respects ethical people) What are the consequences of this behavior for myself, other employees, customers, and society?

Does this behavior conform to my company’s established ethical standards?

Is the behavior illegal?

Does the behavior conform to my profession’s established ethical standards?

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 5: Purchasing Ethics



Will I be proud of my action or behavior?

Because purchasing is a profession, purchasers should follow the professional standards of ethical purchasing behavior. A purchaser must commit his or her energies toward the organization’s benefit rather than personal enrichment at the expense of the organization. A professional purchaser must also act ethically toward suppliers or potential suppliers, treating each professionally and with respect.

Finally, a purchaser must uphold the ethical standards set forth by the ISM code of ethics.

A purchaser who practices unethical behavior exposes him or herself to various types of risk. Some unethical behavior is also illegal. (We can assume that illegal behavior is also unethical). Illegal behavior can lead to fines and/or imprisonment. Unethical behavior can also tarnish an individual’s professional reputation. This can result in dismissal and difficulty finding future employment. Unethical behavior also jeopardizes the integrity of a purchaser’s entire firm.

Purchasers have the authority to act as the legal agent of a firm. As such, they must be careful in their business dealings.

SCENARIO 1 DISCUSSION 1. What should Bryan do about the clock?

Bryan must determine if accepting this clock violates his personal ethics and moral judgment. Remember, even if Bryan feels he is entitled to keep the clock, he may still be violating company policy or professional codes of conduct. He must determine if his company has a policy on accepting gifts or favors from suppliers. If his company prohibits accepting gifts such as this clock, then Bryan is at personal risk if he accepts the supplier’s favor. Bryan should also notify his manager of this situation. This shows that Bryan is being open and honest about this situation, and it also allows Bryan’s manager to provide guidance. In all likelihood, Bryan should return this clock to the supplier.

2. What does the ISM Code of Ethics say about accepting supplier favors and gifts?

The ISM Code of Ethics is clear about accepting gifts from suppliers. The ISM Standards of Conduct states: ―Nothing can undermine respect for the purchasing profession more than improper action on the part of its members with regard to gifts, gratuities, or favors. People engaged in purchasing should not accept from any supplier or prospective supplier any money, gift, or favor that might influence, or is suspected of

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 5: Purchasing Ethics

influencing their buying decisions. We must decline to accept or must return any such gift or favor offered us or members of our immediate family. The declination of these gifts of favors must be done discreetly and courteously. Possible embarrassment resulting from refusals does not constitute a basis for exception.‖ If Bryan chooses to consult the ISM Code for guidance, then he must clearly and politely return the clock.

3. Why do you think the supplier sent the clock to Bryan’s home and to his wife?

This salesperson is clearly trying to influence Bryan’s future purchase decisions. The salesperson would probably maintain that he was merely trying to establish a relationship with Bryan. Mr. McEnroe’s company does not have a contract with Bryan’s company, so assuming he is trying to influence Bryan’s purchase decision is safe.

Interestingly, many companies with strict codes that buyers must follow are often not as strict when it comes to the marketing side of their business.

Buyers should base purchase decisions on sound business fundamentals, or else place the performance of an entire firm at risk. Suppliers who must give gifts and favors to win business probably cannot deliver world-class cost, quality, and delivery performance. If the supplier excelled in the performance areas that are critical to the buyer, then gift giving would be a nonissue.

4. Does the mere act of sending the clock to Bryan mean that Mr. McEnroe is an unethical salesperson?

Mr. McEnroe did not commit an illegal act, so giving the clock is not unethical from that perspective. He may work for a company where this is a commonly expected practice among salespeople. If this is the case, Mr. McEnroe was merely exhibiting behavior expected of him by his company. However, if his company prohibits this type of marketing, then he was acting unethically.

SCENARIO 2 DISCUSSION 1. Do you think the buyer at Sealgood, Troy Smyrna, is practicing a certain type of unethical behavior. First, what is the term for this behavior, and second defend why you think it is ethical or unethical behavior?

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 5: Purchasing Ethics

Troy, the buyer at Sealgood, wants Assurance Technologies to remove a competitor’s equipment as a condition of awarding a purchase contract. Reciprocity is the practice of linking contracts together. This deals with giving preferential treatment to suppliers who are also customers of the buying organization.

It refers to a purchasing arrangement that dictates that ―I buy from you if you buy from me.‖ The practice is unethical for several reasons. First, and foremost, the Federal Trade Commission has ruled it illegal ―to abusively use large buying power to restrict competitive market opportunities.‖ Reciprocity can easily take on a coercive nature, particularly when large firms force reciprocal agreements onto smaller firms. This practice can also undermine the morale of buyers, since buyers must select suppliers based on factors other than performance. It is often called ―restrictive purchasing‖, as the buyer must buy from suppliers who are customers of the buying firm. Finally, reciprocity is a top management decision, as purchasers should buy from suppliers who provide the best total value, irrespective of them being customers of the buying firm’s products and services.

2. What should Lisa do in this situation? Formulate a response.

Lisa should make it clear that this contract has nothing to do with using a competitor’s equipment or replacing it with Sealgood’s equipment. The buyer should award this contract based on performance merits only, with no reciprocal contingencies attached. She should invite a Sealgood representative to contact the appropriate equipment buyer at Assurance if Sealgood is interested in competing for a future equipment contract. Next, Lisa should inform her executive management of this situation.

Lisa must make it clear that an ethical, and possibly illegal, violation is occurring. The top management at Assurance may want to discuss this directly with the top management at Sealgood.

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 5: Purchasing Ethics

SCENARIO 3 DISCUSSION 1. Is Ben Gibson acting legally? why not?

Is he acting ethically?

Why or

When companies legitimately cannot estimate the cost of a purchased item or are concerned they are paying too much given the condition of the market, they sometimes perform a market test. This involves rebidding an item in an attempt to let the competitive market identify the most efficient producer. For some items, this is a sound business practice.

In this scenario, rebidding the box contract is due to Ben’s attitude more than by legitimate business concerns. He does not like the salesperson, he feels the supplier is taking advantage of him, and he is going to teach Southeastern Corrugated’s salesperson a lesson.

Ben is not acting illegally. However, he and Jeff are likely acting unethically. They plan to include suppliers in the bid process who do not have a legitimate chance of winning Coastal’s business. This is a tactical ploy to drive down the quotation from Southeastern.

Specifically, the behavior exhibited by Coastal managers is a form of sharp practice. A sharp practice is any misrepresentation by a buyer that falls short of actual fraud.

Sharp practices occur whenever a buyer uses his or her position to ―play games‖ with a supplier and operate underhandedly.

Examples of sharp practices include (1) willful use of misinformation, (2) exaggerating problems, (3) requesting bids from unqualified suppliers, (4) gaining information unfairly, (5) sharing information on confidential competitive quotations, (6) not compensating a supplier for work performed, (7) taking unfair advantage of a supplier’s financial situation, and (8) lying or misleading a supplier.

2. As the Marketing Manager for Southeastern Corrugated, what would you do upon receiving the request for quotation from Coastal Products?

If Southeastern wants to maintain Coastal’s business, they should respond, in good faith, with a competitive bid. Southeastern’s marketing manager should assume that losing this business is a real possibility given the attitude that Ben Gibson at Coastal has concerning Southeastern. Clearly, these companies do not have a good working relationship. Part of this could be a legitimate reaction to the bragging of the Southeastern salesperson. Coastal

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 5: Purchasing Ethics

may have been paying too much for boxes and has now reached this conclusion.

(Instructors’ note: This scenario is based on a true incident.

The purchaser requested bids on the boxes, including bids from ―new‖ suppliers, to get a lower price. The existing supplier, Southeastern, came in with a new, dramatically lower price. This price allowed Southeastern to maintain the purchase contract.

Relations between the companies and the individuals representing those companies did not improve. When the manager at Coastal first informed the salesperson at Southeastern that Coastal expected reduced pricing in the new contract, the salesperson replied that this ―will probably cost him his daughter’s summer trip to Spain.‖ Things went downhill from there.)

SCENARIO 4 DISCUSSION 1. What does the ISM Code of Ethics say about financial conflicts of interest?

The ISM Standard of Conduct is explicit about financial conflicts of interest. ―Our conduct must necessarily be subject to more restrictions and to higher standards, not only on the job, but in our outside activities as well. We should not be involved in purchasing transactions with any companies that we, our families or relatives, are owners or have a substantial financial interest.

We should not engage in business and professional activities where we might derive a financial profit or other benefits resulting from our employment as a buyer.‖ While this is explicit about financial conflicts of interest, Dave Cox does not seem too concerned about this issue. He is clearly trying to steer a purchase contract toward a firm where a relative has a significant financial interest. This is not acceptable behavior.

2. Ethical decisions that affect a buyer’s ethical perspective usually involve the: 1) the U.S. business cultural environment; 2) industry environment; 3) organizational environment; and 4) personal environment. Analyze this scenario using these four variables.

Of the four variables affecting a buyer’s ethical perspective, at least three suggest that Dave’s behavior is not ethical. First, the U.S. business culture does not endorse profiting from financial conflicts of interest. Our society does not support insider trading, monopolies, reciprocity, or any other unfair business practice. Business should occur based on the merits of

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the participants. Second, there likely is no common practice within industry to support this behavior.

A third variable in the ethical model is the organizational environment. While we do not know for sure, this company likely has a policy covering financial conflicts of interest. Even if Dave does not benefit directly from this contract, a relative of his will benefit. Often, buyers face issues where a gray area exists concerning the appropriate behavior. Examining these reveals that Dave’s behavior is clearly wrong and self-serving.

Sharon must not award the contract to Micron.

Regarding Sharon's personal experience, Dave’s actions trouble her. Her personal moral and ethical beliefs probably do not endorse awarding the contract on anything other than merit. Her personal beliefs are key to her behavior, however. Even if the other three variables that affect her ethical perspective suggest that financial conflicts of interest are wrong, she might feel obligated to award the contract to Micron. Especially if her morals are similar to Ben’s and she is fearful of losing her job.

3. What should Sharon do in this situation?

Sharon should discuss this situation with Dave on a professional level. She should explain her business reasons for her choice of supplier. If Dave insists that Sharon award the contract to Micron, then she should ask that a higher level of management help resolve this issue. It is unlikely that higher levels of management would endorse Dave’s financial conflict of interest.

If Sharon supports Dave, then she is a party to this unethical behavior. Assuming that Micron is not the best supplier for this contract, then awarding this contract to Micron diminishes the ability of Visionex to satisfy its customers. This places the success of Visionex at risk. Sharon is a new buyer. She must stand firm in her ground and demand that Dave justify his choice of supplier on business fundamentals. Obviously, this places her at risk because she is dealing with an individual who displays a low level of moral behavior. Recall that Sharon is replacing a buyer who failed to endorse one of Dave’s ―preferred‖ suppliers.

If she awards the contract to Micron, then she should expect Dave will offer his ―advice‖ on future purchase contracts. [return to top]

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 6: Insourcing/Outsourcing: The FlexCon Piston Decision

TABLE OF CONTENTS Case 6 Insourcing/Outsourcing: The FlexCon Piston Decision .......... 47 FlexCon’s Insourcing/Outsourcing of Pistons ......................... 47 The Piston Insourcing/Outsourcing Decision .......................... 50 Insourcing Costs .................................................... 52 Direct Materials .................................................. 52 Direct Work Cell Labor ............................................ 53 Indirect Work Cell Labor .......................................... 53 Factory Overhead and Administrative Costs ......................... 53 Preventive Maintenance Costs ...................................... 54 Machine Repair Costs .............................................. 54 Ordering Costs .................................................... 54 Semi-finished Raw Material Inventory Carrying Costs ............... 54 Inbound Transportation ............................................ 55 Consumable Tooling Costs .......................................... 55 Depreciation ...................................................... 55 Finished Piston Carrying Costs .................................... 55 Opportunity Costs ................................................. 55 Outsourcing Costs ................................................... 55 Unit Price ........................................................ 56 Safety Stock Requirements ......................................... 56 Administrative Support Costs ...................................... 56 Ordering Costs .................................................... 56 Quality-Related Costs ............................................. 57 Inventory Carrying Charges ........................................ 57 Transportation Charges ............................................ 57 Tooling Charges ................................................... 59 Supplier Capacity ................................................. 59 ASSIGNMENT ........................................................ 60

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 6: Insourcing/Outsourcing: The FlexCon Piston Decision

CASE 6 INSOURCING/OUTSOURCING: THE FLEXCON PISTON DECISION This case addresses many issues that affect insourcing/outsourcing decisions. A complex and important topic facing businesses today is whether to produce a component, assembly, or service internally (insourcing) or purchase that same component, assembly, or service from an external supplier (outsourcing).

Because of the important relationship between insourcing/outsourcing and competitiveness, organizations must consider many variables when considering an insourcing/outsourcing decision. This may include a detailed examination of a firm’s competency and costs, along with quality, delivery, technology, responsiveness, and continuous improvement requirements. Because of the critical nature of many insourcing/outsourcing decisions, cross-functional teams often assume responsibility for managing the decision-making process. A single functional group usually does not have the data, insight, or knowledge required to make effective strategic insourcing/outsourcing decisions.

FLEXCON’S INSOURCING/OUTSOURCING OF PISTONS FlexCon, a $3 billion maker of small industrial engines, is undergoing a major internal review to decide where the company should focus its product development efforts and strategic investment. Executive management is arguing that too much capacity and talent are being committed to producing simple, commodity-type items that provide small differentiation within the marketplace. FlexCon concluded that in its attempts to preserve jobs, it has insourced parts that are easy to manufacture, while outsourcing those that are complex or challenging.

Producing commodity-like components with mature technologies is adding little to what FlexCon’s customers consider important. The company has become increasingly dependent on suppliers for critical components and subassemblies that make a major difference in the performance and cost of finished products.

Part of FlexCon’s effort at redefining itself involves creating an understanding of insourcing/outsourcing among managers and employees.

The company has sponsored workshops and presentations to convey executive management’s vision and goals, including educating those who are directly involved in making detailed insourcing/outsourcing recommendations.

One presentation given by an expert in strategic sourcing focused on the changes in the marketplace that are encouraging outsourcing. The expert noted six key trends and changes that influence insourcing/outsourcing decisions:

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1. The pressure for cost reduction is severe and will continue to increase. Cost reduction pressures are forcing organizations to use their production resources more efficiently. A 2024 Hackett Group Study found that enterprise cost reduction was one of the top three strategic priorities, along with supply continuity and combating inflationary price increases. As a result, executive management will increasingly rely on insourcing/outsourcing decisions to manage costs.

2. Firms continue to become more specialized in product and process technology. Increased specialization implies focused investment in a process or technology, which contributes to greater cost differentials between firms.

3. Firms will increasingly focus on what they excel at while outsourcing areas of non-expertise. Some organizations are formally defining their core competencies to help guide the insourcing/outsourcing effort. This affects decisions concerning what businesses the firm should focus on.

4. The need for responsiveness in the marketplace is increasingly affecting insourcing/outsourcing decisions. For example, shorter cycle times encourage greater outsourcing with less vertical integration. The time to develop a production capability or capacity may exceed the window available to enter a new market.

5. Wall Street recognizes and rewards firms with higher ROI/ROA. Because insourcing usually requires an assumption of fixed assets (and increased human capital), financial pressures are causing managers to closely examine sourcing decisions. Avoidance of fixed costs and assets is motivating many firms to rely on supplier assets.

6. AI and improved forecasting via real-time data capture and simulation software enable firms to perform insourcing/outsourcing comparisons with greater precision. These tools allow the user to perform sensitivity analysis (what-if analysis) that permits comparison of different sourcing possibilities.

One topic that interested FlexCon managers was a discussion of how core competencies relate to outsourcing decisions. FlexCon management commonly accepted that a core competency was something the company ―was good at.‖ However, this view was not correct. A core competency refers to skills, processes, or resources that distinguish a company, are hard to duplicate, and make that firm unique compared to other firms. Core competencies begin to define a firm’s long-run, strategic ability to build a dominant set of technologies or skills that enable it to adapt quickly to changing market opportunities. The presenter argued that three key points relate to the idea of core competence and its relationship to insourcing/outsourcing decisions. A firm should do the following:

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1. Concentrate internally on those components, assemblies, systems, or services that are critical to the finished product and where the firm possesses a distinctive (i.e., unique) advantage valued by the customer.

2. Consider outsourcing components, assemblies, systems, or services when suppliers have an advantage. Supplier advantages may occur because of economies of scale, process-specific investment, higher quality, familiarity with a technology, or a favorable cost structure.

3. Recognize that once a firm outsources an item or service, it usually loses the ability to bring that production capability or technology in-house without committing a significant investment.

The manager or team responsible for making an insourcing/outsourcing decision must develop a true sense of what the core competency of the organization is and whether the product or service under consideration is an integral part of that core competency.

The workshops and presentations have given most participants a greater appreciation of the need to consider factors besides cost when assessing insourcing/outsourcing opportunities. One breakout work session focused exclusively on developing a list of the key factors that may affect the insourcing/outsourcing analysis at FlexCon, which appears in Exhibit 1.

Exhibit 1 Key Factors Supporting Insourcing/Outsourcing Decisions FACTORS SUPPORTING INSOURCING 1. Cost considerations favor the buyer.

2. A need or desire exists 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. Product design secrecy is an important issue.

6. The supply market is characterized by a lack of reliable suppliers.

7. Firm desires to maintain a stable workforce in a declining market.

8. Item or service is directly part of the firm’s core

FACTORS SUPPORTING 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. Buying firm does not want to add fixed assets and or fulltime employees.

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

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competency or links 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.

sources.

9. Short cycle time requirements discourage new investment by the buyer—versus using existing supplier assets.

10. Buyer firm capacity additions require high capital costs.

11. Process technology is mature with minimal likelihood of providing a future competitive advantage to the purchaser’s firm.

THE PISTON INSOURCING/OUTSOURCING DECISION FlexCon is considering outsourcing production of all pistons that are part of the company’s ―R‖ series of engines. FlexCon has machined various versions of these pistons for as long as anyone at the company can remember. In fact, the company started 50 years ago as a producer of high-quality pistons. The company grew as customers requested that FlexCon produce a broader line of products. This outsourcing analysis has generated a great deal of interest and emotion among FlexCon engineers, managers, and employees.

FlexCon produces pistons in three separate work cells, which differ according to the type of piston produced. Each cell has six numerically controlled machines in a U-shape layout, with a supervisor, a process engineer, a material handler, and 12 employees assigned across the three cells. Employees, who are cross-trained to perform each job within their cell, work in teams of four. FlexCon experienced a 30 percent gain in quality and a 20 percent gain in productivity after shifting from a process layout. Previously equipment was grouped by similar capabilities, it is now arranged in work cells, where equipment was grouped to support a specific family of products. If FlexCon decides to outsource the pistons, the company will likely dedicate the floor space currently occupied by the work cells to a new product or expansion of an existing product. FlexCon will apply the work cell equipment for other applications, so the outsourcing analysis will not consider equipment write-offs beyond normal depreciation.

Although there are different opinions regarding outsourcing the pistons, FlexCon engineers agreed that the process technology used to produce this family of components is mature. Gaining future

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 6: Insourcing/Outsourcing: The FlexCon Piston Decision

competitive advantages from new technology was probably not as great as other process applications within FlexCon’s production process.

This did not mean, however, that FlexCon could avoid making new investments in process technology if the pistons remained in-house or that some level of process innovation is not possible.

Differences over outsourcing a component that is critical to the performance of Flex-Con’s final product threatens to affect the insourcing/outsourcing decision. One engineer threatened to quit if FlexCon outsourced a component that could ―bring down‖ the entire engine in case of quality failure. He also maintained, ―Our pistons are known in the industry as first-rate.‖ Another engineer suggested that FlexCon’s supply management group, if given support from the engineers, could adequately manage any risk of poor supplier quality.

However, a third engineer noted, ―Opportunistic suppliers will exploit FlexCon if given the chance—we’ve seen it before!‖ This engineer warned the group about suppliers ―buying in‖ to the piston business only to coercively raise prices. Several experienced engineers voiced the opinion that they could not imagine FlexCon outsourcing a component that was responsible for making FlexCon the company it is today. Several newer members of the engineering group suggested they should wait until the outsourcing cost analysis was complete before rendering final judgment.

Management has created a cross-functional team composed of a process engineer, a cost analyst, a quality engineer, a procurement specialist, a supervisor, and a machine cell employee to conduct the outsourcing analysis. A major issue confronting this team involves determining which internal costs to apply to the analysis. Including total variable costs is straightforward because these costs are readily identifiable and vary directly with production levels.

Examples of variable costs include materials, direct labor, and transportation.

The team is struggling with whether (or at what level) to include total factory and administrative costs (i.e., fixed costs and the fixed portion of semi variable costs). Factory and administrative costs include utilities, indirect labor, process engineering support, depreciation, corporate office administration, maintenance, and product design charges. Proper allocation of overhead is a difficult, and sometimes, subjective task. The assumptions the team makes about how to allocate total factory, and operating costs can dramatically alter the results of the analysis.

The aggregated volume for pistons over the next several years is critical to this analysis. Exhibit 2 provides a monthly forecast of expected piston volumes over the next two years. Total forecasted volume is 300,000 units in Year 1 and 345,000 units in Year 2. The team arrived at the forecast by determining the forecast for FlexCon

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 6: Insourcing/Outsourcing: The FlexCon Piston Decision

―R‖ series engines, which is an independent demand item. Pistons are a dependent demand item (i.e., dependent on the demand for the final product).

Exhibit 2 Aggregated Two-Year Piston Demand January February March April May June July August September October November December Total

YEAR 1 EXPECTED DEMAND 30,000 30,000 30,000 27,000 25,000 25,000 23,000 21,000 22,000 23,000 23,000 21,000 300,000

YEAR 2 EXPECTED DEMAND 34,000 34,000 34,000 31,000 28,000 28,000 27,000 25,000 25,000 27,000 27,000 25,000 345,000

Although this is a long-term decision likely to extend beyond 10 years, the team has confidence in its projections (including supplier pricing) only through 2 years. Although maintaining piston production internally would require some level of process investment in Years 3 through 10, the team believes any projections past Year 2 contain too much uncertainty. (Conducting a net present value for expected savings from outsourcing, if they exist, is beyond the scope of this assignment.)

INSOURCING COSTS The team has decided that a comprehensive total cost analysis should include all direct and indirect costs incurred to support piston production. FlexCon tracks its materials and labor by completing production worksheets for each job. The team collected data for the previous year, which revealed that the three work cells produced 288,369 pistons.

DIRECT MATERIALS FlexCon machines the pistons from a semifinished steel alloy purchased directly from a steel foundry. The foundry ships the alloy to FlexCon in 50 lb. blocks, which cost $195 per block. Each piston requires, on average, 1.1 lb. of semifinished raw material for each finished piston. This figure includes scrap and waste.

The team expects the semifinished raw material price to remain constant over the next two years. Although FlexCon expects greater

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piston volumes in Years 1 and 2 compared with current demand, the team does not believe additional material economies are available.

FlexCon spent $225,000 last year on other miscellaneous direct materials required to produce the pistons. The team expects to use this figure as a basis for calculating expected Year 1 and 2 costs for miscellaneous direct material requirements.

DIRECT WORK CELL LABOR The direct labor in the three work cells worked a total of 27,000 hours last year. Total payroll for direct labor was $472,500, which includes overtime pay. The average direct labor rate is $17.50 per hour ($472,500/27,000 total hours = $17.50 per hour). As a rule of thumb, the team expects to add 40 percent to direct labor costs to account for benefits (health, dental, pension, etc.). The team also expects direct labor rates to increase 3 percent a year for the next two years. The team does not expect per-hour production rates to change significantly. The process is well established, and FlexCon has already captured any learning curve benefits.

Work cell employees are responsible for machine setup, so the team decided not to include machine setup as a separate cost category.

INDIRECT WORK CELL LABOR FlexCon assigns a full-time supervisor, material handler, and engineer to the three work cells. Last year, the supervisor earned $52,000, the material handler earned $37,000, and the engineer earned $63,000 in salary. Again, the team expects to apply an additional 40 percent to these figures to reflect fringe benefits. The team expects these salaries to increase 3 percent each year.

FACTORY OVERHEAD AND ADMINISTRATIVE COSTS This category of costs is, without doubt, the most difficult category of cost to allocate. For example, should the team prorate part of the plant manager’s salary to the piston work cells? One team member argued that these costs are present with or without piston production and, therefore, should not be part of the insourcing calculation.

Another member maintained that factory overhead supports the factory, and the three work cells are a major part of the factory. Not including these costs would distort the insourcing calculation. She noted that the supplier is most assuredly considering these costs when quoting the piston contract. Another member suggested performing two analyses of insourcing costs. One would include factory overhead and administrative costs, and the other would exclude these costs.

The team divided the factory into six ―zones‖ based on the functions performed throughout the plant. The piston work cells account for 25

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percent of the factory’s floor space, 28 percent of total direct labor hours, and 23 percent of plant volume. From this analysis, the team has decided to allocate 25 percent of the factory’s overhead and administrative costs to the piston work cells for the analysis that includes these costs. Exhibit 3 presents relevant cost data for the previous year. The team expects these costs to increase 3 percent each year.

PREVENTIVE MAINTENANCE COSTS FlexCon spent $40,250 on preventive maintenance activities on the 18 machines in the three cells last year and expects this to increase by 10 percent in each of the next two years (due to the increasing age of the equipment).

MACHINE REPAIR COSTS An examination of maintenance work orders reveals that the 18 work cell machines, which are each five to seven years old, required total unplanned repair expenses of $37,000 last year. The maintenance supervisor expects this figure to increase by 8 percent in Year 1 and 12 percent in Year 2 of the analysis due to increasing age and volumes.

ORDERING COSTS Although FlexCon produces pistons in-house, the company still incurs ordering costs for direct materials. The team estimates that each monthly order to the foundry and other suppliers costs FlexCon $1,500 in direct and transaction-related costs.

Exhibit 3 Total Factory Overhead and Administrative Costs COST CATEGORY

PREVIOUS YEAR EXPENSE/COST

Administrative staff

$ 1,200,000

Staff engineering

$

900,000

Taxes

$

120,000

Utilities

$ 1,500,000

Insurance

$

Plant maintenance Total

$ 800,000 $5,020,000

500,000

SEMI-FINISHED RAW MATERIAL INVENTORY CARRYING COSTS FlexCon typically maintains one month of semifinished raw material inventory as safety and buffer stock. The carrying charge assigned to this inventory is 18 percent annually.

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INBOUND TRANSPORTATION FlexCon receives a monthly shipment of semifinished alloy that the work cells use to machine the pistons. Total transportation costs for the previous year amounted to $31,500 (which resulted in 288,369 pistons produced).

The team expects transportation charges for other direct materials used in production to be $0.01 per unit in Years 1 and 2 of the analysis.

CONSUMABLE TOOLING COSTS The machines in the work cell are notorious for ―going through tooling.‖ Given the consumable tooling costs realized during the previous year, the team estimates additional tooling expenses of $56,000 in Year 1 and $65,000 in Year 2.

DEPRECIATION The team has decided to include in its cost calculation normal depreciation expenses for the 18 work cell machines. The depreciation expense for the equipment is $150,000 per year.

FINISHED PISTON CARRYING COSTS Because FlexCon coordinates the production of pistons with the production of ―R‖-series engines, any inventory carrying charges for finished pistons are part of the cost of the finished engine and are not considered relevant to this calculation.

OPPORTUNITY COSTS The team recognizes that opportunities may exist for achieving a better return on the space and equipment committed to piston production. Unfortunately, the team does not know with any certainty what management’s plans may be for the floor space or equipment if FlexCon outsources piston production. The team is confident, however, that management will find a use for the space. If the facility no longer engages in piston production, then FlexCon must allocate fixed factory and overhead costs across a lower base of production. This will increase the average costs of the remaining items produced in the plant, possibly making them uncompetitive compared with external suppliers.

OUTSOURCING COSTS The following provides relevant information collected by the team as it relates to outsourcing the family of pistons to an external supplier. Although it is beyond the scope of this case, the team has

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already performed a rigorous assessment of the supply market and has reached consensus on the external supplier in the event the team recommends outsourcing. This was necessary to obtain reliable outsourcing cost data.

UNIT PRICE The most obvious cost in an outsourcing analysis is the unit price quoted by the supplier. In many respects, outsourcing is an exercise in supplier evaluation and selection. Insourcing/outsourcing requires the evaluation of several suppliers in depth-the internal supplier (FlexCon) and external suppliers (in the marketplace). The supplier that the team favors if FlexCon outsources the pistons quoted an average unit price of $12.20 per piston (recall that this outsourcing decision involves different piston part numbers). The team believes that negotiation will occur if FlexCon elects to outsource, perhaps resulting in a lower quoted price. Because the team does not yet know the final negotiated price, some members argued that several outsourcing analyses are required to reflect different possible unit prices. Quoted terms are 2/10, net 30. The supplier says it will maintain the negotiated price over the next two years.

SAFETY STOCK REQUIREMENTS If the team decides to outsource, FlexCon will hold physical stock from the supplier equivalent to one month’s average demand. This results in an inventory carrying charge, which the team must calculate and include in the total cost analysis. Although FlexCon likely will rely on or draw down safety stock levels during the next two years, for purposes of costing the inventory, the team has decided not to estimate when this might occur. Inventory carrying charges include working capital committed to financing the inventory, plus charges for material handling, warehousing, insurance and taxes, and risk of obsolescence and damage. FlexCon’s inventory carrying charge is 18 percent annually.

ADMINISTRATIVE SUPPORT COSTS FlexCon expects to commit the equivalent of one-third of a buyer’s total time to supporting the commercial issues related to the outsourced family of pistons. The team estimates the buyer’s salary at $54,000, with 40 percent for fringe benefits. The team expects the buyer’s compensation to increase by 3 percent each year.

ORDERING COSTS The team expects that FlexCon will order monthly, or 12 material releases a year. Unfortunately, suppliers in this industry have not been responsive to shipping on a just-in-time basis or using

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electronic data interchange. Although FlexCon would like to pursue a JIT purchasing model, the team feels that assuming lower volume shipments on a frequently scheduled basis is not appropriate. The company expects the supplier to deliver one month of inventory at the beginning of each month. The team estimates the cost to release and receive an order to be $1,500 per order.

QUALITY-RELATED COSTS The team has decided to include quality-related costs in its outsourcing calculations. During the investigation of the supplier, a team member collected data on the process that would likely produce FlexCon’s pistons. The team estimates that the supplier’s defect level, based on process measurement data, will be 1,500 parts per million. FlexCon’s quality assurance department estimates that each supplier defect will cost the company an average of $250 in nonconformance costs.

INVENTORY CARRYING CHARGES FlexCon must assume inventory carrying charges for pistons received at the start of each month and then consumed at a steady rate during the month. For purposes of calculating inventory carrying costs for finished pistons provided by the supplier, the team expects to use the average inventory method. The formula for determining the average number of units in inventory each month is the following: [(Beginning Inventory at the Start of Each Month + Ending Inventory at the End of Each Month)/2] × Carrying Cost Per Month For calculation purposes, the team assumes that ending inventory each month is zero units (excluding safety stock, which requires a separate calculation). The team expects production to use all the pistons received at the beginning of each month. The carrying charge applied to inventory on an annual basis is 14 percent of the unit value of the inventory. Appendices 1 and 2 on pages 854 and 855 will help in the calculation of monthly carrying charges associated with holding supplier-provided piston inventory.

TRANSPORTATION CHARGES Although it is FlexCon’s policy to have suppliers ship goods FOB shipping point, the company does not accept title or ownership of goods until receipt at the buyer’s dock. However, the company assumes all transportation-related charges. The team estimates that transportation charges for pistons will average $2,100 per truckload, with 14 truckloads expected in Year 1 and 16 truckloads expected in Year 2. The outsourcing supplier is in the United States, which means the team does not have to consider additional costs related to international purchasing.

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Appendix 1 Year 1 Inventory Carrying Charges Outsourcing Option

January February March April May June July August September October November December

BEGINNING INVENTORY

ENDING INVENTORY

30,000 30,000 30,000 27,000 25,000 25,000 23,000 21,000 22,000 23,000 23,000 21,000

0 0 0 0 0 0 0 0 0 0 0 0

AVERAGE INVENTORY

INVENTORY CARRYING COSTS $ $ $ $ $ $ $ $ $ $ $ $

Total Inventory Carrying Costs Appendix 2 Year 2 Inventory Carrying Charges Outsourcing Option

January February March April May June July August September October November December

BEGINNING INVENTORY

ENDING INVENTORY

34,000 34,000 34,000 31,000 28,000 28,000 27,000 25,000 25,000 27,000 27,000 25,000

0 0 0 0 0 0 0 0 0 0 0 0

AVERAGE INVENTORY

INVENTORY CARRYING COSTS

$ $ $ $ $ $ $ $ $ $ $ $ Total Inventory Carrying Costs

Appendix 3 Insourcing/Outsourcing Cost Factors Worksheet INSOURCING COSTS PER UNIT

YEAR 1 Direct materials

OUTSOURCING COSTS PER UNIT

YEAR 2

YEAR 1

YEAR 2

Purchase costs

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Semifinished Other Direct Labor Indirect Labor Factory Overhead and administrative Preventative maintenance Machine repair Ordering Depreciation Inventory Carrying Inbound transportation Consumable tooling Other costs Total insourcing cost per unit

Transportation New Tooling Administrative Support Inventory carrying Safety stock Quality-related costs Ordering Other Costs Total Outsourcing costs per unit Total savings (1) Less: Taxes on savings (40%) Net outsourcing savings

Total Savings = (Total Insourcing Costs − Total Outsourcing Costs) × (Total Volume) Note that the total savings could be negative if the analysis shows that outsourcing costs are greater than insourcing costs.

TOOLING CHARGES The supplier said that new tooling charges to satisfy FlexCon’s production requirements would be $300,000. The team has decided to depreciate tooling charges over two years or $150,000 per year.

SUPPLIER CAPACITY The team has concluded that the supplier has available capacity to satisfy FlexCon’s total piston requirements.

Appendix 3 provides a worksheet to help in the insourcing/outsourcing cost analysis.

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 7: Golden Elephant Risk Assessment

ASSIGNMENT 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 FlexCon should do with its family of pistons? Support your arguments with evidence gathered during your analysis.

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

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

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?

5. Discuss the major issues associated with an insourcing/outsourcing analysis and decision. . [return to top]

Instructor Manual Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 7: Golden Elephant Risk Assessment

TABLE OF CONTENTS Case 7: Golden Elephant Risk Assessment ............................. 62 SOLUTION ............................................................ 62 Creating a Supplier Risk Matrix ..................................... 62 HANDOUT ............................................................. 69 Creating a Supplier Risk Matrix ..................................... 76 Creating a Supplier Risk Matrix with Multiple Suppliers ............. 77 SLIDE 31 – Factors that Can Reduce Supply Chain Risk and Reduce the Impact of Disruptions ............................................... 78 Strategically Positioned Excess Resources ......................... 79 Supply Chain Planning and Collaboration ........................... 79 Disruption Discovery Visibility Systems ........................... 79

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Supply Chain Redesign ............................................. 79

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CASE 7: GOLDEN ELEPHANT RISK ASSESSMENT In the lecture, you should go through and have students identify all of the elements of supplier risk. You should also identify methods of identifying the revenue impact. Based on this information, provide students with the following hand-out, and ask them to read through the case, and be ready to discuss. Have them identify the sources of risk, and then ask them to evaluate each risk using the handout. Use the following Handout and give to students. You can also send it as an email exercise.

SOLUTION Based on this assessment, it is fair to say the following: The following risks are present with this supplier:         

This is a sole source of a major component for a new product line Quality control and defect rates of this supplier are not validated Supply of steel is at risk.

Technical engineering talent is at risk.

The ability to ramp up and meet capacity requirements is uncertain Inbound transportation to port of departure is uncertain Potential labor problems are possible Fuel costs and transoceanic shipping rates are likely to increase Supplier is inexperienced in export shipping documentation and regulatory procedures.

One possible set of evaluations is shown below. These evaluations might reflect a ―typical‖ set of scores associated with this scenario.

There are clearly a number of significant risks associated in working with this supplier.

CREATING A SUPPLIER RISK MATRIX Next, we combine these assessments to develop a Risk Probability Score as an input into a Supplier Risk Matrix. The logic used to do so is shown below.

1. Combine all of the scores by sector.

2. Divide each score by 5, and convert to a percentage. This is a baseline probability that the supplier will experience a major disruption during the next year.

3. Take an average to derive the final risk probability score.

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4. Plot the risk score against the revenue impact factor.

To illustrate, we use the evaluation of the Golden Elephant Castings company here: Other solutions are possible, but these are representative of the types of risks for this supplier. It is worth discussing the risks in reviewing the case with students.

GOLDEN ELEPHANT CASTINGS COMPANY ABOVE AVERAGE Supplier Relationship

1

How much business do you give this supplier, and what percentage is your company of their total annual revenue?

How profitable are you vis-à-vis their other customers?

BELOW AVERAGE

AVERAGE 2

3

4

5

2

1

How much business does the supplier believe you will grow with them in the next five years?

2

How cooperative and trustworthy are you as a customer based on your history with this supplier?

4

How much data do you share with this supplier on forecasts, business requirements, etc.?

1

Average Score

2

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ABOVE AVERAGE Information Sharing

1

AVERAGE BELOW AVERAGE 2

3

How much information is shared by the supplier on changes in product costs, including the supplier's labor and/or material cost inputs?

3

How much information is shared by the buyer on material planning, production schedule, and inventory status?

3

How often is information on the supplier's supply base shared with the customer?

5

4

How often is regularly required administrative information on EPA violations, proof of insurance, financial ratios, etc. shared with the customer by the supplier?

3

How much information on upcoming order fulfillment requirements, order changes, expedited requirements, forecasts, etc. is shared with the supplier by the buyer?

Average Score

4

4

3.4

Once every 3 years

Once every other year

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Once a year

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ABOVE AVERAGE Performance

1

BELOW AVERAGE

AVERAGE 2

The supplier has had a serious quality problem.

2

The supplier has had a serious delivery problem.

2

The supplier's tier 2 supplier has stopped production.

3

4

3

The supplier has had a serious service or engineering support problem.

4

The supplier has been shut down by the EPA, FDA, OCEA, or other regulatory agency.

2

The supplier has expanded too quickly and does not have capacity for production.

Average Score

5

3 ABOVE AVERAGE

Human Resource Risks

1

BELOW AVERAGE

AVERAGE 2

3

The supplier has a high level of turnover among its employees.

4

5

4

The supplier has had a recent turnover of its major leadership team and is under new management.

5

Pay rates for employees at this supplier are below the average wage rates.

There are serious grievances that have been filed by employee

5

4

3

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representatives against the management team.

The supplier has a strong and active union.

Average Score

4

4

ABOVE AVERAGE Supply Disruption Risks

1

BELOW AVERAGE

AVERAGE 2

3

4

The supplier is subject to major changes in the cost of their raw materials in the market.

4

There is a high probability that this supplier may have a raw material shortage, resulting in a supply disruption.

4

This supplier has a single source and is entirely dependent on this source for a major raw material or service.

5

2

There is a high probability that this supplier may experience a quality problem resulting in a supply disruption.

5

There is a high probability that this supplier may experience a capacity problem, resulting in a supply disruption.

5

There is a high probability that this supplier may experience a disaster-related or other

5

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force majeure disruption.

There is a high probability that this supplier may experience a shut-down due to a government agency regulation.

2

This supplier is in a geographic region that is highly unstable and may result in a supply disruption.

3

This supplier does NOT have a good Risk Reduction and Business Continuity Plan.

Average Score

4

3.77777778 ABOVE AVERAGE

Financial Risk

1

BELOW AVERAGE

AVERAGE 2

3

The supplier's business rate of growth is sustainable (not growing too fast, nor shrinking too quickly).

4

4

The supplier's overall financial performance and risk compared to competitors.

5

The supplier's overall level of customer satisfaction in the industry.

3

The supplier's level of profitability compared to the industry.

The supplier's accounts receivable are at a reasonable level compared

5

4

2

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to the industry (e.g. less than 60 days).

The supplier's account payables are at a reasonable level compared to the industry (e.g. less than 60 days).

2

The supplier's level of debt is at a level that is considered reasonable in the industry.

2

Average Score

4

5

3.44444444

Combining all of these factors, this supplier is likely to result in a severe supplier disruption of some form. That is, the likelihood that one of these factors will result in an unexpected quality problem, shipment delay, or cost overrun is high (probably on the order of almost 68%). This will occur at a major bottleneck in the supply chain, with no alternative suppliers identified, which has the potential to bring this organization’s entire new product line rollout to a screeching halt, and could result in up to $50M in lost revenue for the new C-series product line.

Supplier Relationship Risk Score

2.00

Information Sharing Risk Score

3.40

Performance Risk Score

3.00

Human Resource Risk Score

4.00

Supply Chain Disruptions Risk Score

3.78

Financial Risk Score

3.44

Probability Supplier Relationship Risk Score

40%

Information Sharing Risk Score

68%

Performance Risk Score

60%

Human Resource Risk Score

80%

Supply Chain Disruptions Risk Score

76%

Financial Risk Score

69%

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 7: Golden Elephant Risk Assessment

HANDOUT You have been assigned to a thorough evaluation on all forms of supply risk for a particular supplier (Golden Elephant), and mapping that risk relative to the financial impact associated with that risk.

Consider the following email that was sent to you by a Global Procurement Office representative from you satellite office located in New Delhi, who is passing on information he has received on shipping conditions in a major shipping channel. Based on the facts provided by this individual, complete a supply risk evaluation, and estimate the dollar impact associated with this supplier. If there is no information available for a particular variable in the model, enter a ―1‖, meaning that it does not pose a significant risk.

To:

Victor Kliossis

From:

Anil Patel

Victor, I was following up on your request to explore sourcing from a castings supplier located in India. I have identified a suitable candidate, the Golden Elephant castings company. As you stated, this is an important decision, as this supplier will be a single source providing castings for your entire new line of product in the C-series. As you know, the C-series forecast is $50M in revenue during the first year, and growing to $75 M in the second year. Based on your process specifications, this is the only available castings supplier in our supply base with the required heat treat ovens capable of meeting your specifications as well as the cost and price targets you specified.

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Essentially, this supplier has the lock on this business for the Cseries. He seems to know this.

We visited the supplier’s location, and were greeted by the company’s owner. He was very pleased with the results that our negotiating team came to terms with, and afterwards gloated with some pleasure that this was going to be a very profitable business deal for Golden Elephant. He noted that the firm was under new management as of six months ago, and that he was taking over management of the factory from the previous owner, who had sold out and gone into retirement. Upon taking a tour of the facility, we found it was well-lit, and workers seemed to know what they were doing. In private, the owner told us that he felt these workers were overpaid, but that he was trying to keep labor costs below the average for New Delhi, and tried to keep his workers in the dark. We did not see evidence of any statistical quality control charts but the owner assured us that workers were well-trained in these methods. The owner also noted that they are anxious for this business, as this will represent an order that will double their current business volume. We met with some of their technical engineers, and they seemed very young. In fact, one of them shared with us that he had just started the day before, and was replacing someone who had lasted only two months in that role.

We met with their purchasing group. Their offices was full of paper piled up high to the ceiling, and they emphasized how busy they were processing PO’s with their vendors. When we asked who their primary steel supplier were, we were told that they liked to shop around for the cheapest price, and rarely bought any steel except at spot prices through intensive negotiations. They also noted that there had been some problems in getting steel in some cases, due to the recent shortages being driven by the high demand for steel.

We then identified how shipments would get to your factory location in Omaha, NE. Golden Elephant will arrange for in-land transportation, as the owner’s brother-in-law has a trucking company. The shipment would then go through the Indian port. There have been some rumors of union problems with the dockworkers at this location, but our sources believe that this is only a rumor. Once the shipment arrives in the port of Los Angeles, it will be unloaded, put onto a trailer, and driven the Omaha location. We are still waiting on quotes for shipment times, as the recent hike in fuel prices means the shipping companies will not commit to a firm trans-oceanic shipping cost. This is the first time this supplier has exported product to the United States, but the owner has assured me that his administrative assistant has worked on shipping documentation in her former job, so this shouldn’t be a problem.

Let me know what your decision is on whether to proceed.

Anil

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One possible set of evaluations is shown below. These evaluations might reflect a ―typical‖ set of scores associated with this scenario.

There are clearly a number of significant risks associated in working with this supplier.

GOLDEN ELEPHANT CASTINGS COMPANY ABOVE AVERAGE Supplier Relationship

1

BELOW AVERAGE

AVERAGE 2

3

4

5

How much business do you give this supplier, and what percentage is your company of their total annual revenue?

How profitable are you vis-à-vis their other customers?

How much business does the supplier believe you will grow with them in the next five years?

How cooperative and trustworthy are you as a customer based on your history with this supplier?

How much data do you share with this supplier on forecasts, business requirements, etc.?

Average Score

ABOVE AVERAGE Information Sharing

1

BELOW AVERAGE

AVERAGE 2

3

4

5

How much information is shared by the supplier on changes in product costs, including the supplier's

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labor and/or material cost inputs?

How much information is shared by the buyer on material planning, production schedule, and inventory status?

How often is information on the supplier's supply base shared with the customer?

How often is regularly required administrative information on EPA violations, proof of insurance, financial ratios, etc. shared with the customer by the supplier?

How much information on upcoming order fulfillment requirements, order changes, expedited requirements, forecasts, etc. is shared with the supplier by the buyer?

Average Score

Once every 3 years ABOVE AVERAGE Performance

1

2

Once every other year

Once a year

AVERAGE

BELOW AVERAGE

3

4

5

The supplier has had a serious quality problem.

The supplier has had a serious delivery problem.

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The supplier's tier 2 supplier has stopped production.

The supplier has had a serious service or engineering support problem.

The supplier has been shut down by the EPA, FDA, OCEA, or other regulatory agency.

The supplier has expanded too quickly and does not have capacity for production.

Average Score

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ABOVE AVERAGE Human Resource Risks

1

BELOW AVERAGE

AVERAGE 2

3

4

5

The supplier has a high level of turnover among its employees.

The supplier has had a recent turnover of its major leadership team and is under new management.

Pay rates for employees at this supplier are below the average wage rates.

There are serious grievances that have been filed by employee representatives against the management team.

The supplier has a strong and active union.

Average Score

ABOVE AVERAGE Supply Disruption Risks

1

BELOW AVERAGE

AVERAGE 2

3

4

5

The supplier is subject to major changes in the cost of their raw materials in the market.

There is a high probability this supplier may have a raw material shortage resulting in a supply disruption.

This supplier has a single source and is entirely dependent on this source for a major raw material or

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service.

There is a high probability this supplier may experience a quality problem resulting in a supply disruption.

There is a high probability this supplier may experience a capacity problem resulting in a supply disruption.

There is a high probability that this supplier may experience a disasterrelated or other force majeure disruption.

There is a high probability this supplier may experience a shut-down due to a government agency regulation.

This supplier is in a geographic region that is highly unstable and may result in a supply disruption.

This supplier does NOT have a good Risk Reduction and Business Continuity Plan.

Average Score ABOVE AVERAGE Financial Risk

1

BELOW AVERAGE

AVERAGE 2

3

4

5

The supplier's business rate of growth is sustainable (not growing too fast, nor shrinking too quickly).

The supplier's overall financial performance and risk compared to competitors.

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The supplier's overall level of customer satisfaction in the industry.

The supplier's level of profitability compared to the industry.

The supplier's accounts receivable are at a reasonable level compared to the industry (e.g. less than 60 days).

The supplier's account payables are at a reasonable level compared to the industry (e.g. less than 60 days).

The supplier's level of debt is at a level that is considered reasonable in the industry.

Average Score

CREATING A SUPPLIER RISK MATRIX After assigning scores to these risks combine these assessments to develop a Risk Probability Score, as an input into a Supplier Risk Matrix. The logic used to do so is shown below.

1. Combine all of the scores by sector.

2. Divide each score by 5, and convert to a percentage. This is a baseline probability that the supplier will experience a major disruption during the next year.

3. Take an average, to derive the final risk probability score.

4. Plot the risk score against the revenue impact factor in an Excel spreadsheet.

What does this risk mapping suggest to you is are the relative risks of working with this supplier?

How would you mitigate these risks?

Should you find another supplier?

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CREATING A SUPPLIER RISK MATRIX WITH MULTIPLE SUPPLIERS The matrix shown is not all that meaningful however. Moreover, we applied a set of baseline assumptions and estimates to derive a risk probability of 68%, which is probably not very precise.

However, as we noted earlier, the meaning of this score becomes much more apparent when it is compared to other suppliers who are also part of a general category of products and services. In this example, let’s look at all of the suppliers of castings and finished steel components that are currently used by your organization. Then let’s assume that we have completed risk analyses on all of them, which would lead us to the following supplier risk map: Golden ElephantSumo

65% $50,000,000 $

Alchem Superior Minivan Locomotive Mynord Nexcor Ballinger Conchord 55% 25% 88% 78% 18% 84% 61% 42% 92% 40,000,000 $ 20,000,000 $ 10,000,000 $ 4,000,000 $ 99,982,004 $ 83,222,998 $ 26,000,000 $ 22,000,000 $ 93,548,996

As shown in this risk map, Golden Elephant now falls into the ―yellow category‖, in that they are clustered along with other suppliers who have a medium risk profile, but a sizable impact. Other suppliers such as Locomotive have a high potential impact, but a low risk score (23%), so are a safer bet. Others such as Superior and Minivan have a higher risk, but a lower impact. However, the highest potential for disruption in this case is likely to come from a handful of suppliers.

In this case, Conchord has a 92% probability of a disruption, and could impact close to $94M in revenue. Similarly, Mynord has an 84% risk probability with a $84M revenue impact.

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This type of analysis then leads to the next logical discussion: what can your organization do to mitigate or reduce risk?

SLIDE 31 – FACTORS THAT CAN REDUCE SUPPLY CHAIN RISK AND REDUCE THE IMPACT OF DISRUPTIONS Once a supply management organization have narrowed down their list of potential risk incident nodes to a manageable set, the next task is to prioritize actions to mitigate and manage these risks. The probability of disruptive events can be controlled for in some cases by remedies, but in other cases, when significant amplifiers are present, may not be possible. Therefore, executives must seek to reduce the impact through various approaches. This is shown in the second and third steps of our risk mitigation process below.

3a.

Excess Resources 3b. SC 2. Identify Risk

Collaboration &

Measure the Risk

Reduction

Planning

of Critical Nodes in

Mechanisms for

the Network

High-Risk

1. Map the Supply Chain &

Nodes GOAL: Resilient Supply Chain

3c. Invest in Visibility Systems 3d. Major

Supply Chain Redesign

With On-going Knowledge and Risk Mitigation

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STRATEGICALLY POSITIONED EXCESS RESOURCES  

Expediting Safety Stock

SUPPLY CHAIN PLANNING AND COLLABORATION                  

Supplier Qualification/Assessment tools C-TPAT and Other Customs Programs Risk Enumeration, Severity Analysis & Contingency Planning Relationship Management and Joint Planning Supply Chain Education and Risk Management Training Process Control (to facilitate management by exception) Cross-functional risk planning at partner locations Demand / supply forecast reviews across entire supply chain Weekly teleconferences / meetings on potential new risks Optimization of supply chain system Risk management command center Defined communication network protocols and mechanisms Daily status meetings Defined hierarchical meetings to share key performance indicators Defined contingency plan responsibilities with decision-making authority for critical events at all nodes Defined or self-executing contingency plans Post event analysis and lessons learned meetings Diversification planning to reduce constrained node options

DISRUPTION DISCOVERY VISIBILITY SYSTEMS      

Risk Monitoring Systems Inventory Visibility systems Event Management Systems (Managing by Exception) Deploy RFID at strategic nodes in supply chain Predictive analysis modeling tools – early awareness of impending disruptions Command group to analyze end-to-end supply chain operations

SUPPLY CHAIN REDESIGN  

Network redesign Product or process re-design

A variety of different risk reduction mechanisms are employed by companies, to reduce the risk probabilities of suppliers and supply chain nodes. A full list is shown in Table 3. These mechanisms can be

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classified into several categories. To first understand these categories, consider the impact of a disruption and the approach to deal with it is shown below.

Disruption Discovery and Recovery

Disruption Amplifiers (Globalization and Complexity)

Impact of Disruption ($, Customer Account, Market share)

Impact (B)

Disruption Discovery and Recovery time (B)

Disruption Discovery and Recovery time (A)

Excess Resources Impact(A)

Visibility Systems

Discovery(A)

Recovery (A)

Discovery(B)

Recovery (B)

28

Time

Figure 1: Disruption, Discovery, and Recovery Process Figure 1 illustrates the critical components to a risk planning strategy: (1) the ability to discover that a disruption has occurred; and (2) the ability to establish plans to effectively recover from the disruption. From the moment a major supply chain disruption occurs, the speed at which an organization recognizes and responds to the disruption effectively determines how well the problem is contained and the resulting cost to the organization. Once the disruption occurs, the first critical action is to recognize that it has occurred and deploy a mitigation effort. Although it may sound absurd, many companies fail to recognize that a disruption has even occurred! The difference between examples A and B in Figure 1 suggests that early recognition of a problem in the supply chain will allow the company to deploy a mitigation strategy more quickly. The second critical action is the effectiveness and speed of the mitigation strategy.

Organizations who have well-thought-out action plans know how to react and pre-establish resources to guard against the problem. The third component is the ability of an organization to create a more robust supply chain, through complexity reduction and process improvements.

Once they have identified ―high risk‖ nodes, executives have several risk reduction strategies they can use to eliminate the impact of disruptions on the end customer. The elements of risk reduction are as follows:

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1) Excess resources reduce the time between disruption discovery and recovery.

2) Supply Chain Planning and Collaboration ensures that the design of the supply chain is made more robust to reduce the probability of these events occurring again.

3) Improved information visibility reduces the time between the disruption and its discovery and reduces the impact of the disruption.

4) Supply Chain Redesign involves a significant investment in product or process redesign to reduce risk. [return to top]

Instructor Manual Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 8: Electric Motor Outsourcing Decision

TABLE OF CONTENTS Case 8 Electric Motor Outsourcing Decision .......................... 82 Assignment ........................................................ 83 Case 8 Instructor Notes ............................................. 83 Assignment: ....................................................... 84

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CASE 8 ELECTRIC MOTOR OUTSOURCING DECISION Joan Riley is the supply manager for Foxcroft Corporation is a division of a large U.S. industrial power equipment manufacturer located in northern Virginia. Joan is responsible for all Foxcroft purchases. Her largest dollar expenditures are for electrical components and other mechanical assemblies. Ms. Riley reports to Andrew Moore, the Division Manager at Foxcroft. Andrew has assigned Joan the responsibility of analyzing whether Foxcroft should outsource or internally manufacture a motor assembly. Recently, a Vietnamese supplier, who produces motors for several Fortune 500 companies, has submitted a very competitive quote. However, there has been a strong bias against outsourcing the motor within the company, particularly since there is a strong union presence in many of the facilities. This assembly controls a key function on a new line of power equipment. As an initial step, Joan’s team is responsible for gathering the required information to guide the firm’s decision process.

Foxcroft’s marketing group estimates that volumes for the motor assembly are: Year 1—1,500 units, Year 2—2,700 units, and Year 3—4,000 units. The Vietnamese supplier of electric motors has quoted a price of $150 per unit with a 10% price decrease per year for years 2 and 3.

Ms. Riley assumes these price decreases are due to productivity improvements from higher volumes, the positive effects of learning at the supplier, and greater operating efficiencies. Shipping terms (using Incoterms) are DPU Long Beach, CA. The supplier is not responsible for U.S. inland freight but has agreed to pay 50% of the tariff costs. Joan estimates her portion of the current tariffs, custom broker fees, and inland shipping will total $11.00 per unit for all years.

If the new line of industrial power equipment that these motors become part of is successful, it is estimated that the life cycle will be seven years. There is one motor per unit of equipment. The volume of the equipment is forecasted to reach a peak of 4,000 units per year in Year 3, with 10% reductions per year in volume as the product reaches the end of its product life cycle. It is estimated that the product will be completely phased out at the end of year 7.

The industrial engineering department has provided Joan’s team with the following per unit cost estimates for internal manufacturing and assembling the motors during year 1 of a three-year planning cycle: Direct labor

$18.750 $1.250

Cost of receiving components

Direct materials

36.250

Indirect labor

5.500

Factory supplies

3.135

Transfer price profit

18.750

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In addition, initial tooling and line modification costs in Year 1 would total approximately $25,000, which would be spread over the seven-year contract life. Fringe benefits for direct labor are 50% of direct labor rates, variable burden is assigned at 100% of direct labor rates, and fixed overhead is 250% of direct labor rates. Fringe benefits on indirect labor are assigned at 50% of indirect labor rates.

Depreciation expense and engineering/design costs are $20,000 and $80,000, respectively, to be spread evenly across the seven years of total volume.

In years 2 and 3, Joan’s buyer has a goal of achieving a 4% annual decrease in material costs. However, the new union contract provides for a 3% rise in direct and indirect labor rates. Joan assumes that this contract will increase the per-unit direct and indirect labor costs by 3%. Finally, Mr. Vincent in accounting also claims that because the Foxcroft unit is manufactured in one division and sold through another internal business unit, a 5% ―transfer‖ price should be added to the total final cost of production (including tooling, depreciation, and engineering/design costs).

ASSIGNMENT 1. Andrew has asked Joan and her team to prepare a detailed threeyear insource or outsource analysis on a per-unit total cost analysis basis. Joan needs to be sure to include all quantitative costs.

2. Further he has asked the team to prepare a seven-year insource or outsource analysis that includes the total cost of each sourcing alternative.

3. In addition to the 3- & 7-year quantitative analysis above, what qualitative factors should Joan’s team consider?

4. Considering both quantitative and qualitative factors, what recommendation should Ms. Riley make to Mr. Moore?

CASE 8 INSTRUCTOR NOTES This case is useful for directing students’ attention towards the types of arguments typically used in justifying insourcing vs. outsourcing decisions. Moreover, the decision on whether to include fully burdened or partially burdened total costs can often influence an insourcing/outsourcing decision in one direction or the other, depending on how these arguments are made. Internal manufacturing personnel will often argue that overhead costs should not be included in this analysis, as ―they are already covered by our existing product line‖. However, this is a short-term view of the decision, as even over the long-term (in this case, a seven-year period), the additional

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volume will not consume overhead costs. From this perspective, the correct approach is to compare all relevant costs and make the decision on the basis of whether insourcing vs. outsourcing the product and process results in a competitive advantage for the enterprise. The spreadsheet on the following pages illustrates the relevant calculations to apply in this insourcing/outsourcing decision.

ASSIGNMENT: 1. Prepare a three-year make versus buy per unit cost analysis. Be sure to include all costs.

The per unit cost of buying the product from a supplier in the first three years is $132.50. This considers the expected volumes, and the price decreases for years two and three.

Assuming that the product line is successful, the long-term per unit cost (assuming the price remains constant after year 3) is $119.45. The unit cost of making the product appears to be lower if one only considers the variable costs associated with producing the product. ($87.53 after three years). However, it is evident that after adding the costs associated with fixed overhead, indirect labor, and fringe benefits, the costs are substantially higher ($146.01 cumulative cost after three years).

2. Further he has asked the team to prepare a seven-year insource or outsource analysis that includes the total cost of each sourcing alternative.

When one includes the other costs associated with producing the product in-house over a seven-year period (engineering and design, depreciation, and tooling), the make option appears even less appealing, as the total costs increase to $151.61, a $32.16 (21%) incremental cost over the buy option. When one includes the internal transfer price (which is oftentimes equivalent to the internal profit margin on the product, the total cost to produce the product is $159.19, or $39.74 (25%) higher than the supplier’s quoted costs. Note that the supplier already has their profit margin built into the quoted price to the buyer, as this is all they are paid! Other total cost elements are not included in the analysis, but may include the potential costs of nonconformance on the part of the supplier, late delivery, etc.

3. In addition to the 3-& 7-year quantitative analysis above, what qualitative factors should Joan’s team consider? Other non-cost elements that may affect this decision include the following:  What is the status of the tariffs on Vietnamese products?

Currently, the supplier will pay 50% of the tariffs, and Joan’s portion is included in the $11/unit. Given the political climate and potential tariff wars, these costs could

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





 

increase substantially. However, overall, Vietnam is considered a more favorable sourcing spot than China.

Is the supplier keeping abreast of new technology, and will they continue to improve the performance of the motor assembly into the future?

Is the motor assembly a critical, promising new technology that may provide a significant competitive advantage in the future? If so, the outsourcing possibility should be reconsidered more carefully.

Are the cost elements provided by the supplier accurate? Is there any chance of the price rising in the future, instead of going down?

Will the supplier be able to ramp up production capacity sufficiently to meet demand in the next three years?

Have internal cost estimates been double-checked for accuracy?

For instance, is it appropriate to allocate fixed and indirect costs in the manner shown?

These and other elements can provide an interesting background for a discussion of the issues to consider in an insourcing/outsourcing decision.

4. Considering both quantitative and qualitative factors, what recommendation should Ms. Riley make to Mr. Moore?

In the current tariff-driven environment, uncertainties abound.

However, Vietnam should be considered more of a friend-sourcing country, and the supplier is picking up 50% of the tariff costs.

The savings at the current tariff rate are substantial. Barring poor performance on the part of the supplier, the buy option clearly appears to be a winner. Although the motor assembly is a key function on the new line of power equipment, it is clearly not a core competence and can be outsourced from the supplier. A long-term contract with the cost reduction elements discussed earlier can be negotiated satisfactorily. The cost analysis should be shared with union representatives, with a careful explanation of the fact that if the motor is not outsourced, the business will surely suffer, which in the end could result in several financial difficulties for the enterprise. One key issue will be keeping a close watch over tariff negotiations, as at one point, 46% duties were proposed on exports from Vietnam. Given this economic climate, many students may argue for maintaining insourcing. If they opt for this, they should also obtain buy-in from the union to accelerate internal learning to reduce the cost to be competitive with the Vietnamese source.

ELECTRIC MOTOR Per unit

Shipping

BUY OPTION Total cost

Units

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Total Cost

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Year 1

$150.00

$11.00

$161.00

1500

$241,500

year 2

$135.00

$11.00

$146.00

2700

$394,200

Year 3

$121.50

$11.00

$132.50

4000

$530,000

Year 4

$121.50

$11.00

$132.50

3600

$477,000

Year 5

$121.50

$11.00

$132.50

3240

$429,300

Year 6

$121.50

$11.00

$132.50

2916

$386,370

Year 7

$121.50

$11.00

$132.50

2624

$347,733

TOTAL

$2,458,370

Avg. Cost/unit

$119.45

MAKE OPTION YEAR 1 Variable Direct Labor

$18.75

Total Factory cost Variable costs

$87.51

Fringe (50%)

$9.38

Fixed overhead

$46.88

Direct materials Factory supplies Receiving Variable burden

$36.25

Indirect labor

$5.50

$3.14

Fringe benefits on indirect

$2.75

Cost per unit

$87.51

Cost per unit

$142.64

$19.31

Total Factory cost Variable costs

$87.47

Fringe (50%) Direct materials Factory supplies Receiving

$9.66 $34.80

Fixed overhead Indirect labor

$48.28 $5.67

$3.14

Fringe benefits on indirect

$2.83

Variable burden

$19.31

Variable Cost per unit

$87.47

Cost per unit

$144.25

$19.89

Total Factory cost Variable costs

$87.53

YEAR 2 Variable Direct Labor

$1.25 $18.75

$1.25

YEAR 3 Variable Direct Labor

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Instructor Manual: Handfield, Purchasing and Supply Chain Management, 8e, 2026; 9798214042039; Case 8: Electric Motor Outsourcing Decision

Fringe (50%)

$9.95

Fixed overhead

$49.73

Direct materials Factory supplies Receiving

$33.41

Indirect labor

$5.83

$3.14

Fringe benefits

$2.92

Variable burden

$19.89

Cost per unit

$87.53

Cost per unit

$146.01

$1.25

TOTAL COST - MAKE Per unit

Units Total Cost

Year $142.64 1500 1 Year $144.25 2700 2 Year $146.01 4000 3 Year $146.01 3600 4 Year $146.01 3240 5 Year $146.01 2916 6 Year $146.01 2624 7 TOTAL

Cumulative Cost/unit

$213,960.00

$142.64

$389,475.00

$143.68

$584,039.20

$144.81

$525,635.28

$145.51

$473,071.75

$145.36

$425,764.58

$145.46

$383,188.12

$145.53

20580 $2,995,133.93 $145.53

WITH TRANSFER PRICE

Engineering /design Depreciation

$80,000.00

$3.89

Transfer Price Engineering /design

$156,006.70 $80,000.00

$7.58 $9.76

$20,000.00

$0.97

Depreciation

$20,000.00

$2.44

Tooling

$25,000

$1.21

Tooling

$25,000

$1.71

TOTAL $3,120,133.93 $151.61 Difference

$661,763.93

$32.16

TOTAL $3,276,140.62 $159.19 Difference

21.21%

$817,770.62

$39.74 24.96%

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