Identify Wintel’s Optimal Outsourcing Inventory Policy

Identify Wintel’s optimal inventory policy of outsourcing monitors from Bay Electronics Co

Wintel Inc. manufactures and sells desktops and notebooks, sourcing monitors from Bay Electronics Co. The annual demand for monitors is 24,000 units at a unit price of $60. The ordering cost per purchase order is $1,000, and the inventory holding cost per unit per year is $300. The company’s objective is to determine the optimal order quantity that minimizes total inventory costs, considering the economic order quantity (EOQ). This analysis will facilitate an effective inventory management policy for outsourcing monitors from Bay Electronics.

To determine the EOQ for outsourcing, we utilize the classical economic order quantity model with the following parameters:

• Annual demand, D = 24,000 units
• Order cost per order, S = $1,000
• Holding cost per unit per year, H = $300

The EOQ formula is given by:

EOQ = sqrt((2 D S) / H)

Substituting the known values:

EOQ = sqrt((2 24,000 1,000) / 300) = sqrt((48,000,000) / 300) = sqrt(160,000) ≈ 400 units

This suggests that Wintel should order approximately 400 monitors per order to minimize total costs associated with ordering and holding inventory.

The total annual inventory cost is calculated as:

Total Cost = (D / EOQ) S + (EOQ / 2) H

Substituting values:

Total Cost = (24,000 / 400) 1,000 + (400 / 2) 300 = 60 1,000 + 200 300 = $60,000 + $60,000 = $120,000

Therefore, the optimal number of monitors to order annually is 24,000 units, with each order consisting of approximately 400 units, resulting in an annual inventory cost of about $120,000. This policy balances ordering frequency with inventory holding costs, leading to a cost-effective procurement strategy for outsourcing from Bay Electronics.

Identify Wintel’s optimal internal production policy, including order quantity and total inventory cost

If Wintel considers producing monitors internally, additional factors need to be incorporated into the inventory policy analysis. The in-house production incurs a setup cost of $750 per production run, a production rate of 800 monitors weekly, a lead time of two weeks, and a production cost of $65 per monitor. The key is to determine the optimal production batch size that minimizes total costs, considering setup costs, production costs, and inventory holding costs.

The production occurs at a rate of 800 monitors per week. Given a lead time of two weeks, the company can produce the needed monitors just-in-time, with production schedules synchronized to meet demand. The demand rate remains at 24,000 units annually, equating to approximately 461.54 units weekly (since 24,000 / 52 weeks). However, given the production rate exceeds weekly demand, the firm can produce in batches that align with demand while minimizing setup costs and inventory costs.

The optimal production batch size, Q*, can be computed using the classical production order quantity model, which accounts for the production rate (p), demand rate (d), and setup costs. The formula for the Economic Production Quantity (EPQ) is:

Q = sqrt((2 D S) / (H (1 - d/p)))

where:

• D = 24,000 units/year
• S = $750 (setup cost)
• H = $300 (holding cost per unit/year)
• d = demand rate per week = 24,000 / 52 ≈ 461.54 units/week
• p = production rate per week = 800 units

First, compute (1 - d/p):

1 - (461.54 / 800) ≈ 1 - 0.5769 ≈ 0.4231

Now, calculate Q*:

Q = sqrt((2 24,000 750) / (300 0.4231)) = sqrt((36,000,000) / (127.0)) ≈ sqrt(283,464.57) ≈ 532.88 units

Thus, the optimal production batch size is approximately 533 monitors per production run.

The total annual cost of internal production is calculated by summing setup costs, production costs, and inventory holding costs:

Total Cost = (D / Q) S + (Q/2) H + D * C

where C is the production cost per monitor ($65). Substituting the known values:

Total Cost = (24,000 / 533) 750 + (533 / 2) 300 + 24,000 * 65

Calculations:

• Number of setups per year: ~45.01, so total setup cost: 45.01 * 750 ≈ $33,757.50
• Average inventory: 533 / 2 ≈ 266.5 units, holding cost: 266.5 * 300 ≈ $79,950
• Total production cost: 24,000 * 65 = $1,560,000

Summing these components gives a total estimated annual cost of approximately:

$33,757.50 + $79,950 + $1,560,000 ≈ $1,673,707.50

This internal production strategy balances setup costs and inventory costs, optimizing batch sizes for cost efficiency while ensuring consistent supply aligned with demand.

Recommendation and Comparative Analysis

Based on the detailed cost analyses, Wintel should consider producing monitors internally if the total annual cost of internal production (~$1,673,708) remains competitive or better than outsourcing costs (~$120,000). However, the stark difference in total costs suggests that outsourcing from Bay Electronics, with an annual inventory cost of approximately $120,000, is significantly more economical than internal production costs.

The decision to outsource or produce internally should also consider qualitative factors such as flexibility, control over quality, and supply chain reliability. Nonetheless, from a purely cost perspective, outsourcing offers major savings—approximately $1,553,708 annually—making it the more financially advantageous strategy under the current parameters.

Therefore, Wintel should primarily favor outsourcing monitors from Bay Electronics. The substantial cost savings free up resources that could be invested in other areas of the business, supporting sustained profitability and operational efficiency.

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