JWI 530 The Mary Story Decision Time: Make Or Buy

Jwi 530the Mary Storydecision Time Make Or Buydecision Time Make

JWI 530 The Mary Story DECISION TIME – MAKE OR BUY? DECISION TIME – MAKE OR BUY? We watched as Mary participated in a quarterly earnings call. She was anxious to put some of the information and strategies that she learned to work – and it wasn’t too long before she found the opportunity to do just that. The new Perfume team was looking to take advantage of a short-term opportunity to make a small batch of special perfume in support of the upcoming World Cup event.

After reviewing a memo from Mike, her operations manager, Mary learned that the assembly line required to make the perfume was already operating at full capacity. Since Mike didn’t want to interrupt his normal production plan, he and the Purchasing Dept. identified a small supplier who was willing and able to take on the project and produce the new fragrance for ABC Perfume. Mary was excited…this would be a one-time effort, and she could certainly use the incremental profit the order represented! Mike reminded Mary of the capacity challenge and pointed out that based on the P&L from Accounting for this product; his cost was $15.50 per oz. Since the 3rd party was willing to produce it for just $15.00 per oz., he explained that contracting with the smaller supplier was cheaper and avoided a conflict with his assembly plan.

This seemed reasonable to Mary, but then she remembered her discussion with Andrea about fixed and variable cost. She knew that the $15.50 was the total cost, including both fixed and variable cost. Further, she also knew that by definition, fixed costs would not change with changes in the number of units. Therefore, the actual cost of production would solely be based on the variable cost. She pulled out a separate report from Accounting and discovered that the variable cost of producing a similar product was just $10.00 per oz.

If she compared the variable cost of producing to the supplier quote, then producing in-house would be much more cost effective. Mary paused for a moment and began to consider her options for this project. She recalled Andrea discussing the need to consider opportunity cost when at full capacity. She realized that producing this one new unit would reduce the number of the current units produced. Therefore, the lost profit (or really contribution) from selling fewer of the current unit needed to be considered. It was like a cost from “lost sales”.

She remembered that contribution was the difference between a unit’s variable revenue and its variable cost. Since the product sold for $40 per oz., it generated a ton of benefit…or contribution as Andrea called it. Therefore, she needed to recognize that not producing 1 oz. of the current perfume would “cost” her $30 per oz. in lost contribution. If she added the variable cost and the opportunity cost, she came to a net cost of $40 per oz. if she chose to produce in-house. Comparing this to the supplier quote of $15 made this a “no-brainer”.

Leveraging the outside supplier would be the best economic choice. Mary picked up the phone to call Mike. He was going to be happy with her answer - even though she was going to have to explain all the ways his proposal was flawed!

Paper For Above instruction

The decision to manufacture or outsource a product is a critical strategic choice for organizations, especially when faced with capacity constraints and cost considerations. The case of Mary and her perfume project exemplifies the importance of economic analysis in the make-or-buy decision-making process, integrating cost structure analysis, opportunity cost evaluation, and strategic considerations.

At the core of the make-or-buy decision is the distinction between fixed and variable costs. Fixed costs remain unchanged with variations in production volume, while variable costs fluctuate directly with output. In Mary’s scenario, the total cost of $15.50 per ounce included both fixed and variable components, but it was only the variable part ($10.00 peroz) that directly influenced operational costs associated with additional units. The supplier’s quote of $15.00 per oz was above the variable cost but did not consider fixed costs, which are irrelevant in incremental decision-making when capacity is limited or when fixed costs are unavoidable regardless of production choice (Drury, 2018). Consequently, if only variable costs are relevant, the in-house production would be more cost-effective than contracting out, assuming capacity was available. However, given that the assembly line was at full capacity, this analysis becomes more complex.

Opportunity cost plays a significant role in such decision-making processes. When capacity is constrained, producing one additional unit means sacrificing the opportunity to produce and sell other profitable units. In this case, Mary realized that each additional ounce of the special perfume at full capacity would displace profit-generating units of the current perfume. Contribution margin analysis reveals that each ounce of current perfume yields a contribution of $30, derived by subtracting the variable cost ($10) from the selling price ($40). Therefore, ignoring opportunity costs could lead to suboptimal decisions, such as outsourcing at a lower price when the true cost to in-house production includes the contribution foregone.

The comprehensive approach involves summing the variable cost with the opportunity cost, representing the contribution margin lost. Adding these, the net cost of producing the perfume in-house becomes $40 per oz, which is significantly higher than the supplier’s quote of $15 per oz. Hence, from an economic standpoint, outsourcing the production is the preferable strategy. This conclusion aligns with the principles of incremental and relevant costing, underscoring that decisions should be based on the additional costs and benefits associated with each alternative (Horngren, Sundem, & Stratton, 2014).

Furthermore, strategic considerations extend beyond purely economic analysis. Outsourcing can allow flexibility, reduce capital investment, and focus internal resources on core competencies. Conversely, insourcing can offer greater control over quality and lead times, but only if capacity constraints can be managed effectively. In Mary’s case, the analysis indicates that leveraging an outside supplier aligns best with cost efficiency, especially noting her capacity limitations and the opportunity costs involved.

In conclusion, the decision to outsource or produce in-house must account for cost structure, opportunity costs, capacity constraints, and strategic fit. The case demonstrates that while initial cost comparisons may favor in-house production based on variable costs alone, the broader picture including opportunity costs and capacity limitations strongly favor outsourcing. Managers must employ a comprehensive and nuanced approach, integrating financial analysis with strategic considerations to make optimal decisions that align with organizational goals and capacity realities.

References

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• Horngren, C. T., Sundem, G. L., & Stratton, W. O. (2014). Introduction to Management Accounting. Pearson Education.
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