Louisiana Luggage Components Manufactures Handles For Suitca

Louisiana Luggage Components Manufactures Handles For Suitcases And Ot

Louisiana Luggage Components manufactures handles for suitcases and other luggage. Depending on the size of the luggage piece, attaching each handle to the luggage requires between two and six standard fasteners, which the company has historically produced. The costs to produce one fastener (based on capacity operation of 4,000,000 units per year) are: direct materials $0.08, direct labor $0.06, variable factory overhead $0.04, fixed factory overhead $0.07, totaling $0.25. Fixed factory overhead includes $100,000 of depreciation on equipment with no alternative use and no market value. The remaining fixed factory overhead pertains to the salary of the production supervisor. Saratoge Suitcase Co. recently approached Louisiana Luggage Components with an offer to supply all required fasteners at $0.19 per unit. Anticipated sales demand for the coming year will require 4,000,000 fasteners.

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Introduction

The decision to outsource production in a manufacturing firm involves a detailed analysis of relevant costs and qualitative factors that influence the overall strategic outcome. In the context of Louisiana Luggage Components, which produces handles for suitcases that require fasteners, the decision to outsource these fasteners entails examining whether the direct costs saved by outsourcing outweigh the costs of maintaining in-house production, alongside considering non-financial factors that might impact the company's long-term viability.

Relevant Costs in the Outsourcing Decision

In considering whether to outsource the fasteners, it is crucial to identify costs that are relevant—costs that will be affected directly by the decision. Relevant costs include both avoidable costs associated with in-house production and the price offered by the external supplier.

Variable Costs:

The variable costs to produce one fastener include direct materials ($0.08), direct labor ($0.06), and variable factory overhead ($0.04), totaling $0.18 per unit. Since these costs vary directly with production volume, they are relevant to the outsourcing decision. If manufacturing is halted internally, these costs will be avoided.

Fixed Costs:

Fixed factory overhead of $0.07 per unit amounts to $280,000 annually ($0.07 × 4,000,000). Notably, fixed costs consist of depreciation on equipment ($100,000) and supervisory salaries. Since depreciation is a sunk cost—an expense that will be incurred regardless of the decision—it is irrelevant to the outsourcing analysis. However, the supervisory salary of Jeff Wittier, which is part of the fixed costs, may be considered relevant if it can be eliminated or reassigned, but since Wittier has a lifetime employment contract, this cost is effectively fixed and unavoidable.

Therefore, the relevant costs are primarily the variable costs ($0.18 per unit) and any avoidable fixed costs, which appear minimal or non-existent within this context because fixed costs like depreciation are sunk costs.

Cost of Outsourcing:

The external supplier offers the fasteners at $0.19 per unit, which includes all costs and profit margins. Since this price exceeds the variable cost per unit ($0.18), outsourcing would result in a marginally higher expense on a per-unit basis unless other benefits or costs are considered.

Financial Analysis of the Outsourcing Decision

To determine the financial advantage or disadvantage of outsourcing, it is necessary to compare the total costs of manufacturing in-house versus purchasing externally.

In-House Production Cost:

- Variable cost per unit: $0.18

- Total for 4,000,000 units: $0.18 × 4,000,000 = $720,000

- Fixed costs like depreciation are sunk and thus ignored in decision-making.

Outsourcing Cost:

- Cost per unit: $0.19

- Total for 4,000,000 units: $0.19 × 4,000,000 = $760,000

Net Financial Impact:

The difference in total costs is $760,000 (outsourced) minus $720,000 (in-house), resulting in a $40,000 higher expense if outsourced, ignoring other factors. Since the in-house variable cost is lower, outsourcing appears less advantageous financially solely based on costs.

Additional Considerations:

- If fixed costs and supervisory roles are truly unavoidable, they do not affect the marginal decision.

- Any potential savings from avoiding fixed costs or reallocating supervisory resources are not clearly indicated and appear minimal.

- If outsourcing allows the reallocation of supervisory staff, or if the fixed equipment depreciation could be avoided or repurposed, additional financial implications might influence the decision.

Qualitative Factors in the Outsourcing Decision

Beyond direct costs, several qualitative factors should be considered:

Quality Control:

Manufacturing internally allows tighter control over fastener quality, which directly impacts the quality of luggage handles. Outsourcing could risk quality inconsistency, affecting customer satisfaction and brand reputation.

Supply Chain Reliability:

Dependence on an external supplier introduces potential risks related to timely delivery, supply shortages, or quality flaws. Establishing reliable supplier relationships is essential to avoid production delays.

Strategic Flexibility:

In-house production offers flexibility to adjust production volume or design, whereas reliance on external suppliers may limit responsiveness to market changes or custom requirements.

Core Competencies:

Manufacturing fasteners may not be a core competency for Louisiana Luggage Components; outsourcing can allow the company to focus on its primary product lines and innovation, potentially leading to long-term strategic benefits.

Long-term Cost Trends:

Cost stability and the potential for supplier discounts or volume-based negotiations could influence long-term costs, making outsourcing more attractive over time.

Employment and Morale:

Outsourcing could impact employee morale or lead to layoffs, affecting company culture and community relations.

Intellectual Property and Confidentiality:

Sharing production details with external suppliers might pose risks related to intellectual property protection, especially if specialized manufacturing processes are involved.

Conclusion

The financial analysis indicates that, based solely on relevant costs, in-house production of fasteners at a cost of $0.18 per unit is more economical than outsourcing at $0.19 per unit, saving approximately $40,000 annually. However, these calculations exclude considerations of fixed costs like depreciation, which are sunk costs, and do not account for qualitative factors. Strategic considerations such as quality control, supply chain reliability, core competencies, and long-term flexibility play critical roles in the final decision.

Given the minor cost difference, the company must weigh the qualitative aspects heavily. If maintaining control over quality and supply chain integrity is paramount, in-house production may be preferable. Conversely, if external supplier reliability and long-term cost reductions are achievable, outsourcing might be justified despite the slightly higher immediate cost.

Ultimately, the decision should align with Louisiana Luggage Components' strategic priorities, operational capabilities, and risk management considerations, emphasizing a comprehensive approach beyond mere cost analysis.

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