Module 3. Value Enhancement Strategies. Ch.1 Sourcing Analysis. Edited by Dr. Seung Hyun Lee (Ph.D., CPM) IEMS Research Center, E-mail : lkangsan@iems.co.kr
Make-or-Buy Analysis. Procedures For Make-or-Buy Analysis. [Task 301] Determining Feasibility. The first step in a make-or-buy analysis involves determining the feasibility of the idea. Is it possible for the organization to make the product or provide the service? To do so requires equipment, personnel, material, space, supervision, overhead, maintenance, taxes, insurance, and other costs. Inability to meet these requirements would favor a "buy" decision, which involves lower investments in facilities; smaller labor forces; lower plant costs; reduced overhead, taxes, and insurance; and less supervision. - 1 -
Make-or-Buy Analysis. Procedures For Make-or-Buy Analysis. [Task 301] Determining Need. The organization also must determine need. - What to be bought? - In what quantities? - What part or parts can be manufactured by the organization and what can outside suppliers produce? - What service can be rended most effectively by the organization and which ones by outside suppliers? - 2 -
Make-or-Buy Analysis. Procedures For Make-or-Buy Analysis. [Task 301] Methods/Processes. The basic approach to make-or-buy analysis involves determining the total of all costs to the organization with and without the product. After dependability of supply, cost is usually the overriding factor in a make-or-buy decision. Methods used for make-or-buy analysis. - Analysis of components. All cost components must be analyzed, including direct costs of materials, labor, energy, overhead, and so on. - Break-even analysis. It can show at what volume one system of activity might be more economical that another. - Cost estimation process. Buying costs vs. Making costs. - 3 -
Make-or-Buy Analysis. Procedures For Make-or-Buy Analysis. [Task 301] Factors Influencing Make-or-Buy Decisions. Long-term supply implications. Strategic factors. Labor and other organizational constraints. Quality Considerations. Socioeconomic goals/objectives. Expertise in the area. Assistance in development. Speed to market. Risk. Supplier technical support capability. - 4 -
Privatization/Outsourcing. Privatization/Outsourcing. [Task 301] Definitions. Privatization is the partial or complete transfer of control over government - owned assets to the public or private sector firm. Privatization is the transfer of public service delivery to private suppliers. Privatization also refers to the transfer of government-owned enterprises to private investors. Outsourcing refers to a version of a make-or-buy decision, whereby organization practice buying goods or service that previously were part of their own responsibilities. As organizations downsize and they start to examine the value added by internal functions, many such functions are being outsourced. - 5 -
Privatization/Outsourcing. Privatization/Outsourcing. [Task 301] Some consideration for Privatization/Outsourcing. Is the process or function part of the organization's core capabilities? What type of supplier relationship is needed? How much will be saved in direct and indirect costs? What is the current level of integration with other parts of the organization? What type of delivery, quality, capacity, price, and service level must be supplier provide? Are there any intellectual property issues that need to be considered? Will the privatization or outsourcing decision affect current union-represented employees? - 6 -
Privatization/Outsourcing. Privatization/Outsourcing. [Task 301] Procedures for Conducting the Decision. Select a team. Identify the organization's cost structure. Develop a draft agreement (including the expected term, SOW and other information) Select the appropriate procurement methodology. Obtain and analyze information from suppliers. Select suppliers and manage transition. Measure and evaluate performance. Identify successes and problems. Enhance steps for next project. - 7 -
Privatization/Outsourcing. Privatization/Outsourcing. [Task 301] Criteria. Cost Technology Investment Differentiation. Quality. Political considerations. Service level (Flexibility) - 8 -
Lease or Buy Equipment. Lease or Buy Equipment. [Task 302] Some Considerations for Leases. A lease is a contract in which one party(the lessee) has use and possession of an asset owned by anther party (the lessor) for a period of time in return for a monetary payment. Lessees do not own the assets, but are permitted to claim rental payments made on such assets as expense on the organization's income statement. - 9 -
Lease or Buy Equipment. Types of Leasing Arrangement. [Task 302] Operating Lease. These types of leases satisfy short-term requirements, and are used for a period of time considerably shorter than the asset's useful life. They are used when capital intensive equipment is required for short periods or is subject to rapid obsolescence, and when the leasing organization is not interested in owning the equipment. - 10 -
Lease or Buy Equipment. Types of Leasing Arrangement. [Task 302] Financial Lease. This type of lease runs for the full life of the equipment, and is typically entered into for financial considerations. A financial, or capital lease is represented as an asset on the lessee's books. there are three major types of financial leases : - Full payout. With this type of lease, the lessee pays the full purchase price, plus interest charges, maintenance, insurance, and administrative costs. - Partial payout. This type of lease gives the lessee credit for the residual value of the leased item after the lease period is completed. - Lease/purchase. Under this type of contract, the lessee has the option to purchase the equipment at the end of the lease, or at specific time intervals. - 11 -
Lease or Buy Equipment. Types of Lessors. [Task 302] Third-Party Lessors. Third party lessors produce no actual product. Instead, they purchase equipment from manufacturers and, in turn, lease the equipment. These normally include organizations or individuals who find returns from this type of investment attractive, making a profit on the difference between lease payments received, less the total cost of the asset. Manufacturers. Manufacturers who make high-technology or high-cost products often find that offering leasing options can increase sales. - 12 -
Lease or Buy Equipment. Types of Lessors. [Task 302] Banks. Banks operate as lessors in a similar fashion to that of third-party lessors. Typically, banks put up a portion of the capital, borrow the remainder, and use the lessee's payments to cover the costs of borrowing, plus profit. Internal Lessor. Leasing arrangements can also be made within an organization. particularly in large multi-divisional or multi-national organizations. - 13 -
Lease or Buy Equipment. Factors in a Lease/Buy Decision. [Task 302] A number of factors in a Lease/Buy Decision. Inflation Obsolescence Maintenance services Capital/Budget Consideration Administrative overhead Reimbursement from third parties Interest Ownership benefits Limitation of sources of supply Balanced sheet considerations Cash flow analysis Depreciation Tax considerations Operating costs Life of the asset Residual value Customization of asset Early termination Payment schedules Insurance Company/organization policy Term of lease Emergency situation - 14 -
Lease or Buy Equipment. Legal/Accounting Considerations. [Task 302] Uniform Commercial Code 2A-Leasing. Article 2A of the Uniform Commercial Code overs lease and legal implications for materials. The section has five parts. - Part 1. General provisions. - Part 2. Formation and construction of lease contract - includes offers, performance, warranties, casualties to identified goods. - Part 3. Effect of lease contract - includes enforceability, title, sublease, liens on assets or equipment, and creditor rights. - Part 4. Performance of lease contract - repudiated, substituted, and excludes assurance of performance, anticipatory regulation, excused or substituted performance, and irrevocable promises. - Part 5. Default - includes notices of default, lessor/lessee remedies, waiver of objections liquidation of damages, cancelation, and termination. - 15 -
Lease or Buy Equipment. Legal/Accounting Considerations. [Task 302] FASB-13. FASB details proper methods for recording accounting transaction in business. Statement 13 deals with leases, and lists appropriate transaction for lessors, lessees, and third parties in various types of leasing arrangements. FASB differentiates between two basic kinds of leases. The first is a capital lease. Under this type of contract, the benefits and risk of ownership are transferred to the lessee. In this case, the property or equipment should be recorded as an acquisition by the lessee, and a sale by the lessor. FASB considers all other types of leases as operating leases - the rental of property. Under an operating lease, neither an asset nor an obligation is recorded on the lessee's balance sheet. - 16 -
Lease or Buy Equipment. Legal/Accounting Considerations. [Task 302] Other. As alternative forms of financing become more of an issue in supplying an organization's assets, legal concerns and the issue of how to properly record activity on financial statements will grow in complexity. Aside from the actual equipment or property, decisions will be based more and more on the tax and/or legal implications of the financing options. For this reason, a working knowledge of the issues will be required of the purchaser. - 17 -
Performance Check. 1. Which of the following department is LEAST likely to participate in a "make-or-buy" decision? A. Engineering/systems B. Purchasing. C. Production/operations D. Legal. 2. Consider the following data regarding a certain product : Variable cost per unit = $ 15 Annual fixed costs = $300,000 Price per unit = $ 20 On the basis of this information, the number of units that must be sold to break even is A. 15,000 B. 20,000 C. 40,000 D. 60,000-18 -
Performance Check. 3. All of the following are potential benefits of outsourcing EXCEPT : A. Lower fixed costs. B. Greater flexibility. C. Transfer of risk. D. Decreased control. 4. All of the following are factors favoring a "buy" decision by a business EXCEPT : A. Limited production facilities. B. Small volume requirements. C. Rapidly changing technologies. D. Design secrecy requirements. 5. Which of the following is TRUE of financial leases? A. They can be cancelled by either party upon notice. B. They are best suited for short-term equipment needs. C. The lessee's payment period closely matches the asset's useful life. D. They are similar in function to blanket order contracts. - 19 -
Performance Check. 6. In a lease or buy analysis, the buyer computes the net present value of a leased asset by using the A. Lessor's cost of capital. B. Prime rate. C. Lessee's cost of capital. D. Rate of inflation. 7. Which of the following statements about a third-party lessor is TRUE? A. The lessor owns the equipment. B. The lessor must guarantee the safety of a lender's debt. C. The lessor receives full depreciation benefits. D. The lessor receives limited depreciation benefits. - 20 -
Performance Check. 8. A partial payout lease is characterized by which of the following? A. The lessee pays the full original purchase price. B. The lessor does not charge interest. C. The lessor pays the interest and maintenance costs. D. The lessee pays the full original purchase price less any resale value. 9. A sale and lease back involves which of the following? A. The sale of the asset to the lessee at the end of the lease term. B. The sale of the asset to the lessor by the lessee. C. The execution of a concurrent operating lease. D. None of the above. - 21 -
Performance Check. Question 10-12. Stuart-Reem Corporation is a major home appliance manufacturer. The company is planning for the production of a new model washing machine. One of the components of this new model is Part B-402, a type of shock resistant mounting bracket. The B-402 bracket is a stamped and dipped part and is fitted with a neoprene bushing. Three of these brackets are used to hang the tub in each washing machine. Stuart-Reem Corporation has only one plant, but has manufactured Part B-402 in-house in the past, as well as bought the part outside. The company has retained the tooling to manufacture the part, and can make this tooling available to any supplier. A representative of Purchasing and Material Management (P&MM) is part of a production team designated to perform a make-or-buy analysis of Part B-402. The manufacturing budget projection is that 85,000 new model washing machines will be produced in the coming year. The estimated standard costs for each bracket are : Materials : $1.10, Labor : $0.75, Overhead : $0.45 (Total : $2.30) The only variance is an unfavorable labor variance of $0.15. P&MM's representative states that purchase records indicate that several outsider sources have supplied Part B-402 under fixed price contracts. The purchase history shows the following. Quantity Last Year Current Year ($ Unit Price) 150,000 $ 2.20 $ 2.35 200,000 $ 2.10 $ 2.25 250,000 $ 2.05 $ 2.20-22 -
Performance Check. 10. Consideration of all of the following would favor Stuart-Reem making Part B-402 EXCEPT A. Comparative total costs. B. Integration of production. C. Absorption of fixed overhead. D. Control over quality. 11. Because of quantity discount considerations, the P&MM representative recommends placing the entire order for Part B-402 with a sole source. The response of the Production Team should be which of the following? A. No, because the risk of supply interruption is too great. B. No, because it is always wisest to maintain a multiple-source purchasing policy. C. Yes, because the cost comparison is significantly favorable, and in the event of an emergency, the company can supply the part. D. Yes, because having a single source quantity that produces the entire quantity will provide an excellent check on the company's standard costs. - 23 -
Performance Check. 12. Given the situation described in the case, which of the following departments would be LEAST important to include in the make-or-buy analysis team? A. Research and development. B. Production. C. Finance. D. Engineering. - 24 -
Performance Check. Solutions. 1 2 3 4 5 6 7 8 9 10 11 12 D D D D C C A D B A C A - 25 -