Would there be any dollar savings by contracting with Akron Foundry if the Donley Brothers’ machine shop were operating at full capacity?

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CASE
STUDY DONLEY BROTHERS

The
Donley Brothers Company had encountered the problem of latent defects in some
of its purchased castings. Being latent, the defects did not show up until
after machining had taken place at Donley Brothers. This group of failures
greatly irritated the manufacturing boss, who declared that “repairing those
darn castings is eating up all our profits.”

When the defects were
discovered, the rough casting had to be taken off the machine, the defect
chipped out and repair-welded, and the casting re-machined when possible. Even
with this process, almost 12 percent of the incoming castings ended up as
scrap. Actually, 1,140 raw castings had to be purchased and machined in order
to produce 1,000 good machined ones. The raw castings cost $600 each from either
of two suppliers. Worse than the costs associated with rework and high scrap
rates were the continual changes in production scheduling necessitated by a
machined casting not being available as scheduled. These changes were costly
because they required shop personnel to tear down the job they were working on
and set up a new job. Marketing was constantly complaining about the firm’s
inability to meet delivery commitments for the finished machinery that
incorporated the castings. Marketing claimed that many sales were lost as a
result of this failure.

George Donley, the production
manager, and Terry Donley, the vice president for marketing, asked Bob Donley,
the supply manager, to investigate the costs involved in supplying finished
machined castings. If finished castings were purchased, the responsibility for
finding hidden defects would be that of the supplier. Such action would
encourage the supplier to improve the casting quality. Donley Brothers would
accept and pay only for finished, usable castings.

The internal cost of machining
each incoming rough casting and repair welding and re-machining it, as
necessary, was approximately $312 per casting. This figure included $156 of
direct labor and $156 of overhead. The accounting department estimated that
overhead, which was 100 percent of direct labor, consisted of 50 percent
variable and 50 percent fixed costs. No estimate was available on the cost of
disrupted production schedules and operations.

Bob approached all
his major suppliers of castings in an attempt to generate interest for the
supply of finished machined castings. Only one supplier, Akron Foundry, showed
genuine interest. Of major concern to all the foundries was the $120,000 to
$160,000 investment necessary to set themselves up to machine the raw castings.
Akron was willing both to invest in the necessary machines and to guarantee
delivery of up to 150 units per month—provided Donley Brothers would
contract with it as a sole source for the castings for the next three years.
The price per casting would be $1,000 the first year, with an annual increase
or decrease in price tied to an appropriate economic index.

Bob was faced with
the problem of deciding whether to recommend contracting with Akron Foundry for
finished castings, continue as in the past buying rough castings, or developing
a more attractive alternative. The Donley machine shop was currently operating
at 90 percent of capacity, but it was not possible to make a reliable estimate
of what would happen in the next few months, let alone the next three years.
The decision of whether to buy finished castings was of major dollar importance
to Donley Brothers because the firm used at least 1,000 finished
castings per year and anticipated that this usage would continue for each of
the next five years

(Source:
Adapted from Burt, D. N. and Dobler, D. W., (2003). The World Class Supply
Management, 7^th edition, McGraw-Hill)

As
a consultant for DONLEY BROTHERS, you are required to assess the
aspects of Purchasing & Procurement Management and use your own
assumptions to answer the following questions: