Running head: FLEXCON PISTON CASE STUDY 1

FlexCon Piston Case Study Analysis

By Matt Monaghan

Business Administration 234: Fundamentals of Supply Chain Mangament

Chemeketa Community College

FLEXCON PISTON CASE STUDY 2

FlexCon Piston Case Study Analysis

QUESTION 1

FlexCon is a $3 billion maker of small industrial engines that is faced with a critical

decision: continue producing the basic elements of its highly-regarded line of pistons, or fully

outsource them. The company already relies heavily on outside suppliers for the pistons most

critical parts and management believes that too much of FlexCons production capacity and

skilled personnel is used in the manufacture of the remaining parts of their pistons that result in

only a small amount of differentiation in the marketplace. The company has also admitted that

this current situation is at least in part a result of wanting to keep FlexCons employees in their

jobs.

On the other hand, FlexCon is also 50-year-old company with a strong reputation as a

reliable maker of pistons as well as other engine-related products. As a result, its employees-

especially its veteran engineers and production workers-take a great deal of pride in the quality

of the companys products. To them, FlexCon wouldnt be the same company if it no longer

made at least a portion of their pistons and pushback has been noticeable. One engineer has

threatened to quit if the decision to fully outsource is made while others have voiced concerns

about quality and cost control.

While both arguments are compelling, the need for a quantitative analysis to compare the

costs of insourcing versus outsourcing is required. The result of this analysis over a period of two

years is shown in the table on the next page with figures based on the cost per unit (piston).
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Table 1
Insourcing/Outsourcing Cost Analysis

Insourcing Outsourcing
Costs Per Unit: Year One Year Two Costs Per Unit: Year One Year Two

Direct Materials
Semi- Purchase Cost 12.20 12.20
Finished 4.29 4.29
Other .78 .78

Direct Labor 2.37 2.44 Transportation .10 .10

Indirect Labor .73 .65 New Tooling .50 .43

Factory 4.31 3.86 Administrative .09 .08

Overhead and Support
Administrative

Preventive .15 .14 Inventory .07 .07

Maintenance Carrying
.18 .18
Machine Repair .13 .13 Safety Stock

Ordering .06 .05 Quality-Related .38 .38

Costs

Depreciation .50 .43 Ordering .06 .05

Inventory .06 .06 Other costs

Carrying

Inbound .11 .11 Total 13.58 13.49

Transportation Outsourcing
Costs Per Unit

Consumable .19 .19 Total Savings 30,000 -124,200

Tooling

Other costs 0 0 Less: Taxes on 12,000 0

Savings (40%)

Total Insourced 13.68 13.13 Net 18,000 0

Cost Per Unit Outsourcing
Savings
*Additional tables concerning inventory carrying charges for each year can be found at the end of this report.

Based on these figures, it would be in FlexCons best interest to continue its insourcing.

While a one-year change to outsourcing would result in a modest savings of $18,000, it would

result in a much greater loss of $124,200 over a period of two years. The primary reason for

FlexCon to retain the production of its pistons is that a forecast for the demand of the pistons
FLEXCON PISTON CASE STUDY 4

shows a steady rise (from 300,000 to 345,000) over the next two years which should more than

offset in-house production costs. This is indicated by a reduction in the per unit cost of insourced

production from $13.68 in Year One to $13.13 in Year Two. Even with expected increases in the

total cost of overhead, administration, and labor, in Year Two the forecasted increase in demand

actually lowers the per unit piston cost.

Additionally, flat depreciation costs and increased productivity are two more reasons

FlexCon should continue insourcing. Over a two-year period, an addition $.07 of savings per unit

is achieved through steady depreciation costs, and by changing the layout of production, the

company achieved a 30 percent gain in quality and a 20 percent increase in productivity. These

dramatic improvements also offset the increase in costs elsewhere within the company.

An argument could be made that outsourcing would be economically beneficial in the

short run; however, it is a poor idea overall-and not just because of the savings produced in Year

Two. From a qualitative perspective, the internal upheaval such a change would cause among

personnel would be significant. It is important to note that no cost analysis of this potentiality has

been done but it would most certainly be costly in the event experienced employees quit and new

ones had to be hired. Productivity and efficiency would likely drop thereby skewing the numbers

in the original analysis.

Other qualitative factors against outsourcing include the possible negative reaction by

FlexCons customers to the idea that the company no longer was producing its own products. A

dip in sales could occur. FlexCon already has a good reputation and it would not be worth

jeopardizing for such a meager return. Furthermore, by keeping production of their pistons in

house, the company maintains greater quality control. This minimizes the likelihood and

resulting expense of defective pistons.

FLEXCON PISTON CASE STUDY 5

Because this cost analysis only represents two years, the decision to continue insourcing

is one that will need to be revisited annually and a close eye kept on forecasted demand. A

decline in demand would likely make outsourcing a more attractive option, even at the expense

of some of the aforementioned qualitative factors.

QUESTION 2

In the event that FlexCon decided to outsource its pistons to an external supplier, there

are a number of factors that would need to be considered in order to formulate a plan that could

be successfully implemented. The major parts of that plan are 1) goal setting; 2) research and

identification of critical criteria; 3) execution; and 4) periodic review.

Beginning with goal setting, FlexCons executive management would need to identify

specific and measurable goals that they hope to achieve as a result of outsourcing their pistons.

Some possible goals could be a reduction in overall business expenses or an improvement in

efficiency. Perhaps a supplier with superior technology can make a better piston. Whatever

outcome FlexCon seeks, it needs to have a clearly defined goal.

Upon deciding on a goal, the executive management group would need to engage in

communication with experts in the auto engine parts market to identify the most important

factors involved in choosing a supplier or suppliers to work with. This research would include

everything from talking with other vendors who have worked with the prospective suppliers to

seeking as much information about each suppliers financial situation to ensure that any

agreement made would be a safe one.

After completing the research phase, FlexCon would approach specific suppliers and

engage in preliminary discussions to see if the two could be a match. Does the supplier have

experience producing the product that FlexCon needs? What kind of quality records or
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deliverability assurances can be cited to show that the pistons being produced will be of the same

quality as those being produced in house and that they will reach the consumer market in a

reasonable time? What is the suppliers corporate structure and how does communication flow

within it?

When these questions have been satisfied, then it is time to negotiate an outsourcing deal

with the supplier or suppliers chosen. Any agreement would have to be a partnership between

both the supplier and FlexCon so that each has a vested interest in seeing the deal successfully

executed. Issues such as the transfer and holding of sensitive or proprietary data would need to

be addressed as would specific benchmarks for success.

Lastly, no outsourcing deal is complete at the signing of the contract. In fact, it is after

this that problems begin to arise. Both parties are motivated to make a deal at the bargaining

table, but then it is up to FlexCons management to regularly monitor the execution of that

contract. When and if problems arise, those problems need to be addressed clearly and in a

timely fashion. FlexCon executives would be wise to make periodic trips to visit the supplier to

check on the quality of production and reaffirm their interest in the suppliers success.

QUESTION 3

The decision to insource or outsource requires a company to consider many factors that

will ultimately impact its future success. One major challenge of insourcing is keeping

production costs within a budget so as to preserve profits while also maintaining a high level of

quality. This can be particularly difficult for North American companies because labor costs are

much higher than many other places in the world. That reason alone is one of the great draws of

outsourcing. Outsourcing opens up the possibility for a company to make its products for a
FLEXCON PISTON CASE STUDY 7

fraction of the price that it could domestically. But, while outsourcing may have obvious

benefits, it also has drawbacks that could be detrimental for the company.

When a company chooses to outsource, it gives up a degree of quality control as well as

allows suppliers to buy in to the companys business. An increased number of defective

products is possible which could hurt sales and damage a companys reputation. Additionally,

outsourcing gives suppliers the ability to increase the costs associated with production. By

contrast, insourcing allows a company to better manage the costs of production because it is not

susceptible to outside demands.

Then there are factors such as technology, competency, and deliverability. When a

company decides to outsource, it has to be certain that the supplier has the technical abilities and

personnel capable of matching the production that could be accomplished by insourcing. Finally,

the ability to deliver a product on time is critical because any delays could disrupt distribution to

retailers and ultimately allow competitors to take away business. A reduction in market share and

loss of customers to competitors is potentially catastrophic to any business.

Lastly, the start-up costs associated with outsourcing can be prohibitive and risky. A

supplier may not have exactly what is needed for production and may ask a company to make an

investment to reach the necessary capabilities. The shipping of the raw goods to the supplier will

also be costly, and that does not factor in the possibilities of delay or other unforeseen

occurrences that can happen in international transport. For that reason, it is wise to do an

outsourcing analysis to determine the all of the costs involved and to determine if the risks are

worth taking.

QUESTION 4
FLEXCON PISTON CASE STUDY 8

Whenever a decision to outsource or insource is made, it is critical that a host of voices

with experience and knowledge of various aspects of a companys operations be sought out for

input. These voices include not just the executive management but also the engineers and

production staff who best understand the day-to-day challenges of production. And beyond the

walls of the company, outside experts who know the marketplace of the product being produced

should be consulted to offer guidance.

A companys executive management is going to be able to best provide a financial picture

of how a company would be impacted by either insourcing or outsourcing. This can be done by

conducting a total cost analysis such as the one completed for Question 1. Amassing and

interpreting that data can be challenging, but if done correctly it will provide a clear answer of

the financial impact on a firm that such a decision would make.

To make a fully informed decision, other personnel beyond the board room must also be

consulted. This includes engineers and workers who are on the production floor day in and day

out. No one better than them will better understand the production challenges and they may be

able to provide anecdotal data that can provide ways to increase production or efficiency, or

show that production capabilities are already maxed out. Furthermore, since these workers are

likely to be significantly be impacted by a resulting insourcing or outsourcing, it is important to

get their input on qualitative concerns such as workplace environment and morale. A major

decision to insource or outsource will undoubtedly cause some upheaval and making a decision

without factoring in how that change will affect the companys culture is a recipe for disaster.

While internal data is important, so is external data, which is why research and expert

consultation are also needed to make an accurate analysis. A company should find out as much

information as possible about the market they are in as well as the vendors and suppliers who
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represent it. Potential outsourcers need to identify possible locations for contracting with

suppliers and how other competitors have similarly rolled out new outsourcing operations. Once

potential suppliers have been located, they should undergo a thorough vetting process to

determine their financial and corporate strength and structure. What is the reputation of each

supplier and what kind of experience do they have meeting the specific requirements of the

company? In plain terms, can this supplier be trusted? Supplier relations is a major component of

a successful outsourcing relationship.

Finally, it is important to know how consumers are likely to take the decision, especially

if it is to outsource. Some domestic customers might lose respect for a firm that chooses not to

make its own products. A potential backlash could be bad for sales. Are the cost savings

associated with the outsourcing move greater than the potential decline in revenues because of it?

QUESTION 5

When companies weigh the decision to insource or outsource there are a number of major

issues that require analysis. First, the company must know what its core competencies are now as

well as what they are likely to be in the future. If a company can identify an advantage it has in

the market that cannot be easily replicated, then it should consider insourcing. But if in-house

production costs are high and are not resulting in added value, then that production should be

outsourced.

Another issue to consider is the window available to get the product to market. If a

company forecasts a sharp increase in consumer demand for a product but does not have the

capability to meet that demand, then it should consider the possibility of outsourcing. This is

especially critical if that market window is short. It may not be wise to make large cost
FLEXCON PISTON CASE STUDY 10

investments in infrastructure to meet a demand that will likely be only temporary. On the other

hand, a company with the technology and capacity to increase production through either

increased efficiencies or greater manpower can capitalize on a small market window.

Quality is another major issue. By keeping production in house, a firms management can

closely observe and manage production quality. This will likely result in fewer production

problems or defective products going to market that would damage a companys reputation

among its customers. It is also possible, however, that a supplier may offer better production

facilities and technologies that actually improve the quality as a result of outsourcing.

Infrastructure also represents a factor to consider. A company with limited warehouse and

production space may not have the desire or ability to invest in expansion. As a result,

outsourcing could be the most cost-effective best way to meet production goals. The opposite

would be true for a decision to insource. A company with ample space or resources to

accommodate an expansion of production infrastructure would benefit from becoming a supplier

for outside vendors.

Finally, risk analysis is crucial to determining whether insourcing or outsourcing is a

viable option. Both options bring their own unique set of risks. In outsourcing, a company can

cut labor costs, decrease investment, and greater gain flexibility. At the expense of these benefits

is the ability to closely manage quality and monitor delivery schedules. For insourcing, the risks

are likely going to be more financial related as it might require increased investment in

infrastructure. If current and future demands for production stay strong, then this is a risk

possibly worth taking, but if consumer demand is difficult to gauge, then such a risk may be

unwise.

In conclusion, any decision must be strategic, which means a complete understanding and
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consideration of cost, market factors, quality control, technological capabilities, customer

demands and a companys core competencies. Such a decision must include a wide range of

voices both inside and outside of a company.

Table 2
Year One Inventory Carrying Charges
Outsourcing Option

Beginning Ending Average Inventory

Inventory Inventory Inventory Carrying Costs

January 30,000 0 15,000 $2,100

February 30,000 0 15,000 $2,100

March 30,000 0 15,000 $2,100

April 27,000 0 13,500 $1,890

May 25,000 0 12,500 $1,750

June 25,000 0 12,500 $1,750

July 23,000 0 11,500 $1,610

August 21,000 0 10,500 $1,470

September 22,000 0 11,000 $1,540

October 23,000 0 11,500 $1,610

November 23,000 0 11,500 $1,610

December 21,000 0 10,500 $1,470

Total Inventory $21,000

Carrying Costs
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Table 3
Year Two Inventory Carrying Charges
Outsourcing Option

Beginning Ending Average Inventory

Inventory Inventory Inventory Carrying Costs

January 34,000 0 17,000 $2,380

February 34,000 0 17,000 $2,380

March 34,000 0 17,000 $2,380

April 31,000 0 15,500 $2170

May 28,000 0 14,000 $1,960

June 28,000 0 14,000 $1,960

July 27,000 0 13,500 $1,890

August 25,000 0 12,500 $1,750

September 25,000 0 12,500 $1,750

October 27,000 0 13,500 $1,890

November 27,000 0 13,500 $1,890

December 25,000 0 12,500 $1,750

Total Inventory 24,150

Carrying Costs