Question

PeCo sells a single type of mobile phone screen protector. The annual demand for the its screen protectors is 50,000 units and demand seems to be continuous and uniform throughout the year. They currently sub-contract a local manufacturer to produce the screen protector for them at a cost of $3 per unit. The fixed cost associated with each delivery of screen protectors is estimated at $1,200 and careful analysis of quality assurance data has shown that a product held for a whole year in stock has a 0.1 probability of being faulty. This probability is linear with the time spent in stock, i.e., products spending 6 months in the warehouse have a 0.05 probability of being faulty, etc.

The company is also investigating the option of producing the screen protectors in-house. To do so, PeCo would have to lease machines and equipment at a cost of $65,000 per year. Every time a production run is initiated, calibration and cleaning of the production line would need to be performed at a cost of $1,500. The production line produces screen protectors at a constant rate of 60,000 units per year if it is never turned off. The variable cost of production is $1.8 per unit (raw materials and energy consumption). It is assumed that the quality of the screen protectors PeCo produces is identical to that of screen protectors that are produced by the sub-contractor. Hence, the faulty rate of products is identical in both cases (in house production and sub- contracting).

PeCo owns a small warehouse. The storage capacity of the warehouse is 10,000 products. If required, they can lease two additional warehouses, each with the capacity to store 5,000 additional products. One is offered for lease at a cost of $1,000 per year, while the second is fully renovated and offered at $1,500 per year. Assume that throwing out screen protectors (or giving them away for free) is not an option.

Investigate the various production/purchasing options the company should consider.

Answer 1

This problem is an example of the aggregate planning concept. The goal of aggregate planning is to achieve a production plan that will effectively utilise the organisation’s resources to match the expected demand.

In this case study, the product is screen protector and the demand is continuous and uniform throughout the year.

Annual demand for the screen protectors = 50,000 units

The case points out two ways of production and the costs involved.

1. Subcontracting to a local manufacturer

Cost per unit = $3

Fixed cost for each delivery = $1,200

Fault probability = 0.1 for one year [linear]

Total cost for delivery of batch of 50,000 units = Fixed cost + variable cost

                   = $1200 + ($3*50,000)

                   = $1200 + $1,50,000

                   = $1,51,200

2. In-house production

In order to produce the screen protectors in-house, PeCo would have to lease machines and equipment at a cost of $65,000 per year.

Lease cost per year = $65,000

Each production run cost (calibration, cleaning) = $1,500

Yearly Production rate = 60,000 units [if it is never turned off]

Variable cost(raw materials and energy consumption) of production per unit = $1.8

Fault probability = 0.1 for one year [linear]

Variable cost for 60,000 units = $1.8*60,000

Fixed cost per year= lease cost per year + production run cost

                             = $65,000 + $1,500

Total cost to produce 60,000 units a year= fixed cost + variable cost

                   = ($65,000 + $1,500) + ($1.8*60,000)

                   = $66,500 + $1,08,000

                   = $1,74,500

Hence according to calculations, cost of production can be compared as follows:

Subcontracting Cost for 50,000 units = $1,51,200 Effective cost per unit = $3.024

2. In-house production Cost for 60,000 units = $1,74,500 Effective cost per unit = $2.90833

Production options

• This above table shows that the cost of production per unit is more in the case of sub-contracting. According to case facts, probability for fault is 0.1 for one year and it is linear.
• The quality of the screen protectors PeCo produces in-house is identical to that of screen protectors that are produced by the sub-contractor. Hence, the faulty rate of products is identical in both cases (in house production and sub- contracting).
• This effective cost of $2.9 per unit incurred while producing in-house stays the same as long as the production is never interrupted throughout the year.
• Government strikes, unexpected power outages, malfunctioning of machineries, unexpected absence of employees are possible reasons that could affect the smooth functioning of any manufacturing floor. If in any way the production in-house is affected, then the cost per unit would increase. In such cases, the cost may go more than the per unit cost incurred for sub-contracting. Hence excessive care must be taken to ensure such events does not occur.

Pepco owned Storage warehouse

In-house storage capacity = 10,000 products

Additional warehouse 1 Capacity = 5,000 products Lease cost per year = $1,000

Additional warehouse 2 Capacity = 5,000 products Renovated cost per year = $1,500

Inventory management is very essential in this case since the in-house storage capacity is only 10,000 units. An additional warehouse could give 50% more capacity. Since the cost for the second warehouse is 50% more than the first warehouse that can be leased out, going for the first warehouse is a better choice for PeCo. This decision would allow them in cost cutting as well.

The main aggregate planning strategies companies follow are either chase capacity strategy or level capacity strategy.

• Chase strategy : Here, the demand requirements are kept constant, and the capacities including workforce, output rates etc are adjusted to match the demand
• Level strategy : Here, the capacities including workforce, output rates etc are kept constant during planning, and supply may not necessarily match the demand.

In this case study, since sufficient data regarding workforce levels are not given, we can say that PeCo follows the level capacity strategy. Here, when the overall supply per year does not match the yearly demand (50,000 units approximately), variations may occur. These variations in demand can be met by using overtime effort or inventories or part-time workers or sub-contracting or back-orders or a combination of the above. Since according to the analysis of the costs shows that even sub-contracting costs more than in-house production provided production never stops, PeCo can opt for in-house production itself.

In case of storage facility, PeCo can opt for the first warehouse on lease since they can opt and use it when their in-house storage capacity gets full.