91Ó°ÊÓ

Cow Spot Computer Co. outsources the production of motherboards for its computers. It is currently deciding which of two suppliers to use: Maji or Induk. Due to differences in the product failure rates across the two companies, \(5 \%\) of motherboards purchased from Maji will be inspected and \(25 \%\) of motherboards purchased from Induk will be inspected. The following data refers to costs associated with Maji and Induk. $$\begin{array}{lcc} & \text { Maji } & \text { Induk } \\ \hline \text { Number of orders per year } & 50 & 50 \\ \text { Annual motherboards demanded } & 10,000 & 10,000 \\ \text { Price per motherboard } & \$ 93 & \$ 90 \\ \text { Ordering cost per order } & \$ 10 & \$ 8 \\ \text { Inspection cost per unit } & \$ 5 & \$ 5 \\ \text { Average inventory level } & 100 \text { units } & 100 \text { units } \\\ \text { Expected number of stockouts } & 100 & 300 \\ \text { Stockout cost (cost of rush order) per stockout } & \$ 5 & \$ 8 \\ \text { Units returned by customers for replacing motherboards } & 50 & 500 \\\ \text { cost of replacing each motherboard } & \$ 25 & \$ 25 \\ \text { Required annual return on investment } & 10 \% & 10 \% \\ \text { 0ther carrying cost per unit per year } & \$ 2.50 & \$ 2.50 \end{array}$$ 1\. What is the relevant cost of purchasing from Maji and Induk? 2\. What factors other than cost should Cow Spot consider?

Step by step solution

01

Total Product Cost Calculation

For Maji, the cost of purchasing the motherboards annually is calculated as follows: \( \text{Price per motherboard} \times \text{Annual motherboards demanded} = 93 \times 10,000 = \\(930,000 \). For Induk, the calculation is similar: \( 90 \times 10,000 = \\)900,000 \).

02

Calculate Ordering Costs

The ordering cost for Maji is calculated as \( \text{Number of orders per year} \times \text{Ordering cost per order} = 50 \times 10 = \\(500 \). For Induk, the ordering cost is \( 50 \times 8 = \\)400 \).

03

Inspection Costs Calculation

The inspection costs are calculated using the percentage of inspections and the costs: For Maji, \( 10,000 \times 0.05 \times 5 = \\(2,500 \). For Induk, \( 10,000 \times 0.25 \times 5 = \\)12,500 \).

04

Stockout Costs Calculation

Stockout costs account for rush orders due to shortages. For Maji, \( 100 \times 5 = \\(500 \). For Induk, \( 300 \times 8 = \\)2,400 \).

05

Product Return Costs Calculation

The cost to replace returned motherboards is calculated as \( \text{Units returned} \times \text{Cost of replacement per unit} \). For Maji, \( 50 \times 25 = \\(1,250 \). For Induk, \( 500 \times 25 = \\)12,500 \).

06

Inventory Holding Costs Calculation

Calculate the cost to hold the average inventory, using required return investment and other carrying costs: For both Maji and Induk, \( 100 \times (93 \times 0.10 + 2.50) = \\(1,150 \) for Maji and \( 100 \times (90 \times 0.10 + 2.50) = \\)1,150 \) for Induk.

07

Total Relevant Cost Calculation

Summing all costs for both Maji and Induk gives the total relevant cost. For Maji: \( 930,000 + 500 + 2,500 + 500 + 1,250 + 1,150 = \\(936,900 \). For Induk: \( 900,000 + 400 + 12,500 + 2,400 + 12,500 + 1,150 = \\)928,950 \).

08

Consider Other Factors

In addition to cost, Cow Spot should consider factors such as supplier reliability, quality consistency, lead times, and flexibility in order fulfilment.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Supplier Selection

When choosing a supplier, companies must evaluate numerous factors beyond just cost. For Cow Spot Computer Co., selecting between Maji and Induk requires considering multiple dimensions.

• Cost Efficiency: It's crucial to consider not only the initial cost but also associated expenses such as ordering, shipping, and after-sales service costs. Maji and Induk have different cost structures, which will affect the bottom line.


• Quality Assurance: Assess the supplier’s quality management practices. The percentage of inspections required differs between suppliers due to varying product quality. Higher inspection rates might imply lower initial quality, as seen with Induk.


• Supplier Reliability: Consistent delivery schedules and accurate fulfillment are essential. Any delay or inconsistency can lead to increased stockout costs, impacting operations.


• Long-term Partnership Potential: Evaluate the supplier's willingness to collaborate on improvements and innovations that can benefit the business in the long run.

Inventory Management

Effectively managing inventory helps ensure that the company has the right stock without overspending. Cow Spot Computer Co.'s decision hinges on various aspects:

• Average Inventory Levels: Keeping the right amount of stock is essential to meet demand without incurring excess holding costs. Both suppliers maintain an average inventory of 100 units, so managing reorder levels is critical.


• Reorder Frequency: This is determined by factors like order size and lead time. Maji and Induk have similar reorder frequencies, which simplifies decision-making.


• Inventory Holding Costs: These are costs incurred for storing unsold goods and include insurance, taxes, obsolescence, and capital costs. The necessary annual return on investment is similar for both providers, so these should be compared alongside other costs.

Stockout Costs

Stockout costs refer to the expenses incurred when demand exceeds supply and stock isn't available to fulfill orders. For Cow Spot Computer Co., this is a significant consideration:

• Demand Forecasting: Anticipating customer demand accurately helps minimize the chances of stockouts. Frequent stockouts will result in rush orders, as seen with Induk, and higher rush order costs at $8 per stockout reflect this.


• Customer Relationship Impact: Frequent stockouts can harm customer satisfaction and loyalty, leading to lost sales and customer dissatisfaction.


• Stockout Frequency: The expected number of stockouts is much higher with Induk than with Maji, indicating potential service disruptions and increased costs.

Inspection Costs

Inspection costs arise from the need to ensure product quality and compliance with standards. For Cow Spot Computer Co., these costs vary between Maji and Induk based on failure rates:

• Percentage of Inspected Units: The higher the percentage of products needing inspection, the higher the inspection costs. Maji inspects 5% of motherboards, a significantly lower rate compared to Induk's 25%.


• Cost Implications: These costs contribute directly to the overall purchase price and affect the total relevant cost. Induk’s higher inspection costs increase the overall expenses before accounting for other factors like stockout costs penalizing Induk even further.


• Ensuring Quality: Regular inspections help maintain product reliability and fulfill customer expectations. Consistent inspection processes can help identify trends and prevent defects.