Birdgeton Case

Memorandum To microphvirtuoso Lewis From Overseas Consulting Group Date December 9th 1990 Subject Manifolds Retention vs. Outsourcing compendium Our team of financial analysts has taken an in depth look at the consultants recommendation to potentially outsource the abstruse doing line. Through our digest you will see that the consultants have non considered the dear financial furbish up that this outsourcing would have on the company. This is likely because the recommendation has non taken into consideration the range of be affecting Bridgeton industries.Through our analysis it becomes empty that the decision to retain the manifold work line will be more financially beneficial to the company. We will begin with some of the assumptions of our analysis, and the conclusions from our diverse analyses of Bridgeton Industries cost. Please key out to the attached excel file for particular analysis of the numbers. We know that Bridgeton uses an absorption approaching system w hich does not easily speciate between mend and vari suitable be.The problem with that system defends it very dispute to forecast appropriately the cost of excess capacity and furthermore the impact of outsourcing the manifold emergenceion line. Therefore the reported cost argon not appropriate for this type of analysis. Our team began our own analysis of the be to pass judgment the recommendation. We began by calculating vulgar margin for for apiece one point of intersection, by commencement identifying how much(prenominal) command processing command processing operating expense should be allocated to each category. We broke out the overhead by using Direct Labor (DL) as a % since intimately of the overhead accounts ar labor related.As a result, overhead allotment for each product in 1987 is the following Fuel Tanks 17%, Manifolds 24%, Doors 11%, Muffler/Exhausts 23%, and Oil Pans 26% for 1987. Muffler/Exhausts, manifolds and Oil Pans are both labor intensive, s o under this method, they bear a high percentage of the overhead cost. Now that Bridgeton stopped producing Muffler/Exhausts and Oil Pans, the manifold line carries an even greater proportion of the overhead costs of 46%. Therefore, the cost per manifold goes up because of the larger share of overhead it has to absorb.Please refer to the analysis file, tab 2 for 1991 forecasts. We assumed the sales and costs for each category would increase close to the identical percentage as earlier year. The overhead forecast required greater detailed analysis. The question is how to reside how much overhead would go down callable to discontinuation of manifolds. In 1989, DL and direct material (DM) went down 46% and 47% one by one from the outsourcing of the other production lines. If manifolds were to be outsourced and all DL and DM were eliminated, accordingly we are looking at approximately 44% decrease in DL and 49% decrease in DM.We assumed for the purpose of our analysis, that the r eductions in DL and DM for these 2 year are comparable. Thus, we applied the same percentage of overhead reduction in each account to the 1989 to the 1991 overhead accounts. Once we established these overhead accounts, we then analyzed how the costs are allocated across the remaining lines. As you locoweed see in detailed spreadsheet, the most profitable product, the fuel tanks, now has to absorb 61% of the overhead cost and its gross margin is down to 33% from 43%. The doors gross margin also went south from 27% to 17%.Clearly the fixed costs, which werent removed with the outsourcing, have eroded the profitability of all of the remaining products. The consultants suggestion to outsource production is actually not a good option after all. Fix costs embedded in the cost per unit wont go away because less(prenominal) profitable parts are outsourced. If Bridgeton industries wants to seriously considering outsourcing the manifold line or any other some significant overhead restructur ing is necessary to crusade and cut out the fixed cost profitability dilution. Changes to cost structureAs we mentioned previously Bridgeton presently uses a single overhead pool for the entire plant that allocates costs based on direct labor hours. Since the production process of the respective(a) product lines vary greatly, this causes the overhead allocation to be inaccu regulate. The products have contrastive levels of automation and manual work (refer to descriptions in exhibit 1). While one product line may be diligently working to reduce costs, another product line can simply reduce production and receive the same relative decrease in overhead costs.Also, the overhead percentage is calculated only once a year at budget time and is used throughout the entire model year. With an annual calculation, there is little to no incentive for employees to continuously reduce their costs month to month. Bridgeton should recalculate the overhead percentages on a monthly radix to be more accurate if possible. We recommend creating multiple overhead pools by taking the overhead cost elements and assigning them to the product lines that are authentically driving those expenses (basically link overhead to the product).Having a product specific allocation of OH expenses will allow management to have better visibility to the product cost reduction efforts of the employees. Variable Costs, Fixed Costs & Excess capacity Ultimately the problem Bridgeton is facing is related to fixed costs due to excess capacity. Once production lines are outsourced, the remaining fixed costs in OH which are not outsourced represent the excess capacity. This is a cost problem for the company as the other products must absorb this. The two obvious consequences to this problem are to cut these costs as much as possible.Through restricting initiatives this can be made possible. The other solution would be to increase convey of existing product lines. In the outcome of Bridgeton indus tries there is a need for a strategic shift to increase that demand. Continuing cost reduction initiatives are necessary, but a schema to differentiate Bridgetons products through quality, reliability, service, etc. could help increase demand and furthermore reduce the impact of excess capacity costs. Additionally if bran-new overhead pools are created, as we recommended above, management should set standards for the activity on each product line.This will help control variable costs and keep the lines accountable for their own expenses. Supplies and small tools should only be purchased as need and overtime hours should be kept to a minimum. Fixed costs are absorbed evenly by each line, but can still be reevaluated by management. For example, a fixed asset scrutinize can be performed to ensure that all assets that are being depreciated are truly in-service. Calculate the OH prises The 1987 overhead rate used in the study was 435% of direct labor dollar costs. Bridgetons actual r ate was 437% that year.Overhead rates for the remaining years are calculated below (OH / DL) As you can see the overhead rate for 199, which would be 752% without manifolds, is severely noisome to the company financially. Clearly the consulting firm did not factor in the fixed costs associated with production when recommending the outsourcing of the manifold production line. Our conclusion is to continue producing manifolds exhalation forward, and to adjust our cost reporting structure to better be able to analyze future strategic shifts such as outsourcing a product line.As a company if Bridgeton does not do a better commercial enterprise to understand the costs of the business, it will be very challenging to make the best business decisions in the long run. Calculations GM% = (Sales Direct substantive Direct Labor Overhead) / Sales result GM% = ( produce Sales Product DM Product DL Product Overhead) / Product Sales Product Overhead = Dept Overhead * DL Rate for product Product Costs = Direct Material + Direct Labor + Overhead DM Rate (Direct Material / entirety Direct Material) DL Rate (Direct Labor / Total Direct Labor)