Question:
Lowry Locomotion receives an offer from a local plastic injection molding company to take on the basic fabrication of its toy racing car production line, though Lowry would still have to paint and package the cars. The offer is to provide Lowry with the cars at a price of $5.00 each. Lowry's variable cost of producing the cars (not including paint and packaging) is $3.50, while an ABC analysis at the product line level reveals that the overhead cost is $2.25 per car. Thus, Lowry's full cost per car is $5.75.
It appears that Lowry can save $0.75 per car by outsourcing the plastic molding work. However, the savings only applies if Lowry eliminates the overhead associated with the product line, which involves terminating the production manager and two maintenance technicians, selling off three plastic injection molding machines, and sub-leasing the space in which the product line is currently located. Doing so also eliminates Lowry's ability to ever bring the work back in-house.
Given the strategic implications of completely dismantling the production line and putting the company at the mercy of outside suppliers, Lowry's president elects to forego the $0.75 per unit savings, and rejects the supplier's offer.