The Donley Brothers Company had encountered the problem of latent defects in some of its purchased castings. Being latent, the defects did not show up until after machining had taken place at Donley Brothers. This group of failures greatly irritated the manufacturing boss, who declared that "repairing those darn castings is eating up all our profits."
When the defects were discovered, the rough casting had to be taken off the machine, the defect chipped out and repair-welded, and the casting re-machined when possible. Even with this process, almost 12 percent of the incoming castings ended up as scrap. Actually, 1,140 raw castings had to be purchased and machined in order to produce 1,000 good machined ones. The raw castings cost $600 each from either of two suppliers. Worse than the costs associated with rework and high scrap rates were the continual changes in production scheduling necessitated by a machined casting not being available as scheduled. These changes were costly because they required shop personnel to tear down the job they were working on and set up a new job. Marketing was constantly complaining about the firm's inability to meet delivery commitments for the finished machinery that incorporated the castings. Marketing claimed that many sales were lost as a result of this failure.
George Donley, the production manager, and Terry Donley, the vice president for marketing, asked Bob Donley, the supply manager, to investigate the costs involved in supplying finished machined castings. If finished castings were purchased, the responsibility for finding hidden defects would be that of the supplier. Such action would encourage the supplier to improve the casting quality. Donley Brothers would accept and pay only for finished, usable castings.
The internal cost of machining each incoming rough casting and repair welding and re-machining it, as necessary, was approximately $312 per casting. This figure included $156 of direct labor and $156 of overhead. The accounting department estimated that overhead, which was 100 percent of direct labor, consisted of 50 percent variable and 50 percent fixed costs. No estimate was available on the cost of disrupted production schedules and operations.
Bob approached all his major suppliers of castings in an attempt to generate interest for the supply of finished machined castings. Only one supplier, Akron Foundry, showed genuine interest. Of major concern to all the foundries was the $120,000 to $160,000 investment necessary to set themselves up to machine the raw castings. Akron was willing both to invest in the necessary machines and to guarantee delivery of up to 150 units per month-provided Donley Brothers would contract with it as a sole source for the castings for the next three years. The price per casting would be $1,000 the first year, with an annual increase or decrease in price tied to an appropriate economic index.
Bob was faced with the problem of deciding whether to recommend contracting with Akron Foundry for finished castings, continue as in the past buying rough castings, or developing a more attractive alternative. The Donley machine shop was currently operating at 90 percent of capacity, but it was not possible to make a reliable estimate of what would happen in the next few months, let alone the next three years. The decision of whether to buy finished castings was of major dollar importance to Donley Brothers because the firm used at least 1,000 finished castings per year and anticipated that this usage would continue for each of the next five years
As a consultant for DONLEY BROTHERS, you are required to assess the aspects of Purchasing & Procurement Management and use your own assumptions to answer the following questions:
QUESTION 1
(a) Would there be any dollar savings by contracting with Akron Foundry if the Donley Brothers' machine shop were operating at full capacity?
(b) What are the dangers involved if Akron Foundry becomes a single source for Donley Brothers' castings
QUESTION 2
(a) Who is responsible for the make-or-buy decision?
(b) What other suggestions can you make for improving the situation at Donley Brothers