Make vs. Buy; Strategy GianAuto Corporation manufactures parts and components for manufacturers and suppliers of parts for automobiles, vans, and trucks. Sales have increased each year based, in part, on the company’s excellent record of customer service and reliability. The industry as a whole has also grown as auto manufacturers continue to outsource more of their production, especially to cost-efficient manufacturers such as GianAuto. To take advantage of lower wage rates and favorable business environments around the world, GianAuto has located its plants in six different countries. Among the various GianAuto plants is the Denver Cover Plant, one of GianAuto’s earliest plants. The Denver Cover Plant prepares and sews coverings made primarily of leather and upholstery fabric and ships them to other GianAuto plants, where they are used to cover seats, headrests, door panels, and other GianAuto products. Ted Vosilo is the plant manager for the Denver Cover Plant, which was the first GianAuto plant in the region. As other area plants were opened, Ted was given the responsibility for managing them in recognition of his management ability. He functions as a regional manager, although the budget for him and his staff is charged to the Denver Cover Plant. Ted has just received a report indicating that GianAuto could purchase the entire annual output of Denver Cover from suppliers in other countries for $50 million. He was astonished at the low outside price because the budget for Denver Cover Plant’s operating costs for the coming year was set at $82 million. He believes that GianAuto will have to close operations at Denver Cover to realize the $32 million in annual cost savings. Denver Cover’s budget for operating costs for the coming year follows:
Additional facts regarding the plant’s operations are as follows: • Due to Denver Cover’s commitment to use high-quality fabrics in all its products, the purchasing department placed blanket purchase orders with major suppliers to ensure the receipt of sufficient materials for the coming year. If these orders are canceled as a result of the plant closing, termination charges would amount to 15% of the cost of direct materials. • Approximately 400 plant employees will lose their jobs if the plant is closed. This includes all direct laborers and supervisors as well as the plumbers, electricians, and other skilled workers classified as indirect plant workers. Some would be able to find new jobs, but many would have difficulty doing so. All employees would have difficulty matching Denver Cover’s base pay of $14.40 per hour, the highest in the area. A clause in Denver Cover’s contract with the union could help some employees; the company must provide employment assistance to its former employees for 12 months after a plant closing. The estimated cost to administer this service is $1 million for the year. • Some employees would probably elect early retirement because GianAuto has an excellent plan. In fact, $3 million of the 2019 pension expense would continue even if Denver Cover were closed. • Ted and his staff would not be affected by closing Denver Cover. They would still be responsible for managing three other area plants. • Denver Cover considers equipment depreciation to be a variable cost and therefore uses the unitsof-production method to depreciate its equipment. The company uses the straight-line method to depreciate its building
Required 1. Explain GianAuto’s competitive strategy and how this strategy should be considered with regard to the Denver Cover Plant decision. Identify the key strategic factors that should be considered in the decision. 2. GianAuto Corporation wants you to prepare an analysis of whether to close the Denver Cover Plant. Specifically, what is the estimated year 1 cost savings associated with closing the plant (i.e., purchasing from an external supplier)? State your answer in thousands (000s), with the final answer rounded to the nearest thousand. 3. Supplement the financial analysis in requirement 2 with a consideration of global competition and GianAuto’s competitive strategy.