Birdgeton Case
Memorandum
To: Mike Lewis
From: Overseas Consulting Group
Date: December 9th 1990
Subject: Manifolds Retention vs. Outsourcing Analysis
Our team of financial analysts has taken an in depth look at the consultant’s recommendation to potentially outsource the manifold production line. Through our analysis you will see that the consultants have not considered the full financial impact that this outsourcing would have on the company. This is likely because the recommendation has not taken into consideration the range of costs affecting Bridgeton industries. Through our analysis it becomes clear that the decision to retain the manifold production 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 various analyses of Bridgeton Industries Costs. Please refer to the attached excel file for detailed analysis of the numbers.
We know that Bridgeton uses an absorption costing system which does not easily distinguish between fixed and variable costs. The problem with that system makes it very challenging to forecast appropriately the cost of excess capacity and furthermore the impact of outsourcing the manifold production line. Therefore the reported costs are not appropriate for this type of analysis. Our team began our own analysis of the costs to evaluate the recommendation. We began by calculating gross margin for each product, by first identifying how much overhead should be allocated to each category. We broke out the overhead by using Direct Labor (DL) as a % since most of the overhead accounts are labor related. As a result, overhead allocation 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, so under this method, they bear a higher percentage of the overhead costs. Now that Bridgeton stopped producing
To: Mike Lewis
From: Overseas Consulting Group
Date: December 9th 1990
Subject: Manifolds Retention vs. Outsourcing Analysis
Our team of financial analysts has taken an in depth look at the consultant’s recommendation to potentially outsource the manifold production line. Through our analysis you will see that the consultants have not considered the full financial impact that this outsourcing would have on the company. This is likely because the recommendation has not taken into consideration the range of costs affecting Bridgeton industries. Through our analysis it becomes clear that the decision to retain the manifold production 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 various analyses of Bridgeton Industries Costs. Please refer to the attached excel file for detailed analysis of the numbers.
We know that Bridgeton uses an absorption costing system which does not easily distinguish between fixed and variable costs. The problem with that system makes it very challenging to forecast appropriately the cost of excess capacity and furthermore the impact of outsourcing the manifold production line. Therefore the reported costs are not appropriate for this type of analysis. Our team began our own analysis of the costs to evaluate the recommendation. We began by calculating gross margin for each product, by first identifying how much overhead should be allocated to each category. We broke out the overhead by using Direct Labor (DL) as a % since most of the overhead accounts are labor related. As a result, overhead allocation 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, so under this method, they bear a higher percentage of the overhead costs. Now that Bridgeton stopped producing