Case Study: Decision Analysis

TO MANUFACTURE OR NOT TO MANUFACTURE — WHICH LOCATION?

Larry Ming has been hired to conduct a thorough analysis of Aurora, a midsize clothing company. For the past decade, Aurora has outsourced their manufacturing process to a contract manufacturer in Honduras. Given their global supply chain that Aurora has developed, they are considering if they should vertically integrate into manufacturing their own clothing and if so, where to locate their manufacturing facility.

In the textile industry, the trend has been to locate manufacturing facilities in low wage countries since the labor content to produce the finished product is significant. As a result, Mr. Ming has narrowed his alternatives for manufacturing locations to Taiwan, Nepal, or Mexico. However, he is not ruling out the option to continue to outsource manufacturing (in Hounduras).

Major determinants of whether or not to integrate the manufacturing process is labor costs and economic stability in potential locations. Regardless of the location, opening a manufacturing facility will require a significant initial investment with an estimated annual mortgage payment of approximately $1.4 million dollars. In addition, given the sales forecasts for the coming years, Aurora estimates that they will need at least 400,000 labor-hours per year.

Outsourcing the manufacturing process has both pros and cons which need to be considered. While Aurora does not need to be concerned about the daily processes and issues at the manufacturing facility in Honduras (managing employees, machine breakdowns, etc.), it frequently is confronted with unexplained delays in fulfilling orders that are beyond their control. Currently, Aurora spends $4,300,000 a year manufacturing through the contract manufacturers.

The three possible locations for opening a manufacturing facility have various costs and benefits that need to be considered. In Taiwan, the average hourly wage would be dependent on the economic conditions, there is a 50% chance that average hourly wages will remain at the current rate of $5.65 per hour. However, given the economic growth in that country, there is a 30% that average wages will increase to $5.85 per hour and a 20% that average wages will increase to $6.00 per hour. In addition to labor costs, overhead costs in Taiwan will be an additional $40,000 per month.

In Nepal, the average hourly wage would also be dependent on the economic conditions, there is a 30% chance that average hourly wages will remain at the current rate of $6.60 per hour and a 70% that average wages will increase all the way to $7.20 per hour. The overhead costs in Nepal will be only be $40,000 for the entire year.

In Mexico, the economic conditions are not expected to affect wages. The average hourly wages will remain at the current rate of $4.90 per hour. In addition, overhead costs in Mexico will be an additional $70,000 per month. Use this information, to advise Aurora whether or not they should integrate into manufacturing and if so, where should they locate their manufacturing facility?

Use this information, to advise Aurora on their decision. Prepare an Executive Summary report (approximately 1 to 2 pages (plus appendices) and include the following sections) that summarizes your findings and recommendations. Be sure to include the following in your report: 1. (20 points) Case Synopsis (include a brief summary of the case and the business issue(s)being

studied)

2. (40 points) Methodology (including a discussion of what information was provided and how you used this information to analyze the problem) (a) Organize the available data on cost, revenue, and probability estimates in a table. (b) Draw and solve the decision tree that shows the logical sequence of the decision problem.

You may either draw out the decision tree using the drawing tools in Word/PPT or you may use TreePlan to enter the problem into Excel. Be sure to label all branches.

3. (20 points) Findings and Conclusions (include summary of analysis results) Based on your

analysis, respond to the following: (a) Provide a recommendation for Aurora including their decision to continue to outsource or

vertically integrate the manufacturing and if so, which location. Included the expected return/cost for the decision.

(b) SENSITIVITY ANALYSIS 1: If the annual mortgage payment was $1.6 million dollars, would your decision change? If so, how?

(c) SENSITIVITY ANALYSIS 2: If Nepal’s economic condition seems to improve and there is now a 60% chance that the current hourly wage will remain constant, would your decision change? If so, how? (assume annual mortgage rate of $1.4 million dollars).

4. (20 points) Recommendations. For your management perspective, what other factors (not

included in the model) need to be considered in making the recommendations? Do you agree with the decisions from your quantitative analysis? Why or why not.