case study

INFO 300

Southwest Airlines Team Assignment: Inventory Management

MAKE OR BUY DISPOSABLE EARPHONES

Southwest Airlines distributes disposable earphone to customers on select flights. Up until now, SWA has been outsourcing the production of these earphones. SWA is considering purchasing a manufacturing facility in Texas called Southwest Goods to support their core business functionality where they can produce food containers, uniforms, safety equipment, and possibly earphones. Kal Fisher’s team needs to determine whether or not they should consider producing the earphones in-house at this manufacturing Southwest Goods facility. However, there are many factors to consider.

Based on historical data, the forecasted annual demand for the disposable earphones is 19750 units. The SWG’s manufacturing plant will operate 50 weeks per year.

SWG's financial analysts have established a cost of capital of 14% on the use of funds for investments within the company. In addition, accounting information shows that a total of 9% of costs were spent on taxes and insurance related to the company's inventory. It has been estimated that another 2.5% was lost due to inventory shrinkage, which included damaged goods as well as pilferage. Finally, 4.5% was spent on warehouse overhead, including utility expenses for heating and lighting.

An analysis of the purchasing operation shows that approximately two hours are required to process and coordinate an order for Southwest Airlines regardless of the quantity ordered. Purchasing salaries average $26 per hour, including employee benefits. In addition, a detailed analysis of 125 orders showed that $5375 was spent on telephone calls, e-mails, paper, and postage directly related to the ordering process.

Currently the company has a contract to purchase the disposable earphones from a supplier at a cost of $0.44 per unit. However, with the opening of the Southwest Goods manufacturing facility, Southwest Airlines will now have the capacity to produce support items themselves. As a result, Southwest Goods is considering the alternative of producing the disposable earphones itself.

Forecasted utilization of equipment shows that production capacity will be available for the earphones being considered. The production capacity is available at the rate of 1000 sets of earphones per week. It is felt that with a short lead-time, schedules can be arranged so that the disposable earphones can be produced whenever needed. Production costs are expected to be $0.41 per pair of earphones.

A concern of management is that setup costs will be significant. The total cost of labor and lost production time is estimated to be $75 per hour, and it will take a full 5-hour shift to set up the equipment for producing the earphones.

Requirements:

Develop a one page executive report for Southwest Airlines management that will address the question of whether the company should continue to purchase the earphones or produce the earphones in-house at Southwest Goods manufacturing. Include the following factors in your report:

a. Findings and Conclusions (include responses to the following)

i. Clearly define the holding cost (h), ordering cost (S) (when ordering from supplier), and set-up cost (S) (when producing the part) for each scenario (ie. Make and Buy).

ii. Develop an inventory policy (how many earphones to order and how frequently) for the following two alternatives (a) ordering a fixed quantity Q from the supplier or (b) ordering a fixed quantity Q from in-plant production. Be sure to include the (1) Optimal quantity Q* and (2) the total annual cost for each option.

iii. Sensitivity Analysis : Would the decision change if production costs increase by just $0.02 per pair of earphones? If so, how?

b. Recommendation (based on your analysis, which option do you recommend? Why?)

i. Make a recommendation as to whether Southwest Airlines should purchase or manufacture (at Southwest Goods) the disposable earphones. What is the savings associated with your recommendation as compared with the other alternative? Besides the differences in cost, what other factors need to be considered? (MAKE SURE TO PROVIDE A THOROUGH DISCUSSION)

c. Appendix (this should include a summary table of the costs for each option)

This is team assignment – you must work with your assigned team partner.

Please show all calculations. You may want to use the Equation Writer (under Symbols ribbon) in MS Word.