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Assess the effect of each possible strategy on the overall profitability of the Company.
Assess the level of inventory that should be produced given the parameters from
outsourcing options with the least possible cost (obsolescence, storage, etc.)
production.
Seasonal demand
market.
for handbags.
OPPORTUNITIES
Club Monaco)
outsourcing.
THREATS
(i.e. customization)
Counterfeiting
market positioning, the brand associated with 442 McAdams products are not very well known
in the market.
Target Market
McAdams primary target market are women between the ages of 20 and 45. These women are
typically considered as young professionals and are capable and willing to spend slightly more
money for fashion items suited for their styles. With the price setting of the McAdam bags
(priced at the lower end of the luxury handbag market), the bags surely have attracted these
young professionals who are looking for their first real luxury fashion handbag. With the transfer
of the companys headquarters to Toronto, Ontario, Canada, this line of handbag may be
introduced to a larger market of women who would like to have a cheap top of the line luxury
bag.
Production Outsourcing
The transfer of the company headquarters from Calgary, Alberta to Toronto, Ontario, 442
McAdam recognized the possibility of an increased demand for the products. Due to the lack of
available resources to produce large volume of handbags (especially human resources), the
company would want to resort into outsourcing of the production of the bags from either a local
or an overseas manufacturer. This consideration, however, does not limit/prohibit the company
from hiring additional labor force to retain the production of the bags in-house to keep its design
secrets as secret.
Quantitative Considerations
Inventory Computations
Based on the case facts, the following are the projected demand and inventory requirements for
the Fiscal Years 2016 and 2017:
2016
Retail store sales (12 stores x 8 bags x 2 seasons)
Online sale
Total Projected Demand
192
24
216
2017
(@ 150% of 2016)
288
36
324
5
4
2
40
Given that the company desires a minimum total number of design volumes of 40 per year, and
each manufacturer requires a minimum order quantity per design, the following will be the
projected minimum order quantity per annum for each producer:
Local
Overseas
Manufacturer
40
10
400
Manufacturer
40
50
2,000
Based on this order requirement, the following are the projected order balances and ending
balances per year under the assumption of each manufacturer:
Beginning inventory
Minimum order
Units available for sale
Sale
Ending inventory
Local Manufacturer
2016
2017
0
184
400
400
400
584
216
324
184
260
Overseas Manufacturer
2016
2017
0
1,784
2,000
2,000
2,000
3,784
216
324
1,784
3,460
Looking into this computation, making orders through overseas manufacturer would cost the
company large carrying cost and would cost larger losses on the part of the entity given the
expected demand.
Contribution Margin Under Each Production Outsourcing Strategy
The following shall be the estimated contribution margin for both retail store and online sale in
case the production shall be outsourced locally and overseas:
Local Manufacturer
Retail Store
Online
$ 198
$ 440
120
120
$ 78
$ 320
Sales Price
Production Cost
Contribution Margin
Contribution Margin Ratio
39.39%
72.73%
Overseas Manufacturer
Retail Store
Online
$ 198
$ 440
80
80
$ 118
$ 360
59.60%
81.82%
Thus, in case unit sales will be attained as projected, the following total contribution margin will
be expected per year:
Selling Price
Cost
Contribution
Margin per unit
Demand (in
units)
Outsource to Local
Manufacturers
2016
2017
Retail Onlin Retail
Store
e
Store Online
198
440
198
440
120
120
120
120
Outsource to Overseas
Manufacturers
2016
2017
Retail
Retail
Store Online Store Online
198
440
198
440
80
80
80
80
78
320
78
320
118
360
118
360
192
24
288
36
192
24
288
36
Projected
Contribution
Margin
14,976
Total CM
7,680
22,464
22,656
11,520
22,656
33,984
8,640
33,984
31,296
12,960
46,944
Due to the fact that the overseas manufacturers charge smaller production cost than the local
manufacturers, the contribution margin will be larger when production is outsourced through
them compared when the production is locally outsourced. Thus, setting other things aside, it can
be inferred that the production shall be better when outsourced overseas than locally.
However, due to the order requirement of the manufacturers and the seasonality of the bag
designs, the tendency for excess orders that will not be sold at the original price should be
considered. The following table summarizes the effects of excess orders on the Companys
profitability assuming the scenario that such excess orders is sold at 95% of cost:
Excess Orders
Discounts on
excess orders
(5% of cost)
Loss on sale
at below cost
Local Manufacturer
2016
2017
Overseas Manufacturer
2016
2017
184
76
1,784
1,676
6.00
6.00
4.00
4.00
1,104
456
7,136
6,704
Finally, we compute the projected 2-year margins net of expected discounts due to excess orders
for local and overseas manufacturers:
Local manufacturers
Overseas manufacturers
56,640
78,240
(1,560)
(13,840)
55,080
64,400
Note that in spite of the larger figures for expected excess orders and an assumption of sale at
below cost (95% of cost), contribution margin figures are higher if production is outsourced to
overseas manufacturers.
IV. ALTERNATIVE COURSES OF ACTION (ACOAs)
ACOA #1 Outsource production of bags from local manufacturers only. Increase market
share through intensifying marketing campaigns of the products online via social media
advertisements and other internet platforms.
Pros:
There is a more likely possibility that a repeat order of each color of the design can be
made compared to the overseas production.
Risk and time associated with the shipment of products can be reduced.
Easier monitoring since the Proprietor can access the production sites
Increased marketing can bring increased awareness of the products especially to the
companys target market members.
Allows the Proprietor to focus more on marketing the products and creating new designs
Cons:
Higher production costs are charged to the company than international manufacturers,
thus leading to a lower contribution margin per unit.
ACOA #2 - Outsource production of bags from overseas manufacturers only. Partner with
more boutiques for a larger market of the bags. Enter into a contract with the distribution
channels that enables an automatic sale of the products to the boutique within a specific
period (say, three months after initial delivery of the bag).
Pros:
The cost of production charged is low, enabling a higher unit contribution margin for
every product sold.
In the long run when the companys market is already well established and its brand is
already well known, the overseas outsourcing will enable large profit for the company
(i.e. long-run approach)
The payment terms of net 60 enables the company to use the cash intended for payment
of production cost to be invested initially into a profitable short-term financial
investments within the given time period.
Allows the Proprietor to focus more on marketing the products and creating new designs
Cons:
High order requirements for the manufacturers can lead to excessive inventory orders.
Due to the seasonality of the designs, there is the possibility that such excess orders will
be sold at cost or even at below cost.
It would be timely for the Proprietor to look for qualified and trusted manufacturers
overseas since the Companys brand is not yet well-established in the global market.
May result to a high contribution margin considering that the cost of labor (standard five
hours per unit, thus resulting to a labor cost of $56.25 in 2016 and $57.00 in 2017 per
unit) plus a specific amount for materials costs, would be expectedly lower compared to
the cost of local producers and probably even that of the overseas manufacturers.
More controlled inventory levels can be attained, as production can be done using a justin-time approach.
The Proprietor can more carefully monitor the quality of the handbags.
The uniqueness and intricacy of the design of the handbags will be preserved since there
will be no need to reduce the design seams which outsourcing would require.
Cons:
The company will be responsible for the training and other more requirements for
employment by the direct laborers.
Additional employee accommodations, like desk, chair and other working materials.
May lead to exhaustion to both the Proprietor and the hired laborers and production
bottlenecks as demand further increases.
Laborers may demand higher pay, and if such is not provided, it can lead to work
dissatisfaction which would affect efficiency and quality of production
The opportunity of widening the market scope of the brand through outsourcing
production is foregone.
V. RECOMMENDATION
ACOA #1 Outsource production of bags from local manufacturers only. Increase market
share through intensifying marketing campaigns of the products online via social media
advertisements and other internet platforms.
Rationale
Local manufacturers
Overseas manufacturers
56,640
78,240
(1,560)
(13,840)
55,080
64,400
Another factor that must be considered is the number of local manufacturers available and the
terms of the contract between the manufacturers and the Proprietor. There must be a sufficient
number of local manufacturers to cater to the demand on a continuous basis. Also, the terms of
the contract should make it clear to the parties the nature and timeframe of the supplier
agreement.