Ace Automotive, a manufacturer of automobile parts, was in a difficult situation in early March 1991. Bruce McCullough, president of the company and plant manager of its Missouri plant, had to deal with capacity restrictions in the foundry. However, some attractive alternatives could solve the company’s short- and long-term problems. One of these alternatives was a new contract with Laclede Gas Company, a utility serving the St. Louis metropolitan area, which needed 18,000 large fittings for its construction projects. The idea of doing business with Laclede was good for both the short and long term because it would make the company less reliant on business cycles. The fittings were thought to cost $27.46 to make, which included $12.87 for fixed-cost allocation. Laclede and Ace had tentatively agreed on a selling price of $31.57 per unit. After full manufacturing costs and 4% SG&A, Ace would earn a profit margin of 11% on the contract. Ace had until May 1, 1991, to make a firm commitment to Laclede.
Another option was to give a quote for the HV6 contract using two-cavity dies on the 400- and 500-ton presses. These presses did not currently have the capacity available to handle the contract, but capacity could be found if Ace did not renew its contract with Chrysler. Ace had been working on the Chrysler job for a few years, and each year’s estimates were very close to what was actually bought. For 1992, the Chrysler volume was estimated to be 100,000 units at a selling price of $12.55 per unit, which included $2.15 per part in allocated fixed overhead, a 4% markup for SG&A, and an 8% profit margin.
In Exhibit 2, there is also an estimate of how much it will cost to make the HV6 water pump for the 400-ton and 500-ton presses. This estimate was higher than for production on the 800 and 1,000-ton presses primarily because only 2-cavity dies (instead of 4) could be used on the smaller presses. While the finished part would be identical using either of the dies, the longer unit cycle times for parts produced on the 2-cavity dies would consume added labour and variable overhead and draw a larger allocation of fixed overhead.
Using the 400-ton and 500-ton presses to make the HV6 water pumps would probably take extra time. In the past few years, the St. Peters plant had operated without planned overtime, and McCullough believed that the no-overtime discipline had been good for the plant. There was still a chance that in-house foundry capacity could not handle 1-V6 volumes. As a last resort, however, McCullough knew that he could outsource some other casting work.
If a 400- or 500-ton press was needed, a bracket would be sent to GM’s Buick-Oldsmobile-Cadillac Group. This part would be bought from a third party. Outsourcing the bracket castings would result in a variable-cost penalty of $4.00 per part. So, there would be an extra $200 in variable costs for every standard hour of capacity needed that was more than what the 400- and 500-ton presses could handle.
If an 800- or 1,000-ton press capacity was needed, a water-pump casting for Ford could be outsourced. The variable-cost penalty for outsourcing this casting was estimated to be $10.00 per part. McCullough had to carefully consider the alternatives and their costs before making a decision.
In the end, Ace Automotive had problems with its foundry’s capacity, but it also had some good options. One of these alternatives was a new contract with Laclede Gas Company.
