Question:
EXTERNAL LINKAGES, ACTIVITY-BASED SUPPLIER COSTING
Aldredge Company manufactures dental equipment. Aldredge produces all the components necessary for the production of its product except for one. This component is purchased from two local suppliers: Grayson Machining and Lambert, Inc. Grayson sells the component for $144 per unit, while Lambert sells the same component for $129. Because of the lower price, Aldredge purchases 80 percent of its components from Lambert. Aldredge purchases the remaining 20 percent from Grayson to ensure an alternative source. The total annual demand is 1,000,000 components.
Grayson's sales manager is pushing Aldredge to purchase more of its units, arguing that its component is of much higher quality and so should prove to be less costly than Lambert's lower-quality component. Grayson has sufficient capacity to supply all the components needed and is asking for a long-term contract. With a 5-year contract for 800,000 or more units, Grayson will sell the component for $135 per unit with a contractual provision for an annual product-specific inflationary adjustment. Aldredge's purchasing manager is intrigued by the offer and wonders if the higher-quality component actually does cost less than the lower-quality Lambert component. To help assess the cost effect of the two components, the following data were collected for quality-related activities and suppliers:
I. Activity data:
|
Activity
|
Cost
|
|
Inspecting components (sampling only)
|
$ 1,200,000
|
|
Expediting work (due to late delivery)
|
960,000
|
|
Reworking products (due to failed component)
|
6,844,500
|
|
Warranty work (due to failed component)
|
21,600,000
|
II. Supplier data:
|
|
Grayson
|
Lambert
|
|
|
Unit purchase price
|
$144
|
$129
|
|
|
Units purchased
|
200,000
|
800,000
|
|
|
Expediting orders
|
10
|
90
|
|
|
Sampling hours
|
20
|
980
|
|
|
Rework hours
|
90
|
1,410
|
|
|
Warranty hours
|
200
|
3,800
|
|
|
|
|
|
|
Required:
1. Calculate the cost per component for each supplier, taking into consideration the costs of the quality-related activities and using the current prices and sales volume. Given this information, what do you think the purchasing manager ought to do? Explain.
2. Suppose the quality control department estimates that the company loses $4,500,000 in sales per year because of the reputation effect of defective units attributable to failed components. What information would you like to have to assign this cost to each supplier? Suppose that you had to assign the cost of lost sales to each supplier using one of the drivers already listed. Which would you choose? Using this driver, calculate the change in the cost of the Lambert component attributable to lost sales.