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School of Innovation, Design and Engineering
Mälardalen International Master Academy (MIMA )
Master Program in Product and Process Development – Production and
Logistics Management
KPP231- Master Thesis Work, Innovative Production (Advanced
Level 30 hp)
Advisor: Sariya Sripipat
Supervisor: Sabah Audo
A Feasibility Study of Setting-Up New Production
Line – Either Partly Outsource a Process or Fully
Produce In-House.
Authors: Piansiri Cheepweasarash (740621-P180)
Sarinthorn Pakapongpan (780827-P188)
Abstract
This paper presents the feasibility study of setting up the new potting tray production line based on the two alternatives: partly outsource a process in the production line or wholly make all processes in-house. Both the qualitative and quantitative approaches have been exploited to analyze and compare between the make or buy decision. Also the nature of business, particularly SMEs, in Thailand has been presented, in which it has certain characteristics that influence the business doing and decision, especially to the supply chain management. The literature relating to the forecasting techniques, outsourcing decision framework, inventory management, and investment analysis have been reviewed and applied with the empirical findings. As this production line has not yet been in place, monthly sales volumes are forecasted within the five years time frame. Based on the forecasted sales volume, simulations are implemented to distribute the probability and project a certain demand required for each month. The projected demand is used as a baseline to determine required safety stock of materials, inventory cost, time between production runs and resources utilization for each option. Finally, in the quantitative analysis, the five years forecasted sales volume is used as a framework and several decision making-techniques such as break-even analysis, cash flow and decision trees are employed to come up with the results in financial aspects
Keywords: Outsourcing, decision making, inventory cost, SMEs, resource
utilization, break-even, cash flow, decision tree.
I
Table of Contents
ABSTRACT ............................................................................................................................................ I
ACKNOWLEDGEMENT ....................................................................................................................II
- CHAPTER 1: INTRODUCTION ......................................................................................................... TABLE OF CONTENTS III
- 1.1 BACKGROUND ................................................................................................................................
- 1.2 P ROBLEM I DENTIFICATION .............................................................................................................
- 1.3 P URPOSE OF S TUDY ........................................................................................................................
- 1.4 P RODUCT D ESCRIPTION ..................................................................................................................
- 1.5 P RODUCTION P ROCESS ...................................................................................................................
- 1.5.1 Process Mapping: Potting Trays ...........................................................................................
- 1.6 P ROJECT D IRECTIVES ......................................................................................................................
- 1.7 P ROJECT LIMITATIONS ....................................................................................................................
- CHAPTER 2: THEORETICAL BACKGROUND .............................................................................
- 2.1 F ORECASTING TECHNIQUES ............................................................................................................
- 2.1.1 Qualitative Methods...............................................................................................................
- 2.1.2 Quantitative Methods.............................................................................................................
- • Historical Projection or Time Series Methods ......................................................................
- • Causal Methods.....................................................................................................................
- 2.2 O UTSOURCING ................................................................................................................................
- 2.2.1 Definition of Outsourcing ......................................................................................................
- 2.2.2 The reason for outsourcing decision......................................................................................
- 2.2.3 Disadvantage of outsourcing ...............................................................................................
- 2.2.4 Methods to avoid the problem of outsourcing......................................................................
- 2.2.5 Outsourcing decision framework .........................................................................................
- • A composite outsourcing decision .......................................................................................
- • A conceptual Framework for evaluating the make or buy decision ....................................
- 2.3 I NVENTORY ...................................................................................................................................
- 2.3.1 Role of Inventory..................................................................................................................
- 2.3.2 Type of Inventory .................................................................................................................
- 2.3.3 Inventory Cost......................................................................................................................
- • Non-instantaneous Replenishment ......................................................................................
- 2.3.4 Inventory Control System.....................................................................................................
- • Independent Demand...........................................................................................................
- • Dependent Demand .............................................................................................................
- 2.4 F EASIBILITY S TUDY AND I NVESTMENT A NALYSIS ........................................................................
- 2.4.1 Feasibility Study...................................................................................................................
- 2.4.2 Investment Analysis..............................................................................................................
- • Cash on cash return ............................................................................................................
- • Payback Period ...................................................................................................................
- • Internal Rate of Return........................................................................................................
- • Net Present Value................................................................................................................
- CHAPTER 3: EMPIRICAL STUDY..................................................................................................
- 3.1 S ALES F ORECAST ..........................................................................................................................
- 3.1.1 Annual Sales Forecast: Linear Regression..........................................................................
- 3.1.2 Monthly Sales Forecast: Seasonal Patterns.........................................................................
- 3.1.3 Forecast Accuracy ...............................................................................................................
- 3.2 A N O VERVIEW OF BUSINESS IN T HAILAND : S MALL AND MEDIUM E NTERPRISE (SMES )..............
- 3.2.1 SMEs Definition by Thai Government .................................................................................
- 3.3 P REVIOUS OUTSOURCING ..............................................................................................................
- 3.3.1 Stage one: Define the core activities of the business ...........................................................
- 3.3.2 Stage two: Profile the appropriate value chain links...........................................................
- 3.3.3 Stage three: Total cost analysis of core activities................................................................
- 3.3.4 Stage four: Analysis of potential suppliers for partnership .................................................
- 3.4 I NVENTORY A PPLICATION ............................................................................................................
- 3.4.1 Sales Forecast and Demand Simulation ..............................................................................
- 3.4.2 Inventory Cost......................................................................................................................
- • Inventory Carrying cost.......................................................................................................
- • Setting-Up Cost ...................................................................................................................
- 3.4.3 Ordering Quantity (Lot-Sizing)............................................................................................
- 3.4.4 Time between Production Runs (TBP) and Resources Utilization.......................................
- CHAPTER 4: ANALYSIS AND RESULT.........................................................................................
- 4.1 Q UANTITATIVE A NALYSIS : D ECISION-M AKING TECHNIQUES ......................................................
- 4.1.1 Break-Even Analysis: Make or Buy .....................................................................................
- 4.1.2 Cash Flow Analysis..............................................................................................................
- 4.1.3 Decision Tree Analysis.........................................................................................................
- 4.2 A GGREGATE A NALYSIS AND R ESULT ...........................................................................................
- CHAPTER 5: CONCLUSIONS AND RECOMMENDATIONS.....................................................
- REFERENCES .....................................................................................................................................
- APPENDIX ...........................................................................................................................................
produce, not only the company has to pay for the creation of new mold but also the suppliers would have the mold for that product. Though these plastic manufacturers whom the company outsource is closed to the company’s business market, yet they in different industry, they can produce the products using the company’s mold and supply it to other customers, becoming the company’s direct competitors. This issue triggers the company to reconsider soberly in acquiring back the production of potting trays in-house.
1.2 Problem Identification
Current situation of outsourcing the whole potting tray production line gives some threats to KT Plastics rather than opportunities. Deciding to backsource the whole production line, with limited resources, the company needs to thoroughly identify the core process of this production line and make sure to keep this process to be performed in-house. However, for the other non-core processes, the company also needs to evaluate the option of outsourcing and in-house making to see which one would offer the best opportunity. The two options the company is considering are as followed:
- Option 1: Company would invest in the thermoforming machine while buying plastic sheets from supplier (partly outsource).
- Option 2: Company would manufacture everything in-house by investing in the sheet extrusion machine and thermoforming machine.
1.3 Purpose of Study
The aim of this study is to help KT Plastics to achieve an effective decision making with regard to the setting up of new potting tray production line, providing both qualitative and quantitative aspects to consider. Since the company decides to invest in this vacuum forming machine (core process), they want to make the most out of their investment. Therefore, the company wants us to perform the feasibility study of establishing the new production line of potting tray, evaluating whether manufacturing all production processes in-house or partly outsourcing a process would be more efficient and yield a better profit.
1.4 Product Description
The plastic potting tray is made by the plastic type PS (polystyrene). The potting tray is used in the agriculture field to grow seeds before planting into the land field. With the dimension of 55cm x 36cm x 70 micron and weight 160 gram, a tray can have different number of holes, yet the potting tray with 72 holes and 104 holes is widely used and highly demanded in the market.
1.5 Production Process
The production line of potting tray consists of two sub-production processes, in which each process will be contained in a production cell that can be separated from each other. There are two main machines used in the potting tray production line; one is the sheet extrusion machine and the other is thermoforming machine.
Sheet extrusion machine
Thermoforming machine
As illustrated in the process mapping, the production of potting tray starts with mixing Polystyrene (PS) plastic with mater batches: black color in the mixing machine. This process will take approximately 15 minutes. When the mixture is ready, mixed plastics will be taken out and put into sheet extrusion machine. Then, the extrusion machine will process plastics into a roll of plastic sheet. In this step, it can process 140kg of plastics per an hour, depending on the capacity of machine. After that, a roll of plastic sheet will be taken to a station of thermoforming machine and some of the plastic sheet rolls will be kept in the inventory, waiting to be processed further in the thermoforming machine. At the thermoforming station, a staff will feed plastic sheet into thermoforming machine, processing to be potting tray with the cycle time of approximately 75 seconds per two trays. Then, this potting tray will pass through the process of edges trimming and holes punching, finally, to the packing process with 100 trays per box and ready to be delivered.
Among the production processes of this product line, thermoforming machine is considered as the company’s core competency since forming plastic sheet into shape requires molds. The variation of the product in this production line depends on molds, for example 104 holes potting tray and 72 holes potting tray requires different set of molds whereas these products use the same type of plastic sheet to feed into thermoforming machine.
1.6 Project Directives
As KT Plastics has to decide between the two options of partly outsource or wholly- produce in-house the potting tray production line, the company has given certain conditions and requirements to use as a scope for this study. Expecting to have a return on investment within five years and the total production cost of product should not exceed the current price of buying from supplier or at least the company should be able to sell to its customers at the same selling price and is still profitable, thus, this study of feasibility is set the timeframe to be within five years. Given a few years historical sales data, five years sales forecast of potting tray is developed to use as framework to compare and evaluate between the two options.
1.7 Project Limitations
Our study present the solution based on the maximum production time available, three working shifts, and the optimism of market trend. Since the production line has not yet been in place, there might be unforeseen circumstances emerging such as unplanned stop-time, machine break-down, market fluctuation, changes in government policy, level of competition, etc., when the actual production line has been setup, thus deviate the result from what has been analyzed and presented. Due to different time zone and location between the company and the authors, there is a difficulty in gathering some data and information from both the suppliers and the company.
Chapter 2: Theoretical Background
2.1 Forecasting Techniques
Forecasting demand levels is essential to the firm as a whole as it provides the basic inputs for the planning and controlling the use of limited resources in all functional areas (Ballou, 2004). The objective of forecasting is to develop a useful forecast by applying information at hand with the forecasting technique that best fit the different pattern of demand, such as spatial/ temporal demand, lumpy/ regular demand, and derived/ independent demand. Forecasting methods are categorized into two types: qualitative and quantitative methods.
2.1.1 Qualitative Methods
Qualitative or judgment methods are those that use intuition e.g. management or expert opinions, surveys, or comparative techniques to produce quantitative estimates about the future. The available information relating to the forecasting factors are nonquantitative and subjective (Ballou, 2004). Judgment method is useful when there is inadequate historical data. Due to the nature of the nonscientific methods, it makes them difficult to standardize and validate for accuracy. However, in some cases like predicting the success of new products, government policy changes, or the impact of new technology, judgment methods are the only practical way to make a forecast. It can be used to modify the forecast that generated by quantitative methods to anticipate the special events so as to reflect and give a more reliable forecasts and to adjust the historical data that will be analyzed with the quantitative method in order to minimize the impact of special events that occurred in the past. Qualitative or judgment methods are likely to be the choice for all time horizons of forecasting: short term, medium term and long term.
2.1.2 Quantitative Methods
Quantitative methods include historical projection methods or time series models and causal methods. They rely heavily on historical information to predict or project the future demand.
- Historical Projection or Time Series Methods
When an adequate amount of historical data is available and the trend and seasonal patterns in the time series are stable and well defined, projecting these data into the future can be an effective way of forecasting for the short-term.
2.2 Outsourcing
The management of an outsourced process is fundamental for the future growth of a firm (Fine and Whitney, 1996; Ruffo, Tuck and Hague, 2007). Outsourcing is the act of transferring the work to an external party. Whether or not to outsource is the decision of whether to make or to buy. Organizations continuously face with the decision of whether to expand with existing to create an asset, resource, product or service internally or to buy it from an external party (Power, Desouza and Bonifazi, 2006). Making the wrong decision for outsourcing can result in cost overruns, project delays, or solution that does not fit business needs.
2.2.1 Definition of Outsourcing
Fill and Visser stated that Hiemstra and van Tilburg (1993) define outsourcing as: subcontracting the custom-made articles and constructions, such as components, sub-assemblies, final products, adaptations and/or services, to another company.
According to Bendor-Samual (1998), outsourcing provides certain leverage that is not available to a company’s internal departments. This leverage may have many dimensions: economies of scale, process expertise, access to capital, access to expensive technology, etc. The combination of these dimensions creates the cost savings inherent in outsourcing.
Mylott (1995) views outsourcing in terms of full outsourcing, selective outsourcing, and everything-in-between outsourcing. Full outsourcing refers to the vendors who are in charge for all activities while, in selective outsourcing, the vendor provides services for one or a few activities such as payroll. Everything-in-between outsourcing is exactly to the meaning of its name.
Mornme (2001) indicates different sourcing strategies: make or buy, outsourcing, in-sourcing, and strategic sourcing.
Doing everything in-house might be manageable, but it is not always efficient. Outsourcing is an effective tool, and when exploits reasonably it can become a key factor for change, irrespective of whether the change is radical or incremental (Rebernik and Bradac, 2006). Outsourcing implies a business relationship between two parties: the outsourcing subject (also called the principal or the client) who makes the decision of whether to outsource or not; and an external outsourcing firm (also called the supplier or subcontractor) (Arnold, 2000). Outsourcing occurs when a company uses an outside firm to provide a necessary business function that might otherwise be done in-house. It is a strategic management tool for transferring part of the business process to another company; its aim is predominantly to make a company more competitive by enabling it to stay focused on core competencies (Rebernik and
Bradac, 2006). Gillley and Rasheed (2000) also point out that outsourcing occurs in two situations. First is when the client outsources activities that were originally sourced internally, resulting from a vertical disintegration decisions. Secondly, when the client sources activities that are within the client’s capabilities, and hence could have been sourced internally, although they have not been completed in-house in the past
The major distinction between outsourcing and subcontracting are when the outsourced activities are specific to the client. The outsourced activities must perform according to a plan, specification, form or design, varying detail, provided by the client (Webster et al., 1997). Hence, a firm buying an off-the- shelf, standardized component or a supplier’s proprietary part is not considered as outsourcing as no customization is performed for the buyer (Sousa and Voss, 2007).
2.2.2 The reason for outsourcing decision
Traditionally, buying by organizations had been done largely on the basis of obtaining the best price, exceptionally taking into account a few other factors such as quality and delivery (Mclvor and Humphreys, 2000). In general, there exist three main clusters of reasons driving the outsourcing decision – reducing cost, improving operational performance and developing competencies (Rebernik and Bradac, 2006). Beulen (1994) defined five drivers of outsourcing which are quality, cost, finance, core-business and cooperation (Fill and Visser, 2000). As well as, Winkleman et al. (1993) stated that there are two basic drivers behind the growth of outsourcing, cost reduction and a strategic shift in the way that organizations are managing their business. However, in many cases, the significant numbers of factors such as delivery reliability, technical capability, cost capability and the financial stability of suppliers were not taken into consideration (Dooley, 1995). Few organizations have taken a strategic view of make or buy decisions while many companies decide to buy rather than make for short-term reasons of cost reduction and capacity (Ford et al., 1993; Humphreys et al., 2000).
- Improved company focus : Outsourcing allows a company to focus on its core competencies by having operational functions assumed by an outside expert.
- Access to experts and specialists : Experts and specialists make extensive investments in technology, procedures, and people. Expertise can be gained by working with many clients who face similar obstacles. This combination of specialization and expertise gives customers a competitive advantage and helps them to avoid the cost of investment and training.
- Freeing of resources for other purposes : Every organization has the limitation on the resources availability. Outsourcing allows an organization to redirect its resources, most often people, from noncore activities toward strategic activities that serve its customers.
- Resources not available internally : Companies outsource because they do not have access to the required resources within the company. Outsourcing is a good alternative to build the needed capability from the beginning.
- Improved efficiency : To improve efficiency, a company must aim for dramatic improvements in critical measures of performance such as cost, quality, service, and speed. In some instances, the need to increase efficiency can directly conflict with the need to invest in the primary focus of the business. Outsourcing the non-core functions to a specialist allows the organization to realize the benefits of maximizing efficiency.
- Better control over difficult or complex functions : Outsourcing is a smart option for managing complex tasks. When a function is viewed as complex or out of control, the organization needs to examine the underlying causes. The organization must understand its own needs in order to communicate those needs to an outside provider.
- Reduced capital expenditures : There is an enormous competition within most organizations for capital funds. Deciding where to invest these funds is one of the most important decisions that top management makes. It is often difficult to justify secondary capital investments when primary departments compete for the same money. Outsourcing can reduce the need to invest capital funds in these secondary business functions.
- Reduced risk : Tremendous risks are associated with the investments an organization makes. All aspects of the environment—such as markets, competition, government regulations, financial conditions, and technologies—change rapidly.
- Asset infusion : Outsourcing often involves the transfer of assets from the customer to the provider. Equipment, facilities, vehicles, and licenses used in the internal operations have value and are sold to the supplier. Certain assets sold to the supplier reveal a win–win approach for both parties.
2.2.3 Disadvantage of outsourcing
Although there are many advantages to outsourcing, there are also a number of disadvantages. In some instances, advantages can become disadvantages, depending on the organization and the problems involved. Some organizations do not achieve the expected benefits from outsourcing, Lonsdale (1999) and Mclvor (2000) survey suggested that only 5 percent of companies achieved significant benefits from outsourcing. Fill and Visser (2000) also added that companies that continue to make sourcing decisions based solely on cost will eventually wither and die.
There is an initial tendency to overstate benefits and that the suppliers are likely to perform better in the beginning of the contract to make first good impressions (Schwyn, 1999). Lonsdale (1999) highlighted reasons for this: focusing from achieving short-term benefits; lacking of formal outsource decision-making processes, as well as medium and long-term cost benefit analyzed complexity in the total supply network. Anderson and Anderson (2000) identified three main problem that might occurs which are;
- The diffusion of secret information.
- The direct dependence on suppliers; they can cause delays or other problems
- Losing the knowledge to integrate what has been outsourced, expanding in the long-term, costs of integration.
As quoted by Ashe (1999) in “Outsourcing relationships: why are they difficult to manage?” the research by InfoServer (1999) stated that the drawbacks of outsourcing include the following:
- No benefit from a drop in cost of work outsourced : In some industries, when a long-term contractual agreement ends, a drop in the cost of outsourcing work does not necessarily mean a lowering of the cost to perform the work internally.
- Problems occurring in the aftermath of layoffs/downsizing : Morale becomes a concern in the aftermath of some outsourcing deals. The remaining employees might have to work more extensively, struggling with problems such as meeting schedules, budget, and quality specifications while getting the same rate of pay.
- Outsourcing impeding the work of the organization : On rare occasions, organizations have experienced production delays caused by the outsourcing provider
- Managing long-term relationships : Several factors contribute to a not- so-perfect outsourcing relationship. The factors include (1) pricing and service levels, (2) differing buyer and supplier cultures, (3) lack of flexibility in long-term contracts leading to increased dissatisfaction, (4) both parties failing to make the most of the relationship at the expense of one another, (5) underestimating the time and attention required to manage the relationship or giving management responsibility to the vendor, and (6) lack of management oversight.
2.2.4 Methods to avoid the problem of outsourcing
Ruffo, Tuck and Hague (2007) suggested methods to avoid these problems include: Taking long-term view. Never outsource core capabilities. Prudently examine if any critical activities need to be outsourced, though only partially. If outsourcing is made on a critical function, use two or more suppliers, in order to maintain quality and price competition. However, this will also increase the opportunity of technology diffusion. Joint ventures.
2.2.5 Outsourcing decision framework
- A composite outsourcing decision
Figure 1: A Composite Outsourcing Decision Framework
Contextual Factors
Strategy & Structure
Transaction Costs
Management Consideration & Judgement
Outsourcing
Source: Chris Fill and Elke Visser (2000), The outsourcing dilemma: a composite approach to the make or buy decision., Management Decision, No. 38, Issue 1, page. 43-
Fill and Visser (2000) proposed a manufacturing outsourcing decision framework named “composite outsourcing decision framework” (CODF), by examining previous literature on the outsourcing decision that bring together the key decision criteria that management needs to regard when making outsourcing decisions. CODF consists of three main key aspects:
Element 1 – contextual factors
The contextual factors associated with both quantifiable (costs, investments, revenues, etc.) and non-quantifiable contextual factors (strategic interest, confidentiality, stability of employment, manageability, etc.). These factors can be internal and/or external conditions, analyzing by using Likert scale from 1 to
5, where it ranges from having low to high desirability for outsourcing 1 is low desirability for outsourcing respectively.
Element 2 – strategy and structure
The strategic and structural aspects associated with the company’s decision are based on a set of question proposed by Ewaltz in 1991. The question discusses the properties of production processes (e.g. uniqueness, capital needs, and idiosyncrasy), market conditions (e.g. cycles and customer behaviour), as well as supplier capabilities and corporate culture. The conclusion about outsourcing can be drawn from these answers (Palva, 2007). The nine guideline questions are developed to help the organization to consider the structural aspects associated with the decision and, in particular, to focus on how integrated the organization should be.
Table 3: Nine Guideline Questions
- How unique are the production processes?
- How severe are the market cycles? And how frequent?
- Just how much capital does internal manufacturing require?
- How does geographic dispersion of customers influence resourcing decisions?
- Does the market expect the firm to be a manufacturer?
- How long will the process be viable?
- Are these suppliers capable of doing the work, in terms of both technology and capacity?
- Are there idiosyncrasies in the product, the manufacturing processes, or the market that force a sourcing decision?
- Can the corporate culture be changed?
Source: Ewaltz, D.B. (1991), “How integrated should your company be?”, Journal of Business Strategy , Vol.12 No. 4, pp. 52-55.
Element 3 – costs
The costs associated with two types of costs classified in production costs and coordination or transaction costs, as proposed by Williamson in 1979. Transaction cost analysis combines economics theory with management theory to determine the best type of relationship a firm should develop in the marketplace.(McIvor, 2000) Economic of scale for standardized products may obtain a lower production cost advantages. However, a high degree of customization involved in in-house production costs may be advantageous. Fill and Visser (2000) pointed out that it is difficult for decision-maker to narrow down whether which products are standard and which products require high customization. Regarding the coordination costs, high costs may incur when only a few alternative suppliers are available and monitoring of supplier behavior is required.
