SMG

Influential Factors in the Outsourcing Decision Increased manufacturing and operating costs of spreader production at the Temecula plant have influenced the decision to consider relocating production to China to increase profit margin. After thoroughly analyzing the present and future logistical and financial risks of both the Temecula and China plants, the team determined that Scotts Miracle-Gro should maintain spreader operations at the Temecula plant. The following quantitative and qualitative analyses support the team’s conclusion.

Quantitative Factors & Sensitivity Analysis When evaluating the decision to outsource production, the team analyzed the total quantitative costs of the supply chain (Figure 1). Production, SG&A, and initial investment costs have a significant impact on the decision to outsource the Scotts Miracle Grow spreader from Temecula to China. Quantitative factors evaluated in the analysis include total costs for transportation, labor, raw materials, electricity, management, overhead (startup, molds), and the initial investment. Detailed Net Present Value (NPV) analyses are shown in Figure 2 for Temecula and Figure 3 for China. Upon conducting the impact of the ten-year analysis, the quantitative factors that have the most significant impact on total cost between operations in China and Temecula are transportation and labor costs.

the number of workers remaining the same in both operations, it is evident that the cheaper labor rates (18 times less than Temecula) in China are a significant advantage. There are inherent risks and uncertainties in some of the factors that financially impact the decision to outsource to China. Changes in Transportation and Labor costs can affect the total landed costs of the product. Figure 4 and Figure 5 illustrates that an increase in transportation costs from 3% to 9.4% per year, shifts the financial drivers to favor Temecula over China. A detailed transportation cost sensitivity analysis is graphically illustrated in Figure 6.

On the other hand, productivity at the

Temecula plant needs to increase by 16.2% annually as shown in Figure 7 and Figure 8 and hourly labor cost in China requires an unprecedented increase of 39.5% annually to financially prefer Temecula over China (Figure 9 and Figure 10). Transportation costs had the most significant impact on maintaining operations at the Temecula facility. Freight charges accounted for over $90 million in additional charges by outsourcing production to China. This expense is almost double the benefit of labor costs and thus plays an instrumental part in maintaining production in the Temecula facility.

Qualitative Factors Influencing the Outsourcing Decision Although many of Scotts’ outsourcing analysis factors are highly measurable in nature, some are

inventory, associated holding costs, and risk. Given larger lot sizes, the potential for poor quality production tremendously increases costs from replacement orders coupled with long lead time, rework, and finally customer dissatisfaction in the form of missed sales. Supplier viability depends on sustainability in the form of quality and reliability, thus an accepted level of quality deterioration for cost savings tradeoff may eventually inhibit the supplier’s sustainability.

The most visible tradeoff with the China option is decreased manufacturing and labor costs versus increased inbound transportation costs at Temecula. However, the lack of information coordination capabilities expressed by Chinese manufacturers accentuates freight costs associated with lack of visibility and the bullwhip effect, which minimizes the optimism outlook. Lastly, if the Chinese government allows the Yuan to float or begins charging taxes and duties on agricultural products, costs in China would soar. Heavy financial hedging would protect Scott from general fluctuations but would not be a sufficient strategy to evade the inevitable.

Outline & Recommendations The team recommends that Scotts should not outsource the manufacturing capabilities to a contractor in China. Scotts would offer up a core piece of the business (as well as all of the technical

Figure 1  – Summary Sheet

COMPARISON OF NET PRESENT VALUES Temecula Analysis Total Cost

YEAR 0 YEAR 1 YEAR2 YEAR 3 YEAR 4 YEAR 5 YEAR 6 YEAR 7 YEAR 8 YEAR 9 YEAR 10 Total $17,562,750 $17,288,907 $17,026,784 $16,531,368 $16,296,679 $16,072,730 $16,075,843 $16,082,082 $16,091,420 $16,103,832 $16,119,297 $181,251,691

15% Discount Rate 1.0000 0.8696 0.7561 0.6575 NPV $17,562,750 $15,033,832 $12,874,695 $10,869,643 Total NPV

0.5718 $9,317,679

0.4972 $7,990,987

0.4323 $6,950,031

0.3759 $6,045,850

0.3269 $5,260,314

0.2843 $4,577,714

0.2472 $3,984,444 $100,467,939

$100,467,939

China Analysis Total Cost $19,466,742 $12,340,613 $12,624,736 $12,919,439 $13,225,061 $13,941,953 $13,870,484 $14,211,035 $14,564,005 $14,929,806 $15,708,870 $157,802,744 15% Discount Rate 1.0000 0.8696 0.7561 0.6575 0.5718 0.4972 0.4323 0.3759 0.3269 0.2843 0.2472 NPV $19,466,742 $10,730,967 $9,546,115 $8,494,741 $7,561,471 $6,931,615 $5,996,593 $5,342,454 $4,760,999 $4,243,983 $3,882,992 $86,958,673 Total NPV

$86,958,673

SPECIFIC COST BREAKDOWN OVER THE TEN YEAR PERIOD Raw Material Labor Electricity Lease Temecula ($1,420,679) $62,014,061 $16,100,688 $33,000,000 China $0 $3,896,102 $7,387,529 $2,200,000 Difference* $1,420,679 ($58,117,959) ($8,713,159) ($30,800,000) * Note: Black indicates money saved by staying in Temecula

Management Overhead Freight Safety Stock $18,815,401 $34,434,425 $12,807,796 $0 $4,515,696 $14,387,997 $102,462,366 $5,060,000 ($14,299,705) ($20,046,428) $89,654,570 $5,060,000

Investment $5,500,000 $17,893,054 $12,393,054

TOTAL COST COMPARISON OVER THE 10 YEAR PERIOD Temecula China Cost of Goods $109,694,070 $13,483,631 S,G and A Cost $66,057,621 $126,426,059 Investment Cost $5,500,000 $17,893,054 Total $181,251,691 $157,802,744 * Note: Black indicates money saved by staying in Temecula

Difference* ($96,210,439) $60,368,437 $12,393,054 ($23,448,948) 4

Figure 2 - Cash Flow and NPV Calculations for Temecula 0

Year: 

1

2

3

4

5

6

7

8

9

10

PRODUCTION COSTS Raw Materials Current savings from use of regrind

($100,000)

Annua l increa se in sa vings due to regrind usage Cost savings from use of re grind Hourly Labor Costs

($100,000)

5%

5%

5%

5%

5%

5%

5%

5%

5%

5%

($105,000)

($110,250)

($115,763)

($121,551)

($127,628)

($134,010)

($140,710)

($147,746)

($155,133)

($162,889)

Only hourly wage employees counted (i.e. direct labor personal and temporary workers) $16.25

Current Avg. hourly ra te Annua l increa se % Avg. hourly la bor ra te

$16.25

Current no. of workers

3%

3%

3%

3%

3%

3%

3%

3%

3%

3%

$16.74

$17.24

$17.76

$18.29

$18.84

$19.40

$19.99

$20.59

$21.20

$21.84

6%

6%

6%

6%

3%

3%

3%

3%

3%

(Productivity assumed to increase at 6% for the first 5 years and then at 3% for the last 5 years) 172 162 152 143 139 135 131

127

123

$5,372,534

$5,367,699

195

Annua l productivity increase

6%

Number of hourly worke rs Tota l annua l hourly labor cost

195

183

$6,337,500

$6,135,968

$5,940,844

$5,751,925

$5,569,014

$5,391,919

$5,387,066

$5,382,218

$5,377,374

(Assuming a 5 day work week, 8 hours/day and a 50 week year) Electricity Costs

4.00%