A service provider needs to figure out if logistics function should be outsource

Question

A service provider needs to figure out if logistics function should be outsourced. The service provider works with a logistics company at an annual fixed cost of $85,000. He forecasts that the variable cost per order would be $15. The logistics company offers to work with the service provider at a fixed annual fee of $100,000 and $5 for each order. The service provider placed 1450 orders last year. What is the total cost of insourcing alternative? What is the total cost of outsourcing alternative? What is the indifference point for the two alternatives? If the estimated order for the next year is 1600, should the service provider work with logistics firm? 2. a. b. c. d.

Explanation / Answer

For insourcing

For outsourcing

Volume of output = Q = 1450

a) Total cost of insourcing = FC+(QxVC) = 85000+(1450x15) = 85000+21750 = $106750

b) Total cost of outsourcing = FC+(QxVC) = 100000+(1450x5) = 100000+7250 = $107250

c) Indiffereence point is that point of volume of output where both the alternatives would have the same total cost.So if the volume of output = Q,the indiffrence point can be calculated with the help of the following equation

Total cost of insourcing = Total cost of outsourcing

=> FC +(QxVC) = FC+(QxVC)

=>85000 +(Qx15) = 100000 +(Qx5)

=> 85000 + 15Q = 100000+5Q

=> 15Q-5Q = 100000-85000

=>10Q = 15000

=> Q = 15000/10

=>Q = 1500

So the indifference point is 1500 orders

d) If the volume of output(Q) = 1600 orders

Total cost with insourcing = FC+(QxVC) = 85000+(1600x15) = 85000+24000 = $109000

Total cost with outsourcing = FC+(QxVC) = 100000+(1600x5) = 100000+8000 = $108000

So the service firm should work with the logistic firm as the cost of outsourcing is lower than the cost of insourcing

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