Dave Flatch, CEO of Flatch\'es Latches Hardware Distributors, is trying to decid

Question

Dave Flatch, CEO of Flatch'es Latches Hardware Distributors, is trying to decide if it makes sense to outsource their warehouse order picking activity. Currently, Dave employs three order pickers each with an annual salary of $29,000. In addition, Dave estimates the cost per order picked is around $5 each (for packing supplies and other incremental expenses). Pickers Unlimited claims that they will pick orders for a fixed (one time) fee of $150,000 and will charge only $3.25 per order picked. Last year, a total of 34,000 orders were picked in Dave's warehouse.

a.    What was the total cost Flatch experienced last year due to the order picking function? (25%)

b.    What would the cost have been if Flatch'es Latches would have used Pickers Unlimited last year? (25%)

c.    What is the indifference quantity between the two alternatives? (25%)

d.    If Flatch expects the picking volume to be 37,500 orders next year, should he use Pickers Unlimited? In doing this, how much would he save over the alternative? (25%)

Explanation / Answer

(a)

Order pickers' annual wages paid = $29,000 x 3 = $87,000
Total variable cost of picking = $5 x 34,000 = $170,000

So, total cost of last year = $87,000 + $170,000 = $257,000

(b)

Fixed cost of outsourcing = $150,000
Total variable cost = $3.25 x 34,000 = $110,500

So, the total cost would have been = $150,000 + $110,500 = $260,500

(c)

Let the indifference quantity = N

87,000 + 5 N = 150000 + 3.25 N
or, N = 36,000

(d)

When the volume is 37,500,

Cost of in-house option = 87000 + 5*37500 = $274,500

Cost of outsourcing option = 150000 + 3.25*37500 = $271,875

So, the outsourccing option will be less costly and the savings will be $274,500 - $271,875 = $2,625

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