Scott Mills was originally a producer of fabrics, but several years ago intense foreign competition led management to restructure the firm as a vertically integrated cotton garment manufacturer. Scott purchased spinning firms that produce raw yarn and fabricators that produce the final garment. The firm has both domestic and international operations.
The domestic spinning and knitting operations are highly automated and use the latest technology. The domestic operations are able to produce cotton fabric for $1.52 per pound. The domestic fabricating operations are located exclusively in rural areas. Their locations keep total average labor costs to $16.40 per hour (including fringe benefits). The cost to ship products to the firm’s distribution center is $0.10 per pound.
The firm’s foreign subsidiary is a fabricating operation located in the Maldives, a group of islands near India. The average wage rate there is $0.70 per hour. The subsidiary purchases cotton fabric locally for $1.60 per pound. The finished products are shipped to Scott Mills’ distribution center in New Orleans at a cost of $1.80 per pound. Both the domestic and foreign subsidiary use the same amount of fabric per product. Scott Mills has been producing three products for the private label market: sweatshirts, dress shirts, and lightweight jackets. In the past the firm processed a new order at whichever fabricating plant had the next available capacity. However, projections for the next few years indicate that orders will far exceed capacity. Management wants each plant to specialize in one of the products.
The plants are constrained by the amount of sewing time available in each. The domestic plant has 8,000 hours of sewing machine time available per week, while the foreign subsidiary has 10,000 hours available per week. The domestic plant’s variable overhead is charged to products at $4.00 per machine hour, while the subsidiary’s variable overhead averages $1.00 per machine hour.
The sweatshirts require 1 pound of cotton fabric to produce, the dress shirts use 4 ounces of fabric, and the jackets require 1 pound of fabric. The domestic plant has special-purpose equipment that allows workers to sew a sweatshirt in 6 minutes, a shirt in 15 minutes, and a jacket in one hour. The foreign plant’s equipment constrains production to five sweatshirts per hour, three dress shirts per hour, or two jackets per hour. The wholesale prices are $8.76 each for the sweatshirts, $7.50 for the dress shirts, and $37.00 for the jackets.
A. Using only quantitative information, should the firm close its domestic operations and expand the foreign subsidiary?
B. Assuming that wages in the domestic operations remain constant, at what level of wages in the foreign subsidiary would the managers be indifferent between producing sweatshirts at one location versus the other?
C. Discuss qualitative factors, including risk and ethical issues that might influence the decision in part (A).
D. Discuss whether production quality is likely to be a bigger concern for products produced at the foreign subsidiary versus products produced in the domestic operation.
E. If demand for each product exceeds capacity, in which product should each plant specialize?
F. Management insists on manufacturing all three products to maintain good customer relations
If demand for each product exceeds capacity, management would prefer to specialize according to your answer to part (E). At which plant should management produce the third product?