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Patterson Manufa...

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IMA EDUCATIONAL CASE JOURNAL

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VOL $6,$ NO$.4,$ ART. $1,$ DECEMBER $2$Using the controller$$s projections, prepare an analysis of the expected effect of outsourcing the product on Patterson$$s profitability.

INTRODUCTION

The vice president at your company, Columbia Holdings, has given you a new assignment: $$Recently I asked the folks at Patterson Manufacturing to develop a strategy for improving their profitability. They have responded with a proposal. I want you to evaluate the proposal: Is it viable? Is it sustainable? Visit their operations and bring back a recommendation.$$

As you travel to the site you review a brief history of the firm. Patterson Manufacturing was founded in a small northeastern city more than a century ago. Wesley Patterson started the firm alongside a fast$-$moving stream that provided mechanical power to drive cutting tools, grinders, lathes, and polishers. These tools were used to produce precision parts other manufacturers needed. The firm quickly established a reputation for producing high$-$quality products to exacting tolerances. The firm prospered.

Wesley studied the industries he served to develop new products that could fill his customers$$ emerging needs. He often met with customers to design unique products for them. He referred to his approach as providing $$customer$-$driven creative solutions.$$ He also kept abreast of new manufacturing materials and technology to ensure his products were of the highest quality.

The firm grew steadily and, by $1925,$ was $($and still is$)$ the community$$s largest employer. Wesley donated the land that is now the city$$s central park. He also paid for constructing the first municipal buildings. More recently, the company was the primary donor for the construction of the municipal library and the local hospital. And the taxes paid by the firm and its employees are responsible for an excellent array of community services, including the Patterson Sports Complex and Patterson Community Center.

The Great Depression in the $1930$s brought hard times to the company, yet none of its employees were discharged. Instead, the firm and its employees cooperated to spread the available work among its employees by reducing each individual$$s working hours $($and wages$).$ During that time, the firm also suspended paying dividends to its owners. After the company returned to prosperity in the $1940$s$,$ it continued to emphasize customer$-$driven creative solutions, and its loyal workforce enthusiastically overcame product design challenges.

Wesley passed leadership of his business to his son, who later passed it down to Wesley$$s grandson, and then to Wesley$$s great granddaughter, Jessica Patterson. But five years ago, when Jessica wanted to retire, there was no heir willing to take over the business. Consequently, the plant was sold to your employer, Columbia Holdings.

BACKGROUND

Columbia invests in family$-$owned businesses with a strong presence in niche markets. Columbia retains existing management and local business practices but provides centralized services, such as finance, accounting, insurance,and corporate$-$level management. Patterson has remained profitable since the acquisition, but its return on investment has been declining.

Your first stop at the Patterson complex is a meeting with the controller. He provides some additional background: $$Jessica$,$ like her predecessors, spent most of her time with customers developing new products to meet customer needs. She didn$$t concern herself with costs. Customers were willing to pay for products that solved problems. Upon Jessica$$s retirement, Columbia appointed Paul, our former production manager, to CEO. Paul has done wonders in rationalizing and standardizing our product lines. He substantially reduced manufacturing costs, which led to record profits in the two years following the sale of the company. Those early results have apparently set high expectations for our continuing performance. Our proposal will help move us toward meeting those expectations,$$ he said.

$$Our proposal is to stop manufacturing our largest$-$selling product, the Gudgeon EH$40,$ and instead acquire it from an overseas supplier,$$ continued the controller. $$This product currently represents $30\%$ of our total sales revenue and production volume. But sales have been declining because competitors are offering a similar product at lower prices. We think that by reducing our price by $5\%$ we can increase our unit sales volume by $15\%.$ The increased volume coupled with a lower product cost from the offshore supplier should nearly double our firm$-$wide profit.$$

The controller also provided some supporting documents. Exhibit $1$ summarizes operations for the five years since Patterson Manufacturing was sold to Columbia Holdings. Year $1$ represents the first full year after Jessica retired, and Year $5$ is the year that just past. Exhibits $2,3,$ and $4$ provide an income statement for Year $5,$ the current employee staffing l