Chemical Processing at MBM Tool&Machine
OnMarch23,2005,BorisKikely, president ofMBMTool&Machine(MBM), atier2aerospacecompanylocatedinVaughan,Ontario,wasreviewinghisprofit/lossstatementsfromthepreviousmonth.Hewasupsettodiscoveryetanotherreportfromhisvice-presidentofFinanceandAdministration,indicatingthatcostsforoutsourcedchemicalprocessinghavebeenescalatingand,inaddition,therewerecontinuousqualityproblemswiththecompanythatMBMhadcontractedtoperformchemicalprocessing.Herealizedthatthissituationhaddefinitelygoneonlongenoughandit wastimethatMBMstoppeddragging itsfeetonadecisiontoinsource chemicalprocessing.
TheAerospaceIndustryin Ontario
In2005,amongthecompaniesintheOntarioaerospaceIndustry,therewereabout45CNCPrecisionmachiningshopsmanufacturingproductprimarilyforthefollowingTier1orOriginalEquipmentManufacturingcustomers(T1-OEM):GoodrichAerospace,BombardierAerospace,Messier-Dowty,andBoeingAerospace.Thesefourcustomerscontrolledanddirectedthesourcingofproductforapproximately85-90%ofprocuredproduct.QualityisparamountfortheT1-OEMcustomers.Assuch,thesecustomerscontrolledallprocessstepsalongeachproductsvaluechain.Indeed,theT1-OEMcontrolledwhereeachmachineshopwastohaveitsproductschemicallyprocessedinorderforproducttomeetfinal expectations
ChemicalProcessing
In2005inOntario,T1-OEMcustomershadonlycertified3supplierstoperformchemicalprocessing.Therefore,mostmachineshopswereforcedtoseekchemicalprocessingabroad:US,Quebec,andeveninsomecasesasfarawayasEurope.Thisusuallypresentedlogisticalproblemsandcostpremiumsassociatedwithtransportation.ToestablishanewchemicalprocessingcompanyinOntariorequiredabout18monthsofpermissionsandapprovalsfrombothGovernmentandcustomers.Intheend, evenifsuccessful,thisdidnotguaranteeworkfortheprocessing company.
MBMTooland Machine
BorisKikelyopenedMBMininthesummerof1967.Initiallyscramblingandtakinganytypeofworkhewaspresented,Kikelywouldtravelfromcustomertocustomerseekingworkanddevelopingrelationships.By2005,MBMhadevolvedfromasmallmom-poptypecompanyintoamid-sizeenterprisewithsalesofabout$17MillionCADperyear,andgrossprofitmarginsrangingfrom25to30%.
Thebusinessfocusedoncomplexmid-to-largersizecomponentsandassembliesExhibit1providesasampleofthecomplexityofthetypical component’svaluechain.
TheCurrent Process
Afterincurringmuchtroublewithlocalchemicalprocessingcompanies(quality,deliveryandpricingissues),MBMhad,forthelastcoupleofyears,outsourcedmostofitschemicalprocessingworktoa
companyinMontreal.Althoughthechemicalprocessingwasdonefairlywell,MBMquestionedthequalityoftheworkandwasforcedtoinspectallproductreceivedfromthechemicalprocessingsupplier.Indeed,productwasnotdeliveredtothe expectedhighqualitystandards.
MBMpurchasedabout$5Millioninchemicalprocessingservicesayearrepresenting about40%ofallofitsannualexpenses.Tosupportthemovementofproducttothechemicalprocessingsuppliers,MBMpurchasedatruckatacostof$45,000andhiredtwodriversatacostof$25perhour,specificallywiththetaskofmovingproductbetweenVaughanandMontrealonadailybasis(6daysaweek,assume12hourworkdays per driver,withtheoperating costforthetruck at$.52/Km. Each driver driving about600km/day,notincludedintheprocessing spendvalue).
Insource Processing
KikelyrealizedthatMBMwouldnotbeabletorepatriateallprocessingandassuch,hefocusedhiseffortonout-sourcedprocesssteps14-22inExhibit1,representingabout75%ofallchemicalprocessingcosts.Inordertosetupaprocessingline,MBMwouldberesponsibleforenvironmentalandcustomer approval ofthenewfacility.Total fixedcostsassociatedwithbuilding theprocessing facility:
1. Building Expansion:$2.5Million
2. ApprovalsandCertifications:$500Thousand
3. ProcessingEquipment:$1.5MillionVariable costs:
1. Labour:9peopleat$15/hr(assume3personpershift,24hroperation,300days)
2. Chemicals:$250/Hr(assume 300 daysayear, 24hoursperday)
3. 1Maintenanceworkerat $30/hr,8hourshift,300 daysayear
4. Drivers—Assume the drivers are reassigned, with cost to driver reduction the vehicle only.
Thecompanywouldstillrequirethedriverandthetruckforthebalanceofoutsourcedprocessingrequirements.Howeverthetruckwouldberequiredtooperate,onaverageonly6hours,or driving only 600km per day. Mostoftheremainingoutsourcedoperationsare performedlocally.
Inadditiontotheaddedlaborcosts,Kikelyknewthatrunninganewchemicalprocessingplantwoulddramaticallyincreasetheplant’shourlyconsumptionofenergyandgas.BasedontheCFO’sestimates,thenewfacility wouldlikely consumeanadditional$15.00ofelectricityand$7.50ofgasevery hourthatitwasrunning.Further,MBMwouldhavetoproperlydisposeofusedchemicalsatacostof$35percubicmeter,wherethecompanywasgenerating,onaverage,1cubicmeterofwastechemicalsperhour.
Withthisnewinvestment,Kikelyexpectedon-timedeliverytocustomerstoimprovetoover90%,andqualitytoexceed98%.Furthermore,hesawtheadditionofthenewfacilitytobeapositivemoveinthequesttowinnewordersandcontracts.
Kikelyestimatedthatthechemicalfacilityneededtorun300days/year(6daysaweek,24hoursperday,for50weeks).Kikelyassumedthefacilityneededtooperateat80%efficiencytomeethiscurrentdemandneeds.
Decision
AsKikelylookedthroughalloftheinformationthatheandhisteamhadcollectedregardingthisinvestment,hehadseveralconcerns.Hequestionedwhetherthebuildingofanewchemicalprocessingplantwastherightchoice.KikelybelievedthatinsourcingchemicalprocessingwastherightmoveforMBM;itwasagoodsteptowardgrowthandwouldhelpthecompanyimproveitscontrolofthequalityofitsproducts.However,healsoknewthathewouldneedtomakeastrongcasetohisinvestmentpartnerstogainapprovalforthismajorinvestmentexpense.Hewantedtoensurethathehadconvincing quantitativeandqualitativeargumentsfortheinvestment.
Questions
1. QualitativeAnalysis:
a. Provideareviewoftheindustrygiving thoughttothefollowing:Continuedoutsourcing,Insourcing,orcompanyacquisition.Pleasediscussthepros/consofeachoftheabove.
2. QuantitativeAnalysis:
a. Determinetheannual costs forinsourcing product at MBM.
b. AssessMBM’spaybackonthenewFacility—InYears,howlongbeforethefacilityispaidoff.AssumingthatKikelyhasapaybackrequirementof3yearsonanycapitalinvestments,doestheinvestmentmeetthisobjective
3. Asopposedtobuildingachemicalprocessingplantfromscratch,ifKikely hadtheopportunitytopurchaseanexistingchemicalprocessingcompanyfor$6Milliondollars,withoperatingcosts30%lessthanthoseprojectedtobespentatMBM,shouldKikelybuythecompanyinsteadofconstructing thenewfacility? Pleaseprovideyoursupporting information
4. In2008,thegovernmentislobbyingtoimposenewenvironmentregulationsthat, ifpassed,willresultsin$1Millioninincreasedannualcostsinforallprocessingfacilities.Assesshowthisannualexpansemaychangeyourassessmentabove(keepin mind thatifyou optto notconstructorbuyafacility,processingsupplierswillpasson50%ofthefeetoyou,asitsprimarycustomer.
Exhibit1:TypicalProductValueChain Profile:HardSteel
#
Activity
Sourcing
1 ProfileMilling In-Source
2
DeepHoleBoring/RoughHoleDrilling/LugFaceMilling
In-Source
3 Polishing/Blending In-Source
4 HeatTreat Out-Source
5 FinishMachining/Grinding Out-Source
6 Deburring In-Source
7 ElectrochemicalDeepEtchMarking In-Source
8 NitalEtchInspection In-Source
9 Embrittlementand/orStressRelief In-Source
10 MagneticParticleInspection Out-Source
11 ShotPeening Out-Source
12 ChromePlating(orHVOFcoating–Embrittlementreliefisnotrequired)
Out-Source
13 Inspection In-Source
14 CoatingStripping Out-Source
15 Bake/EmbrittlementRelief Out-Source
16 Chrome/HVOFGrind Out-Source
17 Rollscan Out-Source
18 CadPlating,Nickel Out-Source
19 CoatingStripping Out-Source
20 Bake/EmbrittlementRelief Out-Source
21 MagneticParticleInspection Out-Source
22 EpoxyPrime Out-Source
23 Bushing,HardwareInstallation In-Source
24 SealingofBushings,etc In-Source
25 PolyurethaneEnamelTopcoat Out-Source
26 WipeonPrimer Out-Source
27 FinalAssembly&QualityInspection In-Sour