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Leasing and Purchasing are two major options available to most of the organizations when it comes to acquisition of fixed assets especially capital resources. At the same time these decisions are tricky to be made and therefore require that not only quantitative but also qualitative factors are taken into account.
Arrowvale Electronics is one of the leading Electronics manufacturer and Electronic solution provider in the United Kingdom. The company is located in Worcestershire and was established in 1985. Since then it has seen a phenomenal growth in the electronics industry. Arrowvale offers a broad spectrum of services. It holds an outstanding track record with respect to providing rail safety equipment. The company manufactures a wide range of electronic products including Printed Circuit Board Assembly, Loom and Wiring Harnesses, Pneumatic Assembly, Global Positioning Systems and Driver's Safety Devices.
Arrowvale's electronic products are manufactured under strict assurance of quality management and efficiency. Since it is a Business to Business entity, the products are delivered directly to customer's product line on ship to stock basis. Manufacturing electronic products involves manufacturing assembling of many smaller components like motor assemblies, engines, circuits and turbines. Even the smallest of these components has an integral and important role to play in the functioning and reliability of the final product. As innovation is the key in businesses dealing with electronics, Arrowvale is critically concerned that the innovation and quality is ensured in the smallest of the components. Recently, Arrowvale developed its new product line for Rail Safety equipments. This product line requires a certain type of motor assembly to be installed. Arrowvale is considering whether to outsource and purchase the required motor assembly from another manufacturer or supplier, or to manufacture the motor assembly in the company's own factory. This is a critical decision as there are many crucial factors that need to be taken into account such as quality, cost efficiency, reliability and above all safety standards, as the motor assembly in question has to become a part of an important rail safety equipment. As a member of the production department at Arrowvale, I have been assigned a task of evaluating as to what would be a more beneficial decision.
Scope of Activities
In order to reach a more sound and accurate decision, both qualitative and quantitative elements are needed to be taken into account. A thorough cost benefit analysis will also be required. Taking all relevant customer relationships is also very vital. It is important that opinions from all functional departments must be considered.
With the global market getting more competitive each day lease or buy decisions have become very crucial for the company. These decisions require the firm to review and consider its technology and processes and the costs pertaining to those processes. This is because the firm also has to keep room for strategic growth along with operational growth. If in house manufacturing of components that can be out sourced is consuming the finances that could otherwise be invested in achieving strategic objectives, then the firm needs to reconsider its operational cost and out sourcing might be a better option. Apart from that, outsourcing the motor assembly from a renowned and reputable vendor might also help improving sales revenue for that particular product line. On the other hand, outsourcing an important motor assembly would mean that the final product is not a pure Arrowvale product. However, this requires critical consideration of both the opportunity cost and the firm's operational and strategic objectives. Along with that, incorporating all commercial relationships is also important. It is important that the firm takes into account that how much secrecy does it want to maintain as far as the financial and monetary information is concerned and what amount of financial information is it ready to disclose to other stake holders.
Lease or Buy Analysis and Theoretical Application
The lease or but analysis with respect to the motor assembly for Arrowvale's new line of rail safety equipment requires a thorough study of both quantitative and qualitative elements. These elements are discussed under the following sections.
A quantitative analysis of lease or buy decision involves taking all the costs and opportunity cost pertaining to the decision in to account. It will then have to be considered whether the revenues and profits generated from the sale of that product line justifies the cost or not. When making analysing the decision using a quantitative approach, it should be noted that this analysis directly deals with the cost of production. This means opinions from production department and procurement department must be taken into account. Finance department's opinion must also be considered, as it is them who will be allocating the budgets. The commercial relationships with respect to third party vendors must also be fully utilized so that essential information about costs of outsourcing can be gathered.
In order to study the quantitative aspect, it will be required to compare the cost to lease the motor assembly with the cost of buying the motor assembly. In order to do so, four main elements will have to be taken into consideration. The first essential element that will be required is the volume of rail safety equipment that Arrowvale will be producing. This is important because the motor assembly in question is required to be installed in the safety equipment. Information and figures related to output volume must be accurate, or at least, as close to accuracy as possible. This is necessary to avoid any over estimation or under estimation of costs production of the rail safety equipment. In order to gather the volume information past year trends with respect to the sale of rail safety equipment must be closely studied. Furthermore, expected sales figures for the new rail safety product line must also be taken into consideration. In order to gather information about expected sales volume, Sales and Marketing department's opinions and recommendations must be considered. The next important element that is needed to be considered is the Supplier's per unit landed costs. Landed costs are the cost of an outsourced motor assembly once it has arrived at the production line of Arrowvale. These landed costs include original cost of purchasing the motor assembly, freight and insurance costs, logistic fee, handling fee, and breakage and damage costs. In case the motor assembly is outsourced from a supplier in another country such as the United States of America or Japan rather than the United Kingdom itself, then other costs pertaining to imports must also be taken into consideration. These costs include the complete shipping costs, custom clearance, crating fee, insurance, duties, tariffs, taxes and costs related to currency conversions.
The next cost element, which is required in the quantitative decision making, is the fixed cost of in house manufacturing of the motor assembly. These fixed costs include the machine cost, cost of tools and equipment required, and premises rent in case an extra space will be needed. Along with the fixed costs, per unit variable costs of in house manufacturing of motor assembly will also be required. These variable costs include labour costs, cost of raw materials, and all other overhead costs which directly vary according to the volume of output produced.
Incorporating all the above mentioned elements into mathematical calculations will give the results for cost to buy the motor assembly and cost to manufacture it. In order to get the cost to buy the motor assembly, all the landed costs must be added up together and then the result must be multiplied with the volume. This will give the total cost to buy the motor assembly. In order to acquire the cost to manufacture it, all the variable costs of manufacturing must be summed up and then multiplied with the volume. The final result must be added to the total fixed costs of in house manufacturing to get the total cost of manufacturing the motor assembly. If the cost to buy the motor assembly exceeds the cost to manufacture it, then it is financially advisable that the motor assembly should be manufactured in the Arrowvale's in house production line. Conversely, If cost of manufacturing it exceeds the cost to buy the motor assembly, then outsourcing would be more financially viable.
While the quantitative analysis gives an idea about how financially feasible a lease or buy decision would be, however, qualitative elements must also be taken in to account. These qualitative elements may come from both external and internal influences.
If the quantitative results reflect that it would be more financially desirable to outsource or buy the motor assembly then a lot of critical issues must be taken into consideration. Firstly, if the motor assembly is being imported from another country all the issues pertaining to government trade policies and regulations of both the trading country must be taken into account. Sensitive issues related to custom clearance must also be considered. Next, it is important to consider the probability of broken or damaged units.
There are certain qualitative elements with respect to…[continue]
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