Scott\'s Miracle Gro Scotts Miracle-Gro

Scott's Miracle Gro

Scotts Miracle-Gro needs to decide on the future location of production for its spreaders. It has three main options. The first is to retain the Temecula plant. The second is to outsource production to a Chinese company. The third is to offshore production to China.

Quantitative Considerations

The impetus behind considering China as a source for products is based on the perception of cost savings. There are three main areas where the cost savings accrue. The first is labor. At the Temecula plant, labor costs are currently $6.591 million per year. With productivity improvements, this is expected to decrease such that in five years' time the figure is $5.607 million. In China, the hourly labor cost will be approximately $398,520 for the first year, including the manufacturer's markup. This is expected to escalate to $484, 000 by the fifth year. The rate of growth could be higher than expected, but the same could be said for the Temecula plant, located in a country where health care premiums are skyrocketing.

The second area of predicted cost savings is in the lease. The Temecula lease is for $3 million per year. The cost of the Chinese lease would be $216,000, including the markup. The Temecula lease can be broken, which keeps the cost of the Chinese lease low.

The third area of predicated cost savings is in the energy costs. At Temecula, energy costs are presently around $1.48 million per year. In five years' time, the energy costs are expected to be $1.412. In China, the energy costs for this year are expected to be $561,000 for the first year, escalating to $859,000 by the fifth year. The energy costs could also increase more rapidly than expected, as energy prices in both markets have been unstable at times.

There are also a handful of cost areas where China is more expensive. The increased freight costs, which are not subject to the markup since they will probably be born by Scotts, will be $8 million per year.

It is also worth considering some of the costs that will not change. The management expenses are not expected to change, since there is no indication that managerial staff will be let go. So that is an area where savings are unlikely to accrue. Overhead changes are not included in the calculation either. The overhead indicated in the case is all assigned overhead, which is not a cash flow and thus should not be included in this calculation. Also not included will be the impact of the currency fluctuations. Predicting exchange rate shifts is best left to the experts; any estimates made by Scotts will be speculative at best. Furthermore, if exchange rate risk worries management, there are a wide variety of hedging techniques that can be used to minimize this risk.

On the basis of the calculations, the Temecula plant will be more expensive over the course of the next five years than outsourcing. Offshoring is the most expensive of the three options in the next five years, because of the high cost of constructing the facility. Choosing this option would be on a strategic basis only. After five years, the trend is for Temecula to become more affordable than China. However, estimates beyond five years are difficult to make with any accuracy. For example, the terms of the next Temecula lease are an unknown but significant factor five years out.

Strategic Concerns

Outsourcing production has several ramifications. The first is that the company risks losing technological competitive advantage, including key members of the manufacturing staff. Offshoring would allow the company to retain better control over production, but at a higher initial cost than outsourcing. The company needs to consider these options on the basis of its future direction. The spreaders are a functional product. This places the emphasis on lower production cost and larger shipment sizes. Indeed, the increase in inventory is immaterial to the final calculation. However, the manufacturing strength at Temecula means that production innovation is a key source of value for the company. They could move those workers to other plants, but it is not reasonable that many workers would move from southern California to Ohio just to stay with the company.

Recommendations

It is recommended that Scotts retain the Temecula plant. There are two key reasons. One is that the cost structures of Temecula and China trend towards each other. While China is cheaper now, it is not expected to be so in the long run. Furthermore, China's cost estimates are more volatile, so that option could be more expensive than Temecula in less than five years. This is especially if the yuan appreciates rapidly, which is presently expected by economists. While China appears cheaper today, it may not be so for very long, even though it will always maintain a competitive advantage in wage and energy costs.