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ST
260
Project 2: Kilgore Manufacturing |
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Case/Project
2: Kilgore Manufacturing., Inc. Kilgore
Manufacturing, Inc. (KMI) is a small manufacturing company in the St.
Louis area that produces components used in the aerospace industry. James
Kilgore, the president and owner of KMI, started the company five years
ago. Kilgore graduated with an electrical engineering deGREe from Georgia
Tech and then went to work for Mitsuyo Electronics, another company with
ties to the aerospace industry. In less than three years, he and another
engineer at Mitsuyo left to start their own company which eventually
became Kilgore Manufacturing. Although business has been reasonably steady
for the last two years, KMI has yet to establish any long-term
relationships with major aerospace contractors. This is important, because
small companies like KMI only get business as subcontractors to the large
aerospace manufacturing companies that win major contracts, many of which
are with the federal government. In
the aerospace business, after the federal government approves a new
defense project, a request for bids is sent to the major aerospace
contractors, such as General Dynamics, McDonnell-Douglas, and
Lockheed. Typically, many man-hours are devoted to the development
of these bids. Submitted bids are evaluated and the contract is awarded to
the company with the best proposal. This company, in turn, sends out a
request for subcontractor bids to smaller companies like KMI for specific
work related to the project. Often, the subcontract goes to the company
with the lowest bid for the required work. Cost
overruns in federal government contracts are commonplace, but are becoming
increasingly less accepted. The news media often report on projects in
which the federal government, and therefore taxpayers, is severely
overcharged. (In one widely publicized case, the government was charged
$500 each for hammers!) In their desire to win subcontracts from the major
aerospace companies, some subcontractors submit unreasonably low bids to
perform the work on specific aspects of a major project. With hundreds of
subcontractors ultimately winning a "piece of the pie" in the
bidding process, the total dollar amount of underbidding on a major
contract can be enormous. Of course, eventually all parties involved,
including the taxpayers, find out about the cost overruns. Recently, the
federal government has been cracking down severely on the major
contractors, who in turn have demanded more accountability from their
subcontractors. More and more contracts between the major contractor and
its subcontractors are including harsher penalties for low production
levels, late deliveries, cost overruns, and other failures by the
subcontractors to meet the promises of their original bids. Jim
Kilgore has just learned that a new defense contract related to the
Strategic Defense Initiative (SDI) has been awarded to one of the major
aerospace contractors. A certain system in the project requires one of the
components produced by KMI, a relay switch manufactured by only three
other companies in the U.S. After finding out about the new contract,
Kilgore held a strategy meeting with Tim Reynolds, vice-president of
manufacturing, and Bill Shelton, plant manager. Jim:
"I don't know if you have heard yet, but a new SDI contract has been
awarded to Avionics, Inc. The good news for us is that our R-7 relay
switch plays a big role in the project. I think this is the opportunity
we've been waiting for." Tim:
"How many units will Avionics need?" Jim:
"One of my contacts in Washington has given me enough information to
estimate that the project will require at least 600 R-7 relay
switches per day. But, my guess is that the subcontract will be awarded to
the company that can provide the largest number of relay switches per day
at the lowest cost to the government. Fortunately, our current contracts
for the R-7 are about to run out so that we could devote that entire
line of production to this new subcontract with Avionics. What do you
think of this possibility, Bill?" Bill:
"We can easily meet the 600-per-day quota. Our production
data over the past two years show an average daily production run of
around 635 relay switches per day when we're running at full
capacity." Jim:
"That's well and good, Bill, but we also need to know something about
the amount of variability in daily production levels. In this new
subcontract, we have to specify a guaranteed minimum level of daily
production in addition to an average or typical daily production level.
The government is really serious about contractors and subcontractors
meeting their obligations. On those days we fall short of the guaranteed
minimum, a $5,000 penalty is assessed!" Tim:
"$5,000! Ouch! Isn't that a little severe?" Jim:
"Unfortunately, we don't make the rules. However, we do want to play
the game. Now, look, I want
this contract; it's the break we've been looking for to get in solid with
one of the key aerospace manufacturers. We can't afford, however, to lose
money on this contract." Bill:
"Well, let's see what we know. Over the past two years, our lowest
daily production run was 494 units and the highest was 768 units. In fact,
if I remember right, the actual distribution of daily production levels is
described fairly well by a normal distribution with a mean of about 635
units and a standard deviation of about 40 units." Tim:
"So there are definitely days when we are unable to make 600 units.
If we were to bid 600 units, we would be hit with the $5,000 penalty from
time to time. What sort of profit margin can we expect from Avionics,
Jim?" Jim:
"I don't think that's going to be a problem. As best we can tell, our
competitors are pretty close to us in terms of their production
capabilities and production costs. As a result, I think we can maintain
our usual profit margin of $3.80 per relay switch. It really boils down to
who can produce the most relay switches daily. But we have to be very
careful with our bid. Bid too low on the guaranteed minimum daily number
of units and we lose the contract to one of our competitors; bid too high
and we get the contract, but we lose our shirts in penalties." Tim:
"Let me make sure I understand the situation. Suppose, for example,
that we were to guarantee a minimum daily production level of 600 units,
but we fell short, say 5% of the time. Then, by my calculations, we would
net an average daily profit of $2,163." Jim:
"Whoa! Slow down! How did you come up with that figure?" Tim:
"Well, each day's production level will be different and there is no
way we can predict when we will fall short of the guaranteed bid level,
but we can still talk in terms of averages. Going back to my example,
suppose we fall short 5% of the time. We would incur the $5,000 penalty
about once in every 20 days which averages out to $250 per day. If we
actually average 635 relay switches per day, then over a typical
20-day period we would produce about 12,700 relay switches. At a
$3.80 profit margin, the average profit for a 20-day period would be
$48,260, which comes to $2,413 per day. After subtracting the $5,000
penalty for one day out of the twenty, our average net daily profit over
the 20 days drops to $2,163." Bill:
"Where did the 5% figure come from?" Tim:
"I just made it up for the example. It should be pretty close to
correct, but I'm not sure." Jim:
"Good job! That's a GREat example of how to think through this
problem. Of course, everything depends on how often we fall short and that
is determined by our guaranteed bid level." Tim:
"You know, one way we could cut out some of the penalty costs would
be to stockpile relay switches on those days that we produce more than the
guaranteed bid level." Jim:
"Nice idea, Tim. I had already thought of that but then found out
from Avionics that we have to turn over our entire production to them each
day. Besides, we don't have the space for inventory." Bill:
"And we can't use any overtime to meet the minimum when we are just
short because we will be operating 24 hours a day with our three shifts.
If we borrow a little from the next day's production to meet the minimum,
we stand a higher chance of not meeting the minimum the next day." Jim:
"That's right. So in our calculations to come up with a guaranteed
minimum daily level of production, we need to assume that we sell
everything we produce each day, that we cannot stockpile or create a
stand-by inventory, and that we can't use any overtime or borrow
from later production to avoid a penalty." Bill:
"When do we have to submit the bid?" Jim:
"That's the good news. The deadline for submitting a bid is
approximately three months away." Bill:
"GREat! Here's why I ask. A new worker in the plant suggested some
changes to our R-7 production process during one of our quality
circle meetings last week. I think the idea's a winner. These changes
would result in a more complicated production process with a steep
learning curve for the workers, but it could eventually lead to higher
production levels. Here's the best part. We can do it with only minor
modifications to our current equipment and it will cost practically
nothing to make the changes! We could implement the new procedure in less
than a week's time." Jim:
"This could be what we need to pull off this deal. Bill, start making
the necessary changes. We'll monitor production levels for the next 60
production days. If the new process works as you suggest, we should see
higher production levels. If so, we'll make our bid based on the new
process; otherwise, we'll switch back to the old procedure and base our
bid on the data from the past two years." Tim:
"Getting back to profits again, how much profit do we really need to
make in order to pursue this contract?" Jim
"I can't overemphasize the importance of this contract to us. If we
are awarded the contract and do a good job, it could lead to a
long-term relationship with Avionics and would certainly enhance our
reputation with other major aerospace companies. We can't afford to lose
money on this contract. I'd be willing to break even just to get these
non-monetary benefits, but we can't. I'll tell you what, if we could
just make $ 1,000 per day on this job, the accountants and I would be
happy. Bill, report back in 60 days to let us know how the new production
process is working. The three of us will assess the situation at that time
and develop the bid proposal."
Assignment During
the next 60 days of production, Bill Shelton keeps track of daily
production levels of the R-7 relay switch after making the changes
to the manufacturing process suggested by one of the workers. The data are
contained on the ST260-990 website and in the file KIILGORE.MTW and
KILGORE.DAT in the Outlook public folders. The Data Description section
contains a description of this data file. Using
this data set and other information given in the case, help Jim Kilgore
determine how to bid for the R-7 relay switch contract with
Avionics. In particular, you need to decide whether to go with the old or
the new R-7 production process and then determine what the
guaranteed minimum daily production level should be. The Case Questions
will assist you in your analysis of the data. Use important details from
your analysis to support your recommendation. Your
report should consist of a one-page executive summary memo from your
consulting group to the appropriate person in the case. Briefly discuss
the problem, the results of your analysis, and your recommendation in this
memo. Your memo should be followed by a more detailed report (up to three
pages) that outlines your analysis of the data and provides support for
your recommendation. Include important output, tables, and graphs to make
your points.
Data
Description The
data for the Kilgore Manufacturing case is contained on the ST260-990
website and in the file KILGORE.MTW and KIILGORE.DAT in the Outlook public
folders. The file contains data for the first 60 days of production under
the new manufacturing process implemented at KMI for producing the
R-7 relay switch. A partial listing of the data is shown below.
These
data are coded as follows: Month:
Month of production for that production day (6 = June, 7 = July, and 8 =
August). Date:
Date of the month for that production day. Units
Produced: Number of units produced on that day. Case
Questions: Kilgore Manufacturing 1.
Calculate the guaranteed minimum daily production level under the existing
production process that will result in an average net daily profit of $
1,000, the amount needed by KMI. 2
On what percentage of production days will KMI incur a penalty if they bid
this number of units? 3.
Analyze the distribution of daily production levels under the new
production process suggested by one of the workers. a.
What are the mean and standard deviation? How do these values compare to
the mean and standard deviation of daily production under the existing
method? b.
Does a normal distribution seem appropriate for the daily production
levels under the new method? If not how would you describe the shape of
this data distribution? 4.
Bill Shelton said that the workers would most likely have a steep learning
curve with the new production process. a.
Do the data support his claim? What numerical and/or graphical summaries
of the data are useful in checking out this claim of a learning effect? b.
Based on your findings, what would you suggest as the next step in the
analysis of these data? 5.
Under the new production process, what guaranteed minimum daily production
level would you recommend that KMI propose in their bid? Explain why. 6.
Make your final recommendation to KMI. What should they bid on the
contract with Avionics?
Copyright
1994 Lawrence H. Peters and J. Brian Gray |