Dude Skis has received an inquiry from a Japanese ski manufacturer that wants to outsource a production run of 5,000 skis. The total revenue from the proposed deal is $1,000,000 and Dude’s direct cost is projected to be $800,000, which is based on the $700,000 of materials and $100,000 of labor required to manufacture the skis. Initially, it therefore appears that Dude can earn $200,000 on the deal.
However, Dude’s production equipment is fully utilized during its single shift of operation, so this order will require employing a second shift that is paid a 10% shift differential, as well as an on site supervisor and maintenance technician. There will also be an assumed 10% scrap rate caused by having a less well trained work force on that shift. These additional costs are:
|
Cost Item |
Amount |
|
Overtime |
$10,000 |
|
Scrap |
70,000 |
|
Supervisor |
65,000 |
|
Maintenance technician |
45,000 |
|
Total |
$190,000 |
Given that these additional costs leave a paltry $10,000 profit, Dude should either reject the inquiry or negotiate a higher price. The increased costs caused by the production being outside of Dude’s normal operating range caused the deal (as proposed) to fail.