This case follows the outsourcing decisions of the Scotts Miracle-Gro company in June 2007. The company’s main production facility, located in Temecula, CA, produces all of the company’s domestic lawn seed and fertilizer spreaders. This facility was acquired after Scotts merged three fertilizer spreader production factories from the acquisition of Republic Tool & Manufacturing Company in 1992. A fifteen year lease was signed in 2001 on the current Temecula facility.
Although this lease is noted as a 15-year contract, the Scotts company believes that they could terminate it early. This is important because they believe that the $3 million annual fee for the facility and other factory costs are creating a large amount of cost pressure. Bob Bawcombe, the Temecula factory’s director of operations, has been trying his best to fight off the corporate plans to outsource the factory’s production to a possibly cheaper facility in China. Bawcombe has improved production six percent each year over several years and he believes that the production cost cuts created by outsourcing would be offset by the rise in freight costs and inventory costs.
Several innovations have also been created through Bawcombe’s management and direction. Through his work with the research and development team, Bawcombe created an in-house automated assembly line which only took four people instead of six to assemble their hand spreader product. He believes that this innovation would not be possible without “production capability being in-house” and if the production were to be outsourced to China, these innovations would not be possible because the labor would be less knowledgeable about product design and engineering. Another innovation created by Bawcombe’s team at the Temecula plant was the implementation of “in-mold labeling”.
This put the company’s label on their spreaders directly through imprinting instead of sticking labels on their products which could fade and scratch off over time. This greatly improved the quality of their product and put them above other competitors. Unfortunately, if Scotts was going to outsource the company to China, this technology would not be able to be utilized because it was created by the researchers at the Temecula plant and it would cost too much to provide the plants in China with the machines needed and to teach the managers at the plant how to perform the process. This would result in the company sacrificing some of their product quality in return for a possible lowering in costs. Both of these innovations didn’t only help the Temecula plant, they also helped other production facilities in the Scotts Miracle-Gro company think of ways to innovate cost-effective methods in production.
Costs in factories in China are very low, but the rate that they are is fairly high. China’s relevant labor costs were at around $.91 per hour at the time of the proposal to outsource, but labor costs were already jumping up 10% in 2005 and as much as 40% in some facilities. Electricity prices were also estimated to rise about 20% in the next decade and freight costs were estimated to cost around $8 million if the company were to outsource Temecula’s production. Inventory costs would also increase due to the increase in Scotts’ lead time.
This would also result in a lower turnover ratio because average inventory would increase stock by 8 weeks’ worth of inventory. The shipment time from China’s facilities would also increase the time in which a product would be detected as defective or rejected. This could cause serious problems in having to rework or dispose of large batches of product. There are also concerns with the appreciation of the Chinese yuan. This is because if the yuan appreciates too quickly or too much, the cost of production could rise dramatically within the next few years and in order to move away from production in China, Scotts would have to undergo set up and shutdown costs once again.
If Scotts Miracle-Gro were to shut down the Temecula plant and outsource all production of domestic lawn seed and fertilizer spreaders, the company would most likely have to consider several possible issues. Three main problems that they could face are: decrease in quality, decrease morale in both customers and employees, and possible long term rise in production costs.
First, if Scotts were to outsource all production, their “in-mold labeling” method would not be worth the extra cost to implement in China’s facilities. This would create a noticeable drop in quality of most fertilizer spreaders and the reputation of Scotts’ products could be in danger. Also, without in-house design engineers to innovate new production improvements, production costs could no longer decrease due to new innovative procedures. This could possibly hinder even the creation of new products and improvement in seeds due to the disconnect between the corporate office and China’s factories.
Next, an outsourcing of the Temecula plant would definitely result in the decrease of morale in existing customers and employees. Typically in any company, once a factory is outsourced to cut production costs, fear is spread throughout the company’s existing domestic plants. This causes current employees to fear their own job security and some employees even begin looking for other jobs in order to escape a possible outsourcing. For customers, product quality and assurance are very important when choosing a product. With Scotts’ outsourcing plan, the time to detect a defect or problem in a product is increased which means more than just a few customers could receive a defected product which may require a recall. This would discourage a trust with Scotts Miracle-Gro and some customers may even decide to stay away from the company in the future due to unreliable products in the past.
Finally, production costs are one of the main reasons why Scotts is considering a switch from domestic production to overseas production and in the long term, rising costs in China may actually cause costs to become even greater than they are at the Temecula plant. This is due to rising labor costs, electricity costs, freight costs, and even inventory costs. Labor costs in 2005 increased an average of 10% in China which could be highly significant if that rate continued for the next few years.
Electricity costs are also estimated to increase by 20% over the next decade which is may still be a low estimate due to environmental regulation pressures. Freight costs are expected to be around $7 million a year after being offset by components already sourced by China and are expected to increase by 3% each year. Also, inventory costs will increase dramatically due to an increase in lead time which will definitely result in the turnover ratio of the company to decrease.
To Scotts Miracle-Gro:
Outsourcing the Temecula plant for the Scotts Miracle-Gro company should not take place due to the risks and downfalls your company will face by executing this plan. In the short run, your company will be burdened with multiple setup costs and shutdown costs along with low morale workers. This would hurt your company’s reputation dramatically and it would not get better since the quality of your fertilizer spreaders would decrease as well. Although costs will seem low and income may seem to increase in the beginning, time could create a disaster. Almost every cost driver in the new factory has an increasing rate that is higher than the rate that the Temecula plant faces.
The only rate that is increasing at a higher rate in the Temecula plant are electricity costs, but the rate that is projected in China is expected to be greater than projected. Freight costs will also be much higher than current freight costs due to overseas shipping. Therefore, in the long run, once setup costs and shutdown costs have diluted, the cost of running the plant could almost match Temecula’s production costs. Also, Temecula’s net income has risen at a rate of 62% over the past 4 years.
This is partially due to innovations and procedure improvements increasing productivity at a rate of 6% each year for the past 5 years. If the plant were to be outsourced, these innovations could not be created due to the lack of the in-house production capabilities that the Temecula plant has. In the end, the risks do not outweigh the benefits of outsourcing the Temecula plant to a contracting factory in China. The costs have a chance to rise far beyond expectations and the Temecula plant has the potential to increase quality while lowering production costs by raising productivity.
Courtney from Study Moose
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