Question

1. Moon Micro is a small manufacturer of servers that currently builds its entire product in Santa Clara, California. As the market for servers has grown dramatically, the Santa Clara plant has reached capacity of 10,000 servers per year. Moon is considering two options to increase its capacity. The first option is to add 10,000 units of capacity to the Santa Clara plant at an annualized fixed cost of $10 million plus $500 labor per server. The second option is to have Molectron, an independent assembler, manufacture servers for Moon at a cost of $2,000 for each server (excluding raw materials cost). Raw materials cost $8,000 per server, and Moon sells each server for $15,000. Moon must make this decision for a two-year time horizon. During each year, demand for Moon servers has an 80 percent chance of increasing 50 percent from the year before and a 20 percent chance of remaining the same as the year before. Molectron's prices may change as well. They are fixed for the first year but have a 50 percent chance of increasing 20 percent in the second year and a 50 percent chance of remaining where they are. Use a decision tree to determine whether Moon should add capacity to its Santa Clara plant or if it should outsource to Molectron. What are some other factors that we have not discussed that would affect this decision?

Answer 1

Prepare the decision tree as shown below:

0.8 Price = 0.5*15,000 + 0.5*18,000 0.8 Price = 0.5*15,000 0.5*18,000 0.2 Add additional capacity at SC Price = 0.5*15,000 + 0.5*18,000 0.2 0.8 D Outsource Price = 0.5*15,000 + 0.5*18,000 0.2

Calculate the total cost for 2 year as shown below:

Add additional capacity = 2*(fixed cost + labor cost) = 2*(10,000,000 + 500*10,000) = 2*15,000,000 = 30,000,000 Outsource = 2* (outsource cost + raw material) = 2* (2,000*10,000 + 8,000*10,000) = 2*100,000,000 = 200,000,000
From this calculation it is clear that the cost involved in in-house production is much lesser as compared to the outsourcing cost. Therefore, the manufacturer should outsource the product. Apart from the given information, capacity of plant, technology and skilled manpower should also be considered before taking the final decision.