Discussion Topic: Managerial Decision Making
Read Concepts in Action, “Starbucks Brews Up Domestic Production” in Chapter 11.
- What is a relevant cost?
- Provide a scenario illustrating analysis of relevant costs in a make or buy scenario.
- How did Starbucks’ management use their decision making analysis in evaluating their outsourcing decisions?
Just do response each posted # 1 to 3 down below only.
A relevant cost is a cost that is expected in the future based on a course of action in the present. These outcomes are divided up between quantitative and qualitative factors. Quantitative factors are based on financial terms and qualitative factors are not based on something that can be measured numerically. (Datar, 2018) In Starbucks case, they found that they could have cost savings benefits from making their own items domestically. They were paying more in labor, but the quality of labor was higher. This increased their production efficiency. Reducing the cost of freight to bring in the products from off shore vendors allowed them to save money on manufacturing the product, as well. Starbuck’s management saw that outsourcing was not saving them any money. This is different than decisions made by Chipotle that we reviewed a couple of weeks ago. They found cost savings in outsourcing the preparation of their meats and some of the vegetables they used in their products. (Datar, 2018)
Datar, S. M. & Rajan, M. V. (2018). Horngren’s Cost Accounting: A Managerial Emphasis, Global Edition. Pearson Education Limited: London
The costs differ among alternative costs, that occur in the future and affect decision making are relevant costs (Datar & Rajan, 2017, p.427). In other words, relevant costs are the costs that change or affect revenue with each decision management made. These costs do directly affect the cash inflows and outflows of the business. A make-or-buy decision happens when choosing between manufacturing a product inhouse (insourcing) or buying from outside vendors (outsourcing) (Datar & Rajan, 2017, p.434). The purpose of a make-or-buy decision is to reduce relevant costs to result in more profit. Therefore, in order to make a decision, managers calculate the relevant costs of both options A and B to see which option is better or cheaper. Relevant costs include differential, avoidable, and opportunity costs. Differential costs are the variance costs between the two options A and B. Avoidable costs are costs that can be avoided when choosing option A over B or otherwise. Opportunity costs are losses for choosing one option over the other. Some of the relevant costs are direct material, direct labor, and variable overhead.
For example, company Y needs to manufacture 1,000 bicycles and company Z offers the same quality products at $45 each. In order to make a decision about buying the product from Z, company Y has to consider all the relevant costs. Below are the costs to make 1,000 bicycles:
- Raw material cost $20,000
- Direct labor cost $16,000
- Manufacturing overheads $9,000 (variable)
- Office administrative cost $5,000 (variable)
Total cost $50,000
Unit cost = $50,000 / 1,000 = $50, therefore the differential cost is $5 per unit
Based on the results, company Y should purchase bicycles from company Z instead. By doing this, the company can save a total of $5,000 = $5 x 1,000.
Starbucks started to outsource its products like coffee mugs, ready-brew VIA coffee, and the coffee base for its Frappuccino beverages in 2012. The purpose of doing this is saving its high direct labor cost, transportation, warehousing, time, and inventory costs (Datar & Rajan, 2017, p. 437).