Royal Shoes (RS) is a Romanian shoe chain operating 10 stores across the country. RS prides itself on its quality products, with all the shoes it sells being hand-made with the best leather and materials. The company is responsible for manufacturing all its products, operating a small factory employing 10 workers.
However, recently RS has noticed a decrease in the quality of the products its factory manufactures, which in turn has led to a decrease in sales. The company has hired us to help devise a strategy to optimize production quality.
Identify the problem
The candidate should brainstorm for a few minutes on possible causes of quality issues. They should take a structured approach to identifying different possibilities.
- number of staff has remained steady at 10 for several years
Production quality has decreased because some craftsmen have become negligent, producing more defects. Some are also close to retirement and are less able to perform the manual tasks required.
All other factors the candidate might have identified have remained constant, for example:
- raw materials have remained unchanged and of the same quality
- number of staff has remained steady at 10 for several years
Lead the analysis
The candidate can brainstorm for a couple of minutes as to some ideas on how to bring quality back up.
- retraining the craftsmen - hiring new craftsmen - investing in a program training young apprentices straight out of school - outsourcing production Each employee's salary is $30,000/year. Hiring replacement craftsmen would mean paying $10,000 in severance per old employee made redundant. Apprentices trained internally would then stay on to work for the company at the comparatively lower salary of $25,000/year.
To help make this choice, we have access to the following information:
Each employee produces 2000 pairs of shoes/year and shoes are sold on average at $50/pair.
The costs of retraining are $5000/employee.
With help from government grants etc, training a batch of young apprentices would cost the company $25,000/year for 3 years.
Outsourcing production would cost $200,000/year, plus severance for existing employees. However, production would be partly automated, which would mean an employee would be able to produce 2500 pairs of shoes per year.
- retraining the craftsmen
- hiring new craftsmen
- investing in a program training young apprentices straight out of school
- outsourcing production
Each employee's salary is $30,000/year.
Hiring replacement craftsmen would mean paying $10,000 in severance per old employee made redundant.
Apprentices trained internally would then stay on to work for the company at the comparatively lower salary of $25,000/year.
The candidate should evaluate the different options the company is considering, calculating the relevant costs and benefits for each.
Retraining existing employees
Cost = 10 x 5000 = $50,000
The candidate should note that there is no absolute guarantee that manufacturing problems would not recur, or that it would solve the problem of ageing craftsmen.
Hiring new employees
Cost = 10 x 10,000 = $100,000
The candidate could note that this might pose the additional problem of experience producing the client’s specific models. This will take time to accrue and might mean some sub-par manufacturing at first, even if the quality of manufacturing is then satisfactory going forward.
Starting an apprentice program
This would carry the described annual cost of $25,000, but would also reduce the yearly costs by 10 x 5000 = $50,000 in salaries, effectively bringing in $25,000 per year
However, it should be noted that it is not an immediate solution as the first batch of recruits would take 3 years to train.
You can inform them that, in three years time, 70% of current employees will have retired, resulting in only a $30,000 severance fee payment.
This would eliminate the cost of salaries currently paid by 10 x 30,000 = $300,000.
Outsourcing would carry a yearly cost of $200,000, plus the $100,000 one-time severance cost for making current staff redundant.
Since the outsourcing company can produce more shoes per year, this allows for an increase in sales and thus increased revenue.
We can calculate this increase in revenue as follows:
Revenue = number of employees x shoes per employee per year x price of shoe
Revenue = 10 x 2000 x 50 = $1m
Note the higher number of shoes per employee per year
Revenue = 10 x 2500 x 50 = $1.25m
Difference = outsourcing revenue - current revenue
Difference = 1.25m - 1m = $250,000
So, in the first year, all things being equal, reducing costs and increasing revenue should lead to an increase in profit.
We can calculate the value of this increase.
Thus, for year one:
Increase in profit = increase in revenue + cost savings - costs
Increase in profit = increase in revenue + savings in salaries - severance costs - cost of outsourcing
Increase in profit = 250,000 + 300,000 - 100,000 - 200,000 = $250,000
For year two onwards:
No $100k severance fees, so the increase in profit is $350,000
However, the candidate should remark that this assumes that all the shoes will be sold and that the outsourcing option might affect sales by damaging the brand's image. Customers might be less keen to buy now that products would no longer be fully hand-made and produced in-house. This might result in unsold shoes.
Deliver the recommendation
In light of the client's timeframe, the candidate should recommend that RS outsource production. The reasons for this are threefold:
It is the less risky option in terms of the skill required to produce the clients’ products, as quality would have to be checked and guaranteed by the company to which RS would outsource.
While the apprentice program would be the optimal way to ensure quality by having direct control over craftsmen, it is not feasible considering the client’s timeframe for operational improvement.
Outsourcing is the most cost-efficient option, yielding immediate and future savings on employees’ salaries.
Automation increases production capacity and, consequently, revenues and profits.
A good candidate would, however, point out the risk of potential brand damage, as products would no longer be fully hand-made. This might lower revenues.