CASE STUDY NO. 01.04
TURBO, INC. Background Turbo, Inc., is a wholly owned subsidiary of National Engine Corporation, located in Cityville, Ohio. Sales for 2005 were $29,803,000, on which Turbo earned $1,788,180 before tax. Turbo manufactures and sells turbochargers for use on new and used cars and trucks and spare parts for repairing these turbochargers. The plant normally employs about 40 hourly people for inspection, machining, assembling, material handling, shipping and receiving, machine setup, and maintenance. Ken Bauer is on the operational audit staff of National Engine Corporation, which purchased purchased Turbo in in 2003. Nationa Nationall Engine's Engine's policy policy is to conduct conduct a review of purchasing purchasing practi practices ces at each newly acquired subsidiary within the first two or three years of National Engine's ownership. Early in 2006, Ken was sent to Cityville to perform this review. On his first day, he requested a plant tour in order to familiarize himself with the product and its manufacture. To help him understand the product, the manager of manufacturing engineering, Martha Johnson, gave him a general bill of material (see Exhibit 1). She explained that different finished turbocharger models are made by creating combinations of turbine wheels, turbine housings, compressor wheels, compressor housings, and compressor plates. Over 40,000 such model combinations are possible, but in practice Turbo makes only about 2,300 turbocharger models each year. In addition, it sells the parts individually to repair shops for use in repairing turbochargers. The plant uses a material-requirements-planning (MRP) system to convert its forecast sales of finished turbochargers and parts into net machining and purchasing requirements. Each week the purchasing purchasing department department receives receives computer-ge computer-generat nerated ed schedules schedules of Turbo's Turbo's purchased purchased materials materials requirements projected for six months.
Organization After learning this basic information, Ken met with the purchasing manager, Doug Mitchell, who gave Ken a copy of his organization chart (see Exhibit 2). He explained that he had divided the parts among among the buyers buyers so that each each buyer had had the same number number of part numbers numbers (p/n's (p/n's)) assigned assigned to him. Doug commented that Carl Potter was his strongest buyer with the best record on cost reduction, delivery performance, and quality acceptance. Doug also supplied Ken with a list of 2005 purchases purchases (see (see Exhibit Exhibit 3).
Corporate Discounts Ken reviewed the list of purchases against the National Engine headquarters' list of corporate discounts. This list consists of items for which the parent company has negotiated favorable prices due to the large volume purchased by all National Engine's subsidiaries combined. Of Turbo's purchases, all the hardware and packing items and some production chemicals, maintenance sup plies, and office supplies were available under the National Engine's corporate discount program. If Turbo had purchases from the corporate suppliers, savings in 2005 would have
been $30,354.30. National Engine had also developed a Korean casting supplier whose prices were considerably lower than going rates in the United States. Potential savings from using this vendor could not be quantified, since each p/n would have to be quoted separately. In discussion with the buyers, Ken discovered that they were not aware of the corporate discount program.
Sourcing Noting that turbine wheels and compressor wheels were single-sourced (that is, Turbo had only one supplier on these items), Ken scheduled a meeting with Art Gunn. Art explained that the turbine wheels were very difficult to cast and that no other supplier had been able to make them reliably. Since a turbine wheel is subjected to extreme heat when in use on the engine, quality is critical. The compressor wheels, Art felt, could probably be cast by other vendors. But engineering had refused to allow him to solicit quotations from any other vendors, so the turbine-wheel vendor produced compressor wheels as well. Art did not agree with this approach but had been too busy to pursue the matter with Doug. In reviewing Exhibit 3, Ken noticed that Turbo's current inventory of bearing housings was almost half of the 2005 purchases. He asked Art to explain this situation. Art showed Ken the financial statements of Castco, one of the vendors for this part. Clearly, Castco was in financial difficulty. Art felt that Castco was a valuable vendor that worked hard to accommodate its customers, so he ordered extra bearing housings to help keep them afloat. Turbo does not have a formal policy regarding purchases beyond current production requirements. Art had not obtained approval from Doug before ordering these extra parts because the part is used in all turbocharger models, so he saw no obsolescence exposure.
Tooling Ken was concerned about the large amount of money spent for tooling, so he scheduled a meeting with John Harris. John explained that the major part of the expense ($1,932,816 of the $3,017,983 for tooling and repairs) was for patterns and dies made for Turbo by the casting vendors. Upon receiving the drawings and specifications for a new part number, the casting vendor makes the equipment required to produce the casting. Turbo pays the casting vendor for making this equipment, and therefore owns the equipment, although it stays at the vendor's location for use in producing additional castings. First, a wooden pattern is made in the exact shape of the part. Then this pattern is used to make dies for casting the part. With usage, the patterns and the dies wear out. Thus, patterns and the dies must be made both for new parts and for production parts whose volume has been high enough to wear out the original equipment. John had not inspected any of Turbo's equipment at vendor locations. Although in many cases he felt that Turbo was charged too much or too often for patterns and dies, he was too busy to question the vendors, so he accepted their charges. Recently, John had heard rumors that some of the casting vendors were using Turbo's equipment to produce castings for sale to other companies. At this stage, Ken returned to headquarters to write up the first sections of his audit before revisiting Cityville to complete the review.
Required 1. 2. 3. 4.
What operational deficiency(s) explain that buyers were not aware of the corporate discount program? In what ways could that deficiency(s) have been discovered? If National Engine elects to pay for casting molds for its vendors what protective actions should be taken? Art Gunn had ordered an unusually large amount of bearing housings from Castco to help the firm (Castco) weather financial difficulties. What issues are present in this action?
Exhibit 1 General Bill of Material Part Qty. in Each Turbocharger Wheel and shaft 1 Turbine wheel 1 Shaft 1 Compressor wheel 1 Turbine housing 1 Compressor housing 1 Bearing housing 1 Bearing 1 Compressor plate 1 Nuts 16 Washers 16 Seal rings 4 O-rings 2 Grease 2 Plastic packing cap-housings 2 Plastic packing cap-oil ports 2 Box 1 Shrink wrap 10 Silica pack 1
No. of Different P/N's* 4 4 1 12 12 12 1 1 6 3 3 15 4 1 1 1 1 1 1
*For example, there are 12 different sizes of compressor wheels. Each turbocharger uses one compressor wheel. Wheels are combined with other components to make different finished turbochargers.
Exhibit 2 Purchasing Department's Organization
Doug Mitchell Purchasing Manager Marty Smith Purchasing Secretary
Arthur Gunn Buyer Turbine wheels Compressor wheels Turbine housings Bearing housing Shafts
Bruce Norman Buyer Compressor housings Bearings Compressor plates Nuts Washers Rings Grease Plastic cap-housings Plastic cap-oil ports Shrink wrap Silica packs
Carl Potter Buyer Seal rings Boxes Plastic bags
John Harris Buyer Tooling and repairs Production chemicals Maintenance supplies Office supplies
Exhibit 3 Purchases in 20X5 Part P/N's UP Turbine wheels 4 158,902 Compressor wheels 12 177,816 Turbine housing 12 135,614 Compressor housing 12 143,806 9,983 Bearing housing 1 265,803 132,750 Shafts 1 160,700 Bearing 1 203,642 Compressor plates 1 147,819 Nuts 5 4,302,817 Washers 2 4,032,008 Seal rings 15 1,020,015 O rings 4 516,473 Grease 1 240,000 Plastic caps: housings 1 255,000 Plastic caps: oil ports 1 247,000 Boxes 10 380,550 Shrink wrap 1 1,300,000 Silica pack 1 125,802 Plastic bags 5 9,035,000 Tooling & repair N/A N/A N/A Production chemicals N/A N/A Maintenance supplies N/A N/A Office supplies N/A N/A
Total LEGEND: P/N is part numbers. UP is units purchased in 20X5. AUC is average unit cost. TP is type of part. NS is number of supplier. UI is units in inventory in 12/31/X5. IIC is iron investment casting. AC is aluminum casting. SBS is steel bar stock H is hardware. C is chemical. P is packing.
AUC 4.53 3.27 9.18 7.46
6.24
Dollars TP 719,826.06IIC 581,458.32AC 1244,936.52IC 1,072,792.76
Buyer NS ARG 1 ARG 1 ARG 2 AC BCN
UI 13,497 12,217 15,301 2
1,658,610.72
AC
MG
2
2.97 1.58 2.03 .004 .001 .002 .14 .01 .05 .03 .54 .05 .30 .02 N/A
477,279.00SBS 321,754.36AC 300,072.57AC 17,211.27 H 4,032.01 H 2,040.03 H 72,306.22 H 2,400.00 C 12,750.00 P 7,410.00 P 205,497.00 P 65,000.00 P 37,740.60 P 180,700.00 P 3,017,983.15
ARG BCN BCN BCN BCN CFP BCN BCN BCN BCN CFP BCN BCN CFP N/A
3 2 2 4 4 4 4 2 1 1 2 2 2 2 JMH
12,591 17,670 13,318 350,602 326,007 86,001 40,039 21,327 23,250 21,583 30,712 98,333 12,483 654,916 N/A
N/A N/A N/A
402,016.15N/A 153,249.36N/A 97,004.14N/A
JMH JMH JMH
N/A N/A N/A
N/A N/A N/A
10,654,070.24
