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Statement of the Problem

Komatsu Ltd. is a multinational company in Japan that specializes in manufacturing heavy construction equipment. Company revenues reached 989 billion yen in 1993 and target revenue of on trillion through aggressive expansion plans. The major areas in which the company operates are construction equipment, industrial machinery and electronics.

Komatsu Ltd. manufactures only 30% of its products. 50% or products are designed by the company, but outsourced from other suppliers and the balance 20% is bought from the market. The problem faced by the company is that it is not able to products at expected prices from its suppliers. This is significant because, as mentioned above, 70% of total products and product components are through outside sources and hence a deviation from target prices will affect the bottom line of the company. In most cases the prices paid to suppliers would be higher than the estimated price and this makes target costing figures inaccurate.

Assumptions

Komatsu Ltd. is planning an aggressive expansion strategy. As a result, it plans to increase its revenues from its current figures of 989 billion yen to one trillion yen by the year 2000. The company plans to enter into three new areas of business, namely electronic, plastics and robotics. These three areas have high potential for growth since its applications are increasing worldwide in many industries. Being technology driven areas, it also requires heavy investment for research and development. Investment in infrastructure for manufacturing will also be very high. If the company follows the same strategy of outsourcing, it will create the above mentioned problems in these areas also. It is assumed that once these new operations get under way, revenues form non-construction products will generate at least 50% of total group revenues.

Key facts

Komatsu Ltd is the worlds second largest manufacturer of construction equipment with a turnover of 939 million yen. It has a product range about 300 models of equipment which can be classified as bulldozers, hydraulic excavators, wheel loaders and dump trucks. The company is the market leader in Japan for excavators with a market share of 30%. It is also the only company in Japan that produced both bulldozers and excavators. All its major competitors which includes Hitachi, Kobelco, and Sumitomo produced only excavators. The only other competitor who also produced bulldozers was Caterpillar Mitsubishi.

Alternative Solutions

Komatsu Ltd. has a problem with the pricing of its suppliers which comes up to 70% of its total production. The company is trying to correct this by including all its suppliers in the design stage of new products through periodic meetings. The company can look at the two alternative suggestions and select on of them to deal with the problem in the future.

Manufacture all or at least majority of components and products: Komatsu Ltd. could invest heavily and manufacture all or at least a majority of all products and components themselves. This method will help the company reduce or eliminate reliance on outside suppliers. The company already has expertise in manufacturing of heavy machinery and it would not be a major problem for them to take over the manufacture of these items themselves.
Invite quotations from suppliers through open tenders: The Company can alternatively invite quotations for supply machinery and components. The quotations can be called for through advertisements in general and industry publications and trough other media like newspapers.

Alternative b would involve very little expenditure when compare to alternative a. With the presence of a larger she cost of calling for quotations also will be very negligible. But the disadvantage of this strategy is that the company will still be dependant on outside sources. With only 30% of own production, there is a limit as to how much costs can be controlled. Moreover, being in such a specialized field, the number of suppliers too would be limited.

Alternative a would entail heavy capital expenditure for creating infrastructure. New plants and building would be needed and additional staff and would have to be hired. Facilities for research and development also would need to be made available. But the company is already in a diversification process. The company is already committed to investing heavily for this purpose. If it can plan and incorporate both these expenditures, this alternative would be the ideal long term solution. A simulated model in cost savings is given as appendix.

Decision

Komatsu Ltd. needs to look ahead into the future. With self sufficiency in manufacturing it would have control over costs which in turn will make the company more competitive. With increasing levels of globalization, competition is bound to be fierce and reliance on outside suppliers to such an extent will not become feasible. After due consideration of all the facts, the management of Komatsu Ltd. has decided to go in for the first alternative. It will invest in necessary and plans to reduce reliance on outside suppliers in a phased manner. Ultimately Komatsu Ltd plans to outsource only five percent of its products within a period of 10 years.

Appendix

Simulated model of Cost Savings by having self sufficiency is production

Cost of excavator with 70% outsourcing of components

Material cost 20,000
Outsourced material cost 65,000
Direct Labor cost 2,000
Indirect labor (Salary etc) 1,000
Depreciation 1,250
Other direct expenses 500
Other indirect expenses 600
TOTAL 90,350

Cost of excavator with 5% outsourcing of components

Material cost 50,000
Outsourced material cost 9,000
Direct Labor cost 5,000
Indirect labor (Salary etc) 1,000
Depreciation 2, 750
Other direct expenses 500
Other indirect expenses 600
TOTAL 68,850

Note: Depreciation costs would become reduced every year resulting in additional cost savings.

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