MAKE V/S BUY

JYOTI ELECTRONICS

Jyoti Electronics is a 600 Crore turnover company based in Bengaluru having a range of
products for the exploding Indian Telecom networking market. The Company is known
for its growing range of R & D led innovative application products for the active
infrastructure requirements of the Telcos.

The R & D team has developed a new 3G environment related product code named D234
which, after all trials, is ready for its commercial launch. The Company expects to sell at
least 10,000 numbers per annum in the foreseeable future and, if the market accepts it
well, the requirement could go upto 20,000 numbers pa. The average price of the product
is expected to be Rs 50,000 per unit and after the usual quantity discounts and
brokerage/commissions, the net realisation is expected to be around Rs. 42,000 per unit.

Based on the bill of material and estimates received from the regular vendors, the
material cost (including packaging) is expected at Rs 25,000 per unit. There is 10,000 sq.
ft. space available in an extra bay in the Company’s Pondicherry plant where the
necessary manufacturing and assembly facilities can be set up. The constructed cost of
this plant in the Company’s books is Rs 2000 per sq. ft and the market rate in that area is
Rs 3000 per sq. ft. The investment in new machinery and other fixed assets will be Rs
100 million. Jyoti will have to earmark an incremental complement of about 35 managers
and skilled workmen for the manufacturing program and the total annual direct CTC of
this team is estimated at Rs 22 million p.a. Incremental power, consumables, utilities and
maintenance are estimated at Rs 1000 per unit of production. In addition to the capital
expenditure indicated above, the manufacturing and supply chain management process
will require carrying material and WIP inventory equivalent of 2 months’ material cost.

Based on past experience, factory and administrative overheads allocated to all products
is @ 10% of material cost. The Company considers pre-tax weighted average cost of
capital for all projects @ 18% pa. Also, based on past experience, the company adds 5%
contingency for all future product cost estimations for new product launches like D234.

As project team is finalizing all details, the supply chain team has got an active enquiry
for outsourcing the entire manufacturing and assembly of product D234 to AP
Electronics who has (or has access to) facilities in India, China and Philippines. AP
Electronics have made a budgetary quote (subject to final discussion and negotiation of
commercial terms) to make and supply the completed product as per Jyoti design and
quality standards at an indicative price of Rs 32,000 fob Bengaluru. They have further
offered a 5% reduction if the quantity required exceeds 15,000 pa.

Discuss: How should Jyoti proceed on this matter? What are the non-financial
considerations go into the make or buy decision?