Date: November 17, 2011 From: Andy Moon – A00838117 To: Mr. Karl Fichter Subject: Case Study 2 – Pressure Vessel

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1. Problem

The supply manager of Oceanics Inc., Jack Toole, is faced with a situation in decision-making for purchasing one manufactured pressure vessel from either one of the two suppliers, Atomic Products Company and Nuclear Vessels, Inc., who will provide the best value. While Jack needs to choose the best value from a purchasing standpoint, he also needs to choose a supplier that satisfies the requisitioner of the pressure vessel, the engineering department of Oceanics, Inc. Another critical issue to be considered would be that pressure vessels are closed containers designed to hold gases or liquids at substantially higher pressure than the atmospheric pressure (Wikipedia, 2011). Pressure vessels are dangerous objects sensitive to pressure differentiations, at which could cause fatal accidents. Therefore, Jack carries the responsibility in acquiring a capital asset that could possibly affect other people’s lives.

2. Summary

The engineering department of Oceanics, Inc., had given out a purchase requisition of a pressure vessel to the supply manager, Jack Toole. Out of twenty suppliers, eighteen submitted their proposals, and only two suppliers were left after a preliminary evaluation. The two suppliers, Atomic Products and Nuclear Vessels, differentiated in price, shop facilities, past experience, subcontracting, organization, delivery, and guarantee. After Jack and Oceanics’ engineer, Mr. Holpine and the manufacturing engineer, Mr. Grinn, visited the two suppliers’ plant sites, Mr. Holpine and Mr. Grinn ended up having differing arguments in choosing the better supplier. Jack’s objective is to satisfy Oceanics’ engineering department’s requisition specifications while choosing the supplier with the best value from a purchasing perspective.

3. Site Observations

Jack, Mr. Holpine, and Mr. Grinn focused in observing the age, quality, and inspection levels on the machines, laboratories, incoming materials, and other general shop facilities at both plants of Atomic Products and Nuclear Vessels.

One thing that the Oceanics’ team should have investigated at both suppliers’ plant sites is a sample of each supplier’s pressure vessel. By observing the largest samples of pressure vessels available at both plants, the Oceanics’ team could have learned the level of quality in meeting the requisition specifications from Oceanics in the most direct way. Furthermore, a sample pressure vessel would reveal the quality of design compared to specifications.

After noting that Atomic Products has confined space for placing a pressure vessel of such size specified by Oceanics inside their plant, Oceanics’ team should have investigated the volumetric space required to store the entire pressure vessel inside Atomic’s building. Also, the investigation should have continued as to determining any outdoor factors such as heat or water that may have any adverse affects on the quality of the pressure vessel. Should there be no relation to outdoor storing and the quality of the pressure vessel, Atomic Products would eliminate one issue that could possibly be recongnized as a defect.

After finding out that Nuclear Vessels’ plant facilities such as machines and laboratories seemed to be of considerable age, Oceanics’ team should have asked Nuclear Vessels for a continuous record of maintenance, repair, and operation for Nuclear’s plant facilities. In this way, Oceanics would be more assured for Nuclear Vessels’ quality of manufacturing processes.

4. Supplier Evaluation

In order for a better aid in supplier evaluation, consider the following table of basic cost analysis for the two suppliers, Atomic Products and Nuclear Vessels.

Table 1. Supplier Evaluation - Cost Analysis | Atomic Products | Nuclear Vessels | Total Estimated Cost | $1,232,000 | $1,560,001 | Shop Rate | $24/hr | $16/hr | Overhead Rate | $43.20/hr (24×1.80=180% of shop rate) | $25.60/hr (16×1.60=160% of shop rate) | Total Shop Rate per Hour | $67.20/hr | $41.60/hr | Total Time Requirement (Hours) | $1,232,000$67.20/hr=18,333 hours | $1,560,001$41.60/hr=37,500 hours |

Advantages and Disadvantages of Atomic Products

Atomic Products proposed a lower estimated price, but higher shop and overhead rate. This could mean that there is a possibility for Oceanics to purchase their pressure vessel at a lower total cost from Atomic Products, but at the same time, Oceanics could be charged with unexpected cost overruns at a greater factor due to Atomic’s higher costing rate. Atomic’s machinery were new and well maintained, laboratories and quality control departments were well staffed and equipped with updated tools, and other plant facilities such as lighting, ventilation, and inventory were very clean and organized. The excellent quality of Atomic’s plant facilities does correspond to Atomic’s production manager, Mr. Strickland’s, statement that Atomic’s shop is equipped with the best in the United States, and that the company is capable of yielding faster lead times than any other competitors for manufacturing pressure vessels. One disadvantage of Atomic Products that was noted on the part that Mr. Strickland could not offer evidence of material control. Pressure vessels are very dangerous and sensitive objects, at which the quality of the material used to manufacture the vessels must be critically controlled and analyzed. Should any wrong material to be used in manufacturing, the pressure vessel would pollute the entire nuclear system, and incur Oceanics with greater problems and issues (financial and legal) incomparable to purchasing a pressure vessel. Furthermore, not only Atomic Products did not have previous experience in supplying pressure vessel to Oceanics, but Mr. Strickland stated that Atomics never did have a contract for manufacturing such a large vessel in size as the one requested from Oceanics. Atomic Product’s inexperience in producing a large vessel could incur a new learning curve to the company’s production, and thus, result in a longer lead time. Ultimately, a longer lead time requires longer production hours, and result in increase in total cost. The last disadvantage that could be noted for Atomic Products was the lack of enthusiasm in taking the job from Oceanics.

Advantages and Disadvantages of Nuclear Vessels

Nuclear Vessels had a higher estimated price, but lower costing rates. The fact that Nuclear’s higher estimation of their total cost, itself, is a disadvantage; however, since Nuclear has lower costing rates, the effect of cost overruns will be less adverse to Oceanics. A critical advantage from Nuclear Vessels would be their past experience in manufacturing a pressure vessel that is even larger than the vessel needed by Oceanics. As a result of this past experience, Nuclear Vessels lower the risk of their production going over-time, and will more likely avoid cost overruns. Also, Nuclear Vessels have previous experience working for Oceanics’ engineering division, at which makes Nuclear Vessels more familiar to Oceanics’ expectations and specification requirements. Nuclear Vessels also showed great enthusiasm to take Oceanics’ job as Mr. Winninghoff, the president of Nuclear Vessels, himself showed courtesy to Oceanics’ team. Another advantage of Nuclear that was evident was the well managed structure of the organization including project management and supply chain management. These advantages make an addition to Nuclear Vessels lowering any risks involved in production delays and cost overruns.

A huge disadvantage of Nuclear Vessels was that the machines at Nuclear’s plant were outdated and seemed to have smaller capacity, at which made Atomic Product’s machines to seem more adequate for the job. Nuclear’s laboratories were large in size, but the staff seemed to be equipped with outdated tools. Also, Nuclear’s plant did not have all the required machinery as Mr. Winninghoff stated that some subcontracting work needs to be done at Nuclear’s subsidiary plant. Although Mr. Winninghoff guaranteed that there would not be a delay in schedule due to moving the work into other divisions, this part does raise some uncertainties.

In brief, from assessing the two suppliers, Atomic Products and Nuclear Vessels, and based on the information provided, Nuclear Vessels seemed to provide a better overall value. The supporting reason is that because Atomic Products had no previous experience in producing a pressure vessel as large as specified by Oceanics, there is a great possibility for Atomic’s production to fall into over-time, at which results in Atomic’s price and delivery date to alter negatively for Oceanics. Continuing from this point, since Nuclear Vessels already had a previous experience, the risk of keeping safety requirements for the pressure vessel is going to be lower with Nuclear. Also, Oceanics is assured of Nuclear’s material control as noted from discussion with Mr. Winninghoff regarding Nuclear’s improvement in material control. As mentioned earlier, since pressure vessels are dangerous objects that could lead to fatal accidents, cost may be considered as a second-hand issue while quality requirements such as reliability and serviceability may be considered more greatly.

5. Missing Information

From both suppliers, information regarding detailed cost breakdown of the total estimated cost including information pertaining to material cost or over-time labor cost had not been presented.

Financial conditions of both suppliers had not been given out to demonstrate each supplier’s capability of operating Oceanics’ project.

An adequate reference list of past clients had not been presented as to reinforce the validity of both suppliers.

6. Comparison of Hours

There is significance in calculating the amount of hours required for each supplier. Referring back to Table 1., the difference in hours required to complete Oceanics’ project for the two suppliers is 19,167 hours. The difference in the total estimated cost between the suppliers is $328,001.00. Based on Atomic’s costing rate, the amount of hours required for making up this difference is 4,881 hours. Should Atomic’s production go over the allowance of 4,881 hours, Oceanics will be charged more than the total estimated price given from Nuclear Vessels. Meanwhile, even at the time, when Atomic Products has spent the extra number of hours, Nuclear Vessels still has the tolerance of 14,286 hours until Oceanics is over-charged from the proposed estimation. Therefore, this analysis adds another upper hand to Nuclear Vessels considering the fact that it will be Atomic Product’s first time experience to manufacture a pressure vessel at a size required by Oceanics.

7. Incentives

Under the Tender policy, an incentive must be equally applied to both suppliers.

Since the current purchase requisition of a pressure vessel specified by Oceanics is a very attractive proposition for both Atomic Products and Nuclear Vessels, becoming the successful candidate, by itself, could be a great incentive for both companies. However, to reinforce both suppliers’ enthusiasm, establishing a payment system that enables a full payment to the supplier upon received of goods would be an attractive incentive for both suppliers.

8. Cost Overruns

In order to avoid time delays and cost overruns, an incentive and penalty system must be enforced. Proposing to both suppliers, if the suppliers keep their total estimated cost at Oceanics’ required date, both suppliers’ shop rate will be increased by a dollar. On the other hand, if the suppliers go over the estimated cost while delayed in schedule, both suppliers’ shop rate will decrease by two dollars. While this practice motivates the supplier to go under the estimated costs, the practice also discourages them to go over the proposed costs.

9. Recommendations

Considering the advantages and disadvantages of both suppliers, Nuclear Vessels revealed the best value for Oceanics’ proposal, and the following recommendation will be made only towards Nuclear Vessels.

Considering Oceanics’ purchasing proposal that worth over 1.5 million dollars on hand, and at the same, Nuclear Vessels’ willingness to take on the job while demonstrating sufficient level of capacity and experience should be attractive for both companies.

Under recommendation, Oceanics will sign the current contract with Nuclear Vessels with a guarantee of the subsequent project, only under the following conditions:

The shop rate of $16/hr will decrease to $13/hr while the total overhead cost remains fixed from the previous. The shop rate of $13/hr after 37,500 hours (refer to Table 1.) equals $487,500, which is 81% of the formal total shop cost. Since the total overhead cost remains to be $960,000, the total estimated cost now becomes $1,447,500. This is 93% of the formal total estimated cost of $1,560,000. Hence, Oceanics will receive 7% discount from Nuclear Vessels in their total cost. Furthermore, the bonus and penalty system as discussed in cost overruns will apply equally for Oceanics’ purchases from Nuclear Vessel. Any final price under the estimated cost of $1,447,500, Nuclear’s shop rate will be charged $14/hr while any final price over the final cost will incur Nuclear’s shop rate to become $11/hr.