Question

1. Presbyterian Hospital has been hit with a number of complaints about its food service from patients, employees, and cafeteria customers. These complaints, coupled with a very tight local labor market, have prompted the organization to contact ABC Food Service about the possibility of an outsourcing arrangement.

The hospital's business office has provided the following information for food service for the year just ended: food costs, $890,000; labor, $85,000; variable overhead, $35,000; allocated fixed overhead, $60,000; and cafeteria net income, $80,000.

Conversations with ABC personnel revealed the following information:
a. ABC fwill charge St. Luke’s Hospital $14 per day for each patient served..
b. Presbyterian’s 250-bed facility operates throughout the year and typically has an average occupancy rate of 70%.
c. Labor is the primary driver for variable overhead. If an outsourcing agreement is reached, hospital labor costs will drop by 90%.

4. ABC plans to use the hospital’s facilities for meal preparation.
5. Cafeteria net income is expected to increase by 15% because ABC will offer an improved menu selection.

REQUIRED:
A. What is meant by the term "outsourcing"?

B. Should the hospital outsource its food-service operation to ABC?

C. What factors, other than dollars, should hospital management consider before making the final decision?

Answer 1

A. Outsourcing is basically the question of make or buy decision, the decision of whether the product shall be manufactured internally or from outside supplier.

B. Allocated fixed overhead is irrelevant cost for make or buy decision. Variable overhead changes with changes in labor. That means it is directly proportional to it.

Particulars	Make Internally	External supplier
Food costs	890,000	250*70*14*365 =894250
Labor	85,000	85000 (1-0.9) =8500
Variable overhead	35,000	35000/85000 * 8500 = 3500
Cafeteria net income	(80,000)	80,000 +15% = (92,000)
Net costs	930,000	814,.250

The hospital would be better off to outsource its food operation, as tit would benefit by $115,750 ($930,000 - $814,250)

C. Factors to consider would include

· improvement in food quality

· reliability of NIFS

· elimination of labor problems

· data validity in future years