Export Order Decision with a Machine-Hour Constraint
Kaveri Ltd produces a single component on machines that provide 1,40,000 machine hours a year. Each unit needs two machine hours. Normal output and sales are 60,000 units at ₹40 per unit. Cost data at that volume are: direct material ₹12, direct labour ₹8, variable overhead ₹5 and fixed overhead ₹6,00,000. An export buyer offers to take 15,000 units at ₹34 each. The export order needs extra packing of ₹2 per unit and will not affect domestic selling costs, which are included in variable overhead. Fixed costs will not change. The marketing manager wants to accept because ₹34 exceeds the variable cost of ₹25. The production manager warns that machine hours are finite and that the offer would displace some domestic sales.
1. Evaluate the export order using contribution per machine hour and the opportunity cost of displaced domestic sales.
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| Per unit | Domestic ₹ | Export ₹ |
|---|---|---|
| Selling price | 40 | 34 |
| Material | 12 | 12 |
| Labour | 8 | 8 |
| Variable overhead | 5 | 5 |
| Extra packing | - | 2 |
| Variable cost | 25 | 27 |
| Contribution | 15 | 7 |
| Machine hours | 2 | 2 |
| Contribution per hour | 7.50 | 3.50 |
Capacity check: 60,000 units × 2 = 1,20,000 hours used; spare hours = 20,000. The export order needs 30,000 hours, so 10,000 hours must be taken from domestic production, i.e. 10,000 / 2 = 5,000 units.
Net effect:
- Export contribution: 15,000 × ₹7 = ₹1,05,000
- Less lost domestic contribution: 5,000 × ₹15 = ₹75,000
- Net gain = ₹30,000
Accept on financial grounds, but the margin is modest and qualitative factors matter. Fixed overhead is irrelevant because it does not change.
2. Compute the minimum price per unit for the export order, and re-evaluate it if the spare hours could instead be used to make a component in-house, saving ₹8 per machine hour.
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Minimum price without the alternative use:
- Variable cost per unit = ₹27
- Opportunity cost per unit = lost contribution ₹75,000 / 15,000 units = ₹5
- Minimum price = ₹32 per unit
At ₹32 the order merely breaks even; at ₹34 it adds ₹30,000.
With the in-house alternative: the 20,000 spare hours could save ₹8 per hour = ₹1,60,000. Total opportunity cost of the export order becomes:
- Lost domestic contribution: ₹75,000
- Lost in-house savings: ₹1,60,000
- Total = ₹2,35,000
Export contribution ₹1,05,000 − ₹2,35,000 = net disadvantage ₹1,30,000. The order should now be rejected: the spare hours are more valuable making the component than filling the export order.
3. Identify the qualitative and strategic factors that should accompany the numerical analysis.
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- Price leakage: a ₹34 export price may become known to domestic customers and undermine the ₹40 price.
- Precedent: accepting a low price may set a benchmark for future export negotiations or invite demands for similar concessions.
- Market access: the order may open a long-term export market, but it may also create obligations (delivery deadlines, penalties, quality certification) whose cost is not in the figures.
- Capacity and workforce: using all spare hours removes the buffer for breakdowns, maintenance and rush domestic orders; overtime or idle time may change the variable cost.
- Customer and credit risk: export receivables carry currency, payment and collection risk, and the buyer's reliability is unknown.
- Strategic fit: if the in-house component saves ₹8 per hour, the export order should be rejected unless it brings benefits (learning, market entry) that outweigh ₹1,30,000.
- Cost behaviour: the analysis assumes variable costs per unit stay constant at higher volumes; discounts on materials or step costs could alter the answer.