Northline Components: Inspection Automation vs. Standard Work Under a Capital Cap
Northline Components operates one plant producing 40,000 units per month on three shifts. Overtime is 12% of direct labor hours, the defect rate is 3.8%, and on-time delivery is 91%. Direct labor averages 0.5 hours per unit, and the overtime premium is $14 per hour. The plant has $700,000 of capital available this year, but $250,000 is already committed to regulatory compliance. Two proposals are on the table. Proposal A: $600,000 automated inspection cell that would cut defects to 1.2% and free four inspectors costing $55,000 each fully loaded; installation would take six months and reduce capacity by 15% during that period. Proposal B: $150,000 for standard-work redesign and supervisor coaching, cutting defects to 2.5% and overtime to 9% over three months with no capacity loss. Each defective unit costs about $25 in scrap and rework, and contribution margin is $18 per unit. The plant manager must choose within two weeks; sales says delivery reliability is already a constraint.
1. Quantify the first-year financial and operational tradeoffs of Proposals A and B. Which proposal has the better payback, and what does the capacity constraint do to the comparison?
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Proposal A. Defect reduction is 3.8% − 1.2% = 2.6 points, or 0.026 × 40,000 = 1,040 units per month. At $25 per defective unit, that is $26,000 per month, or $312,000 per year. Freed inspectors add 4 × $55,000 = $220,000. Gross annual benefit is $532,000. Capex is $600,000, so simple payback is 600/532 ≈ 1.13 years, or about 13.5 months.
The capacity loss is the hidden cost. A 15% reduction for six months removes 0.15 × 40,000 = 6,000 units per month, or 36,000 units total. At $18 contribution per unit, forgone contribution is $648,000 if sales are capacity-constrained. That exceeds the first-year gross benefit of $532,000 before counting the capex.
Proposal B. Defect reduction is 3.8% − 2.5% = 1.3 points, or 520 units per month. At $25, that is $13,000 per month, or $156,000 per year. Direct labor hours are 40,000 × 0.5 = 20,000 per month; a 3-point overtime reduction is 600 hours per month, worth 600 × $14 = $8,400 per month, or $100,800 per year. Total benefit is $256,800. Capex is $150,000, so payback is 150/256.8 ≈ 0.58 years, or about 7 months.
B has the better payback and no capacity loss. A's payback looks acceptable only if the plant can protect delivery during installation; otherwise the $648,000 contribution loss dominates.
2. Given the capital constraint and the delivery-reliability constraint, what should the plant manager recommend, and on what conditions?
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Recommend Proposal B, and treat Proposal A as infeasible under the current capital plan. The arithmetic is decisive: $250,000 compliance plus $600,000 for A equals $850,000, which exceeds the $700,000 available. Even if A were affordable, its six-month 15% capacity loss would put further pressure on a 91% on-time delivery rate that sales already describes as a constraint. Losing 6,000 units per month for six months risks expediting costs, penalties, and customer defection, none of which is in the $532,000 benefit estimate.
B is affordable, yields roughly $256,800 in annual benefit, pays back in about seven months, and does not reduce output. The manager should approve B, hold the remaining $300,000 as contingency, and require a 90-day validation that defects actually fall to 2.5% and overtime to 9%. If B delivers, the plant can revisit automation later with better data and a plan to install during a low-demand window or with buffer inventory.
The recommendation is conditional on B's pilot results. If defect reduction stalls above 3.0% or overtime does not fall by at least two points, the savings case weakens and the manager should not release the full $150,000.
3. What evidence would cause you to reverse the recommendation in favor of Proposal A?
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Reverse if the capacity-loss cost can be eliminated or sharply reduced. For example, if installation can occur during a seasonal trough, or if 36,000 units can be pre-built and stored at a carrying cost below the $648,000 contribution at risk, A's economics improve materially. A would then show $532,000 annual benefit against $600,000 capex, a 13.5-month payback, plus the quality and labor benefits.
A second trigger is a higher cost of poor quality. At $25 per defective unit, A's defect savings are $312,000. If scrap, rework, warranty, and expediting actually cost $50 per unit, defect savings double to $624,000, and total annual benefit becomes $844,000. That would justify seeking incremental capital and solving the capacity problem.
A third trigger is a sales constraint that is not capacity-limited. If demand is soft and the plant can absorb a 15% output reduction without losing contribution, the $648,000 penalty disappears. The manager should reverse only when the combined evidence shows a payback under roughly 18 months after including the capacity mitigation cost.