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To know whether domestic or foreign production is least expensive, the total of production and distribution costs must be computed from the source point to the marketplace. Two alternatives are suggested and they can be compared as follows.

Production at Houston:. Production at Taiwan:. Producing in Taiwan would appear to be the least expensive. How reliable would international transportation be compared with domestic transportation? What is the business climate in Taiwan such that costs might change in favor of Houston as a production point? How likely is it that the needed transportation and storage will be available? If the market were to expand, would there be adequate production capacity available to support the increased demand?

The purpose of this exercise is to allow the student, in an elementary way, to examine the tradeoffs between transportation and inventory-related costs when an incentive transportation rate is offered.

Whether the incentive rate should be implemented depends on the shipment size corresponding to the minimum of the sum of transportation, inven- tory, and order processing costs.

These costs are determined for various shipping quantities that might be selected to cover the range of shipment sizes implied in the problem. Table gives a summary of the costs to Monarch for various shipment sizes.

From Monarch's point of view, the incentive rate would be beneficial. Shipment sizes should be approximately doubled so that the 40, lb. It is important to note that the individual cost elements are not necessarily at a minimum at low shipment sizes, whereas order-processing costs are low at high shipment sizes. They are in cost conflict with each other.

Transportation costs are low at high shipment sizes, but exact costs depend on the minimum volume for which the rate is quoted. In preparation for a broader planning perspective to be considered later in the text, the student might be asked what the place of the supplier is in this decision. How does he affect the decision, and how is he affected by it?

This will focus the student's attention on the broader issues of the physical distribution channel. TABLE Type of cost Transportation. Order processing c. The principle applies to sales and items where 80 percent of the dollar volume is generated from 20 percent of the product items. While this ratio rarely holds exactly in practice, the concept does. We can apply it to these data by ranking the products by sales, and the percentage that the cumulative sales represent of the total.

The following table shows the calculations. The rule cannot be applied exactly, since the cumulative percent of items does not break at precisely 20 percent. However, we might decide that only products and should be ordered directly from vendors. The important principle derived from the rule is that not every item is of equal importance to the firm, and that dif- ferent channels of distribution can be used to handle them.

The rule gives some rational basis for deciding which products should be shipped directly from vendors and which are more economically handled through a system of warehouses.

The transport rate structure is reasonably fair, since ground rates generally follow distance and size of shipment. These are the factors most directly affecting transport costs. They are not fair in the sense that customers within a zone are all charged the same rate, regardless of their distance from the shipment origin point.

However, all customers may benefit from lower overall rates due to this simplified zone-rate structure. This is a delivered pricing scheme where the seller includes the transport charges in the product price. The seller makes the transport arrangements. The seller prices the product at the origin, but prepays any freight charges; however, the buyer owns the goods in transit.

This is a delivered pricing scheme where the freight charges are included in the product price, however the freight charges are then deducted from the invoice, and the seller owns the goods in transit. The seller initially pays the freight charges, but they are then collected from the buyer by adding them to the invoice.

The buyer owns the goods in transit, since the pricing is f. The price is f. The buyer pays the freight charges and owns the goods in transit.

Regardless of the price policy, the customer will ultimately pay all costs. If a firm does not consider outbound freight charges, the design of the distribution system will be different than if it does.

Since pricing policy is an arbitrary decision, it can be argued that transport charges should be considered in decision making, whether the supplying firm directly incurs them or not. This shows how Pareto's law principle is useful in estimating inventory levels when a portion of the product line is to be held in inventory.

An empirical function that approximates the curve is used to estimate the level of sales for each product to be. According to Equation , the constant A is determined as follows:. The type curve according to Equation is:. This formula can be used to estimate the cumulative sales from the cumulative item proportion. For example, item 1 is 0. By applying this formula to all items, the following inventory investment table can be developed which shows sales by item.

The average inventory investment by item is found by dividing the turnover ratio into the item sales. Inventory Investment Table. This problem involves the application of Equations and We can develop an 20 curve based on 30 percent of the items accounting for 70 percent of sales. That is,.

Therefore, the sales estimating equation is:. By applying this estimating curve, we can find the sales of A and B items. For example, 20 percent of the items, or 0. The product group C will be the remaining sales, but these are not of particular interest in this problem.

The average inventories for A and B products are found by dividing the estimated sales by the turnover ratio. Total inventory.

The total square footage for products A and B is divided by the stacking height. This problem is an application of Equations and We first determine the constant. Solving algebraically for X , we have:. That is, about 29 percent of the items 0. The price would be the sum of all costs plus an increment for profit to place the automotive component in the hands of the customer.

Based on the varying transportation cost, the following price schedule can be developed. Price per unit. This company is fortunate to be able to estimate the sales level that can be achieved at various levels of distribution service. Because of this, the company should seek to maximize the difference between sales and costs. These differences are summarized as follows:. Percent of orders delivered within one day. Contribution to.

The company should strive to make deliveries within one day, 80 percent of the time, for a maximum contribution to profit. If a competing company sets its delivery time so that more than 80 percent of the orders are delivered in one day and all other factors that attract customers are the same, the company will lose customers to its competitor, as the sales curve will have shifted downward.

Cleanco should adjust its service level once again to the point where the profit contribution is maximized. Of course, there is no guarantee that the previous level of profits can be achieved unless the costs of supplying the service can correspondingly be reduced. The first task is to determine the increase in sales that can be attributed to the change in the service policy.

To determine if there is a significant change in the control group, we set up the following hypothesis test:. Now, referring to the normal distribution table in Appendix A of the text, there is a significant difference at the 0. That is, some factors other than the service policy alone are causing sales to increase.

Next, we analyze the test group in the same manner. This change is also significant at the 0. Therefore, for each sales unit, an incremental increase in profit of 0. The service improvement should be continued. The use of the before-after-with-control-group experimental design is a methodology that has been used for some time, especially in marketing research studies. The outstanding feature of the design is that the use of the control group helps to isolate the effect of the single service variable.

On the other hand, there are a number of potential problems with the methodology:. The optimum service level is set at that point where the change in gross profit equals the change in cost.

The change in gross profit:. The change in cost:. From the tabulated changes in service level with those changes in z , the service level should be set between percent. This implies that a sales-service relationship is known. The methodology is essentially the same as that in question 7, except that we are asked to.

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