solution

The case study material :

“Arrrgh!” exclaimed James L. Heskett, president of Innovative Distribution Company (IDC). “Pirates have struck again off the coast of Somalia. It seems like every time we turn around, there is another piracy on the High Seas.”

“Unfortunately, that is nothing new,” replied John L. Hazard, VP of Supply Chain Excellence. “Piracy has been going on for centuries and is still going on today. Did you know piracy has been dramatically increasing? In 2005, there were 276 piracy incidents1 and in 2009 there were 406 incidents worldwide.”

“Wow! That has got to cost someone a bundle. Who pays for that?” asked Heskett.

“I read a segment on MSN about that,” responded Hazard, “and the cost of insuring ships has gone up. Insurance premiums increased by 10 times in 2009. Some companies are spending more time training their crews, whereas others are avoiding the area altogether—taking long trips around Africa’s southern tip can add 2,700 miles to each trip and increase fuel costs by $3.5 million annually. And, because the ships can only make five round trips per year instead of six, delivery capacity has dropped by 26 percent. Who pays? The customer!”

“Gee, I never thought of those costs. The supply chain really takes a hit. It is a good thing we do not ship anywhere around Somalia,” exclaimed Heskett.

“But there is risk everywhere,” challenged Hazard. “Piracy occurs around the world. They have piracy problems in Malaysia and off the coast of Brazil as well. And there are lots of other risks in the supply chain that need to be mitigated. We have embraced outsourcing because of lower unit prices, but we need to consider the total cost of ownership of the supply chain. Longer transit times, fluctuating exchange rates, uncertain delivery schedules, disruptive weather patterns, multilanguage requirements, political turmoil, unique tariffs, and duties all add to the cost of doing business internationally. I’m not sure we understand the true cost of our supply chain.”

“You have a great point. We ought to take a look at all the costs of sourcing IDC’s next new product—Schachtel Schmuggel Bannware—and consider the entire supply chaincosts,” pondered Heskett. “See what numbers you can gather and we’ll take an all-in look at the numbers.”

A few days later, Hazard and Heskett met to review all of the information they had gathered about the new product.

New Product Sourcing Details

“What did you find?” asked Heskett.

“There are only two possible sources of supply for IDC’s new product. We cannot buy or hold fractional units of a product and we have a projected annual demand (based on a 365-day year) of 21,500 units with a deviation in daily sales of 11 units. Our goal is to maintain an in-stock probability of 98.0 percent for our customers,” replied Hazard.

“All product (regardless of supplier) will be shipped by rail, utilizing 20-foot equivalent units (TEUs) to IDC’s distribution center in Alliance Fort Worth (AFW) where we will service all of IDC’s customers’ needs. A single TEU container can hold up to 600 units of Schachtel Schmuggel Bannware. Due to the nature of the product, no other product may be loaded into the same container. IDC’s inventory carrying cost throughout the supply chain is 32.2 percent.”

Hazard and Heskett recognize it will cost $105 to place
each order with the domestic supplier and due to the complexity of international trade will cost $182 to place each order with the foreign supplier.

Domestic Supplier Details

One of the possible sources of supply is CousinsAg, located in Wahoo, Nebraska. The U.S. Department of Labor reported that in 2002, 88,000 of Nebraska’s wage and salary workers were members of unions. CousinsAg is a union shop with an average labor rate in their Wahoo, Nebraska, facility of $25.30 per hour. In responding to IDC’s Request for Quote (RFQ), CousinsAg’s price is $85.00 per unit.

As shown in Figure 1, when an order is placed with CousinsAg, it will take 10 days for them to process and

manufacture the order, and an additional 5 days to ship it FOB Origin Prepaid to IDC’s Alliance Fort Worth Distribution Center. Rail shipping cost from CousinsAg to AFW is $1,850. Based on similar rail shipments from that part of the country, Hazard assumes the standard deviation of the shipping time from Wahoo will be 1.14 days.

Figure 1 Domestic procurement scenario

Global Supplier Details

The other possible source of supply is Dong Hai Supply, in Chengdu, Sichuan, China. Over the past decade, China aggressively developed its transportation and logistics infrastructure inland from the coast. As shown in Figure 2, the Chinese government is now actively promoting trade in areas such as Chengdu. Located 2,107 kilometers from the port of Shanghai, the Sichuan Administration of Price Control, Sichuan Department of Finance, and the Sichuan Labor Department have maintained strict wage controls to help develop manufacturing for export. The average labor rate in Chengdu is 10.36 Yuan per hour. The current exchange rate is 1 CNY China Yuan Renminbi (¥) = 0.14646 U.S. Dollar. In responding to IDC’s Request for Quote

(RFQ), Dong Hai Supply’s price is 547 ¥ per unit.

Figure 2 Global Procurement Scenario

The global procurement scenario is shown in Figure 2. When an order is placed with Dong Hai Supply (EXW Chengdu, China), it will take 15 days for them to process, manufacture, and stuff the order into a TEU container. Dong Hai Supply will use the Interface Exporting Company (IEC) to ship the container FCA Long Beach.

As a part of China’s aggressive development in infrastructure, the high-speed Shanghai-Chengdu Railroad has recently been completed and will take IEC one day to move the container by rail from Chengdu to Shanghai. It will wait four days at the Port of Shanghai waiting to be loaded onto a ship, 16 days to cross the Pacific Ocean to the Port of Long Beach, and three days waiting to clear customs and be unloaded onto a dockside rail spur in Long Beach.

IEC charges ¥ 12,414.5 for each TEU shipped. Import tariffs and duties are $325 per TEU and are incurred at Long Beach U.S. Customs and charged separately to IDC on a monthly basis. Once the shipment clears customs and is off-loaded to railcar in Long Beach, it will take an additional four days to ship it FOB Origin Prepaid to IDC’s Alliance Fort Worth Distribution Center. Rail shipping cost from Long Beach to AFW is $2,250. Based on similar mini-landbridge shipments from inland China, Hazard assumes the standard deviation of the shipping time will be 3.45 days.

Faced with this information, Heskett has asked Hazard the following questions.

Using the current exchange rate, what is the initial purchase cost per unit (in U.S. dollars) paid to Dong Hai Supply? (Do not include transportation costs.)