Question

lpha Appliances, Inc.

Alpha Appliances, Inc. is a major distributor of household appliances. Its customer base consists of local retailers who stock a variety of products including appliances. Alpha purchases bulk of its products from China, Mexico, India, and Thailand. The business has been good.

In past few months, Jay Adams, VP-Marketing has received numerous complaints from its customers that they have not been receiving supplies on time, costs have gone up, etc. Jay calls a meeting of his sales manager Kathy Land, production manager Abraham King, and procurement manager Ashley Thompson.

Jay Adams: Good morning ladies and gentlemen! How are you guys!

Kathy, Abraham and Ashley all respond with a smile.

Jay: Lately I have been receiving a lot of complaints from our customers and that worries me.

Ashley: I am not aware of it! What are the complaints about?

Jay: There are complaints such as our product prices have gone up, we are not able to deliver on time, and so on!

Abraham: Are the complaints specific to a product, or across the board?

Jay: Well, I am not sure. We probably have problems with many of our products. The most serious problem however seems to be with our very popular ceiling fan model B23Y5. Ashley, are you aware of any issues either with this product or its supplier?

Ashley: Well, we have buying this product from China with a company named Xanu Enterprises. They have recently raised prices, so we were forced to raise ours, in order to maintain our margins.

Jay: Abraham, do you think we can buy parts and assemble this fan in house? Abraham: Yes, we have the capability to do so.

Jay: Kathy, why do our customers complain about late deliveries? Do not we have a good idea of the future demand?

Kathy: We do forecast as best we can. But, I guess sometimes we screw it up! If we do better job of forecasting, this problem can be minimized.

Jay: Well, we have had good discussion of the situation. I am giving you guys one week of time to do your home work. Ashley, try to identify more reliable vendors; Abraham, estimate the cost if we do in-house production; and Kathy, you come up with a more reliable forecast.

Kathy, Abraham and Ashley all nod their heads and the meeting is adjourned.

AFTER ONE WEEK

The meeting takes place, and the following data is presented.

ASHLEY THOMPSON: We have identified two more reliable vendors with following cost structure.

Xanu Enc. - $33 per fan, lead time fixed - 3 weeks

Weni Inc.- - $34 per fan (if purchase quantity is below 1,000)

$33 per fan (if the purchase quantity is between 1,000 and 2,000) $32 per fan (if the purchase quantity is between 2,000 and 5,000)

$31 per fan, if the purchase quantity is above 5,000 (Lead time for Weni Inc. is fixed, 2 weeks)

Yama Inc. - $32 per fan, lead time variable, it will require a safety stock of 300 fans.

The ordering cost is $400, irrespective of the vendor.

ABRAHAM KING: We can produce this product with following cost and related data.

Cost of production of fan: $32 per fan

Production rate: 400 fans/day

Production Set up cost: $3,000

KATHY LAND: We have examined recent past sales data and recent market trends. We expect daily demand to about 50 fans.

The management estimates inventory costs to be about $5 per year per fan. After accounting for holidays, it is estimated the company is in business for about 250 days in a year.

Answer the following questions. Show all work that you need to arrive at the final answer.

If Alpha did not want to go for in-house production, which of the three vendors it should choose? Why?

If Alpha decides to produce, how many fans should it produce every time?

Should company buy or produce? Justify your answer based on the costs involved.

Round all numbers to numbers to the nearest whole number.

This is a group case assignment. A group cannot have more than two students. Both students must contribute equally. You can form your own group. Only one of the members of the group needs to submit. If you cannot form group and wish to do this assignment alone, you can do so. Remember this case is worth 20% of the course grade.

Answer 1

Let’s consider the options one by one. We have some common data such as

Annual demand (D) = 50*250 = 12500

Holding cost (H) = 5

Xanu Enc.

They have a fixed lead time. Thus we do not need safety stock. We can use the EOQ model here. In addition to the above data, we also know that their ordering cost (S) is 400 and product cost (P) is $33. Now we know the EOQ is

EOQ = sqrt(2*D*S/H) = sqrt(2*12500*400/5) = 1414.2 or 1414 units (rounding to whole number)

This means that the total cost for Xanu will be

Total cost = Annual purchase cost + Annual holding cost + Annual ordering cost

Total cost = D*P + H*Q/2 + S*D/Q = 12500*33 + 5*1414/2 + 400*12500/1414 = 419571.1 or 419571 (rounded to whole number)

Weni Inc.

They have quantity discount model. The ordering cost is 400 and the price of the fan varies. Thus we need to calculate the EOQ first then consider the total cost.

From the previous part (Xanu) we already know the EOQ.

This is in the second bracket. This means we need to consider the edges of the price ranges quantity that slopes towards the EOQ. This means we need to find the total cost at 999 units, 1414 units, 2000 units, and 5000 units. We will use the same formula for total cost but change the value of Q 4 times

Total Cost (at Q=1000) = 12500*34 + 5*999/2 + 400*12500/999 = 432502.5

Total cost (at Q = 1414) = 419571

Total cost (at Q = 2000) = 12500*32 + 5*2000/2 + 400*12500/2000 = 407500

Total cost (at Q = 5000) = 12500*31 + 5*5000/2 + 400*12500/5000 = 401000

Best option with Weni Inc is to order 5000 units at one go with a total annual cost of 401000

Yama Inc.

Since we will be maintaining a safety stock of 300 we will continuously have this quantity in the inventory.

EOQ = 1414 units

The total cost will be slightly different as we will need to consider an additional cost for the safety stock. Thus it will be

Total cost (at Q = 5000) = 12500*32 + 5*(1414/2+300) + 400*12500/1414 = 408571

So among the vendors, the best option is Weni Inc. with an order of 5000 units every time.

In-house

Now let’s calculate the cost of in house production. For this we need to use some additional information and use the EPQ (economic production quantity) model

We have

Daily demand (d) = 50

Production/day (p) = 400

Set up cost (S) = 3000

EPQ is given by the formula

EPQ = sqrt(2*D*S/H)*sqrt(p/(p-d))

EPQ = sqrt(2*12500*3000/5)*sqrt(400/(400-50)) = 4140.39 or 4140 units (rounding to whole number)

Total cost will be

Total cost = P*D + (Q/2)*(p-d)/p + S*D/Q

Total cost = 32*12500 + (4140/2)*(400-50)/400 + 3000*12500/4140 = 410869.2 or 410869

Now that we have all the values, we can answer the questions

If Alpha did not want to for in-house production, they should choose Weni Inc due to the lowest total cost incurred of $401,000

If Alpha decides to produce it should produce 4140 units of fan every production run

The company should buy and buy from Weni Inc. Because the overall annual cost is lesser than producing in-house.