CASE 11
Supply Chain Management at Dream Beauty
Company
Dream Beauty (DB) Company is a manufacturer of consumer beauty supplies
and cosmetics. Based out of Money City, Nevada, the company services its
customers across the U.S. Recently, a supply chain expert was elected to the
board of directors. With his insight into supply chain operations, heightened
attention was turned toward that area. The costs in this area have been
increasing, and management became very concerned about the issue. The company
annual sales reached $130,000,000 for the first time since inception.
Management believed that some of the increase in supply chain costs may be
attributed to additional sales, but they were confident that other factors
existed that needed to be addressed. The situation had management’s full
attention, especially since supply chain costs (and savings for that matter)
flow directly to the bottom line.
DB supplies its products through three distinct channels: retail stores
(direct), convenience stores, and mass merchants. Each channel is considered an
independent profit center with full financial responsibilities for income
statement and balance sheet. From DB sales, retail accounted for 50 percent,
convenience stores for 30 percent, while mass merchants picked up the remaining
sales. Cost of goods sold accounted for 40 percent of sales. All three channels
seem to be profitable, and contribute equally to DB, according to the company’s
cost accountant.
The order fulfillment cycle at DB consists of four areas:
The total order fulfillment averages three days. All orders are
processed through a central location, and delivered from distribution centers
located across the U.S. Usually retail and convenience store orders are shipped
unlabeled on standard nonmixed pallets. Mass merchants, on the other hand, have
placed a lot of pressure on DB and want the company to take an active role in
helping them manage their inventory. To accommodate this channel, DB has
assumed some of the jobbers’ functions in the store and started labeling the
orders for mass merchants. To accomplish that, the company recently purchased a
labeling machine that can process labels at a speed of 30 labels/second. The
machine’s historical value was determined to be $10,000,000. The company
usually depreciates similar equipment on a straight-line basis over a period of
five years.
The company has a discount policy for all three channels that it
services. The net is due in 30 days. While this policy is explicitly
stated on all DB’s invoices, retail stores are the only ones that pay according
to invoice terms. Mass merchants usually pay within 15 days, while
convenience stores usually pay within 45 days. The company’s cost
accountant reported that all sales were sold on credit. Cash sales and C.O.D.
sales were rare; therefore, they can be ignored for the purpose of this
analysis. DB does not engage in any barter transactions.
The company received a total of 3,600 orders. Retail orders amounted to
1,000; convenience stores to 2,500; and mass merchants had 100 orders. Each
order has a corresponding delivery that is usually completed within the
three-day fulfillment cycle. The company’s practice has been to allocate
logistics-related costs to its three channels based on their relative
percentage of sales volume. The orders were shipped in 2,000 packages, with
retail accounting for 800 packages, convenience stores for 1,100 packages, and
mass merchants for 100 packages. Packaging cost is estimated to be the same
regardless of size. To service these orders, the company has maintained an
inventory safety stock so that it can meet the level of service that it
promises its customers (the three-day fulfillment cycle). It is estimated that
the company holds an average of 90 days’ inventory for retail, 60 days’
inventory for convenience stores, and 40 days’ inventory for mass merchants.
The company’s cost accountant estimated the total carrying costs of inventory
to be approximately 15 percent of total average annual inventory. These costs
also include the cost of capital.
The company’s customer base in convenience stores includes 13 different
stores located in major U.S. cities. Table 1 provides a
breakdown of sales per store, as well as the number of orders, and packages for
each store.
TABLE 1 Activity
Summary by Account
Historically, DB has offered its customers a level of service that is of
the highest standards. One of the fulfillment managers has been quoted, “We do
not discriminate between customers; our three-day fulfillment cycle in my
opinion is becoming an industry benchmark, and I like it that way. I do not
think that our strategy should change in that regard.”
The board has some second thoughts about this strategy, and what type of
value-added it is generating to the company.
On your first day, you get accustomed to your surroundings, and you
become familiar with the computer system. On your second day, the vice
president for supply chain (and your hiring manager) comes up to you. He
proceeds to brief you on a high-level meeting that he just concluded with the
top brass at the company. He states that management wants to know why supply
chain costs seem skewed, as well as a full analysis of the three logistical
channels that the company employs. Management would like you to answer the
following questions.
Questions
1. Analyze the way that
current costs are being allocated; what potential changes can you recommend to
make the system more efficient and more accurate?
2. What is the
profitability level and return on investment by distribution channel, under
both the current and the recommended allocations?
3. What are your
recommendations regarding the company policy of offering all its customers the
same service level (three-day fulfillment cycle)?
Note: The company’s
cost of capital for both borrowing and lending can be estimated at 9 percent.
Ignore tax effects on all transactions.
