Question

Short answer question:

Mr. Jones needs to send a shipment from China to the United States. His boss asks him to prepare a set of potential crash options for accomplishing this in 5 days, 4 days, 3 days, 2 days, and 1 day. He calls an air transport company and finds out that the shipment can be flown in one day for a cost of $1000. Then he calls an ocean shipping company and finds out that it can be transported in 5 days for a cost of $200. He uses these two numbers to find the slope: it costs $800 more to reach the US 4 days earlier, or $200 per day. Then, he uses the slope to calculate the cost of a 4-day trip ($400), a 3- day trip ($600), and a 2-day trip ($800). What is wrong with Mr. Jones’s approach?

Answer 1

The approach is wrong because the cost of transportation does not vary linearly with time. It is a function of many factors which determine final cost of an option. For example, Air freight is High because of the high fixed cost of equipment, availability of limited space or high overhead costs while the cost of ocean shipping is low due to economy of scale. It also depends on the paying capacity of target group and their perceived value of service. In the same way, the cost for a customer is different for different options, depending on cost of item transported. For example, a diamond consignment, which has a holding cost of 500 per day would be better transported by air,as it will prove cheapest of three, while an iron ore weighing 50 tonnes is cheapest to transport by sea, owing to low cost of holding.

It is therefore, wrong to measure cost in this way, as time is not the determining factor alone.