Question

An online retailer of small gifts orders products from a number of suppliers, stores them, packs them to customers’ orders, and then dispatches them using a distribution company. Although broadly successful, the business is very keen to reduce its operating costs. A number of suggestions have been made to do this. There are as follows:

• Quality: Make each packer responsible for his or her own quality. This could potentially reduce the percentage of mis-packed items from 0.5% to near zero. Repacking an item that has been mis-packed costs RM1 per item.
• Speed: Negotiate with suppliers to ensure that they respond to delivery requests faster. It is estimated that this would cut the value of inventories held by the retailer by RM200,000.
• Dependability: Institute a simple control system that would give early warning if the total number of orders that should be dispatched by the end of the day actually is dispatched in time. Currently 2% of orders is not packed by the end of the day and therefore has to be sent by express courier the following day. This costs an extra RM1 per item.

If the online retailer dispatches two million items every year and if the cost of holding inventory is 9% of its value, how much cost will each suggestion save the company? State the total savings.

Answer 1

Items dispatched per year = 2000000

holding cost = 9% of the inventory value

Suggestion 1: Quality

Percentage of mispacked items = 0.5%

Total no. of mispacked items per year = 2000000*0.5% = 10000

Cost of repacking of mispacked items = 1

Total cost of repacking = 10000*1 = 10000

The suggestion reduces the repacking percentage to near 0.

Total Savings would be 10000

Suggestion 2: Speed

If the supplier responds to the delivery faster the reduction in inventory value of the retailer is 200000.

Reduction in holding cost = 200000*9% = 18000

Total savings = 200000+18000 = 218000

Suggestion 3: Dependability

Orders not packed by the end of the day = 2%
No. of orders per year not packed by the end of the day = 2000000*2% = 40000

Cost of shipping by express courier = 40000*1 = 40000

If there is simple control system which can alert the total number of orders to be shipped in the day and the orders shipped by the express courier is reduced to 0 then total saving would be 40000.