Question

Palu Gear is mountaineering gear retail store operating in Northern Colorado. From its humble beginning of one store, the chain has expanded to 5 stores spread across the area. The most popular items sold by Palu Gear is an in-house designed hightech "Palu jackets". These jackets are sold throughout the entire year and their demand is not materially affected by time of the year. Annual jacket revenues for each store were of similar size and amounted to roughly $1,000,000 per store. The jackets are manufactured by suppliers located in Maxico, and are sold at the price of $325 per unit, which represented a mark-up of 30% above what Palu paid the supplier. Palu Gear has an annual cost of inventory of 20% (a) The current supply chain for Palu Jackets operated as follows. Being a profit center, each store made its own inventory decisions, and each store is supplied directly from the supplier by a truck. A shipment of up to a full truckload, which was more than 5000 jackets, was charged a flat fee of $2,200. What is the optimal order quantity each store should order? What is the total the inventory and ordering costs with this quantity? Looking into the future, Palu Gear is contemplating a new initiative to transform the brick-and-mortar retail business into an Internet store. This would involve closing down the five retail stores and opening up one fulfillment center to serve the entire market. The freed-up rent and store operating cash flow would easily cover the rent for the fulfillment center and web hosting. In addition, the management of the Palu Gear feels that consolidated inventory management should provide considerable savings over the current setup. (b)Assuming the total demand for Palu Jackets stays the same, what are the savings in the inventory and ordering costs on Palu jackets resulting from implementing the aforementioned Internet Initiative? (c) What other factors besides the inventory and ordering costs they should consider before implementing the Internet Initiation?

Answer 1

(a) Annual demand of each store, D = Annual revenue / selling price = 1000000/325 = 3077

Order cost, S = 2200

Item cost = 325*(1-30%) = 227.5

Holding cost, H = 227.5*20% = 45.5

Optimal order size, Q = SQRT(2DS/H) = SQRT(2*3077*2200/45.5) = 545

Total inventory holding and ordering cost for each store = (D/Q)*S + (Q/2)*H = (3077/545)*2200 + (545/2)*45.5 = 24820

Total cost for five stores = 24820*5 = $ 124,100

(b) Annual demand for single store = 3077*5 = 15385

Ordering cost (S) and inventory holding costs (H) are same as in part a

Optimal order size, Q = SQRT(2*15385*2200/45.5) = 1220

Annual ordering and inventory holding cost = (15385/1220)*2200 + (1220/2)*45.5 = $ 55,500

Cost Savings resulting from internet initiative = 124100 - 55500 = $ 68,600

(c) The other important factors that needs to be considered before implementing the internet business model are consumer adaptation of ecommerce, cost of returns, transit damages and pilferage, customer service level.