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Senco Electronics Company (Senco) is a U.S.-based manufacturer of personal computers and other electronic equipment. Current assembly operations are still located in the United States and primarily serve the U.S. market. Transportation in the United States from Senco sites to its customers is primarily performed by motor carriers. Rising costs in its U.S. operations caused Senco to evaluate the construction of a new assembly plant in China. Subsequently, Senco decided to also consider Viet Nam. Jim Beierlein, the new executive vice president of supply chain management for Senco, is concerned with how Senco will transport its products from Asia to the United States. “We’ve had the luxury of a well-developed ground transportation infrastructure in the United States to move our products. Now we will be faced with moving enormous quantities of electronic products across several thousand miles of ocean. We really don’t have that much experience with other modes of transportation.” Skip Grenoble, director of logistics for Senco, was called on for his advice. “Obviously, we need to decide on whether to use ocean or air transportation to move our products from the new locations. Air transportation will cost more than ocean but will result in lower inventory costs because of the faster transit times. The opposite is true for ocean transportation. Moving products by air will also result in higher ordering costs since we will be ordering more often for replenishment for our U.S. distribution centers. Using either mode will require some fixed investment in loading/unloading facilities at both the new plant and our U.S. distribution centers. Projected annual demand from the new facility is 2.5 million pounds. However, we expect this demand to grow by 5 percent annually over the next five years. Although the air transportation system appears to be the more expensive option right now, we need to take into consideration our growth and how each mode will help us achieve our profit and service goals.” The relevant cost information for each alternative is presented in the following table.
OCEAN AIR
Transportation costs $150,000 $290,000
Inventory costs
Carrying 48,000 23,000
Handling 20,000 22,000
Ordering 7,000 15,000
Fixed cost 600,000 450,000
Total costs $823,000 $800,000
1. If you were Skip Grenoble, which alternative would you advise Jim Beierlein to implement? What criteria would you use to arrive at your decision?
2. At what level of demand (in pounds) per year would these two alternatives be equal?
Expert Answer
| projected annual demand | 2,500,000 | pounds |
| annual growth rate | 5% | |
| Ocean | Air | |
| Transportation cost | $ 150,000 | $ 290,000 |
| Inventory costs | ||
| Carrying | $ 48,000 | $ 23,000 |
| Handling | $ 20,000 | $ 22,000 |
| Ordering | $ 7,000 | $ 15,000 |
| Fixed costs | $ 600,000 | $ 450,000 |
| Total | $ 825,000 | $ 800,000 |
| 1. Being Sip Grenoble, I would suggest Jim Beierlein to use air transportation mode to ship the products from their new production facilities, as the total cost of air transportation is lower than that of ocean transportation. This will also allow the company to maintain an inherent flexibility in their model, as the inventory will be less, and they will be in a better position to respond to fluctuations in demand if any, as air transport will also offer them the advantage of a faster transportation medium. | ||
| If the demand increases by 5% rate, as analyzed, then also, timely analysis of the costs of both the mediums will help us make a more informed decision. But the benefits of air transportation weigh down ocean mode currently, and hence air transportation mode should be selected. | ||
| 2) total cost = fixed cost + variable cost per unit * annual demand | ||
| Ocean | Air | |
| total variable cost | $ 225,000 | $ 350,000 |
| variable cost/unit in first year | $ 0.09 | $ 0.14 |
| hence, for these alternatives to be equal, | ||
| total cost of ocean mode = total cost of air mode | ||
| 600000+0.09x=450000+0.14x | ||
| (if x pounds is the demand at which both the options are equal) | ||
| solving for x: | ||
| 600000-450000=0.14x-0.09x | ||
| 150000=0.05x | ||
| x | 3,000,000 | pounds |
| Hence, at 3,000,000 pounds per year would these two alternatives be equal. | ||
