Palu Gear is mountaineering gear retail store operating in Northern Colorado. Fr

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 high- tech "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?

Explanation / Answer

First let us find out the Price of the jacket (P)

30% mark up price on P = $325

1.30 * P = 325

P = 325/1.3 = $250

Now we figure out the annual demand for each store (D)

D = Total Revenue/ Price = $1,000,000/$250 = 4000 units

Now we apply the EOQ formula

EOQ = (2 * Annual Demand * Cost per order)/ (Cost per unit * Holding cost)

EOQ = (2 * 4000 * 2200)/ (250 * 0.2) = 593.3 units 594 units

Ordering cost = ( Annual Demand/ EOQ ) * 2,200 = (4000/594) * 2,200 = $14814.8

Inventory cost = 0.2 * Price * q/2 = 0.2 * 250 * 594/2 = $14850

For 5 stores:

Ordering Cost = $14814.8 * 5 = $74074

Inventory Cost = $14850 * 5 = $74250

Assuming demand remains same, closing all stores and opening one fulfillment center changes our annual demand to 20,000 units.

Now lets apply EOQ formula

EOQ = (2 * Annual Demand * Cost per order)/ (Cost per unit * Holding cost)

EOQ = (2 * 20000 * 2200)/ (250 * 0.2) = 1326.6 units 1327 units

Ordering cost = ( Annual Demand/ EOQ ) * 2,200 = (20000/1327) * 2,200 = $33157.50

Inventory cost = 0.2 * Price * q/2 = 0.2 * 250 * 1327/2 = $33175

Hence, respective savings are:

Ordering cost savings : $74074 - $33157.50 = $40916.50

Inventory cost savings : $74250 - $33175 = $41075

Other factors to consider before implementing the Internet Initiation:

Lay-offs to be done at each store
Technological equipment and services needed
Technical know-how of the new system
Set up costs of fulfillment center
Factoring in the loss of sales due to foot fall at 5 locations
Online exposure of their webstore

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