1. Mike McNeely, logistics manager for the Illumination Light Company, has consi
ID: 415692 • Letter: 1
Question
1. Mike McNeely, logistics manager for the Illumination Light Company, has considered replacing the firm’s manual customer order management system with electronic ordering, an EDI application. He estimates that the current system, including labor costs $2.50/order for transmission and processing when annual order volume is under 25,000. Should the order volume equal or exceed 25,000 in any given year, Mr. McNeely will have to hire an additional customer service representative to assist with order reception in the manual process. This would raise the variable cost to $3.00/order. He has also estimated the rate of errors in order placement and transfer to be 12 per 1,000 orders.
EDI would cost $100,000 up front to implement, and variable costs are determined to be $0.50/order regardless of volume. EDI could acquire and maintain order information with an error ate of 3 per 1,000 orders. An EDI specialist would be required to maintain the system at all times as well. Her salary would be $38,000 in the first year and would increase 3 percent each year there after.
Order errors cost $5.00 per occurrence on average to correct in the manual system. EDI errors cost $8.00 on average to correct.
If the firm expects order volume over the next five years to be 20,000, 22,000, 25,000, 30,000 and 36,000 annually, would EDI pay for itself within the first five years?
2. Michael Gregory, logistics manager of Muscle Man Fitness Equipment, has determined that his current forecast system for national sales has historically shown a 20 percent error rate. Because of this level of error, Muscle Man’s distribution center managers maintain inventory at their locations costing the company, on average, $3,000 per month.
By improving his forecast methodology and shortening forecast horizons, Mr. Gregory anticipates cutting the error level down to 12 percent. With improved forecasting, Muscle Man’s distribution center managers have indicated that they would feel comfortable with lower inventory levels. Mr. Gregory anticipates monthly inventory carrying cost reductions of 40 percent.
If the forecast system improvement will cost $1,000 more per month than the old system, should Mr. Gregory implement the change?
Explanation / Answer
Answer 1:-
a. To determine if EDI will pay for itself within the first 5 years, we must begin by determine the annual costs associated with the currents, manual customer order management system over this period:
Yr order volume x cost/order + error x cost/error =Annual cost
1 20,000 x $2.50 + (20,000x0.012) x $5.00 =$51,200
2 22,000x$2.50 + (22,000x0.012) x $5.00 =$56,320
3 25,000x$3.00 + (25,000 x0.012)x $5.00 =$76,500
4 30,000x$3.00 + (30,000x0.012)x $5.00 =$91,800
5 36,000x$3.00 + (36,000x0.012)x$5.00 =$11,0160
The calculative total cost of the manual system is $385,980
Now calculate the cost of EDI over the same period:
Yr order volume x cost/order + error x cost/error + salary = Annual cost
0 upfront implementation cost =$100,000
1 20,000x$0.5 + (20,000x0.003) x $8.00 + $38000 =$ 48,480
2 22,000x$0.5 + (22,000x0.003) x $8.00 + $38,000 x (1+3%) = $50,668
3 25,000x$0.5 + (25,000x0.003) x $8.00 + $38,000 x (1+3%)^2 = $53,414
4 30,000x$0.5 + (30,000x0.003) x $8.00 + $38,000 x (1+3%)^3 = $57,244
5 36,000x$0.5 + (36,000x0.003) x $8.00 + $38,000 x (1+3%)^4 = $61,633
The calculate total cost of EDI system is $371,439
By comparing the two total fiveyear cost, we can see that EDI would pay for itself within the first 5 years.
Answer 2:- Yes, Mr. Gregory should implement the change
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