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The Applied Business Analytics Casebook
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The Applied Business Analytics Casebook
Applications in Supply Chain Management, Operations Management, and Operations Research
Matthew J. Drake, Ph.D., CFPIM
Pearson Education, Inc.
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Vice President, Publisher: Tim Moore
Associate Publisher and Director of Marketing: Amy Neidlinger
Executive Editor: Jeanne Glasser Levine
Operations Specialist: Jodi Kemper
Cover Designer: Chuti Prasertsith
Managing Editor: Kristy Hart
Project Editor: Katie Matejka
Copy Editor: Seth Kerney
Proofreader: Chuck Hutchinson
Indexer: Johnna VanHoose Dinse
Senior Compositor: Gloria Schurick
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© 2014 by Matthew J. Drake
Publishing as Pearson
Upper Saddle River, New Jersey 07458
Pearson offers excellent discounts on this book when ordered in quantity for bulk purchases or special sales. For more information, please contact U.S. Corporate and Government Sales, 1-800-382-3419, [email protected] . For sales outside the U.S., please contact International Sales at [email protected] .
Company and product names mentioned herein are the trademarks or registered trademarks of their respective owners.
All rights reserved. No part of this book may be reproduced, in any form or by any means, without permission in writing from the publisher.
Printed in the United States of America
First Printing November 2013
ISBN-10: 0-13-340736-5 ISBN-13: 978-0-13-340736-5
Pearson Education LTD.
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Library of Congress Control Number: 2013946942
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For my wife, Nicole, and my daughter, Noelle. You are the inspiration for
everything that I accomplish.
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Table of Contents
Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xvi
Part 1 Forecasting and Process Analysis . . . . . . . . . . . . . . . . . . . .1
Case 1 Forecasting Sales at Ska Brewing Company . . . . . . . . . . . . . . . 3
Eric Huggins, Fort Lewis College
Case 2 Maintaining Financial Success and Expanding into Other Markets at FeedMyPet.com . . . . . . . . . . . . . . . . . . . . . . 15
Charles A. Wood, Duquesne University
Case 3 Forecasting Offertory Revenue at St. Elizabeth Seton Catholic Church . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Matthew J. Drake, Duquesne University Ozgun Caliskan-Demirag, Pennsylvania State University—Erie, The Behrend College
Case 4 Pizza Station . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
Kathryn Marley, Duquesne University Gopesh Anand, University of Illinois at Urbana–Champaign
Part 2 Optimization and Simulation . . . . . . . . . . . . . . . . . . . . . . .45
Case 5 Inventory Management at Squirrel Hill Cosmetics . . . . . . . . 47
Paul M. Griffin, Pennsylvania State University
Case 6 Safety Stock Planning for a Hong Kong Fashion Retailer . . . 65
Tsan-Ming (Jason) Choi, The Hong Kong Polytechnic University
Case 7 Network Design at Commonwealth Pipeline Company . . . . . 77
Matthew J. Drake, Duquesne University
Case 8 Publish or Perish: Scheduling Challenges in the Publishing Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81
Beate Klingenberg and David Gavin, Marist College
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Part 3 Decision Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99
Case 9 Narragansett Brewing Company: Build a Brewery . . . . . . . . 101
John K. Visich, Christopher J. Roethlein, and Angela M. Wicks, Bryant University
Case 10 Aluminum Versus Plastic: A Life-Cycle Perspective on the Use of These Materials in Laptop Computers . . . . . . . . 107
Ryan Luchs, Drew Lessard, and Robert P. Sroufe, Duquesne University
Case 11 HealthCare’s Corporate Social Responsibility Program . . . . 131
Robert P. Sroufe and Marie Fechik-Kirk, Duquesne University
Case 12 PaperbackSwap.com: Got Books? . . . . . . . . . . . . . . . . . . . . . 143
Brandy S. Cannon and Louis A. Le Blanc, Berry College
Case 13 Stranded in the Nyiri Desert: A Group Case Study . . . . . . . 161
Aimée A. Kane and Mercy Shitemi, Duquesne University
Part 4 Advanced Business Analytics . . . . . . . . . . . . . . . . . . . . . .165
Case 14 Joe’s Coin Shop: Entry into Online Auctions . . . . . . . . . . . . 167
Charles A. Wood, Duquesne University
Case 15 Vehicle Routing at Otto’s Discount Brigade . . . . . . . . . . . . . 181
Matthew J. Drake, Duquesne University
Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 189
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Acknowledgments
I am forever grateful to the efforts of all of the contributors to this book. Many of them have been friends and colleagues for a long time, but I met some others for the first time through working on this proj- ect. I look forward to many more years of collaboration with them. This book would not have become a reality without the contributors’ willingness to share their hard work with me. I am also indebted to Barry Render, Consulting Editor at FT Press, who invited me to work on this project, and to Jeanne Glasser Levine, Executive Editor at FT Press, whose guidance and advice was instrumental throughout the publication process.
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About the Author
Matthew J. Drake, Ph.D., CFPIM , is an Associate Professor of Supply Chain Management and the Director of International Business Programs in the Palumbo-Donahue School of Business at Duquesne University. Dr. Drake primarily teaches analytical courses in the Supply Chain Management program. He holds a B.S. in Business Administration from Duquesne University and an M.S. and Ph.D. in Industrial Engineering from the Georgia Institute of Technology. His first book, Global Supply Chain Management , was published by Busi- ness Expert Press in 2012. Dr. Drake’s research has been published in a number of leading journals including Naval Research Logistics , the European Journal of Operational Research , Omega , the International Journal of Production Economics , OR Spectrum , the Journal of Busi- ness Ethics , and Science and Engineering Ethics . Several of his previ- ous cases and teaching materials have been published in INFORMS Transactions on Education and Spreadsheets in Education .
Dr. Drake lives in suburban Pittsburgh, Pennsylvania, with his wife, Nicole; his daughter, Noelle; and his dog, Bismarck.
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Contributor List
Gopesh Anand is an Associate Professor of Process Management in the College of Business at the University of Illinois at Urbana– Champaign. His research is aimed at understanding continuous improvement of work processes and execution of operations strategy in organizations.
Ozgun Caliskan-Demirag is an Assistant Professor of Supply Chain Management in the Sam and Irene Black School of Business at Penn State Erie, The Behrend College. She holds a Ph.D. in Indus- trial and Systems Engineering from Georgia Tech, and her main research interests are in the areas of supply chain management, oper- ations/marketing interface, inventory management and decentralized resource allocation. Her work has appeared in journals such as Oper- ations Research , Production and Operations Management , Naval Research Logistics , and European Journal of Operational Research .
Brandy S. Cannon is employed as an accountant in the Business and Finance Office at Berry College, Mount Berry, Georgia, USA. She earned a B.S. in Accounting and the M.B.A. from the Campbell School of Business at Berry College.
Tsan-Ming (Jason) Choi is an Associate Professor in Fashion Business at The Hong Kong Polytechnic University. Over the past few years, he has actively participated in a variety of research proj- ects on supply chain management and systems engineering. He has authored/edited 10 research handbooks and published extensively in leading OR/OM journals such as Annals of Operations Research , Automatica , Decision Support Systems , European Journal of Opera- tional Research , IEEE Transactions on Automatic Control , Produc- tion and Operations Management , Service Science , Supply Chain Management , and various other IEEE Transactions . He is now an area editor/associate editor/guest editor of journals which include Annals of Operations Research ; Decision Sciences ; Decision Support
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Systems ; European Management Journal ; IEEE Transactions on Sys- tems, Man, and Cybernetics Part A: Systems; Information Sciences ; Journal of the Operational Research Society ; and Production and Operations Management .
Marie Fechik-Kirk , a Fulbright alumnus, earned an M.B.A. with a focus in sustainability at Duquesne University in 2009. Since then she has helped organizations from Bayer MaterialScience to The Hill School in reducing waste, increasing efficiency, and enhancing their reputation through sustainability initiatives.
David Gavin is an Associate Professor of Management at Marist College. He received his doctorate in Strategic Management from the University at Albany. His professional experience includes upper executive positions in the publishing, technology, food service, and retail industries. He has authored or co-authored articles appearing in the Journal of Business and Economics Studies , International Journal of Humanities and Social Science , and International Journal of Orga- nization Theory and Behavior .
Paul M. Griffin is a Professor in the Harold and Inge Marcus Department of Industrial and Manufacturing Engineering, where he serves as the Peter and Angela Dal Pezzo Department Head Chair. His research and teaching interests are in health and supply chain systems. Dr. Griffin earned a Ph.D. in Industrial Engineering from Texas A&M University.
Eric Huggins is an Associate Professor of Management at Fort Lewis College in Durango, Colorado. When he’s not busy teaching, working with student, or analyzing data from local companies, he enjoys spending time in the great outdoors of southwestern Colorado, and he can occasionally be found in the tasting room at Ska.
Aimée A. Kane holds a Ph.D. in organizational behavior and theory from the Tepper School of Business at Carnegie Mellon Uni- versity. She is an Assistant Professor of Management at the Palumbo- Donahue School of Business at Duquesne University. Her research,
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which focuses on how groups capitalize on the knowledge of their members, has appeared in several top publications, including the Academy of Management Annals and Organization Science .
Beate Klingenberg is an Associate Professor of Management at Marist College, with a focus on Operations Management and Decision Sciences. Her areas of research include sustainability and environmental management in operations, knowledge management in technology transfer settings, as well as operations management issues in real estate. Her publications appear in academic as well as practitioner publications. Her credentials include a master’s in Chemistry and Ph.D. in Physical Chemistry (both University of Erlangen-Nürnberg, Germany) as well as an M.B.A. from Marist College. Furthermore, she has extensive industry experience in technology transfer and project management.
Louis A. Le Blanc is Professor of Business Administration at the Campbell School of Business, Berry College, Mount Berry, Georgia, USA. He received a Ph.D. from Texas A&M University, followed by postdoctoral study at the University of Minnesota and Indiana Uni- versity. Dr. Le Blanc teaches courses in strategic use of information technology and operations management.
Drew Lessard is a strategy and analytics professional with expe- rience in Global Fortune 500 companies and has a current passion for startups. He holds an M.B.A. concentrating in Sustainability from Duquesne University and a Master of Arts in Economics from Boston University. He hails from Portland, Maine, and currently resides in Pittsburgh, Pennsylvania.
Ryan Luchs is an Assistant Professor of Marketing in the Palumbo-Donahue School of Business at Duquesne University. He teaches marketing and supply chain management courses to under- graduates and also teaches the Strategic Marketing course in the Sustainable M.B.A. curriculum. Dr. Luchs received a Ph.D. and an M.B.A. from the University of Pittsburgh and a B.S. in Chemical Engineering from Penn State University.
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Kathryn Marley is an Assistant Professor of Supply Chain Man- agement in the Palumbo-Donahue School of Business at Duquesne University. Her research interests include lean management and con- tinuous improvement programs, supply chain disruptions, and peda- gogical methods.
Christopher Roethlein is a Professor in the Management Department at Bryant University where he teaches courses in opera- tions management and supply chain management. He has a Ph.D. in Management Science and Information Systems from the University of Rhode Island; and his research interests include quality and com- munication within a supply chain, strategic initiatives through align- ment of supply chain goals, collaborative relationships, and leadership excellence. He has published in a numerous journals, and he was a co-winner of the 2011 Case Studies Award Competition presented by the Decision Sciences Institute.
Mercy Shitemi holds a B.S. in Informatics from Indiana Uni- versity and is currently completing a master’s degree in Information Systems Management at Duquesne University’s John F. Donahue Graduate School of Business. Mercy hails from Eldoret, Kenya.
Robert P. Sroufe is the Murrin Chair of Global Competitive- ness in the John F. Donahue Graduate School of Business and Direc- tor of Applied Sustainability within the Beard Institute at Duquesne University. Dr. Sroufe is an award-winning scholar and teacher. These awards include instructional innovation and best environmen- tal papers from the National Decision Sciences Institute. Within the M.B.A. Sustainability program, he develops and delivers courses on sustainable theories and models including life-cycle analysis, business applications of sustainability tools, and processes for new initiatives; and he oversees action-learning consulting projects every semester with corporate sponsors.
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John K. Visich is a Professor in the Management Department at Bryant University, where he teaches courses in operations manage- ment and supply chain management. He has a Ph.D. in Operations Management from the University of Houston, and his research inter- ests are in supply chain management, radio frequency identification, and corporate social responsibility. He has published in a numerous journals, and he was a co-winner of the 2011 Case Studies Award Competition presented by the Decision Sciences Institute.
Angela M. Wicks is an Associate Professor in the Manage- ment Department at Bryant University, where she teaches courses in operations management and project management. She has a Ph.D. in Operations Management from the University of Houston, and her research interests include hospital performance, patient satisfaction, and health care technology. She has published in numerous journals including the International Journal of Quality Assurance in Health- care , Hospital Topics , and the International Journal of Healthcare Technology and Management .
Charles A. Wood is an Assistant Professor in the Manage- ment Information Systems area at the Palumbo Donahue School of Business at Duquesne University in Pittsburgh, Pennsylvania. After spending over a decade in the “real world” as a systems analyst, team leader, manager, systems architect, and finally as the owner of a suc- cessful consulting company, Chuck returned to academia to complete an M.B.A. and a Ph.D. He has taught at several institutions, including Notre Dame and at the University of Minnesota.
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Preface
The field of business analytics has been thrust into the global spotlight in recent years. This surge in popularity is largely because of a barrage of books and periodical articles highlighting its potential to help firms create a competitive advantage. Although some techniques contained within the umbrella of business analytics, such as data min- ing, text mining, and neural networks, truly represent cutting-edge methodologies that mainly appear in advanced graduate courses, the building-block techniques of business analytics, such as statistical analysis, optimization, and decision trees, are mainstays in business- school curricula around the world.
Business analytics can be broadly defined as “the scientific pro- cess of transforming data into insight for better decision making.” 1 As a result of this focus on decision making, courses that cover material related to business analytics can benefit greatly from utilizing case studies as a supplement to the core analytical material. Case studies are an effective method for exposing students to the entire decision- making process because they put the student in a simulated active role as a decision maker who must perform the analysis and use the output to recommend a course of action.
Although cases are a mainstay of many graduate business courses, they are used somewhat less frequently in undergraduate courses. One reason for this lack of extensive case adoption in undergraduate courses is the preponderance of long cases published by the major case libraries. Cases appropriate for undergraduates need to be somewhat more focused because the students do not have as much experience as graduate students. Many textbooks include one- or two-page cases at the end of a chapter to illustrate the application of the techniques presented in the chapter. Because they are so short, these cases often amount to little more than a slightly expanded homework problem.
1 http://www.informs.org/About-INFORMS/What-is-Analytics
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This collection of cases is designed to supplement core material covering business analysis techniques in courses as varied as statistics, operations management, management science, supply chain mod- eling, and decision analysis. This book fills the gap in the library of business analytics case materials appropriate for undergraduate stu- dents with cases of moderate length. The cases are also appropriate for introductory-level graduate courses, as instructors can focus the analysis and discussion on more of the complex issues raised in the cases.
The cases in the collection are grouped by the primary analytical technique appropriate for each decision environment. Part 1 , “Fore- casting and Process Analysis,” includes three forecasting cases and one case that focuses on quality control and process improvement. Part 2 , “Optimization and Simulation,” contains cases that utilize the classic management science methods of optimization and simulation. The optimization cases address inventory control and logistics net- work design, and the simulation case addresses the management of process flows. Part 3 , “Decision Analysis,” includes cases that require the application of a variety of decision analysis tools from decision trees and factor rating to the Analytic Hierarchy Process (AHP), multi-criteria decision analysis, and group decision making. The deci- sion environments vary from facility location to sustainability manage- ment. Part 4 , “Advanced Business Analytics,” contains two advanced cases—one that is truly a “big data” case with a large data set and another centered on vehicle routing, a traditionally difficult problem in logistics.
It is my hope that the cases in this collection expose students to the power of business analytics and the utility of these techniques in the decision-making process. Students armed with an effective tool- box of analytical skills and techniques are well positioned to make thoughtful, reasoned decisions informed by data analysis for their
PREFACE xvii
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companies and organizations. These analytical skills are transferrable across companies and industries and can enhance students’ attractive- ness and value to employers throughout their careers.
Matthew J. Drake Pittsburgh, Pennsylvania, USA August 2013
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1 Forecasting and Process Analysis
1. Forecasting Sales at Ska Brewing Company 3
2. Maintaining Financial Success and Expanding into Other Markets at FeedMyPet.com 15
3. Forecasting Offertory Revenue at St. Elizabeth Seton Catholic Church 25
4. Pizza Station 33
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3
Case 1 Forecasting Sales at Ska Brewing
Company
Eric Huggins, Fort Lewis College
Background
Ska Brewing Company is a purveyor of fine craft beers located in Durango, Colorado. With its flagships Pinstripe Red Ale and True Blonde Ale, medal-winning Buster Nut Brown Ale and Steel Toe Stout, and seasonal Mexican Logger and Euphoria Pale Ale, Ska has enjoyed double-digit growth for more than a decade with no signs of slowing down. Learn more about Ska by visiting its tasting room at 225 Girard Street, Durango, Colorado, or online. 1
In the early ‘90s, founders/owners Dave and Bill were dissatisfied with watered-down corporate beer and decided to take matters into their own hands, literally. They began brewing their own beer in their basement, much to the delight of everyone who knew them. Eventu- ally, it became clear that they might be able to make a living doing what they loved to do, and they founded Ska Brewing Company in 1995 with third owner/founder Matt. Through hard work and a laser- like focus on brewing great beer, Ska continued to grow, and in 2008
1 http://www.skabrewing.com/
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the company moved into its $4.8 million, 24,000-square-foot world headquarters. In 2012, Ska brewed more than 25,000 barrels of beer (1 barrel = 2 standard kegs = 252 pints = 4,032 ounces), with sales exceeding $6.5 million.
Ska was not alone in its success. Durango, a town with fewer than 20,000 people, has four long-term successful breweries/brewpubs, a brand new brewpub that opened in 2012, and another one in the works. Rather than considering these other breweries as competition, Ska has worked together with them (as well as others across the state of Colorado) to brew specialty beers for festivals and other occasions; Ska also contract brews beer for Steamworks Brewing Company (using its recipes) because Steamworks has exceeded its own brew- ing capacity. Owner Dave calls this unique relationship “coopitition.” Steamworks and Ska are just examples, however.
The craft brewing industry has seen phenomenal growth during the last three decades across the United States and in other coun- tries as well. According to the Brewers Association, 2 the craft brewing renaissance started in the late 1970s and saw periods of incredible growth during the 1990s. Historically, before Prohibition, small brew- eries were everywhere across the United States; the 18th Amendment caused most of the small breweries to go out of business, and only the larger breweries survived until the 21st Amendment repealed Prohi- bition 13 years later. It took several decades for smaller breweries to begin the resurgence that we see today.
But our concern is more specific: Will the growth and success at Ska continue? Can Ska anticipate how much beer it will produce, and what sales will be so that the company can plan wisely for the future? In fact, current plans are to increase brewing capacity yet again—a costly investment with potentially high returns. Is this a good decision or not? This is where you come in.
2 http://www.brewersassociation.org/pages/about-us/history-of-craft-brewing
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CASE 1 • FORECASTING SALES AT SKA BREWING COMPANY 5
Mission
Despite its success, Ska is still a relatively small operation. The company has one main numbers person, accountant Erik. In a nut- shell, Erik would like to predict Ska’s sales dollars and barrels sold for the current year, 2013. He has done some of this work on his own, but he would like you to confirm (or refute) his forecasts, and to do so in much greater detail, as Erik is too busy (presumably because he spends his days counting all of Ska’s money). To get you started, Exhibit 1.1 contains Ska’s total barrels (BBLS) sold and sales ($$$) over the previous 13 years. More precise monthly data is available in Exhibits 1.2 through 1.6 . Please note that this is actual (not phony textbook) data.
Even a cursory glance at the information in the table shows that both the number of barrels and sales are increasing annually at a pretty good rate. In fact, both values have shown tenfold growth between the years 2000 and 2012. What will these two numbers look like at the end of 2013? You might have studied forecasting techniques previ- ously, and ideally you learned that when forecasting real data, there is no “one-size-fits-all” approach; ahead you will try several approaches and then combine them to make a final prediction.
Your task is not only to forecast these two values for 2013, but to give Erik, Dave, Bill, and Matt a better picture of what is happening with their business overall. To do so, you will be asked to produce sev- eral graphs, both on annual and monthly bases, to consider growth as a percentage, and to consider the likely errors that go along with your forecasts. You will first be asked to learn a little more about the brew- ing industry in general, to give you a better idea of the current status of craft brewing. Your final report should be thorough, professional, and accurate. Good luck!
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Questions about Breweries
1. What is a craft brewery? How is it different from a brewpub? Go online and research these definitions. You should fairly eas- ily find a quantitative definition of the number of barrels pro- duced by a craft brewery (or microbrewery). For comparison, find out how many barrels are produced annually by a very large brewery such as Anheuser-Busch, MillerCoors, or Heineken. Write a paragraph or two with your findings and, as always, be sure to cite your sources.
2. Are there any local breweries in your area? If so, which catego- ries do they fall under? If not, why not? Discuss the feasibility and likely success or failure of a new brewery in your area. Of course, a cool name like Ska might be one of the keys to a new brewery’s success; what will you name your new brewery?
3. The claim was made earlier that the “craft brewing industry has seen phenomenal growth during the last three decades.” Go online and find evidence to support this claim. Specifically, how many craft breweries are there now compared to 30 years ago? How has the craft brewing market share grown (out of total beer sales)? How have the major breweries reacted to the growth of craft brewing? Write a paragraph or two with what you learn.
Questions about Ska’s Annual Data
4. Now onto Ska’s annual data: Use Microsoft Excel to draw scat- ter plots of both year versus barrels and year versus sales. (Hint: You might want to change the year range from 2000–2012 to 0–12 to simplify the equations of the curves that Excel will eventually fit to the data.) What kind of curve do both scatter plots look like? Consider the barrels data first; then repeat for the sales data:
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CASE 1 • FORECASTING SALES AT SKA BREWING COMPANY 7
a. Have Excel fit a linear trendline to the data and determine the equation of the line and the r 2 value. Interpret the slope of the line and the coefficient of determination. Is this a good fit?
b. The pattern on the graph should be clearly nonlinear. Now instead, have Excel fit an exponential curve to the data and again determine the equation of the curve and the r 2 value. Is this a better fit?
c. Using the equation for the curve from 4b, plug in 13 (or 2013) to get your first forecast. Does it seem reasonable, or does it seem too low or too high? (Note: To see where the forecast falls, Excel will let you extend the curve by one period when you draw the trendline. When you format the trendline, forecast forward one period.)
Be sure to do 4a–4c for both barrels and sales.
5. Now draw a scatter diagram of barrels versus sales. This pattern should appear quite linear. Fit a line to the data and interpret both the slope of the line (Hint: 1 barrel = 2 kegs) and the coef- ficient of determination. Can you reasonably conclude that the more beer Ska produces, the more money it makes?
6. Reconsider the graphs from question 4. Although the growth does appear to be exponential, your predictions in 4c shouldn’t quite look right. Let’s try it another way: Consider the last four points on each graph, from 2009 to 2012. Ignoring the rest of the data, do those four points appear to have an (obvious) pattern?
a. Using only the last four years’ data, fit a line for both barrels and for sales. Interpret both the slope and r 2 value for each line.
b. Plug a 13 into each line to get your second forecast for bar- rels and sales in 2013. How confident do you feel with these predictions?
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7. Your predictions in question 6 might seem pretty good, but take it one step further:
a. For both barrels and sales, determine the MAD for each of your predictions. If you are not familiar with the concept of MAD, go online and search for “mean absolute deviation.” You should quickly find a website that explains the concept and shows you how to calculate it. What are your forecasts for 2013 including the MAD? What information does the MAD tell you?
b. Repeat 7a but now for the MAPE, or mean absolute per- centage error. Interpret the MAPE.
c. As one final check, repeat what you did in question 6 but this time use the data from 2008 to 2011 to predict 2012 and compare your prediction for 2012 to the actual value. Do this for both barrels and sales. Does this forecasting method appear to be promising?
8. In both 4c and 6b, you forecasted barrels and sales for 2013. Consider one more way to do this before you make your final decision. Determine the percentage growth for both bar- rels and sales for each year. For example, from 2000 to 2001, barrels increased from 2,595 to 3,025, or a growth rate of (3025 – 2595)/2595 = 17%. Calculate these rates for years 1 to 12 for both columns of data.
a. Determine the average and median growth rates for both barrels and sales.
b. Considering only sales, draw a scatter plot of year versus sales growth. Do any of the growth rates look like outliers? (Hint: Recall that Ska moved into its new world headquar- ters in 2008, increasing its brewing capacity tremendously.)
c. The outliers in 8b might be obvious, but they aren’t always so easy to identify. So, use a box plot (Tukey’s Method) to find the outliers. For each column of percentage data,
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CASE 1 • FORECASTING SALES AT SKA BREWING COMPANY 9
determine the first and third quartiles; these are the points where 25% of the data are below and 25% of the data are above, respectively. (Hint: Use Excel’s =quartile() function to find both Q 1 and Q 3 .) Calculate the IQR = Q 3 – Q 1 and the range of “typical” values (Q 1 – 1.5*IQR, Q 3 + 1.5*IQR). Any data point within the range is typical, whereas any point outside the range is atypical, or an outlier. What are the two outliers for each column in this case?
d. Eliminate the outliers and recalculate the average and median growth rates for both barrels and sales. Multiply these growth rates by the 2012 actual values for barrels and sales and make your third (and final ) set of forecasts for 2013. How do you feel about these predictions?
e. As a side note, Erik, the accountant, asked the owners to do a quick, back-of-the-beer-coaster estimate of what growth would be for 2013. Their immediate response was “20%.” Would you say that Dave, Bill, and Matt are guessing, or do they know their business very well?
Questions about Ska’s Monthly Data
Another concern at Ska is seasonal variation. The brewery is much busier during the summer months than during the winter months. Two possible explanations for this phenomenon are that 1) people simply buy more beer during the summer, and 2) Ska releases two very popular seasonal beers, Mexican Logger and Euphoria Pale Ale, at the beginning and end of the summer season. To get a better han- dle on the seasonal variations at Ska, your task is to draw some clear pictures of what’s happening (sometimes called data visualization ).
To achieve this goal, consider Exhibits 1.2–1.6 with the complete monthly data for all 13 years. You will see the barrels information in
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white and the sales information in gray. Use this data to display the seasonal patterns at Ska:
9. Thirteen years provides 156 months’ worth of data. In Excel, develop one column from 1 to 156. In the next column, list the barrels sold for each year in chronological order (so the first 12 data points will be the 196.5–238.1 from year 2000, the next 12 will be the 243.2–258.9 from year 2001, and so on.) (Hint: You can build this using simple cut/copy and paste, or there’s likely a better way.) In the third column, list all the monthly sales data.
a. Graph a scatter plot of both month versus barrels and month versus sales.
b. Fit exponential curves to both graphs.
c. Look carefully at the last four years of each graph. When does Ska tend to get busier during these four years? Does each graph indicate that summertime is crunch time? Which months in particular appear to be the busiest?
10. For the final forecasts for 2013, predict each month of 2013 and add them to the scatter plot from question 9. As you did in question 4, use only the last four years from 2009 to 2012 to forecast 2013.
a. For each month, make a linear forecast using the monthly data from 2009 to 2012. So, for example, to predict barrels for January 2013, use the data points 706.6, 1017.3, 1272.4, and 1484.9, and make a straightforward linear prediction. Do this for both barrels and sales for each month.
b. Now, add these forecasted values onto the scatter plots from question 9. Make the forecasted values a different color from the actual data to make them stand out and label the final graphs accordingly. These two graphs should give the stakeholders at Ska a clear picture of what 2013 might look like, depending on how accurate the forecasts end up being.
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(Note: Adding these extra points to a pre-existing scatter plot in Excel is a little tricky. To do so, right-click on the scatter plot itself and choose Select Data. Click the Add but- ton and add your forecasted values as a new series of data.) According to the two graphs (including actual monthly data and forecasted values), when will Ska be busiest in 2013?
Conclusion
Congratulations, you have just completed a very thorough analy- sis of Ska Brewing Company’s production in barrels and sales figures. At this point, it might be worth reconsidering how accurate forecasts will help Ska. According to Erik, “An accurate sales budget is the root of the entire budgeting process.” In addition, Dave says that accu- rate forecasts would help “tremendously,” allowing Ska to “increase efficiencies from a production standpoint,” and help “make decisions about whether or not Ska could enter any new markets.”
Now it’s time to tie everything together and make your best fore- cast for 2013 for both barrels and sales, including some kind of esti- mate of the error term. Carefully combine your forecasts from 4c, 6b, 7a, 7b, and 8d. Be bold and use a large font— you are an expert now!
Year Forecasted Barrels Forecasted Sales
2013
(Note to students: The actual values for 2013 have not yet been realized as I (the author) prepare this case study. When they become available in early 2014, I will get them from Ska and record them. If you are curious about how good your final forecasts actually were, send them to Dr. Eric Huggins, 3 and I’ll reply with the actual values when they become available.)
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Exhibits
Exhibit 1.1 Barrels Sold and Sales Volume at Ska Brewing Company Year BBLS $$$
2000 2,595 $521,050
2001 3,025 $629,866
2002 3,465 $739,153
2003 4,031 $883,378
2004 4,525 $1,011,409
2005 5,273 $1,234,628
2006 6,268 $1,481,759
2007 7,289 $1,754,272
2008 7,943 $2,080,795
2009 11,681 $3,179,390
2010 16,026 $4,376,982
2011 21,258 $5,317,535
2012 25,771 $6,553,145
Exhibit 1.2 Monthly Data for Barrels and Sales (2000–2002) 2000 2001 2002
BBLS $$$ BBLS $$$ BBLS $$$
Jan 196.5 $40,458 243.2 $53,093 290.80 $62,989
Feb 193.2 $35,615 239.9 $48,819 254.80 $53,912
Mar 229.7 $43,306 241.3 $49,782 267.50 $56,477
Apr 190.2 $34,885 214.2 $44,515 252.30 $54,720
May 195.1 $40,879 227.6 $50,671 306.90 $67,387
Jun 261.9 $53,378 309.3 $64,764 323.80 $68,196
Jul 230.2 $46,850 292.5 $59,947 336.80 $71,179
Aug 247.7 $50,118 327.9 $67,821 326.00 $69,643
Sep 210.6 $43,872 226.2 $46,102 272.70 $57,426
Oct 203.3 $41,805 242.9 $50,403 262.90 $55,944
Nov 198.2 $39,317 201.3 $40,892 248.70 $55,639
Dec 238.1 $50,569 258.9 $53,058 321.70 $65,643
Total 2.594.7 $521,050 3.025.2 $629,866 3.464.9 $739,153
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Exhibit 1.3 Monthly Data for Barrels and Sales (2003–2005) 2003 2004 2005
BBLS $$$ BBLS $$$ BBLS $$$
Jan 336.3 $74,218 336.6 $74,072 411.1 $93,769
Feb 269.4 $57,567 317.6 $69,847 374.7 $83,907
Mar 284.8 $58,822 405.6 $86,334 396.2 $95,687
Apr 273.5 $59,089 344 $76,337 388.4 $91,712
May 367.0 $81,849 391.5 $94,853 435.9 $101,683
Jun 383.0 $85,636 492.1 $110,477 526.3 $122,572
Jul 388.3 $87,031 410.9 $90,578 492.1 $114,097
Aug 416.1 $91,560 418.4 $90,768 492.7 $114,925
Sep 292.5 $65,976 411.3 $90,308 449.6 $103,899
Oct 386.0 $84,438 309.6 $69,961 434.3 $104,706
Nov 266.0 $58,368 308.7 $69,073 433.4 $102,354
Dec 368.1 $78,824 378.9 $88,800 437.9 $105,317
Total 4031 $883,378 4525.2 $1,011,409 5272.6 $1,234,628
Exhibit 1.4 Monthly Data for Barrels and Sales (2006–2008) 2006 2007 2008
BBLS $$$ BBLS $$$ BBLS $$$
Jan 455.9 $107,422 598.7 $141,177 581.5 $153,098
Feb 437.2 $101,485 512.4 $124,511 628.7 $163,893
Mar 619.7 $140,082 560.3 $133,152 658.3 $164,180
Apr 368.6 $88,973 628.5 $142,942 628.5 $176,973
May 635.2 $149,576 621.9 $151,621 685.7 $177,043
Jun 587.5 $139,916 780.1 $182,735 661.8 $168,823
Jul 597.8 $141,982 641.9 $152,912 780.8 $201,482
Aug 557.1 $133,007 728.6 $176,702 725.5 $190,317
Sep 567.6 $132,330 571.3 $136,517 626.8 $156,337
Oct 478.3 $115,470 641.2 $159,959 676 $186,388
Nov 424.1 $100,695 418.8 $107,104 518.5 $138,374
Dec 538.8 $130,823 585 $144,939 770.9 $203,889
Total 6267.8 $1,481,759 7288.7 $1,754,272 7943 $2,080,795
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Exhibit 1.5 Monthly Data for Barrels and Sales (2009–2011) 2009 2010 2011
BBLS $$$ BBLS $$$ BBLS $$$
Jan 706.6 $193,481 1,017.3 $267,782 1,272.4 $319,313
Feb 641.3 $170,674 853.3 $225,592 1,275.9 $323,726
Mar 884.8 $228,095 1,124.2 $356,604 1,333.2 $342,353
Apr 862.4 $232,372 999.1 $274,723 1,356 $361,315
May 1,061.3 $288,188 1,434.1 $377,369 2,471.1 $612,500
Jun 1,110 $304,763 1,673.3 $439,907 2,276.3 $564,599
Jul 1,269.5 $337,825 1,626.7 $430,999 2,102.3 $518,422
Aug 1,269.7 $342,121 1,871.7 $485,822 2,556.2 $623,860
Sep 1,147.5 $320,011 1,398 $407,577 1,631.4 $412,091
Oct 1,107.4 $304,756 1,649.4 $450,234 2,140.4 $530,636
Nov 766.1 $221,514 1,111.2 $315,238 1,258.1 $313,034
Dec 854.8 $235,591 1,267.5 $345,135 1,584.3 $395,686
Total 11,681.4 $3,179,390 16,025.8 $4,376,982 21,257.6 $5,317,535
Exhibit 1.6 Monthly Data for Barrels and Sales (2012) 2012
BBLS $$$
Jan 1,484.9 $375,117
Feb 1,520.9 $391,677
Mar 1,624.2 $426,746
Apr 2,136.1 $535,876
May 2,622.2 $659,204
Jun 2,349.6 $582,670
Jul 2,635 $663,534
Aug 2,292.9 $564,901
Sep 2,495.2 $636,399
Oct 2,856.7 $727,822
Nov 2,088.3 $539,011
Dec 1,664.7 $450,188
Total 25,770.7 $6,553,145
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Case 2 Maintaining Financial Success and
Expanding into Other Markets at FeedMyPet.com
Charles A. Wood, Duquesne University
Introduction
The first-ever 10-Q quarterly financial reports have just been filed with the SEC (U.S. Securities and Exchange Commission), and John McCloud is very happy with his company’s performance so far. Feed- MyPet.com just conducted its first IPO last month, and has raised an amazing $89 million after only one year in business (see Exhibit 2.1 ). After starting FeedMyPet.com last February, just a little over a year ago, Cindy Jones, FeedMyPet.com’s COO (Chief Operating Operator), joined John McCloud, founder and CEO (Chief Executive Officer) of FeedMyPet.com, to review the year’s company activities.
Like many new startups, FeedMyPet.com had a rough time get- ting started. Expenditures were high, especially in the area of adver- tising, which was necessary to increase name recognition. There were also some problems with an inadequate business plan formulation and a lack of initial market research that caused some industry analysts (“negativos” as McCloud calls them) to be unenthusiastic about the company, but the market has spoken, and McCloud couldn’t help but smile as he thought of the investing community—the true visionaries
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in the business world—who flocked to the recently held IPO. The additional capital will allow the firm to accomplish amazing things.
FeedMyPet.com is an online business that sells pet food, pet accessories, and pet supplies direct to consumers over the Internet. The public offering raised so much money that FeedMyPet.com was able to purchase its main competitor, KennelTime.com, leaving it to rule the entire online pet marketplace. McCloud attributes his vast success to several factors:
• FeedMyPet.com has a dedicated support staff of 280 people (whereas most online pet shops have around 30 employees). This staff is much more responsive to customer needs than the skeleton staff at other online pet product companies.
• FeedMyPet.com offers free shipping. Dog food bags and cans are heavy, and the cost of shipping can approach the cost of the dog food. Some competitors have tried to pass these costs on to the consumer, thus alienating the client base; but FeedMyPet. com did not make that mistake and has been rewarded with the largest market share of any online pet product retailer.
• FeedMyPet.com has an advertising campaign that spans across a variety of media, including TV, print, radio, web-based ads, and even its own FeedMyPet.com magazine. This marketing was important, especially right before the IPO, when advertis- ing drove up the price of the initial stock!
The advertising campaign started last year with a 5-city advertis- ing campaign rollout and has now expanded to 10 cities, and has finally gone nationwide with a $1.4 million Super Bowl ad that introduced the country to its answer as to why customers should shop at FeedMy- Pet.com: “Because Pets are People Too!” The cute ad featured a large man in a dog costume, won several awards, and had the highest recall of any ad that ran during the Super Bowl. Name recognition was at an all-time high. After the ad, FeedMyPet.com went public with an IPO that raised millions. McCloud is sure that extensive advertising has
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played a large part in FeedMyPet.com’s success and that the advertis- ing budget will continue to grow to ensure that the company remains successful.
To deliver pet supplies, FeedMyPet.com made significant invest- ments in infrastructure such as computer networking and data ware- housing. FeedMyPet.com’s management maintained that the company needed to realize a revenue run rate that supported this infrastructure build-out. McCloud’s fellow executives believe that revenue needs to approach $400 million to hit the break-even point, and that it will take a minimum of four to five years to hit that run rate. But investors are still on board; with the stock price on the way up, McCloud perceives no problem with cash flow at FeedMyPet.com.
As McCloud and Jones contemplate the future, they discuss two important topics that require Jones to conduct some additional investigation:
• Maintaining financial success— Clearly, FeedMyPet.com has become the de facto leader in the online pet products industry in a fairly short time. Investment and revenues have followed this market leadership. How might FeedMyPet.com’s leadership leverage into other ventures? And how does FeedMyPet.com not only dissuade future online competitors, but also coerce current offline “bricks and mortar” shoppers to move their shopping for pet products online?
• New marketing plan— Marketing has clearly been the key to FeedMyPet.com’s success. The Super Bowl ad drove up invest- ment, and all the previous marketing campaigns have increased market share. Now that FeedMyPet.com is flush with capital, additional marketing plans should be considered.
With so much available cash, McCloud feels comfortable in attack- ing these issues. McCloud and Jones have discussed various responses to these topics, and the $89 million that they have raised in the recent IPO will fund strategies that heretofore have not been possible.
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Maintaining Financial Success
Jones’s first task is to ensure FeedMyPet.com maintains its strong financial position. Both McCloud and Jones agree that FeedMyPet. com is in an excellent financial position, especially after the last infu- sion of $89 million in capital from the recent IPO. McCloud knows that there is a reason for the investor exuberance. Exhibit 2.5 (taken from data found in Exhibit 2.3 ) graphically shows the explosive growth in sales since the company’s inception in the second quarter of last year.
The growth in revenue has been a boon to the company. Total assets have increased 25% from the second quarter to the third quar- ter. Exhibit 2.6 (taken from data found in Exhibit 2.2 ) shows the increase in asset value of the company during the same period.
McCloud and Jones discuss how the explosive growth in revenue has sent a strong message to the investor community that FeedMyPet. com is not just a niche small company, but a major player in online retail, and a safe yet profitable investment.
In addition, there are some challenges when operating in the pet supplies industry. Dog food is heavy and costly to ship. Also, to gain market share and name recognition before competitors could swoop into this lucrative market, FeedMyPet.com was very aggressive in the initial pricing of its products, paying $16 million for goods sold to cus- tomers for $7 million. This means that in that initial period, for every dollar that FeedMyPet.com paid employees, pet food manufacturers such as Purina, and delivery services such as UPS, it charged the cus- tomer about 44 cents. BusinessWeek 1 notes that operating margins for pet products retailers are typically much higher; for example, offline “bricks and mortar” pet supplies companies such as Petco typically post a profit margin of up to 4.5%. Jones is confident that after the convenience of online pet delivery catches on, FeedMyPet.com will
1 Arlene Weintraub and Robert D. Hof, “For Online Pet Stores, It’s Dog-Eat- Dog,” BusinessWeek , March 6, 2000.
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19
be able to command an even higher 20%–30% operating margin. Customers are very loyal, and appreciate having pet products, like dog toys and bird food, shipped directly to them rather than forcing the customers to visit a store.
The question remains as to how to best ensure that the success of FeedMyPet.com continues into the future. McCloud and Jones both understand that weak financial positions can drive down stock price and can be exploited by new entrants into the lucrative online pet products market space. Jones’s first task is to examine the financial statements (found in the exhibits) to examine how to continue this strong performance into the foreseeable future.
New Marketing Plan
Jones’s second task is to formulate a new marketing plan that picks up from the highly successful previous marketing plan. McCloud believes that marketing was the key to FeedMyPet.com’s initial suc- cess, and Jones is expected to devise a plan to continue that market- ing success...no small feat, to be sure! There are several advertising mediums that are available to FeedMyPet.com:
• TV advertising— This is the most expensive type of advertis- ing, but the amazing results with the Super Bowl ad show its effectiveness.
• Magazine/newspaper— Magazines ads are one of the most targeted advertising mediums. For example, an advertiser can select a pet magazine in which to advertise. Newspapers facili- tate geographic targeting.
• Direct mail— Direct mail allows a company to target an indi- vidual, regardless of online access. It is often inexpensive, and a company can purchase a potential customer list based on demographic information.
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• Telemarketing— Telemarketing requires a temporary service or employees, but allows a script to be delivered to the target over the phone lines. However, some states enforce a do-not- call list that might interfere with the marketing effort.
• Search engine optimization (SEO)— This is probably the most cost-effective method of online advertising. With SEO, you design your web pages and links to optimize their appear- ance within a web page within the “free” listings, which are then often clicked by the end user.
• Pay per click (PPC)— PPC advertising is when search engines charge companies for each click. The bright side of this adver- tising is that you only pay for the clicks you receive. The down- side is that many end users avoid clicking on advertisements.
• Email marketing— Email marketing, often called spamming, is reviled by many recipients. However, the positive side is that you can easily send out millions of emails for free after you have the email addresses, and a very small percentage of conversions can result in a large increase in sales.
Jones is aware of the various costs of each advertising medium (see Exhibit 2.4 ). FeedMyPet.com has proven itself willing to spend quite a lot for advertising. Exhibit 2.7 shows how much FeedMyPet. com has spent on advertising since its inception; although, a leveling off has been observed in the last two quarters, perhaps indicating an optimal advertising level for the company.
Final Thoughts on Analysis
Jones has to hit the ground running on these two goals. First, she needs to isolate any potential problem areas in the financial state- ments. With $89 million, the company is sure to be set for years to come, and it will benefit the company to leverage its new revenue to
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make the company even more profitable and competitive. Second, she has to develop a marketing plan that allows the company to con- tinue its upward path. Perhaps viewing the numbers as a percentage of sales or developing a nonlinear trend line in Excel to project future financial statement values is in order.
Exhibits
Exhibit 2.1 FeedMyPet.com IPO Capital Raised Statement Price Per Share Shares Total Revenue
Public offering price $12.00 8,000,000 $96,000,000
Underwriting discount $0.88 8,000,000 $7,040,000
Proceeds, before expenses, to FeedMyPet.com
$11.12 8,000,000 $88,960,000
Exhibit 2.2 Quarterly FeedMyPet.com Balance Sheet Data Last Year This Year
Third Quarter Fourth Quarter First Quarter
Cash and cash equivalents
$52,172 $43,482 $84,137
Current assets $54,275 $51,967 $110,096
Total assets $69,695 $86,846 $137,750
Current liabilities $8,934 $10,903 $16,402
Total liabilities $10,231 $11,028 $17,376
Total stockholders’ equity, including convertible preferred stock
$59,464 $75,818 $120,374
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Exhibit 2.3 FeedMyPet.com Statement of Operations (in Thousands) Last Year This Year
Second Quarter
Third Quarter
Fourth Quarter First Quarter
Net sales $47 $682 $6,202 $9,181
Cost of goods sold ($91) ($2,119) ($13,884) ($15,018)
Gross profit ($44) ($1,438) ($7,682) ($5,837)
Operating expenses:
Marketing and sales 1,346 12,832 36,811 34,626
Product development 1,949 2,633 3,175 3,223
General and administrative
1006 1,446 2,653 2,797
Amortization of stock- based compensation
-- 1,367 1174.8 1,290
Total operating expenses
($4,301) ($18,277) ($43,814) ($41,936)
Operating profit (EBIT)
($4,345) ($19,715) ($51,497) ($47,773)
Interest income $148 $692 $589 $868
Net income ($4,198) ($19,022) ($50,908) ($46,906)
Outstanding shares 1,744 1,744 1,760 9,760
Earnings per share (EPS) (in dollars)
($2.41) ($10.91) ($28.92) ($4.81)
Exhibit 2.4 Advertising Medium Costs 2 Setup Process Setup Cost Cost of Media
National TV ad spot
Design + production
$50,000–$750,000 $35,000 to $2 million per 30-second spot
National magazine
Design $1,500–$20,000 $3,000–$25,000 per full-page ad per issue
National newspaper ad
Design $1,500–$20,000 ~$28,000 per half- page ad per day
Direct mail Design $1,500–$15,000 ~$2.20 per addressee
2 From WebPageFX, 2009, last accessed Feb. 26, 2013, available at http://www. webpagefx.com/blog/business-advice/the-cost-of-advertising-nationally-broken- down-by-medium/ .
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Setup Process Setup Cost Cost of Media
Telemarketing Script writing $1,000–$4,000 $20–$60 per hour per outbound caller
National SEO Website configuration
$4,000–$10,000 ~$500/month to Internet marketer
National PPC Campaign configuration
$4,000–$10,000 5¢–$3 per qualified visitor
National email marketing
Email template design
$4,000–$10,000 ~$500/month to Internet marketer
Exhibit 2.5 Net Sales Quarter by Quarter
$10,000
Second Quarter Third Quarter Fourth Quarter First Quarter
$9,000
$8,000
$7,000
$6,000
$5,000
$4,000
$3,000
$2,000
$1,000
$0
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Exhibit 2.6 Asset Growth in the Previous Three Quarters
$160,000
$140,000
$120,000
$100,000
$80,000
$60,000
$40,000
$20,000
$0
Third Quarter Fourth Quarter First Quarter
Exhibit 2.7 FeedMyPet.com Quarterly Expenditures on Advertising
$40,000
Second Quarter Third Quarter Fourth Quarter First Quarter
$35,000
$30,000
$25,000
$20,000
$15,000
$10,000
$5,000
$0
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Case 3 Forecasting Offertory Revenue at St.
Elizabeth Seton Catholic Church *
Matthew J. Drake, Duquesne University
Ozgun Caliskan-Demirag, Pennsylvania State University—Erie, The Behrend College
Introduction
Fr. Clyde Jarreau could not sleep early in the morning of Octo- ber 10, 2005. The evening before, he had presided over his parish’s monthly finance committee meeting, where concerned parishioners examined the church’s monthly financial statements and provided recommendations to keep the organization on track financially. At the previous night’s meeting, a few of the committee members continued to voice their concern that spending was out of control. The church’s bank account balances had fallen sharply for the sixth month in a row, and the committee members were worried that the church would run out of funds sometime early in 2006.
Fr. Jarreau appreciated their commitment to the parish, but he did not need them to remind him of the church’s financial struggles. As the pastor of the church, he was greeted by the stack of unpaid bills dominating his desk every time he entered his office. He also saw the
* Finalist in the 2011 INFORMS Case Competition
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stagnant, if not dwindling, weekly offertory collection figures that he had to publish in the weekly bulletin. With expenses increasing with- out the additional revenue from collections to cover them, Fr. Jarreau knew that he would have many more sleepless nights if he could not find a way for the church to live within its financial means.
After contemplating the problem over a cup of coffee in the rec- tory’s kitchen, Fr. Jarreau knew that he could not construct a solution to such a big problem by himself. He decided to place a call in the morning to a few of his most trusted advisors on the finance commit- tee. These people had been parishioners at the church for more than 15 years, predating himself by a half dozen or so years. They knew the history of the parish over this time and had seen the financial position deteriorate over the past few years, as well. Fr. Jarreau knew that they would do anything they could to help the parish; he only hoped that he was not reaching out to them too late.
St. Elizabeth Seton Catholic Church
Fr. Jarreau’s parish, St. Elizabeth Seton, was founded in 1976 in Daphne, Alabama, a small Gulf town just outside of Mobile. The par- ish grew rapidly throughout the 1980s and 1990s as a large number of workers from the northern United States moved into the south, chas- ing both displaced jobs and better weather. Although the church itself is the same size as the original building built in 1976, the parish con- ducted two successful capital campaigns in the subsequent decades after the parish was founded. The first campaign, kicked off in 1985, raised funds to build an educational building for religious education classes for children and adults. The second campaign, begun in 1996, enabled the church to build new offices for its staff and parishioner organizations.
By the year 2000, membership in the church was strong, and the cash reserves were rising each month as parishioners gave generously
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each week. With the crash of the dot-com bubble in late 2001, how- ever, offertory revenue slid in 2002, and a few years passed before it showed signs of any significant recovery. In an effort to revitalize the church and in keeping with the historical 10-year cycle, Fr. Jarreau spearheaded a new capital campaign toward the end of 2004 with the goal of raising money to build a new recreational hall for the church. This would enable the parish to hold more fellowship activities, as well as generate additional sources of revenue by hosting wedding receptions and other banquets. Unfortunately for the pastor, these new revenue streams would only begin after the building was com- pleted in early 2007.
When Fr. Jarreau initially discussed the new capital campaign in the summer of 2004, several members of the finance committee were worried that many parishioners would simply direct a large portion of their weekly offertory contribution to the new capital campaign. This would severely hinder the church’s ability to meet its normal operat- ing expenses. Luckily, however, Fr. Jarreau’s explanation of the capi- tal campaign had largely convinced the parishioners to support it in addition to maintaining their normal weekly offertory contributions. The offertory figures thus far in 2005 appeared to be unaffected by the capital campaign.
Cash Flow Analysis
Fr. Jarreau was able to arrange a meeting with his trusted finance committee members, John Gust and Charlie Stewart, a few nights later. When they arrived in his office around 7 p.m., Fr. Jarreau wasted no time summarizing the problem facing the church. “Our bank balances have consistently fallen throughout this year. At this rate, it looks like the parish is going to be out of money by this time next year. What do you guys think we should do?” Charlie and John had thought that they were going to have to open Fr. Jarreau’s eyes to
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the church’s financial problems in this meeting, but now it was obvi- ous that the pastor understood them all too well. After a brief sigh of relief, Charlie started, “John and I have been members of the finance committee for years, and we’ve got a lot of ourselves invested in this parish. We’ve been trying to suggest subtly that the church’s spend- ing was getting out of control, but now it appears as if the time for subtlety has passed. We need to drastically rein in expenses.”
Fr. Jarreau recalled their previous concerns but could not recon- cile one aspect of the church’s financial operations. “But the Archdio- cese requires that we have a balanced budget each year. They won’t accept a budget from us that isn’t balanced. How could we be in this situation with a balanced budget?”
John chimed in, “Well, Father, the problem seems to be with the budget process itself. In my opinion, we’ve been doing the whole thing backwards. We have been asking each department head to sub- mit his or her expected expenses for the upcoming year, and we have most of our discussions as a committee about these expenses.
“I’m not saying that expenses aren’t important, but we haven’t spent nearly enough time trying to estimate the revenue from our weekly offertory collections. In the past, we’ve basically just estimated whatever revenue we needed to cover the estimated expenses and plugged that number into the budget without any real thought as to whether we could actually expect to collect those amounts. We need to start the budget process with the revenue piece this year and make sure that we have a realistic estimate of our collections. Then we can try to estimate expenses that coincide with these revenue projections.”
Fr. Jarreau liked what he had just heard from John and Charlie. It was obvious to him that the old budgeting process had some fatal flaws which could not be allowed to continue. The advisors’ recom- mendations made a lot of sense to him. He knew that the department heads would complain about the significant spending cuts that would likely be required with a more realistic revenue estimate, but the financial viability of the entire parish was at stake. The department
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CASE 3 • FORECASTING OFFERTORY REVENUE AT ST. ELIZABETH SETON CATHOLIC CHURCH
29
heads would simply have to prioritize between expenditures that they absolutely had to make and those that they could live without. It seemed like a much better idea to allow increased spending later on if collections turned out to be higher than expected, rather than have to cut expenditures that the department heads had planned to make as of the beginning of the year.
Budgeting for 2006
Because the budgeting process was scheduled to begin at the November meeting of the finance committee, Fr. Jarreau decided to call an additional meeting in the meantime to inform the committee about the new focus on revenue projection during the budgeting pro- cess. At this meeting, he asked the group for suggestions about how the offertory revenue could be predicted.
Frank Lawson, a vocal member of the committee but one who usually spent more time looking at his watch at meetings than actually contemplating the issues at hand before he spoke, characteristically blurted, “Why don’t we just use the current year’s actual offertory and be done with it? Whatever we collected this past January can be the forecast for this coming January. We should be spending more time thinking up additional ways to raise money beyond the collection basket. We need to be increasing the revenue to enable us to meet the expenses that we have now.”
Trying in vain to conceal her exasperation, Megan Fisher, demand planner at a local consumer packaged goods company, responded quickly,
“You’ve been on this committee long enough, Frank, to know that the offertory collection is overwhelmingly the largest component of the church’s total revenue. Any additional fundraising that we do is fine, but it’s not going to totally make up for offertory projections that are way off.
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“One of the most important parts of my job is to produce weekly forecasts of demand for our various product lines to make sure that we plan to have enough units to satisfy our customers. Why don’t I take some time over the next few weeks and use some of the models that I use at work to forecast the offertory collections for each month of next year? That can be a starting point for our budget meeting in November.”
Megan turned to Ernie Jackson, the church’s bookkeeper. “Ernie, how much past data about the offertory collections can you get me? The more the better!”
“I think I can get you the last four years’ worth of data. That shouldn’t be a problem. Oh, and I’ll also get you a list of the dates of the Holy Days for each year. That should have some kind of effect on the collections in those months because parishioners are obligated to attend Mass those days.”
“Sounds good, Ernie. That’s a great point about the Holy Days. I wasn’t thinking about those. I wonder if the offertory revenue is related to any other factors. I’m going to have to think about those when I run the models. I’ll let you know if I need any more data from you.”
As the meeting wound down, Fr. Jarreau started to feel a little better about the church’s future. Certainly some difficult financial decisions were on the horizon, but at least the committee had a plan that they were committed to and should help to stabilize the net cash outflows. He prayed that Megan would get the whole budgeting pro- cess off to a good start by producing a good forecast.
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31
Exhibits
Exhibit 3.1 Monthly Offertory Revenue from July 2001 to September 2005 Month 2001 2002 2003 2004 2005
January $110,492.56 $92,298.44 $98,005.33 $131,627.02
February $90,979.03 $78.930.37 $114.943.12 $90,711.98
March $128,952.91 $111,539.47 $88,289.13 $108,976.43
April $79,301.47 $102,117.76 $100,502.85 $123,005.88
May $76,936.52 $79.484.64 $111,646.53 $93,311.73
June $94,806.21 $101,758.24 $83,580.73 $82,907.85
July $99,061.10 $77,038.89 $85,851.77 $81,039.41 $97970.72
August $89,066.57 $82,764.19 $98.602.05 $107,677.54 $78,723.84
September $115,003.28 $104,756.91 $79,139.66 $85,619.97 $83,625.49
October $86,224.72 $79,724.52 $79,178.51 $111,837.81
November $92,264.05 $96,470.47 $115,691.27 $82,599.90
December $181,938.85 $160,005.98 $155,950.77 $158,685.01
60000
80000
100000
120000
140000
160000
180000
200000
2 0
0 1
M 0
7
2 0
0 1
M 0
9
2 0
0 1
M 11
2 0
0 2
M 0
1
2 0
0 2
M 0
3
2 0
0 2
M 0
5
2 0
0 2
M 0
7
2 0
0 2
M 0
9
2 0
0 2
M 11
2 0
0 3
M 0
1
2 0
0 3
M 0
3
2 0
0 3
M 0
5
2 0
0 3
M 0
7
2 0
0 3
M 0
9
2 0
0 3
M 11
2 0
0 4
M 0
1
2 0
0 4
M 0
3
2 0
0 4
M 0
5
2 0
0 4
M 0
7
2 0
0 4
M 0
9
2 0
0 4
M 11
2 0
0 5
M 0
1
2 0
0 5
M 0
3
2 0
0 5
M 0
5
2 0
0 5
M 0
7
2 0
0 5
M 0
9
Exhibit 3.2 Graph of Monthly Offertory Revenue from July 2001 to September 2005
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Exhibit 3.3 List of Catholic Holy Days of Obligation or Major Feast Days from 2001–2006 Holy Day/Feast 2001 2002 2003 2004 2005 2006
Solemnity of Mary
Jan 1 Jan 1 Jan 1 Jan 1 Jan 1 Jan 1
Ash Wednesday Feb 28 Feb 13 Mar 5 Feb 25 Feb 9 Mar 1
Easter Sunday Apr 15 Mar 31 Apr 20 Apr 11 Mar 27 Apr 16
Ascension May 24 May 9 May 29 May 20 May 5 May 25
Assumption of Mary
Aug 15 Aug 15 Aug 15 Aug 15 Aug 15 Aug 15
All Saints’ Day Nov 1 Nov 1 Nov 1 Nov 1 Nov 1 Nov 1
Immaculate Conception
Dec 8 Dec 8 Dec 8 Dec 8 Dec 8 Dec 8
Christmas Day Dec 25 Dec 25 Dec 25 Dec 25 Dec 25 Dec 25
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Case 4 Pizza Station
Kathryn Marley, Duquesne University
Gopesh Anand, University of Illinois at Urbana–Champaign
Background
Established in 1980, Pizza Station is located in the trendy down- town area of Salina, Pennsylvania. Situated within walking distance of Salina State College, the restaurant initially offered in-house dining and a variety of food items on its menu. However, as competition among local restaurants grew, Pizza Station’s staff decided to limit their offerings to delivery of pizzas in early 2001. Since then, they have developed a loyal following among customers who have come to expect quick and reliable delivery of good-quality pizza from the res- taurant. Nevertheless, in the past two years, manager Tom Smith has noticed that customer complaints have increased significantly. With new pizza outlets and other restaurants opening up in the area every year, Tom is concerned that unless changes can be made quickly, Pizza Station will lose market share, and might eventually have to close its doors permanently.
Pizza Station operates seven days a week. On Sunday through Thursday, the hours are noon through 1 a.m. On Fridays and Sat- urdays, the hours are noon through 3 a.m. The busiest hours are on Fridays and Saturdays between 9 p.m. and 2 a.m. Demand for pizza
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varies throughout the week and times of day. From Sunday through Thursday, the average daily demand is 300 pizzas. Fridays and Sat- urdays are busier, with average demand increasing to 650 pizzas per day. On these two days, the demand during each busy 9 p.m.–2 a.m. period averages 400 pizzas. Currently, Pizza Station is promising a delivery time of 45 minutes to customers.
Tom recently hired Kate Fox, a business major from Salina State College, to manage the weekend shift. He asked her for assistance in identifying the necessary changes that would enable Pizza Station to decrease complaints, increase customer satisfaction, and win back lost customers. Kate recently completed a Lean Six Sigma training course as one of her business school classes; and, eager to apply some of the things she learned, she sat down with Tom to discuss the situation.
“I don’t know where we went wrong and, frankly, I don’t know where to begin!” exclaimed Tom. “All I know is that our troubles seem to have suddenly multiplied since last January when the students came back to campus. Things started off normally, but over the next three months I noticed a steadily increasing number of complaints.” Tom pulled out a file folder from the bottom of a stack on his desk. Inside were papers of varying sizes with notes scribbled on them. He squinted as he tried to read them. “This customer said the crust was too thin, while this one said the delivery time was too long.” As he read from the stack of mismatched notes, Kate realized that they were going to have to implement a better system for capturing customer feedback—and fast, if they were going to turn this place around.
“Okay, Tom, I get the idea,” said Kate. “Let’s start at the begin- ning. We need to approach this problem from a systematic process improvement perspective—which first involves figuring out what is the voice of the customer.” Tom looked confused. Kate continued, “The voice of the customer (or VOC) consists of customer require- ments, which is what the customer is expecting Pizza Station to deliver. There is no chance that customers are going to keep ordering pizza from Pizza Station if these expectations are not being met. So
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CASE 4 • PIZZA STATION 35
you need to capture this information to know where to begin to make changes.”
“Sounds great, Kate,” said Tom. “Let’s get started!”
A customer satisfaction study was commissioned to figure out the voice of the customer (VOC). It pointed to delivery time and crust thickness as being critical to quality (CTQ) characteristics. An anal- ysis of recent sales data revealed that the most commonly ordered crust from Pizza Station was the unique medium crust. In addition, three focus groups with eight customers each revealed that the ideal medium pizza crust was found to be between 4.25 mm and 5.75 mm. To measure what the process was actually producing (voice of the process, or VOP), Kate took a sample of five medium pizza crusts every day over a period of 30 days, and measured their thickness. The data that she collected is provided in Exhibit 4.1 .
Kate’s training in Lean Principles also prompted her to talk with the employees who actually work on the pizza-making line. As she told Tom, people working on the frontlines of any process know the most about how the work is done. From the spirited discussion that Kate had with the staff, it soon became apparent that they believed the task of order-taking had problems. So, she asked them to collect data on this task. For 30 days, they took samples of 50 orders every day, inspected them, and recorded all the errors involved. This data is provided in Exhibit 4.2 .
Next, choosing one of the busiest times at Pizza Station, Kate walked the process to map the value stream for pizza-making and delivery. She explained to Tom that this exercise was aimed at 1) getting some measurements of different tasks in the process, and 2) gaining additional insights into the current length of delivery time. Because the peak demand period for Pizza Station is Friday nights between 9 p.m. and 2 a.m., Kate and Tom walked the process at that time and observed the following steps involved in making pizzas. Their observations are described in the following sections.
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There are a total of five employees in the store on Friday nights, along with nine delivery drivers on staff. The pizza-making process begins with orders received by phone. Next, pizzas are assembled and baked. Finally, the pizzas are cut, boxed, labeled, and delivered to the customers.
Ordering
There are no designated operators who answer the phones at Pizza Station. The phones are answered by whoever is “nearby” at the time. That can be any of the four employees who are working the pizza line during the shift, with the exception of the employee who is dedicated to the baking process. It is estimated that each of the four employees spends 20% of her time answering phones. Kate watched the order-taking process for 15 minutes. During that time, orders for 20 pizzas were received. After the customer places the order, the employee who took the order informs the customer about the price and the estimated delivery time. The order is written on a note pad and hung on a board for the assembly station workers to retrieve as they become available. Kate observed during those 15 minutes that there were orders for 5 pizzas waiting to be assembled; an order waits on average 225 seconds before moving to assembly.
Pizza Assembly
Each of the four employees dedicates 60% of her time to assem- bling pizza. After an order is received, an assembly worker retrieves a ball of pizza dough from the refrigerator at the back of the store. Employees only retrieve one ball of pizza dough at a time. It takes, on average, three minutes for one employee to walk to the refrigera- tor and back every time an order is received. The worker begins by
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CASE 4 • PIZZA STATION 37
flattening the dough to the desired thickness and forming the crust. Next, the worker drizzles oil on the crust and assembles the pizza, which includes adding sauce, cheese, toppings, and seasonings. Kate noticed that this process took an average of 90 seconds per pizza. After the pizza is completed, it is placed on a tray until there is an available rack in the oven. Kate observed six pizzas waiting to be baked. A pizza waits 270 seconds before baking on average.
Baking
The oven used for baking the pizzas is set at 500 degrees to ensure crisp and efficient baking. The baking process takes nine minutes and the oven can hold six pizzas at a time. There is one worker at the oven station, who dedicates 100% of her time to putting the pizzas in the oven and removing them, as well as monitoring the baking time of each pizza. After the pizza is baked, it is removed and placed on a large wooden tray. Kate observed 15 pizzas waiting to be cut. A pizza waits an average of 675 seconds before moving to the next station.
Cutting/Boxing/Labeling
The four employees dedicate 20% of their time to cutting and boxing the pizzas. When the pizza is removed from the oven, a worker uses a metal cutter to cut the pizza into the appropriate number of slices. Then he assembles the box and places the cut pizza in the box. The employee then goes to the order station, retrieves the address information from the order slip, and writes this information on the pizza box. The boxed pizza is placed on the delivery counter and waits for delivery. Cutting the pizza takes an average of 5 seconds. Making the box takes 20 seconds. Placing the pizza in the box and closing the lid takes 5 seconds on average. Retrieving the order information and
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writing the information on the box takes 90 seconds on average. Kate observed 10 pizzas waiting to be delivered, and that, on average, the pizzas wait 450 seconds before being taken out for delivery.
Delivery
There are nine dedicated delivery drivers. When a driver returns from a delivery, she checks to see whether there is another pizza wait- ing to be delivered. If there is, she proceeds with delivering that pizza. If there is not, she is free to wait in the break room until there is a pizza waiting to be delivered. Each delivery driver delivers one order at a time. Because the majority of Pizza Station customers live within a five-mile radius of the restaurant, a worker is usually able to deliver a pizza and be back in the restaurant within 18 minutes; therefore, the delivery time to the customer is approximately 9 minutes.
Suppliers
Tom Smith is in charge of ordering all the supplies and ingredi- ents for the restaurant. The pizza dough is made by a local bakery and delivered once a week by truck to Pizza Station. Each delivery consists of 2,500 pizza crusts. After the crusts are received, they are stored in a large refrigerator in the back of the storeroom. Because the delivery day varies, on average there are 1,250 balls of dough on hand.
Analysis
After walking the process with Tom, Kate started scrutinizing the current state of operations as depicted in the value stream map to con- sider potential areas of improvement. Tom was skeptical but excited.
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CASE 4 • PIZZA STATION 39
“Let’s get going, Kate; I don’t want to lose one more customer if I can help it. Let’s get Pizza Station back on top where we belong!”
Assume you are a new addition to Kate’s Lean Six Sigma team. Answer the following questions:
1. Based on the sample data on pizza thickness collected for the 30-day period and presented in Exhibit 4.1 , construct an X-bar–R chart. Include the information on customer require- ments obtained through the focus groups, conduct a process capability analysis, and interpret its result.
2. Based on the data on errors in order-taking provided in Exhibit 4.2 , construct a Pareto chart to identify the areas that should be top priorities for Pizza Station.
3. Compute the DPMO and sigma level of the order-taking task using the data in Exhibit 4.2 .
4. Using the data on total daily errors provided in Exhibit 4.2 , conduct an analysis of variance (ANOVA) test to determine whether there is a significant difference in errors on different days of the week.
5. Construct the appropriate control chart (based on the nature of the data collected) for the total number of defects or errors per 50 orders shown in Exhibit 4.2 . Is this process in statistical control?
6. What is the Takt time for this process (in seconds)? (Note: Because the information was gathered during the Friday eve- ning shift, use that time period for this analysis.)
7. Draw a Current State Map of this pizza-making process. Pizza Station is quoting a delivery lead time of 45 minutes to its cus- tomers. What is the total lead time between ordering and deliv- ery? Is Pizza Station capable of meeting this promise based on your Current State Map calculations?
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40 THE APPLIED BUSINESS ANALYTICS CASEBOOK
8. Develop a list of the symptoms that indicate problem areas in the pizza-making and delivery value stream. Provide sugges- tions for how the problems underlying the symptoms might be reduced or eliminated.
9. Draw a Future State Map of the pizza-making process, incor- porating the changes you suggested in #8.
10. Develop an implementation plan for your suggested improve- ments at Pizza Station.
Exhibits
Exhibit 4.1 Pizza Crust Thickness (in Millimeters) Sample Number Observations
1 2 3 4 5
1 5.33 5.44 5.21 5.3 5.2
2 5.11 5.09 4.92 4.97 4.82
3 5.12 4.85 4.92 5.02 5.03
4 4.82 4.92 5.01 5.2 5.19
5 5.46 5.47 5.32 5.42 5.11
6 5.01 5.21 5.24 5.26 5.31
7 5.21 5.24 5.33 5.41 5.55
8 4.92 4.81 4.94 5.01 5.21
9 5.12 5.31 5.41 5.25 5.34
10 5.12 5.11 5.42 5.34 5.32
11 5.62 5.43 5.21 5.19 5.18
12 5.24 5.41 5.42 5.31 5.5
13 4.9 4.82 5.01 5.21 5.01
14 5.21 5.55 5.41 5.32 5.42
15 5.21 5.32 5.45 5.56 5.01
16 5.01 5.21 5.31 5.49 5.32
17 4.91 5.21 4.81 5.24 5.34
18 5.04 5.14 5.17 5.32 5.41
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CASE 4 • PIZZA STATION 41
Sample Number Observations
1 2 3 4 5
19 5.26 5.32 5.41 5.56 5.21
20 4.81 4.92 5.03 5.24 5.14
21 4.95 5.19 4.89 5.31 5.21
22 4.98 5.23 5.21 5.24 5.22
23 5.41 5.42 5.55 5.11 5.14
24 4.91 5.21 5.34 5.11 5.01
25 5.12 5.13 4.98 4.81 4.91
26 4.91 5.12 5.21 5.03 5.21
27 5.24 5.34 5.56 5.33 5.31
28 4.91 5.12 4.94 5.32 5.21
29 5.3 4.92 4.99 5.01 5.02
30 4.91 5.21 5.34 5.44 5.55
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p tg
1 6
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8 9
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K Exhibit 4.2 Errors in the Order-Taking Task Sample Number
Number of Orders
Incomplete Address
Out of Range Address
Toppings Unclear
Missing Coupon
Forgot to Record Time Others Total Days of Week
1 50 1 7 0 1 5 0 14 Monday
2 50 0 5 0 0 1 1 7 Tuesday
3 50 0 0 2 2 3 1 8 Wednesday
4 50 1 6 1 0 8 0 16 Thursday
5 50 2 14 1 0 18 3 38 Friday
6 50 0 1 0 2 8 4 15 Saturday
7 50 0 1 1 1 3 0 6 Sunday
8 50 2 6 1 1 11 0 21 Monday
9 50 0 7 1 0 2 1 11 Tuesday
10 50 0 3 0 0 3 0 6 Wednesday
11 50 1 7 0 1 1 0 10 Thursday
12 50 1 18 1 0 11 0 31 Friday
13 50 2 9 2 0 0 0 13 Saturday
14 50 0 3 0 0 2 3 8 Sunday
15 50 0 5 2 0 6 1 14 Monday
16 50 3 2 1 1 3 0 10 Tuesday
17 50 2 3 2 1 9 1 18 Wednesday
18 50 1 8 0 0 5 3 17 Thursday
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1 6
2 5
8 9
4 7
C
A S
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IZ Z
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Sample Number
Number of Orders
Incomplete Address
Out of Range Address
Toppings Unclear
Missing Coupon
Forgot to Record Time Others Total Days of Week
19 50 1 18 1 0 3 1 24 Friday
20 50 0 1 0 1 2 0 4 Saturday
21 50 0 1 2 1 8 3 15 Sunday
22 50 0 7 1 1 9 2 20 Monday
23 50 0 0 2 0 1 0 3 Tuesday
24 50 1 1 2 2 2 0 8 Wednesday
25 50 2 9 1 1 6 1 20 Thursday
26 50 1 12 0 0 12 2 27 Friday
27 50 0 8 1 0 5 1 15 Saturday
28 50 0 10 0 0 4 1 15 Sunday
29 50 0 4 2 0 9 2 17 Monday
30 50 0 4 1 0 8 1 14 Tuesday
Totals 21 180 28 16 168 32 445
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2 Optimization and Simulation
5. Inventory Management at Squirrel Hill Cosmetics 47
6. Safety Stock Planning for a Hong Kong Fashion Retailer 65
7. Network Design at Commonwealth Pipeline Company 77
8. Publish or Perish: Scheduling Challenges in the Publishing Industry 81
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Case 5 Inventory Management at
Squirrel Hill Cosmetics
Paul M. Griffin, Pennsylvania State University
Company Background
Founded in 1978, Squirrel Hill Cosmetics, Inc., is a privately held company that sells cosmetic products including eyeliner, mascara, lip- stick, face powder, and nail polish. The company originally made its name with a popular medicated lip balm that it manufactured in Pitts- burgh. In the 1980s and 1990s the company grew primarily through acquisitions and rapidly increased its product offerings. By 2003, most of its production was moved to China, and currently it contracts out all of its manufacturing.
Squirrel Hill Cosmetics now manages more than 1,200 SKUs; approximately 15% of the SKUs turn per year because of changing customer preferences. Last year the company made roughly $200 million in profit with approximately 900 employees. The two channels that it sells through are retailers, with Walmart and Target being the two key customers, and drugstores, including CVS and Walgreens.
In 2010, Squirrel Hill Cosmetics significantly redesigned its sup- ply chain. More than 95% of its SKUs are sourced from China, and these products are now brought by container to a large central distri- bution center (DC) in Nanty-Glo, Pennsylvania. At the DC, some of
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48 THE APPLIED BUSINESS ANALYTICS CASEBOOK
the products are packaged for specific customers, such as CVS. Prod- ucts are then typically shipped to the regional DCs of its customers, although this does vary some by customer.
The containers brought to Nanty-Glo from China have approxi- mately a 12-week lead time. The average cost per container is $6,800, and approximately 1,000 containers were shipped this past year. For key customers, namely Walmart, Nanty-Glo will emergency ship product by air. This reduces the 12-week lead time to 2 days, assum- ing that the Chinese supplier has available stock. Last year, expediting orders through air freight was done for roughly 20% of the backor- dered items. Shipping products by air costs 56.3% more. The average value of an item across all SKUs is $1.
Shortly after the supply chain redesign, Squirrel Hill Cosmetics updated its business management software to SAP. Although there were some significant hiccups in the implementation, the software was running smoothly in about six months. Squirrel Hill is now much better at tracking information and integrating it with its financial and operational systems.
Current Operations
Kim Deal was recently promoted to the position of Vice President of Global Supply Chain Operations. The promotion was due in large part to her successful modernization efforts of the Nanty-Glo DC. This included the design and installation of a large sortation process and supporting software, which will meet its payback period in about half the company standard of two years. She has also built a solid reputation as someone who is quite good at accurately estimating the financial impact of engineering changes.
Within two weeks of taking her new position, Kim felt that the biggest opportunity was to better manage global inventory and the related distribution costs, particularly for those items sourced from
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CASE 5 • INVENTORY MANAGEMENT AT SQUIRREL HILL COSMETICS 49
China. To better understand the inventory operations, Kim set up a meeting with Tanya Donelly, inventory manager of the Nanty-Glo DC. Kim knew Tanya fairly well, as they had worked together on sev- eral projects in the past, although Kim had not directly worked on inventory-related projects.
During the meeting, Tanya explained the basic inventory man- agement process currently in use. In particular, she walked through a specific example for SKU QED0001 (provided in the “Appendix: Inventory Example Given by Tanya Donelly” at the end of this case). Tanya pointed out that the beauty of the system is its simplicity; the same approach can be used for all the SKUs, and all that is really required is a good forecast.
Kim had several questions about the system. In particular, she was interested in why a four-week interval was chosen for the desired safety stock level for a SKU in each period. Tanya replied that this was something that they experimented with when they first imple- mented SAP, and they felt that a four-week interval gave the best performance results.
The financial performance of the system was another area about which Kim had several questions. In particular, she wanted to know the annual inventory holding cost, the backorder cost, the distribu- tion cost, and the expediting cost for items that are backordered to key customers. Tanya replied that over the past year, there were 934 containers that had been shipped from China to the United States, resulting in a total shipping cost of $6,351,200. Further, there was a budget of $400,000 allocated for air freight of expedited orders for the past year, but the actual total was roughly $1.1 million (and roughly 14.73% of all items were shipped by air freight). Tanya also men- tioned that they do not track holding or backorder costs, but only units; with the relatively new SAP system, they do not rely on such cost estimates to operate. She also pointed out that in her view, this was one of the benefits of their system; namely, only units need to be tracked, and costs do not need to be estimated.
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Potential Problems
Kim left the meeting with Tanya somewhat troubled by what she had heard. Kim was particularly bothered by the lack of financial per- formance measures. One of her first actions was to determine how good the forecasts were for their China-sourced products. Kim pulled two years of weekly data on 200 different SKUs and found that there was unfortunately not much correlation between forecasted and actual demand. As the entire inventory model relied on having an accurate forecast, this left Kim with two options for what to do next: work on improving the forecasting system or develop a new way to manage the inventory. Both of these were important to her; however, she realized that even if she had a perfect forecasting system, she still did not feel comfortable with the current inventory management system.
Three aspects of the current system bothered her. First, all of the SKUs are treated the same, regardless of their demand characteristics. Second, if certain performance characteristics such as inventory hold- ing and backordering are not measured financially, how can appro- priate tradeoffs be considered? It seemed clear to her, for example, that holding additional inventory for a few items might greatly help to reduce the expediting costs from backordering. Finally, since they were not particularly good at forecasting, could they design a system that was robust to the forecast error?
Kim decided that the inventory management system needed to fundamentally change. She wanted it to be driven by financial trade- offs and yet be simple enough that it could be easily implemented within the SAP system. She had already had enough bad experiences with projects that led to costly consulting fees to modify the SAP implementation. She contacted Tanya to set up a meeting to discuss her ideas.
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A Second Meeting
Kim explained to Tanya her concerns about the current system. Although Tanya listened politely, she responded that they were com- ing into the busiest time of the year and that she really did not have the time to devote to making any changes. In addition, she explained that the systems had worked well for more than a year and that there were certainly other better areas on which Kim could spend her time, such as renegotiating the contracts with their Chinese shipping con- tainer lines.
This response did not sit well with Kim. She stated rather firmly that overspending their budgeted expedited shipments by more than $600,000 should be sufficient cause for alarm to anyone about the lack of effectiveness of the current inventory management practices. She also informed Tanya that she was making this project a prior- ity. Although she understood that Tanya has tremendous pressures in Nanty-Glo, she stated that she has tremendous respect for her abili- ties and would like her to consider taking on the project. The expecta- tion was that Tanya would agree.
The Memo
After the second meeting, Kim sent a memo to Tanya detailing her desired actions.
TO : Tanya Donelly, Inventory Manager–Nanty-Glo, PA
FROM : Kim Deal, VP of Global Supply Chain Operations
DATE : July 8, 2013
RE : Inventory Management Process
As I stated in our meeting on July 1, I believe we need to funda- mentally change our inventory management system. I firmly believe that significant savings and improved performance can be achieved if
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done well. I am therefore putting you in charge of a project to develop it. I will make whatever resources you need available to you, but I want this to be your top priority. In particular, I would like you to take the following actions:
• Develop an appropriate way for us to estimate the holding, transaction (or fixed), and backorder costs. I want holding and backorder costs to be expressed at the unit level.
• Customer service is important to us, but it comes at a cost. Dis- cuss the relationship between the service level and shortage cost (fractional charge per unit short). Discuss how we might establish this relationship quantitatively.
• I have been reading quite a bit about continuous and periodic review order systems, and believe this would be appropriate for us to use. Develop a system for us that uses a continuous review approach. I am particularly interested in making shortage costs a part of this. I also want to be able to see what the impact of setting different service levels would be. As you know, I under- stand things better by example. Please illustrate the method for the QED0001 example that you showed me using the following data (assume annual demand is 484,119):
Week 1 2 3 4 5 6 7 8 9 10 11
D 10,124 15,432 13,988 9,845 6,756 5,322 4,988 5,796 7,013 5,932 5,844
Q 19,697 15,004 10,951 6,685 5,445 4,722 5,186 5,773 7,950 7,363 6,492
• For this example, determine the probability of a stockout and an average holding cost (on hand plus on order). Further, use this example to discuss sensitivity of the holding, fixed, and backorder costs. Discuss how this might compare to our cur- rent system.
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• I have done some preliminary work and noticed that many of our SKUs have quite different values for variability of demand over our lead time. Looking at the data, I picked three SKUs that I believe are representative and have given you their his- torical data in an attached appendix. For this example, please determine the current holding cost and emergency ship (expe- diting) cost. To easily compare with our current method, apply the periodic review method (period = 1 week) to the data and compute the same estimates. Discuss the differences. Assume that all backordered items use expedited shipping. Note that the analysis should be done for the data over weeks 1 to 52. I have given you the previous 12 weeks of order quantities for this year and the forecast for the 12 weeks following this year to enable you to compute all the estimates for the year of interest (weeks 1 to 52). Assume that an item of each SKU has a value of $1 to us.
• Give me your overall recommendations and next steps based on this preliminary analysis. Make sure to address how this new approach would be implemented into our SAP system.
• I realize that I am asking you to focus fairly narrowly on inven- tory here. I am also interested in your thoughts about other areas that you believe could lead to savings.
Please be prepared to give a 20-minute presentation of your find- ings at the next operations review meeting in two weeks. In addition, please prepare a brief report to me that addresses each of the preced- ing points. The report should be no more than six pages in length. Please be clear about any assumptions you made in your analysis.
I appreciate your effort with this, Tanya. Please let me know at your earliest convenience whether you will accept this assignment.
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Appendix to the Memo
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Appendix: Inventory Example Given by Tanya Donelly
Squirrel Hill Cosmetics manages more than 1,200 SKUs that are sourced from China with a lead time of 12 weeks. For each SKU, it holds 28 days (4 weeks) of safety stock. Its ordering policy is set up to maintain this desired safety stock level. A minimum order quantity of 7,200 units is used.
An example for SKU QED0001 is presented to illustrate the pol- icy. It has a unit cost of $1.53, and makes up roughly 1.5% of total sales. The notation used in the example is as follows:
L = Lead time (in weeks; it is equal to 12)
F t = Forecasted demand for period t (in units)
DSS t = Desired safety stock level for period t (in units)
OH t = On-hand inventory level in period t (in units)
POH t = Projected on-hand inventory level in period t (in units) Q t = Order quantity in period t (in units; this is the decision variable)
The formulas used to compute the order quantity are (note that 12 is used for L ) as follows:
12tt )DSS( POHFQ + −=
= �
+
tOH + −=
12tDSS iF+ 12t+ 4+
ti= 12+
� i iQ 1t−
ti= 12− 1− �F 12t+ 1−
i t=
12t+ 12t+
POH 12t+
A completed spreadsheet for QED0001 is given in the following for a 26-week time period:
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In this example, all of the calculations are given for the first 12 weeks. Also, the order quantity arrives 12 periods later in the Receipts column. In addition, the forecast for the next 14 weeks is provided. The desired safety stocks and projected on-hand inventory levels can be computed for the remaining periods. We compute the desired safety stock for period 13 and projected on-hand inventory for period 25. The desired safety stock is based on the forecast.
For period 13, this would be computed by looking at the forecast over the next four weeks:
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Given the forecast, all the desired safety stocks can be computed. Next, the calculation for projected on-hand inventory is shown for period 25. Note that for projected order quantities in earlier periods, the order quantities in earlier time periods given in the spreadsheet would be used. However, the calculation is the same.
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The remaining calculations are the On-Hand Inventory ( OH t ), Backorder Quantity ( B t ), and Expedite Quantity ( E t ). Expedite quan- tity is the amount backordered that is required at key customers. The remaining formulas are as follows, where receipts in period t are denoted R t :
),0min( 1
tt
tttt
OHB DROHOH
=
−+= −
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The completed spreadsheet for the entire period is then as follows:
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Case 6 Safety Stock Planning for a Hong Kong
Fashion Retailer
Tsan-Ming (Jason) Choi, The Hong Kong Polytechnic University 1
Introduction and Company Background
Inventory management is a critical part of fashion retail supply chain management. For most fashion products, consumer demand is very difficult to forecast, which makes inventory planning more dif- ficult. In this case analysis, we explore the safety stock management problem in a fashion retailer in Hong Kong. With the (adapted) real data from the company, a systematic analysis on safety stock level can be conducted.
JTMC 2 is one of the well-known chain store fashion retailers in Hong Kong. JTMC currently has 20 retail shops in Hong Kong 3 (each of which carries approximately 400 items), and its annual sales turnover is approximately U.S. $100 million. In addition, it also has an overseas retail network extending to China, Macau, Indonesia, Australia, and many countries in the Middle East, with
1 Tsan-Ming (Jason) Choi can be contacted at [email protected] . 2 Company JTMC is a fictitious name for a real company. 3 To keep the company details anonymous, we modified and/or scaled the num-
bers provided in this case from the real values, but they do show the essential feature of the company and its inventory practice.
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a combination of direct operation, franchising, and licensing. The company’s objective is to provide its customers with high-quality service and products at a very reasonable price. One of the compa- ny’s operational philosophies in terms of inventory management is that stock-outs should be avoided as much as possible. To achieve this target, the senior management of the company implements a logistics planning scheme in which (1) the product is replenished every day in a one-to-one replenishment manner (that is, one unit sold today will be filled by a replenishment within one day); and (2) inventory levels should be high and appropriately fill the avail- able display space throughout the year for each in-season item. Thus, for both peak and non-peak seasons, the inventory level (including safety stock) for the same in-season item is the same (if the product is not out of stock, which is also the usual case for JTMC).
Safety Stock Analysis
We have collected a sample of demand data from JTMC ( Exhibits 6.1 and 6.2 ) and inventory data ( Exhibit 6.3 ) for 10 items. With the use of these data sets, we can study quantitatively the appropriate safety stock level with respect to a target inventory service level. We can also comment on the efficiency of the existing inventory planning practice in JTMC.
To conduct the analysis, we make a few assumptions. For the sake of simplicity, we assume the daily demand of each item during each selling season follows a normal distribution. Using the informa- tion from Exhibits 6.1 and 6.2 , we can construct Exhibits 6.4 and 6.5 , which show the mean and the standard deviation of the daily demand of each item directly.
Because replenishment lead time is fixed (in fact, it is equal to 1), we can employ the standard textbook safety stock formula to calculate
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the amount of safety stock needed with a given inventory service tar- get. The specific formula is given here:
)( 1 ασ −Φ= LSS ki
k i
where
• = the amount of required safety stock for item i = 1, 2,..., 10, during season k = peak, non-peak.
•
= the standard deviation of daily demand for item i = 1, 2,..., 10, during season k = peak, non-peak.
• = the lead time measured in days.
• = the target inventory service level, which represents the chance of no stock-out during the replenishment cycle (that is, lead time L) and <100%.
• = the inverse of the standard normal cumulative distri- bution function (cdf).4
With (1), we can calculate the amounts of required safety stock for each item with different inventory service targets. The results are summarized in Exhibits 6.6 and 6.7 .
With the amount of calculated safety stock as shown in Exhibits 6.6 and 6.7 , we can establish the inventory level that should be kept for each item with a given inventory service target for each season scenario. In this case study, the inventory level is equal to the mean of daily demand multiplied by the lead time plus the amount of required safety stock, as shown in the following formula:
Inventory level of item i = Mean daily demand of item i × L + the amount of required safety stock of item i. (2)
Exhibit 6.8 shows the result.
4 In Excel, the inverse of the standard normal cdf can be computed by the built-in function “normsinv().” In this case, the numerical analysis is conducted by the Office 2010 version of Microsoft Excel. A different version of Excel might yield slightly different numerical values.
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Define: The inventory saving (in quantity) = current inventory level in the company ( Exhibit 6.3 ) – calculated inventory level with a given inventory service target ( Exhibit 6.8 ).
From Exhibits 6.3 and 6.8 , we can compute Exhibit 6.9 , which summarizes the inventory saving in quantity.
It is obvious from Exhibit 6.9 that the company has overstocked the majority of the items under consideration; therefore, the current safety stock levels are not correctly determined. As a result, substan- tial inventory savings potentially exist even for the case when the tar- get inventory service level is set to be very high. Notice that the only exceptions, which refer to the cases in which the company has under- stocked, appear in two cases (both highlighted in Exhibit 6.9 : Items 1 and 2 under the peak season scenario). Thus, the current inventory management practice in the company is far from efficient. There is a big opportunity to improve, for example, by re-benchmarking the inventory level with respect to the theoretical benchmark in terms of the required inventory to achieve the specific inventory service target.
Inventory Cost Analysis As shown in Exhibit 6.9 , despite having significant inventory sav-
ings, JTMC senior management is also interested in estimating the monetary value associated with the potential inventory savings. If the monetary cost-savings realized by a change in inventory practice is small, the company might not have an incentive to implement the change. In the following section, we discuss how the company can estimate the monetary saving by changing the safety stock level with the theoretical benchmark. Suppose that according to the accounting manager of the company, the inventory holding cost of an item per season is estimated to be 2.8% of its product value. For the sake of simplicity, suppose that the product value for items 1 to 5 is $10 each, and for items 6 to 10, is $15 each. Exhibit 6.10 shows the monetary value of the inventory saving by adopting the theoretical benchmark for the 10 selected items under consideration in the study.
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From Exhibit 6.10 , we have two findings:
1. The monetary savings are larger when the target inventory ser- vice is smaller. This point can be explained by the fact that the company’s current inventory level tends to be excessive.
2. Comparing between the peak season and the non-peak season, the monetary value of inventory savings is larger under the non- peak season case. This result is intuitive because the company’s current practice simply sets the same inventory level regardless of whether the seasonal demand is high (peak season) or low (non-peak season). Despite being an easy measure, it is in fact very inefficient.
Further Discussions and Analysis In the preceding sections, we investigated the case using the sim-
ple analytical safety stock formula with the given data. Some areas for further analysis are listed in the following:
1. In the preceding analysis, the estimated safety stock levels are not expressed in integer values. Suppose that inventory levels must be expressed as integers, and re-analyze the case assum- ing that the given target inventory service level is the “mini- mum” required target inventory service level.
2. Assuming that the 10 items are good representatives of the whole retail assortment of the company (in terms of inventory savings) and that the peak season occurs over four months of each year, 5 what will be the estimated annual monetary inven- tory savings for JTMC if it changes its safety stock quantity from the current practice to the theoretical benchmark if the target inventory service level is 95%?
5 Notice that each season is one month long. Thus, the remaining eight months are non-peak seasons.
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3. Discuss whether the one-day replenishment cycle under the current “everyday replenishment” inventory practice is neces- sarily the most efficient method.
4. If there is a certain level of uncertainty with respect to the lead time, how will this lead time uncertainty affect the inventory cost savings for JTMC if it changes its safety stock quantity from the current practice to the theoretical benchmark for a certain given inventory service level?
Exhibits
Exhibit 6.1 A Sample of Demand Data During the Peak Season for 10 Items of the Same Product Category (Adapted from and Scaled in Units with Respect to the Real Data Set)
Item
Day 1 2 3 4 5 6 7 8 9 10
1 1 2 2 0 1 1 3 3 2 2
2 1 3 1 1 2 1 1 4 2 1
3 0 1 3 2 1 1 2 2 1 3
4 2 1 1 1 0 2 2 3 4 2
5 2 4 3 2 3 1 3 4 2 0
6 3 2 2 1 1 0 4 4 3 2
7 2 1 2 0 0 3 5 2 5 2
8 2 2 1 1 2 0 3 4 3 0
9 3 1 0 3 1 4 5 6 4 3
10 1 0 1 1 3 0 5 2 3 4
11 0 2 1 2 0 0 6 1 6 1
12 3 1 3 1 1 2 5 2 4 0
13 1 2 2 2 2 4 4 4 4 3
14 4 1 0 1 0 3 3 5 3 5
15 1 3 3 2 0 0 5 6 4 2
16 3 2 1 0 3 5 2 3 3 5
17 1 1 0 1 1 2 3 3 6 0
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18 1 3 2 2 1 0 1 4 4 2
19 4 2 4 1 1 3 1 2 3 3
20 1 4 4 3 0 2 5 1 6 2
21 2 0 1 1 2 3 2 0 4 0
22 1 5 2 4 1 0 1 2 4 1
23 2 2 0 1 3 4 5 3 6 2
24 2 4 1 0 0 2 0 2 3 1
25 2 1 2 1 2 0 1 5 5 4
26 5 3 3 2 2 4 2 3 2 1
27 2 5 1 3 1 5 1 2 5 3
28 6 2 2 1 0 1 4 1 2 4
29 4 1 0 1 2 1 3 1 3 2
30 2 1 2 3 1 1 2 0 3 1
Exhibit 6.2 A Sample of Demand Data During the Non-Peak Season for 10 Items of the Same Product Category (Adapted from and Scaled in Units with Respect to the Real Data Set)
Item
Day 1 2 3 4 5 6 7 8 9 10
1 2 1 1 0 1 0 0 0 0 0
2 0 1 0 1 1 1 1 0 0 1
3 1 0 1 0 1 0 1 1 1 1
4 1 1 0 1 0 1 0 0 0 1
5 1 0 1 0 0 2 0 1 2 0
6 2 0 1 1 1 0 0 1 3 2
7 0 2 0 0 0 0 1 2 1 1
8 1 0 2 1 0 0 0 1 1 0
9 0 1 0 0 1 1 1 1 1 1
10 0 0 2 0 0 1 1 2 1 1
11 1 1 1 0 0 1 1 1 1 1
12 0 4 0 1 0 0 1 2 1 0
13 1 2 1 0 2 0 1 1 1 1
14 2 0 3 1 0 0 1 1 3 5
15 0 3 0 0 0 1 3 1 0 2
16 1 1 2 0 1 1 2 3 0 0
17 0 0 1 1 0 1 1 1 1 0
continued
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18 2 0 0 0 1 0 0 4 0 2
19 0 1 0 0 0 0 0 2 1 3
20 1 0 0 0 1 0 0 1 4 2
21 0 0 1 1 0 0 0 0 1 0
22 2 0 1 0 0 1 1 1 2 1
23 0 2 0 1 1 1 0 0 0 2
24 0 0 1 0 1 2 0 1 3 1
25 0 1 1 1 0 0 1 4 1 4
26 1 0 0 0 0 1 2 0 0 1
27 2 0 0 0 1 0 1 0 0 3
28 1 2 1 1 1 0 0 1 0 4
29 0 0 0 1 0 1 3 1 3 2
30 0 1 0 1 0 0 2 0 3 1
Exhibit 6.3 Inventory Level of the 10 Items of the Same Product Category (Adapted from and Scaled in Units with Respect to the Real Data Set)
Item Inventory Level (Including Safety Stock Kept Every Day on Retail Sales Floor)
1 5
2 5
3 5
4 5
5 5
6 7
7 7
8 7
9 7
10 7
Exhibit 6.2 continued
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Exhibit 6.4 The Mean and the Standard Deviation of the Daily Demand During the Peak Season Item Mean Standard Deviation
1 2.13 1.41
2 2.07 1.34
3 1.67 1.15
4 1.47 1.01
5 1.23 1.01
6 1.83 1.62
7 2.97 1.65
8 2.80 1.58
9 3.63 1.35
10 2.03 1.45
Exhibit 6.5 The Mean and the Standard Deviation of the Daily Demand During the Non-Peak Season Item Mean Standard Deviation
1 0.73 0.78
2 0.80 1.03
3 0.70 0.79
4 0.43 0.50
5 0.47 0.57
6 0.53 0.63
7 0.83 0.87
8 1.13 1.07
9 1.17 1.18
10 1.43 1.30
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Exhibit 6.6 The Amount of Required Safety Stock During the Peak Season with a Given Target Inventory Service Level
Item
Inventory Service Level
90% 95% 99%
1 1.80 2.32 3.27
2 1.71 2.20 3.11
3 1.48 1.90 2.69
4 1.29 1.66 2.34
5 1.29 1.66 2.34
6 2.08 2.67 3.77
7 2.11 2.71 3.84
8 2.03 2.61 3.69
9 1.73 2.22 3.14
10 1.86 2.38 3.37
Exhibit 6.7 The Amount of Required Safety Stock During the Non-Peak Season with a Given Target Inventory Service Level
Item
Inventory Service Level
90% 95% 99%
1 1.01 1.29 1.83
2 1.32 1.70 2.40
3 1.02 1.31 1.85
4 0.65 0.83 1.17
5 0.73 0.94 1.33
6 0.81 1.03 1.46
7 1.12 1.44 2.03
8 1.38 1.77 2.50
9 1.51 1.94 2.74
10 1.67 2.15 3.04
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Exhibit 6.8 The Inventory Level with Different Target Service Levels
Item
Peak Season Non-Peak Season
Inventory Service Level Inventory Service Level
90% 95% 99% 90% 95% 99%
1 3.94 4.45 5.41 1.74 2.02 2.56
2 3.78 4.27 5.18 2.12 2.50 3.20
3 3.15 3.57 4.35 1.72 2.01 2.55
4 2.76 3.12 3.81 1.08 1.26 1.61
5 2.52 2.89 3.57 1.20 1.41 1.80
6 3.91 4.50 5.60 1.34 1.57 2.00
7 5.08 5.68 6.81 1.95 2.27 2.87
8 4.83 5.41 6.49 2.51 2.90 3.63
9 5.37 5.86 6.78 2.67 3.10 3.90
10 3.89 4.42 5.41 3.11 3.58 4.47
Exhibit 6.9 The Inventory Savings with Different Target Service Levels
Item
Peak Season Non-Peak Season
Inventory Service Level Inventory Service Level
90% 95% 99% 90% 95% 99%
1 1.06 0.55 –0.41 3.26 2.98 2.44
2 1.22 0.73 –0.18 2.88 2.5 0 1.8
3 1.85 1.43 0.65 3.28 2.99 2.45
4 2.24 1.88 1.19 3.92 3.74 3.39
5 2.48 2.11 1.43 3.8 0 3.59 3.2 0
6 3.09 2.5 0 1.4 0 5.66 5.43 5 .00
7 1.92 1.32 0.19 5.05 4.73 4.13
8 2.17 1.59 0.51 4.49 4.10 3.37
9 1.63 1.14 0.22 4.33 3.9 0 3.1 0
10 3.11 2.58 1.59 3.89 3.42 2.53
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Exhibit 6.10 The Inventory Cost Savings (in U.S. Dollars) with Different Target Service Level for the 10 Items
Item
Peak Season Non-Peak Season
Inventory Service Level Inventory Service Level
90% 95% 99% 90% 95% 99%
1–5 88.5 0 67 .00 26.8 0 171.4 0 158 .00 132.8 0
6–10 178.8 0 136.95 58.65 351.3 0 323.7 0 271.95
ALL 267.3 0 203.95 85.45 522.7 0 481.7 0 404.75
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Case 7 Network Design at Commonwealth
Pipeline Company
Matthew J. Drake, Duquesne University
Introduction
Commonwealth Pipeline Company is a major pipeline transporta- tion provider in the Northeast, Mid-Atlantic, and Midwestern United States. The commodities the company hauls most often are refined petroleum products as well as propane, butane, refinery feedstocks, and blending components. Commonwealth operates as a common carrier in accordance with published rates and rules tariffs. Common- wealth also provides its customers with bulk storage services at many terminals throughout its service region.
Pipeline Network Repair and Replacement
As the company was founded more than 100 years ago, many of its underground pipes are in need of repair and replacement. The pipes serving its Pennsylvania terminals (listed in Exhibit 7.1 ) are especially worn, and Commonwealth is considering a large-scale replacement of all of its pipes in the state. The firm would like to accomplish this project at the lowest cost. Because the pipes themselves are the most expensive part of the project, Commonwealth wants to identify the
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best network design that uses the least amount of piping, yet still con- nects all the terminals in the state. Exhibit 7.2 lists the possible con- nections and the associated distance between pairs of terminals, and these possible connections are depicted in Exhibit 7.3 .
Note that the distances in Exhibit 7.2 are the driving distances between the terminals, which are obviously different from the amount of pipe that would be needed to make the connections because the pipes are not restricted to traversing road routes. They will, however, serve as a good proxy of the required pipeline distance between the locations for the purposes of this analysis.
Your job is to determine the network design that minimizes the total mileage of pipe utilized, such that all 21 of the Commonwealth terminals are connected. Draw the arcs of the optimal pipeline net- work on the map provided in Exhibit 7.4 .
This analysis is a simplified version of the problem that Com- monwealth Pipeline Company actually faces. Complete your analysis by suggesting several practical considerations that Commonwealth would have to consider when choosing the connections to include in its network to produce the best overall network design. Can you think of a way that these considerations could be incorporated into your basic model to provide a more comprehensive network design model?
Exhibits
Exhibit 7.1 Commonwealth Pipeline Company’s Pennsylvania Terminal Facilities Node # City #
1 Coraopolis
2 Stowe Township
3 Indianola
4 Midland
5 Reading
6 Tuckerton
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Node # City #
7 East Freedom
8 Malvern
9 New Kingstown
10 Carlisle
11 Halifax
12 Highspire
13 Philadelphia International Airport
14 Mount Union
15 Exeter
16 Dupont
17 Lancaster
18 Allentown
19 Macungie
20 Delmont
21 Greensburg
Exhibit 7.2 Possible Connections and Distance Between Commonwealth’s Terminals Arc Mileage Arc Mileage Arc Mileage Arc Mileage
(1,2) 11 (1,3) 31 (1,4) 24 (2,3) 21
(2,4) 34 (2,20) 31 (2,21) 40 (3,4) 62
(3,20) 24 (3,21) 33 (4,20) 64 (5,6) 10
(5,8) 42 (5,11) 79 (5,13) 71 (5,15) 100
(5,17) 27 (5,18) 37 (5,19) 34 (6,8) 44
(6,11) 84 (6,15) 93 (6,16) 89 (6,17) 33
(6,18) 30 (6,19) 27 (7,10) 106 (7,14) 56
(7,20) 76 (7,21) 77 (8.13) 33 (8,16) 114
(8,17) 45 (8,18) 58 (8,19) 43 (9,10) 8
(9,11) 34 (9,12) 19 (9,14) 67 (9,17) 47
(10,11) 41 (10,12) 28 (10,14) 67 (11,12) 31
(11,14) 85 (11,15) 101 (11,17) 59 (11,20) 205
(12,17) 30 (13,17) 88 (13,18) 69 (13,19) 75
(14, 20) 146 (15,16) 6 (15,17) 127 (15,18) 67
(15,19) 73 (16,18) 64 (16,19) 70 (18,19) 7
(20,21) 10
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Exhibit 7.3 Map of Commonwealth Pipeline Company’s Facility Locations and Possible Connections
Pennsylvania
4
1 2
3 21
20 7 14
10 9
11
12 17
5
6
19
18
8 13
16 15
Exhibit 7.4 Optimal Pipeline Network Design
Pennsylvania
4
1 2
3 21 20 7
14 10
9
11
12 17
5
6
19 18
8 13
16 15
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Case 8 Publish or Perish: Scheduling Challenges
in the Publishing Industry
Beate Klingenberg and David Gavin, Marist College
Introduction
Imagine yourself seated at a desk with a pen and a blank piece of paper. After a time, possibly as short as a few weeks, using ordinary words and your imagination, you craft a story that touches the hearts of millions. As a result, you become a millionaire many times over. If this scenario sounds impossible, then realize that it is exactly what J.K. Rowling accomplished with the Harry Potter series. Of course, if the author becomes a multi-millionaire, just think how profitable this project was for the publisher. It seems so easy, doesn’t it? If it were that easy, everybody could get rich writing books. However, not all manuscripts make it to print, and not all printed books really appeal to the public.
Now imagine that J.K. Rowling’s last book is getting ready for release, and a problem occurs during printing. Eager fans are lin- ing up at the booksellers on the release date—and the books are not there. What a disaster for the author, the publisher, and the book- stores. Fortunately, this did not happen—all customers walked away happy on the release date! So what does it take to make a book release
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happen smoothly? Who is working behind the scenes? The following is a case of a small publishing firm, struggling daily to keep projects on time. Unfortunately, things do not go smoothly all the time.
The Book Publishing Industry
The U.S. book publishing industry consisted of approximately 3,100 publishers 1 in 2008 and around 87,000 (mostly small ones) in 2013. 2 Industry revenue expanded 6.9% in 2012 to $15.05 billion. 3 Although e-books had an approximately 22.6% market share in 2012, 4 the printed book market remains healthy. 5 The top four publishers for trade books in 2013 are Penguin Random House, Harper- Collins, Simon & Schuster, and Time Warner. 6 The industry pub- lished approximately 329,000 books in 2012. 7
There are a few basic realities required to understand the book publishing business. The first reality is that quality manuscripts are paramount. A quality manuscript starts with a concept or idea that appeals to a large segment of the population. Then, the idea is crafted into a story that makes the finished product hard or impossible to put down, and when people read the story, they can’t wait to tell others about it. Finally, the manuscript is delivered on time to the publisher, needing minimal development or revision.
1 U.S. Census Bureau, Statistical Abstract of the United States: 2012.
2 Standard & Poor’s NetAdvantage Database, 2013, www.netadvantage. standardpoor.com , accessed July 7, 2013.
3 Ibid.
4 Ibid.
5 Association of American Publishers, www.publishers.org , accessed July 7, 2013.
6 J. Lilliot. “Top Five Pubs Take Half of Sales,” Publishers Weekly , 2005, 252(17), 5–7.
7 Bowker, “Publishing Market Shows Steady Title Growth in 2011 Fueled Largely by Self-Publishing Sector,” http://www.bowker.com/en-US/aboutus/ press_room/2012/pr_06052012.shtml , accessed July 7, 2013.
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The challenge of discovering quality manuscripts usually requires the talents of everyone in the organization. In many publishing com- panies, every employee is charged with being on the lookout for cre- ative, unique ideas for publishing projects. Of course, the editors and executives are primarily responsible for selecting the projects and then turning those ideas into highly salable products.
The second reality is that there are two selling seasons in the book publishing industry. The first is the spring season, during which books are produced and distributed for the summer buying season. The summer buying season caters to people who have additional lei- sure time because of work or school vacations. The second season is the fall season, during which books are produced and distributed for the December holidays. During the fall season, books are not only purchased for personal enjoyment but also to be given as gifts. These two seasons significantly affect overall revenue.
The third reality is that books have to be created, printed, and shipped prior to the new season’s start. If a book project misses the season’s start, it will most likely fail to achieve the projected sales. This is a result of the flood of books hitting the market during each season.
After each season, books are backlisted. 8 After a book is back- listed, book buyers are not enthusiastic about ordering it because of the large quantity of new books coming on the market. However, a backlisted book will continue to be heavily ordered if the book expe- rienced extraordinary sales during its initial release.
APG Publishing Company
Austin Publishing Group (APG) is a book and magazine publishing company located in Austin, Texas. The company grew out of a small advertising agency originally located in Houston, Texas. Initially, the
8 For an explanation of this and other terms used in the publishing industry, refer to Exhibit 8.4 .
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company enjoyed surprising success with its early publishing projects. One of the most successful projects told the story of a local profes- sional quarterback who had captured the hearts of fans across the country. The company produced a beautiful color pictorial book that sold tens of thousands of copies. When the book finally went out of print, it became a collector’s item.
That early success caused the company to cease advertising agency operations to devote all of its resources to book and magazine publishing. After a few years, the magazine division split from the book division and formed a separate corporation. Soon both compa- nies were thriving with very exciting futures ahead.
APG mainly produces trade books for adults; however, occasion- ally there are projects that cater to children. In a typical year, the number of publishing projects fluctuates between 25 and 50. The total number of projects is dictated by the number of quality manu- scripts “discovered” prior to the start of the “season.”
The types of books produced by APG are
• Biographies of famous people, such as politicians and business people
• Sports books about world championship teams and sports heroes
• Children’s education books
• Craft, gift, and humor books
• Cookbooks
• Health and fitness books
Being located in Texas affords APG some great manuscript oppor- tunities. The state is home to many business legends, Fortune 500 companies, high-profile sports teams, and political figures including many presidential candidates. During one particular period, APG was negotiating book proposals with four billionaires. One owned one of America’s premier football teams, another owned one of the world’s
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largest private investment companies, the third owned a very large natural resource pipeline company, and the fourth owned an interna- tional restaurant company. What contributed to the excitement was the fact that APG was able to acquire three of the four manuscripts.
The Production Department
The production department turns raw manuscripts into finished books; this is the place where everything comes together! Any prob- lem, be it with the manuscript itself, layout, or printing, is addressed within this team. APG has just enough employees to accomplish the required tasks. The positions in the production department include the following:
• The Chief Operations Officer (COO) is responsible for manag- ing the overall production process, which requires planning and controlling all process steps.
• The Managing Editor (ME) is primarily responsible for find- ing quality manuscripts or developing ideas into quality manu- scripts. Additionally, this position is responsible for editing the manuscripts for content and readability.
• The Assistant Editor (AE) is primarily responsible for edit- ing projects as assigned by the Managing Editor. The tasks can include second edits, final edits, and galley proof edits, as explained in the production process detailed in the following section.
• The Art Director (AD) is primarily responsible for designing both the exterior and the interior of the book. The interior of the book covers the type font, type size, art, callouts, and so on. The exterior of the book encompasses the front cover, back cover, and the spine; in other words, the complete dust jacket. Of course, the most important design element is the front
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cover because it is the prominent selling feature of the book. The AD completes the dust jacket by combining the chosen art work with the cover marketing developed by the marketing department.
• The Assistant Art Director (AAD) is primarily responsible for the actual layout of the interior (pagination) of the book. The AAD takes the edited manuscript and creates the finished inte- rior look according to the design and art provided by the Art Director.
• The Production Manager (PM) is primarily responsible for coordinating the various steps in the production process and for developing a production schedule. The PM ensures that projects are kept on schedule. Some of the PM’s most impor- tant duties are to find the best printer for each publishing proj- ect, obtain printing quotes, and ensure that the printers deliver products on time.
• The Warehouse Manager (WM) is primarily responsible for delivering printing jobs and processing shipments to retailers. The WM ensures efficient and timely shipping and controls the inventory.
The Book Production Process at APG
During the manuscript selection process, the COO, Vice Presi- dent of Marketing, ME, and PM discuss each project to determine what the final product should look like. The initial specifications become the objectives that guide the production department during the production process. Some of the specifications cover the physical size, number of pages, cover type, and interior art. These specifica- tions are also used to determine a budget and production schedule.
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Production Steps
1. Manuscript received: This is the starting point of the produc- tion process. The author of the manuscript sends the com pleted manuscript to the ME. If the author misses the agreed-upon deadline, the production process suffers.
2. First edit: At this stage, the editor reviews the manuscript to see whether it is worth publishing. Then a thorough reading of the manuscript is done to make sure the story is logical and complete. Also, any writing style changes are done here.
3. Second edit: Following the first edit, the manuscript is reviewed a second time with a focus on readability and punc- tuation. At the completion of this step, the manuscript is con- sidered “clean” and ready to be flowed into the final layout of the book.
4. Interior design and art creation: In this step, the AD cre- ates an interior design that matches the book’s unique features. For instance, if the book is about soccer, the AD tries to pick a type font and other features that would appeal to this particu- lar audience. The AD might choose to add soccer balls with numbers in them as the folios (page numbers). Any interior art, such as photographs or pictures, is also created. These tasks are initiated after the first edit is completed.
5. Cover art: The front cover art is one of the most important tasks for the AD. Typically, he creates up to a dozen different designs for each project. This task starts also after the first edit is completed, meaning that the AD is handling two important design tasks simultaneously.
6. Interior layout (pagination): In this step, the AAD flows the edited manuscript onto the blank pages of the book. The inte- rior design and art are also added during this stage, meaning they have to be complete by this stage. The second edit also needs to be finished.
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7. Final proofread before printing: After the interior of the book is completed, the book is sent back to the ME or AE for one final read-through. This is the last chance to make changes before sending the project to the printer.
8. Cover marketing created: The marketing department usu- ally takes charge of developing copy for the dust jacket includ- ing back cover copy and the inside flap copy. This is a very important task because customers are motivated to purchase books through back cover and flap copy. These areas explain why the book is appealing to a particular audience.
9. Creation of dust jacket design: Based on the cover art and the cover marketing, the AD creates a “look” that matches the front cover art and completes the design of the dust jacket.
10. Printer selection: The PM starts looking for the right printer to print each particular job. At some point in the production process, a printer whose production schedule can accommo- date the job has to be selected. As printers vary in their produc- tion capabilities, this decision is best made after the interior layout is completed. A printer’s production capabilities are gen- erally categorized as one-color books, four-color books, soft- cover books, standard size books (6 × 9 inches), oversize books, short run (fewer than 5,000 copies per run) or long run (more than 5,000 copies per run).
11. Project sent to printer: When the final edit and the dust jacket are completed, the book is sent to the printer by the PM.
12. Creation of galley proofs: After the initial work is done by the printer, a galley proof (basically a printed test version of the book) is created.
13. Galley approval: The ME or AE performs a final review of the book. This is the last chance to make any changes or correct possible errors.
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14. Printing: The book is printed by the printer of choice and shipped to the warehouse.
15. Receiving the project from the printer: This is always an exciting event, with all stakeholders celebrating when a new project is completed and prepared for distribution.
16. Project shipped to booksellers: In the last step in the pro- duction process, books are delivered to the bookstores. This task is completed by the warehouse staff under the supervision of the WM.
Production Schedule
As each project is received from the author, the COO enters it onto the production schedule with data for the processing time of each step of the production process. Each week the schedule is reviewed and updated by the entire production department. During this review, production team members discuss production problems, and the team works together to resolve them.
One of the challenges the production department continually faces is how to effectively schedule the various projects. Given that each project has many unique requirements, estimating the time to complete each step is one of the first challenges. For instance, one project might have a great deal of text, which places extra burden on the editing and proofing steps. Another project might have a lot of graphics or art, which places extra burden on the AD and the AAD. Of course, inexperienced authors are one of the most common sched- uling problems. They often want extra time to complete the manu- script, or worse, they submit a poorly written manuscript, which then requires extensive editing.
Typical schedules for different project types are provided in Exhibit 8.1 . As APG is looking into improving its scheduling process, the COO suggests developing statistical data for each processing step.
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Thus far, the team has compiled mean processing times and standard deviations for each processing step, based on the projects completed in the past three years. The scheduling times for interior design and cover art reflect that only one person, namely the AD, is considered capable to complete this task (in other words, the times are longer as the AD is working on two parallel tasks).
Usually, every step in the production process is completed by APG’s employees. If the production schedule encounters difficulties, the PM can use outside resources to solve bottlenecks. These outside resources are only to be used when absolutely necessary. Over time, APG has developed a backup for most of the primary production steps, except the ones that are either impractical to outsource, such as the printer selection, or considered strategic steps for success, such as the final design of the dust jacket. Backup personnel are provided for the editing, proofing, cover art, interior design, and art steps. These outside resources are experienced professionals who work as inde- pendent contractors. Because they are independent contractors, it is hard to control when and where they work. It is also difficult to ensure that they are indeed available when needed for specific projects, as backups typically work for several publishers. However, the cost to employ these independent contractors is considerably less than what it would cost to hire them on a full-time basis. For example:
• Backup editor for first or second edit: $1,000 per project
• Backup proofreader for final proof and/or galley proof: $700 per project
• Backup cover art: $1,000 per project
• Backup interior design and art: $500 per project
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Rules for Scheduling Projects
• Manuscripts are given priority if they are front-listed. Front- listed means the new projects are in the “front” of the catalog and are due out before the start of the next selling season. These are the books with which the retailers are expecting to meet their sales goals, and failure to meet these deadlines causes the retailers to lose confidence in the publisher’s ability to produce and deliver the promised projects.
• Projects are ranked at the beginning of each season, with high- est priority going to those projects with the best sales potential. The sales potential of each project is gauged through a survey of the national sales teams and the major book retailers. Based on each project’s sales potential, the Vice President of Sales negotiates a delivery date to maximize sales revenues.
• If a project develops production problems, it is considered “derailed” (like a train that has fallen off the track) and is taken out of the production schedule. Then all remaining projects are rescheduled and moved up on the production schedule. Typi- cal problems that derail projects include the following:
• Manuscript delivered late from the author
• Manuscript needs major revisions
• Missing photos (interior artwork)
• Missing cover quotes from famous people
• Preface and foreword arrive late
• Cover art requires major revision
• Trouble completing the index
• Late delivery from the printer
• High-priority projects can be reinserted into the production schedule if they get back on track.
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• Simple projects, such as those with text only, usually go through the production process faster. These projects are used to quickly fill in the production schedule to keep everyone at maximum productivity.
• If a scheduling bottleneck occurs, an independent contrac- tor is utilized to handle the conflicting production step within the project’s budget constraints. Every project is assigned an additional amount of money that can be used to assign tasks to backup personnel if needed. The amount is estimated based on the base project budget and expected revenue. This “budget buffer” is not to be exceeded.
Reality Kicks In...
APG just secured the rights to publish one of the biggest sports books of all time. A very popular sports hero is about to break the record for the most career games played. This record has not been broken in more than 50 years! The production department is excited! The project is expected to be one of the biggest books of the year. In such a situation, timing is critically important. Finished books have to be available just prior to the athlete breaking the record. Everyone connected with the project hopes for two things to drive sales: the massive publicity from the media and consumer excitement to obtain a memento of the event.
The manuscript is to be received the next day. It is late in the eve- ning already, and the COO, Linda Miller, is still in her office, check- ing and double-checking schedules and personnel availability. This project needs to be a complete success! She has estimated a budget buffer of $3,000, and in terms of estimated processing times, the book is considered a “regular book.” Now she is staring at the statistics of the processing times of past projects and the actual availability of the production team members (see Exhibit 8.2 ). As always, everybody is
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booked for parallel projects, and there is no slack time. In fact, some of the team members are available for fewer days than the mean of the processing time for a given production step. Does that mean APG should hire backup resources right away? And if so, for which of the production steps should they be utilized? And how can the statistics help to guide these decisions?
Overwhelmed by the challenging considerations, the COO turns away to stare out of her window. Night has fallen, and she can see the lights of Austin’s city skyline. This is always a calming sight for her, and it also reminds her of other places where she had worked until late at night, inspired by all the other busy people she imagined behind every light around her. With a smile, she recalls her late study nights when she was churning through an Executive MBA program... and abruptly she turns back to her computer. The MBA program... the Decision Science course she took...it all starts to come back to her. The statistics her team had gathered from past projects are probabil- ity distributions. With that, she should be able to build a model that can simulate whether she needs to hire backup resources.
Another big sigh, but now one of excitement! She starts Excel, rummages through her bookshelf to find the textbook used for the Decision Science course, and sets off to develop the model. “Good thing that I just bought myself a little espresso maker for my office; this will be another late night...just as during my MBA program!” she thinks as she starts building the spreadsheet model.
More Trouble on the Horizon
In the end, APG scored a big success with an on-time delivery of the famous sports book. The COO’s model indeed helped greatly to make critical resource decisions. However, there is never time to rest....
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The book publishing industry is subject to similar business cycles as the rest of the American economy. Wondering about a looming economic downturn, Linda Miller begins looking for ways to reduce costs without affecting the quality of products and services provided by APG. She starts with the income statements of the past two years (see Exhibit 8.3 ). The highest expenses after cost of goods sold are royalties, but not much can be done here—without the authors, there are no books! Perhaps APG could use cheaper materials? Intuitively, the COO knows that although this can reduce some costs, more needs to be done. Revenue is so easily lost when projects derail, even with her new scheduling model...she calls for a meeting with the produc- tion department.
“Something needs to be done!” she starts her speech. “Reviewing our income statements, I think we have questions to address. Our process seems to be inflexible, which hurts us when projects derail, resulting in decreasing profits. Where are we going wrong? Can we cut costs AND become more flexible?”
How can APG change its production process to increase effi- ciencies (and therefore, reduce costs) without jeopardizing product quality?
Exhibits
Exhibit 8.1 General Processing Times for Various Book Projects
Task Processing Time, Regular Book (Days)
Processing Time, Small Book (Days)
Processing Time with Interior Artwork (Days)
Mean Standard Deviation Mean
Standard Deviation Mean
Standard Deviation
First Edit 5.1 0.8 4.4 1.1 6.8 1.4
Second Edit 4.9 0.8 4.5 1.1 6.3 1.5
Interior Design and Art
6.6 1.1 3.6 1.1 5.6 1.4
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Task Processing Time, Regular Book (Days)
Processing Time, Small Book (Days)
Processing Time with Interior Artwork (Days)
Mean Standard Deviation Mean
Standard Deviation Mean
Standard Deviation
Cover Art 6.5 1.1 3.7 1.1 3.4 1.1
Interior Layout (Pagination)
2.8 0.9 2 0.9 14.9 1.4
Final Proofreading
5.1 0.8 4.4 1.1 7.4 1.6
Cover Marketing
9.1 0.8 9 0.9 8.9 0.9
Dust Jacket Design
1.5 0.5 1.5 0.5 1.5 0.5
Printer Selection
1.5 0.5 1.5 0.5 1.5 0.5
Project Sent to Printer
1.5 0.5 1.5 0.5 1.5 0.5
Galley Proof Creation
7.5 1.7 7.7 1.7 10.3 1.7
Galley Proof/ Edit
6.5 1.9 4.9 0.8 6.6 1.1
Printing and Shipping to Warehouse
15.1 3.1 11.5 2.3 17.6 2.2
Shipping to Stores
10.7 2.3 10.5 2.3 10.5 2.3
Exhibit 8.2 Availability of Personnel for Different Processing Steps for the Sports Book Project Task Team Member Availability (Days)
First Edit ME 4
Second Edit ME 5
Interior Design and Art AD 7
Cover Art AD 7
Interior Layout (Pagination) AAD 3
Final Proofreading AE 5
Cover Marketing Marketing 9
Dust Jacket Design AD 2
continued
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Task Team Member Availability (Days)
Printer Selection PM 2
Project Sent to Printer Printer 2
Galley Proof Creation Printer 8 (Estimated)
Galley Proof/Edit AE 5
Printing and Shipping to Warehouse
Printer 15 (Estimated)
Shipping to Stores WM 10
Exhibit 8.3 Sample Income Statements for APG Austin Publishing Group Austin Publishing Group
Income Statement Income Statement
Year Ending 12-31-2012 Year Ending 12-31-2011
Sales $6,125,000 Sales $7,589,000
Cost of Goods Sold
$1,531,250 Cost of Goods Sold
$1,897,250
Returns $1,225,000 Returns $1,517,800
Net Revenues $3,368,750 Net Revenues $4,173,950
Salaries Salaries
Executive $200,000 Executive $200,000
Sales $200,000 Sales $200,000
Production $270,000 Production $270,000
Warehouse $110,000 Warehouse $110,000
Accounting $150,000 Accounting $150,000
Administrative $65,000 Administrative $65,000
Rent Rent
Administrative $60,000 Administrative $60,000
Warehouse $50,000 Warehouse $50,000
Independent Contractors
$0 Independent Contractors
$12,500
Office Supplies
$25,000 Office Supplies
$25,000
Warehouse Supplies
$130,000 Warehouse Supplies
$150,000
Shipping Costs
$225,000 Shipping Costs
$250,000
Exhibit 8.2 continued
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Promotional Costs
$500,000 Promotional Costs
$500,000
Royalties $1,225,000 Royalties $1,517,800
Total Expenses
$3,210,000 Total Expenses
$3,560,300
Net Income $158,750 Net Income $613,650
Note: APG produced 50 new projects in 2011 and 25 new projects in 2012.
Exhibit 8.4 Industry Terms for the Publishing Industry Back cover Part of the dust jacket covering the back of the book that
usually contains quotes from prominent people used to sell the book.
Back list Books that have already been produced in earlier seasons.
Callout A phrase or sentence highlighted in the margin.
Copy editor A person who reads the manuscript for content errors.
Dust jacket The paper cover of a hardcover book. Used to protect the book’s cover and as an advertising tool.
Folios Page numbers.
Front cover Part of the dust jacket covering the front of the book containing the title, subtitle, and graphics used to sell the book.
Front list The books for the new selling season.
Galley The first copy of the manuscript after it is set in type. Used to check for errors before printing.
Gantt charts A tool for planning and scheduling projects that graphically shows when individual steps start and stop.
Independent contractors People who are not employees but perform work for the company on an ongoing basis.
Indexer A person who creates the alphabetical list of important words, names, and subjects, and their location within the book.
Oversized books Books whose size is considerably larger than the industry standard book size of six inches wide and nine inches high.
Proofreader A person who reads the manuscript looking for spelling and grammar mistakes.
Quality manuscripts Manuscripts that are worth publishing and that appeal to a large audience.
Selling season The period when “front-listed” projects are heavily marketed and promoted.
Type font A set of characters with a specific size and typeface.
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9. Narragansett Brewing Company: Build a Brewery 101
10. Aluminum Versus Plastic: A Life-Cycle Perspective on the Use of These Materials in Laptop Computers 107
11. HealthCare’s Corporate Social Responsibility Program 131
12. PaperbackSwap.com: Got Books? 143
13. Stranded in the Nyiri Desert: A Group Case Study 161
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Case 9 Narragansett Brewing Company:
Build a Brewery
John K. Visich, Christopher J. Roethlein, and Angela M. Wicks
Bryant University
Introduction to Narragansett Brewing Company
Narragansett Brewing Company (NBC) was originally founded in 1888 in Cranston, Rhode Island, and it experienced tremendous growth right from the start. By 1908, the company was producing 196,000 barrels (1 barrel = 2 kegs = 31.5 gallons) annually, and the rapid rate of growth continued right up until Prohibition. NBC sur- vived Prohibition, and in 1959 production reached 1,000,000 barrels. NBC reached its peak of popularity in the 1960s with 65% of the New England market share, and Narragansett was available at 80% of the bars in Rhode Island and 100% of the retail stores. Competitive pres- sure began to increase significantly during the late 1960s, and in 1974 Falstaff Brewing Company of St. Louis, Missouri, purchased NBC. At the time of sale, NBC was brewing 1.27 million barrels annually. Profitability problems led to the closing of the brewery in July 1981, and the Narragansett Brewery closed its doors for the last time in 1983. Most of the brewery equipment was shipped to China, and in 1998 the once-proud brewery was demolished to make way for a retail complex.
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In 2005, lifelong Rhode Islander Mark Hellendrung and a group of New England investors purchased the rights and licenses to sell and market Narragansett beer. Mark recruited the brewmaster from the former Narragansett Brewery in Cranston, Rhode Island, and in 2006 the original recipe Narragansett lager was available for sale. Nar- ragansett’s sales have grown steadily since the rebirth as both product variety and geographic spread have increased. Currently, Narragan- sett’s beers are brewed in two locations: all bottles and cans and year- round kegs at the High Falls Brewery in Rochester, New York, and seasonal kegs in Coventry, Rhode Island. Because the majority of the beer was produced out-of-state, Mark received push-back from restaurants, bars, and liquor stores in Rhode Island about why they should sell a Rhode Island beer made in another state. Narragansett turned this around with the slogan “Buy a Gansett, Build a Brewery,” which became a major marketing campaign. Building a brewery in Rhode Island would validate the success of Narragansett and help to grow sales in the entire New England region. Pressure to build a brewery in Rhode Island was also coming from new craft beer com- petitors, who were popping up all over Rhode Island and could lay claim to being a locally produced brew.
Mark knew Narragansett needed to brew beer in Rhode Island. Moving the entire production from the High Falls Brewery in New York to Rhode Island would be expensive and disruptive. A signifi- cant investment would have to be made in equipment to brew and package large quantities of beer. Bottled and canned products are pasteurized and have a 180-day shelf life, after which the beer will begin to taste stale and/or flat. Keg beer is not pasteurized and has a shelf life of 60 days, although at 90 days, it is still acceptable. A con- siderable amount of space would be required for storing ingredients and packaging materials, brewing, bottling, canning, and keg filling, as well as temperature-controlled storage for the finished product. Due to the scale that would be required to perform all brewing in Rhode Island, Mark and his team decided that the best strategy would be to operate a keg-only facility in Rhode Island. This would require
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a much smaller investment in a facility and equipment, while giving Narragansett tighter control over a short-shelf-life product. Control was especially critical for the four seasonal beers (Bock, Summer Ale, Fest, and Porter). With a keg-only facility, Narragansett could also compete with the local craft brewers by producing a variety of unique, short-run styles.
The Keg Facility Location Decision
Keg sales in 2011 were around 5,500 barrels, and Mark estimated that the annual production of a keg facility should be approximately 7,000 barrels with a monthly seasonal peak of 700 barrels. This would require a minimum floor space of approximately 30,000 square feet (sq. ft.), provided the space available could be utilized in a highly effi- cient manner. Inefficient floor plans would require a larger amount of space for operations. The minimum ceiling height needed to install the brewing equipment was 12 feet. The facility would need to include room for production, inventory storage, office space, a tasting/ heritage room, and a gift shop. Mark also envisioned plant tours as a way to help promote Narragansett and build customer loyalty.
Rhode Island accounts for the largest percentage of Narragan- sett’s sales and is supplied by two wholesalers that are both located in Cranston off Exit 14 of major highway I-95. The first distribu- tor, McLaughlin Moran, is located at 40 Slater Road. The second, Wayne Distributing Company, is at 45 Sharpe Drive. Being close to the wholesalers would reduce Narragansett’s transportation costs to deliver filled kegs to the wholesalers.
Other factors that are important to NBC included community approval, the advertising and promotion potential of the building through billboards and signage, the number of vehicles that drive by each day, and the accessibility of the building to the general public for facility tours. Because breweries emit a strong aroma that might be considered an annoyance by some residents, a good fit with the
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local community was critical. The cost to lease the building, as well as any costs to upgrade utilities or configure the building for a brew- ery, would have a major influence on the facility location decision. The estimated operating costs were also very important because a low lease cost could be offset by a high operating cost. The number and location of loading docks would also be important. Proximity to a major highway, sufficient space for a heritage/tasting/merchandise room, and possibilities for expansion also needed to be considered.
In the early winter of 2012, Mark and his team began exploring properties throughout Rhode Island to develop an understanding of the commercial real estate market in Rhode Island. They took an unstructured approach by doing online research, visiting buildings, and gathering information from local real estate agents. After a few weeks of fact-finding, Mark’s team identified the three best locations (labeled A, B, and C).
Location A: 90 James P. Murphy Highway, West Warwick, Rhode Island
This 50,000-sq. ft. building on 7.8 acres has 26 foot ceilings and 16 loading docks with bumpers and levelers. The loading dock doors are 10 feet high and 8 feet wide, and can easily allow access for the brewing equipment. The lease cost is $4 per sq. ft., which equates to $200,000 a year. The insulated building is equipped with high- efficiency lighting and motion sensors, which would help keep down operating costs. Renovations and upgrades would be minimal, and there is ample room for parking cars and tractor trailers. There are 40 parking spaces in front of the building for visitors and a large lot nearby for employee parking. Interstate highway I-95 is 1.5 miles away, a four-minute drive; and a billboard on the roof would be visible to the thousands of cars that drive by each day. The building is located in a business park, so noise and odor will not be a problem. The lot has two entrances: one in the front for visitors and another one that leads to the back of the building for deliveries. The open floor plan
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means that a highly efficient layout that does not utilize all 50,000 sq. ft. of space can be designed. However, the vacant space can be used to expand brewing production beyond the 700-barrel maximum peak production.
Location B: 95 Grand Avenue, Pawtucket, Rhode Island
This massive 400,000-sq. ft., two-floor building was constructed in 1930, but it was renovated in 2009 and would require little in the way of utility upgrades. Located in an industrial zone, the building has 14- to 18-foot ceilings and 10 loading docks. Approximately 350,000 sq. ft. on the ground floor is warehouse space, while 50,000 sq. ft. of office space is located on the second floor. One-year leases can be signed as follows: warehouse space at 10,000 to 75,000 sq. ft. for $2.50 to $3.00 per sq. ft., and office space at 10,000 to 50,000 sq. ft. for $6.00 to $7.00 per sq. ft. This space flexibility would facilitate future expansion of the brewery. Renovations will be required to secure both the production area and the office space, and the flow between the two areas will not be smooth unless offices are constructed in the warehouse space. There is ample room for signage, sufficient parking for employees and visitors, and although the building is located only 2.5 miles from I-95, it is a 10-minute drive because of the numerous stop lights. The building is also located near residential properties, so odor might be an issue with the community. However, the mayor and town council of Pawtucket are very business friendly and have streamlined the processes required to open a business in Pawtucket.
Location C: CJ Fox Building, 2 Fox Place, Providence, Rhode Island
This historic Rhode Island building on 2.16 acres of land was con- structed in the year 1900 and has great visibility, as approximately 166,000 cars drive by daily on I-95. There is easy access to both I-95 as well as I-195, which leads to a distributor in southeast Massachusetts.
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The building has four floors, each at 16,125 sq. ft. and the rent is $2 per sq. ft. All four floors are vacant, so Narragansett has the option of leasing any number of floors. The ceilings are 16 feet high; plus, there are three loading docks, a single large drive-in door, and parking for 100 cars. Access is tight for a 40-foot tractor trailer, but manageable if the driver has sufficient skill. The building is fire code-compliant, is fully air conditioned, and has a security system. However, due to the age of the building, extensive renovations would be required to upgrade some utilities. Although brewing operations could be con- ducted on the ground floor and the offices and other rooms could be located on the second floor, expansion of brewing operations would require the use of a new floor, which would lead to costly produc- tion inefficiencies. The building is located within walking distance of the Providence Train Station, the Providence Convention Center, and the downtown area. Visitors to Providence could easily walk to the brewery for a tour and to browse merchandise. The entire area around the building is zoned commercial, so brewing odor would not be a problem with the local businesses. However, due to the proxim- ity to the downtown area, which has a high pedestrian volume, the aroma might be a problem on humid summer days.
The Brewery Location Decision
To back up Narragansett’s “Buy a Gansett, Build a Brewery” slo- gan, a decision needs to be made regarding the location of a keg-only brewery in Rhode Island. Mark needs to utilize one or more formal facility location methods to help him compare the three locations and decide which would best meet Narragansett’s current and future needs.
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Case 10 Aluminum Versus Plastic:
A Life-Cycle Perspective on the Use of These Materials in Laptop Computers 1
Ryan Luchs, Drew Lessard, and Robert P. Sroufe
Duquesne University
Introduction
In recent years, trends in the marketplace have made aluminum an important material in product design due to its light weight, dura- bility, and recyclability. No one might know this better than Steve Kapper, Innovation Manager at Durable Aluminum, Inc. Kapper has been with Durable Aluminum for seven years and in his current role for the past four years. Kapper’s current goals include expanding alu- minum’s market share in the consumer electronics segment. His team has identified laptop computers as a primary entry point. Laptops are a growth driver of personal computers and are mainly designed with plastic for the exterior casing. Increasing aluminum consumption in this market could provide a real revenue boost to companies like Durable Aluminum.
1 Although this case is based on discussion with managers from an actual company, the name of the company and data have been disguised. Additionally, the team meeting was fictional and based partially on conversations with managers from our contact company. Thus, no conclusions should be drawn about the sustain- ability aspects of aluminum versus plastic; instead, the case was developed as a learning tool for future students.
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However, penetrating this market further will be a difficult task. Aluminum has typically been associated with high-end laptops such as the Apple Macbook Pro series. Additionally, while the laptop still commands a price premium over a similarly equipped desktop, prices have continued their long trend downward. How can Durable Alumi- num convince original equipment manufacturers (OEMs) to adopt a more costly material when many consumers continue to focus on price?
Despite the upfront cost disadvantage of aluminum versus plastic, Kapper knows that Durable Aluminum can offer OEMs real value if he can get them to focus on the long-term advantages of aluminum. Consumers continue to demand products that are more environmen- tally friendly, and aluminum offers potential advantages for end users as it is easier to recycle, might offer more efficient cooling, and is more durable than plastic. Furthermore, the improved durability of aluminum might provide a direct advantage to OEMs in the form of lower warranty costs. However, communicating this value proposition to OEMs and helping them profit from it is no easy task.
Kapper decided to bring a broad base of organizational stakehold- ers at Durable Aluminum together on a team to build a strategic plan to address this challenge. The plan will be focused on positioning aluminum as the preferred choice of raw material in laptop casing design for OEMs with regard to the environment, consumer choice, and pricing.
The Aluminum Industry
Aluminum is the second-largest metals industry in the world, with 33.9 million tons produced and $93.7 billion in sales during 2008. 2 Most aluminum is not found in its pure form but rather in several
2 “Global Aluminum Industry Profile.” Datamonitor (2009). Reference code: 0199-2004. Accessed Jan. 16, 2010.
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hundred different aluminum minerals that cannot be used to produce the metal. The source of aluminum that is commercially viable is baux- ite, which is comprised of 40%–60% alumina. Alumina, or aluminum- oxide, is electrolyzed to produce aluminum metal. Approximately 4 tons of bauxite is required to produce 1 ton of aluminum metal. 3
Today, the aluminum industry is dominated by 10 multinational corporations that represent two-thirds of all the aluminum produced in the world. 4 The global aluminum industry has been strong in recent years, growing at a compound annual growth rate (CAGR) of 25.1% in sales and 7.6% in volume. 5 Its recent strength derives from global industry trends that are leveraging the metal’s light weight and strength. For example, automobile manufacturers are relying on alu- minum for these attributes, as consumers are expecting higher effi- ciency vehicles.
Looking forward, Datamonitor predicts the global aluminum industry to continue to grow at a CAGR of 5.5% in sales and 7.7% in volume during the period 2009–2013. 6
Durable Aluminum
Durable Aluminum is a world leader in the production and man- agement of primary aluminum, fabricated aluminum, and alumina combined through its active and growing participation in all major aspects of the industry. Durable Aluminum serves a broad range of industries including aerospace and construction.
3 “How Aluminum Is Produced.” Rocks, Minerals, Fossils and Earth Science Sup- plies. Web. Accessed Jan. 1, 2010. http://www.rocksandminerals.com/aluminum/ process.htm .
4 Ibid.
5 “Global Aluminum Industry Profile.” Datamonitor (2009). Reference code: 0199-2004. Accessed Jan. 16, 2010.
6 Ibid.
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The company is headquartered in the United States and has more than 100 facilities in 20 countries. It has 50,000 employees and is regarded as one of the world’s most sustainable companies because of its innovative use of alternative energy sources for aluminum production.
Sustainability Approach
At Durable Aluminum, the company has built a strategic vision for its progress toward a sustainable business, titled Durable Alumi- num—Our Sustainable Future. Its commitment to sustainability runs deeper within the company culture each year. The goal is to integrate sustainability concepts into key processes to make them part of the core business competencies. One of the major goals within Durable Aluminum’s plan is to work to increase the rate of aluminum recycling to 75% by 2020.
Sustainability reporting and transparency are fully adopted within Durable Aluminum. Exhibit 10.1 shows a summary of recent financial results for Durable Aluminum, and Exhibit 10.2 shows the trend for an important environmental indicator—total waste generated. Dura- ble Aluminum’s first sustainability report was published in 2008. The company follows the Global Reporting Initiative G3 guidelines, the RI Mining and Metals sector supplement, and the 10 ICMM sustain- able development principles.
Computer Hardware Industry
According to Datamonitor, the computer hardware industry in the United States totaled $60.6 billion in 2008, growing 5.6% over the prior year. The industry consists of three primary segments: comput- ers, storage, and other devices. The computer segment encompasses
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desktop and laptop computers. Storage includes memory sticks, CD packs, hard disks, and other data storage devices. The other devices segment includes computer peripherals, PDAs, organizers, calcula- tors, and satellite navigation systems.
The computer hardware industry in the United States has per- formed well in the past few years, managing to report a CAGR of 6.8% during the period 2004–2008. In doing so, the United States outperformed European and Asia-Pacific markets, which recorded CAGR of 3% and 1.1%, respectively.
Market segmentation by product type shows computer sales to be the most dominant segment of the industry with 43.1% of sales in 2008. Peripherals and devices were the next largest segment with 39.2% of sales. Storage devices capture the remaining portion of the market with 17.6% of sales.
Datamonitor predicts the computer hardware industry in the United States to continue to grow at a CAGR of 4.8% (see Exhibit 10.3 ) during the period 2009–2013. 7
Competitive Landscape
The computer hardware industry is concentrated in a small num- ber of OEMs that have well-known brand names. All are multina- tional companies with sales in a number of markets including the United States. The top five companies’ market shares are detailed in Exhibit 10.4 .
Market entry and product competition are based on strong brand recognition and reputation. Buyers have very low switching costs to competitors, but the market is resistant to new competitors because of the high brand recognition.
7 “Global Computer Hardware Industry Profile.” Datamonitor. Reference code: 0199-0049. Accessed Jan. 15, 2010.
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The market has existed in a constant state of change, as new tech- nology and innovation drive consumer demand. For instance, Apple shifted significant market share in the PDA industry with the intro- duction of its iPhone in 2006. Competitors must invest heavily into product design and development. 8 Performance attributes that are emerging relate to functionality, usability, battery life, and durability.
Integration of Aluminum in Product Design
In product design, the major OEMs are beginning to incorporate the use of aluminum cases. However, product strategies have tended to place these products into the premium lines of their brands. There are a number of excellent products that can be described as high- performing but priced at the high end of the market. For example, the case for Apple’s Macbook Pro is made from a single piece of alu- minum, and the final product is priced between $1,200 to $2,300, depending on screen size.
Consumer Electronics End-of-Life
In early 2010, there was a growing concern about the disposal of consumer electronics that have outlived their useful life. This con- cern grew from the fact that the sheer volume of discarded consumer electronic devices was enormous in the United States alone. In 2007, 2.25 million tons of e-waste was generated, with only 18% of this recycled. A significant amount of e-waste was ending up in landfills. The relatively low recycling rate for e-waste was reason for concern, but there were also reasons to be optimistic. The level of awareness of the e-waste problem was increasing, and the recycling rate was
8 Ibid.
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responding. Additionally, consumer electronics take-back programs were on the rise (see Exhibit 10.5 ). Given that the recycling rate was only 15% just two years earlier, there might be evidence that consum- ers are responding and are changing their behavior. 9 However, the question remained whether this increasing trend would continue.
Life-Cycle Comparison of Aluminum and Plastic Laptop Cases
In an effort to develop the value proposition for aluminum, Kap- per enlisted the help of Durable Aluminum’s environmental depart- ment. The following is a summary of the life-cycle data for aluminum and a common plastic that many laptop cases are made out of: acry- lonitrile butadiene styrene (ABS). Kapper needed to figure out how to make sense of the data and whether he could quantify the environ- mental advantages of aluminum that he believed existed.
Aluminum Overview
Aluminum is the most abundant element in the earth’s crust. Given the reactivity of aluminum, it is not found in nature as a free metal; instead it occurs in an oxidized state. Aluminum is strong given its light weight, and it is easy to work with because of its ductility and malleability. These properties, combined with the prevalence of aluminum, have led to its widespread use in industrial and con- struction activities. A downside of aluminum is the energy-intensive process needed to create it. However, aluminum can be recycled without “down-cycling,” and there are significant cost and environ- mental advantages to using recycled aluminum as compared to pri- mary aluminum.
9 http://www.epa.gov/epawaste/conserve/materials/ecycling/faq.htm
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Production of Aluminum
Most frameworks for producing aluminum include four stages: bauxite mining, alumina production, primary aluminum production, and product manufacture. Bauxite mining involves extracting the ore from the ground and moving it to a production plant. From there, the bauxite undergoes a chemical process to create alumina from the ore. The alumina undergoes an electrolytic process to separate the alumi- num and oxygen, with the resulting product typically a molten alumi- num. Finally, the aluminum is cast into ingots, which may undergo further processing into materials such as aluminum sheet.
Plastic Overview
Plastic has become a frequent alternative to many other materi- als. It has rapidly replaced wood, rubber, leather, glass, metal, and other materials in many applications from packaging to construction. The beneficial properties of plastic, including versatility and low cost, make it desirable over other materials. However, the potential impact plastic has on the health of human beings and the ecosystem must be considered as a cost of making plastic.
Production of Plastic
Plastic production begins with the raw material acquisition phase. This stage covers the activities necessary to extract raw material and energy inputs from the environment, including the transportation prior to processing. 10 The main feedstock for plastics is crude oil, which must be extracted from the ground. Crude oil is comprised mainly of carbon and hydrogen, with many other elements contained at lower percentages. The amount of crude oil needed for one pound
10 Chai Hoon, Koo Chai. “A Study of the Plastic Life Cycle Assessment.” Thesis. Universiti Teknologi Malaysia, 2006, p. 46. Accessed Feb. 12, 2009.
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of plastic is 1.95 pounds. 11 The aggregate demand for plastics is large and growing such that 4% of global oil production is used to create plastics. The total demand for oil in 2008 was 87.2 million barrels; 12 thus about 3.5 million barrels were used as a plastic feedstock that year alone.
After the crude oil is extracted, it is separated and refined into commercially important chemicals, which are used as feedstock for further production. In the case of plastic, these chemicals are used as inputs to a polymerization process that creates the plastic resin. This resin is then further processed in operations such as injection molding to make usable product.
Acrylonitrile Butadiene Styrene (ABS)
The primary type of plastic that is used in laptop cases is ABS. The properties of ABS that make it desirable for use in computers are its hardness; stiffness and impact; and weather, temperature, and chemical resistance. It is a synthetic styrene plastic copolymer made by polymerizing styrene and acrylonitrile in various proportions, depending upon the type.
Life-Cycle Analysis for Aluminum and ABS
Exhibit 10.6 contains the life-cycle analysis (LCA) information for aluminum, and Exhibit 10.7 contains the LCA information for ABS. These LCAs are limited to greenhouse gas comparisons, as this mea- sure is easily comparable across the alternative materials. The LCA models the primary material production, injection molding or sheet formation process, and recycling processes. The product assembly
11 “Plastics & Life Cycle Analysis.” American Chemistry Council/Automotive Learning Center. Accessed Apr. 8, 2009. http://www.plastics-car.com/s_plastics- car/doc.asp?CID=407&DID=1609 .
12 “Oil Consumption.” The British Plastics Federation. Accessed Apr. 8, 2009. http://www.bpf.co.uk/Press/Oil_Consumption.aspx .
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and product use phases are not modeled. It is anticipated that these two phases will be very similar for each material, although there might be unquantified differences in the product use phase due to differ- ences in durability and the ability of the material to conduct heat, which might enhance cooling and lower electricity consumption of the device.
Additional pertinent information is contained in Exhibit 10.8 . The cost data is available for both materials as well as for the processes needed to turn the basic material into the end product. In addition, product weight and efficiency data is available. This information is critical to get an accurate comparison between the two materials, as the weight of material needed to create a case differs across mate- rial type. Furthermore, manufacturing inefficiency will affect the end cost, as well as the greenhouse gases created.
New Business Development Initiative
As Innovation Manager, Kapper is a key member of Durable Alu- minum’s New Business Development Initiative. The Initiative seeks to expand the use of aluminum in new and creative applications across a broad array of industries. Generally, no idea is shot down without vetting, and no industry is off-limits. Durable Aluminum dedicates a number of full-time employees to new product development and explores many ideas simultaneously. Kapper believed that the oppor- tunities within consumer electronics and laptop computers were vast for Durable Aluminum.
Kapper formed a team of stakeholders across the organization to collaborate on the development of a strategic plan to increase the market share of aluminum in the design of laptop computers. The Laptop Strategic Planning Team would discuss customer opportuni- ties, product positioning, pricing and profitability, regulatory implica- tions, marketing and communication, and logistics.
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The team was assembled in July 2010, and consisted of Sarah Levens, Director of Sustainability; Bryan Baptiste, Director of Mar- keting; Aaron Clymer, Director of Recycling Operations; James Wir- ick, Director of Finance; and Mary Crigger, Director of Customer Insights. The team would meet during the following months to build a strategic plan to engage OEMs as partners and customers in the broader use of aluminum.
The kickoff meeting introduced the goals and background infor- mation, including market data, OEM briefings, and current product offerings. The team was both intrigued by and apprehensive about the challenge. Laptop computers have tight margins and cost controls for OEMs. Increasing aluminum usage in laptops was not going to be easy, but if it were, there would be no need for the Laptop Strategic Planning Team.
After the initial meeting, the team agreed to meet in a few weeks to discuss each team member’s opinion on the most relevant topics to help build a base for the strategic plan. The following sections are excerpts from the follow-up meeting.
Consumers
There was no denying that the environment is on the minds of consumers more than it used to be. The real question was whether consumers were willing to pay more for an environmentally friendly product. In computers, the environment was not an attribute that OEMs had emphasized in design and marketing in the past. The issue will be new to consumers, but familiar in its application. The cas- ing might contribute to the sustainability of a laptop if made from aluminum because of the increased recyclability. Kapper was excited with the success that Durable Aluminum has had in gaining market share in premium products, but felt that aluminum had a bigger role to play. The team discussed the issue of how consumers would view aluminum at length.
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Levens supported Kapper’s view that aluminum had potential:
Sustainability is definitely becoming more important to con- sumers these days. Products that have sustainability attri- butes or labels have grown rapidly over the past five years, and it seems to be reaching a tipping point. Aluminum can help create the sustainable value proposition for OEMs and thus should be presented to OEMs in this light, instead of just for its superior design attributes.
Baptiste worried how this would affect current positioning:
Consumers have come to understand that aluminum stands for premium design and now associate aluminum with high end products. They don’t expect to see aluminum in value or even mainstream product lines. I’m all for increasing our sales in the consumer electronics (CE) industry, but not if it means destroying our value proposition in the high end lines. The premium line is where the margins are for OEMs, and we can command a price premium over plastic in these markets be- cause of our design capabilities. Besides, the consumers who value sustainability are also affluent. Why not use the idea of sustainability to cement our position in premium product lines?
Wirick concurred:
Aluminum in CE is now a multi-million dollar business. We want to grow this business, but it’s important for us to main- tain our margins, as CE already lags more profitable busi- nesses such as aircraft.
Crigger joined the conversation:
Our research on this area is showing some interesting trends. Sustainability now ranks in the top three of important attri- butes in the CE space, behind product design and cost. Con- sumers clearly want sustainable products, but it’s not clear whether they are willing to pay for this. While Bryan is correct that wealth and concern for the environment are correlated, targeting only the wealthy misses an important demographic. Survey respondents who identified their occupations as
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full-time students ranked sustainability as their second-most important product attribute. The size and importance of the student market to OEMs should not be underestimated.
Kapper seemed pleased with the direction of the conversation:
I’m convinced that expansion in the laptop market needs to be a priority for us, but that it’s also important that we carefully consider how our expansion affects our current relationships.
Potential Product Lines
One of the issues that has typically inhibited the greater use of aluminum in the CE market is that plastic has been the material of choice due to its low cost and the availability of skilled manufacturers. Increasing the recycle rate of CE products would help push down the overall cost of aluminum, but laptops are comprised of many compo- nents derived from multiple materials, making recycling a difficult task. To really make this happen, take-back programs will need to be in place.
Crigger started:
When customers see aluminum, it enhances their perception of design and sustainability, but they expect to pay more. Is there any way we can surprise them on the last part?
Baptiste:
I think it makes sense to limit our discussion to OEMs, where consumers see a fit between their brand image and sustain- ability. This brand perception will help us make the case that we can charge a price premium for products that are easier to recycle. This price premium will enable us to maintain alumi- num’s status in the market place.
Kapper added to the conversation:
Aluminum is going to cost more for the OEMs to create their products. There is no way around that at this point. But they might be able to make up the cost difference by reaping some
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benefits on the back end. Aluminum will need to be integrated into the product in such a way that it will be easier to recycle. Also, the enhanced durability of aluminum might decrease warranty costs. If we can get OEMs to set up take-back pro- grams, this will be a win-win scenario, but how can we con- vince them to do this?
Crigger commented:
First and foremost, consumers want the product that maxi- mizes performance within their price point. Design and func- tionality are the main drivers of performance, and aluminum clearly enhances the design aspect. Additionally, products with sustainable attributes will be perceived as higher-end designs.
Kapper listened to the conversation and realized the complexity of building the business case for aluminum in CE. He believed that greater use of aluminum in CE products benefited OEMs, consum- ers, and Durable Aluminum, but how could Durable Aluminum com- municate that to OEMs?
Environmental Impact
Kapper then asked Levens to discuss the environmental benefits of using aluminum in laptops.
Levens summarized her thoughts:
There’s no question that making primary aluminum is an en- ergy-intensive process. However, remelting and reprocessing aluminum is far less impactful than making primary alumi- num. The life-cycle assessment of post-consumer aluminum is really beneficial for Durable Aluminum. Expanding the use of recycled aluminum helps serve our long-term goals, but get- ting OEMs to share the same goals is the key.
I believe that we can develop two selling points for aluminum with respect to its sustainable aspects. First, for OEMs that have a strong history of environmental awareness, we can
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simply take the approach that aluminum is easier to recycle and thus should be incorporated into the product. Second, for OEMs without that history, making the case that regula- tory reform is likely and will force their hand might get them thinking about alternative materials.
Kapper seemed pleased with Levens’ analysis:
Sarah, I believe that your analysis will give our sales people some great selling points for increasing aluminum consumption.
Levens tempered Kapper’s enthusiasm:
Thank you, Steve. I appreciate your kind words, but let’s not get ahead of ourselves. The plastics people can counter our claims with the fact that plastic outperforms aluminum on the front end. On a pound-for-pound basis, ABS creates about 60% less greenhouse gases in its primary production. Also, it is likely that efforts to increase aluminum recycling in CE will also lead to greater recycling of plastic. Our claims will not be accepted without challenge from the plastics groups.
Kapper responded:
You are correct in pointing out the short-term benefits of plas- tic, but I think our sales force can do the job of getting OEMs to look at the long-term benefits of aluminum.
Pricing and Profitability
Kapper wished to move the discussion toward pricing and profit- ability because this was developing as a key issue for the team.
Kapper began:
Designing a line of laptop cases that use aluminum is not an issue. There are OEMs out there doing that already who have had success. But we need to bring this design more into the mainstream by showing that aluminum can drive profitabil- ity across the spectrum of product lines. We need to show the
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OEMs that it is possible to use aluminum in their product de- sign without increasing their price points. Increased demand for their products should offset any added cost of aluminum.
Levens made her case:
In my mind, it all hinges on the spin of this. It all depends on recycling rates and what applications the recycled materials can be used in that will help to make our case. We have to do all we can to ensure recycling rates are high and rising. There is a real benefit for us, as processing recycled aluminum is cheaper than creating virgin aluminum. This might be the key to unlocking the hidden value in this proposal for the OEM.
Realizing that reserving aluminum for a premium position was not Kapper’s goal, Baptiste reinforced the need for no price increase to consumers:
Price perception is a big deal. We are able to use aluminum to help OEMs create a premium product line, but we cannot propose that an OEM price its entire line of products above the market based on an aluminum case. It will not fly. There are large groups of consumers who will not pay for the en- hanced styling aluminum can offer.
Thus, the team was on board with the notion that they needed to find a way to make aluminum attractive to OEMs without the need to pass along a large price increase to consumers. However, a split remained among the group as to how to price the product to the OEMs. Should they price their cases at a premium and make the case to OEMs that aluminum’s superior design capabilities would drive sales? Or should Durable Aluminum count on increased recycling rates in the future, which would drive down its own production costs?
Communication Strategy
The group also needed to decide to whom they should direct their value proposition. Although Durable Aluminum was a B2B company,
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consumers could clearly drive material preferences and thus their own sales.
Levens explained her thoughts:
The consumer needs to hear the core of this message first and foremost. We’ve seen other companies promote core compe- tencies to consumers when they are only indirectly selling to them (such as GE Ecomagination or Intel Inside). Durable Aluminum might have an opportunity to do the same.
Clymer made the case for a more focused approach:
Participation in recycling is critical. There has to be clear and concise messaging in stores to ensure that consumers get their CE products back into the system. We should focus our mes- sage on recycling at the point of sale, not in expensive televi- sion campaigns.
Wirick added the financial perspective:
If we are talking about moving aluminum from premium to mainstream lines, I’m not sure the price points will support a large communications campaign. My thoughts were that we would need to decrease the investment in marketing for this product line, not increase it.
Kapper felt that a case for increasing marketing spending could be made to management:
This has the potential to be a high profile project for Durable Aluminum. We might be able to make the case that an in- creased marketing budget is warranted, as getting consumers to see aluminum as sustainable might have spillover effects to other product categories.
Logistics
Finally, the group discussed the logistics of an enhanced recycling program and how this would be the key to creating the value proposi- tion for aluminum.
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Levens began:
Participation is key! Consumers have to be involved, and we need high take-back rates for the numbers to work here. We want to make an argument that aluminum will cost less over the long term in both nominal prices and environmental impact.
Clymer added a dose of reality:
Take-back programs have been tried in the past with spotty success. There are too many layers to the reverse supply chain for there to be high participation. You need partnerships with OEMs and retailers, as well as high participation from con- sumers for success.
Third-party providers can be part of the equation for disas- sembly and sorting of materials. Everyone at the table can win and save money from recycling and reprocessing at least one material input.
Kapper wondered what Durable Aluminum’s role should be in take-back programs:
We are not well positioned to start take-back programs on our own because we lack a direct connection with consumers. How can we increase the success of these programs given their strategic importance for our business?
The group had used up its allotted meeting time and thus the meeting drew to a close. Although the discussion was good and gave Kapper and the others many things to ponder, a strategy needed to be developed and time was running short.
Case Challenge
Many at Durable Aluminum felt that this was not the time to aggressively pursue the CE market. In mid-2010, the U.S. economy was fragile and it seemed that consumers were not positioned to lead
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the recovery. The economy was just emerging from a particularly long and deep recession, and most data pointed to consumers improving their personal balance sheets rather than spending on new goods. In this environment, did it make sense to try to sell into markets where aluminum had no immediate cost advantage?
However, at the same time, many consumers were thinking long and hard about their impact on the ecosystem. A 2008 study of con- sumer concerns showed that there was not only a worry about the environment, but many would actually pay a price premium for a product that was more environmentally friendly. 13 Could Durable Aluminum help OEMs find a way to educate consumers on the bene- fits of aluminum? Moreover, do consumers even need to be involved, or could a value proposition be articulated that could benefit OEMs directly without consumer buy-in? Finally, Durable Aluminum needed to decide on how to price the aluminum to OEMs. Should it continue to price the aluminum at a premium to OEMs, making the case that aluminum’s design and sustainability aspects will drive volume, which will increase OEM profits? Or, should Durable Alu- minum price the cases competitively and bank on lower material costs through increased recycling rates?
Time was running short for Kapper. He had two life-cycle analy- ses from two different industry groups, both showing the benefits of their own material. How could he make sense of these numbers? Did they support his belief that aluminum offered long-term benefits over plastic? Or was he being overly optimistic about consumers chang- ing their behavior with respect to recycling? One thing was for sure: Kapper knew that if Durable Aluminum was going to make progress in this market, it would need to happen soon. Three of the five larg- est PC OEMs were doing complete laptop line redesigns in the next 18 months. If Durable Aluminum did not make its case now, it might need to wait years for its chance.
13 S.M.J. Bonnini, G. Hintz, and T.J. Mendonca. “Addressing Consumer Concerns about Climate Change.” The McKinsey Quarterly , 2008 (March), 1–9.
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Exhibits
Exhibit 10.1 Durable Aluminum Income Statement in Millions of Dollars 2009 2008 2007
Sales 18,203 19,739 22,049
Cost of Goods Sold 15,075 15,923 16,573
All Other Expenses 3,335 2,934 1,675
Total Costs and Expenses 18,410 18,857 18,248
Net Income –207 882 4,161
Exhibit 10.2 Durable Aluminum Waste Minimization*
2500
2000
1500
1000
500
0 2000
Total Waste Generated
T h
o u
s a n
d s o
f T
o n
s W
a s te
G e n
e ra
te d
2005 2006 2007 2008 2009
Total Waste Landfilled
*Does not include bauxite residue.
Exhibit 10.3 Computer Hardware Industry Sales 2004–2013 $90
$80
$70
$60
$50
$40
$30
$20
$10
$0
8%
7%
6%
5%
4%
3%
2%
1%
0% 2004
Sales (USD billions)
2005 2006 2007 2008 2009 2010 2011 2012 2013
Growth
48.6
7.6%
6.8%
7.0%
50.1 53.5 57.3 60.6 63.1 65.5 68.7 72.1 76.6
4.2%
5.8%
3.8%
4.8% 5.0%
6.2%
Data source: “United States–Computer Hardware” Datamonitor , August 2009.
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Exhibit 10.4 2008 and 2009 Worldwide Top Five PC OEM Market Share
2009 Market Share 2008 Market Share
Others 41%
Dell 13%
Acer 13%
Acer 11%
Lenovo 7%
Lenovo 8%
Toshiba 5%
Toshiba 5%
Dell 14%
Others 44%
Hewlett- Packard
20%
Hewlett- Packard
19%
Data source: Wilkins, Matthew. “Acer Ascends, Dell Dives in 2009 PC Market.”
Market Intelligence iSuppli . March 9, 2010. Accessed July 15, 2010.
Exhibit 10.5 Current Consumer Electronic Take-Back Programs
Company Program Name
Partnered with Outside Source?
Cost to Consumer
Process to Recycle
Apple Apple free recycling program for computers and monitors
No Free recycling of iPods and cell phones
Free recycling of one computer and one monitor from any manufacturer
Apple sends instructions for packaging old equipment and shipping to the recycler
Best Buy Free electronics recycling pilot program
Consumer electronics recycling program
No Pilot program: Free recycling for two pieces of equipment per day to any participating location
Electronic program: Free recycling of old TVs or appliances with purchase of new Best Buy product
Drop-off kiosks
Recycle phones by mail
Best Buy Trade-In Center determines value
Gives consumers gift card worth the value of product
continued
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Company Program Name
Partnered with Outside Source?
Cost to Consumer
Process to Recycle
Dell N/A Yes: Staples Free, no purchase required
Dell equipment drop-off at any Staples location
Gateway Gateway trade- in and recycle program
Yes: Rechargeable Battery Recycling Corporation (RBRC)
Free recycling with purchase of new Gateway product
Value the product with Trade-In Estimator
Pack and ship to Gateway
Check will be issued
HP HP asset recovery services
HP’s product recycling program
Yes: RBRC Asset recovery: Free recycling of any product (asset recovery program)
Product recycling: Cost of automated, online computer hardware recycling $13–$34 per item
Get quote online
Shipped to HP
LG LG Electronics Recycling Program
Yes: Waste Management
Free for LG products
Charge for any non-LG product
Drop off to one of 160 Waste Management eCycling Centers
Data source: http://www.productstewardship.net/productsElectronicsBizProgramsTakeback.html .
Exhibit 10.5 continued
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Exhibit 10.6 Aluminum LCA Data
Aluminum Notebook Case Production
Primary Ingot
Production
Recycled Ingot
Production
Product Use
Product Manufacturing
Aluminum Remelting
Sheet Production
Pre-Consumer Recycling
Post-Consumer Recycling
Aluminum Greenhouse Gas Data
Process Kg CO 2 -Equivalent/1000 Kg Aluminum
Primary Ingot Production 9,677
Recycled Ingot Production 506
Sheet Production 644
Aluminum Remelting 317
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Exhibit 10.7 ABS LCA Data
Plastic Notebook Case Production
Primary Resin
Production
Recycled Resin
Production
Product Use
Product Manufacturing
Plastic Remelting
Injection Molding
Pre-Consumer Recycling
Post-Consumer Recycling
Plastic Greenhouse Gas Data
Process Kg CO 2 -Equivalent/1000 Kg Plastic
Primary Resin Production 3,760
Recycled Resin Production 3,008
Injection Molding 1,189
Plastic Remelting 1,189
Exhibit 10.8 Manufacturing Process Data
Process Data
Primary Production
Recycled Material
Assembly Cost*
Material Weight
Process Efficiency**
Forming into Laptop
Case
Maximum Recycled Content in
Case
Sheet Production
Material
Aluminum ABS
*Same for both materials
**Assume material lost to inefficiency is recovered in the recycling process at the value of recycled material
$ $
0.99 1.24
0.40 1.00
5.31 6.59
100% 20%
2.10 1.70
1.42 1.33
0.70 Not Applicable
Unknown Unknown
$ $
$ $
$
($/lb.) ($/lb.) ($/lb.) (lbs./laptop)
lbs. input/ lb. output
($/Case) ($/Case) %Recycled Content
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Case 11 HealthCare’s Corporate Social
Responsibility Program
Robert P. Sroufe and Marie Fechik-Kirk,
Duquesne University
Sustainability Coordinator’s First Project 1
From her tenth floor office, Stephanie Meyers watched as the first snow began to fall over the city and thought about how much had changed over the past few months. Stephanie had gone from leading an internal auditing team at HealthCare, one of Pennsylva- nia’s largest health insurance companies, to working independently within the facilities department as the company’s first sustainability coordinator. It was Stephanie’s responsibility to successfully roll out sustainability initiatives to the staff and to select the first sustainable, eco-friendly, and green project at the Pittsburgh office. The success of these sustainability initiatives was crucial, as Stephanie was now evaluated based on the success of the initiatives and on the projects she instituted. Stephanie also wanted this first project to build aware- ness and buy-in.
Stephanie knew there was some internal interest in the company, but she was nervous about selecting the first sustainability project.
1 Preparation of this case is for the basis of class discussion rather than to illustrate either effective or ineffective handling of an administrative situation.
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After eight years in accounting, Stephanie knew how to evaluate the financial, operational, and reputational risk of a project or procedure; but she wanted her first project to offer the staff at HealthCare tan- gible benefits. Stephanie knew she could win over more people if the community and her colleagues at HealthCare believed they benefited from sustainability initiatives. Stephanie’s goal was to select a project that would conserve energy and resources while benefiting Health- Care both economically and socially. Any building renovation project needed to reduce energy usage, decrease operating costs, and benefit the environment and the community.
For the past month, Stephanie had been researching ideas to upgrade HealthCare’s 30-story headquarters. Built in 1988, the build- ing consists of 2 floors of retail space, 28 floors of office space, and a 3-level underground garage. HealthCare is the primary tenant of the building and is exploring the possibility of seeking a LEED for Exist- ing Buildings: Operations and Maintenance certification. After care- ful consideration of the options, Stephanie had narrowed her decision to three possibilities: HVAC replacement, exterior tree replacement, or interior tile replacement. From her experience in accounting and internal auditing, Stephanie knew that building a strong business case for any new project was crucial. However, after going through the information, Stephanie could create a business case for all three proj- ects to varying degrees. Yet, facilities management would make the final decision, as they were responsible for completion of the proj- ect. Looking out into the falling snow, Stephanie decided to call Gary Render, the Contracting Solutions Leader of Santoro, a leading com- mercial HVAC provider in Pittsburgh, to get his input. Stephanie had met Gary at a Green Building Alliance sustainability workshop last year. Gary was well connected and knew the facilities director well, and might offer Stephanie some insight.
The phone rang several times, and as Stephanie was about to hang up, she heard “Hello, Gary Render,” on the line. Grateful for the opportunity to get his input, Stephanie told Gary about her upcoming
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decision. However, much to Stephanie’s dismay, Gary did not offer her a solution. “Stephanie, HealthCare selected you to take on this task because you have the internal knowledge and the understanding of sustainability to make the best choice for HealthCare.” Gary con- tinued, “Instituting change is like driving a truck down a winding hill. You have to go slowly and carefully to avoid tipping over. You don’t want to pick anything too extreme, or you’ll lose people. Similarly, you also have to tie down everything carefully, so that you keep control of your load. When you present your ideas to the committee, prioritize and carefully defend your recommendations. Show that the initiative you select will save HealthCare money and will demonstrate good corporate citizenship and best practice within the industry.” Gary also suggested working with a local university to have a team of business students help to confirm the analysis and opportunities. This kind of experiential learning is beneficial to both parties. Plus, community involvement aligns with HealthCare’s corporate vision and values.
As Stephanie hung up the phone, she looked over the numbers again. Perhaps she needed to look not only at the numbers but also at the alignment between the project and HealthCare’s mission (see Exhibit 11.1 ). No matter which project she selected, Stephanie needed to explain why HealthCare should complete the project and how the project aligns with HealthCare’s commitment to promote and apply sustainable, eco-friendly, and green business practices. Stephanie also needed to consider the interests of multiple stakeholders, so that her project recommendations would be accepted not only by the finance department but also by the facilities department and others working in the building.
HealthCare’s Current Situation
HealthCare is one of the largest health insurance companies in Pennsylvania with 4.6 million people served by HealthCare’s pro- grams. This 70-year-old company is a major employer in Pennsylvania
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and West Virginia, employing 12,000 people in Pennsylvania and 19,000 overall. See Exhibits 11.2 and 11.3 for the company’s financial performance and balance sheet information. HealthCare’s corporate office is located in Pittsburgh, Pennsylvania, and HealthCare’s offices are situated in two buildings in downtown Pittsburgh. Stephanie’s office is in the older 30-story Twelfth Avenue Place Building. The 86-year-old building houses not only office space but also a customer walk-in center, an employee fitness center, a 300-seat auditorium, and a center for grieving that supports children, parents, and fami- lies throughout southwestern Pennsylvania. The building served as a department store until 1995, when HealthCare became the primary tenant. HealthCare also has call centers in Pittsburgh and three other Pennsylvania locations. In 2007, these call centers received more than 6.7 million customers and provider inquiries. HealthCare’s comput- ing infrastructure is provided by a Silver LEED-certified data center, also located in Pennsylvania.
HealthCare’s vision involves being a leader within the industry and meeting the health care needs of members, while maintaining a strong bottom line. In 2007, HealthCare captured $12.4 billion in rev- enues and dedicated $137 million to support its mission of providing “access to affordable, quality health care, enabling individuals to live longer, healthier lives,” and $6.3 million to 1,800 non-profits serving Pennsylvania by providing services that help people to live longer, healthier lives.
Since July 2008, Stephanie Meyers has been coordinating Health- Care’s Corporate Social Responsibility program. This program sup- ports both HealthCare’s vision and mission. Conserving resources and providing a healthy work environment for employees reduce operat- ing costs and increase productivity. Corporate social responsibility also benefits the community by reducing emissions and reducing the impact on the local environment. According to Gary Render, cor- porate programs aligned with sustainability also help to mitigate the health risk associated with poor air quality, which aggravates asthma
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and other respiratory problems. In Pennsylvania, 60% of electricity is produced by coal-burning power plants. 2 These power plants produce particle pollution, which is one of the most dangerous outdoor air pollutants. Breathing particle pollution year-round can shorten life by one to three years and can aggravate respiratory disorders and trig- ger heart attacks or strokes. 3 In the 2008 State of the Air report, the American Lung Association noted that Pittsburgh had the second- highest level of year-round particle pollution and the highest level of short-term particle pollution in the country. 4 In the long term, being better stewards of the local environment could help HealthCare to reduce health care costs. Reducing emissions is particularly impor- tant for children. Studies show that children exposed to air pollution often face reduced lung function, increased incidence of asthma, and increased visits to the doctor’s office and emergency room. Addition- ally, infants and unborn children are also at risk. Exposure to power plant pollutants can lead to low birth rate, increased incidence of pre- mature birth, and stunted lung development. 5
HVAC Replacement
A building’s heating, ventilation, and air conditioning system (HVAC) controls the indoor climate and accounts for 40%–65% of the energy used in commercial or institutional buildings. Large office buildings require some cooling throughout the year to reject heat emitted from lighting systems, equipment, and employees. HVAC systems also allow large buildings to meet mandatory ventilation
2 http://www.cleanair.org/Energy/energyImpacts.html
3 http://www.stateoftheair.org/2008/air-basics/
4 http://www.stateoftheair.org/2008/most-polluted/
5 Bruce L. Hill, and Martha Keating. “A Clear the Air/Physicians for Social Re- sponsibility Report: Children at Risk: How Air Pollution from Power Plants Threatens the Health of America’s Children.” (Boston: Clean Air Task Force, 2002). 1–3.
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requirements. Poorly designed or outdated systems can lead to occu- pant distraction, loss of business, or even lawsuits. 6 Upgrading or replacing an older, less efficient HVAC system can reduce energy costs 7 and improve indoor air quality. Improving indoor air quality through upgrading or retrofitting an HVAC system can lead to better work performance, reduced medical care costs, lower employee turn- over, and lower cost of building maintenance. 8 In a national survey of large office buildings, it was found that employee salaries are on aver- age 72 times higher than annual energy costs, so a 1% improvement in productivity due to a more comfortable indoor environment could offset a building’s annual energy costs. 9
HVAC system manufacturers can provide commercial custom- ers with custom-designed systems that maximize energy efficiency while meeting environmental and cost concerns. 10 To select the best replacement HVAC system, HealthCare will need to identify the base consumption of the current system and compare it to the consump- tion of new models under consideration. A decision tool incorporat- ing assumptions and cost savings would allow for a quick comparison of the old and new systems. For example, HealthCare spends about 8.7 cents for every kilowatt-hour of energy consumed, and the cur- rent HVAC system accounts for about 65% of the building’s energy costs. See Exhibits 11.4 and 11.5 for HVAC information. At the end of 2011, HealthCare’s fixed energy contract with a local energy com- pany will expire. However, costs are expected to rise, as there is talk of deregulating the state’s utilities. Stephanie knows management is
6 http://www.aceee.org/ogeece/ch3_index.htm
7 http://www.fypower.org/com/tools/products_results.html?id=100124
8 Olli Seppänen, and William J. Fisk, “A Model to Estimate the Cost-Effectiveness of Improving Office Work through Indoor Environmental Control” (ASHRAE Transactions, 2005). 663–672.
9 Joseph J. Romm, and William D. Browning, Greening the Building and the Bot- tom Line: Increasing Productivity through Energy-Efficient Design (Snowmass, Colorado: Rocky Mountain Institute, 1998).
10 http://www.trane.com/Corporate/About/solutions.asp
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concerned about changing prices and fluctuating interest rates. It is also important to note that the HVAC system is housed on top of the 30-story building, and there would be costs in excess of $50,000 for the engineering and delivery of HVAC components by helicopter.
Exterior Tree Replacements
Stephanie’s preliminary research shows healthy trees can lower summer temperatures around them, reduce storm water runoff, and improve air quality. Additionally, healthy trees can increase real estate values and increase business income. 11 In regions like Pittsburgh, which are prone to strong winds and long periods of rain, combined sewer overflow systems collect rain water and waste water. Dur- ing periods of intense rain, waste water treatment centers are over- whelmed by the increase in volume and might reach their capacity. To reduce pressure on the system, untreated waste water is released directly into rivers or streams. This can lead to contamination and erosion of streams and waterways. Properly selected and planted trees can reduce storm runoff by taking in excess water. Reducing runoff alleviates some of the pressure on waste water treatment cen- ters. Additionally, trees can reduce wind speed, which decreases the amount of cold outside air penetrating the building. 12 As HealthCare is interested in increasing sustainability, it is important to consider transportation costs and to prioritize native trees during the selec- tion process. However, the maintenance of the trees is also critical. Trees require more care during their first few years of development. For instance, new trees should be watered, mulched, and pruned. 13 Stephanie needs to compare trees against certain criteria to select the best option. For more information about tree replacement options, see Exhibit 11.6 .
11 http://www.fs.fed.us/psw/programs/cufr/products/cufr_672_ PressReleaseAlbuquerque10-06.pdf
12 http://www.fs.fed.us/psw/programs/cufr/products/cufr_189_gtr186b.pdf
13 http://www.clemson.edu/extfor/urban_tree_care/forlf17.htm
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Interior Tile Replacement
Commercial flooring is becoming greener due to customer demand. Manufacturers are increasing the recycled content of prod- ucts, reducing water and electricity usage, and increasingly manufac- turers are relying on alternative energy to fuel operations. Consumers benefit from these processes because greener products not only meet performance criteria but also reduce maintenance and improve indoor air quality. 14 Alternatives to ceramic tile include bamboo, cork, or bio-based flooring. Bamboo is a renewable resource that is hypoal- lergenic, durable, and resists moisture well. Cork flooring is manu- factured from the bark of living trees and is non-slip, comfortable, and sound-reducing. 15 Bio-based products can be made from rapidly renewable, nationally grown plant materials. The result is a tile cat- egory that offers greener flooring options along with performance features that are superior to ordinary vinyl composition tiles. For tile option information, see Exhibit 11.7 .
Due to normal wear and tear, the 50,000-square foot main floor of the headquarters office building needs to be re-tiled. HealthCare would like to select the most environmentally friendly flooring prod- uct possible to replace the existing ceramic tile in this high traffic area. However, the financial impact of the new flooring is still a major consideration, as there is information in the popular press about ris- ing costs of health care and potential economic problems at a national level. Stephanie needs a decision tool to help determine the best replacement option utilizing both qualitative and quantitative inputs.
Given this initial set of opportunities, each with significantly different financial and timing implications and criteria for decision
14 Michael Chmielecki, “Commercial Flooring Asks, Are We ‘Green’ Enough Yet?” National Floor Trends , 2008, 10(11), 10–12.
15 Marianne Wilson, “Eco-Friendly Flooring.” Chain Store Age , 2006, 82(9), 78.
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making, Stephanie needs to choose a project and present her ratio- nale and implementation framework to management and the facili- ties department. Stephanie has engaged a local university’s business school and a team of students to help guide the decision-making pro- cess while drawing from their business analytics toolkit.
Exhibits Exhibit 11.1 Information from HealthCare’s Website We demonstrate our vision and mission through the innovative products, programs and services we provide, and our community involvement.
Our values:
• United in our mission
• Dedicated to excellence
• Committed to integrity
• Focused on our customers, employees and communities.
HealthCare’s diversity and inclusion initiative
Through our diversity initiative, we strive to capitalize on the strengths of our many differences and the advantages of an inclusive workplace.
Sustainable, eco-friendly and green business practices
At HealthCare, we know that creating a healthy environment helps to create healthier people. To this end, we are committed to implementing sustainable, eco-friendly and green (SEG) business practices because it is entirely consistent with our mission to help individuals live longer, healthier lives.
We are committed to integrity
At HealthCare, we value integrity above all else. HealthCare’s Integrity Process and values set the ethical tone for conducting business and create a corporate culture that enhances the reputation of the company. Our Code of Business Conduct points us down the right path. Our employees use the basic Principles of Integrity as a primary road map to be successful at HealthCare and in life.
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Exhibit 11.2 HealthCare’s Income Statement Years Ended December 31 2007 2006
Revenue*
Premium Revenue $10,252,073 $9,433,837
Management Services Revenue $621,555 $685,182
Vision Revenue $963,119 $629,709
Net Investment Income $235,400 $226,363
Net Realized Gain on Investments $159,386 $25,910
Gain on Sale of Business Interests $4,268 $42,059
Other Revenue $116,759 $41,193
Total Revenue $12,352,560 $11,083,803
Expenses
Claims Incurred $9,044,986 $7,896,422
Operating Expenses $2,679,362 $2,432,118
Interest Expenses $68,440 $51,888
Total Expenses $11,792,788 $10,470,428
Income Before Income Taxes $559,772 $613,375
Income Tax Provision $184,410 $215,085
Net Income $375,362 $398,290
*All numbers in thousands
Exhibit 11.3 HealthCare’s Balance Sheet December 31, 2007
Assets *
Cash and Cash Equivalents $1,018,741
Accounts Receivable $6,242,669
Trade $977,217
Government Programs $266,976
Other $65,817
Property and Equipment, Net $354,397
Total Assets $8,925,817
Liabilities and Reserves
Debt $799,542
Total liabilities $4,948,610
Total reserves $3,977,207
Total liabilities and reserves $8,925,817
*All numbers in thousands
Source: HealthCare.
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Exhibit 11.4 HealthCare’s Energy-Saving Project Assumptions 2007 kWh Consumption 25,137,000
% of Electricity Allocated to HVAC Operations 65%
Electricity Costs/kWh (out to 2012) 8.7 cents
Estimated Inflation Rate 4%
% Increase in Material and Supplies 2%
% Increase in Chemical Treatment 2%
% Increase in Small Tools and Equipment 2%
Preferred Rate: “Net Present Value” 9%
Source: HealthCare. The period of time for the analysis is over 20 years, starting with 2007 data.
Exhibit 11.5 HealthCare HVAC Expenses Expense Description 2007 Actual
HVAC Materials and Supplies $43,270
HVAC Chemical Treatment $14,910
HVAC Small Tools and Equipment $2,517
Yearly Motor Replacement $80,000
Source: HealthCare. Any new HVAC system will not require motor replacement for eight years
after the installation and will have at least a 15% improvement in energy conservation.
Exhibit 11.6 HealthCare Tree Replacement American Dogwood Service Berry Red Maple Sugar Maple
Capital Costs
(12’)
$225 $245 $270 $180
Shade Average Minimal Average Average
Characteristics Strong, highly resistant to winds, heavy rains, average growth rate
Naked oak with snowy white flowers, edible fruit; one of the first to flower in PA
Fastest growing maple tree; disease resistant, strong tree that resists ice damage and high winds; grows best in moist soils
Very large and prefers moist, rich soils; can mature in winter (maintain leaves); very resistant to high winds
Source: Information gleaned from student research and input from HealthCare.
Note: All tree replacement options are native to Pennsylvania. HealthCare is looking to replace 21
trees around the perimeter of the building coinciding with sidewalk replacement, with a total cost
range of $4,500–$5,000 per tree.
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Exhibit 11.7 HealthCare 50,000-Square Foot Tile Replacement
Bamboo Terrazzo- Concrete
Vinyl Composition Tile (VCT)
Ceramic Tiling
Bio-Based Tile
Total Cost Range
$3.75–$6.50 commercial grade sq. ft
$2.00–$5.00 sq. ft
$1.50–$2.75 sq. ft
$1.50– $2.50 sq. ft
$2.50–$3.00 sq. ft
Maintenance Cost
Medium Low Medium Low Medium
Durability Average commercial grade
40–80 years High (data not available)
40–80 years
Very good*
Green Attributes
Almost all have formaldehyde binders and are mostly shipped from China
Has low VOC emissions
Be wary of sealants and adhesives, as they emit VOCs
Requires no VOC- emitting products
Made with rapidly renewable ingredients**
Source: Information from MBA team’s online research.
*According to Armstrong Flooring. 2× the indent resistance of VCT and 5× the impact resistance.
**Helps reduce the reliance on petroleum and fossil fuels with 10% pre-consumer recycled
content.
Cork not available from local vendor at this time.
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Case 12 PaperbackSwap.com: Got Books?
Brandy S. Cannon and Louis A. Le Blanc, Berry College 1
Introduction
Many Americans have an ever-growing number of unwanted books and limited options to get rid of them. They can throw the books away if they can bring themselves to do so. Their titles can be taken to a used book store, receiving little cash in return, or given away to a friend or charity. PaperbackSwap.com has created another option by letting members trade their unwanted books with other members across the country for only the cost of postage. With a large inventory of books, hard-to-find titles are easier to locate than with a traditional bookstore.
PaperbackSwap.com began as a very small company based in Suwanee, Georgia (an Atlanta suburb). The enterprise experienced tremendous growth and amassed many loyal customers. However, with any substantial increase in the price of media mail and the rising popularity of electronic books (e-books), PaperbackSwap.com faces real threats to its model. Co-founder Robert Swarthout expressed his concern to the company over the rising prices of media mail and the uncertain future of the company. He wondered if the company would be able to survive the coming threats.
1 Brandy S. Cannon and Louis A. Le Blanc of the Campbell School of Business at Berry College prepared this case as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation.
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Company Background
Robert (Bobby) Swarthout came to Berry College in northwest Georgia from Florida in 2000 to run track and pursue a degree in computer science with a minor in business. He attended Berry from August 2000 through May 2004. In 2002, during the summer break before his junior year, Swarthout had his wisdom teeth removed. He decided to create a website while he was at home recuperating and had some free time. He did not like the way that the Student Govern- ment Association (SGA) ran its book swap at the College. The SGA book swap had no Internet presence. Also, students did not know what books SGA had in stock until the day it opened, which was usu- ally the first day of class.
Two weeks before classes began for the fall 2002 semester, Swarthout placed 250 flyers on the Berry campus advertising a web- site, www.berrybookexchange.com , that he had created for students to swap textbooks. The website allowed students to post their text- books free of cost, and students purchasing the books did not have to pay any fees. Within a few days, all his flyers were down. The Col- lege’s newspaper wrote an article about the incident:
Dean of Students Tom Carver ordered signs for www.berrybookexchange.com removed from dorm halls because they were viewed as solicitation without permission. Swarthout went directly to Carver when he heard about the removal of the fliers. Carver said that when he had all the facts, he was receptive to the idea of a website, 2 although he worried that it would unfairly sway students from the book swap, taking money from SGA.
SGA made an estimated $10,000 a semester from its book swap operation. 3 Swarthout’s website threatened SGA’s business. Swarthout
2 Lindsey Quirk, “Fliers for Book Exchange Website Taken from Dorms,” Berry College, Campus Carrier, (September 5, 2002) 94(2), 3.
3 Ibid.
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had to talk to Dean Carver and then SGA. SGA asked him to give it control of his website, which Bobby refused to do. He later had a meeting with the Berry College administration, including then- President Scott Colley and Dean Carver. He was threatened with being expelled from school because he had allegedly used Berry’s resources to create the website. However, Swarthout had created the website at home, and it was hosted off campus.
SGA then offered to buy the website. Swarthout had taken an estimated 25% of used textbook sales away from SGA. 4 Swarthout’s website had no revenue model, and the students were the ones sav- ing the money. SGA bought the website for $2,000 and assigned 25% of revenues to Swarthout for four subsequent semesters. 5 Also, Swarthout entered into an agreement that called for him to be paid $12.50 per hour to build a text swap website for SGA. It was to be ready for the spring semester 2003, 6 at which time the original site was closed.
Swarthout convinced the College to sign a contract, and he inten- tionally left out a non-compete clause. The following summer (2003), he built another website better than his original. In the fall of 2003, his senior year, Bobby was not allowed to advertise his new site on the Berry campus. He then created websites to swap textbooks for other schools including Shorter University (in Rome, Georgia), the University of Tennessee (Knoxville campus), the University of Mis- sissippi, Florida State University, Clemson University, as well as the University of Kentucky. At Florida State, 3,500 people used the site. 7 No cash was generated at any of the schools as the model was essen- tially a prototype.
4 Ibid.
5 Ibid.
6 Ibid.
7 Ibid.
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Seed Capital and Advice
Swarthout attended an alumni entrepreneurial presentation dur- ing Berry College’s Mountain Day weekend (that is, homecoming) sponsored by its Campbell School of Business in October 2003. Rich- ard Pickering, a Berry alumnus with an MBA from the Harvard Busi- ness School, gave a presentation on starting new business enterprises. While speaking to the group of students, Pickering offered to meet with any students interested in new business opportunities. Pickering offered that, if the students wished to discuss their ideas, he would potentially invest in their idea and help them build a company. Pick- ering assisted Swarthout to overcome the challenges and obstacles that young business leaders face. 8
Bobby also participated in the Students In Free Enterprise (SIFE) competition with his college book swap business model. He did well in the regional competition and advanced to the national competition in 2003.
Pickering and Swarthout began talking daily about the collegiate book swap websites during the fall of 2003, sometimes several times a day. They met again in the spring of 2004. Swarthout then visited Pickering in Atlanta to brainstorm further.
Initial Operations
By this time, Swarthout had expanded the online book swapping model to 12 schools. They were now charging a $1.25 to post a book at three large universities. The business was still not generating much cash, as few students were willing to pay to post their books to swap online. Charging at the big campuses caused many customers to stop using the website.
8 “More on Mentoring,” Berry College, Campbell Columns, (Fall 2003), 2.
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Swarthout graduated in May 2004 during a poor job market. He moved into Pickering’s home in the Atlanta suburbs. During this time, Pickering and Swarthout came up with the idea of Paperback- Swap.com. Pickering had amassed a large collection of books from extensive traveling and thought it would be nice if he could swap the books for different titles.
The Business Goes Live
PaperbackSwap.com was the first online book swap and used a systematic process, instead of forcing users to find someone offline with whom to trade. The site operated on a credit system and was free to use. The most difficult issue for PaperbackSwap.com to explain to members was paying for postage. The party sending the book was responsible for paying for postage. When members listed nine or more books, they received three free credits. After that, every time they mailed a book to a member, they received a credit to get a book. Also, members could receive additional credits by referring a person to the site.
Swarthout bought 600 books from Unclaimed Baggage Cen- ter (that is, unclaimed airline baggage) in Scottsboro, Alabama, and entered these into the system. (This was the initializing inventory to prime the book swap system.) The official launch date of Paperback- Swap.com was September 1, 2004. “In less than 9 months, the num- ber of books had rocketed from 10,000 to more than 300,000 titles,” according to co-founder Richard Pickering. 9 By October 2007, the site had more than 1,620,000 total books and 315,000 unique titles. 10 See Exhibit 12.1 for PaperbackSwap.com’s book requests per day from the launch date until August 2007.
9 “Paperbackswap.com Explodes,” The Glennville Sentinel , June 15, 2006, PaperbackSwap.com, http://paperbackswap.com/press_media_detail.php?id=62 .
10 Robert Swarthout, PowerPoint presentation, October 19, 2007.
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Competitors
Two weeks after PaperbackSwap.com opened, a copycat site (TitleTrader.com) launched. When PaperbackSwap.com added a fea- ture, it would show up on this copycat site shortly afterward. When PaperbackSwap.com started, there were 10 competitors. However, if the sum of the second, third, fourth, and fifth competitors (in size) was doubled, PaperbackSwap.com was still larger. 11
BookMooch
BookMooch.com was conceived, designed, constructed, and administered by John Buckman. As of February 1, 2008, BookMooch. com had 58,155 members. 12 As of February 1, 2010, the total number of books mooched was 523,427. 13 Unlike PaperbackSwap.com, Book- Mooch.com is a worldwide system. Sending to another country gar- ners a shipper three points, and receiving books from another country costs two points. Each book entered into the BookMooch system gets the member one-tenth of a point. After members receive a book and leave feedback for the sender, they earn one-tenth of a point. The catch is that members have to send out at least one book for every two they receive. If a member does not maintain this ratio, he will no longer be able to mooch books, even if he has the points, until he improves his ratio. At BookMooch.com, members cannot purchase points, but they can contribute some of their points to “BookMooch- selected charities.” 14 BoockMooch.com states that it pays its bills by using the Amazon affiliate program. 15
12 “Statistics About BookMooch,” BookMooch website, http://bookmooch.com/ about/stats .
13 Ibid.
14 Mary Pilon, “Online Swap Meets for Books,” Wall Street Journal , August 7, 2008, http://online.wsj.com/article/SB121805999670918387.html .
15 “Overview,” BookMooch website, http://bookmooch.com/about/overview .
11 Robert Swarthout, personal interview, January 13, 2009.
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CASE 12 • PAPERBACKSWAP.COM: GOT BOOKS? 149
TitleTrader
Maggie Abercrombie and her brother Daniel Abercrombie cre- ated TitleTrader.com. Daniel handled the website construction, while Maggie provides customer service. TitleTrader.com of Millsboro, Delaware, allows users to receive and ship books domestically and internationally. TitleTrader.com gives members the option of using the basic free site or paying $19.95 for a premium membership. Pre- mium features include wish list notification, auto-request discount, a newsletter, saved searches, as well as buddy lists. TitleTrader.com also offers games, DVDs, VHS tapes, CDs, and magazines. Title- Trader.com does not give members a free credit when listing their books. Members only receive credits when another member requests an item and that member receives it.
Business Model
PaperbackSwap.com’s business model consists of a target market, revenue sources, and value configuration. PaperbackSwap.com has members who have become extremely loyal to this online enterprise.
Target Market
PaperbackSwap.com’s target market is people with adequate disposable income and enough leisure time to read books. Its pri- mary market remains women aged 40 and over who are typically not employed outside their residences. 16 The membership is comprised of 91% women. 17 These women have an abundant amount of time to read, and they generally read several books a week. They mainly swap erotic romance novels. When PaperbackSwap.com purchased books
16 Robert Swarthout, personal interview, January13, 2009.
17 Ibid.
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from the Unclaimed Baggage Center, Swarthout bought a broad assortment to appeal to a wide demographic. Shortly after the website went live, it became flooded with romance books.
By 2007, PaperbackSwap.com was covering all 50 states and 5 ter- ritories. As of February 2008, the company had approximately 100,000 subscribers, and approximately 66% would post the required 9 books to receive 3 free credits. 18 See Exhibit 12.2 for PaperbackSwap.com’s map of unique member ZIP Codes at the time.
Revenue Sources
The original plan at PaperbackSwap.com was to start charging a membership fee at some point in the future, but this had yet to hap- pen. PaperbackSwap.com used Amazon’s affiliate program. When a book was not listed on PaperbackSwap.com, a member could click on the book to buy it from Amazon. Also, PaperbackSwap.com sold gift certificates and branded merchandise such as clothing, pens, mouse pads, and more. PaperbackSwap.com’s revenue sources mainly came from selling credits, box-o-books, book journals, and postage.
Credits
The way PaperbackSwap.com initially generated cash was by sell- ing credits. If members ran out of credits or had no books to list in the system, they could purchase a credit so they could order a book. This also allowed PaperbackSwap.com to reach people who did not want to list books or actively participate in the club, but just wanted a book for a low price. A credit initially cost $2.00 to purchase, and it cost $1.42 to mail a book. 19
18 Robert Swarthout, presentation, Campbell School of Business, Berry College, April 20, 2010.
19 Robert Swarthout, personal interview, January 13, 2009.
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Box of Books
In January 2006, PaperbackSwap.com introduced a feature called box-o-books for $8 a year. With box-o-books, a member could look at another member’s list of available books (which was the only way to do this). The normal system was a queue that used a first-in, first-out system. With box-o-books, members did not have to use their credits. They just looked at another member’s available books, and two mem- bers decided how many books they wanted to swap with each other. The two members had to agree on the number of books they wanted to swap because no credits were being used, and it was an even swap.
Book Journal
In November 2006, PaperbackSwap.com introduced the book journal feature. Like box-o-books, this feature also cost $8 a year. Book journal made it easy for members to organize their books by cataloguing them. It allowed members to assign books to spaces in their houses. For instance, if another member ordered a book, mem- bers would be able to see in what location of their house the book was located. This feature made it easier for members to keep their books organized and easier to respond to an order for one of their books.
Postage
PaperbackSwap.com calculated postage based on the weight of book. Book wrappers were printed by members on their computers. The books were wrapped in two sheets of paper because one sheet would usually tear. Ninety percent of the books could be wrapped in paper. 20 PaperbackSwap.com allowed members to print postage for a fee between $0.25 and $0.30, which allowed them to get delivery con- firmation. With delivery conformation, PaperbackSwap.com showed the member where the book was traveling by placing a mail truck on
20 Ibid.
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a map. PaperbackSwap.com received data from delivery confirmation and could generally determine when a book would arrive. The com- pany allowed the member to pay for just the delivery confirmation without paying for postage. Generally, a member received a credit when a book arrived at the shipping destination and the receiver marked that it had been received. Delivery confirmation allowed the member to get an instant credit instead of waiting for the book to arrive at its destination.
Value Proposition
PaperbackSwap.com offered a unique value proposition. The company’s extreme dedication to customer service, mixed with the company’s community atmosphere, created a website with loyal and dedicated members.
Customer Service
Almost all companies believe that customer service is part of their value proposition, but PaperbackSwap.com is extremely dedicated to customer service. For the initial two years of operation, Swarthout’s own cell phone number was available on the website. He personally called members when they had a problem. He would also chat with members to see whether they liked the service and to identify poten- tial improvements to be made. The goal was to answer communica- tions within 24 hours. 21
PaperbackSwap.com refused monetary donations from its mem- bers, even though it had many people willing to give money to help out the website. Instead, members donated their time to help operate the website. One member, Ruth H., began working 30 hours a week without compensation after being so impressed by Swarthout’s per- sonal call to her about a service problem with the website. Another member that Ruth H. had found, Linda S., was a medical doctor with
21 Ibid.
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sponge-like retention of information. She also began working with- out compensation. The company started using volunteer tour guides for the site, because it was important for people to learn how to use the system. Every member was assigned a tour guide. There were approximately 120 unpaid tour guides. 22 At times, it was easier to get in touch with a tour guide than paid PaperbackSwap.com personnel. A live chat was available if the member’s tour guide was not online, although there was generally always a tour guide online in the chat area. Also, the company used volunteers to acquire book images and ISBN numbers.
To help get press coverage, PaperbackSwap.com mailed press releases with a book to local newspaper writers and received addresses for local newspapers from its members. Because PaperbackSwap.com had such a strong commitment to customer service, its customers became very loyal to the company.
Community
One of the main attractions for many of PaperbackSwap.com’s customers is the community aspect. Members can create a profile and add members to their buddy list. A great deal of communication between members occurs in the discussion forums and the live chat. This has helped the company immensely, as social networking has increased tremendously in popularity.
The company also has fun competitions for members. Matt Stinnette won more than $300 worth of credits and shipping services from PaperbackSwap.com. He won by predicting the exact time the service would reach one million books traded. Based on figures deter- mined by looking at daily trade averages, Matt predicted 10:38 a.m. on March 2, 2007. 23 His wife predicted the previous day.
22 Ibid.
23 Eric Feber, “Paperback Lover Hits Millionth Trade Jackpot,” The Virginian- Pilot , March 16, 2007, PaperbackSwap.com., http://paperbackswap.com/press_ media/press_media_detail.php?id=139 .
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Extendibility of Business Model
PaperbackSwap.com’s model consists of a member ordering a book from the website, receiving the book through domestic mail, reading the book, and then possibly listing the book for another mem- ber to order. See Exhibit 12.3 for the PaperbackSwap.com model. Minimal modifications were needed to extend the PaperbackSwap. com model, mainly consisting of replacing books with another item. The model was capable of being extended into many areas, similar to what it had already accomplished with CDs and DVDs. The new sites were called SwapaCD.com and SwapaDVD.com, respectively. Paper- backSwap.com allowed members to transfer their credits between the three sites. In addition, the model could be used to swap video games, although a game cannot be sent via the media mail rate.
SwapaCD
On August 7, 2006, SwapaCD.com launched. SwapaCD.com followed the same basic concept as PaperbackSwap.com with some minor changes. With SwapaCD.com, members had to set up a Swa- paCD money account in which they had to make deposits in $5.00 increments. Members used this money to pay a $0.49 transaction fee that was charged for every CD requested from another member.
SwapaDVD
On November 27, 2007, SwapaDVD.com launched. This site also followed the same basic model as PaperbackSwap.com. On the launch date at about 2:30 p.m., there were approximately 2,700 DVDs listed. By 9:30 p.m., about 6,700 DVDs were listed for swapping. 24 By Feb- ruary 2008, there were more than 36,000 DVDs available on the site. There were no transaction fees, unlike SwapaCD.com.
24 Amy Brantley, “SwapaDVD Is Now Open,” Associated Contest, November 27, 2007, Swapadvd.com, http://swapadvd.com/press_media/press_media_detail. php?id=25 .
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Financial Structure
PaperbackSwap.com is a privately held company, and therefore very little financial information is available. The company became cash flow-positive after nine months of operation. See Exhibit 12.4 for PaperbackSwap.com’s approximate revenues for 2006. In the beginning, there were very few costs. The main expense was run- ning the website utility, as no employee was receiving a salary. The company still has very limited costs, because of the small number of paid employees necessary to operate the website and perform other business functions. By 2007, the company only had seven full-time employees and five part-time employees. 25 PaperbackSwap.com owns no inventory, and the only costs are wages and salaries for website hosting, and so on. PaperbackSwap.com does not incur any expenses for shipping or mailing because that is the customers’ responsibility. A prominent Silicon Valley venture capital firm offered to buy Paper- backSwap.com for $7.5 million, but the owners did not sell. 26
Future Risks
Uncertainty with the future of media mail rates could destabilize PaperbackSwap.com’s model. Club members might be unwilling to continue shipping books if the price of media mail continues to rise. Also, electronic book (e-book) readers are steadily gaining in popu- larity, which could be a serious threat to its business model because members cannot swap e-books. With the uncertainty of media mail and the gaining popularity of e-books, co-founder Robert Swarthout is faced with this difficult dilemma: The business enjoys continued growth, but in the future, such an online enterprise risks becoming
25 Robert Swarthout, PowerPoint presentation, October 19, 2007.
26 Robert Swarthout, presentation, Campbell School of Business, Berry College, April 20, 2010.
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obsolete. With that future risk in mind, Swarthout ponders his profes- sional fate with PaperbackSwap.com.
Robert is faced with the decision to remain at PaperbackSwap. com or leave. If he leaves, he must sell back his shares of the business at a relatively steep discount (“take a haircut”). This is required by a standard clause in the by-laws of startup companies such as this one. Robert would also have to agree to not work for a competitor or start another such venture; in other words, he would have to sign a non- compete clause in his buyout. Nevertheless, his settlement would be enough that he might not have to work for as many as 10 years with substantial annual income.
If Robert Swarthout stays at PaperbackSwap.com, several sce- narios could develop. There was an unsolicited offer of $7.5 million to sell the business to a venture capital firm attempting to do an IT rollup. (Such a rollup occurs when a number of similar but independent technology firms are purchased, aggregated, and then sold as a pack- age for significantly more than the combined purchase price of all the parts.) But the deal is contingent on Robert staying with Paperback- Swap.com for three years after the sale, as he is the IT expert at the firm. This type of contingency is not typical of acquisitions by venture capitalists, who usually dismiss the company founders in short order as they may not have the requisite skills for advancing the fortunes of the company that they have established.
A second possibility, assuming that Swarthout stays, is for Paper- backSwap.com to issue an IPO, but the offering is dependent on how well the business is doing against several competitors and whether the media mail rate, which their business model depends upon, is still intact. A third option is that PaperbackSwap.com could remain as a privately held company, with its continued success depending upon the strength of its competition, as well as the continued existence of
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the low media mail rate for books. But if Robert stays too long at what is becoming a boring situation, he might gain the reputation as a one-trick pony, capable of only “swapping” technologies. The relative probabilities of these three last scenarios, as well as the decision to go or stay, present a tough decision environment for Robert Swarthout.
Exhibits Exhibit 12.1 Book Requests Per Day, September 2004–August 2007 6000
5500
5000
4500
4000
3500
3000
2500
2000
1500
1000
500
0
Source: Courtesy of Robert Swarthout
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Exhibit 12.2 PaperbackSwap.com’s Map of Unique Member ZIP Codes
Alaska
Hawaii
Puerto Rico
Source: Courtesy of Robert Swarthout
Exhibit 12.3 PaperbackSwap.com’s Model
Source: Courtesy of Robert Swarthout
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CASE 12 • PAPERBACKSWAP.COM: GOT BOOKS? 159
Exhibit 12.4 PaperbackSwap.com Approximate Revenues for 2006 Approximate Revenues 2006 Percent of Revenues
Delivery Confirmation $40,000 12%
Box-O-Books $10,000 3%
Book Journal $24,000 7%
Branded Merchandise $12,000 4%
Credits $250,000 74%
Total $336,000 100%
Source: Robert Swarthout, PowerPoint presentation, Berry College, November 2006
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Case 13 Stranded in the Nyiri Desert:
A Group Case Study
Aimée A. Kane and Mercy Shitemi, 1 Duquesne University
The Situation
You are part of a group of students participating in a study abroad program in Kenya. As a reward for exemplary performance, your group has been treated to a bus tour of the Nyiri Desert, which encompasses Amboseli National Park. It is the middle of August. You have been driving on a dirt road, far from the main road, to visit a local Maasai community. At about 11 a.m. the driver of your bus veers off the road to avoid hitting a wildebeest. The bus overturns, rolls into a ravine, and catches fire. The driver and the tour guide are both killed. Aside from some minor scratches and bruises, you and your fellow group members are not injured.
Several people in the city know your general itinerary, but due to the size and remoteness of Amboseli, they do not know your exact location, and you do not have any way of communicating with them. The closest settlement to where you have crashed is the Maasai com- munity, which is approximately 40 miles to the south. When you do not arrive back at the hotel, people will realize something has hap- pened, and the next day they are likely to look for you.
1 Adapted from D. R. Johnson and F. P. Johnson, “Stranded in the Desert,” Join- ing Together: Group Theory and Group Skills, 10th ed. (Upper Saddle River, NJ: Pearson, 2008). 332.
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The Nyiri Desert is arid and, according to weather reports, temperatures could reach 92°F with a surface temperature of 100°F. You are all dressed in lightweight clothing and have hats and sunglasses.
As you escaped from the bus, each member of your group sal- vaged a few items, and there are 12 items in all. Your task is to rank these items according to their importance to your survival, from 1 (most important) to 12 (least important).
ITEMS Individual Ranking
Group Ranking
Expert Ranking Group Score 2
Flashlight
Pocket knife
Amboseli Park map
Large clear plastic ground cloth per person
Compass
Loaded gun
Quart of water per person
Book titled Amboseli: Nothing Short of a Miracle
Heavy-duty canvas bus cover
Matches
Overcoat per person
Side-view mirror
Total Group Score:
Go to the next page to fill out and copy individual rankings to turn in.
2 The group score is the absolute difference between the Group Ranking and the Expert Ranking. Lower scores are better as they indicate greater agreement with the expert.
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Second Copy to Turn In
In the following, please copy your ranking from the previous page onto this page so that it can be turned in at the beginning of class session.
ITEMS Individual Ranking
Flashlight
Pocket knife
Amboseli Park map
Large clear plastic ground cloth per person
Compass
Loaded gun
Quart of water per person
Book titled Amboseli: Nothing Short of a Miracle
Heavy duty canvas bus cover
Matches
Overcoat per person
Side-view mirror
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4 Advanced Business Analytics
14. Joe’s Coin Shop: Entry into Online Auctions 167
15. Vehicle Routing at Otto’s Discount Brigade 181
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Case 14 Joe’s Coin Shop:
Entry into Online Auctions
Charles A. Wood, Duquesne University
Introduction
Joe Murphy, founder of Joe’s Coin Shop, sits back in his office chair to reflect on his 15-year-old business. It sure has been tough over the last decade, but the last couple of years have shown a profit. Joe thinks it is going to finally be okay, but he still wonders about the future direction of his company.
Company History
Joe remembered earning an MBA from a local college and work- ing for a major corporation before deciding to go into business for himself. Joe thought that there could be nothing better than running a rare coin shop. Joe had been collecting coins since the fifth grade, and he knew all about how they are graded, what dealers typically offer for coins, and what they sell them for. It seemed like a natural fit. For the first five years, Joe had done really well for himself. He steadily improved sales and profitability up until his pinnacle in 2005, when Joe’s Coin Shop had just broken $1 million in net income. Joe
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was making much more money than he made in the corporate world, and he was doing what he loved.
Joe took pride in providing for his customers—giving them the best advice, delivering a great selection, and allowing customers to purchase items on credit, which seemed to boost sales and encour- aged customers to browse through his store. Unlike many stores that sold rare coins, Joe never took advantage of his customers’ inexperi- ence. He took great care to explain the difference between “blue book value,” or the retail price, and “red book value,” or the price a coin store should be willing to pay for the coin. If a customer did not know the value of a coin, Joe would examine it and be upfront about it, and truthfully describe the value rather than try to low-ball the estimate, as other dealers often do.
The customers appreciated Joe’s honesty and friendliness. Many hung out at Joe’s store on the weekends or every once in a while after work. Some brought him coffee or cookies, and they all sat around talking about coins, investing, and their individual collections.
But in 2006, sales just seemed to drop off. Customers who used to come to his store regularly simply stopped coming. In 2006, net income was reduced to one-eighth of the previous year, and during 2007–2009, the business lost more than $200,000 each year, despite cuts made to operating expenses and increases to liabilities. Joe just thought it was a momentary downturn, but he wondered how long he could hemorrhage money. Then, in 2010, at the height of a par- ticularly bad recession, Joe’s Coin Shop lost around $754,000. The record business profit from 2005 was wiped out during the 2007–2010 downturn. Business equity was down $330,000 from its high point, and times were bleak. Joe was worried that he would have to close the shop. Joe kept cash flow in the business by greatly increasing the debt load, but this could only go on for so long before Joe went bankrupt.
In late 2010, Joe decided to hire Anita Jones, a marketing consul- tant, to help him reach the customers who used to come to his store. Anita was certainly expensive, and Joe was worried about spending
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hundreds of thousands of dollars on a marketing campaign when times were so tough, but Anita was as good as she promised. Her mar- keting plan came through and helped bring the business back from the brink and into the black in 2012 and 2013. Joe is finally able to start paying down the liabilities that Joe’s Coin Shop accrued during the 2006–2011 period. Business, however, is still not at the level that it once was, and Joe realizes that, while he now has some breathing room, something needs to be done if he is going to stay solvent over the long term. Exhibit 14.1 shows the sales revenue and net income from 2005–2013.
Market Survey
Anita surveyed past and present customers. In this market survey, Anita divided subjects into four groups:
• Non-Customers — Coin collectors (current or previous) who have never shopped at Joe’s Coin Shop
• Former Customers — Coin collectors who have shopped at Joe’s Coin Shop but have no plans to do so in the future
• Infrequent Customers — Coin collectors who shop at Joe’s Coin Shop as well as other channels to buy rare coins
• Loyal Customers — Coin collectors who only shop at Joe’s Coin Shop
The purpose of the survey was to determine why Joe’s business was dropping off. Exhibit 14.2 shows the dominant answers to the questions from the market survey.
Anita and Joe discussed how Joe’s Coin Shop is losing out to online coin stores and online auctions. Joe agrees that this might be the case. Joe has always contended that a traditional coin shop with great service and a personal touch would be more appealing to his clients, and indeed, some of them have expressed that exact thought.
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Joe has so far resisted going online, and only has a simple website that talks about how he values the customer and gives the store’s address and phone number, along with directions to the store. Nonetheless, Joe sees the writing on the wall. It is going to be more difficult to get customers in the future, and Anita has convinced him that he needs to start selling online to capture customers who are unwilling or unable to purchase inside his store.
But Joe really likes having a store, and he thinks that current cus- tomers enjoy it as well. He would hate to give that up. (Joe told Anita, “If I have to do all my work online, I would close up the business and go back to the corporate world!”) Because Joe feels so strongly about this, Anita has suggested that Joe use the store to help. She suggested that he could advertise heavily within the Joe’s Coin Shop store rather than covertly go online under another identity, and that a “bricks and mortar” store presence could add to the attraction of the website and to Joe’s online auctions. Joe agrees. Joe also wants to make sure that he does not betray existing loyal customers by selling the same coins for less money in a different environment under an assumed name. Joe feels strongly that existing customers should be rewarded for stay- ing with him, and not be denied opportunities that (hopefully) new customers will have, even if it costs him a little in the margin. Thus, existing customers should always be informed about new online coin collecting opportunities at Joe’s Coin Shop.
Costs of an Online Market
Anita has suggested a two-pronged attack:
• First, an online storefront will sell items that are available at the store, but at the same price as the store. Depending on the level of interest, Anita encourages Joe to consider slightly lowering the prices on the site and at the store.
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• Second, online auctions will allow Joe to reach a larger audi- ence; they can be used as a vehicle to drive customers to Joe’s site, where they can buy coins immediately rather than waiting for an auction to end. Some auction houses also allow custom- ers to set up an online store presence within the auction house, so that if a customer wants to see auctions available from Joe’s Coin Shop, she can simply go to the Joe’s Coin Shop online store. Anita thinks that this is a good idea.
Joe’s margins are at around 53% right now. If he were to sell in online auctions, he might increase the quantity of sales to previous levels, but at a reduced margin. Furthermore, both Joe and Anita feel that an online presence will eat into at least some of their sales as loyal customers purchase from them in online auctions. Anita has often said, “If we don’t cannibalize ourselves, someone else will.” Anita esti- mates that there will be a 25% migration from in-store to online, but also a 20% migration from the auction site to the Joe’s Coin Shop’s website, as some coin collectors do not want the uncertainty of the online auction.
Anita has explained that an online presence will require a web- site with online order capabilities, security, and transaction retrieval, which Anita suggests will cost around $200,000, plus an additional employee (estimated at $100,000 per year, including salary and ben- efits) to maintain the website, as well as enter information, keep the site active, and enter auction data while Joe deals with customers who enjoy the “bricks and mortar” store. In addition, auction participa- tion will require additional listing fees for each item sold. Exhibit 14.3 shows a typical fee structure for an online auction.
Exhibit 14.3 shows a listing fee that depends on the starting bid. Then, if an item is successfully sold to a bidder, the seller owes a sales fee that consists of a fixed fee plus a percentage of the final bid amount. Finally, if a seller wants to place a secret reserve price on the coin for sale that the winning bid must surpass before the item is sold,
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a reserve fee is added. Listing fees and reserve fees are due immedi- ately, whereas sales fees are due upon a successful sale.
Data Analysis
To help Joe with the planning, Anita has Joe purchase a data set of 2006 auction transactions. Analyzing this data will determine a pro- forma income statement (similar to a projected budget) to forecast the profits and expenses from the online information to discover how much income an online presence will deliver compared to the costs of implementing such a system.
The data looks daunting. There is so much data, separated into worksheets with rows in one worksheet pointing to several rows in the other worksheets. Anita and Joe identify five tasks for each question that need to be answered:
1. First, you must decide what questions you want answered. Re- member, the questions should not be dependent upon the data set. Joe has several questions:
a. What revenue can I expect to make compared to the book value of the coin? Do factors such as book value, number of bids, and so on, increase this revenue?
b. Are there any factors that can help guide me to making more money per auction or to attracting more bidders to my auction?
c. How many auction and non-auction coins do I need to sell online to break even with the cost of an online presence?
d. Do bidders cluster into groups, and how can high-paying groups be targeted?
e. How do losing bidders in one auction behave in the next auc- tion when trying to buy the same item?
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CASE 14 • JOE’S COIN SHOP: ENTRY INTO ONLINE AUCTIONS 173
f. How does seller reputation affect sales? How does bidder reputation affect sales? Does the reputation score really mea- sure the reputation?
2. Decide how you can answer the questions by using the data set.
3. Anita and Joe must take all this data and place it into a single data set for each question. Anita feels more comfortable staying with the spreadsheet, and has started coding VLookup com- mands and pivot tables to help with the analysis. Joe feels more comfortable with a database, and has migrated the spreadsheet data there and is using database views and queries, along with some SQL (the computer language of databases), to retrieve the data he needs.
4. Joe realizes that each coin is different from other coins, and there must be a way to standardize any data set. For instance, a 1797 penny in great condition worth $21,000 is very different from a 1909 penny in poor condition worth $15. If the 1909 penny sells for $18, that’s much better than the 1797 penny selling for $20,098. There needs to be a way to compare expen- sive and cheap coins across the data set without simply saying that “this coin sold for more than that coin.”
5. After a data set has been created for a specific question, that data set needs to be analyzed. Anita has informed Joe that sim- ple averages are not enough, and will probably lead him down the wrong path, or leave some paths unexplored. Regression analysis, cluster analysis, and maybe even some time series analysis or panel studies must be in order. There are factors that can corrupt analysis, such as endogeneity or multicollinear- ity, that need to be considered, as well.
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Joe is most concerned with measuring the critical success factors. He knows that he needs to measure and monitor online sales as they approach profitability, and he needs to know what that level will be and how far away from (or beyond) that level Joe’s Coin Shop is right now.
Anita and Joe certainly have some work ahead of them.
Exhibits
Exhibit 14.1 Revenue and Income 2005–2013
12,000
10,000
8,000
6,000
4,000
2,000
0 2005 2006 2007 2008
Sales (in thousands)
2009 2010 2011 2012 2013
1,500
1,000
500
0
-500
-1,000
Net Income (in thousands)
2011 2012 20132005 2006 2007 2008 2009 2010
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CASE 14 • JOE’S COIN SHOP: ENTRY INTO ONLINE AUCTIONS 175
Exhibit 14.2 Main Responses to Multiple Categories of Questions
Non- Customers
Former Customers
Infrequent Customers
Loyal Customers
Why do you/ did you shop at Joe’s Coin Shop?
N/A It’s just a place to get coins for my collection.
I like discussing coins.
Nice service.
It’s just a place to get coins for my collection.
I like Joe.
I like discussing coins.
Nice service.
Honest.
Why do you not or no longer shop at Joe’s Coin Shop?
I only buy online.
I can’t afford to collect coins anymore.
Just too much hassle.
It’s friendly, but I like the in and out of online.
I can’t afford to collect coins anymore.
N/A N/A
What do you look for in a coin shop?
Ease of access.
Online availability.
Ease of access.
Online availability.
Great service.
Online availability.
Knowledgeable staff.
Safe environment/ Joe doesn’t try to rip me off.
Friendly service.
Knowledgeable staff.
Safe environment/Joe doesn’t try to rip me off.
What would make you consider Joe’s Coin Shop, continue shopping there, or increase the number of coins you purchase from Joe?
Online presence
Online presence Online presence Continued friendly service
When you purchase coins online, how much do you save?
45% (average) 28% (average) 25% (average) N/A
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Exhibit 14.3 Sample Seller Fees for an Auction Site
Starting Bid Sales Fee Listing Fee on Starting Bid Reserve Fee
$0.01–$0.99 $0.00 + 5.25% of the winning bid
$0.25 $1.00
$1.00–$9.99 $0.35
$10.00–$24.99 $0.60
$25.00–$49.99 $0.625 + 2.75% of the winning bid
$1.20
$50.00–$199.99 $2.40 $2.00
$200.00–$499.99 $3.60 1% of reserve price up to $100 $500.00–$1,000.00 $4.80
>$1,000.00 $13.125 + 1.5% of the winning bid
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Exhibit 14.4 Joe’s Coin Shop Balance Sheet Balance Sheet (in thousands) 2013 2012 2011 2010 2009 2008 2007 2006 2005
Assets
Current Assets:
Cash and Cash Equivalents
4,551 4,511 4,514 4,477 4,670 4,522 4,382 4,274 4,331
Accounts Receivable
1,587 1,587 1,587 1,587 1,587 1,587 1,660 1,872 2,052
Inventories 461 461 461 461 461 461 464 437 432
Total Current Assets
6,599 6,559 6,562 6,525 6,718 6,570 6,506 6,583 6,815
Property and Equipment 3,774 3,377 3,310 3,392 3,879 4,208 4,494 4,610 4,252
Other Assets 534 494 464 473 542 593 656 704 676
Goodwill 5,530 5,350 5,550 5,140 5,670 5,620 5,760 6,470 7,120
Total Assets 16,437 15,780 15,886 15,530 16,809 16,991 17,416 18,367 18,863
continued
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Balance Sheet (in thousands) 2013 2012 2011 2010 2009 2008 2007 2006 2005
Liabilities and Owner’s Equity
Current Liabilities:
Accounts Payable 1,167 1,278 1,292 1,288 1,093 1,033 959 897 937
Accrued Liabilities 2,836 3,105 3,139 3,130 2,655 2,509 2,330 2,178 2,275
Accrued Compensation and Benefits
913 886 966 1,048 1,115 1,150 1,162 1,151 1,096
Total Current Liabilities
4,916 5,269 5,397 5,466 4,863 4,692 4,451 4,226 4,308
Deferred Rent 690 649 591 543 535 487 482 487 492
Other Long-Term Liabilities 503 550 556 554 470 444 412 385 402
Total Liabilities 6,109 6,468 6,544 6,563 5,868 5,623 5,345 5,098 5,202
Owner’s Equity 10,328 9,312 9,342 8,967 10,941 11,368 12,071 13,269 13,661
Total Liabilities and Owner’s Equity
16,437 15,780 15,886 15,530 16,809 16,991 17,416 18,367 18,863
Exhibit 14.4 continued
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Exhibit 14.5 Joe’s Coin Shop Client Count Client Count 2013 2012 2011 2010 2009 2008 2007 2006 2005
Returning Clients 482 503 464 512 510 522 561 645 691
New Clients 71 32 91 2 57 40 15 2 21
Total Clients 553 535 555 514 567 562 576 647 712
Exhibit 14.6 Joe’s Coin Shop Statement of Operations Statement of Operations (in thousands) 2013 2012 2011 2010 2009 2008 2007 2006 2005
Net Sales $8,793 $8,694 $8,565 $8,430 $8,560 $9,096 $9,326 $9,986 $10,799
Cost of Goods Sold 4,431 4,510 4,203 4,709 4,529 4,711 4,407 4,766 5,097
Gross Profit 4,362 4,184 4,362 3,721 4,031 4,385 4,919 5,220 5,702
Sales and Marketing Expense 1,380 1,669 1,703 1,629 1,229 1,547 2,003 1,927 1,515
Accounts Payable Write-Off 102 88 110 82 99 97 100 112 149
Consulting Expense 50 40 20 5 - - - - -
Salary and Administration Expense 2,403 2,333 2,543 2,759 2,935 3,026 3,057 3,027 2,883
Total Operating Expenses 3,935 4,130 4,376 4,475 4,263 4,670 5,160 5,066 4,547
Net Operating Income (Loss) $427 $54 ($14) ($754) ($232) ($285) ($241) $154 $1,155
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Case 15 Vehicle Routing at
Otto’s Discount Brigade
Matthew J. Drake, Duquesne University
Introduction
Otto’s Discount Brigade is a regional chain of discount stores mainly operating in southeast Ohio, with a few stores in West Virginia border towns. The firm operates a single distribution center in Cam- bridge, Ohio, located in close proximity to the intersection of Inter- states 70 and 77. The distribution center has small refrigerated and frozen sections to accommodate the small number of stock-keeping units (SKUs) that require these special conditions.
Otto’s Distribution Network
Every Otto’s store is only slightly larger than an average, stand- alone drugstore; thus, it is not practical for the stores to receive ship- ments directly from suppliers because the shipments would require expensive less-than-truckload (LTL) transportation, as well as dedi- cated receiving personnel to handle the steady stream of shipments each day. Instead, the Otto’s distribution center receives full truck- load shipments from all suppliers and builds mixed pallets of products
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from many different suppliers to fulfill orders from the individual stores.
Stores submit their orders to the distribution center by 5 p.m. each day, and the distribution center picks, packs, and ships them by 11 p.m. Although the mix of products ordered by each store dif- fers each day, the overall volume of each order (in number of mixed pallets) remains relatively constant. Exhibit 15.1 provides the typical daily demand requirements at each store.
Otto’s operates a private fleet of three refrigerated trucks with drivers that can each drive for a maximum of 11 hours per night. Each truck can accommodate a maximum of 26 standard pallets, which means that delivering all the freight specified in Exhibit 15.1 requires at least one truck to travel on two delivery routes each evening. The locations of Otto’s 15 stores, along with the distribution center, are depicted on the map in Exhibit 15.2 . Exhibit 15.3 provides the typical travel times in minutes between all the locations in Otto’s distribu- tion network. It is safe to assume that the travel times between two locations are the same in either direction because the deliveries from the distribution centers to the stores occur in the late evening, when there is no traffic to speak of in rural southeastern Ohio. The lack of traffic also means that there is little variation in the travel times between locations from night to night; thus, these travel times can be assumed to be deterministic.
Otto’s refrigerated trucks require approximately one gallon of fuel per hour to run the cooling units in addition to the fuel used to power the engine. With diesel prices near an all-time high and with no significant drop in fuel prices in sight, Otto’s VP of Operations has challenged his logistics manager to consider re-establishing the delivery routes to reduce the total travel time. Of course, any travel time saved would also lower Otto’s general fuel requirements (out- side of the refrigeration units) and provide even more cost reduction to enhance the firm’s profitability.
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CASE 15 • VEHICLE ROUTING AT OTTO’S DISCOUNT BRIGADE 183
Currently, Otto’s runs the following delivery routes each evening:
• Route 1: Cambridge–Zanesville–Pataskala–Mt. Gilead–Cam- bridge (25 pallets, 260 minutes)
• Route 2: Cambridge–Newark–Coshocton–Dover–Lisbon– Cambridge (24 pallets, 326 minutes)
• Route 3: Cambridge–Uhrichsville–East Palestine–Calcutta– Cambridge (24 pallets, 274 minutes)
• Route 4: Cambridge–Cadiz–Toronto–Weirton–Cambridge (21 pallets, 199 minutes)
• Route 5: Cambridge–Bellaire–New Martinsville–Cambridge (8 pallets, 195 minutes)
Route 2 is normally the only route that one truck will take in an evening. Another truck is assigned to Routes 1 and 4, and the third is assigned to Routes 3 and 5. The total travel time for all five routes is 1,254 minutes, or 20.9 hours per day.
Challenge for the Logistics Manager
In addition to reformulating the five delivery routes, the VP of Operations has also asked the logistics manager to see whether all of the daily deliveries can be covered by only four routes utilizing two of the three trucks (with a maximum travel time of 11 hours each). This additional consolidation would allow Otto’s to redeploy one of the truck drivers as a warehouse worker (to replace a staff member who just moved out of the area), while keeping him available in reserve to make deliveries when store orders exceed their typical volumes.
After looking at the recent load reports and the vehicle efficiency statistics, the VP of Operations has the feeling that Otto’s is over- spending on its delivery operations. The problem is that he does not have the day-to-day insight into the operations to identify possible
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remedies. He has challenged the logistics manager to identify oppor- tunities to improve the overall efficiency of the firm’s logistics net- work. The stores and the distribution center are all part of the same company; thus, the stores would have to comply with any ordering directives put forward by the corporate logistics department.
Exhibits
Exhibit 15.1 Daily Demand Requirements (in Pallets) for Each Otto’s Store Location Location Pallets per Day
Bellaire, OH 5
Cadiz, OH 5
Calcutta, OH 9
Coshocton, OH 4
Dover, OH 6
East Palestine, OH 10
Lisbon, OH 8
Mt. Gilead, OH 9
New Martinsville, WV 3
Newark, OH 6
Pataskala, OH 10
Toronto, OH 9
Uhrichsville, OH 5
Weirton, WV 7
Zanesville, OH 6
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Exhibit 15.2 Map of Otto’s Store Locations and the Cambridge, OH Distribution Center
Mt. Gilead
Newark
Dover
Coshocton
Toronto
East Palestine
Pataskala
Uhrichsville
Cadiz
Bellaire
New Martinsville
Weirton
Calcutta
Lisbon
Zanesville
Cambridge
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K Exhibit 15.3 Travel Times (in Minutes) Between Each Otto’s Store Location and the Distribution Center
Travel Times (in Min) Cambridge,
OH Bellaire,
OH Cadiz,
OH Calcutta,
OH Coshocton,
OH Dover,
OH East Palestine,
OH Lisbon,
OH
Cambridge, OH 0
Bellaire, OH 56 0
Cadiz, OH 56 46 0
Calcutta, OH 108 70 56 0
Coshocton, OH 47 94 70 119 0
Dover, OH 45 88 47 86 46 0
East Palestine, OH 129 93 79 23 130 90 0
Lisbon, OH 106 85 71 18 107 68 24 0
Mt. Gilead, OH 119 161 163 153 83 109 152 137
New Martinsville, WV 94 45 82 106 128 125 127 117
Newark, OH 62 105 105 154 44 81 165 142
Pataskala, OH 67 110 115 164 65 101 185 163
Toronto, OH 90 52 38 27 104 81 48 38
Uhrichsville, OH 43 77 33 82 43 20 100 78
Weirton, WV 84 46 32 33 98 75 55 44
Zanesville, OH 33 75 80 130 48 67 151 129
From the Library of Jikovey McCurdy
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Travel Times (in Min) Mt. Gilead,
OH New
Martinsville, WV Newark,
OH Pataskala,
OH Toronto,
OH Uhrichsville,
OH Weirton,
WV Zanesville,
OH
Cambridge, OH
Bellaire, OH
Cadiz, OH
Calcutta, OH
Coshocton, OH
Dover, OH
East Palestine, OH
Lisbon, OH
Mt. Gilead, OH 0
New Martinsville, WV 198 0
Newark, OH 72 142 0
Pataskala, OH 63 147 27 0
Toronto, OH 173 90 140 150 0
Uhrichsville, OH 119 114 80 99 65 0
Weirton, WV 174 83 134 144 21 60 0
Zanesville, OH 93 112 37 45 112 65 106 0
From the Library of Jikovey McCurdy
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From the Library of Jikovey McCurdy
ptg16258947
Index
A AAD (Assistant Art Director),
AGP Publishing Company, 86 ABS (acrylonitrile butadiene
styrene) plastic laptop cases, 113 , 115
life-cycle analysis, 116 AD (Art Director), AGP
Publishing Company, 86 advertising
direct mail, 19 email marketing, 20 FeedMyPet.com, 17 , 19 - 20 magazines/newspapers, 19 PPC (pay per click), 20 SEO (search engine optimiza-
tion), 20
189
telemarketing, 20 television, 19
AE (Assistant Editor), AGP Publishing Company, 85
aluminum availability, 113 greenhouse data, 129 industry information, 108 - 109 laptop cases, compared to
plastic, 113 - 116 laptops, 107 - 108 LCA data, 116 production, 114
ANOVA (analysis of variance), Pizza Station, 39
From the Library of Jikovey McCurdy
ptg16258947
190 INDEX
APG Publishing Company background, 84 - 85 history, 84 income statements,
samples, 97 independent contractors, 90
hiring decisions, 93 outside resources, 90 personnel availability, 96 printers, 88 production department,
85 - 86 production process, 86 - 89 production schedule, 89 - 92
budget buffer, 92 general processing
times, 95 problems in, 91 sales potential and, 91
terminology, 94 assets, value increase, 18 average growth rate, 8 - 9
B backordering
costs, 52 measuring, 50
BBLS (barrels sold), 5 BookMooch.com, 148 breweries
NBC (Narragansett Brewing Company), history, 101 - 103
questions, 6 -10
budget buffer, publishing
company, 92 inventory management
and, 51 overspending, 51 sales forecasting and, 11 St. Elizabeth Seton Catholic
Church, 27 - 30 business opportunities,
starting, 146
C CAGR (compound annual
growth rate), 109 cash flow, St. Elizabeth Seton
Catholic Church, 27 - 29 CE (consumer electronics)
Durable Aluminum Inc., 118 recycling, 112 - 113 take-back programs, 128
change, resistance to, 51 collegiate book swap. See
PaperbackSwap.com Commonwealth Pipeline
Company background, 77 - 78 connections and distance
between terminals, 77 facilities, 79
communication, Durable Aluminum Inc., 123
From the Library of Jikovey McCurdy
ptg16258947
INDEX 191
computer hardware Durable Aluminum Inc.
and, 111 market entry, 111 - 112
industry sales, 111 consumers, Durable Aluminum
Inc., 117 - 119 , 123 continuous order systems, 52 control chart, order errors
(Pizza Station), 39 COO (Chief Operations
Officer), AGP Publishing Company, 85
cost analysis, inventory, 68 - 69 craft brewing, 4 , 6 CTQ (critical to quality), 35 cumulative distribution
function, 67 Current State Map, Pizza
Station, 39 curves, 7 customer feedback, 34 customer satisfaction study, 35 customers, VOC (voice of the
customer), 35
D data analysis, methods, 173 databases, data analysis
and, 173 Decision Science, 93
design, Durable Aluminum Inc., integration of aluminum, 112
direct mail advertising, 19 distribution function,
cumulative, 67 Durable Aluminum Inc.
aluminum versus plastic laptop cases, 113 - 116
background, 109 - 110 case challenges, 125 computer hardware industry
and, 111 market entry, 111 - 112
income statement, 110 Laptop Strategic Planning
Team, 116 communication
strategy, 123 consumers, 117 - 119 environmental impact,
120 - 121 pricing, 121 - 122 product lines, 119 - 120 profitability, 121 - 122
laptops, 107 - 108 New Business Development
Initiative, 116 overview, 107 - 108 product design, integration of
aluminum, 112 recycling program, 123 - 124 sustainability, 110 waste minimization, 110
From the Library of Jikovey McCurdy
ptg16258947
192 INDEX
E email marketing, 20 environment
aluminum greenhouse data, 129
Durable Aluminum Inc., 120 - 121
enhanced recycling program, 123 - 124
recycling and, 122 plastic greenhouse data, 130
e-waste, recycling and, 112 - 113
F fashion retail, inventory
manage-ment, 65 feedback, 34 FeedMyPet.com
advertising campaign, 17 assets increase, 18 financial success,
maintenance, 18 - 19 IPO, 15 - 16 marketing, 17 , 19 - 20 operating margins, 19 overview, 15 - 17
financial performance measures, 50
forecasting benefits, 11 offertory revenue, 25
Ska Brewing Company, 3 , 6 - 9 fractional charge per short
unit, 52 fundraising, St. Elizabeth
Seton Catholic Church, 29 Future State Map, Pizza
Station, 40
G Global Supply Chain
Operations, 48 financial performance
measures, 50 inventory management,
49 , 52 financials and, 50 order systems, 52 SKUs, 50
SKU, 50 greenhouse data
aluminum, 129 plastic, 130
growth average growth rate, 8 - 9 median growth rate, 8 - 9 percentage growth, 8
H HealthCare
balance sheet, 134 - 141 Corporate Social
Responsibility program, 135
From the Library of Jikovey McCurdy
ptg16258947
INDEX 193
energy saving project assumptions, 140 - 137
history, 133 - 134 HVAC systems, 136
expenses, 137 income statement, 139 - 134 interior tile replacement,
137 - 138 expenses, 142 - 138
mission statement, 139 sustainability, coordinator,
131 - 133 tree replacement, 136 - 137
expenses, 137 vision, 134 website information, 139
HVAC (heating, ventilation, and air conditioning) system, 136
I implementation plans, Pizza
Station, 40 income statements, Durable
Aluminum Inc., 110 independent contractors,
publishing company, 90 hiring decisions, 93
inventory cost analysis, 68 - 69 inventory management
backorder costs, 52 backordering, 50
budget and, 51 cumulative distribution
function, daily demand, standard
deviation , 66 , 73 fashion retail, 65 financials and, 50 fractional charge per short
unit, 52 Global Supply Chain
Operations, 49 holding costs, 52 order systems, 52 overstock, safety stock levels
and, 68 replenishment lead time, 67 safety stock formula, 69 safety stock level, 66 , 67
overstock and, 68 saving, quantity, 68 savings, 68 service targets, 67 shortage cost, 52 SKUs, 50 stockout, 52 target inventory service level,
66 - 67, 75 transaction costs, 52
IPO (initial public offering) FeedMyPet.com, 15 - 16 PaperbackSwap.com, 157
IT rollup, 156
From the Library of Jikovey McCurdy
ptg16258947
194 INDEX
J -K Joe's Coin Shop, 167
balance sheet, 178 data analysis, 172 - 174
client count, 174 main question
responses, 175 history, 167 - 169 market survey, 169 - 170 online auctions
market costs, 170 - 172 seller fees samples, 171
online auctions and, 170 statement of operations, 174
JTMC inventory levels, 66
daily demand, 66 target inventory service
level, 75 inventory management, 66 - 69 overview, 65 - 66 safety stock, 67
L laptops, aluminum cases versus
plastic, 113 - 116 LCA (life-cycle analysis),
ABS (acrylonitrile butadiene styrene), 116
Lean Principles, 35
M MAD (mean absolute
deviation), 8 magazine/newspaper
advertising, 19 MAPE (mean absolute
percentage error), 8 marketing
direct mail, 19 email marketing, 20 FeedMyPet.com, 17 , 19 - 20 magazines/newspapers, 19 PPC (pay per click), 20 SEO (search engine optimiza-
tion), 20 telemarketing, 20 television, 19
ME (Managing Editor), AGP Publishing Company, 85
median growth rate, 8 - 9 monthly data, Ska Brewing
Company, 9 - 11
N NBC (Narragansett Brewing
Company) community fit, 104 distribution center, 103 - 106 history, 101 - 103 keg facility, location decision,
103 - 106
From the Library of Jikovey McCurdy
ptg16258947
INDEX 195
operating costs, location and, 104
space needs, 103 - 106 Nyiri Desert trip, 161 - 163
O offertory revenue forecasting,
25 - 27 past data, 30
online market costs, 170 - 172 operating costs
FeedMyPet.com, 19 NBC (Narragansett Brewing
Company), location and, 104 order systems
continuous, 52 periodic review, 52
Otto's Discount Brigade, 181 daily demand requirements,
184 - 182 delivery, 182 - 183
logistics, 183 spending, 184 travel times, 182 - 187
distribution, 181 - 183 locations map, 182 overview, 181 refrigerated trucks, 182
outliers, growth rates, 8 - 9 overspending, 51 overstock, safety stock levels
and, 68
P PaperbackSwap.com, 143 , 146
book requests per day, 147 BookMooch.com, 148 business model, 149 - 153
extendibility, 154 credits, 147 financial structure, 155 future risks, 155 - 157 history, 143 initial operations, 146 - 147 launch date, 147 map of unique zip codes, 150 model, 154 origins, 144 - 145 postage payment, 147 revenue sources, 150
book journal, 151 box-o-books, 151 credits, 150 postage, 151 - 152
revenues for 2006, 155 SwapaCD.com, 154 SwapaDVD.com, 154 target market, 149 - 150 TitleTrader.com, 149 Unclaimed Baggage
Center, 147 value proposition, 152
community, 153 customer service, 152 - 153
percentage growth, 8
From the Library of Jikovey McCurdy
ptg16258947
196 INDEX
performance, financial performance measures, 50
periodic review order systems, 52
Pizza Station analysis, 38 - 40 assembly system, 36 - 37 background, 33 - 36 baking system, 37 boxing system, 37 - 38 cutting system, 37 - 38 delivery system, 38 labeling system, 37 - 38 ordering system, 36 storage, 38 supplies, 38
plastic ABS (acrylonitrile butadiene
styrene), 115 life-cycle analysis, 116
greenhouse data, 130 production, 114 - 115
PM (Production Manager), AGP Publishing Company, 86
PPC (pay per click), marketing and, 20
printers, APG Publishing Company, 88
process, VOP (voice of the process), 35
product design, Durable Aluminum Inc., integration of aluminum, 112
production schedule, publishing company, 89 - 92
publishing firm S ee also APG Publishing
Company industry overview, 82 - 83 introduction, 81 - 82 terminology, 94
Q quality, CTQ (critical to
quality), 35
R recycling
CE (consumer electronics), 112 - 113
Durable Aluminum Inc., 122 enhanced recycling
program, 123 - 124 replenishment lead time, 67 resistance to change, 51
S safety stock level, 69 , 67
target inventory service level and, 66
From the Library of Jikovey McCurdy
ptg16258947
INDEX 197
sales, production schedule and, publishing company, 91
sales forecasting benefits, 11 Ska Brewing Company, 3
annual data, 6 - 9 monthly data, 9 - 11
scatter plots, 6 - 7 sales forecasting, 6 -7
schedules, production schedule, publishing, 89 - 92
SEO (search engine optimization), marketing and, 20
shortage cost, 52 Ska Brewing Company, 3
annual data, 6 - 9 background, 3 - 4 BBLS (barrels sold), 5 mission, 5 monthly data, 9 - 11
SKU, 50 spreadsheets, data analysis
and, 173 St. Elizabeth Seton Catholic
Church, 25 cash flow analysis, 27 - 29 fundraising, 29 history, 26 - 27 overview, 25 - 26 past data, 30
Steamworks Brewing Company, 4
stockout, 52 sustainability, 118
aluminum greenhouse data, 129
Durable Aluminum Inc., 110 , 118
HealthCare, 131 plastic greenhouse data, 130
SwapaCD.com, 154 SwapaDVD.com, 154
T Takt time, Pizza Station
ordering, 39 target inventory service level,
66 -67, 75 overstock and, 68
telemarketing, 20 television advertising, 19 tile replacement, 137 - 138 TitleTrader.com, 149 tree replacement, 136 - 137 trendlines, 7
U Unclaimed Baggage Center,
PaperbackSwap.com and, 147 used books, 143 . See also
PaperbackSwap.com
From the Library of Jikovey McCurdy
ptg16258947
198 INDEX
V venture capitalists, IT
rollup, 156 VOC (voice of the
customer), 35 VOP (voice of the process), 35
W WM (Warehouse Manager),
AGP Publishing Company, 86
X-Y-Z X-bar-R chart, Pizza Station
pizza thickness, 39
From the Library of Jikovey McCurdy
- Table of Contents
- Preface
- Part 1 Forecasting and Process Analysis
- Case 1 Forecasting Sales at Ska Brewing Company
- Case 2 Maintaining Financial Success and Expanding into Other Markets at FeedMyPet.com
- Case 3 Forecasting Offertory Revenue at St. Elizabeth Seton Catholic Church
- Case 4 Pizza Station
- Part 2 Optimization and Simulation
- Case 5 Inventory Management at Squirrel Hill Cosmetics
- Case 6 Safety Stock Planning for a Hong Kong Fashion Retailer
- Case 7 Network Design at Commonwealth Pipeline Company
- Case 8 Publish or Perish: Scheduling Challenges in the Publishing Industry
- Part 3 Decision Analysis
- Case 9 Narragansett Brewing Company: Build a Brewery
- Case 10 Aluminum Versus Plastic: A Life-Cycle Perspective on the Use of These Materials in Laptop Computers
- Case 11 HealthCare’s Corporate Social Responsibility Program
- Case 12 PaperbackSwap.com: Got Books?
- Case 13 Stranded in the Nyiri Desert: A Group Case Study
- Part 4 Advanced Business Analytics
- Case 14 Joe’s Coin Shop: Entry into Online Auctions
- Case 15 Vehicle Routing at Otto’s Discount Brigade
- Index
- A
- B
- C
- D
- E
- F
- G
- H
- I
- J-K
- L
- M
- N
- O
- P
- Q
- R
- S
- T
- U
- V
- W
- X-Y-Z
