Answered Essay: Carlos Ramos, head of supply chain at KAR Foods, wondered why his inventories had not declined despite the significant improvement his team had made in its ability to handle mixed-load and small lot orders from custom

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Question: Carlos Ramos, head of supply chain at KAR Foods, w…

Carlos Ramos, head of supply chain at KAR Foods, wondered why his inventories had not declined despite the significant improvement his team had made in its ability to handle mixed-load and small lot orders from customers. He felt that the problem was the discounting scheme offered by the sales team that encouraged customers to place large orders. Carlos arranged for a meeting with Vanessa Rebelo, head of sales and marketing, to discuss future plans.

Historical Pricing and Costs at KAR

KAR was a large Brazilian food processing company, headquartered in São Paulo, that produced fresh and processed meats. Starting as a slaughterhouse, the company had become a major global player after several acquisitions across the world. The company sold its products to several supermarket chains within Brazil. A typical supermarket chain purchased 10,000 kg of meat each month at a price of 4 real/kg from KAR. KAR incurred a cost of 2.50 real/kg to produce the meat. KAR operations were set up to produce at a steady rate that matched demand. Historically, KAR had encouraged its customers to order in large lots by offering quantity discounts of 2 percent (a price of 3.92 real/kg instead of 4 real/kg) if customers ordered lots of 27,500 kg or more. The quantity discounts were justified by the high fixed cost of 4,000 real that was incurred by KAR to process, load and deliver each order.

Supply Chain Improvements at KAR

As the company grew, it became clear that supply chain operations required significant improvement to compete with other multinationals that were entering the Brazilian market. Carlos Ramos was hired to lead this effort, given his extensive experience in the consumer packaged goods industry. A quick review of the status quo by Carlos identified several opportunities for improvement. He decided to focus on the large amount of inventory that was built up to fill customer orders. A reduction in inventory would free up capital and expensive cold storage space, and would also streamline operations. At

the current holding cost of 20 percent, reduction in inventories could save a significant amount in overall holding costs. He quickly realized that the inflexibility of the current distribution system resulted in the high cost of 4,000 real to process, load, and deliver each order. Carlos changed processes and invested in technology to increase flexibility and make it cheaper to handle mixed loads. He also brought in routing software that made it easier to plan deliveries to multiple customers on a single truck. This helped reduce the fixed cost per customer order down to 400 real. Carlos hoped that these improvements would significantly reduce lot sizes and thus inventory.

Costs Faced by Customers

Given that there was very little decrease in lot sizes and inventories, Carlos wanted to understand why things had not changed. Before his meeting with Vanessa, he sought to learn about the costs faced by supermarket chains ordering from KAR Foods. He learned that each supermarket chain itself incurred a fixed cost of 100 real associated with each order. This fixed cost was incurred for order placement and receiving. He also learned that each supermarket chain incurred a holding cost of 20 percent.

2)Once KAR has reduced its fixed cost per order to 400 real, what are the downsides to leaving the discounting scheme unchanged?

Expert Answer

 

There are few downsides in leaving the discounted scheme unchanged. Say If KAR reduces its fixed cost per order to 400 Real, and keeps the discounting routine as it is in place, then supermarket chains will still continue to order lots of 27,500 kg of meat.

If the Lot sizes of 27,500 kg of meat is ordered, then it means, that it results in an annual order plus the holding cost of $8,620 real for KAR.

If there wasn’t a quantity discount, then supermarket chains would order lot sizes of 5,477 which would produce an annual order plus the holding cost of 10,132 Real for KAR.

Although, getting customers to order in lots of 27,500 will reduce the order plus the holding cost for KAR by 1,512 Real, the total discount given by KAR for this is 2% of sales is 0.02*10,000*4 = 9,600 Real.

Hence, after making supply chain improvements by reducing the fixed costs per order, KAR will be losing money by continuing to offer a quantity discount to its customers. So, the downside is, that KAR cannot make money or profit by offering quantity discounts.

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