Answered Essay: Paper2Go.com Colleen Starky never thought she would be able to sell paper products to consumers

   Paper2Go.com

Colleen Starky never thought she would be able to sell paper products to consumers on the Internet. However, after five years in business Paper2Go.com has reached $75 million in revenue. Paper2Go specializes in shipping paper-related products to consumers, including diapers, paper towels, and facial tissue from numerous suppliers. Because these items have a low margin, Colleen knows she needs to control costs and at the same time have high service levels.

Paper2Go receives 500,000 orders annually with an average revenue per order of $150 and an average profit per order of $90. Paper2Go’s current order fill rate is

92 percent. Colleen estimates that of the orders not filled correctly or completely, 15 percent of the customers cancel their orders and 85 percent will accept a reshipment of the correct/unfilled items. This rehandling costs Paper2Go $15 per order and is only applicable on the reshipped orders. In an effort to retain customers, Paper2Go reduces the invoice value of rehandled orders by $30.

Paper2Go pays $2,500,000 for transportation, both inbound to and outbound from its warehouses. Its warehousing costs are $1,950,000 annually. Paper2Go has $40 million of debt at an annual interest rate of 12 percent. Other operating costs are $1 million per year and Paper2Go maintains $100,000 in cash at all times.

Paper2Go has an average inventory of $6.7 million. This level of inventory is necessary to help fill consumer orders correctly the first time. The inventory carrying cost rate is 30 percent of the average inventory value per year. Its accounts receivable averages $350,000 per year. Paper2Go owns three warehouses that are valued in total at $85.7 million. The net worth of Paper2Go is $45 million.

Colleen has decided that a 92 percent order fill rate is not acceptable in the market and lost customers and rehandled orders are negatively affecting profits. She has decided to invest $1 million in a new stock locater system for the warehouses, increase inventories by 10 percent, and increase the on-time delivery of inbound shipments by contracting with a new carrier. This carrier upgrade will increase total transportation costs by 10 percent. Colleen hopes these changes Will increase the order fill rate to 98 percent. Paper2Go faces a current tax rate of 35%.

CASE QUESTIONS

1. You are the logistics analyst at Paper2Go.com and have been asked to do the following:

a.    Calculate the financial impact of increasing order fill rates to 98 percent from 92 percent.

. Discuss how you would Calculate the financial impact of increasing order fill rates to 98% from 92% (The actual calculation is part of the case Study assignment)

* For COGS calculation – Assume 45% of sales = $67.50 per order

b.    Develop a strategic profit model of both the old system and the modified system that reflects the suggested adjustments

Expert Answer

Answer

1)

Order fill rate 92% Order fill rate 98%
Annual orders (AO) 500,000 500,000
Orders filled correctly (OFC = AO * On time rate) 460,000 490,000
Service failure orders (SF = AO – OFC) 40,000 10,000
Lost sales rate (LSR) 15% 15%
Lost sales orders (LS = SF * LSR) 6000 1500
Rectified orders (RO = SF – LS) 34,000 8500
Net orders sold (NOS = AO – LS) 494,000 498,500
Sales (S = Selling price per order * AO) 75,000,000 75,000,000
Less : Invoice deduction (ID = Invoice deduction per service failure * RO) 1,020,000 255,000
Lost sales revenue(LR = LS * Selling price per order) 900,000 225,000
Net sales (NS = Sales – ID – LR) 73,080,000 74,520,000
Cost of goods per order (CG = Selling price – Gross margin per order) 67.50 67.50
COGS = CG * NOS 33,345,000 33,615,000
Gross margin(GM) = NS – COGS 39,735,000 40,905,000
Average inventory 6,700,000 7,370,000
Rehandling cost (Rehandling cost per order * SF) 600,000 150,000
Transportation 2,500,000 2,750,000
Warehouse 1,950,000 1,950,000
Inventory Carrying(Avg inventory * Inventory carrying cost rate) 2,010,000 2,211,000
Other operating cost 1,000,000 1,000,000
Total operating cost 8,060,000 8061000
EBIT (GM – Total operating cost) 31,675,000 32,844,000
Interest = 40% of 40,000,000 16,000,000 16,000,000
EBT 19,380,000 20,549,000
Tax (35% * EBT) 67,83,000 71,92,150
Net income (EBIT – Interest – tax) 8,892,000 9,651,850

With the increasing order fill rate, the net income of the company will increase to 9,651,850

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