production and operations management
production and operations management
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SUPPLY CHAIN STRATEGY VS. SALES STRATEGY TO ACHIEVE A TARGET PROFIT
Hau Lee Furniture, Inc., spends 60% of its sales dollars in the supply chain and has a current gross profit of $10,000. Hau wishes to increase gross profit by $5,000 (50%). He would like to compare two strategies: reducing material costs vs. increasing sales.
APPROACH Use the table below to make the analysis.
SOLUTION The current material costs and production costs are 60% and 20%, respectively, of sales dollars, with fixed cost at a constant $10,000. Analysis indicates that an improvement in the supply chain that would reduce material costs by 8.3% ($5,000/$60,000) would produce a 50% net profit gain for Hau; whereas a much larger 25% increase in sales ($25,000/$100,000) would be required to produce the same result.
CURRENT SITUATION |
SUPPLY CHAIN STRATEGY |
SALES STRATEGY |
|
Sales |
$100,000 |
$100,000 |
$125,000 |
Cost of materials |
$60,000 (60%) |
$55,000 (55%) |
$75,000 (60%) |
Production costs |
$20,000 (20%) |
$20,000 (20%) |
$25,000 (20%) |
Fixed costs |
$10,000 (10%) |
$10,000 (10%) |
$10,000 (8%) |
Profit |
$10,000 (10%) |
$15,000 (15%) |
$15,000 (12%) |
INSIGHT Supply chain savings flow directly to the bottom line. In general, supply chain costs need to shrink by a much lower percentage than sales revenue needs to increase to attain a profit goal. Effective management of the supply chain can generate substantial benefits.
LEARNING EXERCISE If Hau wants to double the original gross profits (from $10,000 to $20,000), what would be required of the supply chain and sales strategies? [Answer: Supply chain strategy = 16.7% reduction in material costs; sales strategy = 50% increase in sales.]
Hau Lee Furniture, Inc., described in Example 1 of this chapter, finds its current profit of $10,000 inadequate. The bank is insisting on an improved profit picture prior to approval of a loan for some new equipment. Hau would like to improve the profit line to $25,000 so he can obtain the bank’s approval for the loan.
a) What percentage improvement is needed in the supply chain strategy for profit to improve to $25,000? What is the cost of material with a $25,000 profit?
b) What percentage improvement is needed in the sales strategy for profit to improve to $25,000? What must sales be for profit to improve to $25,000?