At the end of 2018, Peter Perlman and his management team were busy evaluating the performance of Gadget.com for the year. Total demand had grown by over 2200 percent since business began in 2009. This growth, however, was a mixed blessing. The venture capitalists supporting the company were very pleased with the growth in sales and the resulting increase in revenue. Peter and his team, however, could clearly see that costs would grow faster than revenues if demand continued to grow and the supply chain network was not redesigned. They decided to analyze the performance of the current network to see how it could be redesigned
to best cope with the rapid growth anticipated over the next three years up to 2021.
GADGET.COM
Peter Perlman founded Gadget.com in Missouri of the United States in 2009 with a mission of supplying the techno savvy millennials with affordable consumer electronic gadgets. Like any other perishable consumer products, trendy electronic gadgets can become obsolete very quickly. So, if they are too expensive, consumers will be reluctant to purchase them. Perlman’s initial plan was for the company to purchase the relatively cheap but still with acceptable quality trendy gadgets from China and sell these over the Internet. The idea was very well received in the marketplace, demand grew rapidly, and by the end of 2009 the company had sales of $0.8 million. By this time a variety of products were being sold and the company received significant venture capital support. In June 2009, Sanjay leased part of a warehouse in the outskirts of St. Louis to manage the large amount of product being sold. Suppliers sent their product to the warehouse. Customer orders were packed and shipped by UPS from there. As demand grew, Gadget.com leased more space within the warehouse. By 2018, Gadget.com leased the entire warehouse and orders were being shipped to customers all over the United States. Management divided the United States into six customer zones for planning purposes. As the demand grows, management is thinking of renting more warehouses in St. Louis and/or other cities. Putting all the warehouses in St. Louis – a centralized distribution design – might be more efficient and easier for coordination while placing the warehouses in different cities – a decentralized distribution design – might provide more responsive customer services. The total demand from 2009 to 2018 is shown in Table 1 whereas Table 2 shows the demand from each customer zone in 2018. Perlman expected that the current growth in total demand would continue up to 2021, after which demand would level off. The growth rates are estimated to be 80%, 50% and 20% in 2019, 2020, and 2021 respectively. He also believed that the distribution of the total demand across the six customer zones would be similar to that of 2018.
Table 1: Total Customer Demand from 2009 to 2018
Year Total Demand
2009 62,000
2010 71,000
2011 103,000
2012 123,000
2013 168,000
2014 237,000
2015 356,000
2016 534,000
2017 857,000
2018 1,455,000
Table 2: Regional Demand at Gadget.com for 2018
Zone Demand in 2018
Northwest 340,000
Southwest 220,000
Upper Midwest 155,000
Lower Midwest 260,000
Northeast 310,000
Southeast 170,000
THE NETWORK OPTIONS
Perlman and his management team could see that they needed more warehouse space to cope with the anticipated growth. One option was to lease more warehouse space in St. Louis itself. Other options included
leasing warehouses all over the country. Leasing a warehouse involved fixed costs based on the size of the warehouse and variable costs that varied with the quantity shipped through the warehouse. Four potential locations for warehouses were identified in Denver, Seattle, Atlanta, and Philadelphia. Warehouses leased could be either small (about 100,000 sq. ft.) or large (200,000 sq. ft.). Small warehouses could handle a flow of up to 2 million units per year, whereas large warehouses could handle a flow of up to 4 million units per year. The current warehouse in St. Louis is a small one. The fixed and variable costs of small and large warehouses in different locations are shown in Table 3. The variable cost is associated with order processing.
Table 3: Fixed and Variable Costs of Potential Warehouses
Location Small Warehouse Large Warehouse
Fixed Cost ($ / year) Variable Cost ($ / unit) Fixed Cost ($ / year) Variable Cost ($ / unit)
Seattle 280,000 0.20 500,000 0.20
Denver 240,000 0.15 405,000 0.15
St. Louis 230,000 0.25 365,000 0.25
Atlanta 220,000 0.20 370,000 0.20
Philadelphia 250,000 0.25 410,000 0.25
Perlman estimated that the inventory processing costs at a warehouse was about $450,000Y + 0.17F, where F is the number of units flowing through the warehouse per year. Y = 1 if the facility is used, 0 otherwise. Thus, a warehouse handling 1,000,000 units per year incurred an inventory handling cost of $620,000 in the course of the year. Individual inventory handling costs could then be lumped together to form the total inventory handling cost of all the warehouses in a city.
Gadget.com charged a flat fee of $3 per order from the customers. An average customer order contained three units. Gadget.com in turn contracted with UPS to handle all its outbound shipments. UPS charges were based on both the origin and the destination of the shipment and are shown in Table 4. Management estimated that inbound transportation costs for shipments from suppliers were likely to remain unchanged, no matter what warehouse configuration was selected.
Table 4: UPS Charges per Shipment (Three Units)
Northwest Southwest Upper Midwest Lower Midwest Northeast Southeast
Seattle $2.10 $2.60 $3.40 $4.10 $4.80 $5.20
Denver $2.60 $2.60 $2.60 $3.10 $4.10 $4.40
St. Louis $3.40 $3.40 $2.60 $2.60 $3.10 $3.40
Atlanta $4.10 $4.10 $3.10 $2.60 $3.10 $2.60
Philadelphia $4.40 $4.80 $3.10 $3.40 $2.60 $4.10
CASE QUESTIONS
What will the total costs for Gadget.com be in 2019, 2020 and 2021 under each of the following options?
Keeping the existing small warehouse in St. Louis with additional warehouse(s) all rented in St. Louis as well;
Keeping the existing small warehouse in St. Louis with additional warehouse(s) all rented in other cities, i.e., in St. Louis there is only one small warehouse; and
Not keeping any warehouse in St. Louis with new warehouses all rented in other cities.
Based on the findings of Q1, which option would you recommend to Gadget.com for the next three years from 2019 up to 2021 entirely from a cost saving perspective?
If Gadget.com decides that there is no need to adopt the lowest cost option if there is strong justification for using another option, will you change your recommendation? If yes, which option will you recommend and why? Support your argument with a good discussion using some relevant references.
To simplify administrative work, Gadget.com is thinking of not charging a shipment fee from customers but asking them to pay the shipment charges directly to UPS based on origin and destination using the rates shown in Table 4. In other words, shipment cost will be totally borne by the customers. With this idea in mind, will you change your recommendation in Q2? If yes, which option will you recommend and what will the supply network configurations in 2019, 2020 and 2021 be? If not, why?
