Cost Management and Supply Chain Management - Case Study Example

RUNNING HEAD: COST MANAGEMENT ANALYSIS Cost Management Analysis Institution Name May, 2012 Cost Management Analysis Group Assignment Executive Summary Supply chain management is one of the most important aspects in the operations of most corporate organizations. Any management flaws in this division will impact negatively on the operations of the business. Woolworth (WOW) is among the many corporate organizations whose operations depend entirely on efficient supply chain system. It has been proposed that WOW converts its current direct store delivery (DSD) to Distribution Centers (DCs) in the hope that WOW will gain rebates as well as saving on diesel fuel. This analysis finds that WOW will benefit a lot when this move is approved as the rebates gained will be much higher than the supply chain costs. This report also proposes the study on introduction of electric refrigeration be moved to feasibility stage as it is a sure and efficient way of energy saving initiative. The cost parameters such as COGS, NPV, IRR, GP and capital expenditure are set to show positive improvements through this initiative. Introduction In the modern business operations, it is typical of all executives and managers to account for cost. In a variety of ways, all business professionals control cost, and the majority managers take on capital investment resolution, projections, pricing, and product or service administration. This paper focuses on the cost management analysis of Woolworth Limited on behalf of the Finance director. This analysis involves two stages; a feasibility assessment stage that will focus on beer distribution and transport and the second is concept development stage that will focus on project for energy efficiency initiative. Feasibility Assessment Stage Beer Distribution and Transport This feasibility assessment stage is based on the following business operational activity; currently there is a direct store delivery (DSD) to Woolworth’s liquor stores from the brewers. Now in the ongoing negotiations, there is a proposal to convert this stock keeping units deliveries to delivering into Woolworths distribution centers. This is hoped to result into cost savings for the beer brewers as well as for Woolworths Limited. In the context of Woolworth, would this conversion really lead to cost savings? In actual sense Woolworth would incur extra costs relating supply chain as a result of handling the beer in its distribution centers as well as transporting the beer into its stores (Gokhan and Needy, 2010). Nonetheless, the brewers argue that they would have reverse supply chain cost savings, which they would partially transfer to Woolworths by a purchase price discount; that is, a drop off in the cost of each carton of beer. According to (Hugos, 2011), reciprocated value conception would come about if the rebate was more than the additional costs to Woolworths and also lesser than the brewer cost savings. Value Creation to Woolworth Limited from the proposed supply chain conversion This move presents some cost advantages to Woolworth Limited. Woolworth is characterized with superior pallets utilization of 100% compared with the brewers 75% utilization (Annual Report, 2011). This is also coupled with large trucks that have a maximum capacity of 36 pallets. This superior pallet utilization and truck productivity would imply significant diesel fuel savings from the supply chain conversion. According to (Woolworths Limited – Business Case and Beyond), overall about $1.5bn is estimated to be spent annually on diesel fuel by Woolworth. This conversion has probability of impacting on some aspects of the Woolworth supply chain. In each of the five mentioned distribution centers, there is adequate capacity to handle the delivered beer. Based on financial modeling in projection of the future supply chain outlook, the centers will have reached a full capacity in the tenth year (Wisner, 2011). In this regard the company will have to incur the cost of acquiring new forklifts for these distribution centers and this would be a short term fixed cost alteration (Sehgal, 2009) and (Rosenbaum, 2012). The table below shows the figures for the FY13 fixed cost per carton (FCPC) and variable cost per carbon (VCPC) sourced from the projections in the current WOW rolling forecast. Projected FY13 WOW Costs Per Carton - excl DSD beer Volume     DC Costs Into-Store Transport Costs WOW DC FCPC VCPC FCPC VCPC Sydney 0.5 0.31 0.1 0.4 Melbourne 0.45 0.32 0.11 0.41 Brisbane 0.4 0.33 0.12 0.38 Adelaide 0.475 0.34 0.13 0.42 Perth 0.425 0.35 0.09 0.37 The projected fixed cost per carton and variable cost per carton is set to increase as graphical showed above. This is due to the additional cost involving IT where existing systems would need re-designing at a considerable cost, transition costs and ongoing management costs (Gattorna, 1998). The DSD carton volume estimated for FY13 is arrived at as based on the extract from the excel spreadsheet if the project adopted is expected to take place during the same financial year. Using the results from FY11, the results for FY 13 will be obtained. That is, it is estimated that 25% will be realized on every carton of beer sold with the other liquors realizing the same mark up percentage. Therefore, the actual revenue will increase by 25% in the FY13. In this case, the volume of cartons moved in 2013 financial year would be: Liquor % of sales Liquor sales Actual Revenue 25% Increase in Revenue Volume of carton moved in FY13 Beer 40% 36176 14,470.40 18,088.00 452.20 Wine 35% 36176 12,661.60 15,827.00 395.68 Spirits 20% 36176 7,235.20 9,044.00 226.10 others 5% 36176 1,808.80 2,261.00 56.53           Therefore, the total volume of cartons that will have been moved in FY 13 is 1130.51 million. This compared with the FY11 that operates under DSD is slightly higher an indication of effective supply chain system (Nagurney, 2006). However, the volume is not as high and beneficial in relation to the negative consequences of the converted supply chain. Revenue from attached liquor stores: 70% of 36176 = 25,323 and Volume of DSD beer from two brewers: 85% of 14470.4 = 12,299.84 c) The into-store transportation distance would be estimated as follows; for two ways the distance would be 80kms between a DC and a store. There are five different DCs serving a total of 811 WOW supermarkets (excluding Tasmania) in Australia (Annual Report, 2011 pp. 22-25). Only 60% of the supermarkets (487 stores) have an attached liquor store. On average this would mean that each DC serves close to 162 supermarket stores. Hence, the distance covered by each DC would be 12976kms, and the overall distance covered by the five DCs would be 64880kms. This means that the extra mileage realized may not prove to be a cost saving measure for Woolworth limited as the trucks will consume much diesel fuel in delivering the goods to the supermarket stores. That notwithstanding, as new supply chain operations get streamlined, the revenue and profitability margin would start to sour higher on condition that the projected growth and expansions plans would be fulfilled (Hugos, 2011). There is the common believe that the conversion of DSD to WOW distribution center would ensure that rebate is transferred to WOW and According to Sehgal (2009), the question would be is the rebate to WOW more than the increased supply chain cost. This will be explained clearly by financial way of financial modeling. Estimated carton Volume of the DSD beer in FY13 The estimated volume of beer in 2011 was 361.the 25% increase in revenue was as a result of conversion which raised the volume of beer to be (125% x 14,470)/40 =452.20. The allocation is based on rate of output in revenue by different DCs. DC with high volume allocation leads in revenue output and vice versa. This is supported by annual report under segment reports. a) The Estimated carbon volume of the DSD beer in FY13 WOW DC DSD beer conversion - carton volume Sydney 11,713,557.6377 Melbourne 9,324,910.5900 Brisbane 8,911,490.9087 Adelaide 3,491,099.5312 Perth 3,812,648.1723 National 37,253,706.8400 b) The total incremental handling and processing cost for WOW in FY13: The main interest is the DCs as they are the ones affected directly by the conversion. Costs allocation is estimated based on rate of revenue output. For store and in-store estimation is based on the fact that their costs related to the conversion cannot be higher than that of the DCs and is as well based on regional revenue output. c) Incremental handling and processing costs for WOW in FY13 on a per carton basis: d) The fully costed handling and processing costs for WOW in FY13 on a per carton basis e) The FY13 rebate per carton that needs to meet the WOW hurdle rate of 12.5% (that is, the minimum IRR at which WOW approves projects) From this financial model showing actual rebate that WOW would obtain in the next seven years of business operation, it is clear that the rebates amounts are way higher than the total supply chain costs (that is, the DC, into store transportation cost, store cost and other national cost). The net present values as well as the internal rate of returns also show a strong financial position of WOW despite the changes in supply chain system. It shows that the cost incurred in acquisition of capital assets would result to hefty returns in the next financial years. EBIT in the reporting period would additionally reduce by charges related to optimizing and repositioning the business operations of supermarket stores. The decline in EBIT would be primarily due to the increased cost of risk (Rosenbaum, 2012). However, the seven year projected EBIT values shows the possibility of the company running into debts regarding supply chain costs but this would be mitigated by the rebates the company will enjoy from the two brewers under the new supply chain system (Rosenbaum, 2012). f) The FY13 rebate value per carton that would be needed to deliver EBIT of $22.0m in FY15 is 2.5450. g) In the financial models, both per carton fixed and variable costs of beer are the sensitive variables. They are sensitive because the rebate values depend on the total values. When per carton fixed and variable costs of operating the conversion supply chain goes higher the rebate values would diminish and hence the new system of supply chain would prove less beneficial. However, when these costs remain low, the rebate values would be adequate for WOW and prove the new supply chain model as beneficial in terms of cost saving. As-Yet Undetermined Project Energy Efficiency Initiative The annual energy consumption of WOW is way above 0.5 Peta Joules (PJ) which is the maximum recommended consumption amount by t he energy governing bodies. Hence according to the legislation WOW is supposed to embark on a meticulous and wide-ranging assessment of its energy use and recognize effective cost savings chances (Energydsm.com, 2010) and (Cooremans, 2011). This is a yet to be determined project on energy efficiency and proposes the best initiative for saving on energy use. As a big win to WOW, this energy saving initiative proposes a process change for WOW. The area that needs this process change is in the use of diesel in refrigeration trucks. This should be changed by using electricity in refrigeration when the tracks are packed. This is proposed because the cost making a larger part of WOW expense is fuel (Greening, 2009) and (Richard, 2007). With the current escalating price of fuel means that the EBIT will continue to remain lower and lower. This proposal assumes that the cost of energy will reduce by a rate of 5% during the first year of changes and thereafter by 1.5% each year after the inclusion of conversion of DSD to DCs. The figures were obtained from the 2011 annual year and they are in million US Dollars. The actual workings is shown in the excel spread sheet and the extract is given below; Year 2011 2012 2013 2014 2015 2016 Sydney 3 2.85 2.7075 2.572125 2.443518 2.321342 Melbourne 2.8 2.66 2.527 2.40065 2.280618 2.166586 Brisbane 2.6 2.47 2.3465 2.229475 2.118 2.012101 Adelaide 2.75 2.6125 2.481875 2.35778 2.23989 2.127897 Perth 2.3 2.07575 1.971963 1.873364 1.779696 1.69071 Total 13.45 12.6683 12.0348 11.4334 10.8617 10.3186 Assuming that this move will lead to a 5% decrease in cost of goods available for sales and CODB as well as a 5% increase in capital expenditure, EBIT, GP, NPV and IRR, the outcome will be as shown below. Example; COGS; FY12 40x95% = 38; FY13 38x95% = 36.1 CODB; FY12 11.342x95% = 10.7749 CODB in this proposal include branch expenses, administrative expenses and financial expenses. ITEM FY11 FY12 FY13 FY14 FY15 FY16 COGS 40 38 36.1 34.295 32.58025 30.95124 GP 14 14.7 15.435 16.20675 17.01709 17.86794 EBIT 6.3 6.615 6.94575 7.2930375 7.65769 8.04057 CAPEX 51.73 54.3165 57.032325 59.88394 62.878138 66.022045 NPV 78.5 82.425 86.54625 90.87356 95.41724 100.1881 CODB 10.8168 10.27596 9.762162 9.2740539 8.810351205 8.369834 IRR 31.6 33.18 34.839 36.58095 38.41 40.3305 The COGS, CODB and Gross profit were obtained from the 2011 annual report page 82; EBIT and CAPX was obtained from page 84, NPV and IRR was calculated based on the figures on the FY11 financial year. The figures were obtained from the 2011 annual year and they are in million US Dollars. This energy initiative proposal will affect the in store section of WOW in the supply chain. When the trucks are packed, the incorporated fridges will be supplied with electricity from the main supply so that diesel fuel is not used. In addition to saving on energy usage, this measure will also ensure the safety of the environment. The assumption is that cost of electricity will continue to constant as it has been (Woolworths Limited). Reports indicate that the cost of electricity is lower than that of fossil fuel globally. This project should be preceded into feasibility study since it presents a big win rather a quick win measure. This is because many cost parameters are impacted appropriately. The cost of this proposal is that extra labor would be needed to ensure electrical refrigeration of the tracks when packed and disconnect during departure. The cost is not so much as compared with the benefits of increasing the EBIT, GP NPV as well as keeping capital expenditure low (Department of Resources, Energy and Tourism (RET), 2010). The negative financial aspect is that additional cost will be incurred in connecting alternative power source to the trucks in cases of power outages. This measure is very much aligned to the strategies of WOW of ensuring cost cutting measures on fuel while ensuring maximum profitability. WOW has been on the fore front is attempting to adhere with the requirements of carbon price as well as maintaining a green environment which this measure fits in perfectly (Annual report, 2011, pp. 24-23) and (Woolworths Limited – Business Case and Beyond) COGS means the cost of goods sold GP means the gross profit EBIT means earnings before interest and taxes NPV means the net present value CAPEX means Capital expenditure CODB means the cost of doing business IRR means the internal rate of return Recommendations and conclusion This report with the aid of financial spreadsheets has found very important information relating the supply chain operation of WOW as well as the energy saving initiatives. The new supply chain model appears beneficial since the main question of rebate that WOW would obtain from such a move is higher than the cost of operating the supply chain. Other parameters like the EBIT and capital expenditure (capex) are less negatively affected but rather gain substantially. Additionally, WOW’s benefit is also evident whereby it will enjoy autonomy in delivery of liquor to its supermarket stores without any delays from the brewers. Therefore, it is recommended that WOW takes approves this supply chain model in its operation. It is also recommended that a binding agreement be reached between WOW and brewers regarding distribution and rebate issues so that WOW does not suffer the consequences of distribution delays to its DCs. The energy saving initiative proposal should also be transferred to the feasibility stage as it looks more viable in ensuring cost management of energy by Wow. There will be an improvement in several financial parameters from this move that will impact positively in the growth outlook of WOW. References Woolworths Limited Annual Report. (20113). retrieved from: www.woolworthslimited.com.au. Woolworths Corporate Sustainability Report. (2011). retrieved from: www.woolworthslimited.com.au Nagurney, Ann. (2006). Supply Chain Network Economics: Dynamics of Prices, Flows, and Profits, Cheltenham: Edward Elgar Publishing Gokhan, N. M., & Needy, Norman. (2010). "Development of a Simultaneous Design for Supply Chain Process for the Optimization of the Product Design and Supply Chain Configuration Problem.". Engineering Management Journal, 22 (4): 20–30. Hugos, M. H. (2011). Essentials of Supply Chain Management. New Jersey: John Wiley and Sons Wisner, J.D. (2011). Principles of Supply Chain Management: A Balanced Approach. Mason OH: South Western Cengage Learning Bolstorff, P., & Rosenbaum, R.G. (2012). Supply Chain Excellence. New York: AMACOM Vivek, Sehgal. (2009). Enterprise Supply Chain Management: Integrating Best in Class Processes. New Jersey: John Wiley and Sons. Gattorna, J. (1998). Strategic Supply Chain Alignment: Best Practice in Supply Chain. Hampshire: Gower Publishing Company. Woolworths Limited – Business Case and Beyond. URL: http://eex.gov.au/case-study/woolworths-evaluating-customer-feedback-on-refrigerated-display-case-doors/ Energydsm.com. (2010). “The Impact of Energy Efficiency on Peak demand”. Retrieved 2010-07-16. Greening, L. (2000). "Energy efficiency and consumption ". Energy Policy 28 (6–7): 389–401 Cooremans, C. (2011). “Make it Strategic! Financial investment logic is not enough.” Energy Efficiency (download as PDF from UTS Library online) Woolworths Limited – Business Case and Beyond. URL: http://eex.gov.au/case-study/woolworths-evaluating-customer-feedback-on-refrigerated-display-case-doors/ Department of Resources, Energy and Tourism (RET). (2010). Energy Efficiency Opportunities: Representative Assessment Guide, URL: http://www.ret.gov.au/energy/Documents/energyefficiencyopps/PDF/newsletters%2010/EEORepAssessGuide-FINAL.pdf Accessed 9 May 2012. Richard, C. Dorf. (2007).The Energy Factbook, Sydney: McGraw-Hill. Read More