Ice House Toys Case Study Khalid EL JARRARI Ice House Toys Index of contents Ice House Toys presentation I- Mail-Order Operation and prospects of change I-1 Capacity constraints I-2 Extension of the warehouse capacity I-3 Other ways to overcome capacity constraints I-4 The website impact on operations II- Long-term capacity planning issues III- Alternative purchasing policy IV- Overtime payment V- Appendixes Ice House Toys presentation Ice House Toys (IHT) company consists of five shops and one mail-order business.
The mail-order operations warehouse is situated in a building of three floors, each 1200 m?. Ice House Toys send three catalogues of toys and games every year. The winter and spring catalogues are sent to 90,000 customers and results in 6,900 orders with an average order value of ? 23. The Christmas catalogue is the major catalogue, sent to 160,000 customers and resulting in 22,600 orders with an average order value of ? 42. The stock for the Christmas sales is ordered by the end of July and received in two phases. 5 percent arrives in the first week of October and filled the stock areas to capacity. The remainder is ordered after the first 2,500 orders have been processed in the fourth week of November. In 1999, stock with a resale value of ? 1. 1m was ordered. The mail-order operation is divided into three stages: recording, assembly & packing and dispatch. The appendix 1 shows the operations layout during 1999. IHT plans three main changes for the mail-order operation. - Firstly, IHT will do an agreement with a company which sells upmarket children’s clothes.
This will lead to 30,000 new names and addresses of customers. - Secondly, IHT will spend ? 18,000 on advertising: each ? 1,000 led to 190 additional orders in the past. - And the third future change will be the new website. On this, the ordering will be easier because the user hasn’t to print the descriptions and codes. IHT think that the customer’s average order value will be around ? 60 and five per cent of existing users will use this service. I- Mail-Order Operation and prospects of change I-1 Capacity constraints
IHT should focus its efforts on the bottleneck parts of the operation by identifying the location of constraints, working to remove them and then looking for the next constraint that will pace the output. The main constraint of IHT operation seems to be the limited warehouse space and, therefore, the varying number of staff when it is required. The layout of operations in appendix 1 shows clearly that the packing stage is the main constraint in the supply network. The expected order figure will increase from 22,600 in 1999 to 30,258 in 2000 (appendix 2).
This means an increasing ratio of 34% and the maximum weekly amount of orders is expected to reach 4,954 (appendix 2). IHT could cope only with 3,096 orders in a week as a maximum in a week of five days and 4,334 orders in a week of seven days. Appendix 2 shows the weekly demand-capacity mismatches. IHT should go for a normal week of five days when demand is lower than output capacity. IHT has to hire more workers for a week of seven days when demand is higher than output capacity. In spite of this, IHT should increase his hourly output capacity by increasing warehouse space when the necessary overtime exceeds 2 days.
I-2 Extension of the warehouse capacity Ice House Toys could process its orders on a chase demand basis from October to December. There are different methods of adjusting capacity for example working overtime, varying the size of workforce or using part-time staff. In this case the company should hire additional staff from October to December and/or use part time staff for the weekends. In order to meet its dispatch policy and deliver within three days of order receipt, IHT has two possibilities for chasing demand: By increasing the warehouse space allocated to mail-order operation.
The company has 330 m? for the packing activity and 270m? for dispatch department. Considering the expected maximum weekly orders there should be 26 packers and 12 dispatchers. This would require additional space of 288 square meters as to keep working five days per week (appendix 3). By assuming that additional available space of 600 m? will not cost an excessive investment and working on weekends is more expensive, IHT should choose this solution to chase demand variation. The other possible solution consists on paying overtime for the weekend work to run the operations.
If IHT would go for a week of seven days (from week 1 of November till the week 1 of December), he also needs more warehouse space but in this case only 47 square metres (appendix 4). This varying number of staff and also the different number of working hours meet a chase demand plan but could be more costly. The process “Packing” remains the bottleneck of the whole operation. The possible reduction in the time of processing orders received via the new website will increase the “Recording” process capacity but won’t have any influence on the whole operation output.
I-3 Other ways to overcome capacity constraints In order to cope with varying demand, IHT could use other plans. Additionally to (chase demand plan) studied below and consisting in adjusting capacity to reflect the variation in demand, IHT could manage demand-capacity mismatches by a (level capacity plan) or (demand management) or a mixture of them. In level capacity plan, IHT could set a uniform level of capacity regardless of the fluctuation of forecast demand. This could be achieved by accepting a flexibility of dispatching policy that could allow a delivery within more than three days of order receipt.
IHT could also prefabricate, during periods of low demand, standard parcels of products that are more likely to be ordered by a significant number of customers. In demand management, IHT could try to change the pattern of demand to bring it closer to available capacity by making customers ordering before or after the peak period. This could be achieved by offering Price differentials that means interesting discount during periods of low demand. Market stimulation such as advertising and promotions could be undertaken also at low demand period.
I-4 The website impact on operations Internet is a growing tool that can’t be ignored otherwise the company could find its classical mail-order business outdated and overtaken by competitors. IHT launched the new website that should progressively grow and probably replace the classical business. Nevertheless, the figures pattern regarding Christmas operations seems to show a very slight variations from year to year. The website is a new tool for reinforcement of mail order selling and needs a relative long time to be known and successful.
IHT forecasting regarding year 2000 is taking into account that only 5% of existing customers will use the new website service resulting in an increasing of average order value and simplicity in recording orders with almost no impact on the whole operation output. This means that the risk that this channel failed this first year won’t lead to harmful situation. Nevertheless, although IHT has a good experience of mail-order business and the approaches to forecasting year 2000 seems quite reliable, it is prone to error and uncertainty.
Regarding the following years, IHT will, without any doubt, use the year 2000 figures to consider the future. At this stage, IHT should devise a range of future scenarios or assumption challenging, each of them can then be discussed and the inherent risks considered. One could consider the followings: Weak growth of web channel users, labor unavailability and/or lack of trained workers able to ensure processing performance that matches the forecasting basic elements and insufficient space for stockrooms. II- Long-term capacity planning issues
Appendix 5, 6 and 7 shows a projection to years 2001 to 2005 based on the same demand variation as 1999 and a growth of 15% of the volume each year. The maximum weekly capacity is calculated by considering normal weeks of 5 days and also weeks with overtime extended to 7 days. The goal of each year projection is to know whether the additional warehouse space (600 m? ) could be sufficient for running the operations. It assumes that recording office is not an issue and orders could be processed, in case of high demand, in extra space or offices outside the warehouse building.
It assumes also that the stock areas are always sufficient even when the required capacity is almost doubled. The concerns are especially directed towards the space necessary for packing and dispatching operations. If IHT choose preferably the working weeks of 5 days, then the additional space of 600m? should be sufficient for running the operations in 2001 and 2002 (appendix 5). Nevertheless, when the necessary additional space exceeds 600 m? in weeks of high demand (743 m? needed in 2003 for example) IHT could use the 7 days week solution.
This solution should match the demand on 2003 and 2004 (appendix 6). In the third week of November 2005 (appendix 7) the warehouse space will be slightly insufficient even by working on weekends. Nevertheless, as the uncertainty of such forecast is very high and many changes could affect the operation capacity, we could consider the warehouse sufficient for running mail-order operations during the next five years. III- Alternative purchasing policy How inventory is managed will determine the balance between customer service and cost objectives.
Reduction of stock level or inventory is seen as positive for a number of reasons, including its impact on working capital, storage and administrative cost reductions. Economic order quantity (EOQ) is the order quantity that minimizes total inventory holding costs and ordering costs. It is one of the oldest classical production scheduling models. EOQ applies only when demand for a product is constant over the year and each new order is delivered in full when inventory reaches zero. There is a fixed cost for each order placed, regardless of the number of units ordered. There is also a cost for each unit held in storage.
Although data regarding costs of orders and storage are missing, the lead time for an order to arrive is also missing, this method, extrapolated to a short duration, could be applied to IHT mail-order case as to extract the trends and discuss the purchasing policy and the interest of reducing stock comparatively to a loss in gross profit margin of 7. 5%. The required parameters to perform this extrapolation are the total demand for only the Christmas operation, the purchase cost for each item, the fixed cost to place the order and the storage cost for each item during 11 weeks (W1 of October to W3 of December).
The number of times an order is placed will also affect the total cost. [pic] Assuming that the ordering cost is constant, the lead time is fixed, the replenishment is made instantaneously, the EOQ is the quantity to order: • [pic]= order quantity • [pic]= optimal order quantity • [pic]= Total demand quantity for the operation period • [pic]= fixed cost per order • [pic]= holding cost per unit pertaining to the operation period (~3 months) The single-item EOQ formula finds the minimum point of the following cost function: Total Cost = purchase cost + ordering cost + holding cost Purchase cost: This is the variable cost of goods: purchase unit price ? annual demand quantity. This is P? D - Ordering cost: This is the cost of placing orders: each order has a fixed cost S, and we need to order D/Q times per year. This is S ? D/Q - Holding cost: the average quantity in stock (between fully replenished and empty) is Q/2, so this cost is H ? Q/2 [pic]. To determine the minimum point of the total cost curve, partially differentiate the total cost with respect to Q (assume all other variables are constant) and set to 0: [pic]
Solving for Q gives Q* (the optimal order quantity): [pic] Therefore: [pic]. Q* is independent of P; it is a function of only S, D, H. Where D is the demand quantity pertaining to Christmas operation, S is fixed cost per order and H is the annual holding cost per unit or storage cost. The duration of Christmas mail-order operation is only 11 weeks; the stock is ordered and received in two times. Adopting an alternative purchasing policy which would significantly reduce stock levels means placing orders (or receiving deliveries) more often: every w weeks (w should be 1, 2 or 3 at maximum).
If we take D = 30000 as the total demand quantity delivered during the 11 weeks of operation life at a pace of one delivery each w weeks, we get : Q*= w . 30000/11 ~= w . 3000 Therefore: S/H = 150 x w? orS = 150 x w? x H : Cost per order = 150. w?. Storage cost per unit The alternative policy means that ordering more often (every week for example w=1) could be interesting when storage cost is high and the cost of ordering is less than 150 times the storage cost per unit.
Accepting a 7. 5% reduction in gross profit margin decision could be made by comparing it to the storing cost during the 11 weeks of operation life. One could also argue that demand quantity expected within the five next years is likely to double and would require placing more orders comparatively to the same inventory level in 1999. The operation duration is quite short (3 months) with the Christmas day as a fixed delivery deadline. Furthermore, the lead time is likely to be high especially when items are imported from the Far East.
All those elements leads to ordering policy that couldn’t change significantly comparatively to 1999. IV- Overtime payment One common approach to regulating overtime is to require employers to pay workers at a higher hourly rate for overtime work. Since IHT's added value is based especially on labor activity, the company margin is more likely to be reduced when orders are processed during overtime. Hence, it seems more convenient that IHT mail-order business gets additional area that allows the work to be done on week’s days. This has been discussed on section I-2.