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?

 

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