Graham Darnell, managing director of Kenyon warehousing Ltd, based in Blackburn Lancashire, is unsure what could have gone wrong at the company. He had just finished reviewing the company’s recent financial performance and noticed something that worried him. Cookson and Clegg had experienced a period of robust growth over the last 4 years. “What could be going wrong?” “Our sales have been growing at an average rate of 10 percent over the last 4 years but we still appear to be worse off than before.” Sales had risen consistently over the past 4 years but the future was uncertain. Graham Darnell is aware that part of the past growth had largely been the result of a few competitors in the region going out of business, a situation that was unlikely to continue. Net earnings, however, had been declining for the last 3 years and were expected to decline next year. Graham Darnell is determined to turn the company around within the next 3 years.
The distribution business, in its simplest form, involves the purchase of inventory from a variety of manufacturers and its resale to retailers. Over the last 3 to 5 years, demands on inventory changed considerably; neither manufacturers nor retailers want to handle inventory, leaving distributors to pick up the slack. In addition, an increased tendency of retailers to order directly from manufacturers placed further strain on the profitability of distributorships in general.
After humble beginnings in 1993, the company moved to a 30,000-square-foot leased facility. Ten years ago, Kenyon Warehouse Limited began distributing high-end products to supplement its low-margin products. Kenyon Warehouse Limited entered into an agreement with a large manufacturer located in Blackburn, Lancashire, to distribute to customers in the region. Over the years Kenyon Warehouse Limited enjoyed steady growth and expanded its area of coverage. Currently, Kenyon Warehouse was covering an area with a radius of 200 miles from the company’s main facility. Given the rapid growth, Kenyon Warehouse Limited purchased the leased facility and made additions to bring its capacity to 65,000 square feet.
The demise of several of its competitors resulted in the acquisition of new retailer customers and some new product lines. Traditional ordering in the retailer-distributor-manufacturer chain took place via fax or telephone. Kenyon Warehouse considered implementing an Internet-based ordering system but was unsure of the potential operational and marketing benefits that it could provide.
Direct competition from distributors increased over the past 5 years. As a result, the most successful distributors adopted a value-added strategy to remain competitive. Retailers want dependable delivery to support sales promotions and promises to customers. They also want the freedom to hold sales promotions at any time as competitive conditions dictate and with only short notice to distributors. They also want the opportunity to choose from a wide variety of products Nonetheless, many orders are won on the basis of price and lost on the basis of delivery problems.
Manufacturers commonly demand payment in 30 to 45 days and provide no financing considerations. Retailers, on the other hand, pay in 50 to 60 days.
This difference often leaves Kenyon Warehouse Limited in a cash-poor situation that puts an unnecessary strain on its current operating loan. The company’s borrowing capacity has almost been exhausted. Any additional financing will have to be sought from alternative sources. Given Kenyon Warehouse Limited’s financial situation, any additional financing will be issued at a higher charge than the company’s existing debt.
Inventory turnover also presented a problem for the past 5 years. In the past 2 years, however, a significant downturn in turnover occurred. This trend seems likely to continue.
Orders from retailers come in as their customers near completion of construction or renovations. Even though historical information provided a good benchmark of future sales, the changing market lessened the reliability of the information. The changes also affect Kenyon Warehouse Limited’s ordering. Manufacturers require projections 60, 90, and 120 days out to budget their production. Sometimes penalties are assessed when Kenyon Warehouse Limited changes an order after it is placed with a manufacturer.
3 Strategic Issues
As John Gaskell and Peter Knott walked into Kenyon Warehouse’s office, he was still pondering the report. “Grab a seat,” he grunted. They knew they were going to have a long day. Kenyon Warehouse quickly briefed them on why he had summoned them, and they all immediately dove into a spirited discussion. Kenyon Warehouse pointed out that Kenyon Warehouse Limited would need to be properly structured to deal with the recession and the reality of today’s market. “We need to be well-positioned for growth as the market stabilizes,” he said. To meet this challenge, Kenyon Warehouse Limited must evaluate a number of alternative options. Some of the possible options might include expanding current systems and, when necessary, developing new systems that interface with suppliers, customers, and commercial transportation resources to gain total asset visibility.
Before making any investment decision, Kenyon Warehouse reminded them that Kenyon Warehouse Limited would have to evaluate any new capital requirements, as well as the expected contribution to the company’s bottom line and market share, that any option might provide. Table 1 shows the income statement for the current year.
Table 1: financial statement
Imported into the files.
1 The nominal federal corporate tax rate in the UK is a flat rate of 19%.
4. Investing in New Infrastructure
Peter Knott Jackson, director of operations, said, “Since Green Warehouse Ltd ceased operations 4 years ago, we have been inundated with phone calls and emails from potential customers across the South Atlantic area looking for an alternative to Green Warehouse Ltd’s services. These requests come not only from former Green Warehouse Ltd customers, but also from potential customers that have not dealt with either Green Warehouse Ltd or us in the past. We cannot adequately service this market from our current warehouse because the customers do not want to wait for lengthy deliveries. We are currently servicing some customers in that region; however, I do not think we can keep them much longer because of delayed deliveries. To take advantage of this opportunity, we would have to construct a new storage facility to complement our already strained resources and ‘forward position’ inventory to shorten our delivery times to customers on short notice. We are challenged by an inadequate infrastructure far too small for our requirements.
The company has only a Blackburn warehouse.” The addition of new facilities would provide Kenyon Warehouse with an opportunity for increased penetration in key industrial markets in the south of England where the company has had a very limited presence.
The financing resources for this option must be a challenge, given that Kenyon Warehouse Limited was approaching as credit limit with its principal bank. Additional financing from different banks, however, was not ruled out. It would be expensive (with current interest rates for long -term loans starting at 11 per-cent). According to Peter Knott. this option would cost £5 million for property and £12 million for plant and equipment. The new warehouse facilities would be depreciated over 25 years. The 25-year loan must be repaid with a single balloon payment at the end of the loan. With the additional infrastructure would be able to increase its annual sales by £5,093,000. In addition. delivery lead times to customers in the region would be reduced from 5 days to 2 days, which would be very competitive. Because of the added warehouse, Kenyon Warehouse could also increase the number of brands and models of products to better serve the retailers” needs for more variety. However, certain categories in the costs of goods sold would also increase. Total annual shipping costs, which include supplier deliveries to the warehouse as well as deliveries to the customer. would increase by £10,717,000. Annual materials costs and labour costs would each increase by 6 percent. Total assets would increase from £30,000,000 to £45,000,000. This increase takes into account changes to inventory investment, which would become £7,800,000, accounts receivable, properly, and plant and equipment.
5. Streamlining the Distribution System
John Gaskell, the logistics director, stated, “I believe there is an opportunity to capitalize on the void left by our fallen rivals by utilizing a cost-efficient distribution system. We do not need a new facility: we can continue to serve the customers in the South of England as best as we can. However, what we do need is an efficient distribution system. We are holding a considerable amount of stock that has not moved simply because of our inefficient inventory systems. One of our top priorities is waiting diligently with the inventory control department to keep what we need and dispose of what we do not need. This approach will allow us to use the space recovered from the unneeded items for automated warehouse equipment that will enable us to become more efficient. Everything we do and every dollar we spend affects our customers. We need to keep our prices competitive. Our cost of operations is our customers’ cost. Our goal is to enable customers to spend their resources on readiness and the tools of their trade, not logistics. This option will not help us much with product variety or delivery speed; however. it will increase our on-time delivery performance and improve our flexibility to respond to changes in retailer orders to support their sales programs.” The option of having an integrated centre. comprised of sophisticated automation systems. advanced materials handling equipment, and specially developed information technology, would provide Kenyon Warehouse Limited with both the versatility and capacity to offer improved products and service to Kenyon Warehouse customers. The system would support real time ordering, logistics planning at scheduling, and after-sales service. When an order is received through a call centre at Kenyon Warehouse’s offices in Salisbury, it will be forwarded to a logistics centre for processing. The customer is given a delivery date based on truck availability. Orders would be grouped by destination so that trucks could be efficiently leaded to maximise the truck capacity. The order would then be scheduled for delivery and the customer notified of the estimated arrival. This new information technology would improve Kenyon Warehouse’s reliability in delivering the products when promised.
The system also includes an automatic storage and retrieval system (AS/RS). The AS/RS selects a customer order and moves it to a dock for leading on a truck headed for the Kenyon Warehouse location. The capital costs for this system would be £8 million. which would be depreciated over a 10-year period. The operating costs, including training, would run at £1 million each year. These costs would be considered fixed expenses by Kenyon Warehouse. The improved system, however, would have tremendous cost savings. John Gaskell estimated that the system would save up to 16 percent in shipping expenses and 16 percent in sales expenses annually. Total assets would increase from £30,000,000 to £36,000,000 to nail for changes in accounts receivables and equipment. Aggregate inventories would be only £5,000,000 because of the reduced need for safety stock inventories. Kenyon Warehouse Limited could finance this option using a 10-year Ioan at a 11 percent rate of interest. The loan would be repaid with a balloon payment at the end of the loan.
These savings would come from more efficient handling of customers’ orders by the call centre, better planning and scheduling of shipments, and improved communication with the warehouse and the customer, resulting in a dramatic reduction in the shipping costs in the supply chain. Additional savings would result from the reduction in personnel costs: fewer operators would be required. John Gaskell thought Kenyon Warehouse could maintain its current level of service with her option while becoming much more efficient.
6. The Decision
John Kenyon Warehouse pondered the two options posed by Peter Knott and John Gaskell. Peter Knott’s option enabled the firm to increase Its revenues by serving more customers. The capital outlay was sizable, however. John Gaskell’s option focused on serving the firms existing customers more efficiently. The value of that option was its dramatic reduction in costs; however, it was uncertain whether Kenyon Warehouse could hold onto its current customers based in south of England. Kenyon Warehouse realized that he could not undertake both options, given the company’s current financial position. Kenyon Warehouse uses a 12 percent cost of capital as the discount rate when making financial decisions.
a) How will each option affect the firm’s operational and financial performance measures, which indicators investors should be watching closely?
b) Using information presented in the case study, recommends a design for the supply chain.
c) Contrast and comment on the performance differences between one waiting line feeding all four stations and one waiting line feeding two wellhead pumps and a second waiting line feeding two other wellhead pumps. Assume that the drivers cannot see each line and must choose randomly between them. Further, assume that once a choice is made, the driver cannot back out of the line.