Reducing Costs For Alliance Lamb Meat Shops: An Analysis Of The Quantity Discount Model

Application of Resource Integration Technique

New Zealand is among the top meat producing countries in the world. The country is a net meat exporter accounting for more than 30% of global meat exports. Globally, the meat industry accounts 8% of the US $10.5 trillion processed foods industry (Coriolis, 2017).

The NZ meat sector is dominated by four major meat processors; these are: Alliance Farmers Produce (Alliance), AFFCO, ANZCO and Silver Fern Farms. The four account for over 75% of both beef and lamb production in the country. Apart from chicken, the production and consumption of meat in New Zealand has remained flat for the last few decades (Coriolis, 2017).

According to Coriolis (2017), production particularly in the lamb sector has been on the decline. This has forced the exit of a few players in the market. The demand for lamb and red meat in general is also on the decline in the New Zealand domestic market and key export markets. Coriolis (2017) attributes the decrease in demand to the red meat prices which are relatively higher than other types of meat particularly chicken.

The decline in lamb supply has pushed sheep prices up. Further, falling demand in key markets implies that lamb pricing is important. Therefore, a lamb/meat processor should seek any price cost cuts possible so as to maintain a profit margin without rising prices. (Banker, Byzalov, Fang, & Liang, 2017) The current analysis explores how to reduce Alliance lamb costs by minimising inventory carrying costs and production costs using the quantity discount model.

Alliance is the largest lamb producer, wholesaler and exporter in New Zealand. The business is a farmers owned cooperative. Alliances gets animals for meat from local farmers most of whom are shareholders (Alliance Farmers Produce, 2018). The company then slaughters the animals for meat. More than 60% of every type of meat is sold locally while the rest is exported (Bloomberg, 2018). Locally, the company sells meat to meat retailers such as supermarkets, restaurants and other meat markets. Further, the company operates meat stores and an online market where meat is sold directly to the consumers. To deliver quality meat, the company operates a fleet of refrigerated trucks for distribution of meat (Alliance Farmers Produce, 2017).

For most local customers, the meat is sold either directly at the company’s meat shops or through retailers such as supermarkets and other meat shops. Generally, very little meat is sold at the meat processing plants. Rather, the processed meat is transported to the shops from the processing plants. Therefore, the company’s meat shops are a customer to the processing plants.  

Discounts

The quantity discount model is applied in inventory management to minimize costs. Inventory costs are mainly made up of two components. The inventory which is directly proportional to the size of inventory at hand. The second component is the production setup costs. These are the costs involved in the preparation of an order. The ordering cost is fixed for every order and is independent of the number of units ordered.  The goal is to determine the economic order quantity (EOQ) that minimizes the total inventory costs. The EOQ (Q*) is a function of the annual demand (D), the inventory holding cost (Ch) per unit and the order setup costs (Co) per order and is given by (Du, 2018; Jackson, 2015): 

This model assumes that the annual demand for the product in question is known. Further, stock outs are not permitted. Stock outs cause losses in the form of lost revenue, loss of customer trust and customer dissatisfaction. Therefore, stock outs are not desirable for any business (Paulina, Justyna, Przemys?aw, & Krzysztof, 2016).

Quantity discounts is used by companies to incentivize customers to purchase more. The quantity discount schedule sets lower unit prices for larger bulks of meat. Generally, large orders attract cost savings due to economies of scale. Therefore, sellers are usually in a position to provide discounts to buyers who purchase in large volumes (Varsei, 2016). Alliance processing plants have these type of agreements with its suppliers; the farmers. Assuming that the processing plants pass all of the cost savings to the meat shops, the meat shops will benefit from reduced prices for ordering large amounts of lamb. Table 1 below summarizes the quantity discount information. The prices less the transport fees. All values in this calculations are estimates. 

Table 1: Discount Schedule

From the company records, the company has a demand of 107333 kilograms of lamb per year. The meat shop is charged $200 per order regardless of the amount ordered. Further, the average inventory holding costs are 30% per cent of the raw material costs. Finally, the production cost per kilogram of lamb at no discount is $16.99. This is the hypothetical price that the shops are charged by the processing plants. Using these values, the economic order quantity can be evaluated using the EOQ formula for each discount options available to the company. Table two below summarizes the EOQ calculations for the three discount options.

Table 2: EOQ

EOQ

The total costs of the product are equal to the inventory product and the material costs. The objective is to find the discount option that offers the least total costs. The total costs (TC) can be calculated as:

TC=Ordering Costs+ Carrying Costs + Material Costs

Where

 D=demand in units

Q=order quantity in units

O=ordering cost per order

H=Holding cost per unit

C=material cost per unit

The minimum total cost for each of the three options was calculated using the TC equation. The Table three below summarizes the results from the calculation. Figure 1 shows a plot of the total cost curves for the three options.

Table 3: EOQ    

From the results in table 2, it is observed that increasing the order quantity reduces the order setup costs. This is expected since an increase in the order amount will reduce the number of orders required to meet demand. Second, due to the discounted pricing, increasing the order quantity from discount category to discount category reduces the material costs. On the other hand, increasing the order quantity increase inventory carrying costs. Therefore, there is an apparent trade-off between carrying costs and the other two costs; ordering and material costs (Duan, 2010). Therefore, the goal of the analysis is to determine which among the four discount option offers the optimum combination of the three costs to produce the lowest total cost.

From table two, the EOQ under the no discount option was 2902. This value is above the discount class limit. Second, the EOQ for the 5% discount class is 2978 which is above the upper class limit for the discount. Therefore, the quantity ordered under this discount category is set at the maximum limit of 2000 KG. The 10% discount option has an EOQ of 3059 which is within the discount quantity range. Finally, the EOQ for the last discount option is 3093 KG. This is below the lower quantity range bound and therefore, the quantity ordered was set at the 4001 KG minimum amount.

The 12% discount option produces the least total costs. From table 3 above, the no discount option results in the highest total cost of $1,846,860. This is $229,531 more than the 12% discount option (TC=$1,617,329). Therefore, minimum costs will be realized when the company schedules orders in volumes above 4000KG. It shows a plot of the total costs for the 12% discount option. From the chart, the lowest cost is realized at the minimum amount that would attract the bonus; in this case 4001 KG. In light of this, the optimum order quantity that will minimize the total costs is 4001KG. 

Analysis of Results, Limitations and Recommendations

The number of orders placed annually is the ratio of the annual demand to the economic order quantity (Kasim, Zubieru, & Antwi, 2015). In this case, the economic order quantity is achieved for the fourth discount option at 4001 KG. Therefore, the company will place 107333/4000=27 orders per year. The cycle time will be equal to (4000/107333)*365=13.5 days. This implies that it will take 13.5 days between the first and the second order.

From the foregoing, it is evident that the lower volume discount options do not provide enough incentive for a customer to prefer them. The highest cost savings are realized whenever the volume exceeds the lower bound of the highest quantity discount option. This implies that the cost savings in the discounts are much higher than the inventory carrying costs. Therefore, the company needs to negotiate better discount terms.

The primary weakness in the quantity discount model approach used in this analysis is that it does not account for other costs that factor in the product prices. For instance, marketing investments form part of the product costs. Marketing costs have a direct relationship with the quantity demanded; since marketing is done to increase demand. Factoring in these costs could potentially have a significant effect on the results whether they are at the unit level or batch level. 

Conclusion

From the foregoing, a few important conclusions can be made. From the introduction, it is observed that the supply of sheep is on the decline and hence prices are going up and the demand for lamb is declining pushing prices down. In order to keep prices stable, Alliance global needs to make all of the price cuts it can get. This can be achieved by applying the economic order quantity model to find the optimum order quantity that permits minimizes the total costs.

From the analysis, the highest costs will be incurred if the no discount option is used. This implies that ordering in batches of 1000 or less will incur the highest total costs. The lowest costs are achieved when the 12% discount option is adopted. Specifically, the company will realize the highest cost savings by ordering the raw materials in batches of 4001 KG. Therefore, the company should adopt the 12% discount option to realize maximum cost savings.

Finally, the quantity discount options available to the company now are not effective. The fact that the lowest costs are realized in the last discount category suggests that there is still room for cost reduction by negotiating higher discounts. The company should endeavour to negotiate better discount deals with suppliers so as to achieve the maximum cost cuts possible.

References

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Alliance Farmers Produce. (2018). Our Story. Retrieved October 15Th, 2018, from https://www.alliance.co.nz/about-us/our-story/

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Bloomberg. (2018). Company Overview of Alliance Group Limited. Retrieved October 15Th, 2018, from https://www.bloomberg.com/research/stocks/private/snapshot.asp?privcapId=1017333

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