OBA 613 | Operations Management

Case Study 2: Blanchard Importing and Distributing Co., Inc.

I. Do you think EOQ model is a good fit for choosing the lot size of Blanchard’s
production? Why? Please articulate your reason(s)? (Hint: Please examine
whether the assumptions for EOQ model fit Blanchard’s business environment).

Blanchard’s business environment is setup so that when there is a big change in

demand or the 3 ½ week ROP stock-level has lapsed a production run is triggered.
Since Blanchard’s demand is not constant, any large order will cause production
instability. No safety net in inventory is available because of a lack of space to store
inventory as a result of wine distribution expansion. Additionally, each type of product
has the ability to trigger a production run depending on demand. Stock-outs may occur
if actual demand does not meet the sales predictions or the 3 ½ week ROP.

The EOQ model would have been a good model had Blanchard recalculated its EOQ
and ROP. Since following these methods would have led to lower reordering costs and
more factory space for Bob and Elliot to pursue new ventures.

II. In the current EOQ calculation, the setup cost per bottle-run is incorrectly
estimated. You are invited to correct the calculation. In Exhibit 2, Blanchard
currently calculates the setup cost per bottle-run 𝑆 using this formula:

𝑆​= ​(blending setup cost) + (size changeover cost) + (label changeover

cost) + (order processing cost).

Please correct the calculation for the setup cost for a bottle run, 𝑆. (Hint: To your
information, this formula ​over-estimates the true setup cost per bottle run by
including unnecessary labor cost items in the calculation​.)

The correct setup costs per production run would be $6.25. Blending setup costs, size
changeover and order processing costs are all accounted for by the predetermined
salaries and are therefore, not included in the setup costs.

Setup costs do include: label change over costs (5 part time workers are hired =
$2.50/hour per worker) and the idle time during the label change over time (30 min/0.5
hrs). Therefore, total setup cost is:

S = (5)x(2.50)x(0.5) = $6.25 per setup

III. The inventory holding cost is 𝐻 = 𝐶 × 𝐾 per (unit, year), where 𝐶 is the cost of
producing one unit of product and 𝐾 is carrying cost percentage (i.e., cost of
capital). However, the ​estimation of the value of both ​𝑪 ​and ​𝑲 ​are inaccurate
OBA 613 | Operations Management

due to misconception in the original rationale behind the current formula. Let’s
correct the calculation of 𝐶 and 𝐾.

A. Blanchard currently calculates 𝐶 using the following formula (in Exhibit 2):

𝐶 = (materials cost) + (bottling labor) + (fixed overhead allocation) +

(variable overhead) + (customs duty) + (federal distilled spirits tax) +
(federal rectification tax).

The detailed explanation to each cost category therein is also provided in

Exhibit 2. Please discuss your recommendations for correcting this
formula and explain your reasoning. (Hint: To your information, ​some cost
items in the formula above should not have been included​.)

The unit cost (C) of each product includes the following costs:

● Materials
● Direct labour
● Federal rectification tax
● Customs duty
● Variable overhead

Federal distilled spirits tax is not included since it is not realized until after sale, nor is
fixed overhead allocation since it is fixed and not variable cost. The calculations below
are based off of exhibit 3:

Product Unit Cost (C)

(materials + direct labour + fed.
rectification tax + customs duty + variable
overhead)

Vodka $2.80

Gin $2.95

Scotch $7.88

Whiskey $5.15

Rum $4.61

B. Currently, Blanchard set the carrying cost percentage 𝐾 to be the cost of

capital (in percentage) for financing the production and inventory. While it
is valid to do so, Blanchard believes that the cost of capital (%) arises from
OBA 613 | Operations Management

the interest rate of capital (i.e., bank credit), which is 9%. Please discuss
what you think should be the true cost of capital (in %) and explain why.
(Hint: To your information, ​Blanchard fails to recognize the true cost of
the capital​, given the financial condition and alternative investment
opportunity of the company.)

The 9% interest rate does not consider the opportunity cost of capital available to
Blanchard. The correct carrying cost (K) is 22.5% and is broken down into two types of
costs. First, the opportunity cost is set at 20%, which is the percent Blanchard would
earn if it invested in Wine Merchandising. Second, the other carrying costs are 2.5%,
which included estimated costs of obsolescence, shrinkage, insurance, and year-end
inventory tax. Therefore,

K = opportunity cost + other carrying costs = 20% + 2.5% = 22.5%