Acting as an outside consultant, what would you recommend that Pepe do? Given the data in the case, perform a financial analysis to evaluate the alternatives that you have identified. (Assume that the new inventory could be valued at six weeks’ worth of the yearly cost of sales. Use a 30 percent inventory carrying cost rate. ) Calculate a payback period for each alternative. Pepe Jeans has 3 options: Do nothing Decrease lead time to 6 weeks Build a factory and decrease lead time to 3 months Our calculations on the attached pages.
We would recommend that Pepe choose Alternative 2, given the increase in the yearly profits. Although alternative two has an initial investment of 1. 3 million and 0. 5 million in annual operating costs, it is still less costly then Alternative 1. 2. Are there other alternatives that Pepe should consider? Pepe’s would first need to look at the “big picture”. They should take the holistic approach and look at the entire supply chain, not simply the production portion. They should look at the logistics for the movement of the jeans to the retailers and ultimately the customers.
A review of the supply chain would be required to determine the need for buffers in the processes, to avoid blocking or starving the process. Reducing the lead time in either alternative may solve the lead time/inventory concerns, but it could create other problems, such as quality control issues. Although reducing the lead time would mean the products are produced at a faster rate, it will draw attention to the issue of quality. If the jobs are rushed it can cause their product quality to be reduced, which could damage Pepe’s reputation for great quality.
To mitigate the impact they will need to enforce their Costs of Quality, including the appraisal, prevention and internal costs. It is important to note that Pepe has built their image on good quality. Reducing lead time to 3 months, instead of 6 weeks will increased sales due to more trend specific inventory being available from retailers and as they will not be rushing the process it will less compromise the costs of quality. As Pepe’s product is innovative, they require the demand for their product to be able to maintain their profit.
To keep their competitive advantage they must reduce their lead time, to be able to keep up with fashion trends. Pepe jeans can stay with its current situation and continue the success they are having, but eventually competition will erode their advantage. Pepe’s current process is vulnerable from a marketing standpoint, as the world of fashion is trendy and seasonal, thus making the six month lead time uncompetitive in the long term and Pepe would not be able to stay on top of what customers actually want in a fluctuating industry.
Having the new facility will allow them to design the basic jeans to match the fashion industries at that time, and customized them afterwards. They need to be flexible to meet customer’s every changing diverse needs Alternative 2 would mean moving basic jeans to the Willesden facility, however, they would need to know if they would require a larger storage facility if the basic jeans are produced more rapidly than the finished goods.
Another alternative for Pepe would be to consider Outsourcing their production activities to another country where cost advantages and flexibility can be greater. There are many other countries like India that thrive on the textile industry. Finding another country that has cost benefits and flexibility can decrease Variable cost (cost of goods sold) and improve Pepe’s gross margin ratio. Pepe should do a more specific financial analysis of how the costs changes (COGS and Operating Expenses) with each week the lead time is reduced.
For example, if the current lead time is 6 months (approximately 24 weeks) they should review the numbers at 18 weeks, 12 weeks, and 6 weeks and compare the costs. They do not necessarily need to build a facility, which is the alternative we chose, because they might be able to reduce the costs and the lead time enough to make Alternative 1 more profitable. In the end there are many options for Pepe to consider.
They need to ensure that whatever alternative they choose matches their competitive strategy. They need to know that the final product will still meet their standards, and build their brand. They might consider doing a survey of customers to determine if they are happy with the products and ensure Pepe is listening to the “voice of the customer” before they make any drastic changes. The last thing they need are additional external costs of quality with the customers finding problems.