It's Not Luck - Eliyahu M. Goldratt [28]
“You mean,” I try to understand, “that the price will be based on two-month quantities, but the client will not get the entire amount in one shipment; for two months he will receive smaller quantities every two weeks.”
“Exactly,” Pete confirms. “And after the first shipment, he can cancel the rest, without any penalties, whenever he wants.”
“That’s generous,” Don says. “Too generous.”
“No,” I say, “that’s smart. The client is paying the price for quantities of two months, but suffers obsolescence as if he ordered for only two weeks. That will bring the price-per-usable-unit to be the absolute lowest.”
“And on top of it,” Pete beams, “the buyer will have very low inventories, less than five percent compared to what he currently holds.”
“A perfect breaking of the buyer’s cloud,” I conclude. “Actual price is lower than what he currently pays for even large quantities, and at the same time, he will have lower inventories than what he currently can expect when he orders in what he perceives to be small quantities. From the buyer’s perspective it’s like having his cake and eating it.”
Pete is pleased. “Do you see any negative effects?” he inquires.
“Only the obvious ones,” I answer. “Those you probably already considered.”
“Don’t be too sure,” Pete says. “Let’s hear them.”
“I have one,” Don says. “If I understood you correctly, you are going to hold the remainder of the order in your possession, at your risk. Does it pay? Remember, in ten percent of the cases you are going to be stuck with some of it.”
“Don, this is not a big concern,” I say.
“Why?”
“First of all, do you agree that Pete’s offer would not lead to a price war?”
“Yes. The competition cannot really compete against it. To lower the prices they must go to large quantities, but then the risk of holding the client inventories is too high.” Don starts to get excited about Pete’s idea. “This actually means that Pete gets the large quantity market for medium quantity prices.
“No wonder he can afford to swallow the damage from a little bit of obsolescence. And actually the damage is very small; let’s not forget that the risk of obsolescence for us is much smaller than for our clients. For them it costs the selling price, for us, as long as we have excess capacity, it costs only the raw material. Good solution, I really like it.”
“I’ve calculated the risk.” Pete is visibly flattered, but tries to hide it. “For such orders, it will cost us, on average, less than two percent.”
“Aren’t you afraid that some buyers will abuse your offer?” I ask.
“What do you mean?”
“How are you going to make sure that a client who needs a relatively small, one-shot run, will not put in a large order to get lower prices, and after the first shipment cancel the rest? According to your suggestion they can do it without any penalty or even an explanation.”
“I haven’t thought about it,” Pete says, and after a short while he adds, “I think that we can come up with a good way to close this loophole without insulting our buyers.”
“Yes, I’m sure,” I say. “So you are going to offer the market the best price, relief on cash, the lowest inventories and almost no obsolescence. Coupled with your excellent on-time reliability and high quality, it’s a buyer’s dream. What will be the impact on your bottom line?”
“As I said in the beginning, if I can sell all my excess capacity at those prices, the wrapper department is going to be more profitable than the rest of the operation. It means roughly nine million dollars profit. Big bucks. So, you like it Alex? Do you see any problem with it?”
“I like it. Sure I like it. But I see one problem. So big that it can turn your brilliant solution into nothing but a heartbreak.”
“What is it?” Pete is concerned.
“Your solution is too good and too complicated