China Imports

The goal of this case is to evaluate the cost of using different transportation modes for various product
categories. Air freight and ocean shipping are the two transportation modes considered. Air freight is
faster and has a lower minimum requirement but it is more expensive than ocean shipping.
Smartphones and decorative hardware are the two product categories considered. Smartphones have
high value and low weight while decorative hardware has lower value and greater weight. Also, demand
for smartphones is more unpredictable than demand for hardware.

Questions:

1. What is the annual cost of using air freight to import smartphones? What is the annual cost of using
ocean shipping to import smartphones?
2. What is the annual cost of using air freight to import decorative hardware? What is the annual cost
of using ocean shipping to import decorative hardware?

The input information related to the two transportation modes is as shown below:

The two transportation modes are compared based on the inventory (cycle + safety + transit) and
shipping costs per year. To evaluate the optimal batch size we use the EOQ formula with a fixed cost per
batch based on the minimum shipping quantity for air freight (= 50×10 = $500) and shipping cost /
container ($1,200) for ocean shipping. For air freight, the actual order quantity per batch must be such
that it weighs at least 50 kg. For ocean shipping the order quantity cannot exceed 15,000 kg. For air
freight, order quantity = max {EOQ, 50 kg} while for ocean shipping, order quantity = min {EOQ, 15000
kg}.

In the case of smartphones using air freight,

2DS 2  52000  500

EOQ    833
H 300  0.25
Given that 833 smartphones weigh 833×0.1 = 83.3 kg, the EOQ exceeds the minimum shipping quantity
of 50kg for air freight. Thus, the order quantity per batch for smartphones using air freight is 833
phones. A similar calculation for decorative hardware results in an optimal batch size of 7,211 units.

In the case of smartphones using ocean shipping,

2DS 2  52000 1200

EOQ    1290
H 300  0.25
Given that 1290 smartphones weigh 1290×0.1 = 129 kg, the EOQ is feasible because it is less than the
container size of 1,500kg. Thus, the order quantity per batch for smartphones using ocean shipping is
1,290 phones. A similar calculation for decorative hardware results in an optimal batch size of 11,171
units.

The safety inventory calculation must account for lead time uncertainty using each mode of transport.
For smartphones using air freight we use Equations 12.11 to obtain

Safety inventory = NORMSINV(.98)×√(1 × 4002 + 10002 × 0.22 ) = 918

Safety inventory is calculated similarly for other instances.

Transit inventory is calculated using the mean lead time (transit inventory = mean lead time × mean
weekly demand). Shipping cost by air freight is calculated based on the shipping cost / kg (shipping cost
= $10×number of kg. shipped per year). Shipping cost by ocean is calculated based on the number of
containers shipped per year (number of containers shipped per year = annual demand / order quantity
per batch).

The total annual cost for each product and mode combination is:
Air freight is the optimal shipping mode for smartphones. Even though shipping cost is cheaper by ocean
transport, total cost increases because of the high inventory requirement if ocean shipping is used. In
contrast, ocean freight is appropriate for decorative hardware because the lower cost of ocean
transport more than compensates for any increase in inventory.

In general, ocean freight is best used for heavier, low value, high demand, predictable product (like
decorative hardware) while air freight is best used for lighter, high value, unpredictable demand product
(like smartphones).