Question #1:

In 2006 Airbus, the European consortium that competes with Boeing in the aerospace market, suffered setbacks in its production of the new A380 aircraft. Originally promised by April 2006, the delivery date has been repeatedly delayed.

Singapore Airlines (SIA) is one of the clients whose plans have been disrupted by the delays. When asked, in October 2006, how SIA would be affected by the A380’s problems, a spokesman replied, “The consequence of the A380 delay is the inability to grow capacity on the flights where we would like to replace 747-400s with the larger A380s, … It would mean a delay in capacity increase, rather than a decrease in the number of flights we already have.” (Sreenivasan, Ven. “Opportunity cost adding up for SIA with A380 delay”. The Business Times Singapore, October 3, 2006.) SIA was not going to spend any more money to acquire its airlines, so what kind of cost was the spokesperson describing? How does this cost affect SIA?

Question #2A:

Economic theory explains the existence of firms as the outcome of a cost-minimization process. Following the insight provided by Ronald Coase, we predict that a task will be performed within a firm, as opposed to outside of the firm, only when there is a cost advantage to that arrangement. An example in Chapter 9 illustrates the relative costs of having your car fixed at an established garage versus contracting separately with mechanics, parts suppliers, and equipment providers. The garage owner can exploit economies of scale by buying capital equipment and establishing contractual relationships with mechanics and suppliers and using these assets to serve many customers. The transactions costs per customer are lower than those the customer would incur if he had to make all these arrangements for himself.

Recently, however, technological change in the telecommunications industry has dramatically lowered the cost of transmitting complicated information over large distances. People skilled in the creative use of this technology can reduce the level of uncertainty surrounding routine management decisions such as how many shirts of a given size and color to store in the warehouse. Today, a firm called TAL, based in Hong Kong, specializes in inventory management—traditionally an in-house function—for a host of retailers.

“TAL collects point-of-sale data for Penney’s shirts directly from its stores in North America, then runs the numbers through a computer model it designed. The Hong Kong company then decides how many shirts to make, and in what styles, colors and sizes. The manufacturer sends the shirts directly to each Penney store, bypassing the retailer’s warehouses—and corporate decision makers….It supplies labels such as J. Crew, Calvin Klein, Banana Republic, Tommy Hilfiger, Liz Claiborne, Ralph Lauren and Brooks Brothers. …Now, TAL is negotiating a deal to manage Brooks Brothers’ shirt inventory the same way it does Penney’s. For Lands’ End, TAL stitches made-to-measure pants in Malaysia and flies them straight to U.S. customers, with a shipping invoice that carries the Lands’ End logo.

These retailers have been willing to cede some functions once seen as central because TAL can do them better and more cheaply. Rodney Birkins Jr., vice president for sourcing of J.C. Penney Private Brands Inc., describes as “phenomenal” the added efficiency Penney has been able to achieve with TAL. Before it started working with TAL a decade ago, Penney would routinely hold up to six months of inventory in its warehouses and three months’ worth at stores. Now, for the Stafford and Crazy Horse shirt lines that TAL handles, “it’s zero,” Mr. Birkins says.” (Kahn, Gabriel, “Made to Measure: Invisible Supplier Has Penney’s Shirts All Buttoned Up; From Hong Kong, It Tracks Sales, Restocks Shelves, Ships Right to the Store; Inside a ‘Radical’ Power Shift”. Wall Street Journal (Eastern edition), September 11, 2003: pg. A1)

Explain how TAL exploits economies of scale in the production of inventory management.

Question #2B:

The (former) in-house inventory management department at JC Penney’s was less efficient than TAL for two reasons. First, the employees in that department lacked the software and specialized skill of the innovative entrepreneur at TAL. In addition there were inefficiencies resulting from the imperfect incentive structure of salaried employees. Explain, using the concept of the principal-agent problem.