James DeWalp is a senior buyer of fruit products for FreshFoods, a major U.S. multinational food processing company. Thiscompany, based in California, uses a wide variety of fruitconcentrates, purees, flavors, and extracts in many of its popularfood products. One of James's responsibilities is to negotiateannual purchase contracts for these ingredients. One suchingredient, guava puree, is grown and harvested on a seasonal basisin various countries around the world.

James is currently examining the costs associated with using oneof his existing suppliers, a Philippine grower/processor. FreshFoods has used this supplier's high-quality product for a number ofyears. Farmers grow the product in a remote part of the Philippinesand transport it to the processing plant where it is pureed andpackaged for transoceanic shipment. This particular variety ofguava is highly prized for its flavor, which the aseptic method ofprocessing used by the supplier helps maintain. Unfortunately,guerilla activity by rebels has recently caused some problems forgrowers in this part of the Philippines.

The supplier aseptically packages the guava puree (currentlypriced at $0.29/pound, FOB vessel) in foil bags, each containing 50pounds of product, which workers then place into corrugated boxes.The boxes are stacked on wooden pallets, 40 to a pallet, forloading into overseas containers. Each container holds 20 palletsand arrives via ocean freighter. The ocean freight charge is $2,500per container. Once the containers reach the U.S. port, a truckingcompany moves each container to a local warehouse for storage at acharge of $250 per container. U.S. Customs calculates import dutiesto be 15 percent of the shipment's original purchase priceexcluding freight charges. Fresh Foods requires one container loadper month.

Fresh Foods warehouses each container in a public warehouseuntil needed for processing (average storage is one month). Themonthly storage charge is $6.50 per pallet. In addition, thewarehouse charges a one-time in/out fee of $6.25 per pallet tocover administrative costs. Fresh Foods inventory carrying chargeis 24 percent, which it applies against the unit price of materialin storage at the warehouse (but not in-transit from thePhilippines). The reason why the company does not apply thecarrying charges to intransit inventory is that Fresh Foodstypically does not have to pay the invoice for the guava pureeuntil it reaches the local U.S warehouse. Material planners assumethe demand for guava puree to be relatively constant over theyear.

When a container of guava puree is required at the plant, alocal freight company moves the container from the warehouse, whichcosts $175 per container. The company estimates that incomingreceiving and quality-control procedures cost $4 per pallet.Because of the nature of the product and the distance involved inpurchasing and storing the guava puree, the company estimates itincurs a loss of 3 percent of the total puree purchased.

1. Calculate the total cost of guava puree for Fresh Foods perpound, per pallet, and per container. (12 pts / 4 pts percolumn)

• You do not have to calculate a column for cost of guava perbag/box.

• Make sure you include the cost of spoilage ($25,000 every sixmonths), as well as loss in storage and production.

1. Identify the three (3) biggest cost drivers in your total costanalysis. Provide the percent (%) of the total cost that each ofthese categories represent. (3 pts)

1. Choose five (5) cost elements from your total cost model andperform a sensitivity analysis on each. (5 pts)

• Perform the sensitivity analysis on each cost elementseparately to see its impact on total cost.

• Indicate which of the five cost elements you chose had thebiggest impact as you vary the costs

1. If you were in charge of managing guava puree for Fresh Foods,what would you do to reduce the total cost to the company? Identifywhich costs you’d attack first and why. Give some specific ideas onhow you'd reduce costs. For instance, if storage is a big costdriver, give me some specific ideas you might consider to reducestorage costs. (12 pts)

1. Every TCO model is incomplete to some extent. So how might youexpand your TCO model?

• Describe three additional cost elements that you could buildinto your current TCO model for guava that would capture relevantcosts that have not been considered? (3 pts)

• Copy your original TCO model onto a separate tab in your excelworkbook. Then expand your TCO model by adding in the additionalcosts you described above. Provide a new calculation for the totalcost of guava puree per pound, per pallet, and per container withthese additional costs. (5 pts)

• What are some strategies that you could put in place tomitigate these risks and/or offset the potential costs involved? (5pts)

Product engineers calculate the budgeted factory yield of theguava puree when blending into company products is 98 percent; thismeans the company wastes 2 percent of the product by volume duringproduction, and this is not recoverable.

Occasionally, undetected spoilage of guava puree will requireremoving the product from grocery shelves. Out-of-pocket coststypically total $25,000 for each incident; these costs are notrecoverable from the supplier. The company's records indicate thatsuch an incident occurs about once every six months.

In addition to the other costs noted here, corporate accountingpolicy requires that cost estimators include a 17 percentassessment on purchased product unit cost to cover general andadministrative overhead costs at Fresh Foods.