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Case 3: The Chaos Company

The company is a leading manufacturer and distributor of a line of packaged


goods which it sells nationally under the Chaotic Products trade name. The company
operates three factories from which it ships to regional warehouses or directly to large
outlets. Last year, demand for Chaotic Products was 3.2 million equivalent cases,
distributed as follows (in million cases) according to five sales regions:
North Luzon
0.5

Central Luzon
0.4

South Luzon
0.4

Visayas
1.1

Mindanao
0.8

Total
3.2

One-shift production capacity in each of the three plants were as follows


(in million cases):
Home City
1.2

Branch No. 1
0.7

Branch No. 2
1.5

Total
3.4

Estimated freight costs (P/case) from each of the factories to each distribution
center are as follows:
Sales Region

Home City

Branch No. 1

Branch No. 2

North Luzon
Central Luzon
South Luzon
Visayas
Mindanao

0.95
1.05
0.80
0.15
1.00

0.35
1.80
1.40
0.80
0.30

0.90
1.80
1.60
0.70
0.85

Not all shipments are routed through regional warehouses, but on average, the
freight cost on direct shipments to outlets was quite close to the cost which would have
been incurred if the shipment had been routed through the servicing warehouse.
Chaos Company followed a philosophy of decentralized management. Top
executives favored this approach for a number of reasons. First, by enriching the
experience of subordinate managers, it provided better training for ultimate top
management responsibility. Second, it insured that operating decisions were made by
those persons most familiar with the detailed circumstances which would determine the
success or failure of the decisions. Under the decentralized approach, subordinate
managers were held responsible for the profitability of operations under their control.
Consistent with the policy of decentralization, each of the five regional
warehouses was under the direct supervision of a regional sales manager. The
warehouses were not assigned to a particular plant for servicing, since demand shifts
made a certain amount of flexibility necessary. Rather, the regional sales manager

decided upon which plant to place an order. The price paid by the warehouse was
P6.25/case FOB the plant. This price was set to recover costs plus a reasonable return on
investment for the manufacturing division. Since the regional warehouse was required to
absorb the freight costs, the regional sales managers are expected to place their orders so
as to minimize their own freight costs and hence those of the company as a whole.
Over a period of time, this procedure has led to increasing amounts of
organizational friction, and early this year, some Chaos officials were beginning to
question whether the procedure was even achieving the objective of minimizing freight
costs. Because Branch No. 2 was not the closest plant to any of the regional warehouses,
it was never deliberately selected as a source by a regional sales manager. Rather, the
managers would initially order from the Home City or Branch No. 1, whichever was
closer. Since those plants had inadequate capacity to meet all sales demands, it was then
necessary for the plant managers to reject some orders. No consistent procedure was
followed in determining which orders would be accepted, but it was largely a matter of
first-come-first-served. The regional sales managers whose orders were rejected were
then usually forced to take them to Branch No. 2, typically at a considerable increase in
freight cost. This aspect of the situation resulted in much grumbling by the regional sales
managers.
Moreover, since the orders placed with Branch No. 2 were not placed there in a
conscious effort to minimize freight costs, there appeared to be a strong possibility that
the resulting overall shipping program was not optimal. For this reason, some executives
felt that the practice of leaving shipping decisions to the decentralized judgements of
regional sales managers should be discontinued. They proposed instead that all orders be
routed through a central office which could then determine an optimal shipping program
from an overall company point of view. The actual quantities shipped over each possible
route last year were as follows with total shipping costs that year reaching P2,275,000:
(in million cases)
Sales Region

Home City

Branch No. 1

Branch No. 2

Total

North Luzon
Central Luzon
South Luzon
Visayas
Mindanao

0.1
0.2
0.9
-

0.3
0.2
0.2

0.2
0.3
0.2
0.6

0.5
0.4
0.4
1.1
0.8

Total

1.2

0.7

1.3

3.2

Other executives were concerned about the effect that such a proposal would have
on the general effectiveness of decentralized management. They also observed that one
result of the proposal would be to saddle the regional sales managers with freight costs
over which they could exercise no control.