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9B11E035

DD TRADERS: SOURCING FOR DEMDACO

Carolyn Glasow and Julia Ho wrote this case under the supervision of Professor Peter C. Bell solely to provide material for class
discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may
have disguised certain names and other identifying information to protect confidentiality.

Richard Ivey School of Business Foundation prohibits any form of reproduction, storage or transmittal without its written permission.
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mail cases@ivey.uwo.ca.

Copyright © 2011, Richard Ivey School of Business Foundation Version: 2012-01-16

Carolyn Glasow and her sourcing team at DD Traders met to revisit a recurring issue: how should she
allocate product purchases among the various manufacturers that bid for the opportunity to supply products
to DD Traders?

DD Traders was the Asian branch of DEMDACO, a privately held company that wholesaled unique gift
products at attractive price-points. The gift products were marketed and distributed to the specialty retail
channel in the United States, as well as some international markets. Glasow recognized the opportunity to
leverage a quantitative approach to sourcing future allocations across vendors that would also improve the
short-term demand transparency that was provided to the company’s key business partners. Glasow
believed that ultimately, this could lead to increased bargaining power for price negotiations and
production lead-times.

INDUSTRY BACKGROUND

DD Traders was responsible for product sourcing operations from China for DEMDACO using 100+
contract manufacturing facilities that bid to supply product. DD Traders’ objective was to secure the best
possible pricing in order to maintain strong margins for DEMDACO.

More than 70 of DD Traders’ current 100+ contract manufacturing facilities were located in the
Guangdong Province of China. These suppliers were specifically chosen for each product based on
materials, design and quality with the company’s high standards ensuring competitive pricing, efficient
delivery and precise quality control.

During the past 12 to 18 months, DD Traders had been experiencing significant pressure to manage rapidly
inflating product costs to maintain margin profitability. The major factor that impacted the company’s cost
of goods was supplier pricing which had become increasingly challenging as manufacturers faced intense
cost pressures that resulted in more frequent and significant adjustments to their price lists. Recently the
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frequency and degree of supplier-side price adjustments had increased to a level that required proactive
management to ensure a low cost of goods was achieved across the large number of purchased product
stock-keeping units (SKUs). A regular comparison and review of supplier costs for the large number of
SKUs, was currently performed manually by Glasow and her DD Trader’s procurement team but was time-
consuming and prone to human errors.

COMPANY BACKGROUND

DEMDACO was a privately held company that wholesaled unique gift products at attractive price-points.
The premium gift industry was extremely fragmented and highly competitive; however, DEMDACO had
managed to sustain growth through product innovation and establishing and maintaining strategic supplier
relationships. The firm worked closely with its sister office, DD Traders in Hong Kong, to source product
at select contract manufacturers based across China.

DEMDACO’s mission statement defined that the company “exists to lift the spirit by providing product
that helps people connect in a meaningful way and by pursuing business as it ought to be.”1 Profit was a
primary objective, but not the only driver pushed by the owners in yearly goals. DEMDACO was a
product driven company that worked with a variety of artists (many of them licensed) to create product
offerings for the specialty gift retail market. Although operating in a competitive market, where dozens of
other wholesalers and importers were also sourcing premium gift products from China, the firm had
experienced tremendous growth over the past 10 years. The main product formats were figurines,
ornaments, angels, wall art, and home and holiday décor. Product ranges with annualized sales of $1
million or more were sourced at multiple manufacturers to mitigate production risk and allow for more
capacity flexibility. The firm was also conscious of the possible impact of cost increase due to
macroeconomic factors and wanted to increase its effort in financial risk aversion by quantitatively
optimizing production allocations to ensure maximum margins were achieved.

LIGHT INDUSTRY MANUFACTURING IN CHINA

Light industry manufacturing in China was experiencing rapid change. Increases in fixed and variable
costs (such as raw material cost inflation), labor shortages and local currency appreciation relative to the
US dollar were directly impacting production costs and DEMDACO’s value proposition.

During the global financial tsunami in early 2008, manufacturers in China faced tremendous financial
pressures due to the lack of orders from the developed world. Many small manufacturers were forced to
shut down, and larger more financially stable ones were forced to let go of the large number of low-cost
laborers that came to work to South China from less developed provinces. In the midst of the financial
crisis, China invested heavily in infrastructure projects in many less developed provinces to accommodate
the large influx of factory workers that were being let go from the factories. Following the crisis, rural
laborers were not as keen to return to factories in South China since work was now available closer to
home. Consequently, when the economy picked up pace and orders started to pour in, South China
manufacturers had difficulties attracting sufficient labor to work in factories and hence production could
not be run at full capacity. This situation was foreseen to continue into the near future. Apart from
infrastructural development, there was also a shift towards a more consumer-based economy in China.
New industries and jobs were being created to serve this new demand. The younger generation had less

1
www.demdaco.com accessed September 9, 2011.
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intention to work in factories, as opposed to the new job opportunities arising from a consumer-based
economy. Labor shortages continue to be a significant constraint for South China suppliers.

The second biggest issue affecting U.S. based wholesalers was the appreciation of the Chinese yuan
against the U.S. dollar. Suppliers in China received payment in U.S. dollar but paid their workers in
Chinese yuan, hence they were very sensitive to exchange rate fluctuations. In the past year, the Chinese
yuan had already appreciated 2 per cent against the dollar. There was tremendous pressure from the U.S.
administration and other developed countries’ administrations to push China to allow further and larger
appreciation increments in the future. Should this situation materialize, the cost of goods from Chinese
suppliers would inevitably require suppliers to pass along a cost increase to their customers in order to
sustain operating margins.

CURRENT SITUATION & OPTIMIZATION OBJECTIVES

Two of the most profitable lines of products for DEMDACO were called the Colorful Devotions and Bold
Inspirations collections. These product lines were made of poly-resin material, and were currently sourced
from three suppliers. DD Traders’ procurement team allocated production to each supplier, on a line item
basis, as orders were received. The allocations were largely based on identifying the lowest cost for each
item on the order, or by determining which supplier would be able to ship a full container load. The latter
was often chosen for ease of management, but often did not yield the optimal cost savings. Appendix 1
provides examples of price differentials between the three major suppliers. An issue with this method is
that it does not take into consideration multiple orders or forecasted demand. When monthly purchase
orders were consolidated or when working with forecasted demand, different suppliers may be able to
supply full container loads at lower costs.

One of the key objectives set out by the firm was to implement a quantitative approach to purchase
planning for the top grossing products of the Colorful Devotions and Bold Inspirations lines.
DEMDACO had already classified the products in these lines into three categories, A, B and C, with
category A products being the most profitable SKUs by unit volume and dollar value. There were a total
of 52 SKUs in this category but Glasow decided to focus her attention on the twenty highest volume
products. The initial objective was to examine product purchases for three months to give DD Traders a
monthly allocation plan for the three poly-resin product suppliers who currently produce these lines.
Monthly allocations would be derived primarily from forecast demands provided by DEMDACO’s sales
team, and would be re-computed each month as orders were received, forecasts updated, or changes in
supplier price lists became known.

Upon successful development of a monthly allocation process, DD Traders intended to provide each of its
three suppliers of the Colorful Devotions and Bold Inspirations products quarterly production volume
requirements. Based on feedback from suppliers, Glasow also wanted to try to stabilize volumes (in
dollars) sourced from each supplier to a ±15 per cent month-to-month variation. DD Traders believed
that giving suppliers a higher level of transparency and stability regarding anticipated production
requirements would be helpful in improving lead times which will help DEMDACO reduce out-of-stock
situations. This approach should help DEMDACO maintain solid relationships with its vendors by
satisfying commitment levels, while ensuring that optimal cost of goods could be achieved.

At the start of each year, suppliers submitted an annual capacity plan to DD Traders for Colorful
Devotions and Bold Inspirations production: the original capacity available for Q4 2010 for the 20
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highest revenue items is listed Figure 1. The capacity plan had historically been a very accurate
indication of the actual maximum capacity available for production for DD Traders.

Figure 1

2010 QR CAPACITY PLAN FROM THE THREE SUPPLIERS

2010 CAPACITY PLANNING

MONTH Supplier 1 Supplier 2 Supplier 3
October $850,000 $425,000 $560,000
November $1,500,000 $700,000 $920,000
December $800,000 $400,000 $650,000

The minimum order quantity (MOQ) for each SKU was 300 units for all vendors.

The planned allocations for the last three months of 2010 (October to December) were collected
(Appendix 2) and were to be used to test whether these plans provided the lowest cost purchases for DD
traders. The total costs of the plan by month are summarized in Figure 2.

Figure 2

PLANNED COST OF GOODS (COG) FOR OCTOBER – DECEMBER 2010

MONTH ACTUAL COG

OCTOBER $1,329,276
NOVEMBER $2,189,314
DECEMBER $712,525
TOTAL $4,231,115

It was anticipated that price changes would become more frequent, and it was important that any sourcing
model would be able to allow for price changes and scenario comparison easily.

Appendix 2 provides the planned sourcing for October-December 2010. It was thought that Supplier 2
would increase prices by 5 per cent from November 2010 onwards, resulting in some concern that this
sourcing plan may be more costly than necessary.

DD Traders set out to construct a model to plan product sourcing that would be flexible to handle price
increases and provide scenario comparisons.
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Appendix 1

PRICE LIST OF THREE SUPPLIERS FOR CATEGORY A PRODUCTS

SKU ID Supplier 1 Supplier 2 Supplier 3

1  $7.80 $8.08 $7.65

2  $2.38 $2.44 $2.33
3  $2.49 $2.57 $2.46
4  $5.84 - $5.74
5  $3.49 $3.58 $3.42
6  $3.29 $3.37 $3.23
7  $2.53 $2.59 $2.48
8  $7.04 $7.28 $6.92
9  $3.40 $3.50 $3.25
10  $1.70 $1.50 $1.43
11  $3.53 - $3.53
12  $3.24 $3.55 $3.24
13  $3.24 $2.62 $3.17
14  $2.28 $2.42 $2.47
15  $3.58 $4.09 $3.54
16  $1.61 $1.80 $1.59
17  $2.92 $2.89 $3.26
18  $1.73 $1.53 $1.50
19  $1.89 $1.64 $1.50
20  $1.67 $1.54 $1.49
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Appendix 2

PLANNED ALLOCATIONS BY MONTH (OCT – DEC 2010)