Task 2: Sourcing Decision for CosyHome

Description:
CosyHome is a small home furniture store selling affordable trendy furniture for young people. One of the new products the store plans to sell at the beginning of next year (using the term ‘period’ to represent ‘year’ hereafter) is a vintage 5-tier bookcase. The company has historically outsourced production of its furniture to China, given the lower costs there. For this vintage 5-tier bookcase, it is expected to cost 480 Chinese yuan or renminbi (RMB) per unit to source (inclusive of manufacturing and delivery costs). At the current exchange rate of 4.8 RMB per AUD (i.e., 1 AUD = 4.8 RMB), this gives a variable cost of about 100 AUD per unit. The Chinese supplier, however, has a long lead time, forcing EasyHome to pick an order size well before the product is advertised.

This does not leave the company any flexibility if the actual demand differs from the order size. Sourcing from a local supplier can be an alternative but the cost will be higher at 120 AUD per unit. The advantage is the local supplier can supply quickly enough that EasyHome will basically be able to match demand exactly with supply. EasyHome is conscious about the higher variable cost but finds the flexibility of the onshore supplier attractive especially for a new product with uncertain demand. The challenge is to evaluate the value of responsiveness provided by the local supplier.

Uncertainties Faced by CosyHome
To better compare the two suppliers, CosyHome identifies demand and exchange rates as the two major uncertainties it is facing. If the product were to be sold in the current period, CosyHome estimated that the demand would be 1,500 units per year. Over each of the next two periods, demand may go up by 10 percent, with a probability of 0.5, or down by 10 percent, with a probability of 0.5. Similarly, over each of the next two periods, the RMB may strengthen by 5 percent, with a probability of 0.5, or weaken by 5 percent, with a probability of 0.5. The exchange rate in the current period was 4.8 RMB per AUD.

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