BACKGROUND

Delicious Chocolate Company (DCC) has been developing decadent Italian chocolates, and retailing them in boxed formats, for several years. DCC has to date been profitable enough to satisfy its joint owners, Emanuela and Raffaele. They have no intention of taking on the larger brands in the future, but they realise that DCC needs to shake off its present "artisan" image and expand significantly over the next 5 years, while improving profitability. As Raffaele explains:

Our ambition is for Delicious Chocolate to be the "go-to" brand for that special occasion such as Christmas, an anniversary, a birthday or Valentine's Day, when a box of the best chocolates is essential." Raffaele and Emanuela believe they have the right product strategy, as they offer something different and (in their opinion) far superior to the likes of Cadbury, Ferrero or even Lindt. DCC offers boxed, premium brand, chocolates, which are imaginatively packaged and provide a variety of exquisite tastes. This is a luxury product, a quality gift for that special occasion when price doesn't matter.

Initially, Emanuela and Raffaele produced the chocolates in their own small manufacturing facility in Hamilton (North Island, New Zealand) where they combined Callebaut chocolate paste, with the best New Zealand butter, milk, fruit, herbs and other fillings to create DCC 'Italian masterpieces'. Due to the success of these chocolates, the demand for the DCC brand grew rapidly and soon outstripped the capabilities of their small, cottage industry style, manufacturing facilities.

However, as they had limited capital for expansion, Emanuela and Raffaele decided to concentrate on the firm's key strength - the development of a stream of innovative DCC products. Consequently, the bulk manufacturing itself was not considered a core competence and was outsourced. This decision has enabled Emanuela and Raffaele to avoid the heavy capital investment required for full scale manufacturing facilities, and hence enabled them to retain exclusive ownership of a business with low financial gearing.

Today, DCC chocolates are 'created' under licence by 6 independent chocolatiers (all trained in Europe and vetted by Raffaele). These 6 chocolatiers all supply exclusively to DCC and are kept very busy. Quality control is of high importance, and Raffaele dictates which of the outside chocolatiers will produce which products. The company's original manufacturing equipment is now entirely used for development purposes, to produce the initial runs of new products for test marketing. All new products are extensively tested before large-scale production is outsourced to the chocolatiers.

Raffaele is responsible for the design of packaging and the development of the chocolates themselves, including in-house manufacture of sample products. He is also responsible for liaison with the chocolatier suppliers to secure a reliable supply of quality chocolates to his exacting specifications. The chocolatiers are all local and deliver to the central packaging facility. Within the business, this facility is called 'the box', as it is where the various types of chocolates are packed into specially designed selection boxes. Raffaele oversees this process and leads a small team of designers who produce innovative packaging designed to 'show off' the product. Raffaele and the team are constantly 'refreshing' DCC 'old favourites' with packaging innovations. Adjacent to 'the box' is the storage area for finished goods ready for delivery to a variety of retail stores across New Zealand.

Emanuela has overall responsibility for sales and marketing activities, including customer service (and dealing with customer complaints). She is also responsible for company administration and non-chocolate purchases, but much of this work is delegated to Roberto, a competent accountant and administrator.

INVENTORY AND SUPPLIER ISSUES

DCC promises its customers 'superior' taste and quality ingredients, backed up by innovative packaging. However, over the last couple of months, Emanuela has noticed that she is now dealing with a large number of customer complaints regarding poor quality and late deliveries. To determine the level of impact of these complaints on customer satisfaction, Emanuela commissioned Colmar Brunton to conduct a customer-satisfaction survey. She was surprised by the results which indicated problems with both the quality of the chocolates provided and the standard of customer service offered. Emanuela discusses the survey results with Raffaele, who mentions that recent in-store market testing of a new chocolate product, 'CioccolatoSupremo', indicated that there may be a quality issue, but he did not think it was a major concern, so was going to look at it when he had time. However, in light of the survey results, Emanuela and Raffaele are not sure whether the problem is in their own processes and activities or a fault with the chocolates received from one or more of the 6 chocolatier suppliers.

Raffaele is responsible for liaison with the chocolatier suppliers to ensure reliable supply of quality chocolates to his specifications. He therefore offers to investigate to see if there are supply and quality concerns with any of the chocolatier suppliers. Raffaele organises a meeting during which one chocolatier mentions that there has been a change in one of the Belgian suppliers of the Callebaut chocolate paste and there have been delays in receiving orders from another paste supplier. Another chocolatier is worried about recent media reports regarding pesticide contaminants and potentially harmful bacteria in the milk products they use. The chocolatiers have also noticed a change in the quality of some of the fruit and herbs used to make the fillings. One of the chocolatiers comments that:

"I have had to source extra fruit and herb growers due to a shortage in supply because of the amount of rain and wind we have had over the summer."

Another chocolatier needed to add in 'filler ingredients' to make the fruit go further. The suppliers also complain about the wastage of ingredients when DCC changes the chocolates they want produced by the chocolatiers. One chocolatier exclaims:

"What's worse is that we end up with a lot of ingredients that we have to dump when you change your mind about what we are producing or bring in a new flavour without giving us sufficient notice. In this case, we have to pay a premium for our new high quality ingredients!"

Supplier management and quality control of the outsourced chocolate manufacturing process is of high importance. However, maybe things are not as controlled as Raffaele thought they were. He has also noticed that some of the chocolatiers are delivering incorrect orders and DCC has had to dispose of chocolates that were rejected at 'the box' due to imperfections. Further, some orders are delivered late to 'the box'. Raffaele wonders whether he needs to increase the number of inspection visits he makes to the' manufacturing facilities.

In addition, Raffaele realises that the purchase price of the bulk chocolates is not the only supplier cost that DCC incurs. He questions whether purchasing from only local chocolatiers is the right strategy. Therefore, he asks Roberto to PREPARE AN ESTIMATE of the purchase and other supply-related costs for a local chocolatier that supplied 2,500,000 chocolates in the last year and the Nelson-based (South Island) chocolatier who has recently contacted him regarding the possibility of a supply contract for 2,400,000 chocolates (the capacity of their manufacturing facilities). Roberto extracts the relevant information from his accounting system and estimates that the purchase costs for the local chocolatier are $2,200,000 while the South Island chocolatier's purchase costs would be $2,300,000 (mainly due to additional freight costs). Other supplierrelated costs (e.g. for ordering, inspection, returns and payments) were $275,000 for the local supplier and are estimated to be $100,000 for the prospective South Island supplier.

Raffaele decides to discuss these findings with Emanuela, but he does speculate whether the high supplier-related costs are linked to the quality concerns that the recent customer satisfaction survey and supplier meeting have identified. Raffaele and Emanuela certainly agree on one thing:

"We need some chocolates to help us think!" The chocolates and the thought process lead them to conclude that they need some expert advice.

QUESTION:

(a) Calculates the total cost of ownership per unit and Supplier Performance Index of the current local supplier and the proposed South Island supplier and discusses the relative performance of these two suppliers.