Scenario

Double Olive Oil. Ltd. is a producer of high-quality Olive oil. The company buys raw Olives directly from large agricultural companies and refines them into Olive oil that it sells in the wholesale market.

The company has a maximum input capacity of 150 tons of raw Olives every day (or 54,750 tons per year). Of course the company cannot run at full capacity every day as it is required to shut down or reduce capacity for maintenance periods every year, and it experiences the occasional mechanical problem. The facility is expected to run at 90% capacity over the year (or on average 150 x 90% = 135 tons per day).

Double Olive Oil is planning to purchase its supply of raw Olives from three primary growers, Supplier A, Supplier B, and Supplier C. Purchase prices will not set until the orders are actually placed so Double Olive Oil will have to forecast purchase prices for the raw material and sales prices for the refined Olive oil. The contract is written such that Double Olive Oil is only required to commit to 75% of total capacity up front. Any amounts over that can be purchased only as required for the same price. Historical prices for the last 15 years are in the table below (note that year 15 is the most current year).

Marketing Year	Olive Average Price Index $/ton	Oil Average Price Index $/ton
1	163.7	287.8
2	172.4	455
3	212	642.2
4	220	634.2
5	254	761.3
6	222	702
7	260	911
8	337.2	1013
9	416	1267.3
10	442.8	1302
11	451	1376
12	572	1634
13	518	1307.4
14	418	1142.4
15	414	1304.4

Olive oil contains a number of fatty acids, some which are desirable in food products and others that are not. One desirable fatty acid is Oleic acid. Double Olive Oil produces high Oleic oil for the wholesale market and requires that the Oleic acid content be a minimum of 76%. Olive oil also contains trace amounts of Iodine. The market requires that that Iodine content be a minimum of 0.77% and maximum of 0.87%

The Oleic acid and Iodine content for the Olives from the three suppliers is given in the table below.

Supplier	Oleic Acid	Iodine
A	63%	0.85%
B	74%	0.70%
C	80%	0.92%

Because the Oleic acid and Iodine content varies across the three suppliers, so does the price. It is expected that the cost of supply from the suppliers will be a percentage of the market average price of Olives.

Supplier	Cost as % of Average Market Price of Olive
A	80%
B	75%
C	85%

The company faces an additional variable production cost of $10/ ton and an estimated fixed cost of $1,020,000 over the upcoming production period.

The company is asking you to provide a recommendation on the amount of raw material it should purchase from each supplier to minimize its cost of feedstock.

Management is also looking for an analysis on the profitability of the company in the next production cycle.

Suggested Approach

This is a fairly complex problem. The following approach is suggested:

• Use the historical price data set as input to a time series forecast model in order to generate forecasted prices for the average price of Olives and oil in the next production period. Use standard measures of error to decide between a three-period moving average model or an exponential smoothing model (with = 0.3). Use the type of model for all three time series forecasts. That is, if you decide to use the moving average model, use a three-period moving average model to fit the relevant data for all three series. Dont use the moving average for one time series and the exponential smoothing model for another time series.
• Formulate a linear program to minimize the cost of raw Olives. Use the average price of Olives forecasted from the previous step in order to determine supplier prices.
• Perform a cost-volume-price analysis (review the handout entitled Cost-Volume-Profit Analysis for details) using the average cost per short ton average selling price per short ton.
  • You can generate an effective cost per ton by dividing the total cost of supply (from the linear program) by the total volume (that you assumed in the linear program).
  • You can generate an effective selling price per short ton from the expected percentage yields and the forecasted average price of Olive oil.
  • Because of the way that the contract is written, you can assume that the purchase of raw Olives is a variable cost (you only purchase what you require).

Recall that the cost-volume-price analysis requires you to provide

• an algebraic statement of the revenue function and the cost function,
• a detailed break-even chart that includes lines for the revenue and for the total cost, fixed cost, and variable cost (a total of four lines), and
• a calculation break-even point expressed in number of short tons and percent of capacity.

Management Report

Prepare a written management report that includes, at a minimum, the following sections:

• Purpose of the Report
• Description of the Problem
• Methodology (which would include the model formulation)
• Findings or Results
• Recommendations or Conclusions

Be sure to address all relevant points, discuss any assumptions you are making, justify any modeling choices you have made (for example, the choice of time series forecast model), and highlight the following items in your report:

• a forecast of the next production periods average price index for raw Olives and Olive oil.
• a recommendation for the optimal purchasing strategy from the various suppliers,
• a cost-volume-profit analysis using for the recommended purchase strategy and the forecasted Olive oil sales price,
• a discussion of the risks and uncertainties that are faced by the company, and
• an analysis and opinion on the profitability of the company in the next production period (accounting for the expected profit or loss and the inherent risks/uncertainties.

Remember that you are writing the report from the point of view of a consultant with senior management of Double Olive Oil. Ltd. as the intended audience.