Tāngata Tea: Local Versus Offshore Packaging
Tāngata Tea is a small Dunedin business that blends and sells loose-leaf tea. It uses 18,000 stand-up pouches a year. The current local supplier charges $0.45 per pouch, has no minimum order, delivers in one week and has a 1% defect rate. An offshore supplier has quoted $0.30 per pouch, but requires a minimum order of 20,000 pouches, charges $1,200 freight per shipment and adds 5% import duty to the pouch value. The offshore defect rate is 8%, and the lead time is 12 weeks. Tāngata Tea has $9,000 cash and fixed costs of $4,500 per month. The owner estimates that holding extra stock would cost $300 a year in storage and increase insurance slightly. Demand is steady but the business is introducing two new flavours, so packaging artwork may change within a year. The owner is tempted by the lower unit price but is worried about cash and flexibility.
1. Calculate the cost per usable pouch from each supplier and the annual saving from the offshore order, taking defects into account.
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Local supplier: to obtain 18,000 usable pouches with a 1% defect rate, order 18,000 / 0.99 = 18,181.8, so 18,182 pouches. Cost = 18,182 x $0.45 = $8,181.90. Cost per usable pouch = $8,181.90 / 18,000 = $0.4546.
Offshore supplier: order 20,000 pouches. Pouch cost = 20,000 x $0.30 = $6,000. Import duty = 5% x $6,000 = $300. Freight = $1,200. Total = $7,500. Usable pouches = 20,000 x 0.92 = 18,400. Cost per usable pouch = $7,500 / 18,400 = $0.4076.
The 20,000 order yields 18,400 usable pouches, which is 1.022 times annual demand (18,400 / 18,000). Annualised offshore cost = $7,500 / 1.022 = $7,338.55, plus storage of $300 = $7,638.55. Annual saving compared with local = $8,181.90 - $7,638.55 = $543.35, about $540 a year.
The quantitative case for offshore is real but modest: about 6.6% of packaging cost. It is not a transformation of the business, so the decision should turn heavily on cash and risk.
2. Assess the cash flow and business risk of placing the offshore order.
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Cash flow: Tāngata Tea has $9,000 cash. The offshore order requires $7,500 up front, leaving $1,500. Fixed costs are $4,500 per month, so the remaining cash covers only about 10 days of fixed costs unless sales cash comes in quickly. The local supplier requires no large commitment and matches monthly purchases to demand. A single late shipment or slow month could force the owner to borrow or miss payments.
Inventory risk: the order covers about 12 months of usable stock (18,400 / 18,000 x 12 = 12.3 months). During that time, two new flavours are planned and artwork may change. If the packaging design changes, some of the 20,000 pouches could become obsolete. The 8% defect rate also means the owner pays for 1,600 unusable pouches per order.
Supply risk: a 12-week lead time means the owner must forecast a full year ahead. A demand increase cannot be met quickly, and a demand fall leaves cash tied up in stock. The local supplier offers one-week delivery and flexibility, which has value that does not appear in the unit price.
Judgement: the saving of about $540 a year is too small to justify leaving only $1,500 cash and committing to packaging before the new flavours are settled.
3. Recommend what Tāngata Tea should do about packaging supply, with conditions that would change your recommendation.
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Recommendation: stay with the local supplier for the next 12 months while the two new flavours are launched, and use the time to negotiate. Ask the local supplier for a volume price of $0.42 or $0.43 per pouch at 18,000-20,000 units a year. At $0.42, the local cost for 18,182 pouches is $7,636.44, roughly equal to the annualised offshore cost of $7,638.55, and it keeps cash free and lead time short. Even $0.43 gives $7,818.26, only about $180 more than offshore, which is a reasonable price for flexibility.
Conditions for switching offshore: the recommendation would change if the owner can (a) negotiate a smaller minimum order, such as 10,000 pouches, (b) secure 60-day payment terms or a letter of credit so cash is not drained, (c) finalise packaging artwork for at least 12 months, and (d) build a cash buffer of at least three months of fixed costs, about $13,500. Without those conditions, the offshore saving does not compensate for the risk.