Dandy Collectibles is opening a new warehouse. Bob Lee, the warehouse manager, is trying to determine the labor compensation package that most productively utilizes resources. The typical compensation plan offers an hourly wage rate of $13. Mr. Lee is also considering an incentive plan. The incentive plan rewards solely on performance with order pickers earning $0.40/unit prepared for shipping. A typical week shows the number of ordered units that must be prepared for shipping.
Errors sometimes happen in Dandy’s order picking. Product mishandling occurs in 1% of the orders under the incentive plan and in 0.5% of the orders under the hourly wage plan. Errored orders are scrapped and result in lost revenue of $60 per occurrence. Hourly workers pick 20 units per hour. Incentive workers pick 28 units per hour. Regardless of the plan designation, employees work 40-hour weeks. Union restriction prevent Dandy from operating on Saturday and Sunday. The labor union also restricts Dandy from hiring part-time workers. Orders need not be filled daily, but all orders must be shipped by week’s end (Friday). Assume that hiring and training costs are negligible.
a. How many workers are needed under each plan for the typical week’s demand?

b. Which plan meets the typical week’s demand at the lowest cost, including lost sales resulting from errors?

Explanation:

Following demand data is taken form textbook: Donald Bowersox, David Closs, Logistics Management, Tata McGram-Hill Edition 2000, page no. 453

Day                                      Demand

Monday                                3,400

Tuesday                               3,625

Wednesday                          3,205

Thursday                              3,380

Friday                                   3,670

Weekly demand                  17,280

A) Compensation plan – Hourly based

Wage rate = $13 per hour

Productivity per worker = 20 units per hour

Working hours = 40 hours per week

Error rate = 0.5%

Revenue lost per occurrence of error = $60

Average requirement of the workers = Weekly demand/(productivity per worker x working hours)

= 17,280 units/(20 units per hour x 40 hours)

= 21.6

Actual requirement of the workers = 22 workers

Labor cost = Number of workers x wage rate per hour x working hours

Labor cost = 22 x $13 x 40 = $11,440

Lost revenue = error rate x weekly demand x revenue lost per occurrence of error

Lost revenue = 0.005 x 17,280 x $60 = $5184

Total cost of hourly compensation plan = $11,440 + $5,184 = $16,624

B) Compensation plan – Performance based

Wage rate per unit = $0.40 per unit

Productivity per worker = 28 units per hour

Working hours = 40 hours per week

Error rate = 1%

Revenue lost per occurrence of error = $60

Average requirement of the workers = Weekly demand/(productivity per worker x working hours)

= 17,280 units/(28 units per hour x 40 hours)

= 15.4

Actual requirement of the workers = 16 workers

Labor cost = Number of workers x wage rate per unit x working hours x productivity per hour

Labor cost = 16 x $0.4 per unit x 40 hours x 28 units per hour = $7168

Lost revenue = error rate x weekly demand x revenue lost per occurrence of error

Lost revenue = 0.01 x 17,280 x $60 = $10,368

Total cost of hourly compensation plan = $7,168 + $10,368 = $17,536

Conclusion

                                 Hourly based plan               Performance based plan    

Number                  22 workers                             16 workers

of workers

required

Total cost                 $16,624 per week                       $17,536 per week            

Thus, compensation plan on hourly based with 22 workers is cost effective than performance based plan.