Question #2A: Economic theory explains the existence of firms as the outcome of
ID: 1113649 • Letter: Q
Question
Question #2A:
Economic theory explains the existence of firms as the outcome of a cost-minimization process. Following the insight provided by Ronald Coase, we predict that a task will be performed within a firm, as opposed to outside of the firm, only when there is a cost advantage to that arrangement. An example in Chapter 9 illustrates the relative costs of having your car fixed at an established garage versus contracting separately with mechanics, parts suppliers, and equipment providers. The garage owner can exploit economies of scale by buying capital equipment and establishing contractual relationships with mechanics and suppliers and using these assets to serve many customers. The transactions costs per customer are lower than those the customer would incur if he had to make all these arrangements for himself.
Recently, however, technological change in the telecommunications industry has dramatically lowered the cost of transmitting complicated information over large distances. People skilled in the creative use of this technology can reduce the level of uncertainty surrounding routine management decisions such as how many shirts of a given size and color to store in the warehouse. Today, a firm called TAL, based in Hong Kong, specializes in inventory management—traditionally an in-house function—for a host of retailers.
“TAL collects point-of-sale data for Penney’s shirts directly from its stores in North America, then runs the numbers through a computer model it designed. The Hong Kong company then decides how many shirts to make, and in what styles, colors and sizes. The manufacturer sends the shirts directly to each Penney store, bypassing the retailer’s warehouses—and corporate decision makers….It supplies labels such as J. Crew, Calvin Klein, Banana Republic, Tommy Hilfiger, Liz Claiborne, Ralph Lauren and Brooks Brothers. …Now, TAL is negotiating a deal to manage Brooks Brothers’ shirt inventory the same way it does Penney’s. For Lands’ End, TAL stitches made-to-measure pants in Malaysia and flies them straight to U.S. customers, with a shipping invoice that carries the Lands’ End logo.
These retailers have been willing to cede some functions once seen as central because TAL can do them better and more cheaply. Rodney Birkins Jr., vice president for sourcing of J.C. Penney Private Brands Inc., describes as “phenomenal” the added efficiency Penney has been able to achieve with TAL. Before it started working with TAL a decade ago, Penney would routinely hold up to six months of inventory in its warehouses and three months’ worth at stores. Now, for the Stafford and Crazy Horse shirt lines that TAL handles, “it’s zero,” Mr. Birkins says.” (Kahn, Gabriel, “Made to Measure: Invisible Supplier Has Penney’s Shirts All Buttoned Up; From Hong Kong, It Tracks Sales, Restocks Shelves, Ships Right to the Store; Inside a ‘Radical’ Power Shift”. Wall Street Journal (Eastern edition), September 11, 2003: pg. A1)
Explain how TAL exploits economies of scale in the production of inventory management.
Question #2B:
The (former) in-house inventory management department at JC Penney’s was less efficient than TAL for two reasons. First, the employees in that department lacked the software and specialized skill of the innovative entrepreneur at TAL. In addition there were inefficiencies resulting from the imperfect incentive structure of salaried employees. Explain, using the concept of the principal-agent problem.
Explanation / Answer
2a-TAL is the firm based in Hong Kong that specializes in inventory management and in-house function for a host of retailers. It collects point-of-sale data for penney’s shirts directly from its stores in North America, then runs the numbers through a computer model it designed. TAL is negotiating a deal to manage Brooks Brothers’ shirt inventory the same way it does Penney’s.
The TAL has exploited economies of scale in the production of inventory management by using
technological change which has lowered the cost of transmitting complicated information over large distances. and uing skilled people in the creative use of this technology which hasa reduced the level of uncertainty surrounding routine management decisions such as how many shirts of a given size and color to store in the warehouse.
2b-The in-house inventory management department at JC Penney’s was less efficient than TAL for two reasons. First, the employees in that department lacked the software and specialized skill of the innovative entrepreneur at TAL. In addition there were inefficiencies resulting from the imperfect incentive structure of salaried employees.
The concept of the principal-agent problem can be applied because providing the better communication channels ,innovative entrepreneur , participative decision making and providing good incentive structure of salaried employees.