Question

MIS Field Engineering Inc.

MIS Field Engineering Inc. has been providing general engineering support services for oil fields in Libya. Last month the company received an offer for a long-term contract to services (replace, repair) the mega rotary drill units (the shaft and end drill that actually cuts up the rock; comes in many shapes and made of tungsten carbide steel that are specialized for various drilling tasks). MIS is evaluating whether they should sign this contract, which comes into effect in September 2020. This contract would mandate servicing three new drilling sites and to do that MIS must utilize its central depot. As this depot provides a variety of services to other fields, it would be capable of servicing 700 drill units annually.

Although they are all located southeast of the central depot, the three new sites have varying levels of drilling activity for which they would require different number of repairs for their drill units. With a projected eight repairs per week, the first one is located 160 km south and 200 km east of central depot. Located at 150 km south and 180 km east of the central depot the second site is projected to send ten drill units per week for repair. With the deepest level of drilling that requires twelve repairs per week, the third site is located 140 km south and 160 km east of the central depot. MIS predicts that in all these sites at least eight drill units would need to be repaired in a week.

The management of the company has three options for servicing the damaged drill units. The first option is to pick up the damaged drill units from each site, bring them to the central depot, repair them and ship them back to the sites. The second option is to use a warehouse close to the sites which houses repaired units that have been brought from the central depot. With this option, each site would bring their damaged units to the warehouse and pick a repaired one from there. While the second option would be more cost effective in the long run, it would require MIS to a) find or build a warehouse close to the three sites and b) build a road from the central depot to the warehouse for transportation. Since the new region is flat with no topographic challenges a straight two-lane paved road can be constructed at the cost of $400,000 per kilometer, which would be useable for 10 years. As the region has been recently explored, no existing warehouse could be found. Therefore, the company must build a warehouse. The following three types of warehouse can be built:

Warehouse Type	Land and Building	Transportation & operating Cost per drill unit
Type 1	$500,000	$9,000
Type 2	$900,000	$6,000
Type 3	$1,500,000	$4,000

The third option available to MIS is to use a third party logistic (3PL) partner. The winner of MIS call for bid is SHP Logistics that offered the price of $13,500 for one-way transportation of drill units between the central depot and the three sites.

Consulting the senior foreman at the central depot, the management learned with about $2.3Mn investment in additional equipment MIS can also provide three basic services at the warehouse to generate additional income. These basic services apply to other machinery used on sites, are not as extensive as and do not interfere with the drill unit repairs done at the central depot. Details of these services are summarized in the following table:

Service Type	Projected demand	Price per Service	Cost per Service
Type 1	200	$2,500	$1,500
Type 2	200	$6,000	$2,000
Type 3	400	$20,000	$8,000

The management predicts that with 25% discount in the price of Type 3 service, they can increase their type 3 service business by 200%, but to meet the increased demand they would need to hire ten licenced mechanics at a monthly salary of $40,000.  

The management realizes MIS would need to borrow for warehouse and road construction and additional equipment at the warehouse. In addition, the success of its operation would heavily depend on supplies of parts and material. Timely and secure flow of parts and supplies and the shear cost of supplies are two main concerns for MIS. On the other hand, the lending bank has demanded MIS to show better profit margin to support its loan application. The management realizes that higher profit could result from increased revenue and/or saving in inventory cost. Based on the accounting reports the relationship between increased sales and supply chain saving are summarized in the following table:

Dollars of Additional Sales Needed to Equal $1 Saved through the Supply Chain
	Percent of Sales Spent in the Supply Chain
Percent of Net Profit of Firm	30%	40%	50%	60%	70%	80%	90%
2	$2.78	$3.23	$3.85	$4.76	$6.25	$9.09	$16.67
4	$2.70	$3.13	$3.70	$4.55	$5.88	$8.33	$14.29
6	$2.63	$3.03	$3.57	$4.35	$5.56	$7.69	$12.50
8	$2.56	$2.94	$3.45	$4.17	$5.26	$7.14	$11.11
10	$2.50	$2.86	$3.33	$4.00	$5.00	$6.67	$10.00

The accounting department suggests that if MIS spends 60% of its sales in the supply chain and have a net profit margin of 6% it can invest $100,000,000 in one of the two ventures. One venture aims at new supply chain efficiency, which is expected to increase the company’s revenues (sales) by $600,000,000 (after spending the $100,000,000). The other venture applies the money to technological upgrade that are expected to save $200,000,000 (again, after spending the $100,000,000). Chapter 11 Supply chain

The management is also concerned about the supplies of Dim-4 and Dim-5 (two resistant drills made of heat-treated tungsten carbide steel). The key international suppliers use three major Libyan seaports to avoid interruption in supplies, but all these ports are prone to chaotic events resulting from political unrest. The management believes that the probability in any year of a “super-event” that might shut down all the seaports or severely delay custom clearance at the same time for at least two weeks is 3%. Such incidents would cost the MIS Company approximately $400,000,000. The management estimates the “unique event” risk for any of the ports to be 5% and the accounting department estimates the marginal cost of managing an additional supplier is $15,000,000 per year. The three major ports the suppliers ship to are nearly identical. To avoid any interruption in the supplies, MIS can alternatively use secure expedited air transportation to import Dim-4 and Dim-5 at a cost of $500 per unit. This option would ensure MIS would have the required level of inventory (3,500 units of each drill type per month) to service the sites.

The management has asked your group to review their situation and submit a technical report that could help them with the decision on signing the contract. They believe the answer to the following questions will be crucial to their decision:

QUESTIONS

1. What will be the overall revenue level from basic service at the warehouse if MIS offers the 25% discount and realize the 200% increase in Type 3 service?