Mike McNeely, logistics manager for the Illumination Light Company, has considered replacing the firm's manual customer order management system with electronic ordering, an EDI application. He estimates that the current system, including labor costs $2.50/order for transmission and processing when annual order volume is under 25,000. Should the order volume equal or exceed 25,000 in any given year, Mr. McNeely will have to hire an additional customer service representative to assist with order reception in the manual process. This would raise the variable cost to $3.00/order. He has also estimated the rate of errors in order placement and transfer to be 12 per 1,000 orders.
EDI would cost $100,000 up front to implement, and variable costs are determined to be $0.50/order regardless of volume. EDI could acquire and maintain order information with an error rate of 3 per 1,000 orders. An EDI specialist would be required to maintain the system at all times as well. Her salary would be $38,000 in the first year and would increase 3 percent each year thereafter.
Order errors cost $5.00 per occurrence on average to correct in the manual system. EDI errors cost $8.00 on average to correct.
If the firm expects order volume over the next five years to be 20,000, 22,000, 25,000, 30,000 and 36,000 annually, would EDI pay for itself within the first five years?