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Pepe began to produce and sell denim jeans in the early 1970

Pepe began to produce and sell denim jeans in the early 1970s in the United Kingdom and has achieved enormous growth. Pepeâ??s success was the result of a unique approach in a product market dominated by strong brands and limited variety. Pepe presented a range of jeans styles that offered a better fit than traditional 5-pocket Western jeans (such as those made by Levi Strauss in the United States)â?"particularly for female customers. The Pepe range of basic styles is modified each season, but each style keeps its identity with a slightly whimsical name featured prominently on the jeans and on the point-of-sale material. Variations such as modified washes, leather trim, and even designer wear marks are applied to respond to changing fashion trends. To learn more about Pepe and its products, visit its Web site at http://www.pepejeans.com.
Pepeâ??s brand strength is such that the company can demand a retail price that averages about Ã?£45 ( Ã?£1 = $1.6 ) for its standard products. A high percentage of Pepe sales are through about 1,500 independent outlets throughout the United Kingdom. The company maintains contact with its independent retailers via a group of approximately 10 agents, who are self-employed and work exclusively for Pepe. Each agent is responsible for retailers in a particular area of the country.
Pepe is convinced that a good relationship with the independent retailers is vital to its success. The agent meets with each independent retailer three to four times each year in order to present the new collections and to take sales orders. Because the number of accounts for each agent is so large, contact is often achieved by holding a presentation in a hotel for several retailers. Agents take orders from retailers for six-month delivery. After Pepe receives an order, the retailer has only one week in which to cancel because of the need to place immediate firm orders in Hong Kong to meet the delivery date. The company has had a long-standing policy of not holding any inventory of jeans in the United Kingdom.
After an order is taken and confirmed, the rest of the process up to delivery is administered from the Pepe office in Willesden. The status of orders can be checked from a Web site maintained by Pepe. The actual orders are sent to a sourcing agent in Hong Kong who arranges for manufacturing the jeans. The sourcing agent handles all the details associated with materials, fabrication, and shipping the completed jeans to the retailer. Pepe has an outstanding team of young in-house designers who are responsible for developing new styles and the accompanying point-of-sale material. Jeans are made to specifications provided by this team. The team works closely with the Hong Kong sourcing agent to ensure that the jeans are made properly and that the material used is of the highest quality.
A recent survey of the independent retailers indicated some growing problems. The independents praised the fit, quality, and variety of Pepeâ??s jeans, although many thought that they had become much less of a trendsetter than in their early days. It was felt that Pepeâ??s variety of styles and quality were the companyâ??s key advantage over the competition. However, the independents were unhappy with Pepeâ??s requirements to place firm orders six months in advance with no possibility of amendment, cancellation, or repeat ordering. Some claimed that the inflexible order system forced them to order less, resulting in stockouts of particular sizes and styles. The retailers estimated that Pepeâ??s sales would increase by about 10 percent with a more flexible ordering system.
The retailers expected to have some slow-moving inventory, but the six-month order lead time made it difficult to accurately order and worsened the problem. Because the fashion market was so impulsive, the current favorites were often not in vogue six months in the future. On the other hand, when demand exceeded expectations, it took a long time to fill the gap. What the retailers wanted was some method of limited returns, exchange, or reordering to overcome the worst of these problems. Pepe was feeling some pressure to respond to these complaints because some of Pepeâ??s smaller competitors offered delivery in only a few days.
Pepe has enjoyed considerable financial success with its current business model. Sales last year were approximately Ã?£200M. Cost of sales was approximately 40 percent, operating expenses 28 percent, and profit before taxes nearly 32 percent of sales. The company has no long-term debt and has a very healthy cash position.
Pepe was feeling considerable pressure and felt that a change was going to be needed soon. In evaluating alternatives, the company found that the easiest would be to work with the Hong Kong sourcing agent to reduce the lead time associated with orders. The agent agreed that the lead time could be shortened, possibly to as little as six weeks, but costs would increase significantly. Currently, the agent collects orders over a period of time and about every two weeks puts these orders out on bid to about 1,000 potential suppliers. The sourcing agent estimated that costs might go up 30 percent if the lead time were shortened to six weeks. Even with the significant increase in cost, consistent delivery schedules would be difficult to keep.
The sourcing agent suggested that Pepe consider building a finishing operation in the United Kingdom. The agent indicated that a major retail chain in the United States had moved to this type of structure with considerable success. Basically, all the finishing operation did for the U.S. retail chain was apply different washes to the jeans to give them different â??wornâ?? looks. The U.S. operation also took orders for the retail stores and shipped the orders. The U.S. firm found that it could give two-day response time to the retail stores.
The sourcing agent indicated that costs for the basic jeans (jeans where the wash has not been applied) could probably be reduced by 10 percent because the volumes would be higher. In addition, lead time for the basic jeans could be reduced to approximately three months because the finishing step would be eliminated and the orders would be larger.
The Pepe designers found this an interesting idea, so they visited the U.S. operation to see how the system worked. They found that they would have to keep about six weeksâ?? supply of basic jeans on hand in the United Kingdom and that they would have to invest in about Ã?£1,000,000 worth of equipment. They estimated that it would cost about Ã?£500,000 to operate the facility each year. They could locate the facility in the basement of the current Willesden office building and the renovations would cost about Ã?£300,000.

Q U E S T I O N S
1 Acting as an outside consultant, what would you recommend that Pepe do? Given the data in the case, perform a financial analysis to evaluate the alternatives that you have identified. (Assume that the new inventory could be valued at six weeksâ?? worth of the yearly cost of sales. Use a 30 percent inventory carrying cost rate.) Calculate a payback period for each alternative.

2 Are there other alternatives that Pepe should consider?

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Note to student: The answers to the case questions below are a combination of my teaching notes and the instructorâ??s course teaching notes from this class. Please use the format below as a guideline for your own answers, so that the format of your assignment answers is not identical to that of my teaching notes, which is based on the instructorâ??s notes for this class. Thank you, and best of luck in your studies.

1. Acting as an outside consultant, what would you recommend that Pepe do? Given the data in the case, perform a financial analysis to evaluate the alternatives that you have identified. (Assume that the new inventory could be valued ...

Solution Summary

Pepe began to produce and sell denim jeans in the early 1970s in the United Kingdom and has achieved enormous growth. Pepeâ??s success was the result of a unique approach in a product market dominated by strong brands and limited variety. Pepe presented a range of jeans styles that offered a better fit than traditional 5-pocket Western jeans (such as those made by Levi Strauss in the United States)â?"particularly for female customers. The Pepe range of basic styles is modified each season, but each style keeps its identity with a slightly whimsical name featured prominently on the jeans and on the point-of-sale material. Variations such as modified washes, leather trim, and even designer wear marks are applied to respond to changing fashion trends. To learn more about Pepe and its products, visit its Web site at http://www.pepejeans.com.
Pepeâ??s brand strength is such that the company can demand a retail price that averages about Ã?£45 ( Ã?£1 = $1.6 ) for its standard products. A high percentage of Pepe sales are through about 1,500 independent outlets throughout the United Kingdom. The company maintains contact with its independent retailers via a group of approximately 10 agents, who are self-employed and work exclusively for Pepe. Each agent is responsible for retailers in a particular area of the country.
Pepe is convinced that a good relationship with the independent retailers is vital to its success. The agent meets with each independent retailer three to four times each year in order to present the new collections and to take sales orders. Because the number of accounts for each agent is so large, contact is often achieved by holding a presentation in a hotel for several retailers. Agents take orders from retailers for six-month delivery. After Pepe receives an order, the retailer has only one week in which to cancel because of the need to place immediate firm orders in Hong Kong to meet the delivery date. The company has had a long-standing policy of not holding any inventory of jeans in the United Kingdom.
After an order is taken and confirmed, the rest of the process up to delivery is administered from the Pepe office in Willesden. The status of orders can be checked from a Web site maintained by Pepe. The actual orders are sent to a sourcing agent in Hong Kong who arranges for manufacturing the jeans. The sourcing agent handles all the details associated with materials, fabrication, and shipping the completed jeans to the retailer. Pepe has an outstanding team of young in-house designers who are responsible for developing new styles and the accompanying point-of-sale material. Jeans are made to specifications provided by this team. The team works closely with the Hong Kong sourcing agent to ensure that the jeans are made properly and that the material used is of the highest quality.
A recent survey of the independent retailers indicated some growing problems. The independents praised the fit, quality, and variety of Pepeâ??s jeans, although many thought that they had become much less of a trendsetter than in their early days. It was felt that Pepeâ??s variety of styles and quality were the companyâ??s key advantage over the competition. However, the independents were unhappy with Pepeâ??s requirements to place firm orders six months in advance with no possibility of amendment, cancellation, or repeat ordering. Some claimed that the inflexible order system forced them to order less, resulting in stockouts of particular sizes and styles. The retailers estimated that Pepeâ??s sales would increase by about 10 percent with a more flexible ordering system.
The retailers expected to have some slow-moving inventory, but the six-month order lead time made it difficult to accurately order and worsened the problem. Because the fashion market was so impulsive, the current favorites were often not in vogue six months in the future. On the other hand, when demand exceeded expectations, it took a long time to fill the gap. What the retailers wanted was some method of limited returns, exchange, or reordering to overcome the worst of these problems. Pepe was feeling some pressure to respond to these complaints because some of Pepeâ??s smaller competitors offered delivery in only a few days.
Pepe has enjoyed considerable financial success with its current business model. Sales last year were approximately Ã?£200M. Cost of sales was approximately 40 percent, operating expenses 28 percent, and profit before taxes nearly 32 percent of sales. The company has no long-term debt and has a very healthy cash position.
Pepe was feeling considerable pressure and felt that a change was going to be needed soon. In evaluating alternatives, the company found that the easiest would be to work with the Hong Kong sourcing agent to reduce the lead time associated with orders. The agent agreed that the lead time could be shortened, possibly to as little as six weeks, but costs would increase significantly. Currently, the agent collects orders over a period of time and about every two weeks puts these orders out on bid to about 1,000 potential suppliers. The sourcing agent estimated that costs might go up 30 percent if the lead time were shortened to six weeks. Even with the significant increase in cost, consistent delivery schedules would be difficult to keep.
The sourcing agent suggested that Pepe consider building a finishing operation in the United Kingdom. The agent indicated that a major retail chain in the United States had moved to this type of structure with considerable success. Basically, all the finishing operation did for the U.S. retail chain was apply different washes to the jeans to give them different â??wornâ?? looks. The U.S. operation also took orders for the retail stores and shipped the orders. The U.S. firm found that it could give two-day response time to the retail stores.
The sourcing agent indicated that costs for the basic jeans (jeans where the wash has not been applied) could probably be reduced by 10 percent because the volumes would be higher. In addition, lead time for the basic jeans could be reduced to approximately three months because the finishing step would be eliminated and the orders would be larger.
The Pepe designers found this an interesting idea, so they visited the U.S. operation to see how the system worked. They found that they would have to keep about six weeksâ?? supply of basic jeans on hand in the United Kingdom and that they would have to invest in about Ã?£1,000,000 worth of equipment. They estimated that it would cost about Ã?£500,000 to operate the facility each year. They could locate the facility in the basement of the current Willesden office building and the renovations would cost about Ã?£300,000.

Q U E S T I O N S
1 Acting as an outside consultant, what would you recommend that Pepe do? Given the data in the case, perform a financial analysis to evaluate the alternatives that you have identified. (Assume that the new inventory could be valued at six weeksâ?? worth of the yearly cost of sales. Use a 30 percent inventory carrying cost rate.) Calculate a payback period for each alternative.

2 Are there other alternatives that Pepe should consider?

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