J.L.

Kellogg Graduate School of Management Northwestern University

Kellogg

Operations

CRU COMPUTER RENTAL

Richard Sarkis, General Manager for CRU Computer Rentals, was studying the sales and financial figures for the first quarter of 1997 and was at a loss to explain the numbers. After a period of declining sales towards the end of 1996, sales had picked up over the last quarter. However, profitability continued to decline and was in fact worse than 1996. Richard had scheduled a meeting with his Vice Presidents for sales and operations and was wondering how to proceed. He had asked them to come prepared with data for the meeting.

Background
CRU is one of two national computer rental companies. It was started in 1990 and has seen its business grow rapidly. CRU purchases CPUs, monitors, printers and other peripherals and rents them out for long term leases as well as short term rentals. Duration of leases range from 1 day to 2 years in some cases. CRUs 1996 revenues totaled about $15 million. The majority of CRUs customers fit into one of the following categories: large corporate accounts that want to stay on the cutting edge of technology and replace their machines every year and thus lease for that duration, consulting firms and smaller business customers requiring a computer for the medium term, typically 2 to 4 months, participants in trade shows who require a short term rental for the duration of the show.

Customers expect short lead times in this business (typically one to two days) and place a high value on quick, accurate delivery and installation. All firms in the computer rental business worked hard to ensure quick response. The set of items that CRU carries in inventory is primarily driven by customer demand. CRU tries to be very customer sensitive and often purchases machines requested by good customers, even if they are not typically held in stock. Since the rate of new product introduction is rapid in this industry and prices fall rapidly, CRU is under tremendous pressure to generate revenue quickly from units that it has purchased. If certain models are no longer in demand, CRU sells them in the open market as used machines. So far, CRU has generally managed to recover the undepreciated value on the machine.

CRU Operations and the Rental Cycle

This case was written by Professor Sunil Chopra, Operations Management group, Department of Managerial Economics and Decision Sciences, J. L. Kellogg Graduate School of Management, Northwestern University. Copyright 1999, January 14. To order copies, call (847) 491-3603. No part of this publication may be reproduced without the permission of the author and J. L. Kellogg Graduate School of Management.

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CRU currently has two main warehouses (or Mega Centers at Naperville, IL and Fullerton, CA) and 23 local retail centers (LRCs) located throughout the country. Exhibit 1 shows the Mega Center and LRC locations. All equipment that is available to rent is stocked at one of these locations with over 90% of the equipment at the Mega Centers. All equipment when returned from the customers is returned to the Mega Centers for repair and reconfiguration. The high level flow of orders and units through the CRU system is as follows. A customer calls a toll free number or a local CRU rental services number. Calls are automatically routed to either a nearby LRC or to one of the two Mega Centers with groups of Sales Specialists. The Sales Specialist identifies the customer (existing or new), verifies credit, and takes the order. The Sales Specialist has access to the Available for Rent inventory in each warehouse, by item code, on a screen in front of her. She assigns a particular unit in a warehouse to be shipped to the customer. Once an order is taken, these units are removed from Available for Rent inventory (status 20) to a reserve status (status 32). Sales Specialists are trained to search for substitutes in case a specific piece of equipment is not available. They recommend these substitutes to customers and work with the customer to find something suitable. Once an order has been entered into the system, it is routed to Quality Assurance and Picking where it prints out automatically from a printer linked to the order taking system. The printing takes place as soon as the Sales Specialist finishes entering the order. The printed document contains the details of the order as well as the due date. It may also contain specific instructions with regards to the order that may have been entered by the Sales Specialist. After reviewing the order for accuracy and delivery date, the picker locates the specific item(s) in the warehouse, picks it (them) and delivers it (them) to holding area in the Configuration section. Technicians pick up orders for configuration along with the order form from this holding area. They are required to pick orders in sequence. There is, however, a tendency to pick orders that are perceived to be easy. Machines in the warehouse are stored in a standard configuration in terms of hardware and software. Most orders have some variation from standard in terms of memory, hard drive size, other hardware or even software. The technician in the Configuration section configures the equipment as per customer request by cleaning the equipment, installing any necessary hardware (e.g. memory chips, print cartridges etc.), and loading appropriate software. All technicians are capable of installing all types of hardware and software. Once all items comprising an order have been configured, the technician rolls the cart containing the configured order to the Shipping department. A shipper then reviews the invoice tag to verify contents, ship date, and ship mode. The items are then packaged, labeled and shipped out by the appropriate mode. The shipping cost (borne by CRU) has averaged $25 per unit. Once the customer has finished the rental term, (s)he packages the units and ships them back, using preaddressed labels, to one of the Mega Centers. The return shipping cost (incurred by CRU) has averaged $25 per unit. Some times the units are returned by the customers prior to the end of the rental term because they are broken or need repairs. All returned units are received at a Mega Center in the Receiving department. Each unit received is classified as defective ( status 40) or not defective (status 24). Status 24 units are put into storage to be worked upon by the Pre-Configuration department and status 40 units are put into storage to be worked upon by the Repairs group. Historically, 30% of the units received have been classified as status 40 and 70% of the units received have been classified as status 24 at the Receiving stage. When a technician in the Pre-Configuration department is ready to work on a unit, it is picked from storage and brought to the technician. The technician does a quick check to see that it is not defective. Historically, 15% of the status 24 have turned out to be defective. In other words they should have been classified as status 40 at Receiving but were not classified correctly. In this case the technician changes

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the status of the unit to status 40 and returns it to storage. If the unit works, the technician then removes any stickers that may have been specific to the previous customer, reformats the hard drive, does some basic cleaning and puts the unit back into storage as Available for Rent or status 20. The average material cost to convert a unit from status 24 to status 20 has been $4. When a technician in the Repairs group is ready to work on a unit it is picked from storage and brought to the technician. The technician runs a series of tests to identify any parts that may need to be replaced. An order sheet is filled and sent to the Parts department. A unit for which the order sheet has been filled is classified as status 41. The Repairs technician then sends the status 41 unit into storage. The order sheets themselves queue up at the Parts department. The Parts department uses information from the order form to place orders with the suppliers. Once an order is placed with the parts supplier, it takes on average 1 week before the part arrives to the Parts department. Once the parts come in they are received by the Parts group and added on to the unit in storage. Once all parts become available and have been added to the unit in storage by the Parts department, the unit is now classified as status 42. Repair technicians pull status 42 units from storage, repair them and convert them to status 20 units when they become Available for Rent. The average parts cost when repairing a defective unit has been $150 per unit. This does not include labor cost.

Performance Measures
The key performance measured tracked at CRU has been utilization. It is defined as Utilization = Number of Units on Rent Number of units owned by CRU. Utilization is primarily an inventory related measure and can be restated as Utilization = Inventory on Rent Total inventory owned by CRU. Richard had managed the business by trying to ensure that utilization at CRU never drops below 50%. The idea behind this is the fact that a high utilization ensures that most of the units owned by CRU are with the customer generating revenue. On entering the office of CRU in Naperville, one first encounters a monitor displaying current Utilization figures and historical trends over the last 12 weeks. Each unit in the CRU inventory has an average purchase price of $1,000, and CRU has followed a straight-line depreciation over 36 months.

Situation in 1996
In 1996, units were being rented at the rate of 1,000 units per week. The average rental term (duration of time the unit is with the customer) was 8 weeks. The average weekly revenue per unit for rentals of this term was $30. A study showed the average inventory distribution in the system to be as follows: Units waiting to be received = Units in status 40 = Units in status 24 = 500 1,000 1,500 3

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Units in status 42 =

500

The number of units in status 41 was unknown. However it was known that, on average, there were 500 order forms from the Repair group that the Parts department had yet to enter into the system and place orders with the suppliers. In other words, there were, on average, 500 units for which the Repairs group had requested parts, but the Parts department had not yet placed a parts order. As stated earlier, once the Parts department placed an order, it took one week, on average, for the parts to come in from the supplier. CRU policy required that inventory to cover about 2 weeks demand be available for rent in status 20 at all times.

Situation in 1997
At the beginning of 1997 the rental market started to decline and CRU saw demand fall to 600 units per week. This led to a big drop in Utilization and was of great concern at CRU. One option that CRU had was to dispose of the extra units and only maintain the units required to service the lower demand with the previous utilization. Richard and the VP of sales, however, decided to try and spur demand by offering some customer incentives and also offering extra bonus payments to the sales staff for new demand generated. These efforts bore fruit and within a couple of months CRU saw demand go up to 1,400 units per week. Of the 1,400 units, 600 were being rented for an average term of 8 weeks and brought in revenue of $30 per week per unit. The remaining 800 were being rented for an average term of 4 weeks and brought in revenue of $35 per week per unit (The original pricing would have brought in $40 per week per unit, but the incentives offered to spur sales lowered revenues). A review of the various buffers revealed that the average time spent in various buffers was the same as it was in 1996. The size of the status 20 buffer was still kept at 2 weeks of demand. Of course additional units had been purchased since demand had increased from 1,000 units per week in 1996 to 1,400 units per week currently. All these efforts brought revenues and Utilization back to reasonable levels and Richard expected that profitability would follow. However he was shocked when the next quarter numbers came in and revealed that they were making even less money than before. He wondered whether Utilization was an appropriate performance measure as a leading indicator of future financial performance. He was looking for a framework to analyze the situation and come up with the appropriate recommendation.

Questions
1. What was the utilization achieved by CRU in 1996? 2. For 1996, calculate the average time spent by a unit in each buffer. 3. Calculate the average weekly contribution margin (revenues - variable costs) to CRU in 1996. Ignore labor and facility costs in this calculation. We assume that they are fixed. How does the contribution margin compare with the weekly depreciation?

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4. What do you think about the decision to launch a sales drive in 1997? If you had a chance to advise Richard, what actions would you suggest Richard focus on to improve performance at CRU (give a concrete plan listing the resulting benefits)? What are key performance measures that he should focus on? 5. Exhibit 2 contains the pricing scheme used by CRU. Richard has to decide on how the sales effort is to be assigned among the various market segments (represented by duration of rental). There are three options that have been suggested by the VP of sales and a decision has to be made. The three options have the following outcomes: Capture 60% of the 4 week market, 30% of the 8 week market and 10% of the 12 week market Capture 40% of the 4 week market, 40% of the 8 week market and 20% of the 12 week market Capture 20% of the 4 week market, 50% of the 8 week market and 25% of the 12 week market

(i) Assume that Operations will be able to ensure that all buffer sizes are the same as they were in 1996 for all three options (status 20 buffer continues at 2 weeks). Which of the three options would you recommend? Why? (ii) Assume that Operations will be able to ensure that the time spent in all buffers is the same as it was in 1996. Which of the three options would you recommend? Why?

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Exhibit 1: Center Locations

Mega Center Locations 1. Naperville, IL 2. Fullerton, CA Local Rental Center Locations (Decreasing rental volume) 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. Fullerton, CA Atlanta, GA Naperville, IL Minneapolis, MN Seattle, WA Santa Fe Springs, CA Cleveland, OH Paramus, NJ Kansas City, MO Tampa, FL Dallas, TX Raleigh, NC Tucson, AZ Boston, MA Houston, TX Fort Lauderdale, FL Philadelphia, PA Rochester, NY White Plains, NY Pittsburgh, PA Austin, TX Salt Lake City, UT Detroit, MI St. Louis, MO Washington, DC

Exhibit 2: Rate Plans

The rate charged from the customer is dependent on the duration of the rental. As the term of the rental increased, the rate charged per week declines. The current pricing and total market size (this includes the total demand in the markets that CRU competes in. CRU captures a share of this total demand.) in terms of rental demand per week is as shown below. CRU captures a fraction of the total market (its market share): Rental Term 4 weeks 8 weeks 12 weeks Revenue per Week $40 $30 $25 Total Market Demand 1500 units per week 1000 units per week 600 units per week