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    The MIlika case

    Milika is a large milk producer and wants to sign a one-year contract for the transportation of milk to customers in the Barena County. The company requires daily shipments from a single depot to over 500 customers. Milika produces about 60 thousand liters (=60 kl) of milk daily, which need to be delivered on the same day. The average monthly milk production is 1,800 kl.

    As of next year, Milika's current transportation service provider will not transport perishable products, such as milk. Therefore, Milika contacted several other well- established logistics service providers. Each of these providers conforms to the industry's highest standards, including, on-time transport of perishable products. Each has a fleet of small milk trucks, with a 5 kl or 10 kl capacity.

    Milika wants to sign a one-year service contract with one of these providers. A standard one-year contract contains two freight rates and the penalty for delay. In the one-year contract, the terms (or issues) are specified on a monthly basis so that the payments can be made according to the actual deliveries. All three issues must be agreed upon and specified in the contract:

    1. Standard rate: This is the rate at which the provider reserves transportation capacity for the milk producer. Milika requires a reserved capacity of 1,800 kl per month and assures that the service provider receives no less than 1,600 kl multiplied by the standard rate.
      Example: When the agreed rate is $20/kl, then the provider is assured a minimum of $32,000 (1,600 x 20 = 32,000); for additional milk transported, the provider receives $20/kl until the limit of reserved capacity is achieved.
    2. Rush rate: This is the rate for rush orders requested by Milika’s customers to transport milk on an ad hoc basis. Milika pays the rush rate but the customers pay a higher price than standard orders.
      Example: If the rush rate is $50/kl and 15 kl were requested, then Milika pays $750 (50 x 15 = 750).
    3. Penalty for delay: This is the amount paid by the service provider when milk is delivered on the same day but later than the scheduled time. The penalty is a percentage of the standard rate.
      Example: If the standard rate is $20/kl, the penalty rate is 40%, and if 15 kl is delivered late, then the service provider pays $120 penalty (20 x 40% x 15 = 120).

    To streamline the contract preparation and avoid misunderstanding, Milika prepared the table below and gave it to each service provider.

    Issue

    Description

    Range

    Standard rate

    Transportation price per one kl of milk up to the reserved quantity.

    $20 ~ 40/kl

    Rush rate

    Transportation price per one kl for rush orders.

    $50 ~ 70/kl

    Penalty for delay

    Penalty (fraction of the standard rate) for delayed delivery (late delivery but within the same day).

    30 ~ 50%

    Note: Range provides minimum and maximum allowable values, e.g., standard rate cannot be lower than $20 per kl or more than $40 per kl.