TAKE HOME TEST

MIDTERM EXAMINATION
Supply Chain Management
(TIN 304)

Session: Semester 1 – AY 2019/2020 Date: 23th Jan 2020

Faculty: Engineering and Computer Sains Duration:

(take home test)
Study Program: Industrial Engineering Permitted Materials:
All Material allowed
Level of Study: Undergraduate (S1)

INSTRUCTIONS TO STUDENTS:
1. Check the following exam paper information:
Exam paper:
• Total number of pages : 7
• Attached materials : -
• Total number of sections : -
• Total number of questions : 5
Instructions:
You are required to answer all compulsory questions in sections

2. Please write your name and student ID on the exam paper and answer sheets.
Student Name ……………………………………………..
Student ID ……………………………………………..

3. Candidates may use this exam paper to write notes as necessary, but should not remove
it from the examination venue for any reason.

4. Any form of cheating or attempt to cheat is a serious offence leading to dismissal.

Final-Term Examination – Semester II/ AY 2019/2020

Michigan Liquor Control Commission

On a Friday afternoon in October 2000, Joseph Duncan, a third-year distribution systems

analyst for the Michigan Department of Commerce, was sitting at his office desk reading
through some background material on distilled liquor distribution in Michigan. Prior to his
current position, Joseph had worked as a distribution analyst in private industry for several
years after graduating from a large midwestern university with a degree in materials and
logistics management. His direct supervisor, Donna Mills, had given Joseph his next
assignment earlier that day. “Be prepared to head up a project team and prepare a proposal on
distilled liquor distribution,” Donna said, “We’ll meet Wednesday afternoon at 2:00 P.M. to
lay out an initial plan.” This was Joseph’s first “lead” project assignment, and although he
was unfamiliar with the topic, he was excited about the opportunity to demonstrate his ability.
He placed the background material in his briefcase and decided to reexamine it at home over
the upcoming weekend.

History of Michigan Liquor Distribution System

In the early 1900s, brewers in Detroit were the dominant force in the state due to efficiencies
of size, new bottling technology, and local “option laws,” which restricted or outlawed in-
county production. This created a sharp division between outstate and Detroit brewers and
prevented the formation of a strong state liquor association. Prohibition forces also benefited
from this divisiveness; by the year 1917, Michigan had 45 dry counties. Michigan enacted a
statewide prohibition on liquor in May 1918, approximately 18 months prior to passage of
federal Prohibition (the 18th Amendment). By the late 1920s and early 1930s, significant
pressure existed throughout the country to repeal Prohibition. In early 1933, Congress passed
a bill authorizing 3.2 percent beer. In the same year, a similar bill was considered in
Michigan and along with it, the introduction of a state board which came to be known as the
Michigan Liquor Control Commission (MLCC). In April 1933, Michigan became the first
state to ratify the repeal of federal prohibition and the present-day liquor distribution system
was designed and put into place.
A bill for beer and wine (defined legally as under 21 percent alcohol by volume) was passed
that allowed distribution from brewers and wineries to private wholesalers who then resell to
retailers. However, all distilled “spirits” (defined legally as over 21 percent alcohol by
volume) were to be purchased by the State of Michigan. Michigan “come-to-rest” laws
required that any distilled liquor moving through or stored in state bailment warehouses must
be handled by state employees. Package liquor sales were allowed through any hotel or
established merchant. Many of the merchants were druggists who also had the right to
dispense “medicinal” liquors as well as valid medical prescriptions. A local option was also
set up to provide for on-premise consumption.
The State of Michigan’s decision in 1933 to exercise public, rather than private control over
distilled liquor distribution was due to a variety of reasons. First, Michigan’s geographical
proximity to Canada made politicians familiar with Ontario’s system of monopoly control.

Supply Chain Management Page 2 of 7

Final-Term Examination – Semester II/ AY 2019/2020

Second, there was a strong influence of “dry” sentiment and a fear of bootlegging, which was
common during Prohibition years. Third, druggists exerted considerable political influence at
the time and were positioned to benefit from state control. Finally, the state believed
government control would protect the public from middleman profiteering and excessively
high private enterprise pricing.
Currently, Michigan is one of 18 states in the United States that completely controls the
wholesale distribution of distilled liquor between distillers and retail licensees. The remaining
32 states utilize an “open” private license system in which the state government is not
involved in wholesale distribution at all.
In 1993, Michigan and many other states throughout the country faced the problem of rapidly
increasing costs of government services and strong citizen resistance to any tax increases to
provide those services. Unlike nearly all other Michigan government functions, the control
and distribution of liquor generates a considerable general revenue contribution for the state.
Distilled liquor tax contributions go directly to the General Fund in the Executive Budget for
running the State of Michigan. At present, taxes of 11.85 percent are assessed on the full
price of liquor as follows: 4 percent for excise taxes, 6 percent for a Michigan school-aid
fund, and 1.85 percent on packaged liquor.
Public sensitivity toward liquor as a social issue and its ability to provide the state with
significant revenue make liquor control a high-profile government activity. Under a recent
directive from the governor, all state functions must be examined to determine how state
government efficiency could be improved. Despite the contribution of current operations,
considerable room for improvement appears to exist. For example, even in light of
technological improvements and the addition of more modern facilities, the cost of liquor
distribution has continued to increase. Specifically, administrative cost as a percentage of
sales has risen 121 percent over the past 11 years, while the number of inventory turns has
decreased from 6.7 to 5.5.

The Liquor Distribution Process

Distilled liquor distribution in the State of Michigan during the fiscal year 2000-2001
involved the shipment of 6.97 million cases of liquor to retail markets, and generated $515.0
million in revenue for the state. After purchase costs and operating expenses, the net
contribution to the state came to $61.5 million. The state also realizes roughly $50 million per
year from taxes on distilled liquor.
Contributions from the sale of distilled liquor are generated in the following manner: the state
buys liquor directly from a distiller at a delivered price of, for example, $10.00 per bottle.
Then, the state factors in transportation and other costs and marks up the $10.00 bottle a state
mandated 51 percent to $15.10. Retailers buy liquor from the state at a 17 percent discount
off the “markup” price, and in this example would pay a wholesale price of $12.53. Thus, the
state markup (51 percent) and retail gross profit margin (17 percent) are fixed by Michigan
law. The net result is that consumers pay the same retail price for distilled liquor everywhere

Supply Chain Management Page 3 of 7

Final-Term Examination – Semester II/ AY 2019/2020

throughout the state. The state-imposed taxes of 11.85 percent are assessed on the $15.10
price and collected by the retailer upon sale to consumers.
Any alteration of Michigan liquor distribution must consider potential effects on liquor prices
at the retail level. In terms of consumer purchase behavior, liquor quantity is generally price
inelastic. The price elasticity of liquor sales with respect to total expenditures is, however,
fairly elastic. These conditions imply that as prices are raised, consumers will generally
purchase the same quantity of liquor but will shift their consumption to cheaper brands. This
shift reduces projected consumer expenditures and tax revenues. If system changes require
that prices be raised, the effect on tax revenues could be detrimental.
Currently, distilled liquor is distributed through a two-tier network consisting of three state-
owned-and-operated warehouses, 75 smaller second-tier state warehouses (known as “state
stores”), which function as wholesale outlets, and 12,000 retail licensees serving the
consuming public throughout the state (see Figure 1). Licensees are divided into two
categories of approximately 6,000 members each: (1) on-premise bars, restaurants, and hotels
that serve liquor by the glass and (2) off-premise package liquor dealers/stores. The package
liquor dealers represent a wide variety of businesses, ranging from traditional liquor or party
stores to large retail grocery superstores like Meijer, Inc. The first 600 retail licensee outlets
were authorized in 1934 and have steadily increased to their current level. The number of
state stores has remained fairly constant over the years and most of the original 75 stores are
still in their original cities.
The cost to operate the current distribution network is approximately $20 million per year.
Average distilled liquor inventory within the 75 second-tier warehouses is $25 million.
Inventory carrying cost is assumed to be 15 percent and is considered a conservative estimate
compared to figures used in private industry liquor analysis.
Distillers ship their products to the three state-owned-and-operated warehouses based on
state-suggested shipping quantities. The distillers are charged a handling fee for storage of
their product because the State of Michigan does not take title to the liquor until it has been
shipped from the three warehouses to one of the state stores. The process of title transfer in
the system is essentially a consignment arrangement. Under consignment, a product is sent to
a sales agent (in this case, the State of Michigan) for sale or safe-keeping. From the State of
Michigan’s perspective, the consignment arrangement reduces inventory ownership risk and
inventory carrying costs because the state does not take title until retail licensee demand is
established. This operational arrangement was implemented several years ago; however,
distillers circumvented the state’s fiscal efforts by sufficiently raising prices to cover their
increased storage costs. No direct shipments are made from the three state-owned-and-
operated warehouses to retail licensees. Transhipment among the three state-owned-and-
operated warehouses and the state stores is minimal. Licensees place their orders weekly
through a centralized order processing system and may either pick up an order in person or
have it delivered by common carrier. The only exception to this delivery system occurs in the
Detroit metropolitan area, where state delivery service is mandated from the largest state
store to all its retail licensees.

Supply Chain Management Page 4 of 7

Final-Term Examination – Semester II/ AY 2019/2020

Geographically, Michigan’s liquor distribution network is broken down into three operating
districts. Figure 2 illustrates the districts which each contain one of the major state-owned-
and-operated warehouses. The Lincoln Park warehouse serves the Detroit area (District 1);
the Lansing warehouse serves the western and central portion of the state (District 2); and the
Escanaba warehouse serves the northern portion, or Upper Peninsula, of the state (District 3).
District population, case liquor sales, and facility costs are shown in Table 1.
While the state does not directly pay the cost of inbound freight from distillers, research
indicates that the cost is approximately $1.00 per case. Transfer freight is defined as freight
movements from and between the three state-owned-and-operated warehouses to the 75 state
stores. Customer freight is defined as freight movements between state stores and a retail
licensee. Transfer and custom freight charges are listed in Table 2.
Table 1. MLCC District Operating Characteristics
District 1 District 2 District 3
Population 4,368,850 4,267,531 334,518
(% of state) (48.7%) (47.6%) (3.7%)
Cases sold of distilled liquor 3,945,441 2,749,611 286,013
(% of state) (56.6%) (39,96%) (4.1%)
Fixed cost of district warehouse $924,542 $576,294 $93,825
Variable cost per case at warehouse $0.41 $0.35 $1.48
Warehousing cost per case $2.20 $3,91 $13.13
Average fixed cost per state store $163,810 $65,274 $54,341
Variable cost per case per state store $1.37 $1.43 $3.64
Number of state stores 12 46 17

Table 2. MLCC Transfer and Custom Freight Charge

District 1 District 2 District 3

Transfer freight (per case) $0.35 $0.28 $0.60
Customer freight (per case) $1.00 $0.40-0.70 No service available, pickup only
(south) $1.10-1.30 (north)

Current Issues
Redesigning the liquor control system in Michigan is not a new idea. Lawrence Desmond,
business manager for the MLCC, says “When you talk about the liquor commission you’re
really talking about two distinct aspects. One is a regulatory agency that enforces the state’s
liquor laws. The other is the fact that we’re the state’s sole wholesaler of spirits, and along
with our licensing process, we directly contribute to the state’s general fund.” The subject of
system redesign has been raised numerous times for a variety of reasons, and many powerful
economic and political special interest groups have strong opinions on the two issues of
liquor enforcement and sales and licensing.
Liquor enforcement is a highly sensitive social issue. From 1992–2000, nationwide per capita
consumption of distilled liquor declined about 3 percent per year. Michigan sales figures

Supply Chain Management Page 5 of 7

Final-Term Examination – Semester II/ AY 2019/2020

mirror the national trend (see Figure 3). Increased public awareness of alcohol abuse has been
heightened through the efforts of the distillers and brewers, government agencies, and groups
such as Mothers Against Drunk Driving (MADD). Anti-alcohol groups such as MADD argue
that the state’s highly controlled system contributes to strong enforcements of liquor
violations, and thereby acts as a deterrent to alcohol abuse. “Alcohol is a problem-causing
narcotic drug, and we need to retain as much control as possible,” says Reverend Allen West
of the Michigan Council on Alcohol Abuse and Problems.
The chairperson and the five commissioners of the MLCC are appointed by the governor of
Michigan. Given the nature of the political process, the MLCC and its licensing procedures
have historically been subject to frequent charges of political patronage, graft, and corruption
by whichever political party is out of power in the state legislature. The MLCC employs
approximately 620 people and a considerable number of the positions are well-paying, low-
skill jobs. Although the population of Michigan is concentrated in the lower third of the state,
many of the MLCC positions are located in geographically remote areas where it is unlikely
that employees would be able to secure similar, private sector jobs if system redesign
eliminated their positions. Also, approximately 500 MLCC employees are represented by
United Auto Workers local unions. Teamsters Union delivery firms with long-term contracts
for hauling liquor also exist, especially in the Detroit metropolitan area.
A number of state budget analysts and legislators, as well as academic and professional
consultants, believe that the state liquor distribution system is considerably less efficient than
private industry. They argue that, for example, mandated state delivery contracts and state
employees with little job performance incentive hinder productivity improvement.
Lower volume retail licensees fear that redesigning the current system may hinder their
ability to purchase small quantities of liquor, particularly if minimum order sizes or delivery
freight breaks are instituted. They believe that changing the current setup will severely
disadvantage them relative to larger, high-volume chains and retailers. Jerry Faust,
spokesperson for a state organization representing retailers says, “If the system ain’t broke,
don’t fix it.” Many consumer advocates argue that the current distribution system of state-set,
single pricing at all retail outlets provides consumers with an economically equitable system.

Challenges of System Redesign

Before leaving the office, Joseph outlined two general objectives of distribution network
redesign: (1) increase the state’s return from liquor distribution by reducing distribution costs
and inefficiencies and (2) improve inventory management by utilizing Management
Information Systems (MIS) to further increase efficiency. He also identified four specific
objectives: (1) maintain the current service level; (2) increase inventory turns; (3) decrease
administrative costs; and (4) maintain the current level of control over a highly sensitive
socioeconomic policy area.
Joseph realized he would need to contact a variety of people upon his return to work on
Monday in preparation for Wednesday’s meeting. He sketched out plans to meet with
representative MLCC staff and operations personnel, MIS staff, external industry experts in

Supply Chain Management Page 6 of 7

Final-Term Examination – Semester II/ AY 2019/2020

liquor and custom delivery operations, and academics in marketing and logistics at the nearby
state university.
Joseph decided that any changes in distilled liquor distribution would have to reflect key
operational issues of pricing, service level, projected retail sales and tax impact, direct
delivery from distillers to major chain warehouses, and delivery cost considerations—not to
mention a host of economic and political special interest group concerns. He began to realize
that the topic of liquor distribution in Michigan was a much more complex issue than it had
seemed a few hours earlier.

Questions
1. What alternative designs for distilled liquor distribution in Michigan might be
considered? Explain the rationale for your suggestions.
2. Discuss the benefit and risk of alternative designs for distilled liquor distribution.
3. Are the historical condition which the current liquor distribution system is based upon
still important today? What, if any, other factors exist that require consideration?
4. Does an inherent social conflict exist when state governments rely upon tax
contributions from liquor sales to find educational programs?
5. How would you organize the final report on distilled liquor distribution in Michigan if
you were Joseph Duncan?

---------- end of exam paper ---------

Supply Chain Management Page 7 of 7