48126512-Case-Study-on-Scientific-Glass-Inc-Inventory-Management[1]

SCIENTIFIC GLASS, INC.: INVENTORY MANAGEMENT Candas Demir Onur Yilmaz Burcu Yüzüak January 2010, Ankara

I. INTRODUCTION In this case study, production and operations management (POM) issues of a mid-s ize company, named as Scientific Glass Inc., in a highly growing market are studied. Using th e background information on past actions of the company to correct inventory management and t heir results, and considering the market leadership opportunity, how inventory management approach can be made better is explained by evaluating different alternatives from different aspects. In the first part, critical POM issues are mentioned, following that these problems are analyzed. In the thi rd part, alternative options are listed and then they are evaluated. Finally, considering the trade-o ffs of these evaluations, a conclusion is made. And it must be mentioned that, throughout the case, related points are referenced to the case text and lecture notes with corresponding page and paragraph numbers. II. CRITICAL POM ISSUES As mentioned in the text, there is an identified increasing trend in the balance s of inventory levels. (Page 1, para. 2) For a growing company in a growing market, this high i nventory level, in other words tied up money in the inventory, creates an obstacle for this company to us e this extra capital on other areas, such as expansion to international markets. Also, as mentioned, deb t to capital ratio exceeded the target level of 40% and with the same approach this increase of thi s ratio also jeopardizes the company s funding expansion plans to international markets. Although, there ar e many other POM issues are found in the text, these mentioned two were the most critical ones an d it is thought that if they are solved the other problems will be solved spontaneously. III. ANALYSIS OF THE CRITICAL POM ISSUES In the last part, it is mentioned that average inventory level is high enough to jeopardize company s future plans. Therefore, main reasons behind this problem should be anal yzed. First of all, company has a policy related to 99% fill rate, which is also open to discussion considering the market average of 92%, and warehouse managers are usually exceed even this limit and th ey are keeping more inventory than necessary (Page 4, para. 5). Secondly, company has a policy to no t to exceed 60 day s supply, which is also open to discussion, and most warehouse managers are exceed ing this upper limit

(Page 5, para. 6). Considering all these aspects, it is found that inventory lev els and transshipment costs should be decreased and at the same time responsiveness to customer should be in creased in order to be a market leader. By doing these, simultaneously, approach of the warehouse manag ement could be changed to a better position by changing policies related to them as it is tried in the past with different ways and failed (Page 6, para. 6). In addition, when this inventory level kept u nder control, debt to capital ratio will be saddled since extra capital tied up in the inventory will be available to be used. IV. ALTERNATIVE OPTIONS FOR PROBLEMS In order to solve the analyzed problems in the previous part, there are actually two main aspects to consider: firstly, number of warehouses and their structure can be changed; s econdly, related policies can be changed and of course appropriate ones can be done simultaneously. For changing the number of warehouses, in other words, centralizing or decentral izing warehousing functions, available options are considered as: . Continuing with 8 warehouses: This option makes no change on the network of the warehouses and all regions will be supplied its warehouse if there is no stock-o ut occurs. . One central warehouse: In this option, one central warehouse near to manufacturi ng facility at Waltham will send all customer orders from one location. . Two centralized warehouses: In this option, addition to the main warehouse at Wa ltham, there will be an additional warehouse at the west, at Phoenix, and it will be supplied from Waltham. Demand of east region will be met from Waltham, demand of west region will be me t from Phoenix and demand of central region will be met from both warehouses, assuming to have equal shares on the central region. . Outsourcing the warehousing functions: In this option, all warehousing actions w ill be outsourced to Global Logistics (GL) and distribution will start from main wareho use at Waltham and then GL will be responsible from rest of the operations. In addition to these options, there are some policy change proposals which try t o make POM approach better, like periodic audits and increasing reporting activity levels, stopping trunk stock activities etc. Since these policy changes can be applied at different warehousi ng functions these proposals will be analyzed one by one and their possible effects will be conside red.

V. EVALUATION OF ALTERNATIVE OPTIONS Evaluation of mentioned alternatives will be conducted from mainly five aspects: transportation costs, average inventory levels, time responsiveness, fill rates and finally add itional costs and benefits. 1-) Transportation Costs: Transportation costs for alternatives are calculated f or the two products, namely Griffin and Erlenmeyer, since they are mentioned as the best representati ve for a total of nearly 3000 products of Scientific Glass (Page 2, para. 3). In addition, for each optio n, demand for the next year calculated considering the 20% increase in sales (Page 8, para. 3). When wa rehouse to customer shipments are considered average shipment weight of 19,5 pound is used and to ha ve an average transportation cost value, these two products costs are averaged according to the ir relative proportion in sales (Page 8, para. 3). It also be mentioned that, inter-warehouse transship ments occur only when stock-out occurs and as the number of warehouses are decreasing, effect of this costs will be diminished; therefore, it is only considered in the option where there are 8 war ehouses. For the first option, having 8 warehouses and making no change, from Waltham to all other 7 warehouses all items are sent by bulk shipment. Inter-warehouse transshipments a re calculated by bulk shipment rates and they are considered only when a stock-out occurs, therefore f ill rate is included in these calculations. Finally, for every warehouse, customer shipment costs are ca lculated as all tabulated in Appendix Table 1 and average total cost found as $2701,41. For the second option, when there is only one warehouse, all customer shipments are calculated for rates of Winged Fleet and results are given in Appendix -Table 2. In this op tion, average total cost is calculated as $12210,16. For the third option, when two centralized warehouses considered, it is assumed that Waltham will supply east region, Phoenix will supply will west region and they will equa lly supply the central region. With this approach, transportation costs are calculated in Appendix Tabl e 3 and average total cost is found as $2332,07. For the last option, when warehousing functions are outsourced, assuming the 5 r egions of Global Logistics (GL) will have equal amount of demand, as tabulated in Appendix Table 4, total average cost is calculated as $2276,83. To conclude, as it is expected, when number of warehouses are decreased transpor tation costs are increased as can be seen from the Table 1 below. From the aspect of transpor tation costs, GL option

has the smallest cost amount.

8 Warehouses 1 Warehouse 2 Warehouses Outsourcing 2701,41 12210,16 2332,07 2276,83 Table 1: Average Total Annual Transportation Costs Gathered from Appendix Table 1-2-3-4 2-) Average Inventory Levels: First of all, it must be decided which inventory p olicy that the company should apply. Begin with the review type; although firm monitors all the inventory transfers from Waltham warehouse to other warehouses; they think taking physical counts of inventory at all warehouses (Page 6, para. 6). Therefore, it is concluded that company uses perio dic inventory review policy. Secondly, company did not mention any due date, therefore the inventory plans should consider infinite time horizon. And lastly, although there exists a fixed cost for shipme nts from warehouses to customers; there is no other fixed cost related to transportation to the warehou ses, i.e. no fixed ordering cost. The only order cost is $0.40 per pound bulk shipment cost which is a varia ble cost with weight. As a result, all analysis can be conducted considering critical ratios and the r elated fill rate values, which is the only option that is left and also it is considered as the most appl icable to the situation. Since some of the simultaneous changes can be done, considering ceteris paribus principle and when fill rate is maintained exactly as 99% for all warehouses, we can calculate the average inventory level that must be kept at warehouses. As shown in the Appendix -Table 5, for ha ving 1, 2 and 8 warehouses average inventory levels are calculated for two representative produc ts. When outsourcing option is used, it will be the same for the company in the sense of kept invento ry levels for the onecentralized-warehouse option therefore they are assumed to be equal. Weighted-av erage biweekly levels are found as: 8 Warehouses 2 Warehouses 1 Warehouse Outsourcing 988,53 680,34 597,03 597,03 Table 2: Weighted-average biweekly inventory levels Gathered from Appendix -Table 5 As shown in the Table 2 above, as demand aggregates, in other words, number of w arehouse decreases, level of inventory decreases as it is expected. This is because, reater the degree of

the g

collaboration, the lower the uncertainty (standard deviation of the error or coe fficient of variation) of the demand model (Lecture 9, Slide 6). This implies that the money tied up in the inventory decreases and this extra capital can be used in other areas, like expansion plans to inter national markets.

3-) Time Responsiveness: Delivery system of the company compensates 2 weeks of s hipment cycles including the stock-out situations. In order to be a market leader, diffe rentiation on this subject is also needed and unfortunately since this is not an exact quantitative scale, onl y possible situations could be mentioned. For having one centralized, or two centralized or 8 decentra lized warehouse options, they all include at most 3 days ready to shipment duration (Page 6, par a.2) and Winged Fleet s delivery time of at most 3 days (Page 12, Exhibit 5) if there is no stock-out si tuation and the stock-out probabilites are diminishing with the aggregated demands. On the other hand, GL has 1-day premium shipment in addition to 3-day regular shipments (Page 8, para. 1). Considering t he highly growing market situation and different segment of products, having different delivery ti mes to different products and also to different customers will make this company focus on the most yieldin g areas. Therefore, it can be said that working with GL has the advantage of differentiating customers/ orders and, since there will be 2 warehouses, stock-out probability and related durations will be less compared to other options. And all of these aspects will increase the time responsiveness of the c ompany. 4-) Additional Costs and Benefits: Other qualitative and quantitative issues rel ated to options will be covered in this section. Firstly, in the text, it is mentioned that in o rder to continue with the current warehouses total of $10M investment is necessary (Page 5, para. 5), it i s assumed that all of this amount will be equally shared among all warehouses. Secondly, since warehouse op erating costs will be the %15 of the total warehoused inventory (Page 5, para.3), these costs could be directly compared with the annual average inventory levels that are kept in each option which are calculated in the previous section. Thirdly, the amount paid to sales forces (Page 3, para. 5) wil l not change when the company have 1, 2 or 8 warehouses because it is assumed that as the number of wa rehouses decreased, number of salesperson per warehouse will increase and total of 32 will not chang e. On the other hand, when warehousing is outsourced this amount will not be paid. 1 Warehouse 2 Warehouses 8 Warehouses Outsourcing Warehouse Inventory Level: Inventory Level: Inventory Level: Inventory Level: Operating Costs: 597,3 x 26 = 15529,8 680,34 x 26 = 17688,84 988,35 x 26 = 25697,1 597,3 x 26 =

15529,8 Table 3: Additional Quantitative Comparisons Replacing worn equipment cost: $10M/8 = $1,25 M $10M/8 x 2 = $2,5 M $10 M $10M/8 = $1,25 M Sales Force Payments: 32 x $33.000 + Commision 32 x $33.000 + Commision 32 x $33.000 + Commision No costs

As can be seen ease the replacing worn g costs will decrease also. amount paid to forces.

from the Table 3 above, decreasing number of warehouses will decr equipment costs and since demand aggregates, warehousing operatin It is obvious that outsourcing will relieve the company from the the sales

In addition to these, there are some qualitative issues that must be mentioned. First of all, when GL is used for warehousing, as mentioned in the text (Page 8, para. 2), SG s senio r managers will be able to focus on increasing sales, marketing issues and developing next generati on of products. Secondly, there are some issues that must be mentioned from the proposed policy changes. Stopping the practice of trunk stock could conclude with a decrease in the time responsiv eness and therefore it should not be stopped. Thirdly, also as mentioned in the same proposed policy ch anges, improving the controlling systems will create a better understanding of the current situation after the warehousing functions changed. Finally, when GL is used, the approach of warehouse managers to keep more than 99% fill rate and 60-day-supply will not be a problem, because all of these oper ating issues will be responsibility of GL. This will help to company not to keep excessive amount of inventory and less tied-up money in the inventory which can be used in other areas. 5-) Fill Rate: Company s fill rate policy should also be questioned. It is said th at company replaced the earlier fill rate policy of 93%, which is only marginally better th at the industry average fill rate of 92%, with 99% (Page 4, para. 1). However, there is no sign that the comp any is implementing this policy because it is the best approach that must be taken for the company o bjectives. Moreover, using a fill rate higher than optimal level leads to higher inventories and more money tied up in the inventory. Therefore, company should lower the rates down to optimal levels, if there is no other concern related to market leadership or customer satisfaction. To calculate the optimal levels of fill rates for all four alternatives we shoul d consider cost items which are added to underage and overage costs. However, the sales leadersh ip noted that underage costs are 10% of the gross margin and overage costs are 0.6% of the uni t cost of any product (Page 4, para. 2). Also it is assumed that unit costs covers all the costs such as warehouse rental and operation costs, cost of capital and inventory write-offs. For the three alterna tives other than outsourcing, there is no change in cost items, only the multiplied quantities ar e changed; but the outsourcing alternative eliminates the 15% warehouse rental and operating costs

and 1% inventory write-offs as calculated in the Appendix -Table 6. As a result, overage costs ar e decreased while underage costs are increased. Resulting optimal fill rates are as follows:

1, 2 or 8 Warehouses Outsourcing Outsourcing Griffin 95.4% 96.5% Erlenmeyer 94.9% 96.1% Table 4: Optimal fill-rates for alternatives -Gathered from Appendix Table 6 These numbers can be interpreted in two different ways: First, if company is fle xible about the determination of fill rate, in other words if it can lower the fill-rates from 9 9% to optimal levels, outsourcing option pushes the optimal fill rates to higher levels which results in larger inventories and more money to tie up. Second, if the company still insists on keeping fill rate at 99%, the additional costs that must be paid to maintain 99% fill-rate level is lowered in the outsou rcing alternative. Consequently, the better policy related to fill rates depend on the attitude of the company. Finally, another policy change about fill-rates can be considered. Rather than u sing one fill-rate for over all products of the company, different rates for different products can help the company in decreasing inventory costs related to, at least, for some of the products. VI. CONCLUSION To conclude, since available options are studied from different aspects, it must be mentioned that the company should choose the alternatives and compare the results of evalu ations according to their priorities. For instance, evaluation criteria like inventory levels and tr ansportation costs are conflicting on interests. Company can see their situation from an exchange curve like in the below graph (Graph 1) and make decisions according to priorities. The curve shows the inventory and transportation cost levels as the number of warehouses changes. Graph 1: Exchange curve for inventory level and transportation cost

While exchange curves like given above can be used for the pairwise comparisons, weighted score model can be useful for an overall assesment of options (Lecture 3, Slide 26). A sample weighted score model with hypotetical weights and scores is provided in the Table 5 below , in order to derive a what-if scenario study: O P T I O N S Weight 1 Warehouse 2 Warehouses 8 Warehouses Outsourcing Transportation Costs 1 3 2 4 30 Average Inventory Levels 4 2 1 4 Time Responsiveness 3 2 1 4 15 Fill Rate 3 3 3 2 Additional Costs 5 Replacing Worn Equipment 4 3 2 4 Warehouse Operating 4 3 2 4 5 Sales Force Payments 3 3 3 4 Additional Benefits 5 Extra time of senior managers 2 2 2 4 Changes in warehouse management 1 1 1 4 Total: 100 TOTAL SCORES: 285 245 175 370

1: Poor 2: Acceptable 3: Good 4: Excellent Table 5: Hypotetical Weighted Score Model While assessing the weights for factors, it is considered that average inventory level and the transportation costs are the most important costs for the company. Then, the fil l rate follows them and it is assumed that the first interpretation of fill rates mentioned in the previ ous part is used by the company. Time responsiveness is the next important factor which is followed by a dditional costs and benefits with equal weights for each. Changes in warehouse management is conside red as options other than outsourcing does not provide radical policy changes which could make wareho using management better. These weights and the scores related to our previous investigations yiel d that the outsourcing the warehousing function to Global Logistics is the best alternative among all. All of investigations and cost studies conducted in this case study are to find the most cost effective option in order to getting closer to the target debt to capital ratio of the company and provide more capital to fund expansion into new international markets while maintaining or even improving the high customer satisfaction level.

VII. APPENDIX Table 1: Calculating Transportation Costs for 8 Warehouses Option Griffin Erlenmeyer Comments Total Demand 65,04 19,56 Calculated by 20% increase Fill Rate 0,01 0,01 If there is no policy change about it. Bulk Shipment Rate 0,4 0,4 Inter-Warehouse Transportations (If stockout occurs) Total Biweekly Costs0,0325 0,0196 Fill Rate x Total Demand x Cost Rate x Weight Total Biweekly Cost for 8 w/h 0,2601 0,156 Total Annually Costs (1) 6,7641 4,068 From Waltham to Warehouses Total Amount to Carry 455,28 136,92 To seven other warehouses Total Amount to Carry * Weight * Bulk Rate Total Annually Costs (2) 591,864 355,992 Total Biweekly Cost 22,764 13,692 From Warehouses to Customers (Average 19,5 pounds shipments by Winged Fleet) Total Amount to Carry 520,32 156,48 Total Biweekly Cost 92,123 55,41 Fixed Cost + Total Demand x Cost Rate x Weight Total Annually Costs (3) 2395,20 1440,66 Total Annual Costs (1+2+3) 2993,83 1800,72 Relative Weight in Sales 75,49% 24,51% Related Sales Revenue / Total Sales Revenue from both Average Annual Cost 2701,4 Table 2: Calculating Transportation Costs for 1 Centralized Warehouse Option Griffin Erlenmeyer Comments Total Demand (Biweekly) 520,08 156,36 Demand for one w/h region 65,01 19,545 Calculated by dividing total demand by 8 Demand for Central Region 130,02 39,09 To Toronto and Chicago Demand for West Region 195,03 58,63 To Seattle, Denver and Phoenix

Demand for East Region 130,02 39,09 To Atlanta and Massachusetts Total Costs for Within Region 154,99 46,60 For East Region Total Costs for Across 1 Region 160,825 48,35 For Central Region Total Costs for Across 2 Region 246,234 74,03 For West Region Total Biweekly Cost 562,05 168,979 Total Annual Cost 14613,38 4393,46 Relative Weight in Sales 75,50% 24,50% Related Sales Revenue / Total Sales Revenue from both Average Annual Cost 12109,16

Table 3: Calculating Transportation Costs for 2 Centralized Warehouses Option Tr ansportation Costs for 2 Centralized Warehouses Option Griffin Erlenmeyer Comments Total Demand (Biweekly) 520,08 156,36 Calculated by considering 20% increase Demand for one w/h region 65,01 19,545 Calculated by dividing total demand by 8 Demand for Central Region 130,02 39,09 To Toronto and Chicago Demand for West Region 195,03 58,635 To Seattle, Denver and Phoenix Demand for East Region 130,02 39,09 To Atlanta and Massachusetts [ (Demand of West * Weight) ]* (5 x 1/ 19,5 + Phoenix's Delivery Costs (1) 48,957 29,438 1.16 ) + [Demand of Central * 0,5 * Weight] *(12 x 1/ 19,5 + 1.16) [ (Demand of East * Weight) ]* (5 x 1/ 19,5 + 22,516 Waltham's Delivery Costs (2) 37,447 1.16 ) + [Demand of Central * 0,5 * Weight] *(12 x 1/ 19,5 + 1.16) From Waltham to Phoenix Total Amount to Carry 260,04 78,18 West's Demand + Half of Central's Demand Total Cost (Biweekly) (3) 13,002 7,818 Weight x Amount x Bulk Shipment Rate Total Costs (Biweekly) 99,407 59,7726 (1+2+3) Total Annual Costs 2584,58 1554,09 Related Sales Revenue / Total Sales Revenue Relative Weight in Sales 75,50% 24,50% from both Average Annual Cost 2332,076 Table 4 : Cost Calculation for Outsourcing the Warehouse Bulk Shipment Costs to Atlanta Griffin Erlenmeyer Comments Total Demand 13521,6 4066,8 Calculated by 1.2 x Demand of 2009 Bulk Shipment Cost Rate 0,4 0,4 Total Demand * Weight * Bulk Shipment Cost Rate

Delivery Costs from Atlanta Total Annual Costs (1) 676,08 406,68 Griffin Erlenmeyer Total Demand 13521,6 4066,8 Demand for one region 2704,32 813,36 It is assumed five regions have equal deman d. Demand of Region * Weight * / Average Southeast Region Costs 289,327 87,0191 Shipment Weight * Related Cost (from Exhi bit 5) Northeast Region Costs 327,812 197,1877 Central Region Costs 385,712 232,0162 Southwest Region Costs 424,370 255,267 Northwest Region Costs 443,612 266,845 Total Annual Costs (2) 1870,835 1038,337 Total Annual Costs (1+2) 2546,915 1445,0175 Related Sales Revenue / Total Sales Revenue Relative Weight in Sales 0,75489 0,245 from both Average Annual Cost 2276,834

Table 5: Calculating biweekly overall inventory levels for options Griffin Erlenmeyer 8 W/h 2 W/h 1 W/h 8 W/h 2 W/h 1 W/h Mean (2009) 54,2 216,7 433,4 16,3 65,2 130,4 Variance (2009) 21,4 38,3 51 10,9 19,5 26 Mean (2010) 65,04 260,04 520,08 19,56 78,24 156,48 Variance (2010) 30,816 55,152 73,44 15,696 28,08 37,44 Biweekly Ranges Lower -14,157 118,29936 331,3392 -20,77872 6,0744 60,2592 Upper (Q*) 144,237 401,78064 708,8208 59,89872 150,4056 252,7008 Overall biweekly stock level 1153,897 803,56128 708,8208 479,18976 300,8112 252, 7008 Z(alpha) = Z(0.01) -2,57 Relative Weight in Sales Griffin: Erlenmeyer: Related Sales Revenue / Total Sale s Revenue from 0,7549 0,2451 both 8 Warehouses 2 Warehouses 1 Warehouse Weighted Average 988,526 680,337 597,026 Inventory Levels Table 6: Calculation of fill rates 1-2-8 Warehouse Options Outsourcing Griffin Erlenmeyer Griffin Erlenmeyer Comment Unit Cost 3,96 4,56 3,3264 3,8304 Taken from Exhibit 3 Unit Price 8,8 9,5 8,8 9,5 Taken from Exhibit 3 Insurance Cost 0,0396 0,0456 0 0 %1 of the unit cost Cost of Capital 0,554 0,638 0,465696 0,536 %14 of the unit cost Warehousing Operations 0,594 0,684 0 0 %15 of the unit cost Gross Margin 4,84 4,94 5,4736 5,6696 Underage Cost 0,484 0,494 0,54736 0,5667 10% of gross margin Overage Cost 0,0238 0,0273 0,01995 0,02298 0.6% of unit cost Fill Rate 0,9532 0,9475 0,9648 0,9610