Case Study on Scientific Glass Inc,: Inventory Management

SCIENTIFIC GLASS, INC.: INVENTORY MANAGEMENT

Candaş Demir Onur Yılmaz Burcu Yüzüak

January 2010, Ankara

I.

INTRODUCTION

In this case study, production and operations management (POM) issues of a mid-size company, named as Scientific Glass Inc., in a highly growing market are studied. Using the background information on past actions of the company to correct inventory management and their 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 third part, alternative options are listed and then they are evaluated. Finally, considering the trade-offs 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 balances of inventory levels. (Page 1, para. 2) For a growing company in a growing market, this high inventory level, in other words tied up money in the inventory, creates an obstacle for this company to use this extra capital on other areas, such as expansion to international markets. Also, as mentioned, debt to capital ratio exceeded the target level of 40% and with the same approach this increase of this ratio also jeopardizes the company’s funding expansion plans to international markets. Although, there are many other POM issues are found in the text, these mentioned two were the most critical ones and 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 analyzed. 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 they are keeping more inventory than necessary (Page 4, para. 5). Secondly, company has a policy to not to exceed 60 day’s supply, which is also open to discussion, and most warehouse managers are exceeding this upper limit 1

(Page 5, para. 6). Considering all these aspects, it is found that inventory levels and transshipment costs should be decreased and at the same time responsiveness to customer should be increased in order to be a market leader. By doing these, simultaneously, approach of the warehouse management 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 under 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; secondly, 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 decentralizing 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-out occurs.



One central warehouse: In this option, one central warehouse near to manufacturing facility at Waltham will send all customer orders from one location.



Two centralized warehouses: In this option, addition to the main warehouse at Waltham, 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 met 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 will be outsourced to Global Logistics (GL) and distribution will start from main warehouse 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 to 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 warehousing functions these proposals will be analyzed one by one and their possible effects will be considered.

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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 additional costs and benefits.

1-) Transportation Costs: Transportation costs for alternatives are calculated for the two products, namely Griffin and Erlenmeyer, since they are mentioned as the best representative for a total of nearly 3000 products of Scientific Glass (Page 2, para. 3). In addition, for each option, demand for the next year calculated considering the 20% increase in sales (Page 8, para. 3). When warehouse to customer shipments are considered average shipment weight of 19,5 pound is used and to have an average transportation cost value, these two products’ costs are averaged according to their relative proportion in sales (Page 8, para. 3). It also be mentioned that, inter-warehouse transshipments 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 warehouses. 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 are calculated by bulk shipment rates and they are considered only when a stock-out occurs, therefore fill rate is included in these calculations. Finally, for every warehouse, customer shipment costs are calculated 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 option, 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 equally supply the central region. With this approach, transportation costs are calculated in Appendix – Table 3 and average total cost is found as $2332,07. For the last option, when warehousing functions are outsourced, assuming the 5 regions 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 transportation costs are increased as can be seen from the Table 1 below. From the aspect of transportation costs, GL option has the smallest cost amount. 3

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 policy 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 periodic 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 shipments from warehouses to customers; there is no other fixed cost related to transportation to the warehouses, i.e. no fixed ordering cost. The only order cost is $0.40 per pound bulk shipment cost which is a variable cost with weight. As a result, all analysis can be conducted considering critical ratios and the related fill rate values, which is the only option that is left and also it is considered as the most applicable 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 having 1, 2 and 8 warehouses average inventory levels are calculated for two representative products. When outsourcing option is used, it will be the same for the company in the sense of kept inventory levels for the onecentralized-warehouse option therefore they are assumed to be equal. Weighted-average 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 warehouse decreases, level of inventory decreases as it is expected. This is because, “the greater the degree of collaboration, the lower the uncertainty (standard deviation of the error or coefficient 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 international markets. 4

3-) Time Responsiveness: Delivery system of the company compensates 2 weeks of shipment cycles including the stock-out situations. In order to be a market leader, differentiation on this subject is also needed and unfortunately since this is not an exact quantitative scale, only possible situations could be mentioned. For having one centralized, or two centralized or 8 decentralized warehouse options, they all include at most 3 days ready to shipment duration (Page 6, para.2) and Winged Fleet’s delivery time of at most 3 days (Page 12, Exhibit 5) if there is no stock-out situation 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 the highly growing market situation and different segment of products, having different delivery times to different products and also to different customers will make this company focus on the most yielding 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 company.

4-) Additional Costs and Benefits: Other qualitative and quantitative issues related to options will be covered in this section. Firstly, in the text, it is mentioned that in order to continue with the current warehouses total of $10M investment is necessary (Page 5, para. 5), it is assumed that all of this amount will be equally shared among all warehouses. Secondly, since warehouse operating 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) will not change when the company have 1, 2 or 8 warehouses because it is assumed that as the number of warehouses decreased, number of salesperson per warehouse will increase and total of 32 will not change. On the other hand, when warehousing is outsourced this amount will not be paid. 1 Warehouse

2 Warehouses

8 Warehouses

Outsourcing

Replacing worn equipment cost:

$10M/8 = $1,25 M

$10M/8 x 2 = $2,5 M

$10 M

$10M/8 = $1,25 M

Warehouse Operating Costs:

Inventory Level: 597,3 x 26 = 15529,8

Inventory Level: 680,34 x 26 = 17688,84

Inventory Level: 988,35 x 26 = 25697,1

Inventory Level: 597,3 x 26 = 15529,8

Sales Force Payments:

32 x $33.000 + Commision

32 x $33.000 + Commision

32 x $33.000 + Commision

No costs

Table 3: Additional Quantitative Comparisons

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As can be seen from the Table 3 above, decreasing number of warehouses will decrease the replacing worn equipment costs and since demand aggregates, warehousing operating costs will decrease also. It is obvious that outsourcing will relieve the company from the amount paid to the sales forces. 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 senior managers will be able to focus on increasing sales, marketing issues and developing next generation 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 responsiveness and therefore it should not be stopped. Thirdly, also as mentioned in the same proposed policy changes, 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 operating 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 that company replaced the earlier fill rate policy of 93%, which is only marginally better that the industry average fill rate of 92%, with 99% (Page 4, para. 1). However, there is no sign that the company is implementing this policy because it is the best approach that must be taken for the company objectives. 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 should consider cost items which are added to underage and overage costs. However, the sales leadership noted that underage costs are 10% of the gross margin and overage costs are 0.6% of the unit 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 alternatives other than outsourcing, there is no change in cost items, only the multiplied quantities are 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 are decreased while underage costs are increased. Resulting optimal fill rates are as follows: 6

1, 2 or 8 Warehouses

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 flexible about the determination of fill rate, in other words if it can lower the fill-rates from 99% 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 outsourcing 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 using 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 evaluations according to their priorities. For instance, evaluation criteria like inventory levels and transportation 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 7

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 Weight 20 30 10 15 5 5 5 5 5 Total: 100

Transportation Costs Average Inventory Levels Time Responsiveness Fill Rate Additional Costs Replacing Worn Equipment Warehouse Operating Sales Force Payments Additional Benefits Extra time of senior managers Changes in warehouse management

TOTAL SCORES: 1: Poor 2: Acceptable 3: Good

I O

N S

1 Warehouse 1 4 3 3

2 Warehouses 3 2 2 3

8 Warehouses 2 1 1 3

Outsourcing 4 4 4 2

4 4 3

3 3 3

2 2 3

4 4 4

2 1

2 1

2 1

4 4

285

245

175

370

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 fill rate follows them and it is assumed that the first interpretation of fill rates mentioned in the previous part is used by the company. Time responsiveness is the next important factor which is followed by additional costs and benefits with equal weights for each. Changes in warehouse management is considered as options other than outsourcing does not provide radical policy changes which could make warehousing management better. These weights and the scores related to our previous investigations yield 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. 8

VII.

APPENDIX

Table 1: Calculating Transportation Costs for 8 Warehouses Option Total Demand Fill Rate Bulk Shipment Rate

Griffin 65,04 0,01 0,4

Erlenmeyer 19,56 0,01 0,4

Comments Calculated by 20% increase If there is no policy change about it.

Inter-Warehouse Transportations (If stockout occurs) Total Biweekly Costs

0,0325

0,0196

Total Biweekly Cost for 8 w/h Total Annually Costs (1)

0,2601 6,7641

0,156 4,068

From Waltham to Warehouses Total Amount to Carry

455,28

136,92

Total Biweekly Cost

22,764

13,692

Total Annually Costs (2)

591,864

355,992

Fill Rate x Total Demand x Cost Rate x Weight

To seven other warehouses Total Amount to Carry * Weight * Bulk Rate

From Warehouses to Customers (Average 19,5 pounds shipments by Winged Fleet) Total Amount to Carry 520,32 156,48 Fixed Cost + Total Demand x Cost Total Biweekly Cost 92,123 55,41 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%

Average Annual Cost

Related Sales Revenue / Total Sales Revenue from both

2701,4

Table 2: Calculating Transportation Costs for 1 Centralized Warehouse Option Griffin 520,08 65,01 130,02 195,03 130,02 154,99 160,825 246,234 562,05 14613,38

Erlenmeyer 156,36 19,545 39,09 58,63 39,09 46,60 48,35 74,03 168,979 4393,46

Relative Weight in Sales

75,50%

24,50%

Average Annual Cost

12109,16

Total Demand (Biweekly) Demand for one w/h region Demand for Central Region Demand for West Region Demand for East Region Total Costs for Within Region Total Costs for Across 1 Region Total Costs for Across 2 Region Total Biweekly Cost Total Annual Cost

Comments Calculated by dividing total demand by 8 To Toronto and Chicago To Seattle, Denver and Phoenix To Atlanta and Massachusetts For East Region For Central Region For West Region

Related Sales Revenue / Total Sales Revenue from both

9

Table 3: Calculating Transportation Costs for 2 Centralized Warehouses Option Total Demand (Biweekly) Demand for one w/h region Demand for Central Region Demand for West Region Demand for East Region

Griffin 520,08 65,01 130,02 195,03 130,02

Erlenmeyer 156,36 19,545 39,09 58,635 39,09

Phoenix's Delivery Costs (1)

48,957

29,438

Waltham's Delivery Costs (2)

37,447

22,516

From Waltham to Phoenix Total Amount to Carry Total Cost (Biweekly) (3)

260,04 13,002

78,18 7,818

Total Costs (Biweekly) (1+2+3) Total Annual Costs

99,407

59,7726

2584,58

1554,09

Relative Weight in Sales

75,50%

24,50%

Average Annual Cost

2332,076

Comments Calculated by considering 20% increase Calculated by dividing total demand by 8 To Toronto and Chicago To Seattle, Denver and Phoenix To Atlanta and Massachusetts [ (Demand of West * Weight) ]* (5 x 1/ 19,5 + 1.16 ) + [Demand of Central * 0,5 * Weight] *(12 x 1/ 19,5 + 1.16) [ (Demand of East * Weight) ]* (5 x 1/ 19,5 + 1.16 ) + [Demand of Central * 0,5 * Weight] *(12 x 1/ 19,5 + 1.16) West's Demand + Half of Central's Demand Weight x Amount x Bulk Shipment Rate

Related Sales Revenue / Total Sales Revenue from both

Table 4 : Cost Calculation for Outsourcing the Warehouse Bulk Shipment Costs to Atlanta Griffin 13521,6

Erlenmeyer 4066,8

0,4

0,4

676,08

406,68

Total Demand Demand for one region

Griffin 13521,6 2704,32

Erlenmeyer 4066,8 813,36

Southeast Region Costs

289,327

87,0191

Northeast Region Costs Central Region Costs Southwest Region Costs Northwest Region Costs Total Annual Costs (2)

327,812 385,712 424,370 443,612 1870,835

197,1877 232,0162 255,267 266,845 1038,337

Total Annual Costs (1+2)

2546,915

1445,0175

Relative Weight in Sales

0,75489

0,245

Average Annual Cost

2276,834

Total Demand Bulk Shipment Cost Rate Total Annual Costs (1)

Comments Calculated by 1.2 x Demand of 2009

Total Demand * Weight * Bulk Shipment Cost Rate

Delivery Costs from Atlanta

It is assumed five regions have equal demand. Demand of Region * Weight * / Average Shipment Weight * Related Cost (from Exhibit 5)

Related Sales Revenue / Total Sales Revenue from both

10

Table 5: Calculating biweekly overall inventory levels for options

Erlenmeyer

Griffin 8 W/h

2 W/h

1 W/h

8 W/h

2 W/h

1 W/h

54,2 21,4

216,7 38,3

433,4 51

16,3 10,9

65,2 19,5

130,4 26

Mean (2009) Variance (2009) Mean (2010) Variance (2010) Biweekly Ranges Lower Upper (Q*)

65,04 30,816

260,04 55,152

520,08 73,44

19,56 15,696

78,24 28,08

156,48 37,44

-14,157 144,237

118,29936 401,78064

331,3392 708,8208

-20,77872 59,89872

6,0744 150,4056

60,2592 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: 0,7549

Weighted Average Inventory Levels

Erlenmeyer: 0,2451

Related Sales Revenue / Total Sales Revenue from both

8 Warehouses

2 Warehouses

1 Warehouse

988,526

680,337

597,026

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

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