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Modeling Inventory (Deterministic View)

Modeling Inventory (Deterministic View). John H. Vande Vate Spring 2008. Types of Inventory. Deterministic Inventory Pipeline Inventory: Inventory in transit Cycle Inventory: Goods accumulating for transit Goods delivered and waiting for processing Stochastic Inventory (later).

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Modeling Inventory (Deterministic View)

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  1. Modeling Inventory(Deterministic View) John H. Vande Vate Spring 2008 1

  2. Types of Inventory • Deterministic Inventory • Pipeline Inventory: Inventory in transit • Cycle Inventory: • Goods accumulating for transit • Goods delivered and waiting for processing • Stochastic Inventory (later) 2

  3. Illustrative Example • Develop a distribution strategy to minimize inventory and transportation costs • Purpose: • Outline issues covered in outbound logistics • The importance of transportation in the supply chain • Illustrate costs and investments • Always do a quick analysis first, then refine it. 3

  4. Overview • Products: • Computers: CPU, Monitor, Keyboard • Televisions: TV and Console • Stores • 100 across the US • Sell 10 TVs and 10 computers per day • 250 days/year 4

  5. Components We assume weight not cube determines vehicle capacity Truck holds 30,000 lbs 5

  6. Current Situation • All direct shipments in full truckloads 6

  7. Simplification • Shipments on the order of 1,000 miles Distances 7

  8. What Costs? • Transportation • Pipeline inventory – inventory in transit • Inventory at Plants • Inventory at Stores • Handling • … 8

  9. Transportation Costs • Estimate number of shipments/year • Annual Demand (in units)/Units per Truck Units per Truck = TL Capacity (in lbs) Weight of Unit • CPU: 6,000 = 30,000/5 • Monitor: 3,000 = 30,000/10 • Console: 1,000 = 30,000/30 • Estimate cost per shipment $/mile * Average Miles per shipment • The product gives total cost 9

  10. Direct:Transportation Cost Why 5,000? • How many shipments/year? • Green Bay • Indianapolis • Denver • Total 100 stores * Annual Store Demand /Items to fill a truck 100*2,500/6,000 = 41.67 100*5,000/3,000 = 166.67 100*2,500/1,000 = 250 ~ 460 10

  11. What Costs? • Direct • Transportation ~ • $1/mile*1,000 miles/trip*460 trips/year = $460,000/year • Pipeline inventory • Inventory at Plants • Inventory at Stores • Handling • … 11

  12. Pipeline Inventory • Little’s Law • L = l W Number of items in the pipe (L) = Rate the items arrive (l) * Time each item spends in the pipe (W) • It doesn’t matter how they arrive • One at a time • In parcels • In Truck loads • … 12

  13. Pipeline Inventory • How long are goods in transit? • 1,000 miles at 50+ miles per hour • 2 days + • How fast do they arrive? • Rate of sales • Let’s calculate $ in the pipe instead of items 13

  14. Pipeline Inventory • One Day worth of sales at a Store • 10 TVs at $400+$100 each = $5,000 • 10 Computers at $300+$400 = $7,000 • Total $12,000 per day per Store • Two days of system-wide sales: • 2 days * $12,000/Store/day * 100 stores = $2,400,000 • The $ in the pipe: $2.4 million! • That’s ALWAYS there. • Carrying cost 15% of $2,400,000 = $360,000 per year • We pay that each year 14

  15. What Costs? • Direct • Transportation ~ • $1/mile*1,000 miles/trip*460 trips/year = $460,000/year • Pipeline inventory • $2,400,000 in capital • $360,000 in annual carrying costs • Inventory at Plants • Inventory at Stores • Handling • … 15

  16. Inventory at Green Bay • (Perfectly) Staggered Shipments Average Inventory? 6,000 Inventory Why ~6 days? Time ~6 days 16

  17. Inventory in Green Bay • 3,000 units (Half a truck load) • $300 per unit • $900,000 in inventory • 15% capital charge => $135,000 in carrying costs 17

  18. What Costs? • Inventory at Plants • Perfectly Staggered Shipments • Capital Carrying Cost • Green Bay $900 K $ 135 K • Denver $ 50 K $ 7.5 K • Indianapolis $600 K $ 90 K • Total $1.55 million $ 232.5 K 18

  19. What Costs? • Direct • Transportation ~ • $460,000/year • Pipeline inventory • $2,400,000 in capital • $360,000 in annual carrying costs • Inventory at Plants – Staggered Shipments • $1.55 million in capital • $232.5 K in annual carrying costs • Inventory at Stores • Handling • … 19

  20. Store Inventory from Green Bay 6,000 Inventory Why ~2.4 years? Time ~2.4 years 20

  21. Inventory at Stores • At EACH Store? • ½ truckload or 3,000 CPUs at $300 each: $900,000 • ½ truckload or 1,500 Monitors at $400 each: $600,000 • ½ truckload or 500 Consoles at $100 each: $ 50,000 $1,550,000 Carrying cost: 15% of $1,550,000 or $232,500 Total Capital at the Stores: $155 million Total Carrying cost at the Stores: $23,250,000! 21

  22. What Costs? • Direct • Transportation ~ • $460,000/year • Pipeline inventory • $2,400,000 in capital • $360,000 in annual carrying costs • Inventory at Plants – Staggered Shipments • $1.55 million in capital • $232.5 K in annual carrying costs • Inventory at Stores • $155 million in capital • $23.25 million in carrying costs • Handling • … 22

  23. Total Cost & Capital Direct Costs • Transportation Costs: $ 460,000 • Pipeline Inventory $ 360,000 • Inventory Costs at Plants: $ 232,500 • Inventory Costs at Stores: $ 23,250,000 Total: $ 24,302,500! Capital Required: • Pipeline Inventory $ 2,400,000 • Inventory Costs at Plants: $ 1,550,000 • Inventory Costs at Stores: $ 155,000,000 Total: $ 158,950,000! 23

  24. Return on Capital • Return on Capital = Pre-tax Profit Capital Employed = Pre-Tax Profit * Revenues Revenues Capital Employed = Profit Margin * SPEED • How to improve Return on Capital? • What’s our SPEED? 24

  25. SPEED • Revenues: Well Cost of Goods, we don’t have selling prices…. • $12,000/day per store • $1.2 million per day • 250 days means $300 million • Capital Employed: $159 million (not counting the cost of the stores, the factories, and anything else we own) • Speed is 1.89 = 300/159, i.e., each year we generate $1.89 in revenue for every $1 invested. 25

  26. Your Job is… • As newly hired VP of SC, your job is to improve: • profitability and • capital utilization • Suggestions? 26

  27. Consolidation • Strategy 2: Assemble Products in Indianapolis and distribute by truckload from there • What will happen to costs? • Transportation • Pipeline • At plants • At Indianapolis Warehouse/Cross Dock • At Stores 27

  28. Via Indianapolis Facts 28

  29. What Costs? • Transportation • To Indianapolis • From Indianapolis to Stores • Pipeline inventory • To Indianapolis • From Indianapolis to Stores • Inventory at Plants • Inventory at Indianapolis Cross Dock • Inventory at Stores • Handling • … 29

  30. Indirect: Transportation • To Indianapolis • Green Bay 400 miles* 42 trips = 16,800 • Indianapolis 0 miles*167 trips = ~ 0 • Denver 1,100 miles*250 trips = 275,000 • Total $291,800 • From Indianapolis to Stores • Same as total transport before, we are moving the same goods the same distance (roughly 1,000 miles to each Store) $460,000 30

  31. What Costs? • Transportation • To Indianapolis $291,800 • From Indianapolis to Stores $460,000 • Pipeline inventory • To Indianapolis • From Indianapolis to Stores • Inventory at Plants • Inventory at Indianapolis Cross Dock • Inventory at Stores • Handling • … 31

  32. Pipeline Inventory • To Indianapolis • From Green Bay 400 miles ~ 1 day • 1,000 per day at $300 each ~ $300,000 capital • 15% of $300,000 is $45,000 carrying cost • From Denver 1,100 miles ~ 2 days • 2 days at 1,000 per day at $100 each ~ $200,000 capital • 15% of $200,000 is $30,000 carrying cost • Total • Capital $500,0000 • Carrying Cost $ 75,0000 • From Indianapolis to Stores • Same as before 2 days of sales • Capital $2,400,000 • Carrying Cost $ 360,000 32

  33. What Costs? • Transportation • To Indianapolis $291,800 • From Indianapolis to Stores $460,000 • Pipeline inventory • To Indianapolis • Capital $500,000 • Carrying Cost $ 75,000 • From Indianapolis to Stores • Capital $2,400,000 • Carrying Cost $ 360,000 • Inventory at Plants • Inventory at Indianapolis Cross Dock • Inventory at Stores • Handling • … 33

  34. Inventory at Plants • Same as before • Green Bay holds ½ of a truckload • Denver holds ½ of a truckload • Assume Indianapolis holds ½ of a truckload for delivery to the cross dock • Capital $1,550,000 • Carrying Cost $ 232,500 34

  35. What Costs? • Transportation • To Indianapolis $291,800 • From Indianapolis to Stores $460,000 • Pipeline inventory • To Indianapolis • Capital $500,000 • Carrying Cost $ 75,000 • From Indianapolis to Stores • Capital $2,400,000 • Carrying Cost $ 360,000 • Inventory at Plants • Capital $1,550,000 • Carrying Costs $ 232,500 • Inventory at Indianapolis Cross Dock • Inventory at Stores • Handling • … 35

  36. Inventory at Cross Dock Receiving Shipping WIP Computers & TVs CPUs, Monitors, Consoles 36

  37. Inventory at Indianapolis Cross Dock • Receiving from the Plants • ½ a truckload of CPUs • ½ a truckload of Monitors • ½ a truckload of Consols • Shipping to the Stores • ½ a truckload of Computers and TVs • WIP – like Pipeline inventory • How long does the process take? Capital $1,550,000 Carrying Cost $ 232,500 37

  38. What’s in a Truck • Of Computers and TVs? • In the same mix as demand • 1:1 computers to TVs • X computers in a truck • Weight of the computers 15X lbs • Weight of the TVs 40X lbs • 15X + 40X = 30,000 lbs • X = 30,000/55 = 545 • A full truck of finished goods has • 545 computers and 545 TVs • 545 CPUs, 545 Consoles and 1090 Monitors 38

  39. Inventory at Indianapolis Cross Dock • Receiving from the Plants • ½ a truckload of CPUs • ½ a truckload of Monitors • ½ a truckload of Consols • Shipping to the Stores • ½ a truckload of Computers and TVs • 273 CPUs at $300 each or $ 81,900 • 273 Consoles at $100 each or $ 27,300 • 546 Monitors at $400 each or $218,400 • Total $327,600 • Carrying cost $ 49,140 • WIP – like Pipeline inventory • How long does the process take? Capital $1,550,000 Carrying Cost $ 232,500 39

  40. Inventory at Stores • Inventory at a Store: • Visited by truck 4.6 times per year • Same as before • So inventory costs at Stores are the same as before, right? 40

  41. Wrong! Magic? • Total Inventory Carrying Cost at Stores: $4,914,000 compared with $23,250,000 under earlier strategy. Explain! 41

  42. The Difference Explain? 42

  43. With Consolidation • Transportation Costs: $ 751,800 • Pipeline Inventory: $ 435,000 • Inventory Costs at Stores: $ 4,914,000 • Inventory Costs at Plants: $ 232,500 • Inventory Costs at XDock: $ 281,640 Total: $ 6,614,900 Without Consolidation • Transportation Costs: $ 460,000 • Pipeline Inventory: $ 360,000 • Inventory Costs at Stores: $ 23,250,000 • Inventory Costs at Plants: $ 232,500 Total: $ 24,302,500! 43

  44. Comparison Invest some of the $120 million in the cross dock Spend some of the $18 million on handling 44

  45. SPEED • With consolidation our SPEED (with the same caveats) is • $300 million/$39 million = 7.69! • We generate $7.69 in revenue for every $1 invested • That give us a lot more room to play with margin and still have a high return on capital 45

  46. For Future Reference • Consolidation illustrates two situations • 1-to-1 shipments • E.g. from Green Bay to Indianapolis XDock • Inventory at Green Bay  Inventory of CPUs in Indianapolis • 1-to-Many shipments • E.g., from XDock to stores • Inventory at XDock  Inventory at a SINGLE store • The point: Inventory at the origin of a 1-to-Many system has a smaller impact than in a 1-to-1 system…we will see this next time. 46

  47. Summary • Deterministic Inventory • Pipeline • Cycle • WIP • Pipeline from Days in transit * Value/Day • Cycle from half of shipment • WIP like pipeline • Value of consolidation • Quick & Dirty analysis first 47

  48. Deterministic Supply Chain Design • Next time: should we be shipping in full truckloads? • Later, how to reduce inventory in stores • Reducing inventory in stores is a powerful way to improve return on capital • Wal-Mart has more than 2,300 supercenters in the US • Reducing inventory in each one by a mere $10K frees $23 million in capital. 48

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