Post on 11-Feb-2016
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Modeling Inventory(Deterministic View)
John H. Vande VateSpring 2008
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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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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.
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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
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Components
Computers TV/Monitor ConsoleCost $300 $400 $100
Weight 5 lbs 10 lbs 30 lbs
From Green Bay Indianapolis Denver
We assume weight not cube determines vehicle
capacityTruck holds 30,000 lbs
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Current Situation• All direct shipments in full truckloads
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Simplification • Shipments on the order of 1,000 miles
F
F
F
Green Bay
Indianapolis Denver
Distances
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What Costs?
• Transportation• Pipeline inventory – inventory in transit• Inventory at Plants• Inventory at Stores• Handling• …
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Transportation Costs• Estimate number of shipments/year
– Annual Demand (in units)/Units per TruckUnits 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
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Direct:Transportation Cost
• How many shipments/year?– Green Bay– Indianapolis– Denver– Total100 stores * Annual Store Demand /Items to fill
a truck
100*2,500/6,000 = 41.67100*5,000/3,000 = 166.67100*2,500/1,000 = 250
~ 460
Why 5,000?
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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– …
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Pipeline Inventory• Little’s Law• L = WNumber of items in the pipe (L) = Rate the items arrive (Time each item spends in the pipe (W)• It doesn’t matter how they arrive
– One at a time– In parcels– In Truck loads– …
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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
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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
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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– …
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Inventory at Green Bay• (Perfectly) Staggered Shipments
6,000
~6 days
Why ~6 days?
Inve
ntor
y
Time
Average Inventory?
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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
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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
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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– …
2020
Store Inventory from Green Bay
6,000
~2.4 years
Why ~2.4 years?
Inve
ntor
y
Time
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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
$1,550,000Carrying cost: 15% of $1,550,000 or $232,500Total Capital at the Stores: $155 millionTotal Carrying cost at the Stores: $23,250,000!
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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– …
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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!
Total Cost & Capital Direct
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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?
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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.
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Your Job is…
• As newly hired VP of SC, your job is to improve:– profitability and– capital utilization
• Suggestions?
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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
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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• …
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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
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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• …
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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
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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• …
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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
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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• …
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Inventory at Cross Dock
Receiving Shipping
CPUs, Monitors, Consoles
Computers & TVsWIP
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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 $1,550,000Carrying Cost $ 232,500
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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
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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 $1,550,000Carrying Cost $ 232,500
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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?
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Wrong! Magic?
Product Value Number per year
Number per shipment
Average Inventory
Average Value of Inventory
Inventory Carrying
CostTV 500.00$ 2,500 545 273 136,500$ 20,475$ Computer 700.00$ 2,500 545 273 191,100$ 28,665$
Total: 49,140$
• Total Inventory Carrying Cost at Stores: $4,914,000
compared with $23,250,000
under earlier strategy. Explain!
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The Difference
Product Value Number per year
Number per shipment
Average Inventory
Average Value of Inventory
Inventory Carrying
CostTV 500.00$ 2,500 545 273 136,500.00$ 20,475.00$ Computer 700.00$ 2,500 545 273 191,100.00$ 28,665.00$
Total: 49,140.00$
Part Value Number per year
Number per shipment
Average Inventory
Average Value of Inventory
Inventory Carrying Cost
CPU $300 2500 6,000 3,000 900,000.00$ 135,000.00$ Monitor/Keyboard $400 5000 3,000 1,500 600,000.00$ 90,000.00$ Console $100 2500 1,000 500 50,000.00$ 7,500.00$
Total: 232,500.00$
Explain?
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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: $ 6,614,900Without 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!
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ComparisonCapital Cost Capital Cost
TransportationTo Indianapolis -$ 291,800$ From Indianapolis to stores 460,000$ 460,000$
Pipeline InventoryTo Indianapolis 500,000$ 75,000$ From Indianapolis to stores 2,400,000$ 360,000$ 2,400,000$ 360,000$
Inventory at Plants 1,550,000$ 232,500$ 1,550,000$ 232,500$ Inventory at Cross Dock
Receiving 1,550,000$ 232,500$ Shipping 327,600$ 49,140$
Inventory at stores 155,000,000$ 23,250,000$ 32,760,000$ 4,914,000$ Total 158,950,000$ 24,302,500$ 39,087,600$ 6,614,940$
Direct Consolidation
Invest some of the $120 million in the cross dock
Spend some of the $18 million on handling
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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
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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.
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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
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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.