11

ISyE 6203Transportation & Supply

Chain Systems John H. Vande Vate

Spring 2012

22

My Approach• What aspects of the financial goals of the

organization do Supply Chain activities contribute to?

• How do we measure these aspects of Supply Chain activities?

• Financial goals often conflict. What tools are available to help Supply Chain find the right balance

• What tools are available to help improve SC performance

• Motivate by simple examples• Integrate via an industrial project

33

Goals• That we understand the main SC objectives• That we can assess the effects of proposed

initiatives on those objectives• That we develop some skill and intuition for

identifying effective initiatives• That we are armed with some practical tools

for designing, balancing and optimizing SC activities.

• That we have some real experience doing all of these

44

Deterministic vs Stochastic• Organizations are adept at managing

forecasted flows

• Most still struggle with forecast (in)accuracy and unforecasted variability

• We will start with a deterministic view through the mid-term.

• Focus on managing variability after the mid-term

55

Class Presentation Teams• We will work in teams of 4-5 on a project and

on improving “Our Company” performance• You should select your team members by

Friday, January 13th end of business day • One person from each team should send me an

e-mail with the subject line 6203 Teams with– The names of the team members

– A designated contact (with e-mail) for the team

– I will refer to the team by the contact’s last name

66

Class Presentations• Each Tuesday I will call on one or two teams

to present their solutions to assigned “Challenges”

• I expect a brief presentation that explains briefly how you answered the challenge (what method you used), shows your answer and explains the impact

• Remember, we will be improving the performance of Our Company so relative improvements are of primary interest

77

Projects• Around the mid-term we will stop

working on Challenges and change our focus to industrial projects

• I will be announcing these over the coming weeks

• You will work with a team (possibly different from your Class Presentation Team) on 1 industrial project

88

Project Structure3 Steps (Adaptable)• Step 1: Formal project statement, summary of the

data and rough estimates of the potential impacts of various alternatives.

• Step 2: Analyze and optimize the top alternatives and develop detail assessments of their cost and service impacts

• Step 3: Present your assessment and recommendations to management, including an evaluation of more qualitative risks and opportunities associated with each strategy.

99

Deliverables

• Each team will make a presentation to the class during the last couple weeks of the semester

• Each team will present to the client (probably via phone or internet)

• An organized CD or T-Square files that facilitate the transfer of your project.

• I will set up Team Project Forums on T-Square and invite your sponsor to join

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Project Grade

• Presentations: Content, Clarity and Quality of your presentations

• Project management – Coordinating, attending, managing meetings– Clarifying project scope and direction– Managing information, meeting minutes, data– Staying ahead

• Initiative• Integrity

1111

My Role

• As much help as you want• Eager to meet with you and hear about your

progress and questions at your request• Strongly recommend you share your presentations

with me well in advance for advice. • Will attend initial conference calls to establish the

project, but will step back after that

1212

First Steps

• I will share brief project overviews

• You will organize your project team (may be the same as Class Presentation Team) and send me preferences

• I will assign projects and organize initial conference call with sponsor

• You will take it from there.

1313

Conference Calls• Usually in 226 (arranged via Meka Wimberly

meka.wimberly@isye.gatech.edu)• Not necessary that everyone be there, but it’s

better. • Someone from you team should take

careful notes and post them as meeting minutes on your Project Forum

• You are responsible for organizing conference calls after the first one or two.

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Potential Projects

• Halstead/Vertex

• Acumen Fund ZHL Ziqitza

• Tiffany’s

• VW/Audi

• Projects you organize

1515

Course Organization• Two Exams• Mid-term: Thursday, March 1st • Final: Tuesday, May 1st from 2:50 to 5:40• Grading:

– Project 30%– Mid-term: 30%– Final: 30%– Team Presentations: 10%

• Warning: People struggle with my exams• Academic Honesty

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Text• No text book. • I’ve listed some good resources on the class web

page (see T-Square)• I will provide selected readings and links to

additional information• Radical Tools (an Excel Add-in) in the Labs• MapPoint available in the labs. May also be

available for free from http://msdn08.e-academy.com/gatech_isye

Also available for free as a 60 day trial on the internet.

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Questions?• Feel free to send questions via e-mail• Or drop by my office: 222 of old ISyE bldg• Feel free to schedule a meeting via e-mail• Anonymous feedback on each lecture via T-

Square (under Tests & Quizzes – I used “Anonymous grading only” so I don’t see your identity).

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Travel• I have to be out of the country from February 20th

through March 2nd • Guest lectures during that period

– HDT Case on Cash Flow

– Air Freight 101 & Over-the-Road 101 with Greg Andrews EMIL-SCS Managing Dir.

– Mid-Term Exam

• Be sure to ask questions by Thursday, Feb 16th • I will be available via e-mail, but expect delays

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Our Company

• Today: Introduce Our Company and evaluate its performance

• Coming Weeks: Develop a distribution strategy to improve Our Company’s financial performance

• These will be Team Presentation Assignments

2020

Overview

• Products:– Computers: CPU, Monitor– 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

CPUs TV/Monitor ConsoleCost $300 $400 $100

Weight 5 lbs 10 lbs 30 lbs

From Green Bay Indianapolis Denver

We assume atruck holds 30,000 lbs

and travels 500 miles/day

2222

Current Operations

• All direct shipments in full truckloads

2323

Simplification • Shipments on the order of 1,000 miles

F

F

F

Green Bay

Indianapolis Denver

Use your head!Make an estimate.Refine it. Averages Green Bay: 969Indianapolis: 854Denver: 1,006

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  CPUs TV/Monitor ConsoleCost $300 $400 $100

Weight 5 lbs 10 lbs 30 lbs

From Green Bay Indianapolis Denver

Our Company.xls

• Enable Macros– ArcCos

– Distance: Computes the distance in miles between two latlong coordinates

– Or you can use the Radical Tools add in available in the labs. (We won’t work with distance much initially)

• Components: Cost, weight, source

• Products: BOM, Selling price

• Locations: LatLongs of stores and plants, distances

• Financials: Income Statement, Balance Sheet, Metrics

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Our Company.xlsOur Company

Income Statement (all figures in 000's)% of Revenue

Revenue 450,000$ 100%COGS 301,410$ 67.0%

Raw Materials 300,000$ 66.7%Transportation 0.0%Labor 1,410$ 0.3%

Gross Margin 148,590$ 33.0%SG&A 26,200$ 5.8%Other Operating Expenses 500$ 0.1%Operating Income 121,890$ 27.1%Other Income -$ 0.0%Financial Expenses 6,500$ 1.4%Income before Taxes 115,390$ 25.6%Provision for Taxes 28,732$ 6.4%Consolidated Net Income 86,658$ 19.3%

NOPAT 93,158$ Invested Capital 257,220$ SPEED 1.75 ROIC 36%DSO 15 daysDII - daysDPO 30 daysCash-to-Cash Cycle (15) days

Compute transportation costs using data in the Parameters sheet

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Our Company.xlsOur Company

Balance Sheet (all figures in 000's)

AssetsCurrent Assets:

Cash and cash equivalents 5,000$ Trade accounts receivables 18,493$ Inventory -$

At Green BayAt IndianapolisAt DenverAt StoresPipeline

Other current assets 2,500$

Total Current Assets 25,993$ Property & Equipment, net 260,000$ Other Assets 1,000$

Total Assets 286,993$

Liabilities & Stockholders' EquityCurrent Liabilities:

Accounts Payable 24,773$ Short-term debt -$

Total Current Liabilities 24,773$ Long-term debt 130,000$ Other Liabilities 250

Total Liabilities 155,023$

Total Stockholder's Equity 131,970$

Total Liabilities and Stockholders' Equity 286,993$

Compute inventory values:

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Arrow Electronics Annual Report

• “Operating efficiency and working capital management remain a key focus of the company's business initiatives to grow sales faster than the market, grow profits faster than sales, and increase return on invested capital.”

Market Share

Profitability Return on invested capital

2828

SC & Finance“Corporation managers generally claim that

they have four broad responsibilities: to consumers, to employees, to stockholders, and to the general public … each group is on an equal footing: the function of management is to secure justice for all and unconditional maxima for none. Stockholders have no special priority; they are entitled to a fair return on their investment, but profits above a ‘fair’ level are an economic sin.”

Sutton et al. The American Business Creed 1956

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Financial Goals

Financial Performance

Profitability Revenue Growth Capital Utilization

Income Statement

Balance Sheet

3030

Revenue• SC helps drive revenue

– Superior service commands higher price and loyalty

– Product availability drives sales

– Integrated operations can become a barrier to changing suppliers

– Speed of product introduction can win market share

– …

• Our Company: Revenues = $450 Million

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Income Stmt: Profitability

Profitability

COGS SG&ADepreciation &

Amortization

3333

Profitability• COGS: Cost of Goods Sold

– Includes all costs of material, labor, and allocated overhead, purchase, conversion and other costs incurred in bringing the inventories to their present location and condition.

– Prices change. So there are various methods for reconciling:

• specific identification, • first-in first-out (FIFO)• average cost

– That’s accounting, we won’t worry to much about the accounting standards.

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COGSYou can read more about COGS athttp://en.wikipedia.org/wiki/Cost_of_goods_soldOr for a quick practical overview, http://learndirecthmmdemo.lmmattersonline.com/courses/hmm10/budgeting/documenting_revenue_forecasts.htmlOur Company COGS consists of

Raw Materials: $300 Million Labor: $1.41 Million Transportation: ?

Not required

Not required

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Gross Margin

• Gross Margin = Revenue – COGS• Gross Margin as % of Sales =

Our Company: Low transportation costs ensure high Gross Margin

For more details seehttp://en.wikipedia.org/wiki/Gross_Margin

Revenue Revenue COGS

Not required

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SG&A

• SG&A: Selling, General & Administrative includes costs for research and development, product design, marketing, distribution, customer service, commissions, administration, and overhead.

• Our Company: SGA = $26.2 Million • For more discussion see, for example,

http://www.investopedia.com/terms/s/sga.aspNot

required

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Depreciation & Amortization

• Typically not a major SC consideration for us. Has to do with expensing large capital asset investments like plants and equipment

• Except for Depreciation, Profitability is driven by revenue and operating EXPENSES

38 38

Operating Income (EBIT)• Earnings Before Interest & Taxes• Gross Margin minus

– SG&A– Amortization & Depreciation– Impairments and other expenses+ Non-Operating Income

3939

Balance Sheet: Capital Utilization

Capital Utilization

Fixed Asset Utilization

Working Capital Utilization

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Why Capital Utilization?

• Might find “Capital Productivity: Why the US Leads and Why it Matters” interesting.

• McKinsey Quarterly, 1996 Issue 3• Available from eJournals at

www.library.gatech.edu• Focus on “Why it Matters”. Might be

interesting to reflect on the “Why US leads” aspects in light of financial crisis.

Not required

4141

Digression on US vs German Capital Utilization

• Differences in capital markets

• Differences in employment models

• Differences in political economies

• A broader perspective on “goldplating”

4242

Capital Utilization

• “Productivity” of capital

• How well capital investments are employed to deliver goods and services

• From an investor perspective, related to the return available from investment

• Note the INVESTMENT perspective.

• Capital Utilization driven by Revenue and INVESTMENT

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Productivity of Capital• Productivity of Capital (SPEED)

• Return on Invested Capital (ROIC)

• Our Company: Reducing Inventories improves SPEED and ROIC

• For more information see• http://news.morningstar.com/classroom2/course.asp?do

cId=145095&page=9&CN=COM

RevenueInvested CapitalSPEED

NIBCLs -Cash Excess - Assets TotalTaxes - Income Operating

Capital InvestedNOPATR OIC

Not required

4444

NOPAT & NIBCLs

• NOPAT: Net Operating Profit After Taxes

• NIBCLs: Non-interest bearing current liabilities, eg., accounts payable

4545

Two kinds of Capital

• Fixed Capital Assets– Plants and Equipment

• Working Capital– Inventories or raw materials and finished goods

– Accounts receivable

– Accounts payable

• For more on Working Capital see

http://en.wikipedia.org/wiki/Working_capitalNot

required

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Working Capital

• The cash required to finance operations

• The Cash-to-Cash cycle- Organization must have capital to fund raw

materials, etc. from the time it pays for them to the time it’s customers pay for the corresponding finished goods

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Working Capital

Working Capital

Accounts Receivable

InventoryAccounts Payable

What we finance for

our customers

What our suppliers

finance for us

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Working Capital: AR

• Typically most meaningful when expressed in terms of time

• Days Sales Outstanding

• Example: Our Company– Receivables: $18.493 Million

– Sales: $450 Million or about $1.233 million/day

– DSO: 15 days

dayper Sales Avg.sReceivable

SalessReceivable PeriodinDays*

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Working Capital: AP• Days Payables Outstanding

• Example: Our Company– Accounts Payable: $24.733 Million

– COGS: $301.4 million plus transportation or about $826 thousand/day + avg daily transportation

– DPO: 30 days (ignoring transportation)

dayper Purchases Avg.Payable Accounts

COGsPayable Accounts PeriodinDays*

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Working Capital: Inventory• Days in Inventory

• We will have to do some work to estimate Inventory

• Normally this would be an accounting process: How much inventory do we have?

• We will estimate inventory. Why?

dayper Purchases Avg.Inventory

COGsInventory PeriodinDays*

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Cash-to-Cash Cycle

• Days Sales Outstanding: 15 days

• Days in Inventory: + ? days

• Days Payables Outstanding:30 days

• Cash-to-Cash Cycle: ? days

• Our Company: Net net, our suppliers fund 15 days of operations. Depending on inventories, we must fund the rest.

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Dell’s Cash-to-Cash Cycle

Dell’s suppliers finance a month + of Dell’s operations

Dell 2011Accounts Receivable $ 6.493 BillionInventory $ 1.301 BillionAccounts Payable $11.293 BillionSales $61.494 BillionCOGS $50.089 Billion

DSO 38.54 DaysDII 9.48 DaysDPO 82.29 DaysC2C (34.27) Days

That’s about $4.7 billion

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Discussion

• SC can influence DSO by providing perfect order delivery, prompt accurate billing, etc, integrating with customer accounting systems, …

• SC can influence DSO and DPO by negotiating terms of sale, e.g., when title transfers, mode of delivery, etc.

• We will mainly focus on Inventory. How can SC influence Inventory?

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Fixed Asset Utilization

• Utilization of Capital Equipment• Sometimes at the expense of working capital

– See “The Goal” • Recent story: Intel SC Transformation• http://www.supplychainbrain.com/content/h

eadline-news/single-article/article/through-its-complete-cultural-shift-intel-takes-top-spot-in-supply-chain-innovation-awards/

Not required

Required

5555

Inventory

• Inventory is an INVESTMENT, not an expense

• Can speak of inventory in terms of – Units– $– DaysThe latter are more common except when

dealing with very specific operational details

5656

Apples & Oranges

• How to balance inventory INVESTMENT against operating EXPENSES?

• Should I INVEST more in a hybrid to reduce my weekly fuel EXPENSES?

• Can’t compare the difference in weekly or annual operating expenses with the difference in the investment!

• Associate an operating EXPENSE with the INVESTMENT

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Inventory Carrying Cost

• Usually expressed as a % of the value (at COGS)

• Many companies don’t have a good handle on this.

• Two components– “Average Cost of Capital”– Operational Expenses associated with

Inventory

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Average Cost of Capital

• Sources of Capital– Shareholders – Equity– Bond holders and Creditors – Debt

• Question: – Which gets a higher return?– Why?

5959

Average Cost of Capital

• % of Equity * Cost of Equity, • +% of Debt * Cost of Debt (1-Tax Rate)• Example: Our Company

– From the Balance sheet

• Total Assets: 287 million (ignoring inv.)• NIBCLs: 25 million• 262 million• Long Term Debt $130 million at 5%• Short Term Debt 0 million at 5.5%• Equity $132 million at Cost of Equity?

6060

Average Cost of Capital• % of Equity * Cost of Equity, • +% of Debt * Cost of Debt (1-Tax Rate)• Example: Our Company• Debt 50% Cost of Debt 5%(1-24.9%)• Equity is 50% Cost of Equity 9%• Average Cost of Capital 6.39%• This will change when we include inventory in our

capital and financing for inventory in our liabilities• Don’t worry about its changing.

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Cost of Inventory• Non-Capital Charges as % of Inventory

– Warehousing– Obsolescence– Price Erosion: LCD TV prices fall 24%/year– Pilferage– Damage– Insurance & Taxes– Other

• Does this depend on the SKU?• Typical charge is ~10% • These are PRE-TAX costs• Capital charge was AFTER TAX

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Total Cost of Carrying Inventory• Total (Pre-Tax) Cost of Carrying Inventory

Non-Capital Charge (e.g., 10%)Capital Charge/(1-Tax Rate)

• Our CompanyNon-Capital Charge (we will guess 10%) 10%Capital Charge 6.39%/(1-24.9%) ~8.5%Total Cost of Carrying Inventory 18.5%

• What does this mean? – For every $100 million in inventory we carry– The annual cost of carrying that inventory is ~$18.5 millionWe can compare THAT with annual operating expenses

Let’s be careful to distinguish. Shout if you’re confused!

6363

Summary

• Income Statement focus on Profitability– Usually think of increasing revenues or reducing

expenses

• Balance Sheet focus on Capital Utilization– Usually think of reducing working capital

• Inventory Carrying Cost– Allows us to balance the two approaches

– No one writes a check for Inventory Carrying Cost

6464

Questions?

6565

Next Step

• Estimate Inventory • Depends on how we operate• Today we

– Minimize transportation costs by running full truckload direct (lowest rate and shortest distance)

– Maximizes Gross Margin• What’s the effect on inventories? • How well are we balancing our competing

metrics of financial performance?

6666

Types Of Inventory

• Pipeline Inventory: Goods in transit• Cycle Stock: Goods accumulating or depleting

from batch operations, e.g., accumulating or selling off a truckload quantity

• Safety Stock: Goods held as a buffer against variability in demand and in replenishment

• Anticipation Stock: Accumulated because of limited capacity

6767

Cycle Stock

• Example: Accumulated at a shipping dock awaiting full truckload

• Typically assume constant (long run average) rate of production

6868

Cycle Stock

Inve

ntor

y

Time

Truck Load

Average Inventory? (Units or Value)

Average Inventory? (Days)

6969

Cycle StockIn

vent

ory

Time

Truck Load

Average Inventory? (Units or Value)

Average Inventory? (Days)

7070

Cycle Stock

• Units: Half the size of the batch

• Value: Half the value of the batch

• Time: Half the time to accumulate the batch.

• Simple.

• We will see modifications of this simple model.

7171

Pipeline Inventory

• Little’s Law• L = WNumber of items in the system (L) = Rate the items arrive (Time each item spends in the system (W)It doesn’t matter how they arrive

– One at a time– In parcels– In truck loads– …

Where have we seen this before?

7272

Pipeline Inventory• L, the items or value in the system• the long run average rate at which items

or value arrive (e.g., are shipped)• W, how long (in consistent units) they stay in

the system (e.g., the transit time)• Example: Wal*Mart ships 60%¹ (by value) of

all it sells from Asia to the US on container ships taking 15¹ days

• COGs for 2010: $305 billion• What’s the pipeline inventory (value)

¹ Guesses

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Pipeline Inventory

• the long run average rate at which items or value arrive (e.g., are shipped)

60% * $315 billion = $189 billion

$189 billion/365 = $517 million/day• W, how long (in consistent units) they stay in

the system (e.g., the transit time)

15 days

L = W = $517 million/day* 15 days

= $7.767 billion

7474

Pipeline Inventory

• That’s a $7.767 billion INVESTMENT

• It is always there floating on the water

• Sometimes more, sometimes less

• $7.767 billion on average

• That’s the revenues of the 330th largest company in the Fortune 500

• Eg. Eastman Chemicals, Dillards, Yahoo

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Questions

7676

Challenge 1

• In your groups, complete the financial statements for Our Company under current operating practices

• Transportation costs– As indicated on Parameters page

• Inventory Costs

* We assume weight, not cube, floor space or maximum value determines the capacity of the vehicle.

7777

Deliverables• Completed Financial Statements• Brief presentation outlining your calculations• As VP of SC, what initiatives would you

propose? • We will be building on this example. Organize

and keep your work.• Avoid using values (e.g., Inventory carrying

cost, truck load capacity, …) in formulas. Reference them so you can change them easily later

• Due: Tuesday, January 17th • I will call on 1 or 2 teams to present in class

7878

Discussion

• Questions?

• Next week:– Team presentations on Challenge 1– Begin to explore strategies for balancing

operating expenses (e.g., transportation) and working capital (e.g, inventory)