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Question  17 of Chapter 2: Inventory Management and Risk Pooling
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Question 17 of Chapter 2: Inventory Management and Risk Pooling

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Question 17 of Chapter 2: Inventory Management and Risk Pooling ...

Question 17 of Chapter 2: Inventory Management and Risk Pooling
Simchi-Levi, D., Kaminsky, P., and Simchi-Levi, E., & (2008). Designing and managing the supply chain: Concepts, strategies, and cases (3rd edition). United-States: McGraw-Hill.

Book Reference: Simchi-Levi, D., Kaminsky, P., and Simchi-Levi, E., & (2008). Designing and managing the supply chain: Concepts, strategies, and cases (3rd edition). United-States: McGraw-Hill.

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    Question  17 of Chapter 2: Inventory Management and Risk Pooling Question 17 of Chapter 2: Inventory Management and Risk Pooling Document Transcript

    • Question 17: Chapter 2 Inventory Management and Risk Pooling KLF Electronics is an American manufacturer of electronic equipment. The company has a single manufacturing facility in San Jose, California. KLF Electronics distributes its products through five regional warehouses located in Atlanta, Boston, Chicago, Dallas, and Los Angeles. In the current distribution system, the United States is partitioned into five major markets, each of which is served by a single regional warehouse. Customers, typically retail outlets, receive items directly from the regional warehouse in their market. That is, in the current distribution system, each customer is assigned to a single market and receives deliveries from one regional warehouse. The warehouses receive items from the manufacturing facility. Typically, it takes about two weeks to satisfy an order placed by any of the regional warehouses. Currently, KLF provides their customers with a service level of about 90 percent. In recent years, KLF has seen a significant increase in competition and huge pressure from their customers to improve the service level and reduce costs. To improve the service level and reduce costs, KLF would like to consider an alternative distribution strategy in which the five regional warehouses are replaced with a single, central warehouse that will be in charge of all customer orders. This warehouse should be one of the existing warehouses. The company CEO insists that whatever distribution strategy is used, KLF will design the strategy so that service level is increased to about 97 percent. Answer the following three questions: Issue 1: a. A detailed analysis of customer demand in the five market areas reveals that the demand in the five regions is very similar; that is, it is common that if weekly demand in one region is above average, so is the weekly demand in the other regions. How does this observation affect the attractiveness of the new system? Issue 2: b. To perform a rigorous analysis, you have identified a typical product, Product A. Table 2-11 provides historical data and includes weekly demand for this product for the last 12 weeks in each of the market areas. An order (placed by a warehouse to the factory) costs $5,550 (per order), and holding inventory costs $1.25 per unit per week. In the current distribution system, the cost of transporting a product from the manufacturing facility to a warehouse is given in Table 2-12 (see the column “Inbound”). Table 2-12 also provides information about transportation cost per unit from each warehouse to the stores in its market area (see the column “Outbound”). Finally, Table 2-13 provides information about transportation costs per unit product from each existing regional warehouse to all other market areas, assuming this regional warehouse becomes the central warehouse. Suppose you are to compare the two systems for Product A only; what is your recommendation? To answer this question, you should compare costs and average inventory levels for the two strategies assuming demands occur according to the historical data. Also, you should determine which regional warehouse will be used as the centralized warehouse. Issue 3: c. It is proposed that in the centralized distribution strategy, that is, the one with a single warehouse, products will be distributed using UPS Ground Service, which guarantees that products will arrive at the warehouse in three days (0.5 week). Of course, in this case, transportation cost for shipping a unit product from a manufacturing facility to the warehouse increases. In fact, in this case, transportation costs increase by 50%. Thus, for instance, shipping one unit from the manufacturing facility to Atlanta will cost $18.Would you recommend using this strategy? Explain your answer.
    • Answer (a) In this case, the demands from all warehouses are positively correlated. Therefore the benefits derived from proposed system would not be considerable and new centralized system wouldn’t be attractive.
    • Part 2 Table 1: Historical Data Week Atlanta Boston Chicago Dallas LA Total 1 33 26 44 27 32 162 2 45 35 34 42 43 199 3 37 41 22 35 54 189 4 38 40 55 40 40 213 5 55 46 48 51 46 246 6 30 48 72 64 74 288 7 18 55 62 70 40 245 8 58 18 28 65 35 204 9 47 62 27 55 45 236 10 37 44 95 43 38 257 11 23 30 35 38 48 174 12 55 45 45 47 56 248 Table 2: Current transportation costs per unit Warehouse Inbound Outbound Atlanta 12 13 Boston 11.5 13 Chicago 11 13 Dallas 9 13 LA 7 13 Table 3: Transportation costs per unit in centralized system Warehouse Atlanta Boston Chicago Dallas Atlanta 13 14 14 15 17 Boston Chicago Dallas LA 17 16 22 13 14 14 15 17 13 22 15 17 22 13 15 16 15 15 13 22 LA Service Level 90% and lead time 2 weeks Avg. Demand Centralized CV Q Inbound per Unit Outbound per unit Avg. Inbound Cost Avg. Outbound Cost Avg. Inv. Level (SR = 90% and L=2) Carrying Cost Ordering cost TC 12.8 12.2 21.2 13.2 11.3 0.32 0.30 0.45 0.27 0.25 590.8 599.4 644.8 650.5 635.7 12 11.5 11 9 7 13 13 13 13 13 476.0 469.6 519.8 432.8 321.4 515.7 530.8 614.3 625.1 596.9 397.8 403.5 455.2 445.3 430.2 497.3 504.4 569.0 556.7 537.7 369.3 374.7 403.0 406.6 397.3 1858.2 1879.5 2106.1 2021.1 1853.4 221.8 Atlanta Boston Chicago Dallas LA STD 39.7 40.8 47.3 48.1 45.9 Regions 37.5 0.17 1396.9 766.4 958.0 873.1 Service Level 90% and lead time 2 weeks Centralized Atlanta Boston Chicago Dallas LA Inbound Atlanta Boston Chicago Dallas LA Inbound 13 14 14 15 17 Atlanta Boston Chicago Dallas LA 14 13 22 15 17 14 22 13 15 16 15 15 15 13 22 17 17 16 22 13 12 11.5 11 9 7 515.7 555.3 555.3 595.0 674.3 571.7 530.8 898.3 612.5 694.2 661.5 1039.5 614.3 708.8 756.0 721.3 721.3 721.3 625.1 1057.8 780.6 780.6 734.7 1010.2 596.9 2661.0 2550.1 2439.3 1995.8 1552.3 Decentralized System: Avg. Inventory = 2132.2 Centralized System: Avg. Inventory = 766.4 Percentage reduction in inventory level (approx.) = 64% So, by changing the system from decentralized to centralized, the company is expected to save 64% approximately in average inventory level. Comparing the costs for each regional warehouse, LA is selected to be the centralized warehouse due to its lowest TC. Carrying + Ordering Cost 1831.1 1831.1 1831.1 1831.1 1831.1 TC 7742.7 8008.7 7794.1 7378.3 7162.6
    • Part 3 (L = 2) Table 1: Historical Data Week 1 Atlanta 33 Boston 26 Chicago 44 Dallas 27 LA 32 Total 162 2 45 35 34 42 43 199 3 37 41 22 35 54 189 4 38 40 55 40 40 213 5 55 46 48 51 46 246 6 30 48 72 64 74 288 7 18 55 62 70 40 245 8 58 18 28 65 35 204 9 47 62 27 55 45 236 10 37 44 95 43 38 257 11 23 30 35 38 48 174 12 55 45 45 47 56 248 Table 2: Current transportation costs per unit Warehouse Inbound Outbound Atlanta 12 13 Boston 11.5 13 Chicago 11 13 Dallas 9 13 LA 7 13 Table 3: Transportation costs per unit in centralized system Warehouse Atlanta Boston Chicago Dallas LA Atlanta 13 14 14 15 17 Boston Chicago Dallas LA 14 14 15 17 13 22 15 17 22 13 15 16 15 15 13 22 17 16 22 13 Regions Avg. Demand STD CV Q Inbound per Unit Outbound per unit Avg. Inbound Cost Avg. Outbound Cost Avg. Inv. Level (SR = 90% and L=2) Carrying Cost Ordering cost TC Atlanta Boston Chicago Dallas LA 39.7 40.8 47.3 48.1 45.9 12.8 12.2 21.2 13.2 11.3 0.32 0.30 0.45 0.27 0.25 590.8 599.4 644.8 650.5 635.7 12 11.5 11 9 7 13 13 13 13 13 476.0 469.6 519.8 432.8 321.4 515.7 530.8 614.3 625.1 596.9 397.8 403.5 455.2 445.3 430.2 497.3 504.4 569.0 556.7 537.7 369.3 374.7 403.0 406.6 397.3 1858.2 1879.5 2106.1 2021.1 1853.4 221.8 37.5 0.17 1396.9 798.2 997.8 873.1 Centralized Service Level 97% and lead time 2 weeks Centralized Atlanta Boston Chicago Dallas LA Atlanta Boston Chicago Dallas LA Inbound Atlanta Boston Chicago Dallas LA Inbound 13 14 14 15 17 14 13 22 15 17 14 22 13 15 16 15 15 15 13 22 17 17 16 22 13 12 11.5 11 9 7 515.7 555.3 555.3 595.0 674.3 571.7 530.8 898.3 612.5 694.2 661.5 1039.5 614.3 708.8 756.0 721.3 721.3 721.3 625.1 1057.8 780.6 780.6 734.7 1010.2 596.9 2661.0 2550.1 2439.3 1995.8 1552.3 Carrying + Ordering Cost 1870.8 1870.8 1870.8 1870.8 1870.8 TC 7782.5 8048.5 7833.9 7418.1 7202.3
    • Part 3 (L = 0.5) Table 1: Historical Data Week 1 Atlanta 33 Boston 26 Chicago 44 Dallas 27 LA 32 Total 162 2 45 35 34 42 43 199 3 37 41 22 35 54 189 4 38 40 55 40 40 213 5 55 46 48 51 46 246 6 30 48 72 64 74 288 7 18 55 62 70 40 245 8 58 18 28 65 35 204 9 47 62 27 55 45 236 10 37 44 95 43 38 257 11 23 30 35 38 48 174 12 55 45 45 47 56 248 Table 2: Current transportation costs per unit Warehouse Inbound Outbound Atlanta 12 13 Boston 11.5 13 Chicago 11 13 Dallas 9 13 LA 7 13 Table 3: Transportation costs per unit in centralized system Warehouse Atlanta Boston Chicago Dallas Atlanta 13 14 14 15 LA 17 Boston Chicago Dallas LA 14 14 15 17 13 22 15 17 22 13 15 16 15 15 13 22 17 16 22 13 Regions Avg. Demand STD CV Q Inbound per Unit Outbound per unit Avg. Inbound Cost Avg. Outbound Cost Avg. Inv. Level (SR = 90% and L=2) Carrying Cost Ordering cost TC Atlanta Boston Chicago Dallas LA 39.7 40.8 47.3 48.1 45.9 12.8 12.2 21.2 13.2 11.3 0.32 0.30 0.45 0.27 0.25 590.8 599.4 644.8 650.5 635.7 12 11.5 11 9 7 13 13 13 13 13 476.0 469.6 519.8 432.8 321.4 515.7 530.8 614.3 625.1 596.9 397.8 403.5 455.2 445.3 430.2 497.3 504.4 569.0 556.7 537.7 369.3 374.7 403.0 406.6 397.3 1858.2 1879.5 2106.1 2021.1 1853.4 221.8 37.5 0.17 1396.9 748.3 935.4 873.1 Centralized Service Level 97% and lead time 0.5 week Centralized Atlanta Boston Chicago Dallas LA Atlanta Boston Chicago Dallas LA Inbound Atlanta Boston Chicago Dallas LA Inbound 13 14 14 15 17 14 13 22 15 17 14 22 13 15 16 15 15 15 13 22 17 17 16 22 13 18 17.25 16.5 13.5 10.5 515.7 555.3 555.3 595.0 674.3 571.7 530.8 898.3 612.5 694.2 661.5 1039.5 614.3 708.8 756.0 721.3 721.3 721.3 625.1 1057.8 780.6 780.6 734.7 1010.2 596.9 3991.5 3825.2 3658.9 2993.6 2328.4 With service level of 97% and lead time of 2 weeks: Avg. Inventory Level = 798 With service level of 97% and lead time of 0.5 week: Avg. Inventory Level = 748 Percentage reduction in inventory level (approx.) = 6.27% So, by decreasing lead time from 2 weeks to 1/2 week, the company is expected to save 6.3% approximately in average inventory level. Carrying + Ordering Cost 1808.5 1808.5 1808.5 1808.5 1808.5 TC 9050.7 9261.2 8991.2 8353.6 7916.1
    • LA Warehouse Table 1: Historical Data Week 1 Atlanta 33 Boston 26 Chicago 44 Dallas 27 LA 32 Total 162 2 45 35 34 42 43 199 3 37 41 22 35 54 189 4 38 40 55 40 40 213 5 55 46 48 51 46 246 6 30 48 72 64 74 288 7 18 55 62 70 40 245 8 58 18 28 65 35 204 9 47 62 27 55 45 236 10 37 44 95 43 38 257 11 23 30 35 38 48 174 12 55 45 45 47 56 248 Table 2: Current transportation costs per unit Warehouse Inbound Outbound Atlanta 12 13 Boston 11.5 13 Chicago 11 13 Dallas 9 13 LA 7 13 Table 3: Transportation costs per unit in centralized system Warehouse Atlanta Boston Chicago Dallas LA Atlanta 13 14 14 15 17 Boston Chicago Dallas LA 14 14 15 17 13 22 15 17 22 13 15 16 15 15 13 22 17 16 22 13 Regions Avg. Demand STD CV Q Inbound per Unit Outbound per unit Avg. Inbound Cost Avg. Outbound Cost Avg. Inv. Level (SR = 90% and L=2) Carrying Cost Ordering cost TC Atlanta Boston Chicago Dallas LA 39.7 40.8 47.3 48.1 45.9 12.8 12.2 21.2 13.2 11.3 0.32 0.30 0.45 0.27 0.25 590.8 599.4 644.8 650.5 635.7 12 11.5 11 9 7 13 13 13 13 13 476.0 469.6 519.8 432.8 321.4 515.7 530.8 614.3 625.1 596.9 397.8 403.5 455.2 445.3 430.2 497.3 504.4 569.0 556.7 537.7 369.3 374.7 403.0 406.6 397.3 1858.2 1879.5 2106.1 2021.1 1853.4 221.8 37.5 0.17 1396.9 748.3 935.4 873.1 Centralized Service Level 97% and lead time 0.5 week Centralized Atlanta Boston Chicago Dallas LA Atlanta Boston Chicago Dallas LA Inbound Atlanta Boston Chicago Dallas LA Inbound 13 14 14 15 17 14 13 22 15 17 14 22 13 15 16 15 15 15 13 22 17 17 16 22 13 18 17.25 16.5 13.5 10.5 515.7 555.3 555.3 595.0 674.3 571.7 530.8 898.3 612.5 694.2 661.5 1039.5 614.3 708.8 756.0 721.3 721.3 721.3 625.1 1057.8 780.6 780.6 734.7 1010.2 596.9 3991.5 3825.2 3658.9 2993.6 2328.4 LA Warehouse: Increase in cost when lead time is changed from 2 to 0.5 week = 9.02% If we use this strategy, we will be able to save only 6.3% of average inventory level by increasing 9% of total cost ($707) at LA warehouse. Hence, this strategy does not seem too attractive to be applied. Carrying + Ordering Cost 1808.5 1808.5 1808.5 1808.5 1808.5 TC 9050.7 9261.2 8991.2 8353.6 7916.1