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.

1. 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.

2. 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.

3. 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

4. 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

5. 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

6. 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