There were three major sources of uncertainty that could affect the supply chain:
- Dealing with the delivery of the incoming materials
- With regard to the internal processes
- Demand of the product.
The first two resulted in delays in manufacturing lead time to replenish the stocks at the DCs. Demand uncertainties lead to inventory build-up or backorders at the DCs.
Inventory and Service Crisis:
Though the supplier management was worked on to reduce uncertainties in delivery variability of incoming materials, and also other factors such as improvement in internal processes had happened, the forecast accuracy was still to be improved. The forecast errors in Europe were very high, which lead to product shortages, while inventory of some models were piling up.
Determination of Inventory:
The fixed stock model with safety stock was used to obtain both the average inventory to be held and also the safety stock. The average inventory is given by the formula:
Quantity to be ordered = Average Demand + Safety Stock
q = d * (T+L) + Z σT+L ………………………………………………………. (1)
Where σT+L = σ * √(T+L)
Here d, the demand forecasted is given in Table 1 as the mean of the demand. Lead time for DC within US is one day transporting time from Vancouver to California and one week factory cycle time. That is a total of 8 days. For Europe and Asia the lead time was 42 days (5 weeks to ship and one week factory cycle time) by sea and 14 days (1 week to ship by air and I week factory cycle time). The Reordering interval is assumed to be 7 days as per the question.
The safety stock is obtained from the standard deviation of monthly demand σ. The company target for the line item fill rate which has been estimated by the marketing division is 98%. The z value for 98% fill rate in equation (1) is 2.05. Thus the safety stock for the given lead time and review period can be found.
The average demand is found from the mean of monthly demand and the lead and review times. The quantity of inventory is computed by the addition of the average demand and safety stock.
There are two possible means to calculate the inventory carrying costs. Using HP’s cost of debt and warehousing expenses an inventory cost of 12% is obtained and if the ROI expected on new product development projects is used the inventory carrying cost is 60%. The cost of a single unit is taken to be 400$. Therefore the inventory carrying cost per unit is either 48$ or 240$. The total inventory carrying cost is calculated using both rates by multiplying them with the number of units that forms the inventory of the three DCs [Exhibit 1 and Exhibit 2].
The total sales are 600,000 units which are close to the total of the forecasted demands. Therefore it is assumed that the sales in the different regions are equal to the forecasted demands. This is then used to calculate the weeks of supply.
The steps to be taken to compute the inventory is given above. The data collected by the team to improve the forecast is used here. Only the inventory levels in Europe are considered for comparing the various alternatives.
Taking 12% carrying costs
Inventory costs = Average inventory x Cost of a single unit x 12%
Total annual cost when shipped by sea
= Total inventory holding cost + shipping costs
= 15643377.3 + Σ monthly mean * shipping cost/unit * 12
= 18139106.1$
Taking 60% carrying costs
Inventory costs = Average inventory x Cost of a single unit x 60%
Total annual cost when shipped by sea
= Total inventory holding cost + shipping costs
= 78216886.3 + Σ monthly mean * shipping cost/ unit * 12
= 80712615.1$
Weeks of Supply
= Average inventory value/ weekly sales
= 0.2712
Alternatives to reduce the Inventory problem:
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Use Air transport to ship to Europe and Asia: In this case the lead time will reduce from 42 days to 14 days (1 week factory cycle time and 1 week shipping time). But the costs per unit also goes up to 32$.
For carrying costs of 12%
Total annual cost when shipped by sea
= Total inventory holding cost + shipping costs
= 10777281.9 + Σ monthly mean*shipping cost/ unit*12
= 19650984.3$
For carrying cost of 60%
Total annual cost when shipped by sea
= Total inventory holding cost + shipping costs
= 53886409.7 + Σ monthly mean*shipping cost/ unit*12
= 62760112.1$
Weeks of Supply
= Average inventory value/ weekly sales
= 0.1868
The average inventory has come down to 18710.6 from 27158.6. When considering 12% carrying costs air transportation is costlier but when 60% is considered as the carrying cost the annual costs of using air transportation is cheaper.
-
Setting up a manufacturing plant in Europe: If a manufacturing plant is setup in Europe the lead time will come down. Assuming that the transportation time from the factory to the distribution center will be similar to the time taken to transport from Vancouver based factory to the DC in California. Therefore the lead time can be taken to be 8 days. The inventory required will come down even further from that of transportation by air.
For 12% carrying costs
Total annual cost when it is shipped by sea
= Total inventory holding cost + Expenditure to setup another facility
= 9348925.3. + Expenditure to setup another facility
For 60% carrying costs
Inventory costs = Average inventory x Cost of a single unit x 60%
Total annual cost when shipped by sea
= Total inventory holding cost + Expenditure to setup another facility
= 46744626.6. + Expenditure to setup another facility
Weeks of Supply
= Average inventory value/ weekly sales
= 0.1620
The expenditure required to setup a manufacturing facility in Europe is not know. This will be a long term investment and depends on the scale of demand in Europe. It should be sustainable and have sufficient volume to justify its inception.
-
Assembly can be done in Europe: The manufacturing process should be modified so that final assembly can be done at the DC in Europe. These processes that can be done in Europe include the power supply and the manuals. This will help reduce the lead time by reducing the factory cycle time. These should also enable the DC to be more flexible. The shipping costs will also come down. The actual savings cannot be calculated from the given data and more information is required. The top management prefers to maintain the DCs in a warehouse mode as it will difficult to manage the work in the DCs. Additional expenditure will be incurred in setting up support processes.
Conclusion
If 12% is considered to be the carrying cost of inventory then it is more cost effective to just use the new data to forecast the demand and thus maintain 98% line item fill rate. But if it is 60% transportation by means of air should be used.
In the long term as the demand in Europe builds up the setting up a facility in Europe can be considered. As an initial step in this process assembling in Europe can be considered.
Another alternative that can be considered is inventory pooling by building up finished good inventory in the factory.