ISyE 6203 Transportation & Supply Chain Systems John H. Vande Vate Fall 2011 1

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 2

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 3

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 4

Project 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 Thursday, September 1st end of class One person from each team should send me an e-mail with the subject line 6203 Teams with The names and contact information (e-mails and phone numbers) of the team members Resumes of all the team members T-Square User IDs of the team members 5

The Projects Dell – Confirmed but evolving Project 1 Optimization of the 3rd Party Distributor network Project 2 Optimization of FedEx Ground and FedEx Home networks Project 3 Sensitivity of network to cost drivers, eg pallet weight Project 4. Returns network UTi – 3PL and Freight Forwarder How much capacity on a lane should we secure via block space agreements How would a change in the variability of a customer’s actual freight volumes (weight and cube) affect UTi’s profitability on that lane 6

The Projects Audi TBA 7

Project Structure 3 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. 8

Deliverables Each team will make a 20 – 30 minute presentation to me for each step. Each team will make at least one presentation to the class (most will present the final project) 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 9

First Steps Organize your team Introductory conference call with sponsor (working to schedule these the week of Sept 5. TBA) 10

Conference Calls We will schedule roughly bi-weekly conference calls with our sponsor. 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 the Project Forum You are responsible for organizing conference calls. 11

Course Organization Two Exams Mid-term Final: Tuesday, December 13th from 11:30 – 2:30 Grading: Project 30% Mid-term: 30% Final: 30% Team Presentations: 10% Warning: People struggle with my exams Academic Honesty 12

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 2010 available for free from http://msdn08.e-academy.com/gatech_isye I believe it comes as a DVD and so takes time to deliver. Please let me know if you learn otherwise. 13

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). 14

Travel I have to be out of the country from September 10th through 22nd I will arrange three guest lectures during that period One classes set aside for team project meetings 15

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 16

Overview Products: Stores Computers: CPU, Monitor Televisions: TV and Console Stores 100 across the US Sell 10 TVs and 10 computers per day 250 days/year 17

truck holds 30,000 lbs and travels 500 miles/day Components We assume a truck holds 30,000 lbs and travels 500 miles/day CPUs TV/Monitor Console Cost $300 $400 $100 Weight 5 lbs 10 lbs 30 lbs From Green Bay Indianapolis Denver 18

Current Operations All direct shipments in full truckloads 19

Simplification Shipments on the order of 1,000 miles Use your head! Make an estimate. Refine it. Averages Green Bay: 969 Indianapolis: 854 Denver: 1,006 Total transportation cost: Average truck trip costs $1,000 Number of trips: 100 destinations Trips per destination: From Denver: Consoles at 30 lbs each 1000 per truckload 2.5 trips per year From Green Bay: CPUs at 5 lbs each 6,000 per truckload 1 trip every 6,000/2500 = 2.4 years or 1/2.4 = .417 trips per year From Indianapolis: TVs and Monitor/Keyboard sets at 10 lbs each 3,000 per truckload 5,000/3,000 trips per year = 1.67 That’s 4.6 trips per dc per year or $460,000 20

Our Company.xls Enable Macros Components: Cost, weight, source 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   CPUs TV/Monitor Console Cost $300 $400 $100 Weight 5 lbs 10 lbs 30 lbs From Green Bay Indianapolis Denver 21

Our Company.xls 22

Our Company.xls 23

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 24

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 25

Financial Goals Income Statement Balance Sheet 26

Revenue SC helps drive revenue Our Company: Revenues = $450 Million 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 27

Income Stmt: Profitability 29

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. 30

COGS You can read more about COGS at http://en.wikipedia.org/wiki/Cost_of_goods_sold Or for a quick practical overview, http://learndirecthmmdemo.lmmattersonline.com/courses/hmm10/budgeting/documenting_revenue_forecasts.html Our Company COGS consists of Raw Materials: $300 Million Labor: $1.41 Million Transportation: ? Not required Not required 31

Gross Margin Gross Margin = Revenue – COGS Gross Margin as % of Sales = Our Company: Low transportation costs ensure high Gross Margin For more details see http://en.wikipedia.org/wiki/Gross_Margin Not required 32

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.asp Not required 33

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 34

Operating Income (EBIT) Earnings Before Interest & Taxes Gross Margin minus SG&A Amortization & Depreciation Impairments and other expenses 35

Balance Sheet: Capital Utilization 36

Why Capital Utilization? Not required 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. 37

Digression on US vs German Capital Utilization Differences in capital markets Differences in employment models Differences in political economies A broader perspective on “goldplating” 38

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 39

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?docId=145095&page=9&CN=COM Not required 40

NOPAT & NIBCLs NOPAT: Net Operating Profit After Taxes NIBCLs: Non-interest bearing current liabilities, eg., accounts payable 41

Two kinds of Capital Fixed Capital Assets Working Capital 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_capital Not required 42

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 43

Working Capital = + - What our suppliers finance for us What we finance for our customers + - = 44

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 45

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) 46

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? 47

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. 48

Dell’s Cash-to-Cash Cycle 2011 Accounts Receivable $ 6.493 Billion Inventory $ 1.301 Accounts Payable $11.293 Sales $61.494 COGS $50.089 DSO 38.54 Days DII 9.48 DPO 82.29 C2C (34.27) That’s about $4.7 billion Dell’s suppliers finance a month + of Dell’s operations 49

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? 50

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/headline-news/single-article/article/through-its-complete-cultural-shift-intel-takes-top-spot-in-supply-chain-innovation-awards/ Not required Required 51

Inventory Inventory is an INVESTMENT, not an expense Can speak of inventory in terms of Units $ Days The latter are more common except when dealing with very specific operational details 52

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 53

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 54

Average Cost of Capital Sources of Capital Shareholders – Equity Bond holders and Creditors – Debt Question: Which gets a higher return? Why? 55

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? 56

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. 57

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 58

Total Cost of Carrying Inventory Total (Pre-Tax) Cost of Carrying Inventory Non-Capital Charge (e.g., 10%) Capital Charge/(1-Tax Rate) Our Company Non-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 million We can compare THAT with annual operating expenses Let’s be careful to distinguish. Shout if you’re confused! 59

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 60

Questions? 61

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? 62

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 63

Cycle Stock Example: Accumulated at a shipping dock awaiting full truckload Typically assume constant (long run average) rate of production 64

Cycle Stock Inventory Time Truck Load Average Inventory? (Units or Value) Average Inventory? (Days) Time 65

Cycle Stock Inventory Time Truck Load Average Inventory? (Units or Value) Average Inventory? (Days) Time 66

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. 67

Pipeline Inventory Little’s Law L = l W Number of items in the system (L) = Rate the items arrive (l) * Time each item spends in the system (W) It doesn’t matter how they arrive One at a time In parcels In truck loads … 68

Pipeline Inventory L, the items or value in the system l, 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 69

Pipeline Inventory l, 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 = lW = $517 million/day* 15 days = $7.767 billion 70

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 71

Questions 72

Challenge 1 In your groups, complete the financial statements for Our Company under current operating practices Transportation costs $1/mile 30,000 lbs per truck load* Truck travels 500 miles per day Inventory Costs * We assume weight, not cube, floor space or maximum value determines the capacity of the vehicle. 73

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, Aug. 30 I will call on 1 or 2 teams to present in class 74

Discussion Questions? Feedback T-Square forum Next week: Time to get to know each other for teams I’ll end a bit early today. Hang around Use Challenge 1 as a trial – Are these the people I want to work with? What OR skills will we need? We will do a small amount of Linear/MIP modeling It is unlikely that the projects will require it (except possibly Audi) Pretty basic probability and statistics Feedback Thanks! Please continue. T-Square forum Next week: Team presentations on Challenge 1 Begin to explore strategies for balancing operating expenses (e.g., transportation) and working capital (e.g, inventory) 75