Total Cost in the Supply Chain zIn the past a focus on departmental budgets yPurchasing -- piece price yTransportation -- freight bill yMaterial Handling -- labor and equipment yFinance -- Inventory y… zOften given a bonus for bad behavior

Total Cost Approach zEvaluate decisions on the basis of total cost to the corporation and even the supply chain zWhat is total cost?

Components of Total Cost zPurchase Price zFreight zInventory zLabor zEquipment and Facilities investments zPackaging zTaxes zWaste zReturns

Freight zConsolidation reduces unit cost zLarger, slower modes reduce unit cost yParcel yLTL yTL yRailcar load yUnit Train y...

Purchase Price zQuanitity Discounts xMarginal Discount: price of subsequent items reduced xAll Quantity Discounts: price of all items reduced xAnnounced Price Increases: price of future items reduced zPromotions: ySupplier wants to clear excess stocks ySupplier wants to meet financial goals zAll promote purchasing in larger volumes

Inventory zFocus on three varieties ySafety stock: xAlways hold this xProtection against variability in Lead-time demand xLead-time demand is demand that occurs between time order is placed and it arrives. yCycle Stock xThe inventory created by the delivery quantity yPipeline Inventory xThe inventory in transit

Safety and Cycle Stock Time Inventory Order Quantity Q Safety Stock S

Inventory Cost zHolding Cost yCost of Capital xWhat the firm pays to borrow money or xThe return on investments the firm can achieve yOperating Cost xInsurance xShrinkage xObsolescence xPrice depreciation

Inventory Holding Cost zTwo approaches: yCFO evaluates inventory savings xsave the operating expense of inventory for several years xOne time savings of the inventory value (often not recognized because reductions are not sustainable) OR capital carrying cost of inventory over several years yAssessment of current cost xCapital carrying cost + operational carrying cost

Assessment of Cost zCost of Capital for the firm 10% yThis is an interest rate: Borrow $100 for 1 year costs $10. zOperating cost of inventory 10% yThis is like an interest rate: To hold $100 worth of goods in inventory for 1 year costs $10 in insurance, shrinkage, obsolescence...

Assessment Cont’d zInventory Carrying Cost: I y20% = 10% + 10% zAverage value of goods in inventory: v zAnnual Cost of Inventory: zI*v*(S + Q/2) zWhy S + Q/2?

Safety and Cycle Stock Time Inventory Order Quantity Q Safety Stock S

On Average... Time Inventory Order Quantity Q Safety Stock S

Handling Pipeline Inventory zWe did Ford’s example several times yAnnual Production 4.5million vehicles yDaily Production: 12 Thousand y15 days to deliver y180 Thousand vehicles in the pipe y$20,000 average value y$3.7 billion in the pipe (all the time) y20% holding cost y$740 million holding cost in the pipe

Packaging zFord Example: Returnable racks or containers to hold the parts in transit zRack Cost: $1500 zRack Capacity: 10 parts zDaily Volume of the part to a plant: 1000 zFloat time at Supplier (waiting to be filled or shipped): 2 days zFloat time at Plant (waiting to be emptied or returned): 2 days zDays in transit (round trip): 4 days

Containers Depreciated over 5 years zHow large is the rack fleet? zPlant needs 100 racks per day. z2 days worth of racks are waiting there z2 days worth of racks are waiting at the supplier z4 days worth of racks are in transit zSo we need 800 racks + z$1.2 million investment in racks zOr $240 thousand in annual depreciation

Truck or Rail? zRail yFreight $1,700 per 86’ rail car yTransit 4 days out/4 days back yFloat at each end: 2 days yRack capacity: 15 yRacks per Conveyance: 10 yRack Cost $1,700 zTruck yFreight $700 per 53’ truck yTransit 1 day out/1 day back yFloat at each end: 1 day yRack capacity: 10 yRacks per Conveyance: 6 yRack Cost $1,500 Rack Cost: $1500 Part Value $100 Volume 1000/day Days/Year: 240 Holding cost: 15%

Calculating Total Cost zFreight: 240 days/yr * 1000 parts/day / 15 parts/rack / 10 racks/car zPlant Inventory (Cycle + Safety) 2 float days /2 * 1000 parts/day * $100 /part * 15% zPipeline Inventory 4 days transit * 1000 parts/day * $100 /part * 15% zRack Depreciation 12 days * 1000 parts/day / 15 parts/rack * $1700 /rack / 5 yrs