1 1 Modeling Inventory (Deterministic View) John H. Vande Vate Fall 2009

2 2 Projects Postpone deadline for preferences to September 3 rd. Two new projects from Otis

3 3 TL Optimization Opportunity Statement Better optimize existing cross dock / distribution centers and dedicated fleet by increasing utilization of full truckload opportunities within Otis as well as with sister companies Goals & Objectives 1.Better utilize cross dock / distribution centers 2.Increase utilization of existing backhaul and line haul 3.Consolidate non FTL suppliers into dense line hauls between RDC’s 4.Increase overall truckload density 5.Explore synergies with sister companies (Carrier & Hamilton) Customers RDC’s, Field, Other UTC Divisions, Cemco, WHQ finance Stakeholders RDC’s, Field, Other UTC Divisions, Cemco Success Indicators Reduction in LTL, Increase in FTL average wt per load, and actual number of loads, reduction of overall delivery costs. Making Cemco competitive on West Coast. Georgia Tech involvement Review supply base, customers, lanes, volumes etc., to determine feasibility of routing and timing requirements, to model and construct network to support goals & objectives. Must be able to document current baseline and estimated savings to finance for approval. Proposed UTC division Involvement Initially expose students to overall current network, describe concept and possible courses of action. Meet bi-weekly to discuss progress and answer questions. Project Team Meeting Frequency and medium Initially bi-weekly via conference call and / or webcast Deliverables Completed implementable network model which supports the goals and objectives as stated above, with milestones and timetables.

4 4 Ocean Routing Guide Opportunity Statement Construct interactive web based routing and information guide (initially ocean based) detailing providers and local (origin & destination) customs requirements Mission Statement Construct and maintain a web based platform for shipping sites to determine shipping requirements to Otis entities worldwide, inclusive of local customs and insurance requirements Goals & Objectives Provide shipping entities with detailed information regarding shipping, customs and shipping requirements to insure compliance with selected providers and accurate customs information Customers Short term – Otis China & Korea (2009 – 2010) Long term – All Otis shipping entities (2011 – beyond) Stakeholders Same as above Success Indicators System up and running by ocean bid completion – May 1, 2010 Georgia Tech involvement Construction and population of said web site Proposed UTC division Involvement Gathering data and vetting website construction Project Team Meeting Frequency and medium Weekly or as required Deliverables Interactive, revisable web site as described above

5 5 Types of Inventory Deterministic Inventory –Pipeline Inventory: Inventory in transit –Cycle Inventory: Goods accumulating for transit Goods delivered and waiting for processing Stochastic Inventory (later)

6 6 Illustrative Example Develop a distribution strategy to minimize inventory and transportation costs Purpose: –Outline issues covered in outbound logistics –The importance of transportation in the supply chain –Illustrate costs and investments –Always do a quick analysis first, then refine it.

7 7 Overview Products: –Computers: CPU, Monitor, Keyboard –Televisions: TV and Console Stores –100 across the US –Sell 10 TVs and 10 computers per day –250 days/year

8 8 Components ComputersTV/MonitorConsole Cost$300$400$100 Weight5 lbs10 lbs30 lbs FromGreen BayIndianapolisDenver We assume weight not cube determines vehicle capacity Truck holds 30,000 lbs

9 9 Current Situation All direct shipments in full truckloads

10 Simplification Shipments on the order of 1,000 miles Distances

11 What Costs? Transportation Pipeline inventory – inventory in transit Inventory at Plants Inventory at Stores Handling …

12 Transportation Costs Estimate Units per Shipment Units per Truck = TL Capacity (in lbs) Weight of Unit –CPU: 6,000 = 30,000/5 –Monitor: 3,000 = 30,000/10 –Console: 1,000 = 30,000/30 Estimate Shipments per Year Shipments per year = Annual Demand (in units) Units per Truck Or do everything in lbs….

13 Direct:Transportation Cost How many shipments/year? –Green Bay –Indianapolis –Denver –Total 100 stores * Annual Store Demand /Items to fill a truck 100*2,500/6,000 = *5,000/3,000 = *2,500/1,000 = 250 ~ 460 Why 5,000?

14 What Costs? Direct –Transportation ~ $1/mile*1,000 miles/trip*460 trips/year = $460,000/year –Pipeline inventory –Inventory at Plants –Inventory at Stores –Handling –…

15 Pipeline Inventory Little’s Law L = W Number of items in the pipe (L) = Rate the items arrive (  Time each item spends in the pipe (W) It doesn’t matter how they arrive –One at a time –In parcels –In Truck loads –…

16 Pipeline Inventory How long are goods in transit? –1,000 miles at 50+ miles per hour –2 days + How fast do they arrive? –Rate of sales Let’s calculate $ in the pipe instead of items

17 Pipeline Inventory One Day worth of sales at a Store –10 TVs at $400+$100 each = $5,000 –10 Computers at $300+$400 = $7,000 –Total $12,000 per day per Store Two days of system-wide sales: –2 days * $12,000/Store/day * 100 stores = $2,400,000 The $ in the pipe: $2.4 million! –That’s ALWAYS there. Carrying cost 15% of $2,400,000 = $360,000 per year –We pay that each year

18 Got it?! What is the impact to pipeline inventory of… –Using trucks that are twice as large? –Moving to shipments (one at a time) that take on average 2 days to reach the store? –Adding a cross dock that makes the average delivery time 4 days? Two things matter: –Time (how long) –Money (how much per unit time)

19 What Costs? Direct –Transportation ~ $1/mile*1,000 miles/trip*460 trips/year = $460,000/year –Pipeline inventory $2,400,000 in capital $360,000 in annual carrying costs –Inventory at Plants –Inventory at Stores –Handling –…

20 Inventory at Green Bay (Perfectly) Staggered Shipments 6,000 ~6 days Why ~6 days? Inventory Time Average Inventory?

21 Inventory in Green Bay 3,000 units (Half a truck load) $300 per unit $900,000 in inventory 15% capital charge => $135,000 in carrying costs

22 What Costs? Inventory at Plants –Perfectly Staggered Shipments – Capital Carrying Cost Green Bay $900 K $ 135 K Denver$ 50 K$ 7.5 K Indianapolis$600 K$ 90 K Total $1.55 million $ K

23 What Costs? Direct –Transportation ~ $460,000/year –Pipeline inventory $2,400,000 in capital $360,000 in annual carrying costs –Inventory at Plants – Staggered Shipments $1.55 million in capital $232.5 K in annual carrying costs –Inventory at Stores –Handling –…

24 Store Inventory from Green Bay 6,000 ~2.4 years Why ~2.4 years? Inventory Time

25 Inventory at Stores At EACH Store? –½ truckload or 3,000 CPUs at $300 each: $900,000 –½ truckload or 1,500 Monitors at $400 each: $600,000 –½ truckload or 500 Consoles at $100 each: $ 50,000 $1,550,000 Carrying cost: 15% of $1,550,000 or $232,500 Total Capital at the Stores: $155 million Total Carrying cost at the Stores: $23,250,000! Just like the plants! But there are 100 of them!

26 What Costs? Direct –Transportation ~ $460,000/year –Pipeline inventory $2,400,000 in capital $360,000 in annual carrying costs –Inventory at Plants – Staggered Shipments $1.55 million in capital $232.5 K in annual carrying costs –Inventory at Stores $155 million in capital $23.25 million in carrying costs –Handling –…

27 Costs Transportation Costs: $ 460,000 Pipeline Inventory $ 360,000 Inventory Costs at Plants: $ 232,500 Inventory Costs at Stores: $ 23,250,000 Total: $ 24,302,500! Capital Required: Pipeline Inventory $ 2,400,000 Inventory Costs at Plants: $ 1,550,000 Inventory Costs at Stores: $ 155,000,000 Total: $ 158,950,000! Total Cost & Capital Direct

28 Return on Capital Return on Capital = NOPAT Capital Employed = NOPAT * Revenues Revenues Capital Employed = Profit Margin * SPEED How to improve Return on Capital? What’s our SPEED? Corrected

29 SPEED Revenues: ? –Revenue = Cost/(1-Margin) $12,000/day per store $1.2 million per day 250 days means $300 million Revenue = $300 mil./(1-Margin) Capital Employed: $159 million (not counting the cost of the stores, the factories, and anything else we own) SPEED is 1.89/(1-Margin) = 300/159/(1-Margin), i.e., each year we generate $1.89 in revenue for every $1 invested.

30 How are We Doing? As a low margin business As a “high” margin business

31 Your Job is… As newly hired VP of SC, your job is to improve: –profitability and –capital utilization Suggestions?

32 Consolidation Strategy 2: Assemble Products in Indianapolis and distribute by truckload from there What will happen to costs? –Transportation –Pipeline –At plants –At Indianapolis Warehouse/Cross Dock –At Stores

33 Via Indianapolis Facts

34 What Costs? Transportation –To Indianapolis –From Indianapolis to Stores Pipeline inventory –To Indianapolis –From Indianapolis to Stores Inventory at Plants Inventory at Indianapolis Cross Dock Inventory at Stores Handling …

35 Indirect: Transportation To Indianapolis –Green Bay 400 miles* 42 trips = 16,800 –Indianapolis 0 miles*167 trips = ~ 0 –Denver 1,100 miles*250 trips = 275,000 –Total $291,800 From Indianapolis to Stores –Same as total transport before, we are moving the same goods the same distance (roughly 1,000 miles to each Store) $460,000

36 What Costs? Transportation –To Indianapolis $291,800 –From Indianapolis to Stores $460,000 Pipeline inventory –To Indianapolis –From Indianapolis to Stores Inventory at Plants Inventory at Indianapolis Cross Dock Inventory at Stores Handling …

37 Pipeline Inventory To Indianapolis –From Green Bay 400 miles ~ 1 day 1,000 per day at $300 each ~ $300,000 capital 15% of $300,000 is $45,000 carrying cost –From Denver 1,100 miles ~ 2 days 2 days at 1,000 per day at $100 each ~ $200,000 capital 15% of $200,000 is $30,000 carrying cost –Total Capital $500,0000 Carrying Cost$ 75,0000 From Indianapolis to Stores –Same as before 2 days of sales –Capital $2,400,000 –Carrying Cost $ 360,000

38 What Costs? Transportation –To Indianapolis $291,800 –From Indianapolis to Stores $460,000 Pipeline inventory –To Indianapolis Capital $500,000 Carrying Cost$ 75,000 –From Indianapolis to Stores Capital$2,400,000 Carrying Cost$ 360,000 Inventory at Plants Inventory at Indianapolis Cross Dock Inventory at Stores Handling …

39 Inventory at Plants Same as before –Green Bay holds ½ of a truckload –Denver holds ½ of a truckload –Assume Indianapolis holds ½ of a truckload for delivery to the cross dock –Capital$1,550,000 –Carrying Cost $ 232,500

40 What Costs? Transportation –To Indianapolis $291,800 –From Indianapolis to Stores $460,000 Pipeline inventory –To Indianapolis Capital $500,000 Carrying Cost$ 75,000 –From Indianapolis to Stores Capital$2,400,000 Carrying Cost$ 360,000 Inventory at Plants –Capital $1,550,000 –Carrying Costs$ 232,500 Inventory at Indianapolis Cross Dock Inventory at Stores Handling …

41 Inventory at Cross Dock ReceivingShipping CPUs, Monitors, Consoles Computers & TVs WIP

42 Inventory at Indianapolis Cross Dock Receiving from the Plants –½ a truckload of CPUs –½ a truckload of Monitors –½ a truckload of Consols Shipping to the Stores –½ a truckload of Computers and TVs WIP – like Pipeline inventory –How long does the process take? Capital $1,550,000 Carrying Cost $ 232,500

43 What’s in a Truck Of Computers and TVs? In the same mix as demand –1:1 computers to TVs –X computers in a truck –Weight of the computers 15X lbs –Weight of the TVs 40X lbs –15X + 40X = 30,000 lbs –X = 30,000/55 = 545 A full truck of finished goods has –545 computers and 545 TVs –545 CPUs, 545 Consoles and 1090 Monitors

44 Inventory at Indianapolis Cross Dock Receiving from the Plants –½ a truckload of CPUs –½ a truckload of Monitors –½ a truckload of Consols Shipping to the Stores –½ a truckload of Computers and TVs 273 CPUs at $300 each or $ 81, Consoles at $100 each or $ 27, Monitors at $400 each or $218,400 Total $327,600 Carrying cost$ 49,140 WIP – like Pipeline inventory –How long does the process take? Capital $1,550,000 Carrying Cost $ 232,500

45 Inventory at Stores Inventory at a Store: –Visited by truck 4.6 times per year –Same as before –So inventory costs at Stores are the same as before, right?

46 Wrong! Magic? Total Inventory Carrying Cost at Stores: $4,914,000 compared with $23,250,000 under earlier strategy. Explain!

47 The Difference Explain?

48 With Consolidation –Transportation Costs: $ 751,800 –Pipeline Inventory: $ 435,000 –Inventory Costs at Stores: $ 4,914,000 –Inventory Costs at Plants: $ 232,500 –Inventory Costs at XDock: $ 281,640 Total: $ 6,614,900 Without Consolidation –Transportation Costs: $ 460,000 –Pipeline Inventory: $ 360,000 –Inventory Costs at Stores: $ 23,250,000 –Inventory Costs at Plants: $ 232,500 Total: $ 24,302,500!

49 Comparison Invest some of the $120 million in the cross dock Spend some of the $18 million on handling

50 SPEED With consolidation our SPEED (with the same caveats) is $300 million/$39 million = 7.69/(1- Margin)! We generate $7.69/(1-Margin) in revenue for every $1 invested That give us a lot more room to play with margin and still have a high return on capital

51 How are We Doing? As a low margin business As a “high” margin business

52 Can We Compete Better? As a low margin business As an ultra low margin business

53 What Next? Where do we get our next $120 million from? Oh, that’s right, the supply chain only has 39 million in it. We’re going to have to work harder now…

54 For Future Reference Consolidation illustrates two situations –1-to-1 shipments E.g. from Green Bay to Indianapolis XDock Inventory at Green Bay  Inventory of CPUs in Indianapolis –1-to-Many shipments E.g., from XDock to stores Inventory at XDock  Inventory at a SINGLE store The point: Inventory at the origin of a 1-to-Many system has a smaller impact than in a 1-to-1 system…we will see this next time.

55 Summary Deterministic Inventory –Pipeline –Cycle –WIP Pipeline from Days in transit * Value/Day Cycle from half of shipment WIP like pipeline Value of consolidation Quick & Dirty analysis first

56 Deterministic Supply Chain Design Next time: should we be shipping in full truckloads? Later, how to reduce inventory in stores Reducing inventory in stores is a powerful way to improve return on capital –Wal-Mart has more than 2,300 supercenters in the US –Reducing inventory in each one by a mere $10K frees $23 million in capital. But merchandising will insist you EARN the right.