1. ISyE 6203 Inventory vs Transport
John H. Vande Vate
Spring 2012 1

2. Agenda Team Presentations
Financial Statements
Transport & Inventory
How’d you calculate?
What would you do next as VP of SC?
Improving the balance between transport & inventory 2

3. Our Company Transportation: Inventory:
$435 K
Inventory:
Green Bay: $900 K
Indianapolis: $600 K
Denver: $50 K
Stores: $155 Million
Pipeline: $1.654 million
How to reduce inventory at stores? 3

4. First Step Use full-truck load rates, but don’t fill the trucks
Treat all stores the same
What happens if we ship half a truck load instead of a full truck load?
More generally? If we ship a quantity Q? 4

5. Total Cost Formula Transportation Costs Inventory Costs at the Store
D = Annual Demand at the Store
A = Transportation cost per shipment
Annual Transport cost: AD/Q
Note that’s because we pay for the full truck regardless of what’s on it.
Inventory Costs at the Store
h = Inventory holding cost %
C = Value at COGs
hCQ/2 5

6. Total cost typically flat so anything close to minimum is good
Cost rises quickly as shipments get very small – move to a different mode or…
Total cost typically flat so anything close to minimum is good 6

7. Total Cost Formula
How does changing the shipment quantity Q affect pipeline inventory? 7

8. Minimize Total Cost Total Cost (Q) = AD/Q + hCQ/2
Simple incremental analysis:
Look at increasing Q by small amount ε
Incremental change in Inventory
+hCε/2 inventory impact to order ε more
Incremental change in Transportation
The increase in inventory is independent of Q
The decrease in transportation is declining in Q
Increase Q until the incremental transportation savings = incremental inventory increase, beyond that Total Cost increases again
Recognize this? 8

9. The EOQ
Increase Q until incremental savings in transportation = incremental increase in inventory
AD/Q2 = hC/2
The Economic Order Quantity
Calculus: 9

10. The EOQ Achieving Balance AD/Q2 = hC/2 => AD/Q = hCQ/2
Annual Transport Cost = Annual Inventory holding cost
If Transport Cost > Inventory holding cost, shipments are too large? Too small?
Our Company:
Transport Costs
Inventory Holding Costs at Stores
Inventory at Stores
Conclusion? 10

11. Inventory at Source?
What about inventory at the Source? Green Bay, Indianapolis or Denver
Our Total Cost formula ignored inventory at the source
If we ship Q to every store, what will the Cycle Stock at Green Bay be? Q/2
How does this affect our analysis? It changes the EOQ ever so slightly as we will see. 11

12. So the adjustment to the EOQ really is slight
Inventory at Source?
At the stores
How does this affect our analysis?
Total Cost (Q) = 100 AD/Q hCQ/2
+ hCQ/2
= 100 AD/Q hCQ/2
So we want 100 AD/Q2 = 101 hC/2
At the plant
So the adjustment to the EOQ really is slight 12

13. Our Company: Challenge 2
Determine the appropriate shipping quantities for Our Company
Adjust the financial statements to reflect changes in transportation and inventory
Discuss the impacts
What would you, as VP of SC, do next?
Two Parts 2A and 2B
That’s due Tuesday, Jan 24th 13

14. Challenge 2A
Do the simplest thing first, if it works and elaboration is worth the effort and added complexity, then elaborate
If we ship a different quantity Qi to each store, what is the inventory impact at the source?
Let’s first calculate the appropriate shipping quantities (and the financial impacts) if we treat all stores the same. Think more practically about what to do next. 14

15. Challenge 2B Elaborate on the simple model
Calculate appropriate shipping quantities (and the financial impacts)
Balance between impact and how practical it is to implement
Treating each store separately is not practical 15

16. Treating different stores differently
Two Steps:
What impact will this have on inventory at the source?
Practicalities
Does it make sense to have a separate quantity for each store? How would you implement that? What’s it worth?
Is there a practical way to achieve most of the savings while avoiding most of the complexity? 16

17. Impact at the Source Green Bay ships quantity Qi to store i,
What’s the inventory impact at Green Bay
What’s the appropriate quantity to ship
Think about just one store.
All we have to do is figure out the Cycle Stock contribution at Green Bay 17

18. Cycle Stock at Green Bay
Worst Situation: Synchronized Shipments
Ship to all 100 stores simultaneously
Cycle stock at Green Bay: Qi/2
Assumption: Green Bay will allocate production to minimize Cycle Stock
Rotate full attention to one (a small number of) store at a time, staggering shipments as much as possible.
We will simply assume we can stagger shipments perfectly
What’s the Cycle Stock? 18

19. Area = Item-days of inventory
Cycle Stock
Look at shipments to 1 store
They are of size Q
How long to build up that shipment?
P = Rate of production
Area = Item-days of inventory Q
Q/P 19

20. Area = item-days of inventory
Green Bay Cycle Stock
item-days of inventory at the Green Bay accumulated for each shipment to Store # if the shipment size is Q
Area = item-days of inventory Q 20
Q/P

21. Area = item-days of inventory
Green Bay Cycle Stock
How many shipments to Store 1? D/Q
Total Item-days of inventory at Green Bay for Store 1:
Area = item-days of inventory Q 21
Q/P

22. Green Bay Cycle Stock Total Cost between Green Bay & Store 1
Recognize this? 22

23. Economic Production Quantity
EPQ 23

24. D is the annual demand at a store.
Green Bay Cycle Stock
If we ship a different quantity for each store, Qi for store i, what’s the cycle stock at Green Bay
Store i contributes
So the total is
More generally
Or half the demand-weighted average shipment quantity
D is the annual demand at a store. 24

25. Discussion So the basic EOQ is good enough here
Many, similar customers
EPQ more relevant if there are few customers or large customers so that D and P are comparable
We will return to this 25

26. The cycle inventory at the plant
Frequency vs Quantity
Often more practical to set a regular schedule for replenishment, e.g., weekly or semi-weekly…
n = Shipments per year
Q = D/n (careful with units)
Total Cost (n)
= AD/Q + hCQ/2
The cycle inventory at the plant 26

27. Frequency vs Quantity Total Cost (n) So that the best value for n is27

28. Practical Approach Simplify by grouping Stores into Frequency Bands
For example:
Band 1: Stores served once per 2-months
Band 2: Stores served once per month
Band 3: Stores served twice per month
Band 4: Stores served 3 times per month
The appropriate choices will depend on the “economics”
Observations:
Where will Band 1 stores be?
Where will Band 4 stores be?
Why? 28

29. The higher the frequency the closer the stores should be
Where’s Band 1, Band 4?
Normally think of the EOQ (EPQ) as
Given a fixed transportation cost defined by distance, find the appropriate frequency
Turn that around
Given a fixed frequency, find the appropriate transportation cost and so distance
The higher the frequency the closer the stores should be 29

30. Dividing line between Bands
Dividing line between Band 1 and Band 2
Band 1: Stores Served once per 2-months (6 times per year)
Band 2: Stores Served once per month (12 times per year)
Find the fixed cost (distance) A so that the total cost at
n1 = 6 and at n2 = 12 shipments per year is equal
That’s about 975 miles
Stores closer than 975 are better served 12 times per year. Stores farther are better served 6 times per year. 30

31. Changing Modes
Not necessary to pay full truck load rates for less-than-truck load shipments
Can use LTL services
YRC Worldwide
Fedex Freight
UPS freight
ABF Freight System
Old Dominion Freight Lines
Estes Express Lines
An excellent guide to using LTL services is available at
LTL Training Manual Module 1
LTL Training Manual Module 2
LTL Training Manual Module 3 31

32. LTL
LTL – Less-Than-Truckload: Carrier organizes transport via consolidation terminals
Groupage: Similar concept, but organized by a forwarder who contracts with a carrier for transport.

33. LTL
LTL

34. LTL Rates
LTL Cost
Shoulder
Constant rate
Rate per CWT 34

35. Observations Economies of Scale
Although the cost of larger shipments is higher, the rate is lower
This is generally true across modes: Parcel – LTL – TL – Rail Car …
Under LTL we only pay for the portion of the vehicle we use (but at the higher rate) 35

36. Observations LTL rates depend on So there are lots of LTL rates
Origin
Destination
Weight (in hundred weight CWT)
Class of freight
Includes density, value, …
So there are lots of LTL rates
Rating Engines
CzarLite, (SMC3 Southern Motor Carriers Rate Conference)
Radical Tools (MARS 500 Middlewest Motor Freight Bureau) 36

37. Radical Tools Available in the labs Excel Add-in Includes
Zip code look up
Zip code to City, State
3-digit zip to Zip
Road distance between Zips
Find the closest point in a set of Zips
Find the cheapest (in terms of LTL rates) point
Rate LTL shipments
Rate Parcel shipments 37

38. Includes a 24.2% fuel surcharge
Specific Example
$/CWT
TL Cost
LTL Min Charge
Shoulder
Includes a 24.2% fuel surcharge
After the 70% discount
Pipeline impact 38
Download LTL Rate Worksheet from T-Square

39. Question
How do we determine the appropriate shipment size trading off LTL and TL rates and inventory carrying costs?
A first step:
Between 2,001 and 4,346 lbs the rate is $98.70 per CWT (before the 70% discount) or $29.61 after the discount
How do we think about how much to send in each shipment under this rate?
How is this different than FTL rates? 39

40. Question
A first step:
$29.61 per CWT vs $ per TL
What affect does making smaller shipments have on transport cost at the per CWT rate?
What affect does making smaller shipments have on inventory cost at the per CWT rate?
What shipment size is appropriate at the $29.61 per CWT rate? 40

41. Question
How do we determine the appropriate shipment size trading off LTL and TL rates and inventory carrying costs?
A second step:
Between 4,347 and 5,000 lbs the rate is $ regardless of weight.
How do we think about how much to send in each shipment under this rate?
This is probably over-kill except perhaps at the top shoulders, e.g., 13,820 – 30,000 lbs 41

42. Challenge 3
Determine the appropriate mode and shipping quantity from Green Bay to Store #2 in Los Angeles.
Briefly describe the thinking behind your calculations 42

43. Challenge 4
Roll this strategy out to all Stores. Determine the appropriate mode and shipping quantity to every store
Remember to keep it practical.
Briefly describe the thinking behind your calculations
What are the impacts on SPEED, ROIC and Margin?
What would you do next as VP of SC? 43

44. Warning Low hanging fruit is mostly picked
We are starting to find it requires more and more work to achieve smaller and smaller impacts
The harder we have to work, the more complex we make the operations – diminishing our impact further
We will have to think smart to be effective
Ideas? 44

45. Economies of Scale in Transport
Class 70 LTL rates/lb from Green Bay to LA
Shipment weight (lbs) 45

46. Questions? 46

47. Intro To GIS Useful Tool: GIS Geographic Information System
Links databases and maps
Useful for addressing questions like:
Where should we …?
How far away are…?
How are …. distributed?

48. GIS Spatial data Attribute data
Location
Stored in a shape file, geodatabase, …
Attribute data
Associated characteristics
Stored in DB
GIS systems typically maintain these separately and “join” them for display or analysis

49. Geographic Data Raster model Vector model
Area covered by a grid of square cells
Image data is a Raster model, cells = pixels
Vector model
Features represented as
Points or nodes
Lines or arcs
Areas or polygons

50. Geographic Data Key Properties of Geo Data
Projection: The method of translating locations on the 3-D earth to (X,Y) coordinates on a map or screen
Scale: The ratio between distance on a map to the equivalent distance on earth
Accuracy
Positional: Is it in the right place?
Consistency: Is it correctly categorized?
Completeness: Is it all there?
Resolution: e.g., pixel size

51. Layers Smart Map Vector Layer: Vector Layer: Raster Layer:
Different geo data maintained in different data layers with common location information,
Vector Layer:
Polygons describing land parcels
Raster Layer:
Digital Ortho photo: combines the visual properties of a photograph with the positional accuracy of a map, in computer readable form.
Vector Layer:
Lines defining the street network
Smart Map
Different layers linked by common locations

52. Software Tools ESRI – ArcView, ArcGIS and others
MapInfo – MapInfo and others
MS – MapPoint (Tutorial, etc)
Many others

53. Geocoding Geocoding: Examples: Bank Failures
Placing data with location information on the map
LatLong
Street Address
Examples:
Geocode Stores by ZIP (OurCompany.xls)
Geocode Census Data by ZIP (US Census , Data.gov and private vendors sell demographic data)
Bank Failures

54. Thematic Maps Thematic Maps: Examples:
Display the attributes of geographic data
Examples:
Population
Sized Circles
Shaded Regions
Median Household Income

55. Geographic Queries SQL-type query based on geographic information:
Eg. Average household income within 20 miles of Store # 1
MapPoint is quite poor at this
The 2011 version can do crude selections
Example:
Household income within 20 miles of Store #1

56. Distance Calculations
As the crow flies
Using the Measure Distance Tool
Over the road
Using the Route Tool
Add Store #2 as Start
Add Store #1 as End
Get Directions
Over the road distance
Can adjust route options for speeds, hours of driving, rest stops, …

57. Territories
Given fixed centers develop territories based on proximity to those centers
MapPoint is very poor at this
Either you import them or you build them by hand…
Other (more expensive) packages do this automatically

58. Programming Tools
MapPoint includes software links (COM or Component Object Model) that allow you to integrate MapPoint into your applications (e.g. with VB, into Excel, Access, …)
We won’t go that far.
Interested: See About Programming with MapPoint
Embed within Excel, etc.