1. ISyE 6203 Inventory vs Transport
John H. Vande Vate
Fall 2011 1

2. Dell Projects
Conference call:
4-5 PM EST Wednesday 2

3. 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 3

4. Our Company Well over $100 million in Cycle Stock at the stores!
How to reduce this? 4

5. 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? 5

6. 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 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. 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 9

10. The EOQ
Increase Q until incremental savings in transportation = incremental increase in inventory
AD/Q2 = hC/2
The Economic Order Quantity
Or use Calculus: 10

11. 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? 11

12. Inventory at Source?
What about inventory at the Source? Green Bay, Indianapolis or Denver
If we ship Q to every store, what will the Cycle Stock at Green Bay be?
How does this affect our analysis? 12

13. Inventory at Source? 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 13

14. 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 14

15. 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. 15

16. 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 16

17. 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? 17

18. 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 18

19. 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.
What’s the Cycle Stock? 19

20. 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 20

21. 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 21
Q/P

22. 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 22
Q/P

23. Green Bay Cycle Stock Total Cost between Green Bay & Store 1
Recognize this? 23

24. Economic Production Quantity
EPQ 24

25. 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. 25

26. 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 26

27. 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 27

28. Frequency vs Quantity Total Cost (n) So that the best value for n is28

29. 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? 29

30. 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 30

31. 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. 31

32. 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 32

33. LTL Rates
LTL Cost
Shoulder
Constant rate
Rate per CWT 33

34. 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) 34

35. 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) 35

36. 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 36

37. 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 37
Download LTL Rate Worksheet from T-Square

38. 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? 38

39. 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? 39

40. 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 40

41. 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 41

42. 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? 42

43. 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? 43

44. Economies of Scale in Transport
Class 70 LTL rates/lb from Green Bay to LA
Shipment weight (lbs) 44

45. Questions? 45

46. The HDT Case Challenge 5: The HDT Case Answer the following questions:
Compare the direct costs of the alternatives
Considering cash flow impacts, make a recommendation about which alternative to pursue
Since the buyer pays for the trucks as they are delivered, analyze whether or not it would be advantageous for HDT to pay overtime to speed up production assuming they ship the trucks via Baltimore as soon as they are ready. Assume that HDT’s cost of borrowing is 12% per year. Make reasonable assumptions about the impacts of overtime on production.
Due: ??? 46