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

2. 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

3. 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

4. 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

5. 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 with the subject line 6203 Teams with
The names and contact information ( s and phone numbers) of the team members
Resumes of all the team members
T-Square User IDs of the team members 5

6. 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

7. The Projects
Audi
TBA 7

8. 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

9. 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

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

11. Conference Calls
We will schedule roughly bi-weekly conference calls with our sponsor.
Usually in 226 (arranged via Meka Wimberly
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

12. 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

13. 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
I believe it comes as a DVD and so takes time to deliver. Please let me know if you learn otherwise. 13

14. 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
Anonymous feedback on each lecture via T-Square (under Tests & Quizzes – I used “Anonymous grading only” so I don’t see your identity). 14

15. 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

16. 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

17. 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

18. 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

19. Current Operations
All direct shipments in full truckloads 19

20. 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 = 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

21. 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

22. Our Company.xls 22

23. Our Company.xls 23

24. 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

25. 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

26. Financial Goals
Income Statement
Balance Sheet 26

27. 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

28. Income Stmt: Profitability29

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

30. COGS You can read more about COGS at
Or for a quick practical overview,
Our Company COGS consists of
Raw Materials: $300 Million
Labor: $1.41 Million
Transportation: ?
Not required
Not required 31

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
Not required 32

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,
Not required 33

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

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

35. Balance Sheet: Capital Utilization36

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
Focus on “Why it Matters”. Might be interesting to reflect on the “Why US leads” aspects in light of financial crisis. 37

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

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

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
Not required 40

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

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
Not required 42

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

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

44. Working Capital: AR
Typically most meaningful when expressed in terms of time
Days Sales Outstanding
Example: Our Company
Receivables: $ Million
Sales: $450 Million or about $1.233 million/day
DSO: 15 days 45

45. Working Capital: AP Days Payables Outstanding Example: Our Company
Accounts Payable: $ Million
COGS: $301.4 million plus transportation or about $826 thousand/day + avg daily transportation
DPO: 30 days (ignoring transportation) 46

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

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

48. Dell’s Cash-to-Cash Cycle
2011
Accounts Receivable $
Billion
Inventory $
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

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

50. Fixed Asset Utilization
Utilization of Capital Equipment
Sometimes at the expense of working capital – See “The Goal”
Recent story: Intel SC Transformation
Not required
Required 51

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

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

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

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

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: million
262 million
Long Term Debt $130 million at 5%
Short Term Debt million at 5.5%
Equity $132 million at Cost of Equity? 56

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

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

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

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

60. Questions? 61

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

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

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

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

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

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

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

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

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

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

71. Questions 72

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

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

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