1. 1 1 ISyE 6203 Transportation & Supply Chain Systems John H. Vande Vate Spring 2012

2. 2 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

3. 3 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

4. 4 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

5. 5 5 Class Presentation 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 Friday, January 13 th end of business day One person from each team should send me an e-mail with the subject line 6203 Teams with –The names of the team members –A designated contact (with e-mail) for the team –I will refer to the team by the contact’s last name

6. 6 6 Class Presentations Each Tuesday I will call on one or two teams to present their solutions to assigned “Challenges” I expect a brief presentation that explains briefly how you answered the challenge (what method you used), shows your answer and explains the impact Remember, we will be improving the performance of Our Company so relative improvements are of primary interest

7. 7 7 Projects Around the mid-term we will stop working on Challenges and change our focus to industrial projects I will be announcing these over the coming weeks You will work with a team (possibly different from your Class Presentation Team) on 1 industrial project

8. 8 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.

9. 9 9 Deliverables Each team will make a presentation to the class during the last couple weeks of the semester 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 and invite your sponsor to join

10. 10 Project Grade Presentations: Content, Clarity and Quality of your presentations Project management –Coordinating, attending, managing meetings –Clarifying project scope and direction –Managing information, meeting minutes, data –Staying ahead Initiative Integrity

11. 11 My Role As much help as you want Eager to meet with you and hear about your progress and questions at your request Strongly recommend you share your presentations with me well in advance for advice. Will attend initial conference calls to establish the project, but will step back after that

12. 12 First Steps I will share brief project overviews You will organize your project team (may be the same as Class Presentation Team) and send me preferences I will assign projects and organize initial conference call with sponsor You will take it from there.

13. 13 Conference Calls Usually in 226 (arranged via Meka Wimberly meka.wimberly@isye.gatech.edu) 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 your Project Forum You are responsible for organizing conference calls after the first one or two.

14. 14 Potential Projects Halstead/Vertex Acumen Fund ZHL Ziqitza Tiffany’s VW/Audi Projects you organize

15. 15 Course Organization Two Exams Mid-term: Thursday, March 1 st Final: Tuesday, May 1 st from 2:50 to 5:40 Grading: –Project 30% –Mid-term: 30% –Final: 30% –Team Presentations: 10% Warning: People struggle with my exams Academic Honesty

16. 16 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 available in the labs. May also be available for free from http://msdn08.e-academy.com/gatech_isye http://msdn08.e-academy.com/gatech_isye Also available for free as a 60 day trial on the internet.

17. 17 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 e-mail Anonymous feedback on each lecture via T- Square (under Tests & Quizzes – I used “Anonymous grading only” so I don’t see your identity).

18. 18 Travel I have to be out of the country from February 20 th through March 2 nd Guest lectures during that period –HDT Case on Cash Flow –Air Freight 101 & Over-the-Road 101 with Greg Andrews EMIL-SCS Managing Dir. –Mid-Term Exam Be sure to ask questions by Thursday, Feb 16 th I will be available via e-mail, but expect delays

19. 19 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

20. 20 Overview Products: –Computers: CPU, Monitor –Televisions: TV and Console Stores –100 across the US –Sell 10 TVs and 10 computers per day –250 days/year

21. 21 Components CPUsTV/MonitorConsole Cost$300$400$100 Weight5 lbs10 lbs30 lbs FromGreen BayIndianapolisDenver We assume a truck holds 30,000 lbs and travels 500 miles/day

22. 22 Current Operations All direct shipments in full truckloads

23. 23 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

24. 24 CPUsTV/MonitorConsole Cost$300$400$100 Weight5 lbs10 lbs30 lbs FromGreen BayIndianapolisDenver Our Company.xls Enable Macros –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

25. 25 Our Company.xls

26. 26 Our Company.xls

27. 27 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

28. 28 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

29. 29 Financial Goals Financial Performance Profitability Revenue Growth Capital Utilization Income Statement Balance Sheet

30. 30 Revenue SC helps drive revenue –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

31. 31 SC & Financial Goals Financial Performance Profitability COGSSG&A Depreciation & Amortization Revenue Growth Capital Utilization Fixed Asset Utilization Working Capital Utilization

32. 32 Income Stmt: Profitability Profitability COGSSG&A Depreciation & Amortization

33. 33 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.

34. 34 COGS You can read more about COGS at http://en.wikipedia.org/wiki/Cost_of_goods_sold Or for a quick practical overview, http://learndirecthmmdemo.lmmattersonline.com/c ourses/hmm10/budgeting/documenting_revenue _forecasts.html Our Company COGS consists of Raw Materials: $300 Million Labor: $1.41 Million Transportation: ? Not required

35. 35 Gross Margin Gross Margin = Revenue – COGS Gross Margin as % of Sales = Our Company: Low transportation costs ensure high Gross Margin For more details see http://en.wikipedia.org/wiki/Gross_Margin Not required

36. 36 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, http://www.investopedia.com/terms/s/sga.asp Not required

37. 37 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

38. 38 Operating Income (EBIT) Earnings Before Interest & Taxes Gross Margin minus – SG&A – Amortization & Depreciation – Impairments and other expenses + Non-Operating Income

39. 39 Balance Sheet: Capital Utilization Capital Utilization Fixed Asset Utilization Working Capital Utilization

40. 40 Why Capital Utilization? Might find “Capital Productivity: Why the US Leads and Why it Matters” interesting. McKinsey Quarterly, 1996 Issue 3 Available from eJournals at www.library.gatech.edu www.library.gatech.edu Focus on “Why it Matters”. Might be interesting to reflect on the “Why US leads” aspects in light of financial crisis. Not required

41. 41 Digression on US vs German Capital Utilization Differences in capital markets Differences in employment models Differences in political economies A broader perspective on “goldplating”

42. 42 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

43. 43 Productivity of Capital Productivity of Capital (SPEED) Return on Invested Capital (ROIC) Our Company: Reducing Inventories improves SPEED and ROIC For more information see http://news.morningstar.com/classroom2/course.asp?doc Id=145095&page=9&CN=COMhttp://news.morningstar.com/classroom2/course.asp?doc Id=145095&page=9&CN=COM Not required

44. 44 NOPAT & NIBCLs NOPAT: Net Operating Profit After Taxes NIBCLs: Non-interest bearing current liabilities, eg., accounts payable

45. 45 Two kinds of Capital Fixed Capital Assets –Plants and Equipment Working Capital –Inventories or raw materials and finished goods –Accounts receivable –Accounts payable For more on Working Capital see http://en.wikipedia.org/wiki/Working_capital Not required

46. 46 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

47. 47 Working Capital Accounts Receivable Inventory Accounts Payable What we finance for our customers What our suppliers finance for us

48. 48 Working Capital: AR Typically most meaningful when expressed in terms of time Days Sales Outstanding Example: Our Company –Receivables: $18.493 Million –Sales: $450 Million or about $1.233 million/day –DSO: 15 days

49. 49 Working Capital: AP Days Payables Outstanding Example: Our Company –Accounts Payable: $24.733 Million –COGS: $301.4 million plus transportation or about $826 thousand/day + avg daily transportation –DPO: 30 days (ignoring transportation)

50. 50 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?

51. 51 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.

52. 52 Dell’s Cash-to-Cash Cycle Dell’s suppliers finance a month + of Dell’s operations Dell2011 Accounts Receivable $ 6.493Billion Inventory $ 1.301Billion Accounts Payable $11.293Billion Sales $61.494Billion COGS $50.089Billion DSO 38.54Days DII 9.48Days DPO 82.29Days C2C (34.27)Days That’s about $4.7 billion

53. 53 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?

54. 54 Fixed Asset Utilization Utilization of Capital Equipment Sometimes at the expense of working capital – See “The Goal” Recent story: Intel SC Transformation http://www.supplychainbrain.com/content/h eadline-news/single-article/article/through- its-complete-cultural-shift-intel-takes-top- spot-in-supply-chain-innovation-awards/http://www.supplychainbrain.com/content/h eadline-news/single-article/article/through- its-complete-cultural-shift-intel-takes-top- spot-in-supply-chain-innovation-awards/ Not required Required

55. 55 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

56. 56 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

57. 57 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

58. 58 Average Cost of Capital Sources of Capital –Shareholders – Equity –Bond holders and Creditors – Debt Question: –Which gets a higher return? –Why?

59. 59 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: 25 million 262 million Long Term Debt $130 million at 5% Short Term Debt 0 million at 5.5% Equity $132 million at Cost of Equity?

60. 60 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.

61. 61 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

62. 62 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!

63. 63 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

64. 64 Questions?

65. 65 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?

66. 66 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

67. 67 Cycle Stock Example: Accumulated at a shipping dock awaiting full truckload Typically assume constant (long run average) rate of production

68. 68 Cycle Stock Inventory Time Truck Load Average Inventory? (Units or Value) Average Inventory? (Days)

69. 69 Cycle Stock Inventory Time Truck Load Average Inventory? (Units or Value) Average Inventory? (Days)

70. 70 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.

71. 71 Pipeline Inventory Little’s Law L = W Number of items in the system (L) = Rate the items arrive (  Time each item spends in the system (W) It doesn’t matter how they arrive –One at a time –In parcels –In truck loads –… Where have we seen this before?

72. 72 Pipeline Inventory L, the items or value in the system  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 15 ¹ days COGs for 2010: $305 billion What’s the pipeline inventory (value) ¹ Guesses

73. 73 Pipeline Inventory  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 = W = $517 million/day* 15 days = $7.767 billion

74. 74 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 330 th largest company in the Fortune 500 Eg. Eastman Chemicals, Dillards, Yahoo

75. 75 Questions

76. 76 Challenge 1 In your groups, complete the financial statements for Our Company under current operating practices Transportation costs –As indicated on Parameters page Inventory Costs * We assume weight, not cube, floor space or maximum value determines the capacity of the vehicle.

77. 77 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, January 17 th I will call on 1 or 2 teams to present in class

78. 78 Discussion Questions? Next week: –Team presentations on Challenge 1 –Begin to explore strategies for balancing operating expenses (e.g., transportation) and working capital (e.g, inventory)