Supply Chain Management Homework #2

Supply Chain Management Homework # 2

Adapted from D. Simchi-Levi, P. Kaminsky, and E. Simchi-Levi, Designing & Managing the Supply Chain, 3nd edition. McGraw-Hill/Irwin: New York, NY, 2008.

KLF Electronics is an American manufacturer of electronic equipments. The company has a single manufacturing facility in San Jose, California. KLF Electronics distributes its products through five regional warehouses located in Atlanta, Boston, Chicago, Dallas, and Los Angeles. In the current distribution system, the United States is partitioned into five major markets, each of which is served by a single regional warehouse in their market. That is, in the current distribution system, each customer is assigned to a single market and receives deliveries from one regional warehouse.

The warehouses receive items from the manufacturing facility. Typically, it takes about two weeks to satisfy an order placed by any of the regional warehouses. Currently, KLF provides tier customers with a service level of about 90 percent.

In recent years, KLF has seen a significant increase in competition and intense pressure from its customers to improve service level and reduce costs. To improve service level and reduce costs, KLF would like to consider an alternative distribution strategy in which the five regional warehouses are replaced with a single, central warehouse that would process all customer orders. This warehouse should be one of the five existing warehouses. The company CEO insists that whatever distribution strategy is used, KLF should attain an increased service level of about 97 percent. Please address the following three questions:

1. A detailed analysis of customer demand in the five market areas reveals that the demand in the five regions are very similar; that is, it is common that if weekly demand in one region is above average, so is the weekly demand in the other regions. How does this observation affect the attractiveness of the new system? Please explain (no calculations are needed).

2. To perform a rigorous analysis, you have identified a typical product A. Table 1 provides historical data that includes weekly demand for this product for the last 12 weeks in each of the market areas. An order (placed by a warehouse to the factory) costs $5,500 (per order), and inventory carrying costs are $1.25 per unit per week. In the current distribution system, the cost of inbound and outbound transportation costs per unit is given in Table 2. Finally, Table 3 provides information about inbound and outbound transportation costs per unit from each of the existing regional warehouses to all other market areas (assuming a particular regional warehouse becomes the centralized warehouse).

Table 1: Historical Data

Week

1 33

2 45 35 34 42 43

3 37 41 22 35 54

4 38 40 55 40 40

5 55 46 48 51 46

6 30 48 72 64 74

7 18 55 62 70 40

8 58 18 28 65 35

9 47 62 27 55 45

10 37 44 95 43 38

11 23 30 35 38 48

12 55 45 45 47 56

Atlanta Boston Chicago Dallas Los Angeles

26 44 27 32

Table 2: Current transportation costs per unit

Warehouse Atlanta

Inbound

Outbound

12 Boston Chicago 11.5 11

13 13 13

Dallas Los Angeles

13

13

Table 3: Transportation costs per unit in centralized system

Warehouse Atlanta Boston Chicago 13

Atlanta

Dallas 15 15 15 13

Los Angeles 17 17 16 22

14 13 22 15

14 22 13 15

Boston Chicago Dallas Los Angeles

14 14 15

17

17

16

22

13

Suppose you are to compare the two systems for Product A only, what is your recommendation? To answer this question, you should compare the total costs (i.e., ordering cost, inventory carrying cost, inbound transportation cost and outbound transportation cost) for the two strategies, assuming demands occur according to the historical data. Also, you should determine which regional warehouse should be used as the centralized warehouse.

3. It is proposed that in the centralized distribution strategy, that is, the one with a single warehouse, products will be distributed using UPS Ground Service, which guarantees that products will arrive at the warehouse in three days (0.5 week). Of course, in this case, transportation cost for shipping a unit product from a manufacturing facility to the warehouse increases. In fact, in this case, transportation costs increase by 50 percent. Thus, for instance, shipping one unit from the manufacturing facility to Atlanta will cost $18. Would you recommend using this strategy? Explain your answer.
1) When the demand is negatively correlated, centralized system work the best. Negative correlation means as the values of one of the variables increase, the values of the other variables decrease. In this case, as demands are associated with each other; it shows that the demands from all warehouses are positively correlated. Therefore the benefits derived from risk pooling would not be considerable, and new centralized system wouldnt be attractive.
2) However according to question one because of positively coloration the centralized system didnt

seem attractive but according to these table, centralized system would save 60% of Average inventory also by decreasing the inventory carrying cost and ordering cost this system would have less total cost. The cost of centralized system in all warehouses is less than the cost of decentralized system, and the Total cost in Los Angeles warehouse is less than the other warehouses, therefore Los Angeles should be used as a centralized warehouse.
week Atlanta Boston Chicago Dallas Los Angeles Centralized AVG 39.7 41.3 46.9 48.1 45.9 222 STD 12.8 12.3 21.1 13.2 11.3 37.1 CV 0.32 0.3 0.45 0.27 0.25 0.17 Q 590.8 603.1 642.5 650.5 635.7 1397 Service Level 90%- lead time 2 weeks Centralize Atlanta Boston Chicago Dallas Atlanta 13 14 14 15 Boston 14 13 22 15 Chicago 14 22 13 15 Dallas 15 15 15 13 LA 17 17 16 22 Inbound 12 11.5 11 9 Atlanta 515.67 555.33 555.33 595 Boston 578.67 537.33 909.33 620 Chicago 656.83 1032.2 609.92 703.75 Dallas 721.3 721.3 721.3 625.1 LA 780.6 780.6 734.7 1010 Inbound 2663 2552 2441.1 1997.3 Carrying +Holding 1830.8 1830.8 1830.8 1830.8 TC 7758.8 8021 7813.4 7391.1 Inbound per Unit 12 11.5 11 9 7 outbound per unit 13 13 13 13 13 Inbound 476 475.33 516.08 432.75 321.42 Inbound 515.67 537.33 609.92 625.08 596.92 Ave Inv SR=90% L=2 362.63 368.77 388.49 392.46 385.05 765.95 Carrying Cost 453.29 460.97 485.62 490.58 481.32 957.43 Ordering cost 369.262 376.939 401.592 406.554 397.289 873.406 TC 2176.8 2219.3 2401.7 2347.4 2182

LA

17

17

16

22

13

674.33

702.67

750.67

1058

596.9

1553.4

1830.8

7173.7

Total cost in decentralized system 2176.8+2219.3+2401.7+2182=11327 Average Inv (Decentralized) = 362.3+368.8+388.5+392.5+385.2= 1897.4 Average Inv (centralized) = Q/2+ Z*STD*SQRT (L) = (1397.5/2) + (1.28*37.1*SQRT (2)) =766 Improvement= (1897.4-766)/1897.4 = 0.6 By changing the system from decentralized to centralized company could save 60% in average inventory. 3)
Service level 97% - lead time2 weeks Centralized Atlanta Boston Chicago Dallas LA Atlanta 13 14 14 15 17 Boston 14 13 22 15 17 Chicago 14 22 13 15 16 Dallas 15 15 15 13 22 LA 17 17 16 22 13 Inbound 12 11.5 11 9 7 Atlanta 515.67 555.33 555.33 595 674.33 Boston 578.67 537.33 909.33 620 702.67 Chicago 656.83 1032.2 609.92 703.75 750.67 Dallas 721.3 721.3 721.3 625.1 1058 LA 780.6 780.6 734.7 1010 596.9 Inbound 2663 2552 2441.1 1997.3 1553.4 Carrying +Holding 1870.2 1870.2 1870.2 1870.2 1870.2 TC 7798.2 8060.4 7852.8 7430.5 7213.1

service Level 97% - Lead Time 0.5 week Centralized Atlanta Boston Chicago Dallas LA Atlanta 13 14 14 15 17 Boston 14 13 22 15 17 Chicago 14 22 13 15 16 Dallas 15 15 15 13 22 LA 17 17 16 22 13 Inbound 18 17.25 16.5 13.5 10.5 Atlanta 515.67 555.33 555.33 595 674.33 Boston 578.67 537.33 909.33 620 702.67 Chicago 656.83 1032.2 609.92 703.75 750.67 Dallas 721.3 721.3 721.3 625.1 1058 LA 780.6 780.6 734.7 1010 596.9 Inbound 3994.5 3828.1 3661.6 2995.9 2330.1 Carrying +Holding 1808.5 1808.5 1808.5 1808.5 1808.5 TC 9074 9280.5 9017.1 8371.9 7931.6

Inv Level= Q/2+ Z*STD*SQRT (L) Inv Level (service Level 97% - lead time 2 weeks) = (1397.5/2) + (1.88*37.1*SQRT (2)) =797.5 Inv Level (service Level 97% - lead time 0.5 week) = (1397.5/2) + (1.88*37.1*SQRT (0.5)) =748 Improvement = (797.5-748)/797.5= 0.06 By decreasing lead time to 0.5 week we can have 6% saving in average inventory

Los Angeles warehouse (7931.6-7213.1)/ 7213.1=0.1 It means that in the service level of 97%, by decreasing the lead time from 2 weeks to 0.5 week, the Total cost in will increase by 10%

I dont recommend this strategy because this strategy will increase the cost about 10% (718.5$) and by that the company could save just 6% in average inventory. The service level Vs Inventory level graph is nonlinear and has lower slop in higher service level, increasing the service level from 90% to 97% wouldnt be reasonable .