48126512 case study on scientific glass inc inventory management

SCIENTIFIC

GLASS, INC.:

INVENTORY MANAGEMENT

January 2010, Ankara

Candaş Demir

Onur Yılmaz

Burcu Yüzüak

1

I. INTRODUCTION

In this case study, production and operations management (POM) issues of a mid-size company,

named as Scientific Glass Inc., in a highly growing market are studied. Using the background

information on past actions of the company to correct inventory management and their results, and

considering the market leadership opportunity, how inventory management approach can be made

better is explained by evaluating different alternatives from different aspects. In the first part, critical

POM issues are mentioned, following that these problems are analyzed. In the third part, alternative

options are listed and then they are evaluated. Finally, considering the trade-offs of these evaluations, a

conclusion is made. And it must be mentioned that, throughout the case, related points are referenced to

the case text and lecture notes with corresponding page and paragraph numbers.

II. CRITICAL POM ISSUES

As mentioned in the text, there is an identified increasing trend in the balances of inventory

levels. (Page 1, para. 2) For a growing company in a growing market, this high inventory level, in other

words tied up money in the inventory, creates an obstacle for this company to use this extra capital on

other areas, such as expansion to international markets. Also, as mentioned, debt to capital ratio

exceeded the target level of 40% and with the same approach this increase of this ratio also jeopardizes

the company’s funding expansion plans to international markets. Although, there are many other POM

issues are found in the text, these mentioned two were the most critical ones and it is thought that if

they are solved the other problems will be solved spontaneously.

III. ANALYSIS OF THE CRITICAL POM ISSUES

In the last part, it is mentioned that average inventory level is high enough to jeopardize

company’s future plans. Therefore, main reasons behind this problem should be analyzed. First of all,

company has a policy related to 99% fill rate, which is also open to discussion considering the market

average of 92%, and warehouse managers are usually exceed even this limit and they are keeping more

inventory than necessary (Page 4, para. 5). Secondly, company has a policy to not to exceed 60 day’s

supply, which is also open to discussion, and most warehouse managers are exceeding this upper limit

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(Page 5, para. 6). Considering all these aspects, it is found that inventory levels and transshipment costs

should be decreased and at the same time responsiveness to customer should be increased in order to be

a market leader. By doing these, simultaneously, approach of the warehouse management could be

changed to a better position by changing policies related to them as it is tried in the past with different

ways and failed (Page 6, para. 6). In addition, when this inventory level kept under control, debt to

capital ratio will be saddled since extra capital tied up in the inventory will be available to be used.

IV. ALTERNATIVE OPTIONS FOR PROBLEMS

In order to solve the analyzed problems in the previous part, there are actually two main aspects

to consider: firstly, number of warehouses and their structure can be changed; secondly, related policies

can be changed and of course appropriate ones can be done simultaneously.

For changing the number of warehouses, in other words, centralizing or decentralizing warehousing

functions, available options are considered as:

Continuing with 8 warehouses: This option makes no change on the network of the

warehouses and all regions will be supplied its warehouse if there is no stock-out occurs.

One central warehouse: In this option, one central warehouse near to manufacturing facility at

Waltham will send all customer orders from one location.

Two centralized warehouses: In this option, addition to the main warehouse at Waltham, there

will be an additional warehouse at the west, at Phoenix, and it will be supplied from Waltham.

Demand of east region will be met from Waltham, demand of west region will be met from

Phoenix and demand of central region will be met from both warehouses, assuming to have

equal shares on the central region.

Outsourcing the warehousing functions: In this option, all warehousing actions will be

outsourced to Global Logistics (GL) and distribution will start from main warehouse at

Waltham and then GL will be responsible from rest of the operations.

In addition to these options, there are some policy change proposals which try to make POM

approach better, like periodic audits and increasing reporting activity levels, stopping trunk stock

activities etc. Since these policy changes can be applied at different warehousing functions these

proposals will be analyzed one by one and their possible effects will be considered.

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V. EVALUATION OF ALTERNATIVE OPTIONS

Evaluation of mentioned alternatives will be conducted from mainly five aspects: transportation

costs, average inventory levels, time responsiveness, fill rates and finally additional costs and benefits.

1-) Transportation Costs: Transportation costs for alternatives are calculated for the two products,

namely Griffin and Erlenmeyer, since they are mentioned as the best representative for a total of nearly

3000 products of Scientific Glass (Page 2, para. 3). In addition, for each option, demand for the next

year calculated considering the 20% increase in sales (Page 8, para. 3). When warehouse to customer

shipments are considered average shipment weight of 19,5 pound is used and to have an average

transportation cost value, these two products’ costs are averaged according to their relative proportion

in sales (Page 8, para. 3). It also be mentioned that, inter-warehouse transshipments occur only when

stock-out occurs and as the number of warehouses are decreasing, effect of this costs will be

diminished; therefore, it is only considered in the option where there are 8 warehouses.

For the first option, having 8 warehouses and making no change, from Waltham to all other 7

warehouses all items are sent by bulk shipment. Inter-warehouse transshipments are calculated by bulk

shipment rates and they are considered only when a stock-out occurs, therefore fill rate is included in

these calculations. Finally, for every warehouse, customer shipment costs are calculated as all tabulated

in Appendix – Table 1 and average total cost found as $2701,41.

For the second option, when there is only one warehouse, all customer shipments are calculated

for rates of Winged Fleet and results are given in Appendix - Table 2. In this option, average total cost

is calculated as $12210,16.

For the third option, when two centralized warehouses considered, it is assumed that Waltham

will supply east region, Phoenix will supply will west region and they will equally supply the central

region. With this approach, transportation costs are calculated in Appendix – Table 3 and average total

cost is found as $2332,07.

For the last option, when warehousing functions are outsourced, assuming the 5 regions of

Global Logistics (GL) will have equal amount of demand, as tabulated in Appendix – Table 4, total

average cost is calculated as $2276,83.

To conclude, as it is expected, when number of warehouses are decreased transportation costs

are increased as can be seen from the Table 1 below. From the aspect of transportation costs, GL option

has the smallest cost amount.

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8 Warehouses 1 Warehouse 2 Warehouses Outsourcing

2701,41 12210,16 2332,07 2276,83

Table 1: Average Total Annual Transportation Costs Gathered from Appendix Table 1-2-3-4

2-) Average Inventory Levels: First of all, it must be decided which inventory policy that the

company should apply. Begin with the review type; although firm monitors all the inventory transfers

from Waltham warehouse to other warehouses; they think taking physical counts of inventory at all

warehouses (Page 6, para. 6). Therefore, it is concluded that company uses periodic inventory review

policy. Secondly, company did not mention any due date, therefore the inventory plans should consider

infinite time horizon. And lastly, although there exists a fixed cost for shipments from warehouses to

customers; there is no other fixed cost related to transportation to the warehouses, i.e. no fixed ordering

cost. The only order cost is $0.40 per pound bulk shipment cost which is a variable cost with weight.

As a result, all analysis can be conducted considering critical ratios and the related fill rate values,

which is the only option that is left and also it is considered as the most applicable to the situation.

Since some of the simultaneous changes can be done, considering ceteris paribus principle and

when fill rate is maintained exactly as 99% for all warehouses, we can calculate the average inventory

level that must be kept at warehouses. As shown in the Appendix - Table 5, for having 1, 2 and 8

warehouses average inventory levels are calculated for two representative products. When outsourcing

option is used, it will be the same for the company in the sense of kept inventory levels for the one-

centralized-warehouse option therefore they are assumed to be equal. Weighted-average biweekly

levels are found as:

8 Warehouses 2 Warehouses 1 Warehouse Outsourcing

988,53 680,34 597,03 597,03

Table 2: Weighted-average biweekly inventory levels Gathered from Appendix - Table 5

As shown in the Table 2 above, as demand aggregates, in other words, number of warehouse

decreases, level of inventory decreases as it is expected. This is because, “the greater the degree of

collaboration, the lower the uncertainty (standard deviation of the error or coefficient of variation) of

the demand model” (Lecture 9, Slide 6). This implies that the money tied up in the inventory decreases

and this extra capital can be used in other areas, like expansion plans to international markets.

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3-) Time Responsiveness: Delivery system of the company compensates 2 weeks of shipment

cycles including the stock-out situations. In order to be a market leader, differentiation on this subject is

also needed and unfortunately since this is not an exact quantitative scale, only possible situations

could be mentioned. For having one centralized, or two centralized or 8 decentralized warehouse

options, they all include at most 3 days ready to shipment duration (, para.2) and Winged Fleet’s

delivery time of at most 3 days (Page 12, Exhibit 5) if there is no stock-out situation and the stock-out

probabilites are diminishing with the aggregated demands. On the other hand, GL has 1-day premium

shipment in addition to 3-day regular shipments (Page 8, para. 1). Considering the highly growing

market situation and different segment of products, having different delivery times to different products

and also to different customers will make this company focus on the most yielding areas. Therefore, it

can be said that working with GL has the advantage of differentiating customers/orders and, since

there will be 2 warehouses, stock-out probability and related durations will be less compared to other

options. And all of these aspects will increase the time responsiveness of the company.

4-) Additional Costs and Benefits: Other qualitative and quantitative issues related to options

will be covered in this section. Firstly, in the text, it is mentioned that in order to continue with the

current warehouses total of $10M investment is necessary (Page 5, para. 5), it is assumed that all of this

amount will be equally shared among all warehouses. Secondly, since warehouse operating costs will

be the %15 of the total warehoused inventory (Page 5, para.3), these costs could be directly compared

with the annual average inventory levels that are kept in each option which are calculated in the

previous section. Thirdly, the amount paid to sales forces (Page 3, para. 5) will not change when the

company have 1, 2 or 8 warehouses because it is assumed that as the number of warehouses decreased,

number of salesperson per warehouse will increase and total of 32 will not change. On the other hand,

when warehousing is outsourced this amount will not be paid.

1 Warehouse 2 Warehouses 8 Warehouses Outsourcing

Replacing worn equipment cost:

$10M/8 = $1,25 M $10M/8 x 2 = $2,5 M $10 M $10M/8 = $1,25 M

Warehouse Operating Costs:

Inventory Level: 597,3 x 26 =

15529,8


17688,84


25697,1


15529,8

Sales Force Payments:

32 x $33.000 + Commision



No costs

Table 3: Additional Quantitative Comparisons

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As can be seen from the Table 3 above, decreasing number of warehouses will decrease the

replacing worn equipment costs and since demand aggregates, warehousing operating costs will

decrease also. It is obvious that outsourcing will relieve the company from the amount paid to the sales

forces.

In addition to these, there are some qualitative issues that must be mentioned. First of all, when

GL is used for warehousing, as mentioned in the text (Page 8, para. 2), SG’s senior managers will be

able to focus on increasing sales, marketing issues and developing next generation of products.

Secondly, there are some issues that must be mentioned from the proposed policy changes. Stopping

the practice of trunk stock could conclude with a decrease in the time responsiveness and therefore it

should not be stopped. Thirdly, also as mentioned in the same proposed policy changes, improving the

controlling systems will create a better understanding of the current situation after the warehousing

functions changed. Finally, when GL is used, the approach of warehouse managers to keep more than

99% fill rate and 60-day-supply will not be a problem, because all of these operating issues will be

responsibility of GL. This will help to company not to keep excessive amount of inventory and less

tied-up money in the inventory which can be used in other areas.

5-) Fill Rate: Company’s fill rate policy should also be questioned. It is said that company

replaced the earlier fill rate policy of 93%, which is only marginally better that the industry average fill

rate of 92%, with 99% (Page 4, para. 1). However, there is no sign that the company is implementing

this policy because it is the best approach that must be taken for the company objectives. Moreover,

using a fill rate higher than optimal level leads to higher inventories and more money tied up in the

inventory. Therefore, company should lower the rates down to optimal levels, if there is no other

concern related to market leadership or customer satisfaction.

To calculate the optimal levels of fill rates for all four alternatives we should consider cost

items which are added to underage and overage costs. However, the sales leadership noted that

underage costs are 10% of the gross margin and overage costs are 0.6% of the unit cost of any product

(Page 4, para. 2). Also it is assumed that unit costs covers all the costs such as warehouse rental and

operation costs, cost of capital and inventory write-offs. For the three alternatives other than

outsourcing, there is no change in cost items, only the multiplied quantities are changed; but the

outsourcing alternative eliminates the 15% warehouse rental and operating costs and 1% inventory

write-offs as calculated in the Appendix - Table 6. As a result, overage costs are decreased while

underage costs are increased. Resulting optimal fill rates are as follows:

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1, 2 or 8 Warehouses Outsourcing

Griffin 95.4% 96.5%

Erlenmeyer 94.9% 96.1%

Table 4: Optimal fill-rates for alternatives - Gathered from Appendix Table 6

These numbers can be interpreted in two different ways: First, if company is flexible about the

determination of fill rate, in other words if it can lower the fill-rates from 99% to optimal levels,

outsourcing option pushes the optimal fill rates to higher levels which results in larger inventories and

more money to tie up. Second, if the company still insists on keeping fill rate at 99%, the additional

costs that must be paid to maintain 99% fill-rate level is lowered in the outsourcing alternative.

Consequently, the better policy related to fill rates depend on the attitude of the company.

Finally, another policy change about fill-rates can be considered. Rather than using one fill-rate

for over all products of the company, different rates for different products can help the company in

decreasing inventory costs related to, at least, for some of the products.

VI. CONCLUSION

To conclude, since available options are studied from different aspects, it must be mentioned

that the company should choose the alternatives and compare the results of evaluations according to

their priorities. For instance, evaluation criteria like inventory levels and transportation costs are

conflicting on interests. Company can see their situation from an exchange curve like in the below

graph (Graph 1) and make decisions according to priorities. The curve shows the inventory and

transportation cost levels as the number of warehouses changes.

Graph 1: Exchange curve for inventory level and transportation cost

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While exchange curves like given above can be used for the pairwise comparisons, weighted

score model can be useful for an overall assesment of options (Lecture 3, Slide 26). A sample weighted

score model with hypotetical weights and scores is provided in the Table 5 below, in order to derive a

what-if scenario study:

O P T I O N S

Weight

1 Warehouse 2 Warehouses 8 Warehouses Outsourcing

20 Transportation Costs 1 3 2 4

30 Average Inventory Levels 4 2 1 4

10 Time Responsiveness 3 2 1 4

15 Fill Rate 3 3 3 2

Additional Costs

5 Replacing Worn Equipment 4 3 2 4

5 Warehouse Operating 4 3 2 4

5 Sales Force Payments 3 3 3 4

Additional Benefits

5 Extra time of senior managers 2 2 2 4

5 Changes in warehouse management 1 1 1 4

Total: 100

TOTAL SCORES: 285 245 175 370

1: Poor 2: Acceptable 3: Good 4: Excellent

Table 5: Hypotetical Weighted Score Model

While assessing the weights for factors, it is considered that average inventory level and the

transportation costs are the most important costs for the company. Then, the fill rate follows them and

it is assumed that the first interpretation of fill rates mentioned in the previous part is used by the

company. Time responsiveness is the next important factor which is followed by additional costs and

benefits with equal weights for each. Changes in warehouse management is considered as options other

than outsourcing does not provide radical policy changes which could make warehousing management

better. These weights and the scores related to our previous investigations yield that the outsourcing the

warehousing function to Global Logistics is the best alternative among all.

All of investigations and cost studies conducted in this case study are to find the most cost

effective option in order to getting closer to the target debt to capital ratio of the company and provide

more capital to fund expansion into new international markets while maintaining or even improving the

high customer satisfaction level.

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VII. APPENDIX

Table 1: Calculating Transportation Costs for 8 Warehouses Option

Griffin Erlenmeyer Comments Total Demand 65,04 19,56 Calculated by 20% increase Fill Rate 0,01 0,01 If there is no policy change about it. Bulk Shipment Rate 0,4 0,4

Inter-Warehouse Transportations (If stockout occurs)

Total Biweekly Costs 0,0325 0,0196 Fill Rate x Total Demand x Cost Rate x Weight

Total Biweekly Cost for 8 w/h 0,2601 0,156

Total Annually Costs (1) 6,7641 4,068

From Waltham to Warehouses

Total Amount to Carry 455,28 136,92 To seven other warehouses

Total Biweekly Cost 22,764 13,692 Total Amount to Carry * Weight * Bulk Rate


From Warehouses to Customers (Average 19,5 pounds shipments by Winged Fleet) Total Amount to Carry 520,32 156,48

Total Biweekly Cost 92,123 55,41

Fixed Cost + Total Demand x Cost Rate x Weight


Total Annual Costs (1+2+3) 2993,83 1800,72

Relative Weight in Sales 75,49% 24,51% Related Sales Revenue / Total Sales Revenue from both

Average Annual Cost 2701,4

Table 2: Calculating Transportation Costs for 1 Centralized Warehouse Option

Griffin Erlenmeyer Comments

Total Demand (Biweekly) 520,08 156,36

Demand for one w/h region 65,01 19,545 Calculated by dividing total demand by 8

Demand for Central Region 130,02 39,09 To Toronto and Chicago

Demand for West Region 195,03 58,63 To Seattle, Denver and Phoenix

Demand for East Region 130,02 39,09 To Atlanta and Massachusetts

Total Costs for Within Region 154,99 46,60 For East Region

Total Costs for Across 1 Region 160,825 48,35 For Central Region

Total Costs for Across 2 Region 246,234 74,03 For West Region

Total Biweekly Cost 562,05 168,979

Total Annual Cost 14613,38 4393,46



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Table 3: Calculating Transportation Costs for 2 Centralized Warehouses Option


Total Demand (Biweekly) 520,08 156,36 Calculated by considering 20% increase

Demand for one w/h region 65,01 19,545 Calculated by dividing total demand by 8

Demand for Central Region 130,02 39,09 To Toronto and Chicago

Demand for West Region 195,03 58,635 To Seattle, Denver and Phoenix

Demand for East Region 130,02 39,09 To Atlanta and Massachusetts

Phoenix's Delivery Costs (1) 48,957 29,438 [ (Demand of West * Weight) ]* (5 x 1/ 19,5 + 1.16 ) + [Demand of Central * 0,5 * Weight] *(12 x 1/ 19,5 + 1.16)

Waltham's Delivery Costs (2) 37,447 22,516 [ (Demand of East * Weight) ]* (5 x 1/ 19,5 + 1.16 ) + [Demand of Central * 0,5 * Weight] *(12 x 1/ 19,5 + 1.16)

From Waltham to Phoenix

Total Amount to Carry 260,04 78,18 West's Demand + Half of Central's Demand

Total Cost (Biweekly) (3) 13,002 7,818 Weight x Amount x Bulk Shipment Rate

Total Costs (Biweekly) (1+2+3)

99,407 59,7726

Total Annual Costs 2584,58 1554,09



Table 4 : Cost Calculation for Outsourcing the Warehouse

Bulk Shipment Costs to Atlanta


Total Demand 13521,6 4066,8 Calculated by 1.2 x Demand of 2009

Bulk Shipment Cost Rate 0,4 0,4

Total Annual Costs (1) 676,08 406,68 Total Demand * Weight * Bulk Shipment Cost Rate

Delivery Costs from Atlanta

Griffin Erlenmeyer

Total Demand 13521,6 4066,8

Demand for one region 2704,32 813,36 It is assumed five regions have equal demand.

Southeast Region Costs 289,327 87,0191 Demand of Region * Weight * / Average Shipment Weight * Related Cost (from Exhibit 5)

Northeast Region Costs 327,812 197,1877

Central Region Costs 385,712 232,0162

Southwest Region Costs 424,370 255,267

Northwest Region Costs 443,612 266,845

Total Annual Costs (2) 1870,835 1038,337

Total Annual Costs (1+2) 2546,915 1445,0175

Relative Weight in Sales 0,75489 0,245 Related Sales Revenue / Total Sales Revenue from both


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Table 5: Calculating biweekly overall inventory levels for options

Griffin Erlenmeyer

8 W/h 2 W/h 1 W/h 8 W/h 2 W/h 1 W/h

Mean (2009) 54,2 216,7 433,4 16,3 65,2 130,4

Variance (2009) 21,4 38,3 51 10,9 19,5 26

Mean (2010) 65,04 260,04 520,08 19,56 78,24 156,48

Variance (2010) 30,816 55,152 73,44 15,696 28,08 37,44 Biweekly Ranges

Lower -14,157 118,29936 331,3392 -20,77872 6,0744 60,2592

Upper (Q*) 144,237 401,78064 708,8208 59,89872 150,4056 252,7008

Overall biweekly stock level 1153,897 803,56128 708,8208 479,18976 300,8112 252,7008

Z(alpha) = Z(0.01) -2,57 Relative Weight in Sales Griffin:

0,7549

Erlenmeyer: 0,2451

Related Sales Revenue / Total Sales Revenue from both

8 Warehouses 2 Warehouses 1 Warehouse

Weighted Average Inventory Levels

988,526 680,337 597,026

Table 6: Calculation of fill rates

1-2-8 Warehouse Options Outsourcing

Griffin Erlenmeyer Griffin Erlenmeyer Comment

Unit Cost 3,96 4,56 3,3264 3,8304 Taken from Exhibit 3

Unit Price 8,8 9,5 8,8 9,5 Taken from Exhibit 3

Insurance Cost 0,0396 0,0456 0 0 %1 of the unit cost

Cost of Capital 0,554 0,638 0,465696 0,536 %14 of the unit cost

Warehousing Operations 0,594 0,684 0 0 %15 of the unit cost

Gross Margin 4,84 4,94 5,4736 5,6696

Underage Cost 0,484 0,494 0,54736 0,5667 10% of gross margin

Overage Cost 0,0238 0,0273 0,01995 0,02298 0.6% of unit cost

Fill Rate 0,9532 0,9475 0,9648 0,9610

48126512 case study on scientific glass inc inventory management

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