MSMGT 782 Lesson 2 Important note: Transcripts are not substitutes for textbook assignments.

Transcription

1 MSMGT 782 Lesson 2 Important note: Transcripts are not substitutes for textbook assignments.

2 Supply chain cost to serve analysis is really the powerful tool that we use to weed out alternatives on how we can redesign and redesign supply chain. What we want to accomplish in this section is to make sure we understand the key concepts involved in building a logistics and supply chain network, be able to assign costs to the appropriate cost to the network, and then analyze some trade- offs to allow us to have continuous improvement when it comes to a supply chain network. I think the important takeaway here is that a supply chain network, this is not like a piece of art that's static. The components, each one of the components in a supply chain, they are changing all the time. And as a result, we always need to be looking for opportunities to improve and reduce the total cost to serve.

3 Cost to serve really brings to life all of the trade- offs that are defined in the trade- off model for supply chain management. We're balancing all of the costs between the price of the product versus what type of customer service levels we're going to offer, customer service level offerings versus the transportation and warehousing costs required to support them, any order processing costs, again, to meet the requirements for the customer, more inventory located closer to the customers to be more responsive and have a lower lead time between when the order is taken when the items are actually shipped. So these things are all working against each other, or in concert, if you will, to define what the supply chain network is and what the total cost to serve ends up being.

4 Here is a pretty straight forward example of a disposable razor, if you will, going from the right far left- hand side, tier three, vertically through the supply chain. We have Chevron petroleum providing the raw materials so that the plastic can be made for the packaging that goes to the manufacturer. Again, petroleum being supplied to DuPont for the plastic for the actual handle that would hold the razor. Also, the paper packaging coming from Georgia- Pacific, the cardboard. And then steel coming from Nucor manufacturing that, again, got to the commodity raw material of the iron ore. So we have all the raw materials coming in for suppliers to the manufacturers that allow them to make the blade, make the body, assemble it, and package it, and then ship it to, in this case, Walmart distribution centers where they'll maintain inventory and, ultimately, ship to each one of the stores. So along those paths costs are all incurred that end up determining what the total cost to serve is to provide, in this case, a disposable razor on the shelf when you go to the Walmart stores.

5 Our methodology, or approach for problem- solving, here to determine costs to serve has some very definable elements that need to be followed. First, of course, we need to read and understand the problem and all the nuances associated with it so that we can start identifying the components, the supply chain, which then allows us to create a flow diagram of the supply chain. Again, on the previous slide, how does the petroleum get to DuPont to make the plastic, the petroleum to get to the plastic manufacturer for the packaging? And so we build the network and the various flows that compose the network. And then we assign the costs to the flow diagram and analyze the supply chain for what the cost drivers are as far as the number of units, the distances, the times. Once we have that original network set up, we want to brainstorm alternatives to see if there are ways that make sense, make business sense, to either reduce the cost or make the supply chain more dependable so that we can reconfigure our supply chains, make the recommendations based on the reconfigurations, and then considering the timing of seasonality, time to implement new supplier relationships either with transportation companies or manufacturers or suppliers of the raw material components, figure out an implementation plan.

6 So let's do one. I'll give you a couple of minutes here to look at a problem that we're actually going to go through. And then we'll focus on taking the first step in understanding what the individual components are of the supply chain so that we can build the network.

7 So let's look closely now for the components that are going to be built into our network. And what we need to look for are the processes, the business processes, that add cost and also the storage points where inventory is sitting in we're incurring carrying costs of holding the inventory so that, again, we can define the components. So we need to look for keywords. The first keyword you see there is plan. Plan is a business process. Somebody had to do it. In this case, this person earns $80,000 plus benefits. We have to place the order. That's the next process via EDI. And it tells us that its $0.01 per unit. The company makes the product, again, a business process to make or manufacture the product. And they do it- - when they set up the plant to make it, they make 10,000 at a time. And as a result, that gets the total manufacturing cost to $20 each. Now, some of these costs are what would be considered value- added costs and some are not. We have $18.50 for raw materials, certainly a value- added cost, $0.50 for packaging, $0.49 for labor. And those are the all direct or value- added costs. The 51% is not considered. It's considered overhead or non- value added and an opportunity for improvement. After the production, the product is stored. OK, here's a storage point where it's stored in the factory warehouse for 45 days. Then it's shipped. So that's another process where we're shipping it.

8 That's a cost for us as far as the transportation costs. But it's also inventory carrying costs, because it takes the one day for the product that's being on the truck. So the product on the truck is, again, storage point costs. It's loaded onto the boat and shipped in the US at the cost of $0.03 per unit, again, a process in this case that we have to identify the costs. It's stored on the boat for 45 days. And that's a storage cost, so a storage point that's going to incur inventory carrying costs. And then the product is shipped to the RDC, OK, a transportation cost at $0.05 per unit, they're telling us. Then the product is stored in the RDC. So again, we have an inventory carrying cost at that storage point. It's moved to retail. So we have another transportation cost. And then ownership is transferred at the store. Then the product is placed on the shelf. Then it's gradually, as opposed to a full all 10,000 items that are shipped to the RDC, they're gradually shipped in smaller quantities to the stores. That's why we have the distribution center so we can store these large quantities and then measure them out to the stores. And then also at the stores there's a quantity. And they're gradually consumed as they are taken off the shelf.

9 Here's another look at it in breaking down in good PowerPoint form. Here's another look at the key processes and storage points.

10 If we look at the key concepts here on creating the flow, there's lots of different tools into value streaming, process flow charting, process mapping. You've probably used them in your other courses. We design, measure, analyze, create. Other's exist. We're going to keep it fairly simple here.

11 And to really focus here, again, on where are all the processes- - on slide what are all the processes in creating the flow diagram? And also defining all the inventory storage points. So again, we can plant it. We can order it. We can make the product. We can move it. We can sell it. These would be all business processes. All the inventory storage points, it can be inventory stored at the supplier at their manufacturing site at their warehouses. It can be stored at the manufacturers. It could be either at their plants or at their warehouses. It can be stored at the buyer's warehouse, in this case, Walmart. It can be in transit, either on truck, plane, boat, or pipeline. And then we actually have the retail location. So these are all areas where we need to capture the costs associated with building the supply chain network.

12 So if we take each one of the bullet points that were shown on the earlier slide, we can build a flow. And our expectation is that you can build this flow by analyzing the components. So if we go through those components, again, to create the flow diagram we have here, it starts with the product being planned by the buyer planner, the order actually been entered via EDI, the product is made in China. Then the product has a storage point, because it's stored for 45 days at a carrying cost of 25% at the warehouse at the factory in China. Then the product is, after 45 days, is shipped to the port. And on that one day of shipping, we have a carrying cost of 25%, because that's a storage point while it's on the truck. Then it's loaded on a ship and then moved to the US. Then the product is stored on the ships for 42 days at a carrying cost of 25%. Meaning, again, that's another storage point we have here. The product is shipped to the regional distribution center with a full truckload. It's stored at the regional distribution center for 20 days at 30% and gradually metered out to each one of the retail locations in less than a full truckload. And then, finally, it shows up for and is sold gradually over six days from the retail location. And then after those six days it's replenished again with a less than a truckload shipment from the regional distribution center.

13 The key concepts here are to assign the costs to the flow diagram. So we can always compare apples to apples. We need to convert the all the costs in the cost per unit. So if we identify the cost of a process, we need to then divide it by the number of units processed. As always, be careful with your decimal points and your arithmetic to make sure you're generating dollars and cents appropriately. If we were going to be absolutely true, we would also have to consider the time value of money. Since many of you have not had a finance course or engineering economy, we're going to just use simple interest in our calculations. And since we are using that consistently, we'll be directionally correct. And again, we're addressing two types of costs in assigning these costs, the process cost and the costs associated with inventory storage points.

14 If we do a cost per unit, let's do a couple examples. If our product is planned by our buyer planner at a cost of $0.01 per unit, we already have the information in per unit like we need so that we can compare the as- is supply chain network versus any changes or recommendations that we have to reduce the costs. In another example, we may just get the information that the buyer planner, he or she is making $80,000 a year including benefits. And then they plan for one million items. Well, to get the cost per unit for each item that's shipped, we would take the buyer planners $80,000 salary and divide it by the four million units and get the planning cost, if you will, for the planning process of $0.02 or 0.02 per unit.

15 When it comes to inventory carrying costs, we need to look at two different scenarios as far as what's happening at the storage points. One is what's called full lot. And that means the quantity that goes in equals the quantity that goes out. So what's an example of that in our current problem? Well, they put 10,000 units on the ship. And barring damage and pilferage, our expectation is that 10,000 units will come off the ship and be then transferred to the Retail Distribution center. So that's full lot. Gradual, the quantity going in does not equal the quantity going out. So remember, we're using the regional distribution centers to store the big, full lot that comes in. But you know none of the individual stores want 10,000 units. They just want six days worth. So although 10,000 units came into the region's distribution center, when we calculate the inventory carrying costs, it's going to be gradual. Because it's going to go from 10,000 gradually down as it's metered out in smaller quantities to each one of the retail locations. That's how the inventory will be depleted. And that has to taken into consideration in calculating the carrying costs. And we're going to do that.

16 So if we look at some full lot examples, again, we're shipping between a location 1,000 on the truck, 1,000 off the truck. Warehousing, 10,000 items received, 10,000 items stored, 10,000 items shipped all at once. A retail special ordered 10 items received, 10 items stored, 10 items sold. And if you want to have another visual image on this, look at the way we calculate the area of a rectangle. The area is the length times the width, or the quantity times the time in this case. And we're going to use the quantity times the time to actually calculate the carrying costs.

17 Inventory costs with full lot, again, length times width or quantity times time. The full formula of this is the value of the product times the annual carrying costs. Remember, when you get a carrying cost, it's always annual. We're hoping that we're not holding inventory a full year. So we have to figure out how to convert that. And we will do this in the formula. And we multiply it times the day that it sits in inventory. And to get the daily equivalent of the carrying cost, we divide it by 365, or the number of days in the year. So for an example here, if the value of the product is $10, and the carrying cost is 20%, and the days in inventory is five, to get the carrying cost for the five days that the product is in inventory, we'll take the 10 units and multiply it times 0.2, or the 20% carrying cost, times the five days in inventory and divide it by 365. And we get $0.027 per unit carrying cost associated with this particular $10 item being held in inventory for five days and an annual carrying cost of 20%.

18 Now, when it comes to gradual, it's really defined as having different quantities moving in and out of a storage point, or transportation, or processing at different points in time. So this is selling partial quantities from manufacturing or a retail store. So from the RDC, it could be 10,000 items are delivered, but two shipments of 5,000 items at different points of time. It could be multiple stops deliveries. And this is typically the scenario that exists and what we've talked about in our example, that you get 10,000 items in the regional distribution. And then it's gradually shipped out over a period of time in smaller quantities to all the distribution locations. So when we think about the quantity, the quantity and time that things are held when the inventory is gradually consumed, it's like calculating the area of a triangle where we do the width times the length and divide it by two. And when we apply that to our calculation for inventory carrying costs, it's the quantity times the time divided by 2.

19 So if we look at an example, a key example, in gradual depletion, again, the inventory that's gradually depleted over time is divided by 2. That's just a rough approximation. We're saying, on average, if it's 10,000 items are delivered and we deplete it down to two over a period of time, on average they're going to be 5,000 items for example. So how does this affect the carrying cost equation? For inventory carrying costs, in a gradual depletion situation, the formula, we take the value of the product times the annual inventory carrying costs percentage times the day's inventory, and we divide it by 365. But we also divide it by that two for the quantity times the time divided by two equation just above. So what does the arithmetic look like? Again, for the same situation, but assuming in this case, the same example that we had for full lot, again, adjusting it and making it a gradual depletion situation. So we take the value of the product which is $10 and, again, the carrying costs of 20% and the days in inventory at five days. So we take 10 times 0.2, which is the 20% carrying cost, times 5. And we divide that times the product of 365 times 2. And we get $ per unit. And again, remember, the difference here is that we're gradually depleting the inventory over time. So it's not a full quantity. And we have to reflect that in how much the inventory is costing us for holding it for that period of time.

20 So let's apply the inventory's analysis of full lot versus gradual depletion to our current problem. And if we look at products stored in the factory, 10,000 goes in, 10,000 goes out. It's full lot. If you look at what's stored on the truck, again, barring damage, theft, if we were going to put 10,000 on the truck for one day, 10,000 comes off. Similarly with the ship, we're going to put 10,000 on the ship, 10,000 come off. So those are all full lot situations when it comes to calculating the inventory carrying costs. Remember, in each one of those scenarios, there are two costs associated with that particular part of the supply chain. One would be the transportation costs while it's on the truck or on the ship. And the other would be the actual carrying cost while it's on the ship. Now, the product is shipped to the RDC in a full truckload. Again, what went on the truck came off where the product is stored in the RDC for 20 days. But, although we received the full truckload of 10,000 items, what's going to come out of the RDC, we aren't going to ship 10,000 items to every retail store. We're going to ship smaller quantities and less than full truckloads. And so 10,000 is going to come in, but 10,000 is not going to go out. Smaller quantities are going to go out to each one of the retail locations. And therefore, it's a gradual analysis or a gradual situation for calculating carrying costs, because it's being gradually depleted over time in smaller quantities.

21 So what went in? 10,000 went in. 10,000 didn't go out. Much smaller quantities went out over a period of days. Similarly, the same thing happens at the retail location.

22 So let's take each step and define each one of the costs. And remember there are two types of costs, process and inventory. The first is that we have a process step with the buyer planner. We know that the buyer planner makes $80,000 a year. And he or she is planning four million units. So we take the $80,000 and divide it by the four million units. And we get $0.02 or 0.02 dollars per unit. So that's the first the cost in calculating the total cost to serve that we are doing for the flow that we have created.

23 The second, the product is ordered via EDI. We were given that it was 0.01 dollars or $0.01. So we dropped that down right away right into our total cost calculation.

24 The next costs we have are all the costs associated with manufacturing. This is the material, the labor, the overhead, and the packaging. So $18.50 plus $0.50 plus $0.49 plus $0.51 gives us a total of $20 added to our total cost to serve.

25 We know that it's a full lot situation for the product being stored in the warehouse at the factory in China. So we take the cost of the unit, which we just figured out from the problem with $20, multiply it times the 0.25, or the carrying cost, and times the 45 days. And remember, we have to convert that 25%, or 0.25, into a daily carrying cost. So we divide it by 365. And we get dollars or $0.616.

26 Next, it's shipped to the port. We're told that the truck costs $100 for shipping the 10,000 items. We take the $100 and divide it by 10,000. And we get 0.01 dollars or $0.01.

27 The truck, remember, that is a storage point. That's an inventory carrying cost then. So we have to take the $20, multiply it times the 0.25 carrying cost times the one day, and divide it by 365. And that gives us $0.014 to add to the total cost associated with the inventory carrying costs for the product while it's on the truck.

28 It's loaded on the ship. And we're given that it's $0.03. So we had that directly into our total cost to serve.

29 When the ship leaves the port, the product is, again, it's a storage or inventory storage point. And when the inventory is stored, we incur carrying costs. And so we need to calculate what that carrying cost is. We know, because we did the analysis earlier, that it's a full lot, because 10,000 are going to go on the ship and 10,000 are going to come off. And so then we use the equation of the unit cost times the carrying cost times the number of days divided by 365. So our unit cost is $20. The carrying cost is 20%, or The number or days on the ship is 42. We multiply those three items together, divided it by 365, and we get associated with the inventory carrying costs for when the materials are on the ship.

30 The product is shipped to the RDC. And that was given at $0.05 or 0.05 dollars.

31 The product is then stored in the RDC for 20 days at 30% carrying cost. So what we need to do then is recognize that 10,000 items are going into the RDC, but smaller quantities are going to go out over a period of time. So what goes in doesn't equal what goes out. So we need to use the gradual depletion formula for calculating carrying cost. And you recall that that's the unit cost times the carrying costs times the number of days that it requires to deplete the 10,000 in this case. And then divided by the product of 365 times 2. And remember the 2 is in there to deal with that the inventory is being gradually consumed over those 20 days. So we take the $20 multiply it times 0.30, which is the decimal equivalent of 30%, times 20 days and divide it times 365, the number of days, times 2. And we get dollars or $0.164.

32 The product is shipped to the store. We're given that that's.08 cents.

33 Next, the product is stored on the shelf for six days. It takes six days for it to be gradually consumed before they get a replenishment order from the regional distribution center. So again, it's a gradual depletion. So we use the gradual equation for calculating the inventory carrying costs. So it's the $20 times the 30% carrying cost, or 0.30, times the six days divided by the product of 365 times 2. And we get for the carrying costs for the items as they sit on the shelf as they're consumed gradually by consumers coming and buying them. If we add all those costs together, we get the total landed cost of $ or about $21.62.

34 The next step would be to analyze the cost drivers. What are the big elements of cost that we provide some opportunity to generate some alternatives to reduce our total landed cost? And, really, we need to segregate the value- added versus the non- value added items- - value added being manufacturing. The non- value added, as far as the product is concerned, is when it sits in inventory, when it's being transported, any back office and administration, any inspection or quality steps. Those are all non- value added. And we should be seeking ways to reduce the manufacturing costs and reduce and eliminate any of the non- value added cost drivers.

35 So if we look at the cost that we've defined for each one of the components of our supply chain. We can look at, the items in blue here, are non- value added costs. So back office administration for the buyer planner, the EDI, the overhead at the manufacturing site, those are all back office administration non- value added. The transportation costs for shipping it to the port, loading it onto the ship for to go to the USA, the product being shipped to the regional distribution center, and the product being shipped less than truckload to the retail locations, again, a total transportation cost of 0.17 non- value added. If we look at the inventory carrying costs as it sits at the plant, as it's in the truck one day for 0.014, as it's stored on the ship for 42 days, 0.575, and stored at the RDC, those items all add up to again, non- value added. The value added components would be the packaging the labor and the raw material associated with actually making the product.

36 So the next step and the alternative, brainstorm some alternatives to maximize the value- add, eliminate or minimize the non- value add, and use some structure techniques to determine the feasibility of the solutions.

37 We have a couple scenarios here. We'll go through two of them. The third one, it would be good if you tried it on your own and then got back to the instructor with any questions that you might have. So the first scenario is what if we shipped directly from the end of the line and, basically, eliminated that 45 days on the warehouse. And the next situation is, instead of having it on the boat for 42 days, what happens if we airship it? And then the last scenario is what happens if we ship to the store on full truckloads and, as a result, generating eight days of inventory supplied over a period of time? So we're going to spend some time right now doing the scenarios one and two.

38 First, we need to isolate the affected portion of the supply chain. You'll recall that after it's made in the plant, it was originally stored 42 days. Here, it's only going to be stored one day. And so the changes, again, the product is stored in the factory for one day, not 42, at 25%. And you'll notice when you calculate the full lot calculation for carrying costs, we're replacing the 42 days in the calculation with a one day and coming up with a new inventory carrying cost of

39 So if we look at all the costs incurred here, we can see that- - if we a comparison of what we had originally in our baseline scenario- - that there's a saving of So that's a significant saving. And it's something that we should go ahead with in reconfiguring our supply chain. It may be something that takes a significant investment, or re- planning, or working with suppliers. So it may take some time to implement. But early indications are, with that type of savings times 4 million units, it's probably worth pursuing.

40 If we shipped via air to the US, we're in a scenario where we're isolating this portion of the cost associated with moving it on the ship and also the 42 days on carrying costs when the items are on the ship going from China to the port in the US. So we've isolated these locations. And the $0.03 was given. And we calculated the carrying cost of $20 per unit times the 25%, or 0.25, carrying cost times the 42 days divided by 365. And that gives us a carrying cost for these two elements of the supply chain of loading and for the inventory carrying costs.

41 Now, if we ship it by air, we were given that it's going to cost us a little bit more to actually load it on the airplane. And that was given at 0.07 dollars or $0.07. But because we're shipping it by air, it would just take one day to get to the US. And as a result, instead of having 42 days in a carrying cost, we're going to take the $20 times 0.25, or the 25% carrying cost, multiply it times one day instead of 42 and then divide it by 365. And now the carrying cost is significantly lower, 0.014, or about a penny and a half. Again, all these calculations are per unit

42 So do we do it? It looks like we're going to save $0.521, or a little over 1/2 $1 by doing this. Even though the shipping cost is higher, it's more than offset by the carrying cost reduction. And so this is why it's important to look at all but costs, all the process costs, and all the inventory carrying costs when we actually do the analysis and making choices on how we're going to configure our supply chain.

43 So something for you to spend some time with is actually going through scenario three and making a recommendation of scenario three. And then, as a result is reconfigure the entire supply chain of the flow that we had earlier and put the new costs in and figure out the new costs to calculate the new total landed cost.

44 Key concepts, reconfiguring the supply chain, we need to, again, create the new flow diagram, assign the new costs, analyze the cost drivers, and then reconfigure the supply chain.

45 These things, although we understand the costs and we can compare the dollars, there are other things that have to be considered. These things to make the changes, they may require capital dollars. We may have to buy new equipment at the plant to be able to do, in China, to be able do what they're asking us to do. We may have to pay overtime for the items to be made, 10,000 items all at once. There may be more set- up costs incurred, some more expenses incurred to be able to do this. There may be other benefits that we can put a dollar value on to implement. We need to consider, when we make these changes, that they don't impact the service levels that marketing has defined for the customers in a negative manner. And then we also have to consider the time to implement. Is this going to be time consuming? Do we have to plan for a period of time in the future where we can build up inventory so that we take production facilities down to implement the change? If we're going to change the supplier from shipping via boat to an air carrier, it's going to take time to identify the carrier and negotiate terms. All these things have to be taken into consideration before we make the recommendation.

46 And actually do the implementation. And the implementation then requires resources and commitment to actually make it happen. It's going to require rigorous project management. Because when we put it in, it needs to work. Because if it doesn't work, we aren't going to make the commitments as far as our service levels for our customers. If there are changes in the performance measures in the supply chain as a result of this, we need to make sure that those are properly reflected for budgetary purposes and individual performance objectives. And we need to track the progress frequently. And we need to make sure that what we've put in is very predictable. If it's five- day shipping, it's always five- day shipping, again, so that the total landed cost is consistent.