Question

CASE: Parts Emporium Parts Emporium, Inc., is a wholesale distributor of automobile parts formed by two disenchanted auto mechanics, Dan Block and Ed Spriggs. Originally located in Block’s garage, the firm showed slow but steady growth for 7 years before it relocated to an old, abandoned meat-packing warehouse on Chicago’s South Side. With increased space for inventory storage, the company was able to begin offering an expanded line of auto parts. This increased selection, combined with the trend toward longer car ownership, led to an explosive growth of the business. Fifteen years later, Parts Emporium was the largest independent distributor of auto parts in the north central region. Recently, Parts Emporium relocated to a sparkling new office and warehouse complex off Interstate 55 in suburban Chicago. The warehouse space alone occupied more than 100,000 square feet. Although only a handful of new products have been added since the warehouse was constructed, its utilization increased from 65 percent to more than 90 percent of capacity. During this same period, however, sales growth stagnated. These conditions motivated Block and Spriggs to hire the first manager from outside the company in the firm’s history. It is June 6, Sue McCaskey’s first day in the newly created position of materials manager for Parts Emporium. A recent graduate of a prominent business school, McCaskey is eagerly awaiting her first real-world problem. At approximately 8:30 A.M., it arrives in the form of status reports on inventory and orders shipped. At the top of an extensive computer printout is a handwritten note from Joe Donnell, the purchasing manager: “Attached you will find the inventory and customer service performance data. Rest assured that the individual inventory levels are accurate because we took a complete physical inventory count at the end of last week. Unfortunately, we do not keep compiled records in some of the areas as you requested. However, you are welcome to do so yourself. Welcome aboard!” A little upset that aggregate information is not available, McCaskey decides to randomly select a small sample of approximately 100 items and compile inventory and customer service characteristics to get a feel for the “total picture.” The results of this experiment reveal to her why Parts Emporium decided to create the position she now fills. It seems that the inventory is in all the wrong places. Although an average of approximately 60 days of inventory is on hand, the firm’s customer service is inadequate. Parts Emporium tries to backorder the customer orders not immediately filled from stock, but some 10 percent of demand is being lost to competing distributorships. Because stock-outs are costly, relative to inventory holding costs, McCaskey believes that a cycle-service level of at least 95 percent should be achieved. McCaskey knows that although her influence to initiate changes will be limited, she must produce positive results immediately. Thus, she decides to concentrate on two products from the extensive product line: the EG151 exhaust gasket and the DB032 drive belt. If she can demonstrate significant gains from proper inventory management for just two products, perhaps Block and Spriggs will give her the backing needed to change the total inventory management system. The EG151 exhaust gasket is purchased from an overseas supplier, Haipei, Inc. Actual demand for the first 21 weeks of this year is shown in the following table: Week Actual Demand WK1 104 WK2 103 WK3 107 WK4 105 WK5 102 WK6 102 WK7 101 WK8 104 WK9 100 WK10 100 WK11 103 WK12 97 WK13 99 WK14 102 WK15 99 WK16 103 WK17 101 WK18 101 WK19 104 WK20 108 WK21 97 A quick review of past orders, shown in another document, indicates that a lot size of 150 units is being used and that the lead time from Haipei is fairly constant at 2 weeks. Currently, at the end of week 21, no inventory is on hand, 11 units are backordered, and the company is awaiting a scheduled receipt of 150 units. The DB032 drive belt is purchased from the Bendox Corporation of Grand Rapids, Michigan. Actual demand so far this year is shown in the following table: Week Actual Demand WK11 18 WK12 33 WK13 53 WK14 54 WK15 51 WK16 53 WK17 50 WK18 53 WK19 54 WK20 49 WK21 52 Because this product is new, data are available only since its introduction in week 11. Currently, 324 units are on hand, with no backorders and no scheduled receipts. A lot size of 1,000 units is being used, with the lead time fairly constant at 3 weeks. The wholesale prices that Parts Emporium charges its customers are $12.99 for the EG151 exhaust gasket and $8.89 for the DB032 drive belt. Because no quantity discounts are offered on these two highly profitable items, gross margins based on current purchasing practices are 32 percent of the wholesale price for the exhaust gasket and 48 percent of the wholesale price for the drive belt. Parts Emporium estimates its cost to hold inventory at 21 percent of its inventory investment. This percentage recognizes the opportunity cost of tying money up in inventory and the variable costs of taxes, insurance, and shrinkage. The annual report notes other warehousing expenditures for utilities and maintenance and debt service on the 100,000-square-foot warehouse, which was built for $1.5 million. However, McCaskey reasons that these warehousing costs can be ignored because they will not change for the range of inventory policies that she is considering. Out-of-pocket costs for Parts Emporium to place an order with suppliers are estimated to be $20 per order for exhaust gaskets and $10 per order for drive belts. On the outbound side, the company can charge a delivery fee. Although most customers pick up their parts at Parts Emporium, some orders are delivered to customers. To provide this service, Parts Emporium contracts with a local company for a flat fee of $21.40 per order, which is added to the customer’s bill. McCaskey is unsure whether to increase the ordering costs for Parts Emporium to include delivery charges.

Put yourself in Sue McCaskey's position and prepare a detailed report to Dan Block and Ed Spriggs on managing the inventory of the EG151 exhaust gasket and the DB032 drive belt.

Write a 1,050- to 1,400-word report.

Discuss Parts Emporium supply chain and possible remedies for its supply chain problems.

Present a proper inventory system and recognize all relevant costs.

Discuss how your recommendations for these two items will reduce the annual cycle inventory, stock-out, and order costs.

Include strategic and tactical changes that might improve the company's inventory performance, reduce variability, and improve customer service.

Format your paper consistent with APA guidelines.

Answer 1

Q1) Put yourself in Sue McCaskey’s position and prepare a detailed report to Dan Block and Ed Spriggs on managing the inventory of the EG151 and DB032.

1. EG151 Exhaust Gasket

a. New Plan

We start with estimating the annual demand and the variability during the lead time.

Refer the data for the weekly demand for the first 21 weeks,

Number of business weeks in an year = 52 weeks

Weekly demand average = 102 gaskets/week

Annual demand (D) = 102*52 = 5304 gaskets

Cost to hold inventory = 21% of inventory invenstment

Holding Cost (HC) = 0.21 * 0.68 * $12.99 = $1.85 per gasket per year

Ordering Cost (OC) = $20/order

EOQ = sqrt(2*D*OC/HC)

EOQ = sqrt(2*5304*$20/$1.85)

EOQ = 339 gaskets

Now we find R,

Cycle Service Level = 95%

From normal distribution table, this corresponds to a z value of 1.65

Finding the standard deviation of the weekly demand using the EG151 data

Standard deviation of weekly demand (SD) = 2.86 gaskets

Lead time = 2 weeks

Standard deviation in demand during lead time = SD * sqrt(2) = 4.04

R = Avg demand during the lead time + safety stock

R = 2*102 + 1.65*4.04 = 210.66 ~ 211 gaskets

               

B. Cost Comparison

                                Different types of cost category we have are ordering cost and holding cost

                                Current Plan:

                                Ordering Cost = $707

                                Holding Cost = $139

                                Total Cost = $846

                                Proposed Plan:

                                Ordering Cost = $313

                                Holding Cost = $314

                                Total Cost = $627

               

The total cost is reduced from $846 to $627 which results in a cost save of 26% per year.

The safety stock is higher in the proposed plan. Since the inventory records are inaccurate or with a faulty replenishment, we can assume that there are hardly any safety stock being held and this could be one of the main reason for the large volume of back orders. In the current system, we cannot estimate the safety stock level.

We are proposing only 7 gaskets as safety stock. The annual holding cost = $1.85*7 = $12.95

There is substantial back order related sales loss in the current plan. 11 units are on back order on week 21.

Min Lost sale cost = 0.32 * $12.99 = $4.16

If 10% annual sales is lost as back order, this amounts to

Cost = $4.16*0.10*5304 = $2206 per year.

This cost is reduced with the proposed 95% cycle service level.

2. DB032 Drive Belt

a) New Plan

This demand estimate are based on weeks 13 to 21. Week 11 and 12 are excluded because of the product launch week.

Number of business weeks in an year = 52 weeks

Weekly demand average = 52 belts/week

Annual demand (D) = 52*52 = 2704 belts

Holding Cost (HC) = 0.21 * 0.52 * $8.89 = $0.97 per belt per year

Ordering Cost (OC) = $10/order

EOQ = sqrt(2*D*OC/HC)

EOQ = sqrt(2*2704*$10/$0.97)

EOQ = 236 belts

Now we find R,

Cycle Service Level = 95%

From normal distribution table, this corresponds to a z value of 1.65

Finding the standard deviation of the weekly demand using the DB032 data

Standard deviation of weekly demand (SD) = 1.76 belts

Lead time = 3 weeks

Standard deviation in demand during lead time = SD * sqrt(3) = 3.05

R = Avg demand during the lead time + safety stock

R = 3*52 + 1.65*3.05 = 161.03 ~ 161 belts

               

b) Cost Comparison

               

Different types of cost category we have are ordering cost and holding cost

                                Current Plan:

                                Ordering Cost = $27

                                Holding Cost = $485

                                Total Cost = $512

                                Proposed Plan:

                                Ordering Cost = $115

                                Holding Cost = $114

                                Total Cost = $229

The total cost is reduced from $512 to $229 which results in a cost save of 55% per year.

The safety stock is higher in the proposed plan.

Added cost for Safety stock = $0.97*5 = $4.85

There is substantial back order related sales loss in the current plan.

Min Lost sale cost = 0.48 * $8.89 = $4.27

If 10% annual sales is lost as back order, this amounts to

Cost = $4.27*0.10*2704 = $1155 per year.

This cost is reduced with the proposed 95% cycle service level.

Q2: By how much do your recommendations for these two items reduce annual cycle inventory, stock out and ordering cost?

Stockout

· Substantial loss of sales due to back order will be reduced significantly in the proposed plan

· Max Savings from Gasket = $2206 per year (calculation above)

o Max Savings from belts = $1155 per year (calculation above)

Cycle Inventory

· Cycle stock inventory is the portion of an inventory that the seller cycles through to satisfy regular sales orders. It is part of on-hand inventory, which includes all the items that a seller has in its possession.

· Avg cycle inventory = Lot/2

Cycle Inventory
	EG151	DB032
As per Old purchasing system
Avg Cycle Inventory	75	500
As per New purchasing system
Inventory Level	345	241
Avg Cycle Inventory	173	121

Ordering Cost

Refer the Table below

	EG151	DB032
Annual Demand	5304	2709.78
As per Old purchasing system
LOT size	150	1000
No of Orders (Old)	35.36	2.709778
Rounded Off	36	3
Total Ordering Cost	720	30	750
As per New purchasing system
EOQ Quantity	338	236
No of Orders (New)	15.68341	11.4687
Rounded Off	16	12
Total order cost	320	120	440
Savings in yearly ordering cost	$310.00

Recommendations

The recommendation is to implement a continuous review system

For the gasket with   Q = 339 and R = 211.

For the belt with Q = 236 and R = 161.