Question

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 40 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 12 percent of demand is being lost to competing distributorships. Because stockouts are costly, relative to inventory holding costs, McCaskey believes that a cycle-service level of at least 99 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 Week Actual Demand Week Actual Demand 1 84 8 87 15 86 2 85 9 85 16 85 3 88 10 87 17 82 4 87 11 85 18 83 5 85 12 83 19 85 6 85 13 83 20 85 7 84 14 84 21 87 A quick review of past orders, shown in another document, indicates that a lot size of 500 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 200 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 Week Actual Demand Week Actual Demand 11 16 15 45 19 48 12 29 16 47 20 43 13 47 17 44 21 45 14 48 18 47 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 500 units is being used, with the lead time fairly constant at 3 weeks. The wholesale prices that Parts Emporium charges its customers are $12.50 for the EG151 exhaust gasket and $8.80 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 40 percent of the wholesale price for the exhaust gasket and 36 percent of the wholesale price for the drive belt. Parts Emporium estimates its cost to hold inventory at 20 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 $30 per order for exhaust gaskets and $20 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. Questions: 1. Provide brief answers (including the necessary explanations) to the following questions (no calculations are needed for these questions): i. Enumerate three major problems that Parts Emporium is facing. ii. McCaskey decided 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.” Can you suggest a better strategy? iii. Why limiting the study to two items only? iv. Should McCaskey increase the ordering costs for Parts Emporium to include delivery charges? v. What is the current inventory system? vi. What is the current level of service? vii. What is the proposed inventory system? Why? viii. How to convince the Executives of the company to adopt your recommendations? ix. How would the calculations for the two products be similar? How would they be different? x. What will be the next step for McCaskey if Block and Spriggs give her the backing needed to change the total inventory management system? 2. Complete the table below for the EG151 and show your detailed calculations in a separate file to be submitted as attachment (Excel, OM Explorer or POM doe Windows). Current Proposed % Change How much to order? When to order? Ordering plus holding cost per year: Estimated lost sales (in %): Estimated cost of lost sales per year: Total Cost per year: Most urgent action: The following questions are required only for the students who are submitting individually: 3. What is the role that IT can play in solving the problems faced by Parts Emporium? 4. How were internet sources helpful to you in solving this case?

Answer 1

1. Provide brief answers (including the necessary explanations) to the following questions (no calculations are needed for these questions):

i. Enumerate three major problems that Parts Emporium is facing

The three major problems Parts emporium is facing are as follows:

• The sales growth has stagnated. They have 100,000 square feet warehouse space, the capacity utilization of the warehouse has increased from 65% to 90% in the last few years. This is despite the fact that very few new products have been added to the range.
• They have 40 days inventory in stock but still unable to service the customers and they lose 12% of sales to competing distributors.
• The inventory data for all products and all areas are not maintained.

ii. McCaskey decided 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.” Can you suggest a better strategy?

McCaskey has randomly selected 100 items instead she could have processed the information as follows:

• Analyze 50 fast moving components which could be derived by analyzing the purchasing pattern and sales pattern.
• Analyze 20 highest value item and their inventory and turnaround time
• Find the top 20% items, which contribute to 80% of the sales.
• Analyze the items, which resulted in a loss of 12% sales.
• Then she can compile the inventory and customer service level for these items.

iii. Why limiting the study to two items only?

The study is limited to two items only as she is analyzing the trend of the inventory. She can show to the management the benefits of total inventory management system and how it will help to reduce the turnaround time and improve the service levels. She is trying to get an idea of the ordering cycle, ordering pattern, product demand, the inventory controls, and reordering systems in place.

This will help her to devise an accurate system to minimize inventory of slow-moving items and improve inventory levels of fast moving components.

As the data indicates, the two items selected as follows:

Item	Supplier	Lead Time	Stock in hand	Backorders	Scheduled receipts
EG151 exhaust gasket	Haipei	2 week	0	11	200 units
DB032 drive belt	Bendox Corporation of Grand Rapids	3 weeks	324	0	0 units

The data indicates the ordering is inadequate as the product in demand and with back orders namely EG151 exhaust gasket has 0 inventory and 11 back orders, whereas the product DB032 drive belt has an inventory of 324 units but no orders.

iv. Should McCaskey increase the ordering costs for Parts Emporium to include delivery charges?

The part emporium should not increase the ordering costs to include the delivery charges. This is because of the following reasons:

• Most customers pick up their own parts from Parts Emporium
• Creates a transparent billing system where the customers who get home deliveries can see the cost of shipping separately mentioned indicating clearly the actual cost of the part. The shipping cost is $ 21.40 per order, which is approximately equal to the cost of a part sourced from parts emporium.
• Lastly, the customers have the choice of picking up the part or getting it home delivered.

“*as per guidelines can answer up to 4 parts or 4 questions.”