ISQA 510Sourcing Strategies & Inventory

MGMTLecture 3

Agenda- Nike Shoe-town Questions / Observations?- Supply Chain mitigation strategies- Risks and drivers- Mitigation- Stress testing supply chain- Dual Sourcing..or- Inventory Management- Incentives- Scientific Glass- Tyco Electronics

Supply Chain Risks

Category of Risk

Drivers of Risk

Disruptions •Natural disaster•Labor dispute•Supplier bankruptcy•War & terrorism•Dependency on a single source of supply as well as the capacity & responsiveness of alternative suppliers

Delays •High capacity utilization at supply source•Inflexibility of supply source•Poor quality or yield at supply source•Excessive handling due to border crossings or to change in transportation modes.

Supply Chain Risks & Their Drivers

Category of Risk Drivers of Risk

Systems •Information infrastructure breakdown•System integration or extensive systems networking•E- commerce

Forecast •Inaccurate forecasts due to long lead times, seasonality, product variety, short life cycles, small customer base•“Bullwhip effect” or information distortion due to sales promos, incentives, lack of supply chain visibility & exaggeration of demand in times of product shortage

Intellectual property

•Vertical integration of supply chain•Global outsourcing and markets

Supply Chain Risks & Their Drivers

Category of Risk

Drivers of Risk

Procurement •Exchange rate risk•Percentage of a key component or raw material procured from a single source•Industry wide capacity utilization•Long-term vs, short-term contracts

Receivables •Number of customers•Financial strength of customers

Supply Chain Risks & Their Drivers

Assessing the Impact of Various Mitigation Strategies

Stress Testing Your Supply Chain

Tailoring Reserves for Risk Mitigation

Adding Suppliers to Mitigate RiskPros:-Excess Capacity-Good for low obsolescence & low holding costs-Good for high volume commodity parts-Negotiation leverage

Cons:-JIT systems-Bad for high obsolescence & high holding costs-Costly for low volume or custom parts-Double the ECOs & tolerance issues

11

Supply Chain Management – Key Issues

• Forecasts are never right• Very unlikely that actual demand will exactly equal

forecast demand

• The longer the forecast horizon, the worse the forecast• A forecast for a year from now will never be as accurate

as a forecast for 3 months from now

• Aggregate forecasts are more accurate• A demand forecast for all “related products” will be

more accurate than a forecast for a specific product / SKU

Nevertheless, forecasts (or plans, if you prefer) are important management tools when some methods are applied to reduce uncertainty

Reasons for Inventories• Improve customer service• Economies of purchasing• Economies of production• Transportation savings• Hedge against future• Unplanned shocks (labor strikes, natural

disasters, surges in demand, etc.)• To maintain independence of supply

chain

Adding Value through Inventory

• Quality - inventory can be a “buffer” against poor quality; conversely, low inventory levels may force high quality

• Speed - location of inventory has gigantic effect on speed

• Flexibility - location, level of anticipatory inventory both have effects

• Cost - direct: purchasing, delivery, manufacturingindirect: holding, stock-out.

Which begs the question “who is liable?” :

• Need for Finished Goods Inventories• Is the need to satisfy internal or external

customers?• Can someone else in the value chain carry the

inventory?

• Ownership of Inventories• Specific Contents of Inventories• Locations of Inventories• Tracking

Inventory Carry Costs – Is inventory an asset?Inventory Carrying rate example: total inventory = $34,400$800K – Storage$400K – Handling$600K – Obsolescence$800K – Damage$600K – Administrative$200K – Loss$3,400 – Total

Divide costs by Avg Inventory $3,400 / $34,400 = 10%Add: Opportunity costs of Capital 9%, Insurance 4%, Taxes 6%

=19%

Total Inventory carrying rate is 29%

Cash-to-Cash Cycle Time0ENLI009

Inventory days + Days sales outstanding – Average payment of supply period for materials

Inventory0OPPLAN012

Forecast Accuracy

0OPPLAN008

Production Lead Times

0OPMAKE017

Perfect Order Fulfillment

0OPDEL061

Faultless Invoices

0OPDEL023

Scheduled Achievement

0OPMAKE022Delivery

Performance to Scheduled Commit Date

0OPDEL019

Returns0OPDEL067

Scrap0OPMAKE023

Fill Rates0OPDEL025

Order Fulfillment Lead Time

0OPPLAN030

Machine wait time0OPMAKE007

Yield0OPMAKE033

Number of Supply

Sources0OPSO012Total Source

Lead Time0OPSO041

0ENLI015

Sales0ENPR026

0ENLI0030OPPLAN017

Inventory Measures - Examples

Weeks of SupplyFord: 3.51 weeksSears: 9.2 weeks

Inventory Turnover (Turns)Ford: 14.8 turnsSears: 5.7 turnsGM: 8 turnsToyota: 35 turns

Variances are bad – PPV & Standards

“unfavorable variance” = is reduced from the budgeted expectation

“favorable variance” = is increased from budgeted expectation

When is cost reduction a bad thing?Note: Do not interpret directly as “bad” or

“good” behavior on the part of management; the goal is to be on target.

Hammer Article: Cisco / Altera

Yr. 2000 – Cisco wrote off $2.25BAltera’s answer? – A new PostponementCapacity utilization – 2000 (97%) 2001

(66.2%) What should it be?What is happening now in component lead-

times? Is it real?Is VMI the real answer?Value drops 1.3% per month

Manufacturing PostponementPostponement – A form of DFM that is applicable when

producing families of productsPostponement is defined as “redesigning the product or

production process so that the point of differentiation is delayed as much as possible”a.k.a. delayed product differentiation (DPD), product

differentiation postponement (PDP), design for localization

General postponement strategies:Component and Process StandardizationModular Product DesignProcess RestructuringDesign for Logistics

General Postponement StrategiesComponent and Process Standardization

allow facilities to perform identical operationsreduces complexity of operationsincreases flexibility of WIP inventory usage

Modular Product Designallows for easier assemblyintegration can be performed at later points

Process RestructuringPostponement of operations (postpone operations

downstream)Reversal of operations (re-order adjacent operations)

Design for Logisticsdesigning products for cheaper transportation, with smaller

packaging to reduce freight costs

Postponement of Operations (Sherwin-Williams)

Important points to keep in mind• Segment customers based on service needs.• Modify the supply chain to meet these service

requirements profitably.• Customize the logistics network.• Develop forecasts collaboratively involving every

link of the supply chain.• Locate the leverage point where the product is

unalterably configured to meet a single requirement

• Delay product differentiation till the last possible moment.

Supply Chain Management – Key Issues

Overcoming functional silos with conflicting goals

PurchasingManufacturingDistributionCustomer Service/Sales

Few change- overs

Stable schedules

Long run lengths

High inventories

High service levels

Regional stocks

SOURCE MAKE DELIVER SELL

Low pur-chase price

Multiple vendors

Low invent-ories

Low trans-portation

Scientific Glass

Assessment alternatives: 5 questions1. Implement proposed policy changes?2. Consolidate warehouses?3. Outsource warehousing?4. Reduce the target total order fill-rate?5. Other considerations?

Scientific GlassHelpful Hints:1. What are the Options & savings with

each?1. Fill rate lowered & trunk stock

eliminated2. One Warehouse vs. logistics costs3. Outsource 4. Combination of the above?5. What about Cash????6. Look at incentives

Scientific Glass

Case Questions:What are the problems facing SG in January 2010,

how does the proposed changes fit?How much external funding will have to be raised in

2010 to finance ops & why?How so SG’s problems illustrate the relationship

between the number of warehouses and inventory levels?

What are the alternatives & how do you evaluate those?

What actions should Ava “really” propose?

Scientific Glass – Inventory CaseWhat we know:- Exceeded their target debt/capital of 40%- $2B market; 5% share- High volume / low mix? 3000SKUs- Niche player, custom SKUs, competitive

pressure.- Does the 3-6 month sales cycle matter to

SCM? - Inventory growing faster than sales- Emphasis on short lead-times & customer

satisfaction

Scientific Glass – Inventory CaseWhat do we know?- Dedicated Sales force – Trunk stock 32*$10K- 93% fill-rate, 2 week lead-time- Overage cost .6%. BO 10% GM.- Incentive is on fill-rate to 99%- 8 DCs * $750K + 2 new ones planned- Sales forecasted to grow 20%; Capacity

requested to support = $10M

Scientific Glass – Inventory Case

What do we know?- Warehouse Inventory <60days; 120K orders

processed- Used Min-Max system for each SKU- Period expenses of 1% of cogs – Too much?- Freight Factory -> DC is $.4 / Ilbs- Inventory accuracy was declining – what

happens?

Scientific Glass – Inventory CaseWhat do we know?- Policy changes proposed- Capex is low – 14% ($1.4M..)- Turns were 6- 25% is Raw + WIP; rest is FGI (good?)- Balance sheet – Inventory growth > Sales- Cash 6%

In the end, give trunk stock, consolidate DCs, lower fill rate to 90%,

SAVE $10M on Capex

Tyco Electronics- Provider of engineered electronic components, network

solutions, undersea telecommunication systems, and specialty products for customers in more than 150 countries

- Transportation Solutions (40%)Communications & Industrial Solutions (40%)Network Solutions (20%)Total $12.1 billionThe company has 97,000 employees operating in almost

50 countries. (FY2010)- Wilsonville location designs and distributes connectivity

devices for the medical industry- Look for layout, labor content, factory within a factory