Transcript Total Cost in the Supply Chain

Total Cost in the Supply Chain
In the past a focus on departmental
budgets
Purchasing -- piece price
Transportation -- freight bill
Material Handling -- labor and equipment
Finance -- Inventory
…
Often given a bonus for bad behavior
Total Cost Approach
Evaluate decisions on the basis of total
cost to the corporation and even the
supply chain
What is total cost?
Components of Total Cost
Purchase Price
Freight
Inventory
Labor
Equipment and Facilities investments
Packaging
Taxes
Waste
Returns
Freight
Consolidation reduces unit cost
Larger, slower modes reduce unit cost
Parcel
LTL
TL
Railcar load
Unit Train
...
Purchase Price
Quanitity Discounts
Marginal Discount: price of subsequent items reduced
All Quantity Discounts: price of all items reduced
Announced Price Increases: price of future items
reduced
Promotions:
Supplier wants to clear excess stocks
Supplier wants to meet financial goals
All promote purchasing in larger volumes
Inventory
Focus on three varieties
Safety stock:
Always hold this
Protection against variability in Lead-time demand
Lead-time demand is demand that occurs
between time order is placed and it arrives.
Cycle Stock
The inventory created by the delivery quantity
Pipeline Inventory
The inventory in transit
Inventory
Safety and Cycle Stock
Order Quantity Q
Safety Stock S
Time
Inventory Cost
Holding Cost
Cost of Capital
What the firm pays to borrow money or
The return on investments the firm can achieve
Operating Cost
Insurance
Shrinkage
Obsolescence
Price depreciation
Inventory Holding Cost
Two approaches:
CFO evaluates inventory savings
save the operating expense of inventory for
several years
One time savings of the inventory value (often
not recognized because reductions are not
sustainable) OR capital carrying cost of inventory
over several years
Assessment of current cost
Capital carrying cost + operational carrying cost
Assessment of Cost
Cost of Capital for the firm 10%
This is an interest rate: Borrow $100 for 1
year costs $10.
Operating cost of inventory 10%
This is like an interest rate: To hold $100
worth of goods in inventory for 1 year costs
$10 in insurance, shrinkage, obsolescence...
Assessment Cont’d
Inventory Carrying Cost: I
20% = 10% + 10%
Average value of goods in inventory: v
Annual Cost of Inventory:
I*v*(S + Q/2)
Why S + Q/2?
Inventory
Safety and Cycle Stock
Order Quantity Q
Safety Stock S
Time
Inventory
On Average...
Order Quantity Q
Safety Stock S
Time
Handling Pipeline Inventory
We did Ford’s example several times
Annual Production 4.5million vehicles
Daily Production: 12 Thousand
15 days to deliver
180 Thousand vehicles in the pipe
$20,000 average value
$3.7 billion in the pipe (all the time)
20% holding cost
$740 million holding cost in the pipe
Packaging
Ford Example: Returnable racks or
containers to hold the parts in transit
Rack Cost: $1500
Rack Capacity: 10 parts
Daily Volume of the part to a plant: 1000
Float time at Supplier (waiting to be filled
or shipped): 2 days
Float time at Plant (waiting to be emptied
or returned): 2 days
Days in transit (round trip): 4 days
Containers Depreciated
over 5 years
How large is the rack fleet?
Plant needs 100 racks per day.
2 days worth of racks are waiting there
2 days worth of racks are waiting at the
supplier
4 days worth of racks are in transit
So we need 800 racks +
$1.2 million investment in racks
Or $240 thousand in annual depreciation
Truck or Rail?
Rail
Freight $1,700 per 86’ rail car
Transit 4 days out/4 days back
Float at each end: 2 days
Rack capacity: 15
Racks per Conveyance: 10
Rack Cost $1,700
Truck
Freight $700 per 53’ truck
Transit 1 day out/1 day back
Float at each end: 1 day
Rack capacity: 10
Racks per Conveyance: 6
Rack Cost $1,500
Rack Cost: $1500
Part Value $100
Volume 1000/day
Days/Year: 240
Holding cost: 15%
Calculating Total Cost
Mode
Rail
Truck
Purchase Price
Freight
Plant Inventory Supplier Inv.
Pipeline Rack Depreciation
Total Cost
$
2,720,000 $
15,000 $
15,000 $
60,000 $
272,000 $
3,082,000
$
2,800,000 $
7,500 $
7,500 $
15,000 $
120,000 $
2,950,000
Freight:
240 days/yr * 1000 parts/day / 15 parts/rack / 10 racks/car
Plant Inventory (Cycle + Safety)
2 float days/2 * 1000 parts/day * $100/part * 15%
Pipeline Inventory
4 days transit * 1000 parts/day * $100/part * 15%
Rack Depreciation
12 days * 1000 parts/day / 15 parts/rack * $1700/rack / 5yrs