Managing inventories at Alko, Inc.

Slide 1

How would you structure the ALKO network?

▪ Stick with the current distribution system?
▪ Implement the task force’s recommendation to build a national DC and close all regional DCs?
▪ Other options?
▪ What is the basis on which you will decide?

Holding cost (H) $ 0.15 per unit per day

# of
pdts Region 1 Region 2 Region 3 Region 4 Region 5 All Regions TL cost from plant to DC $ 0.09 per unit

35.48 22.61 17.66 11.81 3.36 90.92 LTL cost from DC to $0.10 per unit
Part 1 Mean 10
customers
6.98 6.48 5.26 3.48 4.49 NA Review period (T) 6 days
Part 1 SD
2.48 4.15 6.15 6.16 7.49 26.43 Lead Time (L) 5 days
Part 3 Mean 20
3.16 6.20 6.39 6.76 3.56 NA Service Level (CSL) 0.95
Part 3 SD
TL cost from plant to $0.05 per unit
0.48 0.73 0.80 1.94 2.54 6.49 Central DC
Part 7 Mean 70
LTL cost from Central DC to $0.24 per unit
1.98 1.42 2.39 3.76 3.98 NA
Part 7 SD customers

LSCM/ISB/Devalkar Slide 2

LSCM/ISB/Devalkar 1
 Decentralized Distribution Network – Inventory policy parameters

Region 1 Region 2 Region 3 Region 4 Region 5 All Regions

Part 1 OUL 428.36 284.06 222.96 148.89 61.45 NA

Part 1 SS 38.08 35.35 28.70 18.98 24.49 145.60

Part 1 Avg. Inv 144.52 103.18 81.68 54.41 34.57 418.36

Part 3 OUL 44.52 79.47 102.51 104.64 101.81 NA

Part 3 SS 17.24 33.82 34.86 36.88 19.42 142.22

Part 3 Avg. Inv 24.68 46.27 53.31 55.36 41.89 221.51

Part 7 OUL 16.08 15.78 21.84 41.85 49.65 NA

Part 7 SS 10.80 7.75 13.04 20.51 21.71 73.81

Part 7 Avg. Inv 12.24 9.94 15.44 26.33 29.33 93.28

𝑅×𝑇
𝑂𝑈𝐿 = 𝑅 × 𝑇 + 𝐿 + 𝑍𝑆𝐿 × 𝜎 × (𝑇 + 𝐿) 𝐴𝑣𝑔 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 = + 𝑆𝑎𝑓𝑒𝑡𝑦 𝑆𝑡𝑜𝑐𝑘
2
LSCM/ISB/Devalkar Slide 3

Decentralized Distribution Network – Annual inventory and distribution costs

# of pdts Region 1 Region 2 Region 3 Region 4 Region 5 All Regions

Part 1 10

Part 3 20

Part 7 70

Total

▪ Annual cost for a part in a region = Annual transportation cost + Annual inventory holding cost
– Annual transportation cost = # of products x average demand / day x (TL cost plant to DC + LTL cost DC to customer) x 365 days / yr
– Annual inventory holding cost = # of products x average inventory x inventory holding cost / unit / day x 365 days / yr

LSCM/ISB/Devalkar Slide 4

LSCM/ISB/Devalkar 2
 Centralized (National) Distribution Network – Inventory policy parameters and costs

Central
Part 1 OUL 1067 # of
parts Central
Part 1 SS 67
Part 1 Avg. Inv 340 Part 1 10
Part 3 OUL 357 Part 3 20
Part 3 SS 66 Part 7 70
Part 3 Avg. Inv 146
Total
Part 7 OUL 107
Part 7 SS 35
Part 7 Avg. Inv 55
▪ Annual cost for a part = Annual transportation cost + Annual inventory
5 holding cost
𝑅𝑐𝑒𝑛𝑡𝑟𝑎𝑙 = ෍ 𝑅𝑖 – Annual transportation cost = # of products x average demand / day x (TL cost
𝑖=1 plant to central DC + LTL cost central DC to customer) x 365 days / yr
– Annual inventory holding cost = # of products x average inventory x inventory
5 5 holding cost / unit / day x 365 days / yr
𝜎𝑐𝑒𝑛𝑡𝑟𝑎𝑙 = ෍ ෍ 𝜌𝑖𝑗 𝜎𝑖 𝜎𝑗
𝑖=1 𝑗=1

LSCM/ISB/Devalkar Slide 5

What drives the savings from centralization/aggregation?

LSCM/ISB/Devalkar Slide 6

LSCM/ISB/Devalkar 3
 Value of aggregation and tailored aggregation strategies

# of Annual Volume thru

Total Investment Marginal Investment Marginal Savings ROI
parts Demand CDC

Part 7 70 165820 165820 350,000 350,000

Part 3 20 192939 358759 650,000 300,000

850,000
Part 1 10 331858 690617 200,000
(1,100,000 – 5*50,000)

Aggregate 100 690617 690617 850,000

LSCM/ISB/Devalkar Slide 7

Effect of Correlation
(Say, Part 7 Demand is Correlated Across Regions)

Option: Savings from centralizing Part 7 inventory

Correlation Annual Savings Marginal ROI

0 $131,404.80 37.5%

0.25 $82,852.15 23. 67%

0.5 $44,693.40 12.76%

0.75 $12,201.90 3.5%

1.0 -$16,581.95 -5.00% Why?

LSCM/ISB/Devalkar Slide 8

LSCM/ISB/Devalkar 4
 Benefits of Aggregation - Effect of Correlation
As correlation increases the benefit of aggregation decreases

Correlation Cofficient
$765,064 0.00 0.25 0.50 0.75 1.00
Target Cycle Service Level

0.9 $701,631 $760,877 $807,298 $846,772 $881,717

0.91 $711,968 $773,951 $822,516 $863,814 $900,373
0.92 $723,197 $788,154 $839,049 $882,328 $920,641
0.93 $735,545 $803,771 $857,228 $902,685 $942,926
0.94 $749,335 $821,213 $877,530 $925,421 $967,815
0.95 $765,064 $841,106 $900,686 $951,351 $996,202
0.96 $783,542 $864,477 $927,890 $981,815 $1,029,552
0.97 $806,259 $893,209 $961,335 $1,019,267 $1,070,552
0.98 $836,457 $931,403 $1,005,794 $1,069,054 $1,125,054
0.99 $884,053 $991,601 $1,075,866 $1,147,523 $1,210,956

Part 1 is decentralized, and parts 3 and 7 are centralized

LSCM/ISB/Devalkar Slide 9

Tailored aggregation
▪ Aggregation decreases inventories and facility costs, but increases transportation
and product design costs and hurts response time

▪ Tailored aggregation: aggregate items with

– high CV
– long replenishment lead time
– high value
– independent or negatively correlated demand (disaggregate items with positively
correlated demand)
– high desired level of availability

LSCM/ISB/Devalkar Slide 10

10

LSCM/ISB/Devalkar 5
 Some Tailored Aggregation Options
▪ Option I: All parts decentralized
▪ Option II : All parts centralized
▪ Option III : Parts 3 & 7 centralized
▪ Option IV : Part 7 centralized
▪ Option V: Part 7 centralized; Part 3 centralized for regions 1-4.
▪ Option VI : Collapse regions 4&5, centralize 3&7
▪ Option VII : Collapse regions 4&5, centralize 7& safety stock centralized for 3

LSCM/ISB/Devalkar Slide 11

11

Transportation costs and inventory aggregation

▪ Types of inventory consolidation
– Physical/Geographical
– Temporal

▪ Inventory aggregation decisions must account for inventory and transportation costs. Aggregation typically
results in
– Decreased inventory costs
– Decrease inbound transportation costs
– Increase outbound transportation costs

▪ Inventory aggregation decreases supply chain costs if

– product has high value to weight ratio,
– high demand uncertainty, and
– customer orders are large (aggregation could increase costs otherwise)

LSCM/ISB/Devalkar Slide 12

12

LSCM/ISB/Devalkar 6
 Tailored transportation: Product demand and value

Product High Value Low Value

Type
High Disaggregate cycle inventory.
Demand Aggregate safety inventory.
Inexpensive mode of transportation
for replenishing cycle inventory. If
need, use fast mode when using
safety inventory.
Low Aggregate all inventories. If needed,
Demand use fast mode of transportation for
filling customer orders.
Disaggregate all inventories
and use inexpensive mode of
transportation for
replenishment
Aggregate only safety
inventory. Use inexpensive
mode of transportation for
replenishing cycle inventory.

LSCM/ISB/Devalkar Slide 13

13

Alko Takeaways
▪ Centralization brings cost and responsiveness tradeoffs

▪ To come up with “good” supply chain design, we need to evaluate the magnitude of the tradeoff
– Decentralized
❑ Pros: Low transportation costs, short response times
❑ Cons: High safety inventory (or, low availability)
– Centralized
❑ Pros: Low safety inventory (or, high availability)
❑ Cons: High transportation costs, long response times

▪ Understanding what drives the magnitude of safety inventory and reduction of the inventory is key to
evaluating supply chain design

▪ A tailored solution can often improve over either extreme case

– We focused on tailored inventories in this case

LSCM/ISB/Devalkar Slide 14

14

LSCM/ISB/Devalkar 7