Silo Manufacturing Corp-Inventory Control
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Educating
and
Connecting
the
World's
Supply
Chain
Professional
s.
™
CSCMP
ACADEMIC CASE STUDY
SERIES
Case studies can supplement a course and be used to teach application of supply chain
management concepts to real-world situations. Others can use the case studies to learn
about supply chain challenges and to analyze the situation to develop solutions.
Silo Manufacturing Corporation (SMC)
Managing with Economic Order Quantity
An Academic Learning Case Study written for the
Council of Supply Chain Management Professionals
Dr. Ted Farris
University of North
Texas
Ted.Farris@unt.edu
(940) 565-4368
Lombard, Illinois 60148 USA
+1630.574.0985 |
education@cscmp.org
| cscmp.org
Council of Supply Chain Management Professionals
333 East Butterfield Road, Suite 140
Lombard, Illinois 60148 USA
+1630.574.0985 |
education@cscmp.org
| cscmp.org
Silo Manufacturing Corporation - Part A
SMC recently re-named itself from Silo Manufacturing Corporation to give the
impression they were a modern manufacturer. Located in Blacksburg, Virginia, SMC is a
regional provider of grain towers/silos for farms as far north as University Park, Pennsylvania, as
far west as Knoxville, Tennessee, and as far south as Statesboro, Georgia. In recent years SMC
has extended their business to include the latest in agricultural engineering services for elevator
design and installation. Their core business still remains the fabrication of the grain elevators.
Vice President of Manufacturing Ferris Martin stopped by the office of SMC’s President
Robert Lewin and remarked, “I need your help resolving an issue between our Financial
Comptroller, Fred Ferguson, and our Purchasing Director, Peter Patrachalski. These two
executives continue to argue with each other about our ordering policies.” “How can I help?”
asked Lewin, peering over his glasses. “Both Fred and Peter are pretty strong-willed and
protective of their areas?”
“It boils down to conflicting goals,” replied Martin. “Ferguson says the cost to carry
inventory is 32% and is trying to keep inventory costs low. Patrachalski had his intern identify
his ordering costs and was shocked to find that every time our employees place an order it
costs us $48 regardless of the quantity ordered. Each one would like to dictate how the other
operates so they can achieve their own performance goals. I’d like to have them meet
somewhere in the middle but I’m not sure if that is the best solution.”
“SMC’s primary performance goals are to reduce cost and increase profitability”
exclaimed Lewin, “These guys need to understand SMC comes first. Offer them a test case to
propose and defend their ordering policy and we’ll sort this out.”
“I suggest part number 64-1909?” replied Martin. “The unit cost is $112.00 and we
order 10,752 units per 365 day year. While we do not have to order by the case, it does come in
The Groundhog’s New Clothes
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2
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15 units per case. The average lead time from when we place the order to the time we receive
it at our dock is 8.2 days with a standard variation of 1.7 days.”
Later that week in the conference room, Ferguson and Patrachalski each offered
proposals for ordering part number 64-1909. Purchasing Director Patrachalski stated he was
trying to keep his purchasing costs down by ordering in larger quantities and suggested buying
32 cases at a time. He has also indicated he would like to avoid ordering in partial cases since
doing so may result in shipments of incorrect quantities and consequent higher costs.
Comptroller Ferguson claimed the most important issue was the cost to carry inventory and
argued for ordering 4 cases at a time to keep average inventories low. Seeking a compromise,
Lewin suggested using economic order quantity (EOQ).
Lewin stated, “economic order quantity can be very complex. The original EOQ, known
as ‘Wilson’s EOQ’, was actually developed by F. W. Harris
1 2
in 1913, but a consultant named R.
H. Wilson, who embraced the model and applied it extensively, was given credit for his early in-
depth analysis of it.
3 4
It determines the lowest total inventory cost by calculating the optimum
order quantity denoted as Q*. Economic order quantity incorporates the trade-off between
inventory carrying cost and ordering cost—exactly the trade-off we are facing with Finance and
Purchasing.”
“You can now find more complicated economic order quantity models extending the
concept to consider discount pricing for ordering in larger quantities, backordering costs,
differences in transportation rates if you ship by full truckload instead of LTL, including the step
function of adding another warehouse as it impacts inventory carrying costs, or bridging into
optimal production quantities. Anything that might influence the economic order quantity
1
Harris, F.W. "How Many Parts To Make At Once" Factory,
The Magazine of Management
, 10(2), 135-136, 152 (1913).
2
Harris, F. W.
Operations Cost
(Factory Management Series), Chicago: Shaw (1915).
3
Hax, AC and Candea, D. (1984),
Production and Operations Management
, Prentice-Hall, Englewood Cliffs, NJ, pp. 135,
http://catalogue.nla.gov.au/Record/772207.
4
Wilson, R. H. "A Scientific Routine for Stock Control"
Harvard Business Review
, 13, 116-128 (1934).
variables—there is probably an extension. There is probably even one considering the phases of
the moon!”
“There are a lot of assumptions for economic order quantity including:
5
A continuous, constant, and known rate of demand
A constant and known replenishment or lead time
Entire order delivered at same time—no in-transit inventory
All demand is satisfied
A constant price or cost that is independent of the order quantity (i.e., no quantity
discount)
No inventory in transit
One item of inventory or no interaction between items
Infinite planning horizon
Unlimited capital
“But we should just use the original Harris-Wilson Model and consider tweaking it later.
As I recall, the basic formula is:”
5
Coyle, John, et al.
Supply Chain Management: A Logistics Perspective
, 8
th
Edition, Mason, Ohio, Southwestern Cengage
Learning, 2009.
At the end of the meeting, Martin agreed to take the proposals and summarize them in
the following chart:
Order
Quantity
(units)
Number
of Cases
per Order
Orders
per
Year
Annual
Ordering
Cost
Annual
ICC
Annual
Total
Cost
Ferguson
EOQ to
nearest whole
case
EOQ
Patrachalski
QUESTIONS:
1.
What is the cost difference between Ferguson's proposal to order 4 cases each time
and Patrachalski's proposal to order 32 cases each time?
2. Lewin suggested looking at economic order quantity. Based on the lowest total annual
cost, what order quantity should Martin recommend?
3. Let's explore the concept of "robustness." Lewin’s proposal to use economic order
quantity may be unrealistic since SMC would like to place orders in whole cases. If the
order quantity is decreased
to the nearest whole case (which is a 2.78% reduction)
what percent would your total annual cost change? What percent would your annual
total cost change if the order quantity is increased
to the nearest whole case? Hint:
Use the formula ([New Total Cost / Old Total Cost] – 1 ).
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Silo Manufacturing Corporation – Part B
Vice President of Manufacturing Ferris Martin stopped by the office of SMC’s President
Robert Lewin and remarked, “Robert, your suggestion last month to use Economic Order
Quantity (EOQ) has already helped us optimize the trade-offs between inventory carrying costs
and order costs.”
“We are doing a better job of working as a cohesive company,” replied Lewin, “but we
are still faced with conflicting management goals. I recently hired Ed Davis as our new Inventory
Control Manager and plan to task him with the goal of reducing our corporate inventories by
8.9% at the next executive strategic roundtable. There are still many people in our company
that think it is a zero-sum game and Ed will have to manage his operations carefully so he does
not step on any toes.”
Two weeks later Ed Davis attended the executive strategic roundtable. The first agenda
item was the assignment of annual performance goals. The 8.9% goal to reduce corporate
inventories did not come as a surprise. In fact, Ed had already started looking at opportunities
to reduce order quantities to meet the goal. Since Lewin supported the implementation of
economic order quantity, Davis knew he would have to manage the variables used in EOQ in
order to succeed.
During the roundtable meeting many aggressive, yet obtainable, performance goals
were proposed. Davis was pleased to see Vice President of Sales Steve Smith, Financial
Comptroller Fred Ferguson, and Purchasing Director Peter Patrachalski all agree to goals to
improve their areas. Davis lef the meeting encouraged at the camaraderie and was delighted
that he had joined such a forward-thinking organization. In this organizational culture he might
even be able to implement a just-in-time inventory system!
The next morning afer a restful sleep, Davis sat down to his double espresso and
orange-cranberry-pistachio biscot to mull over his new performance goal to reduce corporate
inventories by 8.9%. It suddenly dawned on him: Smith, Ferguson, and Patrachalski’s goals all
made strategic sense but if Smith increased annual demand, the economic order quantity and
corporate inventory levels would increase. Likewise, if Ferguson and Patrachalski were also
successful, his inventory levels would further escalate. Their success would exacerbate his
failure. The only action he could take to positively counter these “improvements” was to
reduce the cost of placing an order. Getng to just-in-time may be another thing all together!
His dilemma reminded him of a quote from Albert Einstein:
6
“The mere formulation of a problem is far more ofen essential than its solution, which
may be merely a matter of mathematical or experimental skill. To raise new questions, new
possibilities, to regard old problems from a new angle requires creative imagination and marks
real advances.”
He would utilize the details for part number 64-1909 as a basis to determine what he
needed to do to meet his inventory reduction goal. Last year part number 64-1909 used 10,752
units at an average cost per unit of $112. The cost to place an order was $48 regardless of the
quantity ordered and the SMC cost to carry inventory was 32%.
6
"Albert Einstein." Quotes.net
. STANDS4 LLC, 2011. 21 February. 2011.
http://www.quotes.net/quote/9281.
QUESTIONS:
4.
What would the cost to place an order need to be for Davis to meet his inventory
reduction objective if Vice President of Sales Steve Smith achieves his goal to increase sales
by 9.6% (HINT: a 10% increase in sales of 100 units results in sales of 110 units).
5.
What would the cost to place an order need to be for Davis to meet his inventory
reduction objective if Vice President of Sales Steve Smith achieves his goal to increase sales
by 9.6% and
Financial Comptroller Fred Ferguson achieves his goal of reducing the cost to
carry inventory from 32.0% to 29.4%.
6.
What would the cost to place an order need to be for Davis to meet his inventory
reduction objective if Vice President of Sales Steve Smith achieves his goal to increase sales
by 9.6% and
Financial Comptroller Fred Ferguson achieves his goal of reducing the cost to
carry inventory from 32.0% to 29.4% and
Purchasing Director Peter Patrachalski achieves
his goal of reducing the average cost per unit by 5.2% (HINT: a 10% reduction in a $10 unit
cost results in a $9 unit cost).
7. What would the cost to place an order need to be if Davis implemented a just-in-time
approach so ordering 1 unit at a time is the optimal ordering quantity? Use the original
variables for part number 64-1909. Your answer must be accurate to six decimal places
(e.g. $47.123456)
8. Provide three (3) viable recommendations which would result in a lower cost
to
place
an
order
. Keep in mind that providing a "viable recommendation" means you must move
beyond theoretical statements and be immediately actionable. Do not skimp on your
details (but don't make anything up either)...you must indicate how
to lower the cost in
order to receive full points.
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