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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
