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Inventory Control System The sales and finance teams historically…
Inventory Control System
The sales and finance teams historically set the inventory control policies at SG, and this continued after SG expanded the warehouse network. Company policies regarding target inventory levels at the warehouses were regularly violated. Any trunk stock allocated to individual sales representatives counted against the target inventory level for the originating warehouse.
SG used two separate computer systems to manage the flow of inventory: one for ordering and inventory tracking and another for manufacturing and warehousing operations. Inventory-control policies at the warehouses included minimum stock orders, which SG established for every product. If at the end of the 2-week review cycle a product warranted reordering, the ordering system would automatically generate a manufacturing order. Stock levels were based on on-hand plus in-transit inventory. Inventory write-offs due to theft, loss, or damage have historically been about 1% of total product costs. Once a customer signed a contract, the customer could place orders directly with a sales representative, online, or through the customer’s own materials management software, provided it was configured to send orders to SG. In 2009, SG processed 119,855 orders.
Customer orders were routed to the warehouse serving the appropriate sales territory. If the products were in stock, the warehouse typically had each order ready for shipment within 1 day. A requested product that was not in stock at the warehouse represented an unfilled order and counted against the service level for the warehouse. The inventory management system would identify whether any planned shipments from the manufacturing facility included the product or if other warehouses in the network had the product in stock. SG attempted to optimize delivery costs and customer responsiveness by determining whether it was more effective to wait for delivery from the manufacturing facility, transfer inventory from another warehouse, or make separate shipments to the customer from other warehouses. Several factors were taken into account in this evaluation, including the size of the customer order, the importance of the customer account, the time until the next shipment from the manufacturing facility, and whether the missing product could be included in existing shipments between warehouses. (See Exhibit 4 for a summary of the order fulfillment process.
The warehouses placed orders with the manufacturing facility once every two weeks. Once an order was received from a warehouse, the inventory was considered “in-transit” and was assigned to the ordering warehouse. The “in-transit” period typically lasted five business days during which time the product was prepped, loaded, shipped, unloaded and stocked at the destination warehouse. Currently stock was being delivered from the manufacturing facility to the seven regional warehouses by a third-party bulk shipper at a cost of $0.40 per pound. SG did not have to pay for third-party bulk shipping to the Waltham warehouse since it is adjacent to the manufacturing facility.
Inventory was delivered from the warehouse to customers by a ground delivery service called Winged Fleet. Typical shipping weights, shipping value, and shipping costs for case-packed products are shown in Exhibit 5
Inventory Challenges
Shipping costs and inventory holding costs were steadily rising at the company. In January 2009, Melissa Hayes sent a memo to all sales and warehouse managers to reinforce the objectives of the expanded warehouse network:
1. Improve order fulfillment times for new and existing customers.
2. Reduce the number of customer backorders.
3. Reduce the number of times the sales team needed to get involved to track down or otherwise attempt to expedite delayed customer orders.
4. Increase inventory turns to improve the use of the firm’s financial resources.
SG monitored all inventory transfers from the Waltham warehouse to other warehouses. When SG shipped inventory to customers, it used the data to generate invoices, compute commission payments, conduct sales analyses, and update inventory records. Executives at SG believed that the central inventory records were, at best, an approximation of the actual inventory across all warehouses. In addition to record inaccuracies caused by damaged, lost, and stolen goods, there were opportunities for human error, including inaccurate returns processing, improperly tracking of warehouse transfers, and erroneous order fulfillment. These factors led to a mismatch between computer records and actual inventory.
In March 2009, SG attempted to gain a better tally of the inventory balances by taking physical counts of inventory at all warehouses and of the stock in the hands of salespeople. Without any improvements in the warehouse processes, however, the problems continued and errors gradually crept into the inventory records. Salespeople regularly asked warehouse managers to perform manual inventory checks to confirm that product was available before customers placed large orders, or to try to locate products that were on backorder in other warehouses. Even if a warehouse manager was able to locate sufficient amounts of the backordered product, the time required to track it down, plus the time and cost of the inter-warehouse transfer, absorbed much of the profit from the sale.
Addressing the Inventory Management Challenge
Gregory and Hayes knew they could not afford to maintain the high rate of growth in inventory. SG’s plans to expand its international distribution network would have to be complemented by the development of an effective inventory management system. The severity of the inventory problems highlighted the importance of distributing available inventory as efficiently as possible.
Proposed Policy Changes
Gregory and Hayes gathered the warehouse managers to brainstorm ideas. They developed several proposed policy revisions to alleviate the company’s inventory problems. They also decided to create the Manager of Inventory Planning position, reporting to Hayes, which Beane was hired to fill. This position would be responsible for conducting a more detailed analysis of the situation and implementing any approved initiatives. The proposed policy revisions included:
1. greater enforcement by the warehouse managers of maintaining only sufficient inventories in the warehouses to meet the company’s target service level of 99%
2. discontinuation of the practice of allowing salespeople to maintain trunk stock
3. creation of daily reports and weekly summaries on inventory movements for every warehouse
4. periodic physical audits and control procedures for all warehouse stocks.
During her due diligence effort, Beane learned that the proposed policy revisions were not popular with the sales managers. They were concerned about losing their trunk stock and having less influence on how inventory was allocated across the warehouses and, therefore, the sales territories. Several of the sales managers believed that these policies would undermine their ability to maintain hard-won customer accounts.
Centralizing the Warehousing Function
In addition to assessing the impact of the proposed policy changes, Beane considered new options to address the inventory issues. One possibility was to recentralize the North American warehousing function in Waltham and close down all or some of the regional warehouses. North American customer orders would be filled from fewer locations, possibly even one location. This would allow SG to pool its inventory in order to meet demand. Winged Fleet had already provided rates for customer delivery across multiple regions.
Outsourcing the Warehousing Function
In a late-night discussion with a former college classmate who ran a business importing shoes from Asia, Beane learned about Global Logistics, a competitor to Winged Fleet, which provided a delivery service that included centralized warehousing in Atlanta. Beane gathered preliminary rates and service information from Global Logistics. Based on SG’s daily volume of orders, Global Logistics offered the company discounted rates and agreed to cover all warehouse rental charges. All order-fulfillment and inventory-control functions would be administered by Global Logistics personnel. SG would still be responsible for customer order processing and billing. Global Logistics’ prices were for guaranteed 3-day delivery, but for a substantial premium, 1-day delivery could also be provided. (See Exhibit 5 for a listing of Global Logistics’ rates.)
The advantages of using Global Logistics were attractive: By outsourcing warehousing, inventory management, and order fulfillment (including picking, packing, and shipping), SG’s senior managers would be able to focus on increasing sales, understanding emerging customer needs, and developing the next generation of the firm’s products. However, the advantages of the Global Logistics option were mitigated by the fact that all goods would have to first be shipped from Waltham to Atlanta. Goods could be transported to Atlanta using the same bulk shipment option used to deliver inventory to SG’s regional warehouses.
Preliminary Analysis
To assess the impact of utilizing Global Logistics, Beane performed some preliminary calculations of the impact on shipping costs by employing the numbers in Exhibit 5. Using Global Logistics, transporting one 10-pound shipment of glassware from Waltham to Dallas involved shipping the package from Waltham to Atlanta for $4 (at $0.40 per pound) and then from Atlanta to Dallas for $22.25. The total shipping cost was $26.25. If SG used the regional warehouse in Dallas, the total shipping cost was $20.60. If SG centralized warehousing in Waltham and used Winged Fleet, the total shipping cost was $23.60. At first glance, Global Logistics seemed to be an expensive option, but Beane believed it would be worthwhile to conduct a more detailed evaluation of the different options that included all the other potential cost impacts.
SG’s finance department provided Beane with several additional critical facts for her analysis: The company had a 14% cost of capital.
Customer orders were spread approximately evenly across all of the delivery regions.
The average customer shipment weighed 9.8 pounds.
Prior to the recent inventory problems the company had typically achieved an inventory turnover ratio close to 6.0.
25% of the 2009 inventory balances was raw materials / work in process, whereas the rest was finished-goods inventory across the North American and international regions (see Exhibit 6).
Prices are budgeted to stay flat in 2010, and the forecast 20% growth in sales in 2010 is entirely due to a forecast increase in the number of orders.
As daylight faded, Beane leaned back in her chair. She knew it was imperative that the company have sufficient capital to expand its international distribution network and make the $10 million investment in plant equipment. Rapid growth, innovative product features, and a broad customer base were no guarantee that SG’s future was secure, however. Faced with the inventory challenges, senior management had to make important decisions. What were the merits and risks of implementing the proposed policy changes, of reverting back to fewer warehouses, and of centralizing and outsourcing inventory management with Global Logistics? Were there other creative options the team should consider? Beane reached for her coffee as if the rich brew might contain the answers.
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Exhibit 4 Key Order-Fulfillment Steps Sales Customer Finance
Warehouse Submit Order Finalize -online Check inventory
contract fax within sales territory call Sufficient Insuffi…
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Exhibit 5 Weight and Shipping Costs for Typical Products (2009)
Total Foreca Avera pounds st pounds Pounds/c Unita/c ge shipped
shipped ase ase price/case In 2009 in 2010 Product ca…
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Winged Fleet 3-day rates are calculated using region, fixed fee
and weight fees The regions are West (equivalent to Northwest
and Southwest regions for Global Logistics), Central, a…
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Shipping Comparison Centralized warehousing in Waltham 23.60
Winged Fleet: Waltham warehouse to Dallas customer $ 23.60
Total Decentralized warehousing 4.00 Bulk transport: …
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1. What are the problems facing SG in January 2010?
2. How much external funding will have to be raised in 2010 in order to finance operations?
3. How do SG’s problems illustrate the relationship between the number of warehouses and
inventory levels?
4. What alternatives are available for dealing with the inventory problems? How would you
evaluate the alternatives?
5. What actions should Ava Beane propose ?
