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Case Study Project #2

Alina Logounova

Nany Karlina

DS 855

Professor Bollapragada

San Francisco State University

Fall, 2010
Overview

1. Chapter 10 Case Study: Delivery Strategy at MoonChem


a. Annual cost of existing strategy
b. Considering different delivery options
c. Impact of the proposed recommendation on consignment inventory

2. Chapter 11 Case Study: Managing Inventories at Alko Inc.


a. Annual costs
b. Savings associated with NDC and recommendations
c. Recommendation and evaluation of other distribution systems
1. Chapter 10 Case Study: Delivery Strategy at MoonChem

MoonChem is a manufacturer of specialty chemicals that decides to examine its delivery options to its
customers. The necessary arose from concerns of inventory turnover being very low and discrepancies
between 20 percent of its customers carrying consignment inventory, but over half of the inventory of
MoonChem being in consignment with its customers. MoonChem has eight manufacturing plants, where
base chemicals are made, and forty distribution centers, where chemicals are being mixed to produce
various products and then are being shipped to its customers.

In order to examine current distribution operations, John Kresge, Vice President of Supply Chain,
decides to focus on the state of Illinois area with zip code 615, Peoria, which customers, who carry
consignment inventory, are supplied from Chicago distribution center. MoonChem’s customers’ data is
given in the table 1.a.

Customer category Number of customers Demand per month/ year


Small 12 1,000/ 12,000
Medium 6 5,000/ 60,000
Large 2 12,000/ 144,000
Table 1.a

MoonChem ships its products by trucks, which have 40,000 pound capacity. Transportation cost is fixed
at $350.00 with additional $50.00 for each drop off. Given that MoonChem ships its products independently
to each customer, transportation cost totals to $400.00 per shipment. In addition, MoonChem sends full
truckloads to customer with consignment. In addition, each pound of inventory in consignment costs
MoonChem $1.00. The company also has a holding cost of 25%.

1.a. Total annual cost of existing strategy

Examining current delivering operations, we have to consider that shipments to customers are made
independently.

Lot sizes and costs for independent ordering:

Small Medium Large


Demand per year 12,000 60,000 144,000
Fixed cost/ order $400.00 $400.00 $400.00
Optimal order size 6,197 13,856 21,466
Cycle inventory 3,099 6,928 10,733
Annual holding cost 775 1,732 2,683
Order frequency/ year 1.94 4.33 6.71
Annual ordering cost 775 1,732 2,683
Average flow time (weeks) 13.4 6.0 3.9
Annual cost 1,550 3,464 5,366
Based on calculations (see Appendix 1), annual cost of MoonChem’s current strategy of sending full
truckloads to each customer in the Peoria region to replenish consignment inventory is $10,380.

1.b. Considering different delivery options

There are two alternate distribution models that can be evaluated and implemented instead of the
current distribution operations, if found more efficient.

First, let’s consider the model when products are ordered and delivered jointly.

Lot sizes and costs for products being ordered and delivered jointly for all three customers:

Small Medium Large


Demand per year 12,000 60,000 144,000
Optimal order size 1,633 8,163 19,592
Cycle inventory 817 4,082 9,796
Annual holding cost 205 1,021 2,449
Average flow time (weeks) 3.5 3.5 3.5

Fixed cost (S) per order is $350.00 plus $50.00 per drop off. Therefore, total fixed cost per order is $500.00.

Ordering frequency (n) is 7.35. Annual ordering cost comes up to $3,675.00.

Based on calculations (see Appendix 2), annual cost of proposed strategy 1 of sending products
jointly to all three customers in the Peoria region to replenish consignment inventory is $7,350.

Second, let’s consider the model when products are ordered and delivered jointly for selected
customers.

Lot sizes and costs for products being ordered and delivered jointly for selected subset of customers:

Small Medium Large


Demand per year 12,000 60,000 144,000
Order frequency/ year 3.88 7.75 7.75
Optimal order size 3,093 7,742 18,581
Cycle inventory 1,547 3,871 9,291
Annual holding cost 387 968 2,323
Average flow time (weeks) 8.46 3.35 3.35

Order frequencies for large, medium and small customers for the scenario of independent deliveries
were calculated to be 6.71, 4.33 and 1.94, respectively. The most frequent ordering therefore is required by
large customer. Taking order frequency of large customer as a base, relative order frequencies were
evaluated for small and medium customers being 5.48 and 12.25, respectively. By further calculations, it
was determined that small customer’s order will be shipped with every other shipment and medium
customer’s order will be included with every shipment. Recalculating ordering frequency to the respect of
fixed costs and varying costs, the order frequency for large, medium and small customers were determined
to be 7.75, 7.75 and 3.88, respectively.

Based on calculations (see Appendix 3), annual cost of proposed strategy 2 of sending products
jointly to all three customers in the Peoria region to replenish consignment inventory is $7,360. There has
been discrepancy between holding cost and ordering cost, which differ by few dollars. That can be
attributed to rounding errors. Even if the lowest of two would be taken (holding cost: $3678) to reproduce
the other one, the annual costs would come to $7,356.00.

The recommendation to MoonChem would be to adopt joint shipping for all three customers because
such delivery strategy costs less ($7,350.00 vs. independent deliveries of $10,380.00 and joint deliveries for
selected subset of customers of $7,360.00). While, joint shipping’s smaller costs intuitively make sense
because fixed costs associated with deliveries are being distributed between customers; shipping jointly to
selected subset of customers increases such costs. This can be explained by increased order costs due to
more frequent ordering pattern needed to accommodate such model for some customers and increased
holding costs for the other customer, which has to hold more inventories on hand, since its ordering
frequency is being reduced. As a consequence, the recommendation at the time would be to adopt joint
shipping to all three customers.

1.c. Impact of the proposed recommendation on consignment inventory

The proposed recommendation of adopting joint shipping for all three customers, besides dropping
ordering and holding annual costs, will also reduce the consignment inventory for the region by
approximately 29% (independent deliveries: 41,519 products per order combined from each customer, joint
delivery: 29,388 products per order).
Appendix 1
Optimal order size: Cycle Inventory: Annual holding cost:

2 DS Q
Q=
√ hC
I=
2
AHC = I*H, where H = h*C

2∗12,000∗400 6,197
Qsmall =
√ 1∗0.25
= 6,197 Ismall =
2
=3,099 AHCsmall = 3,099*0.25 = 775

2∗60,000∗400 13,856
Qmedium =

6,928*0.25 = 1,732
1∗0.25
= 13,856 Imedium =
2
=6,928 AHCmedium =

2∗144,000∗400 21,466
Qlarge =

2,683
√ 1∗0.25
= 21,466 Ilarge =
2
=10,733 AHClarge = 10,733*0.25 =

Order frequency: Annual ordering cost:

n* =
√ DhC
2S
AOC = ( QD )∗s
n*small =
√ 12,000∗0.25∗1
2∗400
= 1.94 AOCsmall = ( 12,000
6197 )
∗400 = 775

n*medium =
√ 60,000∗0.25∗1
2∗400
= 4.33 AOCmedium = ( 60,000
13,856 )
∗400 = 1,732

n*large =
√ 144,000∗0.25∗1
2∗400
= 6.71 AOClarge = ( 144,000
21,466 )
∗400 = 2,683

Average flow time: Annual material Cost: Annual cost:

Q
∗1
AFT = 2 AMC = C*D AC = AHC + AOC
∗52
D

6,197
∗1
AFTsmall = 2 = 13.4 AMCsmall = 1*12,000 ACsmall = 775 + 775 =1,550
∗52
12,000

= 12,000
13,856
∗1
AFTmedium = 2 = 6.0 AMCmedium = 1*60,000 ACmedium = 1,732 + 1,732 =3,464
∗52
60,000

= 60,000

21,466
∗1
AFTlarge = 2 = 3.9 AMClarge = 1*144,000 AClarge = 2,683 + 2,683 = 5,366
∗52
144,000

= 144,000

Appendix 2
Order frequency: Optimal order size:

( Ds+ Dm+ Dl ) hC D
n* =
√ 2(S+ ss+sm+ sl)
Q=
n∗¿¿

12,000.00
n* =
√ (12,000+60,000+144,000)∗0.25∗1
2∗(350.00+50.00+50.00+50.00)
= 7.35 Qsmall =
7.35
= 1,633

60,000.00
Qmedium = = 8,163
7.35

144,000.00
Qlarge = = 19,592
7.35

Cycle Inventory: Annual holding cost: Annual ordering cost:

Q
I= AHC = I*H, where H = h*C AOC = (n*) ¿ s
2

1,633
Ismall = =817 AHCsmall = 817*0.25 = 205 AOC = 7.35∗500 = 3,675
2

8,163
Imedium = =4,082 AHCmedium = 4,082*0.25 = 1,021
2

19,592
Ilarge = =9,796 AHClarge = 9,796*0.25 = 2,449
2

Average flow time: Annual cost:


Q
∗1
AFT = 2 AC = AHC + AOC
∗52
D

1,633
∗1
AFTsmall = 2 = 3.5 ACsmall = 3,675 + 3,675 =7,350
∗52
12,000

8,163
∗1
AFTmedium = 2 = 3.5
∗52
60,000

19,592
∗1
AFTlarge = 2 = 3.5
∗52
144,000

Appendix 3
Order frequency: Relative order frequency: Relative order frequency:

DhC
n* =
√ 2(S+ s)
n* = n*large = 6.71 (relative to n*)

12,000∗0.25∗1 Dhc n∗¿


n*small =
√ 2∗( 350.00+50.00 )
= 1.94 n** =
√ 2s
m* =
n∗¿
¿

60,000∗0.25∗1 12,000∗1∗0.25 6.71


n*medium =

1.22
√ 2∗(350.00+50.00)
2
= 4.33 n**small =
√ 2∗50
= 5.48 m*small =
5.48
=

144,000∗0.25∗1 60,000∗1∗0.25 6.71


n*large =
√ 2∗(350.00+50.00)
1
= 6.71 n**medium =
√ 2∗50
= 12.25 m*medium =
12.25
= 0.55

Order frequency: Order Size:

∑ hCimiDi ¿
n=
√ 2∗¿ ¿
¿
Q=
D
n∗¿¿
12,000∗0.25∗1∗2+60,000∗0.25∗1∗1+144,000∗0.25∗1∗1
n=

= 3,093
50 50 50
2∗(350+ + + )
1 1 2
= 7.75 Qsmall =
12,000.00
3.88

60,000.00
n*small = 3.88 Qmedium = = 7,742
7.75

144,000.00
n*medium = 7.75 n*large = 7.75 Qlarge = = 18,581
7.75

Cycle Inventory: Annual holding cost: Average flow time:

Q
Q ∗1
I= AHC = I*H, where H = h*C AFT = 2
2 ∗52
D

3,093
3.093 ∗1
Ismall = =1,547 AHCsmall = 1,547*0.25 = 387 AFTsmall = 2 = 8.46
2 ∗52
12,000

7,742
7,742 ∗1
Imedium = =3,871 AHCmedium = 3,871*0.25 = 968 AFTmedium = 2 = 3.35
2 ∗52
60,000

18,581
18,581 ∗1
Ilarge = =9,291 AHClarge = 9,291*0.25 = 2,323 AFTlarge = 2 = 3.35
2 ∗52
144,000

Annual ordering cost: Annual cost:

AOC = n* ¿ S + n*large * slarge + n*medium * smedium + n*small * ssmall AC = AHC + AOC

AOC = 7.75∗350+7.75∗50+7.75∗50+3.88∗50 = 3,682 ACsmall = 3,682 + 3,678 =7,360

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