Managing inventories at New Light inc.
New Light began in 1943 in a garage workshop set up by Roy Williamson at his Denver home. Roy had always enjoyed tinkering, and in February 1948 he obtained a patent for one of his designs for lighting fixtures. He decided to produce it in his workshop and tried marketing it in the Denver, CO. area. The product sold well, and by 1957 New Light had grown to a $3 million company. Its lighting fixtures were well known for their outstanding quality. By then, it sold a total of five products. In 1963, Roy took the company public. Since then, New Light has been very successful, and the company has started distributing its products nationwide. As competition intensified in the 1980s, New Light introduced many new lighting fixture designs. The company’s profitability, however, began to worsen despite the fact that New Light had taken great care to ensure that product quality did not suffer. The problem was that margins had begun to shrink as competition in the market intensified. At this point, the board decided that a complete reorganization was needed starting at the top. Tim Jones was hired to reorganize and restructure the company. When Jones arrived in 2014, he found a company teetering on the edge. He spent his first few months trying to understand the company business and the way it was structured. Jones realized that the key was in the operating performance. Although the company had always been outstanding at developing and producing new products, it had historically ignored its distribution system. The belief within the company was that once you make a good product, the rest takes care of itself. Jones set up a task force to review the company’s current distribution system and come up with recommendations.
The current distribution system
The task force noted that New Light had 100 products in its 2014 line. All production occurred at three facilities located in the Denver, CO. area. For sales purposes, the contiguous United States was divided into five regions. A DC owned by New Light operates in each of these regions. Customers placed orders with the DCs, which tried to supply them from product in inventory. As the inventory for any product diminished, the DC in turn ordered from the plants. The plants scheduled production based on DC orders. Orders were transported from plants to the DCs in TL quantities because orders sizes tended to be large. On the other hand, shipments for the DC to the customer were LTL. New Light used third party trucking company for both transportation legs. In 2014, TL cost from the plant to DCs averaged $0.09 per unit. LTL shipping cost from a DC to a customer averaged $0.10 per unit. On average, five days were necessary between the time a DC placed an order with a plant and the time the order was delivered from the plant.
The policy in 2014 was to stock each item in every DC. A detailed study of the product line has shown that there were three basic categories of products in terms of the volume sales. They were categorized as type High, Medium, and Low. Demand data for a representative product in each category is shown in table 1. Product 1, 3, and 7 are representative of High, Medium, and Low demand products, respectively. Of the 100 products that New Light sold, 10 were of type High, 20 of type Medium, and 70 of type Low. Each of their demand was identical to those of the representative products 1, 3, and 7, respectively.
The task force identified that plant capacities allowed any reasonable order to be produced in four days. Thus, a plant shipped out an order four days after receiving it. After one day in transit, the order reached the DC. The replenishment lead time was thus five days. The holding cost incurred was $0.15 per unit per day whether the unit was in transit or in storage. All DCs carried safety inventories to ensure a CSL of 95 percent.
Alternative distribution systems
The task force recommended that New Light build a national distribution center (NDC) outside Denver. The task force recommended that New Light close its five DCs and move all inventory to the NDC. Warehouse capacity was measured in terms of the total number of units handled per year (i.e. the warehouse capacity was given in terms of the annual demand supplied from the warehouse). The cost of constructing a warehouse is shown in table 2. However, New Light expected to recover $50,000 for each warehouse that it closed. The CSL out of the NDC would continue to be 95%. Given that NDC is close to Denver, the inbound transportation cost from the plants to the NDC would fall to $0.05 per unit. The total replenishment lead time for the NDC would still be five days (four days for production + one day in transit). Given the increased average distance, however, the outbound transportation cost to customers from the NDC would increase to $0.24 per unit.
Other possibilities the task force considered include building a national distribution center while keeping the regional DCs open. In this case, some products would be stocked at the regional DCs, whereas others would be stocked at the NDC.
Jones’ decision
Tim Jones pondered the task force report. It had not detailed any of the numbers supporting the decision. He decided to evaluate the numbers before making his decision.
Questions
What is the annual inventory and distribution cost of the current distribution system?
What are the savings that would result from following the task force recommendation and setting up an NDC? Evaluate the savings as the correlation coefficient of demand in any pair of regions varies from 0 to 0.2, 0.4, 0.6, 0.8, and 1.0. Do you recommend setting up an NDC?
Suggest other options that Jones should consider. Evaluate each option and recommend a distribution system for New Light that would be most profitable.
Note: Show all work or attach spreadsheet for computation.
Table 1. Distribution of daily demand at New Light
Region1 Region2 Region3 Region4 Region5
Part1 Mean 35.48 22.61 17.66 11.81 3.36
Part 1 Std. dev. 6.98 6.48 5.26 3.48 4.49
Part 3 Mean 2.48 4.15 6.15 6.16 7.49
Part 3 Std. dev. 3.16 6.20 6.39 6.76 3.56
Part 7 Mean 0.48 0.73 0.80 1.94 2.54
Part 7 Std. dev. 1.98 1.42 2.39 3.76 3.98
Table 2. Construction costs for NDC
Units sold 200,000 400,000 600,000 800,000 1,000,000 1,200,000
Dollars 300,000 800,000 1,000,000 1,300,000 1,350,000 1,400,000