COMPLETE HARDWARE SUPPLY, INC.

Teaching Note Strategy Complete Hardware Supply is an exercise involving the control of inventoried items collectively. Data for a random sample of 30 items from the company's total of 500 items held in inventory are given. The objective is to manage the total dollar value allowed to be held as inventory. Several alternatives can be considered for changing inventory levels, some of which require an investment other than in inventory. The number of items that must be analyzed and the multiple scenarios that are to be examined can be computationally time consuming. It is strongly suggested that students use the INPOL module within LOGWARE to aid analysis. The current database has been prepared and is available in the LOGWARE software. The Base Case We begin with the current data optimized as a reorder point design. The optimum order quantities and associated inventory levels are found. The base case costs are shown as follows:

Fixed order quantity policy Purchase cost Transport costa Carrying cost Order processing cost Out-of-stock cost Safety stock cost Total cost Total investment
aIncluded in the purchase cost

$556,912 0 4,425 4,425 0 2,529 $568,291 $27,801

We note that optimizing the current design shows that investment of $27,801 exceeds the allowed investment level of $18,000. Ways need to be explored to reduce this.
Transmit Orders More Rapidly Instead of mailing orders to vendors, Tim O'Hare can buy a facsimile machine and transmit orders electronically. This scenario can be tested by reducing the lead times in the base case by two days, or (2/5) = 0.40 weeks and increasing order processing costs by two dollars, and then optimizing again. INPOL shows that there will be a slight increase in operating costs from $568,291 to $568,640, an incremental increase of $349. Projecting this to all 500 items, we have 349(500/30) = $5,817. Since both operating cost and inventory investment level increase, there is no economic incentive to implement this change. Faster Transportation Suggesting that vendors who are located some distance (>600 miles) from the warehouse use premium transportation is a possible way of reducing lead times, and therefore safety

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stock levels. Of course, the increase in transportation cost for those affected vendors is likely to lead to a price increase to cover these costs. This scenario is tested by reducing the lead-time in weeks to 2.2 for those vendors over 600 miles from the warehouse. For these same vendors, a five percent price increase is made. Compared with the base case, there is little change in the inventory investment ($27,801 vs. $27,746); however, operating costs increase. The total costs now are $585,490 compared with the base case of $568,291, an increase of $27,199. The major portion ($17,159) of this comes from the increase in price. We conclude that this is not a good option for Tim.
Reduce Forecast Error Reducing the forecast error involves reducing the standard deviation of the forecast error. Testing this option requires taking 70 percent of the base-case forecast error standard deviations and optimizing the design once again. These changes have a positive impact on operating costs and inventory investment. Operating cost now is $567,529 and inventory investment is $24,739. This is a saving in operating costs of $762 per year. For all 500, we can project the savings to be 762(500/30) = $12,700. Based on a simple return on investment, we have:

ROI =

12,700 0.25, or 25% / year 50,000

This would appear to be attractive since carrying costs are 25 percent per year and the company's return on investment probably makes up about 80 percent of this value.
Reduce Customer Service At this point, we have only accepted the idea of reducing the forecast error. However, inventory investment remains too high. We can now try to reduce it by reducing the service levels. This is tested by dropping the service index from its current 0.98 level to a level where inventory investment approximates $18,000. This is done, assuming the forecast software will be purchased and the forecast error reduced by 30 percent. By trial and error, the service index is found to be 0.54, which gives an investment level of $18,028. The revised service level compared with the base case is summarized below for the 30 items.

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Item 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Base case 99.88% 99.92 99.96 99.98 99.98 99.96 99.97 99.96 99.92 99.98 99.99 99.99 99.92 99.98 99.96

Revised 96.26% 98.02 98.54 99.15 99.45 98.60 98.84 98.61 97.29 99.26 99.70 99.43 97.30 99.14 98.84

Item 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

Base case 99.98% 99.90 99.95 99.89 99.97 99.69 99.97 99.97 99.96 99.92 99.97 99.93 99.89 99.97 99.91

Revised 99.56% 97.57 97.81 95.96 98.15 89.53 98.96 98.96 97.58 99.33 96.68 97.45 98.78 96.92 96.78

Notice how little the service level changes, even with a substantial reduction in the service index.
Conclusions Tim can make a good economic argument for purchasing software that will reduce the forecast error. The only questions here are whether the software can truly produce at least the error reduction noted and whether a 25 percent return on investment is adequate for the risks involved. Arguing to accept a service reduction in order to lower the investment level is a little less obvious since we do not know the effect that service levels have on sales. However, Tim may point out that the service levels need to be changed so little that it is unlikely that customers will detect the change. He might also raise the question as to whether customer service levels were too high initially, and suggest that customers be surveyed as to the service levels that they do need.

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