1 1 isye 6203 transportation & supply chain systems john h. vande vate fall 2011

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ISyE 6203Transportation & Supply

Chain Systems John H. Vande Vate

Fall 2011

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My Approach• What aspects of the financial goals of the

organization do Supply Chain activities contribute to?

• How do we measure these aspects of Supply Chain activities?

• Financial goals often conflict. What tools are available to help Supply Chain find the right balance

• What tools are available to help improve SC performance

• Motivate by simple examples• Integrate via an industrial project

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Goals• That we understand the main SC objectives• That we can assess the effects of proposed

initiatives on those objectives• That we develop some skill and intuition for

identifying effective initiatives• That we are armed with some practical tools

for designing, balancing and optimizing SC activities.

• That we have some real experience doing all of these

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Deterministic vs Stochastic• Organizations are adept at managing

forecasted flows

• Most still struggle with forecast (in)accuracy and unforecasted variability

• We will start with a deterministic view through the mid-term.

• Focus on managing variability after the mid-term

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Project Teams• We will work in teams of 4-5 on a project and

on improving “Our Company” performance• You should select your team members by

Thursday, September 1st end of class • One person from each team should send me an

e-mail with the subject line 6203 Teams with– The names and contact information (e-mails and

phone numbers) of the team members– Resumes of all the team members– T-Square User IDs of the team members

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The Projects• Dell – Confirmed but evolving

– Project 1 Optimization of the 3rd Party Distributor network– Project 2 Optimization of FedEx Ground and FedEx Home

networks– Project 3 Sensitivity of network to cost drivers, eg pallet weight – Project 4. Returns network

• UTi – 3PL and Freight Forwarder– How much capacity on a lane should we secure via block space

agreements– How would a change in the variability of a customer’s actual

freight volumes (weight and cube) affect UTi’s profitability on that lane

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The Projects• Audi

– TBA

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Project Structure3 Steps (Adaptable)• Step 1: Formal project statement, summary of the

data and rough estimates of the potential impacts of various alternatives.

• Step 2: Analyze and optimize the top alternatives and develop detail assessments of their cost and service impacts

• Step 3: Present your assessment and recommendations to management, including an evaluation of more qualitative risks and opportunities associated with each strategy.

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Deliverables

• Each team will make a 20 – 30 minute presentation to me for each step.

• Each team will make at least one presentation to the class (most will present the final project)

• Each team will present to the client (probably via phone or internet)

• An organized CD or T-Square files that facilitate the transfer of your project.

• I will set up Team Project Forums on T-Square

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First Steps

• Organize your team

• Introductory conference call with sponsor (working to schedule these the week of Sept 5. TBA)

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Conference Calls• We will schedule roughly bi-weekly

conference calls with our sponsor.• Usually in 226 (arranged via Meka Wimberly

meka.wimberly@isye.gatech.edu)• Not necessary that everyone be there, but it’s

better. • Someone from you team should take

careful notes and post them as meeting minutes on the Project Forum

• You are responsible for organizing conference calls.

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Course Organization• Two Exams• Mid-term • Final: Tuesday, December 13th from 11:30 – 2:30• Grading:

– Project 30%– Mid-term: 30%– Final: 30%– Team Presentations: 10%

• Warning: People struggle with my exams• Academic Honesty

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Text• No text book. • I’ve listed some good resources on the class web

page (see T-Square)• I will provide selected readings and links to

additional information• Radical Tools (an Excel Add-in) in the Labs• MapPoint 2010 available for free from

http://msdn08.e-academy.com/gatech_isye I believe it comes as a DVD and so takes time to

deliver. Please let me know if you learn otherwise.

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Questions?• Feel free to send questions via e-mail• Or drop by my office: 222 of old ISyE bldg• Feel free to schedule a meeting via e-mail• Anonymous feedback on each lecture via T-

Square (under Tests & Quizzes – I used “Anonymous grading only” so I don’t see your identity).

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Travel• I have to be out of the country from

September 10th through 22nd

• I will arrange three guest lectures during that period

• One classes set aside for team project meetings

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Our Company

• Today: Introduce Our Company and evaluate its performance

• Coming Weeks: Develop a distribution strategy to improve Our Company’s financial performance

• These will be Team Presentation Assignments

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Overview

• Products:– Computers: CPU, Monitor– Televisions: TV and Console

• Stores– 100 across the US – Sell 10 TVs and 10 computers per day– 250 days/year

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Components

CPUs TV/Monitor ConsoleCost $300 $400 $100

Weight 5 lbs 10 lbs 30 lbs

From Green Bay Indianapolis Denver

We assume atruck holds 30,000 lbs

and travels 500 miles/day

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Current Operations

• All direct shipments in full truckloads

2020

Simplification • Shipments on the order of 1,000 miles

F

F

F

Green Bay

Indianapolis Denver

Use your head!Make an estimate.Refine it. Averages Green Bay: 969Indianapolis: 854Denver: 1,006

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  CPUs TV/Monitor ConsoleCost $300 $400 $100

Weight 5 lbs 10 lbs 30 lbs

From Green Bay Indianapolis Denver

Our Company.xls

• Enable Macros– ArcCos

– Distance: Computes the distance in miles between two latlong coordinates

– Or you can use the Radical Tools add in available in the labs. (We won’t work with distance much initially)

• Components: Cost, weight, source

• Products: BOM, Selling price

• Locations: LatLongs of stores and plants, distances

• Financials: Income Statement, Balance Sheet, Metrics

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Our Company.xlsOur Company

Income Statement (all figures in 000's)% of Revenue

Revenue 450,000$ 100%COGS 301,410$ 67.0%

Raw Materials 300,000$ 66.7%Transportation 0.0%Labor 1,410$ 0.3%

Gross Margin 148,590$ 33.0%SG&A 26,200$ 5.8%Other Operating Expenses 500$ 0.1%Operating Income 121,890$ 27.1%Other Income -$ 0.0%Financial Expenses 6,500$ 1.4%Income before Taxes 115,390$ 25.6%Provision for Taxes 28,732$ 6.4%Consolidated Net Income 86,658$ 19.3%

NOPAT 93,158$ Invested Capital 257,220$ SPEED 1.75 ROIC 36%DSO 15 daysDII - daysDPO 30 daysCash-to-Cash Cycle (15) days

Compute transportation costs using $1 per mile, 30,000 lbs per truck and average 1,000 miles to store

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Our Company.xlsOur Company

Balance Sheet (all figures in 000's)

AssetsCurrent Assets:

Cash and cash equivalents 5,000$ Trade accounts receivables 18,493$ Inventory -$

At Green BayAt IndianapolisAt DenverAt StoresPipeline

Other current assets 2,500$

Total Current Assets 25,993$ Property & Equipment, net 260,000$ Other Assets 1,000$

Total Assets 286,993$

Liabilities & Stockholders' EquityCurrent Liabilities:

Accounts Payable 24,773$ Short-term debt -$

Total Current Liabilities 24,773$ Long-term debt 130,000$ Other Liabilities 250

Total Liabilities 155,023$

Total Stockholder's Equity 131,970$

Total Liabilities and Stockholders' Equity 286,993$

Compute inventory values:

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Arrow Electronics Annual Report

• “Operating efficiency and working capital management remain a key focus of the company's business initiatives to grow sales faster than the market, grow profits faster than sales, and increase return on invested capital.”

Market Share

Profitability Return on invested capital

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SC & Finance“Corporation managers generally claim that

they have four broad responsibilities: to consumers, to employees, to stockholders, and to the general public … each group is on an equal footing: the function of management is to secure justice for all and unconditional maxima for none. Stockholders have no special priority; they are entitled to a fair return on their investment, but profits above a ‘fair’ level are an economic sin.”

Sutton et al. The American Business Creed 1956

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Financial Goals

Financial Performance

Profitability Revenue Growth Capital Utilization

Income Statement

Balance Sheet

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Revenue• SC helps drive revenue

– Superior service commands higher price and loyalty

– Product availability drives sales

– Integrated operations can become a barrier to changing suppliers

– Speed of product introduction can win market share

– …

• Our Company: Revenues = $450 Million

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Income Stmt: Profitability

Profitability

COGS SG&ADepreciation &

Amortization

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Profitability• COGS: Cost of Goods Sold

– Includes all costs of material, labor, and allocated overhead, purchase, conversion and other costs incurred in bringing the inventories to their present location and condition.

– Prices change. So there are various methods for reconciling:

• specific identification, • first-in first-out (FIFO)• average cost

– That’s accounting, we won’t worry to much about the accounting standards.

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COGSYou can read more about COGS athttp://en.wikipedia.org/wiki/Cost_of_goods_soldOr for a quick practical overview, http://learndirecthmmdemo.lmmattersonline.com/courses/hmm10/budgeting/documenting_revenue_forecasts.htmlOur Company COGS consists of

Raw Materials: $300 Million Labor: $1.41 Million Transportation: ?

Not required

Not required

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Gross Margin

• Gross Margin = Revenue – COGS• Gross Margin as % of Sales =

Our Company: Low transportation costs ensure high Gross Margin

For more details seehttp://en.wikipedia.org/wiki/Gross_Margin

Revenue Revenue COGS

Not required

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SG&A

• SG&A: Selling, General & Administrative includes costs for research and development, product design, marketing, distribution, customer service, commissions, administration, and overhead.

• Our Company: SGA = $26.2 Million • For more discussion see, for example,

http://www.investopedia.com/terms/s/sga.aspNot

required

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Depreciation & Amortization

• Typically not a major SC consideration for us. Has to do with expensing large capital asset investments like plants and equipment

• Except for Depreciation, Profitability is driven by revenue and operating EXPENSES

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Operating Income (EBIT)• Earnings Before Interest & Taxes• Gross Margin minus

– SG&A– Amortization & Depreciation– Impairments and other expenses

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Balance Sheet: Capital Utilization

Capital Utilization

Fixed Asset Utilization

Working Capital Utilization

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Why Capital Utilization?

• Might find “Capital Productivity: Why the US Leads and Why it Matters” interesting.

• McKinsey Quarterly, 1996 Issue 3• Available from eJournals at

www.library.gatech.edu• Focus on “Why it Matters”. Might be

interesting to reflect on the “Why US leads” aspects in light of financial crisis.

Not required

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Digression on US vs German Capital Utilization

• Differences in capital markets

• Differences in employment models

• Differences in political economies

• A broader perspective on “goldplating”

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Capital Utilization

• “Productivity” of capital

• How well capital investments are employed to deliver goods and services

• From an investor perspective, related to the return available from investment

• Note the INVESTMENT perspective.

• Capital Utilization driven by Revenue and INVESTMENT

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Productivity of Capital• Productivity of Capital (SPEED)

• Return on Invested Capital (ROIC)

• Our Company: Reducing Inventories improves SPEED and ROIC

• For more information see• http://news.morningstar.com/classroom2/course.asp?do

cId=145095&page=9&CN=COM

RevenueInvested CapitalSPEED

NIBCLs -Cash Excess - Assets TotalTaxes - Income Operating

Capital InvestedNOPATR OIC

Not required

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NOPAT & NIBCLs

• NOPAT: Net Operating Profit After Taxes

• NIBCLs: Non-interest bearing current liabilities, eg., accounts payable

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Two kinds of Capital

• Fixed Capital Assets– Plants and Equipment

• Working Capital– Inventories or raw materials and finished goods

– Accounts receivable

– Accounts payable

• For more on Working Capital see

http://en.wikipedia.org/wiki/Working_capitalNot

required

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Working Capital

• The cash required to finance operations

• The Cash-to-Cash cycle- Organization must have capital to fund raw

materials, etc. from the time it pays for them to the time it’s customers pay for the corresponding finished goods

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Working Capital

Working Capital

Accounts Receivable

InventoryAccounts Payable

What we finance for

our customers

What our suppliers

finance for us

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Working Capital: AR

• Typically most meaningful when expressed in terms of time

• Days Sales Outstanding

• Example: Our Company– Receivables: $18.493 Million

– Sales: $450 Million or about $1.233 million/day

– DSO: 15 days

dayper Sales Avg.sReceivable

SalessReceivable PeriodinDays*

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Working Capital: AP• Days Payables Outstanding

• Example: Our Company– Accounts Payable: $24.733 Million

– COGS: $301.4 million plus transportation or about $826 thousand/day + avg daily transportation

– DPO: 30 days (ignoring transportation)

dayper Purchases Avg.Payable Accounts

COGsPayable Accounts PeriodinDays*

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Working Capital: Inventory• Days in Inventory

• We will have to do some work to estimate Inventory

• Normally this would be an accounting process: How much inventory do we have?

• We will estimate inventory. Why?

dayper Purchases Avg.Inventory

COGsInventory PeriodinDays*

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Cash-to-Cash Cycle

• Days Sales Outstanding: 15 days

• Days in Inventory: + ? days

• Days Payables Outstanding:30 days

• Cash-to-Cash Cycle: ? days

• Our Company: Net net, our suppliers fund 15 days of operations. Depending on inventories, we must fund the rest.

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Dell’s Cash-to-Cash Cycle

Dell’s suppliers finance a month + of Dell’s operations

Dell 2011Accounts Receivable $ 6.493 BillionInventory $ 1.301 BillionAccounts Payable $11.293 BillionSales $61.494 BillionCOGS $50.089 Billion

DSO 38.54 DaysDII 9.48 DaysDPO 82.29 DaysC2C (34.27) Days

That’s about $4.7 billion

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Discussion

• SC can influence DSO by providing perfect order delivery, prompt accurate billing, etc, integrating with customer accounting systems, …

• SC can influence DSO and DPO by negotiating terms of sale, e.g., when title transfers, mode of delivery, etc.

• We will mainly focus on Inventory. How can SC influence Inventory?

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Fixed Asset Utilization

• Utilization of Capital Equipment• Sometimes at the expense of working capital

– See “The Goal” • Recent story: Intel SC Transformation• http://www.supplychainbrain.com/content/h

eadline-news/single-article/article/through-its-complete-cultural-shift-intel-takes-top-spot-in-supply-chain-innovation-awards/

Not required

Required

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Inventory

• Inventory is an INVESTMENT, not an expense

• Can speak of inventory in terms of – Units– $– DaysThe latter are more common except when

dealing with very specific operational details

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Apples & Oranges

• How to balance inventory INVESTMENT against operating EXPENSES?

• Should I INVEST more in a hybrid to reduce my weekly fuel EXPENSES?

• Can’t compare the difference in weekly or annual operating expenses with the difference in the investment!

• Associate an operating EXPENSE with the INVESTMENT

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Inventory Carrying Cost

• Usually expressed as a % of the value (at COGS)

• Many companies don’t have a good handle on this.

• Two components– “Average Cost of Capital”– Operational Expenses associated with

Inventory

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Average Cost of Capital

• Sources of Capital– Shareholders – Equity– Bond holders and Creditors – Debt

• Question: – Which gets a higher return?– Why?

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Average Cost of Capital

• % of Equity * Cost of Equity, • +% of Debt * Cost of Debt (1-Tax Rate)• Example: Our Company

– From the Balance sheet

• Total Assets: 287 million (ignoring inv.)• NIBCLs: 25 million• 262 million• Long Term Debt $130 million at 5%• Short Term Debt 0 million at 5.5%• Equity $132 million at Cost of Equity?

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Average Cost of Capital• % of Equity * Cost of Equity, • +% of Debt * Cost of Debt (1-Tax Rate)• Example: Our Company• Debt 50% Cost of Debt 5%(1-24.9%)• Equity is 50% Cost of Equity 9%• Average Cost of Capital 6.39%• This will change when we include inventory in our

capital and financing for inventory in our liabilities• Don’t worry about its changing.

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Cost of Inventory• Non-Capital Charges as % of Inventory

– Warehousing– Obsolescence– Price Erosion: LCD TV prices fall 24%/year– Pilferage– Damage– Insurance & Taxes– Other

• Does this depend on the SKU?• Typical charge is ~10% • These are PRE-TAX costs• Capital charge was AFTER TAX

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Total Cost of Carrying Inventory• Total (Pre-Tax) Cost of Carrying Inventory

Non-Capital Charge (e.g., 10%)Capital Charge/(1-Tax Rate)

• Our CompanyNon-Capital Charge (we will guess 10%) 10%Capital Charge 6.39%/(1-24.9%) ~8.5%Total Cost of Carrying Inventory 18.5%

• What does this mean? – For every $100 million in inventory we carry– The annual cost of carrying that inventory is ~$18.5 millionWe can compare THAT with annual operating expenses

Let’s be careful to distinguish. Shout if you’re confused!

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Summary

• Income Statement focus on Profitability– Usually think of increasing revenues or reducing

expenses

• Balance Sheet focus on Capital Utilization– Usually think of reducing working capital

• Inventory Carrying Cost– Allows us to balance the two approaches

– No one writes a check for Inventory Carrying Cost

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Questions?

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Next Step

• Estimate Inventory • Depends on how we operate• Today we

– Minimize transportation costs by running full truckload direct (lowest rate and shortest distance)

– Maximizes Gross Margin• What’s the effect on inventories? • How well are we balancing our competing

metrics of financial performance?

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Types Of Inventory

• Pipeline Inventory: Goods in transit• Cycle Stock: Goods accumulating or depleting

from batch operations, e.g., accumulating or selling off a truckload quantity

• Safety Stock: Goods held as a buffer against variability in demand and in replenishment

• Anticipation Stock: Accumulated because of limited capacity

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Cycle Stock

• Example: Accumulated at a shipping dock awaiting full truckload

• Typically assume constant (long run average) rate of production

6565

Cycle Stock

Inve

ntor

y

Time

Truck Load

Average Inventory? (Units or Value)

Average Inventory? (Days)

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Cycle StockIn

vent

ory

Time

Truck Load

Average Inventory? (Units or Value)

Average Inventory? (Days)

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Cycle Stock

• Units: Half the size of the batch

• Value: Half the value of the batch

• Time: Half the time to accumulate the batch.

• Simple.

• We will see modifications of this simple model.

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Pipeline Inventory

• Little’s Law• L = WNumber of items in the system (L) = Rate the items arrive (Time each item spends in the system (W)It doesn’t matter how they arrive

– One at a time– In parcels– In truck loads– …

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Pipeline Inventory• L, the items or value in the system• the long run average rate at which items

or value arrive (e.g., are shipped)• W, how long (in consistent units) they stay in

the system (e.g., the transit time)• Example: Wal*Mart ships 60%¹ (by value) of

all it sells from Asia to the US on container ships taking 15¹ days

• COGs for 2010: $305 billion• What’s the pipeline inventory (value)

¹ Guesses

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Pipeline Inventory

• the long run average rate at which items or value arrive (e.g., are shipped)

60% * $315 billion = $189 billion

$189 billion/365 = $517 million/day• W, how long (in consistent units) they stay in

the system (e.g., the transit time)

15 days

L = W = $517 million/day* 15 days

= $7.767 billion

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Pipeline Inventory

• That’s a $7.767 billion INVESTMENT

• It is always there floating on the water

• Sometimes more, sometimes less

• $7.767 billion on average

• That’s the revenues of the 330th largest company in the Fortune 500

• Eg. Eastman Chemicals, Dillards, Yahoo

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Questions

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Challenge 1

• In your groups, complete the financial statements for Our Company under current operating practices

• Transportation costs– $1/mile– 30,000 lbs per truck load*– Truck travels 500 miles per day

• Inventory Costs

* We assume weight, not cube, floor space or maximum value determines the capacity of the vehicle.

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Deliverables• Completed Financial Statements• Brief presentation outlining your calculations• As VP of SC, what initiatives would you

propose? • We will be building on this example. Organize

and keep your work.• Avoid using values (e.g., Inventory carrying

cost, truck load capacity, …) in formulas. Reference them so you can change them easily later

• Due: Tuesday, Aug. 30• I will call on 1 or 2 teams to present in class

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Discussion• Questions?

– Time to get to know each other for teams• I’ll end a bit early today. Hang around• Use Challenge 1 as a trial – Are these the people I want to work with?

– What OR skills will we need?• We will do a small amount of Linear/MIP modeling• It is unlikely that the projects will require it (except possibly Audi)• Pretty basic probability and statistics

• Feedback– Thanks! Please continue.

• T-Square forum• Next week:

– Team presentations on Challenge 1– Begin to explore strategies for balancing operating expenses (e.g.,

transportation) and working capital (e.g, inventory)