High Inventory as a Reason for Low Operating Margins - Case Study Example

Rosa Chang was recently hired by Carl's Computers as the new inventory manager for the after market service department. Rosa has been talking to all departments involved in the customer service and order fulfillment process in order to evaluate the functional deficiencies in the inventory and order handling procedures. Carl's Computers in the past as a business has grown and differentiated itself from the competition by having the competitive advantage of a business model that allowed him to provide rapid computer production, while offering product delivery in two days which is much faster than his competitors1. Carl's Computers has always prided itself as a business by providing a customer service level policy of 98%, but lately inventory management problems have caused their provided service level to decline significantly. This has negatively affected their customer base, the company's reputation, and it created a high level of customer dissatisfaction. The lack of timely availability of certain critical parts required for service customers has been the major cause for service customer call delays in timely service orders. Due to the fact that their service quality has been declining customers are paying more attention at price, but due to already extremely tight margins significant price discounts are not possible further eroding sales2. One of the main reasons for low operating margins are the extremely high inventory and carrying costs of the company, therefore the company is extremely concerned by these trends3. Carl's Computers needs to analyze their inventory and customer order handling procedures in order improve their operations and be able to provide the level of service their customer base has come accustomed to. Rosa noticed also that there needs to be better functional alignment between the manufacturing operations and engineering department. The company's management needs to better handle the logistics of production and part inventory timing between currently the manufactured product line, negative inventory, and new designs coming down the pipeline for introduction4. Management is always demanding the purchasing department to control costs, but organizationally constant conflicting demands between the currently manufactured inventory requirements and new product introductions (which typically require new parts) are driving inventory costs out the roof. Premium freight costs due to expedited shipments of critical parts are also out of control. Also it is common practice for service technicians are take parts out of general inventory and keep them in a private stash in order to prevent customers from not having certain critical parts available at a moments notice. This practice create unnatural and erratic inventory level patterns which cannot be accounted for and do not correspond to actual use. A lot of time is invested with suppliers aligning the needs of engineering and manufacturing with the timely flow of current inventory parts and new part design. The purchasing process is riddled with constant last minute part changes, tight schedules, and time constraint demands which make the process inefficient and costly which causes a lot of frustration and delays from suppliers and ultimately affecting our customer service quality. Obviously inventory management procedures and methods need to be overhauled. The company's management needs to better manage current production and inventory levels with future product introductions in order to better align our current inventory, timing, service customers and production schedule requirements with our actual operational requirements. According to the chief financial officer inventory service costs have increased over 200% over the last two years, while service revenues have only increased 15%. Lack of an efficient up to date record of inventory levels have caused excess inventory of many parts and at the same time deficient inventory levels of critical service parts, which have cost the company over $67,000 in additional shipping costs alone. Most shocking have been the 80% obsolete inventory write off rate we currently sustained over the same two year period due to deficient inventory management practices. Rosa recommends that tighter controls are placed for part purchasing, acquisition, and inventory control in order to better control inventory flow. Adopting a JIT inventory for easily acquired parts with a short turnaround time, maximizing volume discount for high volume parts and maximizing inventory control of critical replacement parts are keys to minimizing total inventory costs. Implementing changes to improve inventory efficiency would help minimize inventory wastage, obsolete inventory, minimize unauthorized part acquisitions by employees and minimize the chance of negative inventory or stock-out on critical parts5. Some of the changes to include in the inventory system should include; a camera security system, password code entry for inventory room, and the adoption of a computerized bar code inventory system for labeling, scanning part purchases, inventory transfers and departmental part acquisitions6. Additionally in order to minimize unnecessary part requests, expedited orders and cancellations; a procedure for requiring written authorization from the supervising manager must be adopted for all special part order requests. An employee inventory acquisition form will be required for all special part orders or expedited shipping. By requiring employees to complete an electronic inventory acquisition form requiring the pertinent part information and justifying the reasons for ordering or cancellation of the special part orders, it empowers management and employees to make better decisions, streamline inventory and control excess costs. 1) a) The current inventory policy dictates that the bin for each part must be kept full. For circuit for A233 the bin size is 64 units with a weekly use rate of 32 boards. The costs unit costs are $18 per unit and order costs are $16 dollars with an order lead time of 7 days. In order to keep A233 bin full we must make an initial order of 64 units. Based on the seven day lead time, after a week when the first order arrives, we must make an order of 32 units weekly in order to refill the bin at the end of every week. Based on the lead time we must make a total of 52 orders for the year of A233. Our individual unit cost under this scenario is taking into consideration all relevant costs is $18.50 per unit (see appendix) b) For the P656 Power Supply assuming a14 day lead time, the company would make an order for 350 additional units approximately every two weeks in order to maintain an average of one week worth of inventory (120 units) at all times. Due to the 14 day order lead time, we cannot order less than three weeks worth of inventory in order to maintain at least one weeks worth in stock. Since the amount they regularly order does not correspond to their average weekly use or a multiple of it, the company will have to increase their order size to 360 every two weeks in order to eliminate the need to regularly increase their order size in order to make up for the discrepancy. Due to the fact that the supplier does not offer any volume discount and the order costs are only two dollars, there is no benefit of buying more 360 units at one time7. 2) For part A233 by using the EOC model we can minimize individual unit cost by increasing bin minimizing number of orders per year in order to lower order costs. By increasing order size to the production requirements for an 8 week period, we could place orders every 2 months obtaining a saving of $736 a year in service charges alone. The manufacturer has offered a $2 unit discount in the board unit cost if order size is increased to over 200 units. Since the company requires 32 units per week, by ordering 256 units( 8 weeks worth) per order we can decrease total unit average costs from $18.50 to $16.06 per unit(see appendix). Carl's should go for the price break. At the same time we can minimize the risk of obsolete inventory by keeping the order to a reasonable size8. Appendix Current Inventory Costs A233 Circuit Board P656 Power Supply Weekly usage 32 120 Unit Cost $18.00 $35.00 Order Cost $16.00 $2.00 Bin/Order Size(units) 64 350 Total Weekly Costs $592.00 Lead Time(days) 7 14 Initial order $1,168.00 Total Cost for year (52 weeks) $30,784.00 Average unit cost for year $18.50 EOC Model(6 orders per year) Order processing costs savings $736.00 Unit discount $3,328.00 Total Annual Savings $4,064.00 Average unit cost for year $16.06 Case 2 If product Fails: around 10% repeat: Value added Non-Value added Device Diagnostics: holding time(avg.) 1440 x labor: diagnostic 30 x labor: disassemble 60 x Part Ordering: labor: ordering parts 5 x Holding time(waiting for parts) 2880 x Repair: Holding Time:(24 hours after parts arrive) 1440 x Labor: repair, reassemble, testing 180 x Total Minutes 6035 Total hours until second repair 100.5833333 Value added percentage 0.00% Non-Value added percentage 100.00% Total Added value between both stages 2.39% 97.61% Total Hours, first and second repair 202.4166667 Total days 8.434027778 1) If the repair process is successful the first time, a part will to go through the whole repair process and be picked up for delivery an average of 101.83 hours or 4.24 days after delivery. If the part is not successfully repaired the first time it will have to go through the diagnostics, disassembly and repair process for a second time. The total additional time will be 100.58 additional hours for a grand cumulative total of 202.41 hours or 8.43 days9.Under the first scenario the percentage of value added activities was 4.75% and 95.25% for non-value added. Under the rework scenario, value added time was reduced to 2.39% versus 97.61% for non-value added. 2) By evaluating the repair process we can see that there needs to be a significant improvement in the quality control procedures. The company needs to implement new testing requirements upon completion of each of the repair stages. By double checking and testing the product at the end of each repair stage, we can pick up mistakes early in the repair process and correct them before allowing the product to enter the next stage. By implementing these changes we can eliminate the majority of finished products requiring rework. The company will also be able to lower the overall costs of reworking each unit, since the mistakes will be detected earlier in the service process, therefore saving considerable labor and extra expense10. References “Carrying Cost of Inventory,” Last modified 2012, Accessed 17 December 2012, http://www.investopedia.com/terms/c/carryingcostofinventory.asp#axzz2FIdXCzJh Charles Horngren and George Foster and Srikant Datar. Cost Accounting: A Managerial Emphasis (New Jersey: Prentice Hall, 2000). Dat-Dao Nguyen and Dennis Kira. “Value Added Systems.” Accessed 17 December 2012, http://www.csun.edu/~dn58412/Value-Added-Systems.pdf “Environmental Sustainability.” Accessed 17 December 2012, http://toolkit.smallbiz.nsw.gov.au/part/17/86/374 Ray Garrison and Eric Noreen. Managerial Accounting 10th ed. (Boston: McGraw-Hill Irwin, 2003). Reynolds, T., “Why Barcode Your Inventory,” Last modified 2007, Accessed 17 December 2012, http://www.carolinabarcode.com/spec_sheet/Barcode-Inventory-White-Paper.pdf Riley, J., “Competitive Advantage,” Last modified 24 October 2012, Accessed 17 December 2012, http://www.tutor2u.net/business/strategy/competitive_advantage.htm “Negative Inventory,” Last modified 2012, Accessed 17 December 2012, http://www.businessdictionary.com/definition/negative-inventory.html “Valued-added Flow Chart.” Accessed 17 December 2012, http://www.moresteam.com/toolbox/value-added-flow-chart.cfm “Waste Minimization Techniques.” Accessed December 17, 2012, http://www.yale.edu/ehs/onlinetraining/hazwaste/WasteMinimizationTechniques.pdf Read More