Logistics / production & operations management

QUESTIONS TO be addressed/answered:

• Prepare the answer that Mr. Smith will give to the General Manager
related to the justifiable investment in the logistics project.

• Determine the saving sources that contribute most to the Return on
Investment.

• What are your recommendation assigning priorities to the different
sources of savings?

• If the Company has an Internal Rate of Return (IRR) Objective of
37%. How long will it take to accomplish that objective?

Hint: The source of savings are in labor productivity in order taking
and warehousing, cost of lost sales, inventory turns, vehicle
utilization, warehouse density, logistics cycle and inventory accuracy.

Assumptions: Assume independence between improvements and saving
sources, i.e., improvements are not cumulative (at this point of
planning).

Claris

Claris & Co. is in the business of electronics and has a portfolio of
5,500 SKUs that generates $236,500,000 in sales and 37,950 orders per
year from customers. The current investment in finished goods inventory
is $12,447,368 representing 362,915 boxes at the distribution center.
Mr. Smith, logistics manager of the company has called a consulting
company to develop a “logistics audit” to calculate some of the
critical metrics at Claris & Co. The result indicates that the company
has a cost of lost sales originated by the lack of inventory (of the
right products) that amounts to $ 7,095,000 (with an actual fill rate of
97%). Other results indicate low labor productivity (1.4
orders/man-hour), low quality of the logistics function and slow
response time (7 days/order).

The logistics manager has discussed with top management the possibility
of finding internal financing to improve the performance indicators and
be more competitive in the market. As a first step Mr. Smith has made a
benchmark study that describes the performance objectives he should
obtain. Mr. Smith wants to know the financial investment that would
allow him to improve the productivity to 50 orders/man-hour, increase
the inventory availability to 99.98%, increase inventory turns to 30
turns per year, and improve the vehicle utilization to 95% of the
existing capacity for the 21,200 shipments/year currently processed. In
the area of warehousing, Mr. Smith proposes to increase the warehouse
density (in Claris’ 22,000m2 warehouse) to 21 boxes/m2, improve the
accuracy of deliveries to the level of Japanese standards, which is
99.998% (since the cost of delivering a box with any type of error is
$10 per box). Finally, through new technologies he wants to increase the
labor productivity from 27.01 boxes/man-hour to 40 boxes/man-hour.

Given the size of the project, the General Manager of Claris & Co. has
asked Mr. Smith to use the current indicators together with the
benchmark indicators to calculate the financial investment required to
justify improving the logistics operation. The General Manager suggests
to Mr. Smith to take a close look at labor utilization since its cost
has increased to about $3/man-hour. At the same time he informs Mr.
Smith that a capacity utilization of 60% in transport (vehicle
utilization) is not acceptable in the long term. Mr. Smith has done his
own analysis of external logistics providers in the region and found
that to rent space would cost $39 per m2 and transportation cost would
be $82 per shipment.

During the process of justifying the project, Mr. Smith found some
parameters that would allow him to explain the maximum investment. An
accounting report from the company established that the expected payback
period should be 2 years and the opportunity cost of capital approved by
the company is 27%. The marketing department established that the cost
of lost sales is 2.8% of orders without inventory. From the customers’
point of view, the marketing department suggests to analyze the
implementation of an order cycle equal to 5 days (in order to better
compete in the local markets). Additionally, the marketing manager has
offered all the support to Mr. Smith given the connection between
logistics and marketing performance. The closest example is the fact
that currently 0.2% or wrong shipments start at the distribution center.