CASE ANALYSIS IN MATERIALS MANAGEMENT New England Shipbuilding Corporation New England Shipbuilding Corporation is one of the largest shipyards in the United States. It builds not only various types of war ships and supporting for the US Navy but also cargo ships for private ship lines. A shipbuilder is basically an assembler of steel and other components made by specialized suppliers and in the case of New England Shipbuilding, purchased parts and materials account for more than 60% of the sales dollars. In their past purchases, they were able to protect themselves by incorporating price-redetermination or escalation clauses into their contracts that permits them to increase reasonable prices due to unanticipated fluctuations in the market that is passed on to their customers. The company is now bidding on a $30 million order. They’re hoping to get an edge among their competitors with the given price. The company estimated that most of the materials (metals and metal products, machinery etc.) would amount with a ball park figure of $20 million dollars. Walter Rogers (materials manager) estimated that roughly $8 million will be spent for electrical machinery and equipment of various types; $6 million for non-electrical machinery and the balance for various types of metal parts and products. Provided with an order not to pad his estimate to the maximum escalation clause of 15% and not to underestimate materials costs. The company needs the order badly and that it cannot afford to hedge just to avoid fluctuations. Question: Assume that New England Shipbuilding’s costs of purchased parts and materials follow the pattern of the BLS wholesale price indexes for metals and metal products, electrical and non-electrical machinery. Based on present economic conditions, what should New England Shipbuilding include in its estimate of materials costs?
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Proposed Solution Assuming that New England Shipyard followed the BLS wholesale price indexes of metals and metal products, electrical and nonelectrical machinery, based on the economic condition, surely they may have trouble dealing with the cost of these materials. But this is New England Shipbuilding Corporation, a well known and well established shipyard in the US, perhaps they should take it to the next level. They may have thought of needing the new materials but since they needed the order badly, they should try to come up with something to think which is “out-of-the-box”. In this proposal, let us say that Rogers will estimate the cost of shipbuilding based on their previous experience of building similar ships which are nearly of the same type and size. Apart from previous estimates the knowledge of the experts and their self made formulas also go into this type of cost estimation. The main advantage of this type of process is that it works fine and perhaps is very accurate for ships which have been built previously but it would not work with the same degree of accuracy if the shipyard receives an order which is totally different from the type and size of ships it has been constructing. The thing is, a shipyard relying totally on this case has the tendency to get stereotyped and if suddenly those particular types of ships go “out of fashion”, they would certainly be in troubled waters. If this is the case, certainly another solution could be that the shipyard only accepts standard orders and does not cater to “custom made” ships. This would certainly reduce the number of clients wanting to get their ships from such a yard, but on the other hand this also would make the shipyard specialize in building the ships which they offer. One may ask, “If they would be using the same design, size and type of ship, inevitably, they will still be dealing with the present economic condition of the materials?”, “what about it?”. Well, in this case they won’t be having any trouble including electrical and nonelectrical machineries in their estimates, that is, on what will be left and a lesser but not much of a real problem would be the metals and metal products. This is true in the sense that if they will be spending for the said machineries and equipments and that they will have to worry with its fluctuations in prices, it would be better to make use of their current machineries and equipments and rather just spend on its repair and maintenance. Repair and maintenance shouldn’t cost as BY 06-00044-7
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CASE ANALYSIS IN MATERIALS MANAGEMENT much $8 million to estimate if the repair would be made quarterly and maintenance on a monthly basis for the three years to come.
Owen Electric Company Owen Electric is a small producer of electric motors. But close control of costs and goods marketing, it has managed to compete successfully against such giants as General Electric and Westinghouse. Steel is Owen Electric’s second most important commodity after copper and in late 1958, the company steel inventory situation is far from favorable, looking ahead, the anticipates that it will require 50 tons of steel per month through June 30; 35 tons per month until September30; and 65 tons per month for the balance of the year 1959. Owen, like any other purchasing agents, knows that certainly there will be a strike when the steel contract expires July 1, 1959. Owen doubts if he can even gets on any of his steel suppliers first-quarter 1959 rolling schedule for any tonnage over and above what he already has as order. The company doesn’t have any space available to store any extra steel inventories over and above the 20 ton safety stock it hopes to accumulate during the first quarter. However, adequate storage space could be rented for an average cost of $1.50 per ton per month, plus $2.00 per ton to move the steel from the warehouse to the Owen Electric Plant. In addition, the company anticipates other modest looses as a result of damage from extra handling, rust and so forth, which might amount to 1% of the value of the steel stored. The steel strike in 1956 lasted about three weeks and resulted in what both steel producers and users regarded as an inflationary wage settlement. In late 1958, the steel company is not only faced with higher wage costs but are also feeling the effects of much higher scrap prices. During periods of peak demand, as much as half of this scrap must be purchased on the open market. Owen believes that the odds strongly favor a strike, although, of course, he is not certain how long it will last. Owen does not believe that the strike could possibly last more than eight weeks before either a settlement is reached voluntarily or president Eisenhower invokes the Taft-Hartley Act. Owen guesses that if President Eisenhower invokes the act, there would be no second strike, and labor and management would almost certainly reach an agreement. Questions 1. Recommend a plan of purchase and evaluate it with a Bayesian probability analysis. 2. With the benefit of hindsight, we now know that steel production was crippled for more than 100 days in the summer of 1959 until BY 06-00044-7
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CASE ANALYSIS IN MATERIALS MANAGEMENT President Eisenhower finally invoked the Taft-Hartley Act forcing the steel company employees to go back to work. However, the composite index of steel prices remained at $0.0698 per pound from November 1958 through 1960. Partly because of indirect government pressure but mostly because of falling demand and growing inroads from cheaper foreign steel. American steel producers were not able to raise their prices above the 1959 level for more than five years thereafter. a. How would your plan of purchase have worked during the 1959 strike? b. Could Owen have protected himself against a steel stock out, given the assumptions on which he based his decision? Proposed Solution In order to meet the monthly usage, Owen electrics buys 600 tons of steel because it is the second most important commodity after copper of the company. It shows that in July 1, in order to to be protected against strike which is anticipated when the steel contracts expire on July 1, 1959. However, it will result him to have a cost of $157.50 per month (105*$1.50) or a total of 472 for three months. And an additional of $210 to move the steel from the warehouse to the Owen electric. But, the suggested plan reduces the cost of material from $91,020 to $ 89947 having a saving of $ 1073 that can be used to sustain that storage and delivery cost amounting to $ 682 (472+$210) Applying the Bayesian analysis, even the estimates of $96,000 loss for 8 weeks strikes, the probability will only 10 % ( P(8)₌0.10), thus, the expected loss would still be $ 9600 (96000 * 0.10) If there were no strikes, there is a probability ( P(5)₌0.50), ( P(3)₌0.40), ( P(0)₌0.10),and if there is strike ( P(0)₌0), ( P(7)₌0.30), ( P(5)₌0.40), and ( P(3)₌0.30), therefore, there is a 5 % increase even there is a strike or no strike. However, the probability of strikes is come in 4 broad possibilities; ( P(no strike)₌0.20), ( P(3)₌0.40), ( P(6)₌0.30), ( P(8)₌0.10). due to the strike, the steel industry will almost certainly stock with much higher prices.
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Queenstown Chemical Company Queenstown Chemical Company is a leading producer of specialty chemicals. Joanne Mead, Queenstown’s director of purchases, is responsible for both raw material and finished goods inventories, in addition to directing the company’s purchasing activities. Her biggest single problem is managing finished goods inventories, which in the last year have increased from $2 million dollars to $10 million. Not only is the company running of storage space, but its cash position is getting tight. There is no easy solution to the problem. Their customers are aware that chemical shortages are a thing of the past, and they insist that the company stock their needs for immediate delivery. Customers carried 30 to 60 days inventory and insist on getting delivery in 10 days or less. If they do not get this rapid service, they can buy from Queenstown’s competitors, who are willing to carry stocks for their customers. It occurs to Mead that she might try the same approach on her suppliers and get them to carry inventories for Queenstown. At present, the company invested $1 million in nonproduction inventories and $6 million in raw materials. Usage of nonproduction is about$100,000 per month and raw materials are about $2 million per month. Queenstown uses a perpetual inventory system. Mead believes that inventories can be reduced substantially by requiring suppliers to carry inventories. She proposes that Queenstown make contracts with each of its major suppliers that call for them to maintain certain minimum stock of materials available for immediate delivery. Meads assistant, Robert Stark, disagree with his boss’ plan. He points out that if the cost the supplier just as much to carry inventory as it does Queenstown. The result would be that overall costs would be higher than they are in present. He grants that Queenstown would probably able to persuade its suppliers to stock without having to pay a premium. As an alternative, he suggests that Queenstown discuss the problem with its suppliers and persuade them BY 06-00044-7
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CASE ANALYSIS IN MATERIALS MANAGEMENT to offer lower prices. However, that this approach may not work too well on items that are price fixed. Stark also suggests that Queenstown might be able to reduce inventories by trying to schedule its needs for maintenance items in advance. Question How would you evaluate Mead’s and Stark’s proposals? Develop an inventory program for Queenstown?
Proposed answer: Top heavy inventories are a giant cash vacuum that needs to be turned off in order to free up cash for investment in revenue growth activities. So, how can this be accomplished? One of their major impediments to inventory reduction is the mistaken notion that just improved inventory management is all that is required to get the job done. The real culprits are their inefficient business processes that cause excessive inventories to exist in the first place. Certainly some aspects of excessive inventory investment are the result of Inventory Control, but often their behavior is motivated by management’s certain negative reaction to material shortages versus periodic and less severe response to excesses. For the most part, inventory excesses can only be significantly reduced or eliminated when the cross-functional business processes that cause the need for excessive inventory buffers to exist are fixed. It is futile to think inventories can be isolated and singularly managed. Inventories are invariably the result of how well many cross-functional business processes really work. Queenstown based raw material and/or finished goods inventory stocking levels on inaccurate long term sales forecasts. The high cost of these “bad numbers” if they aimlessly drive operations, as they often do, depresses overall business performance. One result is that if they use a total “push” inventory system will end up with high inventories. An excellent method for achieving greater effectiveness with working with their capital is to acquire materials and put them through production so fast that inventory doesn’t have time to become 6 BY 06-00044-7
CASE ANALYSIS IN MATERIALS MANAGEMENT a “liability”. Of course, this requires a well-engineered order-to-delivery process that can have enormous benefits beyond just inventory reduction.
A.E.D. Division In September 1950, National Motors Corporation received a contract to tool a large government-owned facility, in order to become a second supplier of Hornet Engines for the US Air Force, price for the engines was to be negotiated. Before A.E.D. could commence production of acceptable engines which would be subject to extensive testing, however, it had to produce two prototype engines. Until these engines were flight tested and approved, A.E.D. could not go into full-scale production. It was agreeable to the Air Force that A.E.D. buy crankshaft forgings and run this forgings over its machine tools. The crankshaft was a particularly critical component. The production control department did not know how long it would take to pass a forging through a complete machining cycle, but its guess was several months. One problem that production control faced immediately was the ordering the crankshafts needed for two prototype engines. Until in the late 1952 the division still hadn’t finished a single crank shaft and in May the last of the 100 forgings was scrapped. Additional forgings were purchased and the first acceptable crankshaft was completed in November 1952 – roughly six months behind schedule. Questions BY 06-00044-7
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CASE ANALYSIS IN MATERIALS MANAGEMENT 1. Given no advance knowledge that the scrap rates would exceed even the most pessimistic estimates, could A.E.D. have done anything to prevent its crankshaft machining problems from apparently holding up the entire program by about six months? 2. The A.E.D. case occurred in 1950. Certainly problems in manufacturing on the threshold of new technique have, if anything, become greater. However, companies like National Motors now enjoy the benefit computerized material requirements planning system. How would MRP have helped A.E.D.? could the problem still occur if A.E.D. had had a first rate MRP systems? Proposed Solution AED could have done something to prevent its crankshaft machining problems if only they have a minimum number of forgings from the existing supplier, since the company wanted to get its new forging supplier approved and shipping forging as soon as possible. In this case, the production control process is both easy and difficult to visualize. They should’ve grasped the best way on how control and MRP work to create a situation that is so easy to comprehend that no formal system is needed. The MRP could’ve helped them by always having materials on hand when needed without carrying excess inventory. With MRP, each change in end product demand can be instantly reflected in inventory and production planning for each component, including those that are several stages away from the final production process.
A problem in Order-Point control Data on the perpetual inventory card: Date
Purchase Requisition Issued
1/2 1/7 1/12 500 1/29 2/10 2/15 500 3/13 3/16 5/1 1,000 5/18 BY 06-00044-7
Receipts
Disbursement s
Balance on hand
400
922 522
400 500 500 400 722 1,000
122 622 1,122 722 0 1,000 8
CASE ANALYSIS IN MATERIALS MANAGEMENT 5/19 7/12 8/10 10/26 10/27 11/18 12/12
278 400
500
600
722 322 822 222
200
722 522
500 500 500
Suppose you work for a company that controls its inventories on a max-min basis, using perpetual inventory cards. The company is introducing a new line of products that will result in greatly increased usage of a particular component, you analyze the sales forecast for this new product line and calculate that it will cause demand for the component to rise by about 800 units per month. Naturally, you decide to analyze the history of the component to determine what lead time and order quantities should be. It is expected that demand for the component will be more regular from the new product than it will be from other products, which will continue to vary erratically as it has in the past. The unit price F.O.B. buyer’s plant is $1 million lots of 100 to 499 pieces, 95 cents in lots of (more than 5,000 Pcs.) 500 – 999 pcs., 92 cents of 1,000 – 4,999 pcs. And 90 cents in one more than 5,000 pcs. Normal lead time is 4 weeks, but in emergencies you can get delivery in 2 to 3 weeks by doing a great deal of expediting. Question Calculate purchase quantities, safety stock, and order-point quantity, based on the data above.
Proposed Solution
Blue Motors Corporation (A) Blue Motors is a large auto manufacturer, and for them, productive and inventory control is not an easy job. Plant and equipment is the company’s biggest single asset. Control of production parts and materials inventories is particularly difficult at the company’s automobile assembly plants. The company cannot afford to stop its assembly line because of supply failure, and storage space is limited. The company could not carry more than a few days inventory of bulky components even if it were not the least bit concerned about trying up BY 06-00044-7
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CASE ANALYSIS IN MATERIALS MANAGEMENT too much of its working capital in inventories. Blue Motors uses periodic ordering for all periodic parts and materials. Blue Motors stock checkers make periodic counts of materials on hand, the stock checkers use different review periods for different types of item. Any item that is in critical supply is reviewed daily, regardless of its value. Most A items are reviewed daily, B items usually are reviewed twice a week, and C items are reviewed at least once. Until recently, all of Blue Motors basic products have been assembled in reasonably large quantities. The company’s newest product is what its advertising department calls a “customized” sports car. The new product is designed to compete with sport cars turned out by various European manufacturers. Current plans call for assembly of the car at the company’s main plant in Detroit. Its production volume is so low that practically all of the components, few of which are interchangeably with the company’s other cars, will be purchased. Suppliers of major components have been reluctant to accept orders unless they’re authorized to fabricate an entire year’s requirements in one production run. Production is limited to only 15 units per day during peak demand and will probably drop to 5 units during slack season, the company’s normal ordering procedures for ABC items may not be applicable. The company wants to tie up as little as of its valuable factory floor space as possible on the new program. If an item cannot be delivered directly to the assembly line, where there is a limited amount of space, it must be stored in some other area of the plant, and a second handling will be necessary. This would raise costs, particularly for high-volume components. Question Recommend an ordering system for Blue Motors’ new sports car. In making your recommendations, assume that a radiator is a typical A item, a door handling a typical B item, and a fastener a typical C item.
Proposed Solution Blue Motors Corporation can solve the issue if they can change their quantity order of the components that instead of 15 units per day, perhaps they can make it 450 units per month during peak demand and 200 units during slack season including safety stocks. Frequent order is not much to do the job neither care about their BY 06-00044-7
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CASE ANALYSIS IN MATERIALS MANAGEMENT production. But in their case, the production is down to only 15 units per day during the period of strong demand and 5 units per day during the slow season. The thing is, doing the job for all the A, B and C’s should be done and makes the delivery as soon as possible.
Eastern University Hospital The director of materials management of Eastern University Hospital, Mr. Ralph Galerneau, has a problem: despite considerable success in cutting inventories, his storage areas are so jammed that efficiency is being affected. The hospital is a 600-bed institution. The situation is certain to get even worse before it gets better. The hospital is in the midst of expansion. Purchases and withdrawals of supplies from inventory will increase and new items will have to be added to stocks. The new main store room for medical-surgical supplies covers 4,620 square feet. The hospital will soon be opening a new $22 million day care center that will draw its medical-surgical supplies from the same store facilities that serve other buildings in the hospital complex. The materials management department also has available to it two other warehouse facilities which are not located in the hospital premise but are nearby. One of these facilities is rented for $354 per month and the other for $450. However, not only this is extra storage space limited, but it is costly to transfer materials from one storage area to another. Total inventory of medical-surgical supplies is approximately $100,000. Galerneau is convinced that there is very little fat in this inventory. Galerneau would love to build a new facility with up-to-date materials-handling equipment. The hospital’s cash position is tight and its borrowing power is also limited. Land would be a problem even if the hospital were willing to construct a new store building. There simply is no convenient space available nor can additional land be purchased easily. The hospital premises are surrounded by old, privately owned buildings on small plots of land. Galerneau is presently pondering whether or not he should recommend some new store facility to the hospital’s administration and trustees. He has discovered that repairs, maintenance and operation of the building run about $124,000 per year. The hospital calculated depreciation on its equipment to help determine which costs are reimbursable by Blue Cross-Blue Shield and other agencies. Obsolescence and shrinkage are reduced substantially as a result of the extremely close control that is maintained over inventories. At present both order points and purchase quantities are determined largely by judgment. Galerneau has been considering adoption of some sort of economic ordering procedure. BY 06-00044-7
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CASE ANALYSIS IN MATERIALS MANAGEMENT Questions 1. Does Galerneau have sufficient information on carrying cost and ordering cost to use EOQ formulas? 2. Suppose that Galerneau’s rough estimate of $500,000 for a new stores building turns out to be correct and that land adjacent to the hospital’s other buildings becomes available. How would you go about justifying a request to the hospital’s administrator and trustees for funds to construct the building?
Proposed Solution The rough estimate of Galerneau is necessary to give the owner a reasonably accurate idea of the cost to help him decide whether the work can be undertaken as proposed or needs to be curtailed or abandoned, depending upon the availability of funds and prospective direct and indirect benefits. Galerneau must be in a position to know exactly how much expenditure he is going to incur on them: From the estimate of a work it is possible to determine what materials and in what quantities will be required for the work so that the arrangements to procure them can be made. The number and kind of workers of different categories who will have to be employed to complete the work in the specified time can be found out from the estimate that will help in determining amount and kind of equipment needed to complete the work. Their estimate of work and their past experience enable them to estimate quite closely the length of time required to complete an item of work or the work as a whole. Whereas the importance of knowing the probable cost needs no emphasis, estimating materials, labor, plant and time is immensely useful in planning and execution of any work. Galerneau doesn’t really have any sufficient information on carrying costs and ordering cost to make use of the EOQ. It seems that the hospital is into a lot of those expansion investments that somehow they would come to think of not to grant Galerneau’s request for the said estimate. The top management might find it as an excess with the overall operations of the company.
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Owen Electric Company (B) Owen Electric Company controls inventories of hardware used on its assembly line with periodic ordering. Weekly reports from stock checkers are sent to appropriate buyers, who post them to their records and periodically issue orders to bring stocks up to the required balance. For example, the company uses about 10,000 pieces of a small screw machine part each month, the buyer looks at the latest stock report on the 15th of the month and issues an order for quantity sufficient to balance the inventory about 15,000 pieces when it is delivered. Thus, if the stock checker’s report indicates an inventory of 12,000 pieces and estimated usage during the 30 day lead time is 10,000 pieces, the buyer will place an order for 13,000 pieces. The unit price of the part purchased in quantities of 5,000 to 10,000 is $0.10 but the supplier is willing to cut the price to $0.095 if he gets orders that average 20,000 pieces. Owen Electric’s controller estimates that it costs $10 to make each purchase, and the carrying cost of inventory is 24%. Questions 1. Should Owen Electric take advantage of the supplier’s offer? 2. What is the company’s most economic order period if the supplier’s price does not vary with order quantity? Proposed Solution The difference is not that much from 0.10 dollars to 0.095 dollars if they order 20000 pieces when they only need 10000 pieces to 13000 pieces. True that unit prices usually are lower and the larger the order quantity, the fewer the number of orders that must be process and the fewer the shipments that need be handled and this reduces costs. But in the case of Owen Electric if they going to buy 20000 pieces, it will be too much, they will have too much stocks, so that, instead of reducing the inventory or keep it low the result is, they will have more items to be stored which they are not actually needed and if stocks are held long enough, the accumulated carrying charges will exceed its value. When many items are stored, inevitable that some of them will not be used, will shrink, or disappear or will spoil, and the only way to prevent is simply by not investing it in inventory. In the case of Owen Electric, obviously the excess in 20000 pieces from the 10000 pieces needed if they are going to accept the suppliers offer will not be use and become obsolete. BY 06-00044-7
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