Indian Institute of Management,

Indore

Operations
Management II

J & G Distributors

Sarah is facing with few issues on which certain decisions have to be taken. She
gathered some data and this data needs to be analysed to arrive at optimum
solutions to different problems. For each of the key issues our calculations and
recommendations have been given below.
Inexpensive part:
Product: Resistor - #4915082
Lead time is 2 weeks
Cost of the part P = $0.12
Annual demand D = 60,000 units
The average demand, the variation in the demand and the standard deviation
are given below:
Probability (1)
0.5
0.5
0.5 x 0.5
0.25
0.5 x 0.25
0.125

Quantity
2400
2900
3150

Variation
(2)
-354
146
396

0.5 x 0.15

0.075

3400

646

0.5 x 0.10

0.05

3600

846

2754

Variance
Std.
Deviation

Total

(1) x
(2)2
62658
5329
19602
31298.
7
35785.
8
154673
.5
393

EOQ Q* = sqrt(2DC0/CH)
Q* = 6325 units
We have considered a 95% confidence interval. Z = 1.65
R = d x T + Z x sqrt(T) x Std. Dev
R = 3317 units
Safety Stock = 917 units
Hence the firm should procure the resistor in lots of 6325. It should maintain a
safety stock of 917 units to take care of the variations in the demand.
But it is given that the resistor is an inexpensive part which is a commodity item
and hence there is no harm in having excess inventory of the part.
So the maximum demand for the part in the lead time is 3600 units and we can
procure the units in lots of 3600 units and have the excess units as our inventory.
Under this condition the order quantity is 6325 units but the reorder point would
be 3600 units.
Make or Buy (Packaging)
Given data
Product: Wire strippers (#4569802)
Annual demand: 1,000 units
Item cost: $0.7/unit
Cost of buying the wrapping service: $0.4/unit
Cost of in house wrapping:
$0.1 in direct material and labour
$0.3 as amortization cost

$40 is direct labour & material for setup

Since the machinery is already purchased, the $0.3 amortization cost is incurred
in both make or buy the cases. Hence this value should not be considered for
decision making.
Hence the actual relevant cost for in house wrapping is $0.1+$40/1000 = $0.14
This is lesser than the cost of getting the wire strippers wrapped from outside.
Therefore, for the wire strippers it is advised to perform the wrapping in house.
Quantity Discounts
Given data
Product: Connectors
Annual demand: 10,000 units
Here there are two options for procuring the parts
Option #1: From Supplier 1 using all-unit discount pricing structure
Option #2: From Supplier 2 using incremental discount pricing structure
Total cost = Q/2 x CH + D/Q x C0 + P x D
Q* = sqrt(2DC0/CH)
C0 = $10, CH = P/4, D = 10,000
Option #1:
Order
Size
<= 100

Unit Price
5

D
10000

C0
10

101-500
501-1000
>1000

4.75
4.5
4

10000
10000
10000

10
10
10

CH
1.25
1.187
5
1.125
1

Q*
400
411
422
448

For calculating the total cost we should also consider the cost saving obtained
due to the discount provided. We consider three order quantities to evaluate the
most optimum order quantity.

Q1
Q2
Q3

Order
quantity
411
501
1001

Total
cost
47987
45481
40600

Hence, in option #1 the economic order quantity is Q* = 1001 units since the
total cost incurred is least in this case.
Option #2:
Sample EOQ calculation for order quantity between 100 and 500
Inventory cost = Q/2 x CH + D/Q x C0
Here CH = P/4 and here P is the weighted average of the 100 units @ $5 and (Q100) units @ $4.75
Therefore, IC = Q/2 x [5x100+(Q-100)x4.75]/4Q + 10000/Q x 10 + 10000 x
[5x100+(Q-100)x4.75]/Q
Once you get it, differentiate, equate it to zero and obtain Q*= 767.77. This is
not in the given range. We do similar calculation for the next interval too.

If we perform the similar calculation as above we find out that the cost incurred
in option #2 are higher than $40600.
Hence, connectors are advised to be procured from Supplier#1 at all-unit
discount pricing.
Several items ordered together: Overseas vs. Domestic
Overseas:
Cost per order = $10
Shipping cost = $400
Total order cost = $410
There are 3 parts and let they be P1, P2 & P3.
Total no. of units = 1000+1000+500 = 2500
Average unit cost = [1000*10+1000*10+500*30]/2500 = $14
P1

P2

P3

Total

Annual Demand
1,000
1,000
500
2,500
(units)
Unit Cost ($)
10
10
30
14
Variance / per
100
100
81
96.2
week
Lead time
6
6
6
6
(weeks)
A 95% confidence interval is assumed and based on
the variance value given the safety stock is
calculated
Safety stock
40.4
40.4
36.4
Order Qty / per
306.1
306.1
153.1
765.3
order
Number of
3.3
3.3
3.3
Orders
Annual Purchase
10,000
10,000
15,000
Cost
Ordering Cost
535.7
535.7
267.9
1,339.3
0
Holding Cost
382.7
382.7
574
1,339.3
0
Total Cost
37,679
Domestic:
Cost per order = $10
Total order cost = $10
There are 3 parts and let they be P1, P2 & P3.
Total no. of units = 1000+1000+500 = 2500
Average unit cost = [1000*11+1000*11+500*31]/2500 = $15

Annual Demand
(units)
Unit Cost ($)

P1

P2

P3

Total

1,000

1,000

500

2,500

11

11

31

15

Variance / per
100
100
81
96.2
week
Lead time
1
1
1
1
(weeks)
A 95% confidence interval is assumed and based on
the variance value given the safety stock is
calculated
Safety stock
16.5
16.5
14.85
Order Qty / per
order
46.4
46.4
23.2
116
Number of
21.6
21.6
21.6
Orders
Annual Purchase
11,000
11,000
15,500
Cost
Ordering Cost
86.21
86.21
43.1
215.5
Holding Cost
63.8
63.8
87
214.60
Total Cost
37,930

By comparing the cost incurred in the above two options it is advisable that the
company orders these parts from the overseas partner. The difference is due to
the huge demand for the product and relatively low inventory holding cost
compared to ordering cost and the shipping cost.
There some more issues which Sarah is facing which need to be resolved.
Sarah wondered if Jay should consider a radical change in J&Gs mission.
Were his goals realistic?
Jay wanted to develop J&G as a customer focused distributor offering very good
service. He wanted to provide 100% commitment to customer satisfaction and
promised that J&G would provide 95% of the items in the catalogue are always
available while 92% are shipped the same day and 99% within 24 hours.
Sarah is right in her thinking that, there needs to be some amount of flexibility
about the mission and the goals which Jay wants J&G to follow. Since currently
the amount of variation in even inexpensive parts is too high (50% for a special
resistor), this would mean that the current forecasting methods need to be
improved. Moreover certain items which are currently being procured from
overseas suppliers and need to be clubbed would lead to overstocking unless
there is a similar correlation with the demand too.

Assuming J&Gs path would not change, how will she determine how
much inventory J&G should have? How should she think about the
tradeoff between the need for service with the need for lower
inventory? How should she value the capital tied up in inventory? How
can she measure the value of service?

Since currently the major problem which J&G is suffering is that its service levels
are falling and it is not in a situation to acquire more capital. J&G should try to
realize as much value as possible in the tied up inventory. They should take a
stock of their current inventory and categorize the items as slow, medium and
fast rate of turnover. Based on the rates they should craft a policy to reduce the
inventory and hence procurement for slow moving items and release as much
locked capital as possible. At the same time the inventory for fast moving items
should be replenished regularly so that the high level of customer satisfaction
can be maintained. Since there are a lot of competitors maintaining a wide range
of items is necessary to maintain business, however if this puts too much burden
on the financials then the company should identify certain key suppliers and OEM
customers and focus their inventory procurement more towards serving these
customers. The value of service can be identified from the amount of
incremental repeat business which the company is able to garner based on
earlier higher levels of service.

How can she hope to implement change when there are so many items
to manage?
She can hope to implement change by categorizing the number of items into
groups based on the frequency of turnover of the inventory and then clubbing
them again based on the OEM customers and their order item patterns. Since the
items generally follow a pattern based on the trends in the PC sales, monitoring
PC sales trends can also give a better idea of the type and fluctuation of items
from the portfolio.
Should she approach the problem as one of operating at minimum cost?
What if there is a budgetary limit on the inventory investment? How
might that affect her approach to the problem?
She should approach the problem on optimizing her current costs and not
straight dive to minimize costs. This is because the companys focus needs to
remain on giving high level of customer service so that they can compete
effectively with the national suppliers and maintain their customer base. The
process of cost optimization should begin on the procurement side where the
idea of sole sources should be refined so that the suppliers provide items at a
competitive cost to the company while maintaining the expected product
standards. Procuring items from a particular supplier out of old relations will not
be in the best interest of the company unless the items are being supplied
provide a competitive edge to the company either in price or supply regularity.
A budgetary constraint will contain her abilities to provide high levels of service
satisfaction to all the customers. The company will have to make a tradeoff
between the customers it can let go in order to provide high level of service to
others.
Should she keep the (Q.r.) policy framework ? Is it appropriate for all of
the items? If not then what other realistic options are there?

Yes she should keep the (Q.r.) policy framework, however for certain items which
have a lot of variation in the requirements over the weeks, instead of the (Q.r.)
policy framework, the company should adopt a time based approach where, the
inventory is checked periodically to maintain a certain level of quantity of the
items at all times. An example for this would be the Special Resistor, J&G part
number 4915082. The demand for this item varies more than the EOQ almost
50% of the times, however the upper limit of the demand is also known, so we
can decide on a periodic ordering time when the inventory would be replenished
on regular intervals. Moreover since there are no advantages of ordering the
parts together to save shipping, the items can be ordered as frequently as
required in a varying quantity if required.