Burton’s Wine Cellar Burton's Wine Cellar (BWC) is a very large retail outlet that caters to wine enthusiasts, The store carries an extensive variety of different types and brands of wine. The bulk of the volume of the store is based on the sale of “value wine," which satisfies the qual- ity standards of most wine drinkers, while being sold at a moderate price level. The store also carries many different types and brands of relatively exclusive wines to ae, Commodate the tastes of their more discerning consumers, BWC prides itself on the breadth of its extensive inventory. Many customers artive at the store to browse through the selection that is available and then select a brand that appeals to them while they are shopping in the store. Some brands are occasionally stocked out. However, the very knowledgeable sales staff on the floor can almost always direct customers who might be specifically seeking a particular brand that is stocked out to some other brand that is similar to what they were originally seeking. Because of this brand substitution ffect, there is hardly ever an instance of a totally lost sale that results from occasional Stockouts of brands of wine. Customers typically do not buy any one brand in large Quantities when making a purchase at the store, ‘The management of BWC is well aware of the fact that routine stockouts of some of the more popular brands could ultimately lead to customer dissatisfaction and to some lost sales. The general nature of the business is such that BWC management has an ex tablished benchmark policy. such that they wish to maintain inventory at a level to be 95% confident that they will get through the order eycle for any given brand without baving any stockouts for that particular brand. BWC should not expect to incur any sig nificant levels of lost sales, as long as the 95% service level policy is maintained, siven the general standards of this business The very large number of different brands carried by BWC has led management to use a fixed-order-period model for replenishment of inventory, rather than to be in, Folved with perpetual ordering systems. BWC maintains a running inventory count from sales records, but periodie physical inventory counts are required to adjust ad to update these records. Differences between this running count and actual inventory lew, ck result primarily from breakage of bottles, since theft is minimized by a very strict. fecnrity system that is reinforced by the presence of sales staff on the floor. Tight con- {rol of inventory is eritical for BWC, duc to all of the many legal issues that are in. volved with the sale of alcoholic beverages. Because of this, it is not feasible to consider any reordering option that would allow for more than eight weeks between physical inventory counts. The physical counts must be very accurate s354 Part Three Supply Chain Management Shelves in the store are kept fully stocked, whenever possible, so customers will not erroneously conclude that the store is running out of different brands, The bottles for this routine restocking of shelves come from a large storage room in the back of the building that is used to hold much of the total inventory that is maintained. This situa- tion makes precise inventory counting quite difficult. The specific problem is that the wide variety of brands that are sold leads to many small quantities of some lower- volume brands being stored together in carboard boxes, to minimize the total require- ‘ment for storage space. All of these boxes must therefore be opened, and each bottle ‘checked, to be assured that the correct brand is being accounted for during these phys- ical counts, This physical counting of inventory is @ very time-consuming process. In addition, the follow-up ordering procedure is also quite complicated, and finding ade- ‘quate shipping that is secure for bottled alcoholic beverages is expensive. BWC man- agement estimates that it costs an average of $125 for each individual order fora given brand of wine to be placed, to be shipped, and to be received back at BWC. Each indi- vidual order arrives back at BWC in single-lot shipments, notin ineremental deliveries BWC will definitely place orders whenever inventory records are updated after ¢ physical count of inventory has been performed. There are serious concerns about the frequency with which these physical counts should be done, If longer order eycles are used, then larger orders must be placed each time to cover the basic expected usage during the cycle, which will increase the average value of inventory that is being held during the year. I longer order eycles are used, then larger amounts of safety stock will ‘also be required to meet the established benchmark service level. However, longer or- dex cycles will reduce the number of orders that are placed, and the ordering costs are (quite expensive. Management wants some input on the total expected annual cost for holding inventory for various feasible order cycle lengths. The manager of BWC specifically wants estimates of the total expected annual combined cost for carrying basic inventory to meet expected demand, for the expected cost of carrying additional safety stock to meet the benchmark service level, and for the total cost for placing orders. Any fixed-annual-cost components of inventory hold- ing cost can be ignored since they will have no impact on the relative comparison of to- tal expected annual cost for various lengths of order eycles. It is feasible to consider using order cycles of 4, 5, 6, 7 or 8 weeks. The lead time for order will be two weeks for any order cycle. Estimates of holding costs are more difficult to obtain than the stated ordering cost given above. In order to be able to perform analyses for all of the different brands that are carried, we need some measure of the annual unit variable holding cost as a per- centage of the value of the item that is being held in inventory. That is, a percentage that is based on the cost of product to BWC. The accountant for BWC was contacted for input regarding inventory holding costs, and some old sales and tax records have been examined. It was found that the average value of total inventory for all products that were held last year, not just the particular product that will be under consideration later, was approximately $2,327,000, and the total ofall inventory-related expenses for all products was $1,886,000. Some of the inventory-related expenses include substan- tial fixed-cost outlays, including things like the repayment of loans for the original construction of the store. The overall value of total inventory was lower during theEXHIBIT 12.1 Weekly Demand for | a Typical BWC Product Case 12. Burton's Wine Cellar 55 previous year, with a total average value of $2,119,00 with an associated total inven- tory related cost value of $1,861,000. The fixed-cost components of inventory-related costs were approximately equal over both years, and economic conditions and interest rates have been very stable over the associated two-year period. The weekly demand for bottles of a typical product, of the hundreds of products held by BWC, is given in Exhibit 12.1 for the past year. There are no obvious trends in. weekly usage. The BWC cost for acquiring this particular product is $6 per unit for any order quantity, and we wish to know the order cycle length that should be used to min- imize total combined expected annual inventory cost for this product under existing circumstances. BWC operates 52. weeks per yeat. With the reasonably high service level that is being considered, it will be acceptable to assume that weekly demand is constant for the purposes of computing expected costs, The expected order quantity for each cycle will then be equal to the expected usage during an order eycle. The impact of carrying safety stock can be more difficult to precisely determine on a cost basis. The amount of safety stock that is remaining, in inventory at the very end of any particular order cycle will certainly vary, and that amount would have been carried in excess throughout that order cycle. We will approximate the annual incremental holding cost for safety stock with the ‘Week Demand Week Demand assumption that we will, on average, 5 ay a5 S19 _ be carrying the safety stock quantity va 5 As as exeess inventory throughout the 5 459 39 ‘sg _-Year in order to maintain the required a 473 50 632 _target service level 5 460 31 436 The manager of BWC specifi- 6 610 32 516 cally wants a summary of estimates 7 an 3B 608 _of the total expected annual combined 8 478 34 525 cost for various order cycle lengths. 3 bia) a 2 This total cost includes the cost for ue a 3: 580 carrying the basic inventory required 1" a2 37 eae es ie Eirdemena th! on oe a ee meet expected demand, the ex- a ae ae 278 pected cost of carrying additional Hs ee a6 feq__safety stock to meet the benchmark is 565 at fee _service level, and the total cost for 16 481 42 581 placing orders. These costs should be 17 538 3 623 _ obtained for the options of using or- 18 511 a4 483 der cycles of each of 4, 5, 6, 7, and § 19 506 45 434 weeks. Of primary interest are the de- 20 523 45 534 termination of the least cost order cy- a 529 ae “3 cle length and some input on the 22 67 8 att sensitivity of this total cost to changes 8 535 3 514 in order cycle length, 24 551 50 507 aa : 5 oa en a nee ‘management is also very ce ay oy $3g aware of the fact that the determina tion of the optimal length for order56 Part Three Supply Chain Management cycles could change over time. This would result if the variable component of annual unit holding cost changes with such factors as the interest rate that is charged for money that is borrowed to hold inventory. If variable holding costs decline, the option of using longer order cycles, with their associated larger inventory levels, becomes more feasible. BWC management wants to know the ranges of annual Variable holding cost values for which each of the 4-, 5-, 6-, 7-, and 8-week order cycles would be the least total expected annual cost option for the particular product described above. ‘These variable holding cost values should be stated in terms of a percent of value of the item being stored.