Delivery Strategy at MoonChem
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MoonChem is a manufacturer of specialty chemicals that decides to examine its delivery options to its customers. The necessary arose from concerns of inventory turnover being very low and discrepancies between 20 percent of its customers carrying consignment inventory, but over half of the inventory of MoonChem being in consignment with its customers. MoonChem has eight manufacturing plants, where base chemicals are made, and forty distribution centers, where chemicals are being mixed to produce various products and then are being shipped to its customers. In order to examine current distribution operations, John Kresge, Vice President of Supply Chain, decides to focus on the state of Illinois area with zip code 615, Peoria, which customers, who carry consignment inventory, are supplied from Chicago distribution center.
MoonChem ships its products by trucks, which have 40,000 pound capacity. Transportation cost is fixed at $350.00 with additional $50.00 for each drop off. Given that MoonChem ships its products independently to each customer, transportation cost totals to $400.00 per shipment. In addition, MoonChem sends full truckloads to customer with consignment. In addition, each pound of inventory in consignment costs MoonChem $1.00.
1.b. Considering different delivery options
There are two alternate distribution models that can be evaluated and implemented instead of the current distribution operations, if found more efficient. First, lets consider the model when products are ordered and delivered jointly. Lot sizes and costs for products being ordered and delivered jointly for all three customers:
Demand per year12,00060,000144,000
Optimal order size1,6338,16319,592
Annual holding cost2051,0212,449
Average flow time (weeks)188.8.131.52
Fixed cost (S) per order is $350.00 plus $50.00 per drop off. Therefore, total fixed cost per order is $500.00. Ordering frequency (n) is 7.35. Annual ordering cost comes up to $3,675.00. Based on calculations (see Appendix 2), annual cost of proposed strategy 1 of sending products jointly to all three customers in the Peoria region to replenish consignment inventory is $7,350.
Second, lets consider the model when products are ordered and delivered jointly for selected customers. Lot sizes and costs for products being ordered and delivered jointly for selected subset of customers:
Demand per year12,00060,000144,000
Order frequency/ year3.887.757.75
Optimal order size3,0937,74218,581
Annual holding cost3879682,323
Average flow time (weeks)8.463.353.35
Order frequencies for large, medium and small customers for the scenario of independent deliveries were calculated to be 6.71, 4.33 and 1.94, respectively. The most frequent ordering therefore is required by large customer. Taking order frequency of large customer as a base, relative order frequencies were evaluated for small and medium customers being 5.48 and 12.25, respectively. By further calculations, it was determined that small customers order will be shipped with every other shipment and medium customers order will be included with every shipment. Recalculating ordering frequency to the respect of fixed costs and varying costs, the order frequency for large, medium and small customers were determined to be 7.75, 7.75 and 3.88, respectively. Based on calculations (see Appendix 3), annual cost of proposed strategy 2 of sending products jointly to all three customers in the Peoria region to replenish consignment inventory is $7,360. There has been discrepancy between holding cost and ordering cost, which differ by few dollars.
That can be attributed to rounding errors. Even if the lowest of two would be taken (holding cost: $3678) to reproduce the other one, the annual costs would come to $7,356.00. The recommendation to MoonChem would be to adopt joint shipping for all three customers because such delivery strategy costs less ($7,350.00 vs. independent deliveries of $10,380.00 and joint deliveries for selected subset of customers of $7,360.00). While, joint shippings smaller costs intuitively make sense because fixed costs associated with deliveries are being distributed between customers; shipping jointly to selected subset of customers increases such costs. This can be explained by increased order costs due to more frequent ordering pattern needed to accommodate such model for some customers and increased holding costs for the other customer, which has to hold more inventories on hand, since its ordering frequency is being reduced. As a consequence, the recommendation at the time would be to adopt joint shipping to all three customers.
1.c. Impact of the proposed recommendation on consignment inventory The proposed recommendation of adopting joint shipping for all three customers, besides dropping ordering and holding annual costs, will also reduce the consignment inventory for the region by approximately 29% (independent deliveries: 41,519 products per order combined from each customer, joint delivery: 29,388 products per order).