Merloni Elettrodomestici SpA: The Transit Point Experiment

The Organization

Merloni Elettrodomestici SpA (Merloni), is a major Italian manufacturer of freestanding and built-in appliances. Merloni’s distribution network consists of five manufacturing plants, a centralized warehouse, and seventeen regional warehouses.

During the past few years, Merloni has implemented programs that have successfully shortened production-planning lead times and decreased inventory levels. In particular, with the help of a centralized inventory planning system and implementation of an A-B-C inventory classification program, they were able to reduce inventory levels at the regional offices by 75%. The production planning time horizon was reduced from four months to three while the required lead-time to firm orders was reduced from two months to one.

In line with a new wave of efforts to further reduce inventory and enhance production efficiency, management is evaluating a proposal to replace regional warehouses with “transit-points”. At these transit points, products arriving on trailers from the central warehouse and plants would then be transferred directly to smaller local delivery trucks. The primary issue being assessed then is the viability of the transit point solution and its effectiveness in improving efficiency and reducing costs. The secondary issue is the provision of an exhibition center in the Milano area without significant risks to product delivery.

Analysis

The proposal being evaluated utilizes the concept of “cross-docking” and is synonymous with JIT in manufacturing. In cross-docking, goods are received on one dock and are immediately shipped through another, without the need for storage. To carefully assess the benefits and disadvantages of this proposal, a number of critical factors must be addressed:

Inventory: As describe above, the current inventory levels held at the regional offices already reflect a 75% reduction in comparison to historical figures. This level of inventory is established based on customer demands and constrained by production lead-times. Although the transit point concept eliminates inventory stocks at the regional warehouses, it does nothing to reduce the overall required inventory levels. That is, it does not alleviate any of the constraints that determine inventory levels such as reducing production set up times or production lot sizes. Therefore, the current requirements of inventory would not be affected.

Infrastructure: By eliminating the need for inventory storage at the regional offices, the transit point concept could help reduce operational costs at the regional warehouses. These operational cost savings would be associated with reduction in space, utility, and labor usage. However, it is important to remember that Merloni will still need to maintain the facilities needed for cross-docking as well as temporary storage of units that it was unable to delivery immediately. Therefore, Merloni will not be able to completely eliminate the cost of operating its regional warehouses.

Also, as discussed above, the use of transit points alone will not reduce inventory level requirements; it simply pushes inventories upstream to the central warehouse. This means that the central warehouse will need to expand by about 32% in order to accommodate this excess inventory (please refer to Exhibit 1 for calculations). Increased number of trailer departures from the central warehouse may also require that extra shipping docks be installed (please refer to Exhibit 2 for calculations). The cost of modifying the central warehouse would further offset the potential cost savings realized at the regional warehouses.

Labor and staff: As stated above, a transit point system would reduce material handling requirements and associated labor at the regional warehouses. While this yields cost-savings, Merloni must be aware of the negative impacts that downsizing will have on its workforce.

Also, since a transit point system requires much more diligent planning and coordination, the administration staff might need to work longer and later hours, which could offset some of the cost savings realized from warehouse operations. Higher stress levels among the administration staff could also increase turnover and associated costs.

Transportation: Low demand-variance and relatively close distribution distances are critical success factors for cross docking. For example, Wal-Mart is able to benefit from cross docking for distributing some of its non-staple products that have very stable demands throughout its retail stores in a small region. The demand for Merloni’s products however, are quire variable. For example, the average demand for the free-standing products can jump from about 1,000 units in August to over 12,000 in September. Not only this presents serious obstacles to planning and coordinating shipments, the peak in demand could result in serious service disruptions. Also, since units must be shipped to regions on a daily bases, regardless of the quantity ordered, significant inefficiencies result if the trailer is not filled to maximum capacity.

Another significant concern with the transit point proposal is the length of time that transportation would add to product delivery lead times (please refer to the Customer Service issue for further explanation).

Customer Service: Currently, over 65% of products are delivered within 24 hours, directly from the regional warehouses. Only 35% of products are shipped from the central warehouse with a two to six day delivery times. Eliminating inventories at regional warehouses would increase the delivery time for all products to two to six days. Further delays due to problems with the delivery or product damage could potentially double the delivery times. The significant increase in lead time will undoubtedly adversely affect customer-satisfaction.

Although the two months trial that took place between the central warehouse and Milan was successful, the distance between the two locations is quite small relative to the distance to the other regions. Moreover, daily deliveries to some of the regions inaccessible via ground transport are neither possible nor efficient. The experiment does not reflect a typical scenario for Merloni.

Alternatives

Merloni has other alternatives for increasing the efficiency of its distribution network while maintaining the same or improving its delivery times. Some these alternatives are:

1. Transit Point Only at Milan

As explained above, cross docking can be viable and cost-effective under certain conditions. While cross docking is not advisable for most of the regions for the reasons explained above, the two month trial was a success for Milan. Given that the conversion of the Milano warehouse into an exhibition center can lead to sales and marketing strategic advantage, one alternative would be to continue serving the region through a transit point. The current distribution network can then be maintained for the remaining regions. Although this alternative would not address the primary issue (efficiency of the distribution network as a whole), it would allow Merloni to continue operating its exhibition center without significant risks to product delivery.

2. Transshipment

Instead of delivering products from the central warehouse directly to a region for use by that region, Merloni could use the excess capacity on the trailers and regional warehouses for deliver to other regional warehouses. By doing so, Merloni could leverage its excess storage and transport resources to choose optimum transport solutions in order to minimize costs while reducing delivery times. Many distribution resource-planning (DRP) software can be programmed to automatically choose optimum routes if they are provided with necessary information about route-specific transport costs and warehouse specific inventory storage and operational costs. Implementing this Please refer to Exhibit 3 for a demonstration of such a solution.

3. Combination of Transshipment and Cross Docking

While allowing the Merloni to operate the Milano regional warehouse as an exhibition center, this alternative would leverage the benefits of transshipment and transit points to maximize the efficiency of the distribution network. In other words, where it is more cost-effective, a regional office could be converted to a transit point as well as receive shipments from another regional office.

Recommendation and Implementation

After careful analysis of the primary issue and the critical factors, the recommendation is not to deploy the transit point concept across all the regional offices. For the reasons explained above (please refer Analysis), doing so will increase average product delivery times and adversely affect customer satisfaction. At the same time, the cost-savings realized from conversion of warehouses to transit points may be offset by higher costs of transportation, costs of modifying the central office, and cost of lost sales due to customer dissatisfaction.

The third alternative explained above, however, addresses the primary issue. It leverages the benefits of the transit point concept as well as that of transshipment. Furthermore, it ensures that the Milano warehouse continues to operate as an exhibition center for Merloni’s clients.

In order to implement this alternative, careful analysis of transportation costs between different regions as well as operational costs of carrying inventory in each region must be determined. This data can then be used in combination of a linear programming solution or a DRP software capable of determining the optimum distribution and delivery solution for maximizing efficiency and minimizing costs and delivery times.