Steel Works, Inc.
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Questions to consider:
1. How would you characterize Steel Works’ products? What about Steel Works’ customers?
2. What does the coefficient of variation tell us? Can you determine the coefficient of variation for the product lines?
3. How much inventory has Steel Works been holding? How much should they have been holding?
SPECIALTY PRODUCTS DIVISION
Steel Works has a large number of customers for its specialty products – 130 customers for some 120 products. However, majority of these customers (82.3%) are small-sized customers with less than $1million in sales. For example, using data from Spreadsheet S0121958, we see that there is only one major customer, C194, demanding considerable volume of DuraBendTM R12, relatively to other customers.
Given the large number of customers and the large variability in demand (80% of all specialty products had coefficient of variation greater than 0.5), it is comforting to see that Steel Works has made use of risk-pooling to reduce the variability of overall inventory demand for each product. Therefore, although it is important to concentrate efforts on the big customers that bring in more than $24 million in sales each, it is not advisable that Steel Works neglect the smaller-sized customers.
As seen from Table 1, DuraBendTM R15 & R12 have very high impact on the annual revenue since they have very high demand and medium selling prices. The kink in Chart 1 tells us where products should be classified; in this case, we will divide them into two classes.
Chart 1: Distribution of Products by Values
One class consists of DuraBendTM R15 & R12, which require the most managerial attention and review. The other class consists of the rest of the products that have less impact on the annual revenue. Characterizing the products this way will reduce wasted management time and attention on products with low annual value.
As seen from Table 2, DuraBendTM R12 and R15 have very high standard deviations as compared to the rest of the products. However, the deviations are actually quite small when we look at them relative to the average monthly demand. In fact, DuraBendTM R12 and R15 have the smallest c.v. amongst the products, i.e. the demands for these two products are quite stable and therefore, fewer inventories (relative to demand) are required to obtain a high level of service.
On the other hand, the variability of the demand for DuraFlexTM is quite high as reflected by the high c.v. (0.62 – 1.46). Therefore, it is recommended that Steel Works continue to manufacture product families in the same plant as it would be able to enjoy the benefits obtained through risk-pooling of the component parts required for the manufacturing of DuraFlexTM (assuming that majority of the products make use of similar component parts) and also that high demand in one area would be off set by lower demand in another.
Although a higher c.v. would generally suggests a higher level of safety stocks, Steel Works however overestimated the safety stocks for DuraFlexTM and underestimated the safety stock for DuraBendTM R12 and R15, as we will see from the results obtained below. This will also explain the illogicality
of Steel Works having ‘ridiculous’ inventory level and yet, was only able to fulfill 70% of the orders within 48 hours.
Since Steel Works currently do not have a centralized system and its products are not properly tracked, we will use the base-stock policy to calculate the recommended inventory levels even though QR model would probably give us a lower inventory level. Other factors which we took into consideration include:
Each product is produced once a month. Given that the average lot size is almost the same as the average monthly demand, not much value will be obtained from updating the orders continuously. In addition, keeping track of the inventory continuously will require a lot of time, especially since Steel Works does not have a centralized database.
There is a change-over cost between different products. The QR model replenishes the inventory whenever the inventory is below the reordering point. As a result, the manufacturing side cannot plan the production schedule for each produce before hand, and therefore may result in unnecessary change-over costs.
Since each product is manufactured once a month in a rotating sequence, we set to be 1 month, and that the inventory of each product is reviewed on the first day of the period when the product is scheduled to be produced. Since we know from the case that DuraFlexTM R23 is produced monthly and during the 1st week of the month, the lead time L is assumed to be one week, that is, 0.25 months. In addition, given that the company only shipped approximately 70% of the orders within 48 hours, the improvement for the service level up to 95% (z = 1.65) is adequately considerable.
Table 3 shows that DuraBendTM R12 and R15 do not have enough inventories to satisfy the high demands. On the contrary, the rest of the products have too many redundant inventories. Implementing the base-stock model, the average inventory level could be decreased from 3928 to 3460 (13.5%) while the stock-out probability will be reduced to 5%. Therefore, we would recommend:
The company to increase the inventories for DuraBendTM R12 and R15 to meet the demands and allow for some safety stocks. In this way, the entire service level would be raised significantly. In addition, Steel Works should decrease the inventories for the other products to avoid holding unnecessarily excessive items.
However, we also need to consider the coefficient of variation (variability in demand), which is important to the service level. For products with high coefficient, production systems that are able to respond quickly to the variable demand can be implemented, together with more frequent review, if there is enough budget and that cost-benefit analysis shows it is beneficial to do so (especially since most of these products do not contribute much to the annual revenue,
Manufacturing System: Flexible production systems would be beneficial to response to the continuous order. In addition, changes to production plan should have as small extra production cost as possible. The review frequency will depend on how important the customer or demand is and the cost of having such a system.
Logistics System: ID tag is the best way to keep track of the inventory continuously. However, ID tags are still quite expensive. Therefore, we need less expensive ID tags with the bare minimum (appropriate size, acceptable technology, omitting the testing process, etc) so as not to invest too much money on the ID tags. There is also a need to ensure that the ID tags are properly interfaced with the inventory management systems.
A centralized logistics system for the products that have high variation in demand would help reducing risks for the company. Having too many warehouses will result in higher levels of safety stock. In some cases, a direct delivery from manufacturers to customers may incur less cost than holding a huge inventory.
CUSTOM PRODUCTS DIVISION
Certain products, e.g. DuraFlexTM R23, are produced by both the Custom Products Division and the Specialty Products Division. While the Custom Products Division manufactures DuraFlexTM R23 and provides it to the original customer who required the development of the product, the Specialty Products Division also produces the exact same steel and sells it to five other customers.
As seen in Table 2, the coefficient of variation for DuraFlexTM R23 is extremely high (1.29). In this case, a centralized supply chain system could take great advantage from the risk-pooling effect, since the safety stock inventory could be reduced significantly without affecting the service level. Therefore, the Specialty Products Division should be in charge of the product DuraFlexTM R23 and cater for the demand of all customers currently served by both divisions.