Case 2 - Merloni Elettrodomestici: The Transit Point Experiment
1. What are the costs and benefits of Merloni's current distribution system? (Hint – there is enough information presented in the case and exhibits to provide actual quantitative estimates (in lire) of operating, holding and transportation (and/or other) costs, e.g. based on various average inventory levels. You are encouraged to include spreadsheet support for your estimates.)
Merloni has 5 plants in Italy, each one of them manufactures a single product line. Company's current distribution system has plant warehouses, central warehouse and 17 regional warehouses. In other words, it is a decentralized distribution system. Warehouse managers ordered product from the central warehouse. Shipments were sent to each regional warehouse when enough orders had accumulated for a full truckload. It means a high inventory cost, labor cost, and overhead cost. The company has clients all over Italy and in Europe. If the regional warehouse is out of stock, this means an additional cost of delivery. It can be very expensive if it is far into a rural area.
The first step is to distinguish the rural region and urban region according to the population. The second step is to use the average inventory to calculate the operating cost, inventory cost and transportation of each region, and then add them together. Thus we could get the total operation cost, total inventory cost and total transportation cost. Finally, we could get the total costs by adding them together.
Cons of a decentralized warehouse include higher inventory levels are each regional warehouse, discrepancies between each warehouse and how operations should be performed, as well as the substantially higher costs associated with this. It can be assumed that every manufacturers' goal is to keep costs down; having several warehouses all performing under their own supervision may lead to practices that would not be performed if certain responsibilities were removed from that location (centralized system). Furthermore, moving to a centralized system would eliminate the costs associated with numerous regional warehouses needing to keep inventory at varying levels (Figure 1).
2. What were three major changes in inventory policies that Merloni implemented to support the current system? What were the results of these changes?
In 1980's Merloni's competition increased due to the maturity of the market and economic downturn. The company realized the need to “consolidate and rationalize many of the company's functions”(p.4). Average annual sales rate had dropped by 10% (from 30 to 20 percent) between years 1980 and 1984. Following three major changes were implemented to support the current system under a new consultant supervision:
Inventory planning (ABC inventory classification) - items are now categorized by their levels of value consumption. By using A-B-C inventory classification, inventory goals for each SKU were calculated daily by the system to meet the company's goals of each item. ABC system allocates the most used products to the easiest access points, the closest to the front-end of the warehouse. This reduces handling and travel times.
Comprehensive information system allows for centralized inventory planning and shortens the production planning cycle. By piloting a comprehensive information system, inventory levels could be calculated by allowing order information to be transferred electronically (increases information visibility).
Improved manager performance evaluation. Previously managers set their own goals and did not have motivation/incentives to keep the stock levels low. A monetary incentive was introduced to managers who met these inventory goals; they would receive bonuses from 100,000 to 400,000 lire. In addition, in order to fulfill targeted inventory goals the measures used to assess each warehouse manager's ability to achieve the stated inventory goal are now calculated by the information system.
The results of these changes were the decrease of the inventory level at the regional warehouses by 75% by the fall of 1986, production planning horizon was reduced from 4 to 3 months, and fixed time was shortened before production from 2 to 1 month.
3. Describe the Transit Point proposal Merloni is considering. What would be the costs and benefits of the proposed system? (Hint – there is enough information presented in the case and exhibits to provide actual quantitative estimates (in lire) of operating, holding and transportation (and/or other) costs, e.g. based on various average inventory levels. You are encouraged to include spreadsheet support for your estimates.)
Transit point proposal assumes a usage of “transit points” and elimination of the regional warehouses. “Transit-points” are the “T-shaped cross-docking areas where full load trucks could be separated into smaller trucks for local delivery”. This would transform the current decentralized system into centralized/cross-docking system. This would allow for less inventory, increased throughput rate, elimination of product putaway, product-picking. The products are not stored at the cross-docking centers and moved more quickly. Other cost savings with this proposal are no lease expenses, no maintenance of building expenses, reduced employees cost. Due to the smaller chain there is a reduced bullwhip effect, less chances of distortion of information.
During the transit point trial the company set the cut-off time at 3 p.m. (the latest time when a client can order to get it shipped next day). This cut-off time might cost the company reduced clients' satisfaction if they are a little bit late and have to wait an additional day to receive their order. On the other hand, it can be the revenue benefit if the client is willing to pay extra for the next day shipping, the company can have a profit from it. After 3 p.m. the manager of the WH would make a decision on the most efficient delivery route and loading and unloading of the trucks based on the final destinations of the goods. This would require more thorough logistics planning on a daily basis, thus, an increased number of qualified personnel needed to do the job. This is an extra cost for the company. If the delivery volume was too high the manager would call customers and negotiate the delivery day if it was possible. This allows managers to smooth high and low demand days. 5 pm orders went to headquarters electronically and product-picking and trailer-loading began. By 7:30 am the truck arrived in Milano where the local delivery trucks waited to be loaded by Merloni WH personnel. If the Milano location was fully converted to a transit point, this work could be subcontracted to a local handling and distribution company, which could be a potential cost savings on the permanent personnel, and the company can concentrate on their core activities.
Additional cost would be needed to increase the capacity of the central warehouse.With the new system it would be harder and more costly to cater to a fluctuating demand since there will not be extra stock. According to the article in the current system “regions located more than one day's journey from Fabriano held higher inventory levels to buffer demand over longer replenishment lead times”. In a case of unforeseen circumstances (higher than expected demand, mechanical problems, weather conditions), the additional cost would be in hiring more trucks, and keeping them in a very good condition if the company owns them. Centralized distribution system in the case of Merloni can have another cost disadvantage. For instance, if a client that is located closer to the plant that manufactures desired good wants to buy it, the item would have to be shipped first to the central warehouse, and then back to the region. According to the article, 65% of freestanding product sales was delivered through regional warehouses. It is a large number of deliveries to be doing back and forth, in other words, the process is inefficient.
Table 2 showcases how the transit system would be introduced to the entire company. There would no longer be costs associated with inventory at the regional level and operating costs would decrease by 20%.
4. If the proposed system is implemented, which WH/DC stakeholders would be affected by this change? Explain how each stakeholder would be affected.
Both of internal stakeholders and external stakeholders will be affected.
Customers. Personal relationship between regional manager and customers are no longer exist. In the case of when customer prefer to pick up goods, they will not have a physical location to go to. And the outbound logistic time would be longer, which can delay the delivery of goods.
Employees. They will lose their jobs since the elimination of the regional warehouse. Central warehouse will require more skilled workers like the risk managers or inventory managers.
The company's logistic department or third party logistic companies will handle more shipments with Merloni after the implementation of the elimination of regional warehouses.
Sales and marketing department. With the implementation of the new system, the chance of late delivery is higher, therefore the sales and marketing might receive more complaints from a customer.
Competitors can be affected in different ways. In the case of Merloni,if they will experience delivery delays on a regular basis due to long delivery routes, customers can choose to go to another company. On the other hand, if the new process will run smoothly, it would save the company's money to improve service level, which can hurt their competitors.
5. Should Merloni implement the new system? Justify your choice qualitatively and quantitatively. If you think the new system should be implemented, what contingency plans and support systems would be necessary to support the new logistics network? Think strategically.
Yes, the transit point model can be more efficient and flexible when facing various situations. The model can minimize the overall inventory level. Also, it can reduce costs in many angles, mainly on the labor cost since the workforce significantly reduced. However, there are still some concerns; the new model has strict requirements on production line stability, transportation efficiency, and safety stock level in the central warehouse (none stockout).
Continues implementation plan would first start with identifying the benefits after implementation and the requirements both in infrastructure and time or capital investment.
The cost of human resource would potentially go down, because since the regional warehouses would be eliminated, there would be less workers needed. But on the other side, the workers have to be cross trained with the skills like cross docking and new IT system, because the scheduled shipment must be accurate, thus more skilled labors in the system are needed. Moreover, in the past, regional warehouse managers formed their respective customer relations network. Now the central warehouse has to integrate them and maintain or exceed their customer service level.
The implementation also need more infrastructure and more efficient logistics. First, since the regional warehouses will be eliminated, the central warehouse should be expanded because it will accept a larger quantity of goods and using higher volume and frequency of shipments to meet the needs of the previously regional warehouse. If there is an excess demand or potentially stockout in any transit locations, the central warehouse has to insure that there are enough trucks to be used and the traffic condition is good. And furthermore, we recommend the company to outsource the logistic service to a trustworthy third party logistic partner. According to the Exhibit 7, it figures that their plants and warehouse spread all over the entire Italy. And for the matter of fact, cities of southern Italy are scattered around the mountains, near the coast; the exhibit 8 also pointed out such cities like Palermo and Catania, which are located far away from the central warehouse, obtain a high inventory level. That would cost more after the implementation because it increases the frequency of shipments. So, it would be wise to leave the complex things to an expert. This way they can concentrated on their core competencies, such as innovations and quality.
Another system to consider when using just cross-docking instead of regional warehouses, let the goods to be shipped directly to a customer from a plant, if the order is large enough to load the entire truck. This would save unnecessary travel time between the plant, central warehouse, cross-docking and a client.
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