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Operation
Management
Name: Amar Verma
Roll: 13P119

AMERICAN LIGHTING
PRODUCTS

Problem Overview
American Lighting
Products is a manufacturer and distributor of fluorescent lamps and manages it through three
channel Commercial and Industrial (C&I), Consumer and Original Equipment. Top
management wants to reduce the inventory level while maintaining same level of customer
service. Sue Smith and Bryan White have been asked to eliminate 20 percent of the finished
goods inventory. The plan is to reduce the number of stocking locations so as to reduce the total
inventory level. However this will also result in increased transportation cost and time.

Answers to Questions
(1) Evaluate the companys current inventory management procedures.

The company uses some reorder point control for system inventory where the average system
inventory for the product is NSO+1/2. It is also some time modified according to the seasonal
variations and trade promotion activity. However it is not mentioned explicitly how the reorder
point is established. It is not based on the economic order quantity as there is a fixed lot size
produced which is different from the Economic order quantity value.
We have plotted the throughput (i.e. demand) v/s Inventory level with the help of Table 1. We
find using regression technique that the line which is closest to the point has equation of
y=.139x67.89. Now the slope in this case is .139 which is much different from .5 evident in
the equation for economic order quantity.
The inventory curve is I = 2997TP
0.816
with r = 0.816, where I and TP are in lamps. The
projected inventory reduction can be calculated by using this formula.
From the plot of the inventory data, we can see that there is substantial variation about the
fitted inventory curve. There is not a consistent turnover ratio between the warehouses. This
probably results from the centralized control policy. On the other hand, improved control may
be achieved by using a pull procedure at each MDC.










(2) Should establishing the LOC be pursued?

Let us evaluate the idea of consolidating all consumer product line items into one larger order
centre (LOC). From table 2 we get that total consumer demand is 312,211 line items which is
33.4 percent of the total line items.
We assume that same percentage applies to the total demand. Hence, Consumer demand is
33.4%169,023,000 = 56,453,682 lamps.
From the inventory-throughput curve, we estimate the amount of inventory needed at the single
LOC is I = 2.997(56,453,682)
0.816
= 6,339,684 lamps. Since Consumer products account for
33.4% of total inventory, then there are 33.4%23,093,500 = 7,713,229 lamps in Consumer
inventory. The reduction that can be projected is 7,713,229 6,339,684 = 1,373,545 lamps
which is

Reduction = 100 =17.8% in Consumer inventory levels.
Total reduction in inventory = 1,373,545/23,093,499. = 6%
Thus the goal of 20 percent reduction is not achieved. So this alternative can be pursued but options
also need to be evaluated to reach 20% reduction.

(3) Does reducing the number of stocking locations have the potential for reducing system
inventories by 20 percent?Is there enough information available to make a good inventory
reduction decision?

The second alternative proposed in the case is to reduce the number of MDCs from eight to a
smaller number. In order to evaluate this proposal, it needs to be determined which MDCs will
be consolidated and the associated total demand flowing through the consolidated facilities.
The inventory-throughput relationship can then be used to estimate the resulting inventory
levels. For example, if the Seattle and Los Angeles MDCs are combined, the consolidated
demand would be 4,922,000 + 21,470,000 = 26,392,000 lamps. The combined inventory is
projected to be I = 2.997(26,392,000)
0.816
= 3,408,852 lamps, compared with the inventory for
the two locations of 4,626,333, as shown in Table 1. This yields a 26.3 percent reduction from
current levels.
Table 1 shows other possible MDC consolidations and the resulting inventory reductions that
can be projected.

TABLE 1 Inventory Reduction for Selected MDC Combinations, in Lamps


MDC combination
Combined demand Combined
inventory
Inventory
reduction
Seattle/Los Angeles 26,392,000 3,408,852 1,217,481
Kansas City/Dallas 29,194,000 3,701,403 50,181
Chicago/Ravenna 49,174,000 5,664,257 -557,590

Atlanta/Dallas 39,314,000 4,718,862 1,224,721
Kansas City/Chicago 39,271,000 4,714,650 -933,900
Ravenna/Hagerstown 64,046,000 7,027,231 1,715,607
K City/Dallas/Chicago 52,515,000 5,976,377 -36,377
Ravenna/Htown/Chicago 87,367,000 7,508,054 3,423,196
Atlanta/Dallas/K City 55,264,000 5,242,351 2,293,566


From the MDC combinations in Table 1, proximity to each other is a primary consideration in
order to not increase transportation costs or jeopardize delivery service any more than
necessary. Several options can be identified that yield a 20 percent inventory reduction. These
are:




Option


MDC combinations
Inventory
reduction, lamps
Total
inventory
reduction
1 LA/Seattle 1,217,481
Ravenna/Htown/Chicago 3,423,196
Total reduction 4,640,677 20.1%

2 LA/Seattle 1,217,481
Kansas City/Hagerstown 1,224,721
Ravenna/Hagerstown 1,715,602
Total reduction 4,157,804 18.0%

3 LA/Seattle 1,217,481
Ravenna/Hagerstown 1,715,602
Atlanta/Dallas/K City 2,293,566
Total reduction 5,226,649 22.6%


Options 1 and 3 achieve the 20 percent reduction goal, although other MDC combinations not
evaluated may also do so. The maximum reduction would be achieved with one MDC. The
total inventory would be I = 2.997(169,023,000)
0.816
= 15,512,812 lamps, for a system reduction
of 32.8 percent. However, we must recognize that as the number of warehouses is decreased,
outbound transportation costs will increase. Inbound transportation costs to the combined MDC
will remain about the same, since replenishment shipments are already in truckload quantities.
Some difference in cost will result from differences in the length of the hauls to the warehouses.
On the other hand, outbound costs may substantially increase, since the combined MDC
locations are likely to be more removed from customers then they are at present. Outbound
transportation rates will be higher, as they are likely to be for shipments of less-than-truckload
quantities. If the sum of the inbound and outbound transportation cost increases is greater than
the inventory carrying cost reduction, then the decision to reduce inventories must be
questioned.
Calculating all transportation cost changes is not possible, since the case study does not provide
sufficient data on outbound transportation rates. However, they should be determined before

and after consolidation to assess the tradeoff between inventory reduction and transportation
costs increases. On the other hand, inbound transportation costs can be found, as shown below
for option 1, where the consolidation points are Los Angeles and Hagerstown.




Location

TL rate,
$/TL
Annual
demand,
lamps

Transport
cost, $
Combined
annual
demand, lamps

Transport
cost, $
Seattle 1800 4,922,000 253,131
a

Los Angeles 1800 21,470,000 1,104,171 26,392,000 1,357,302
Ravenna 250 25,853,000 184,664
Hagerstown 475 38,193,000 518,334 87,367,000 1,185,695
Chicago 350 23,321,000 233,210
Total 113,759,000 2,293,510 113,759,000 2,542,997

a
(4,922,000/35,000)1800 = 253,131

There will be a net increase in inbound transportation costs of $2,542,997 2,293,510 =
$249,487 for option 1.
In addition, the annual fixed costs for the MDCs will be less, since the total space needed in the
consolidated facilities should be less than that for the existing facilities. Again, the case study
does not estimate the fixed costs for existing or potential locations.
We do know that taking them into account would favor consolidation.
In summary, the costs associated with option 1, that just meets the 20 percent inventory
reduction goal, would be:


Cost type Cost savings, $
Inventory carrying cost reduction
0.200.8824,640,677 = 818,615
Warehouse cost
0.104,640,677 = 464,068
Warehouse fixed cost Unknown, but may be included in warehouse cost
Outbound transportation cost
Unknown data not given
Inbound transportation cost (249,487)


Although Sue and Bryan could report a substantial savings in inventory related costs, they
should be encouraged to include fixed costs and transportation costs so as to report the true
benefits of the inventory reduction plan.



(4) How might customer service be affected by the proposed inventory reduction?

The general effect of inventory consolidation is to reduce the number of stocking points and
make them more remote from customers. That is, the delivery distance will be increased if

inventory consolidation is implemented. Therefore, delivery customer service may be
jeopardized and must be considered before deciding to consolidate inventories.
From Table 3 of the case, it can be seen that customer lead times remain constant for a variety
of locations with the exception of Kansas City. Since consolidation points will be selected
among the existing locations, outbound lead times will remain unaffected. Customer service
due to location should be constant, at least for a moderate degree of consolidation.
Customer service due to stock availability will be affected if safety stock levels are reduced
after consolidation. Although the inventory-throughput relationship projects adequate safety
stock to maintain the current first-time delivery levels, it does not account for any increase in
lead times that may occur between the current system of MDCs and the consolidated ones. By
comparing the weighted inbound lead times for the existing distribution system and option 1, as
shown in Table 2, the average inbound lead-time is slightly reduced through consolidation.
Lead-time variability is usually related to average lead-time. This should have a favorable
affect on inventory levels since uncertainty is reduced. First-time deliveries should not be
adversely affected by consolidation, according to option 1.

TABLE 2 A Comparison of Inbound Lead Times for the Existing Distribution
System and a Consolidated Distribution System (Option 1) (a) Current Distribution
System



Master Distribution Center


Shipments
Inbound lead
time, days
Weighted
lead time,
days
Atlanta 26,070,000 2 0.308
Chicago 23,321,000 1 0.138
Dallas 13,244,000 3 0.235
Hagerstown 38,193,000 1 0.226
Kansas City 15,950,000 2 0.094
Los Angeles 21,470,000 5 0.635
Ravenna 25,853,000 1 0.153
Seattle 4,922,000 6 0.175
Total 169,023,000 1.964




(b) Consolidation Option 1



Master Distribution Center
1



Shipments
Inbound lead
time, days
Weighted
lead time,
days
Atlanta 26,070,000 2 0.308
Dallas 13,244,000 3 0.235

1
Consolidation is assumed to take place at the MDC with the largest number of current shipments.

Htown/Ravenna/Chicago 87,367,000 1 0.517
Kansas City 15,950,000 2 0.094
Los Angeles/Seattle 26,392,000 5 0.781
Total 169,023,000 1.935