Supply Chain

Exercise 1 вЂ" Inventory/Service Crisis

a) During the early 1990s, the famous manufacturer of computers and peripherals, Hewlett-Packard (HP), faced several severe problems concerning the inventory management of its very successful DeskJet printer. The printer was produced in HP’s production facility in Vancouver. The completely finished product was sorted there and then shipped to one of the three distribution centers in North America, Asia and Europe.

To guarantee high product availability to the dealers, HP operated its distribution centers (DCs) in a make-to-stock mode. Therefore the DCs acted as inventory stocking points between the manufacturing site and the dealers who sell the printers to the end-customer.

Under increasing competitor’s pressure the DCs were forced to hold extremely high safety stocks to ensure high service levels. Despite the high safety stock not all customer demands could be satisfied. This led to what HP called the “Inventory/Service Crisis”.

One of the basic causes of the crisis was the magnitude of forecast errors. Besides this, safety stock levels were determined by a judgemental rule of thumb which, together with the inaccurate forecasts, resulted in simultaneously high inventory levels and high backorders. The inventory policy was not based on any scientific rule. Furthermore, neither the choice of inventory carrying costs nor the choice of the target line item fill rate as key figures for a sensible and rational inventory policy was defined clearly. Inventory carrying estimates were between 12% and 60% whereas the company target fill rate of 98% was developed by marketing without taking into consideration the effects this rate had on the production and distribution process. There was no coordination between the different divisions of HP and the inventory policy did not implement the figures accurately.

Due to the long lead time of 4 to 5 weeks caused by ocean freight, the DCs were not able to react flexible enough to un-expected changes in product mix and consumer needs. In the fast-moving computer technology market products tend to become obsolete within a short time. The inflexible transportation mode is not able to cope with that, thereby causing high inventory levels but at the same time high backorders because the inventory stored does not correspond to the latest trends in the market.

Another reason for accumulated inventory at the DCs was that the Profits & Loss statements of HP did not show the impact of inventory holding explicitly. What stroke immediately were the consequences of lost sales which reduced revenues. The cost accounting and financial reporting were not transparent enough to dispose processes effectively.

As the different markets, especially in Europe and Asia, have different requirements for the printer, the product has to be manufactured in many different variants. Although it is the same product in each country, the localization leads to variety which is another reason for high inventory levels. The need for adding country specific power supply modules with the correct voltage and plugs as well as the appropriate manual in a specific language to the printer makes determining appropriate demand-tracking production volumes difficult. It is easier to forecast the total demand of all three markets for a generic product than to forecast country specific demand.

In order to reduce inventory and improve the service level resulting in the realization of HP’s mission statement to become a “Recognized World Leader in Low Cost Premium Quality Printers”, countermeasures have to cover the three main uncertainties affecting the supply chain:

1. delivery of materials (wrong parts, late shipments)

2. internal process (process yields and machine downtimes)

3. demand.

To achieve improvements, short-term as well as long-term options are considered in the following:

b) Short-term options:

The most intuitive change to reduce inventory and increase customer service level is the change of the transportation mode. Instead of using ocean freight, air freight should be chosen to transport the printers from Vancouver to Europe and Asia. Although air freight is more expensive, the lead time reduction from 4 to 5 weeks down to several days and its impact on inventory and service more than outweighs the additional costs.

In order to stabilize the delivery of materials to the materials department in Vancouver, HP already enforced supplier management. Delivery variability of incoming materials should either be penalized in some way or the benefits of a decline in variability should be divided between the outside suppliers and HP to set incentives for improvement.

Machine downtimes should be reduced as far as possible. As production is operated using a Kanban system, every downtime causes high costs due to the fact that the Kanban principle is based on a stabilized and ensured materials flow.

Additionally, the inventory policy should be improved and based on a rational, scientific method which takes into consideration all the important figures like demand uncertainty, the intended fill rate and appropriate cost factors. The periodic-review, order-up-to model HP finally implemented is able to accomplish that.

Last but not least the cost accounting should be adjusted such that it supports information about process costs and inventory carrying costs more precisely. Not until appropriate information is delivered and made available to all different functions of the supply chain (manufacturing, distribution, marketing etc.), people get aware of the consequences of their current handling and are motivated to change things.

c) Long-term options:

The third and most important source of uncertainty in the supply chain is the end customer demand. Due to the fact that the industry is a very fast moving one, demand forecasting has to be improved to be more accurate. This is a very com-plex task needing a large data basis. Therefore it can only be realized in the long run. If more accurate forecasting suc-ceeds, the corresponding safety stocks in the DCs can be reduced significantly, simultaneously improving service level due to the fact that the “right” products are stored in the DCs.

Another long-term option is to set up sister plants in Europe and Asia respectively. Besides much shorter lead times the local production site produces only a few localized generic types of printers and is therefore able to predict the demand more appropriately.

A third option