Operations and Supply Chain Management

XYZ Inc distributes and sells tyres. While most of XYZ's sales come from earthmover and industrial tyres, they also stock and sell a very mixed range of truck, bus, agricultural and passenger tyres. XYZ was owner-managed, but five years ago the owner sold the business to a publicly listed corporation. Since the change in ownership, performance has not met the expectations of the new owners and in recent months, financial performance has been poor with a continued decline in sales and losses recorded.

The company, at the insistence of the parent, allowed a logistics consulting firm to perform a diagnostic of the business. One of the recommendations was that XYZ needed to appoint a full-time Supply Chain Manager - you have just been appointed to that role.

During your recruitment to XYZ, you were provided with a copy of the consultants' report. A summary of this report follows.

BACKGROUND INFORMATION

In the last 12 months XYZ reported sales of $120 million. This is substantially below the $170 million in sales achieved in the prior 12 month period. Most of this drop in sales resulted from a change in supply arrangements. Until 12 months ago, XYZ had total exclusivity on the supply of Goodmich earthmover and industrial tyres in Australia (with the exception of the far north-west of Western Australia). However, three global mining companies negotiated a world-wide agreement for direct supply from Goodmich. In Australia, this meant that sales to these three companies are no longer credited to XYZ. For the first 12 months of this new arrangement, Goodmich compensated XYZ for the loss of these sales. All tyres that XYZ was holding in stock for those three mining companies were transferred to Goodmich at the commencement of the new arrangement. Goodmich tyres are acknowledged world-wide as the best and thus command a price premium. In Australia, under the management of XYZ, Goodmich tyres are sold for the same price as their competitors' tyres.

The markets

Earthmover tyres

These tyres are used exclusively in the mining industry. They are very big tyres with a minimum internal radius of 29 inches (the tyre industry has not yet gone metric) up to a maximum internal radius of 63 inches. The internal radius is the measure of the diameter of the wheel rim to which the tyre is fitted. (It is the hole inside the tyre). Prices range from around $6000 for the smaller tyres, up to $50000 for the largest tyres. The largest tyres weigh more than 5 tonnes and a mining haulage truck has 6 of these tyres as standard fitment. There are four key mining areas in Australia - Bowen Basin in Queensland, Kalgoorlie area in Western Australia, Hunter Valley in New South Wales and the Pilbara/Kimberley area in far north-western Australia. This latter area is supplied direct by all manufacturers. No distributors supply to this area. There are four manufacturers of earthmover tyres, none of which manufacture in Australia.

Industrial tyres

Internal radius starts at 7.5 inches (forklift tyres) and goes up to 27 inches. Prices range from $100 to $25000. Most of these tyres are used by local councils and road-making companies and of course, anyone who has a forklift.

Other items

XYZ also carries a large range of other types of tyres suitable for anything from Ag bikes, lawnmowers, shopping trolleys, tractors, cars, to trucks and buses.

Sales and inventory

The consulting firm's Pareto analysis of XYZ's sales and the split of their inventory by Pareto class is summarised in the table below:

Inventory level

The current inventory is $34.0 million, a historically high level. 12 months ago, the total inventory level was $26.5 million. The CEO of the parent company believed that at $26.5 million, the inventory level was already too high. Over the last 12 months, the combined inventory of A and B class items has declined by $0.1 million, but the combined inventory of C and D items has risen by $7.6 million The consultants were alarmed that the management of XYZ has never seen a Pareto analysis, did not understand what it was, and claimed that they were comfortable with the current level of inventory.

Supply chain

All Goodmich tyres are manufactured overseas, in factories located in Europe, North America, South America and China. Standard supply terms are for an average 'order-receipt-to-tyre-delivery time' of 120 days or less, with payment terms of 120 days from date of receipt by XYZ.

XYZ maintains branches in Perth and Kalgoorlie in Western Australia, Brisbane and Mackay in Queensland, Newcastle and Singleton in New South Wales, Adelaide in South Adelaide and Melbourne in Victoria. Each of these branches is a combined warehouse and retail sales outlet.

Goodmich demands that their tyres are ordered once each month. This is done centrally from the head office in Newcastle. A single order is created for each state and covers both earthmover and industrial tyres. Goodmich delivers the tyres to Perth, Adelaide, Melbourne, Brisbane, Newcastle (industrial tyres only) and Singleton (earthmover tyres only). Goodmich transfers earthmover tyres from Perth to Kalgoorlie and from Brisbane to Mackay free of charge, provided the tyre is to meet a specific customer order. Industrial tyres must be transferred at XYZ's cost. XYZ pays the same price to Goodmich for a specific tyre, regardless of its destination.

Under current conditions, transfers between all branches are commonplace, especially between Brisbane and Perth. For this particular transfer, for an average earthmover tyre, the transport cost from Brisbane to Perth is $2500, while transfers from Perth to Brisbane cost on average $2000. In the last 12 months about 100 earthmover tyres were transferred between Perth/Brisbane/Perth.

Under normal conditions, Goodmich's average 'order-receipt-to-tyre-delivery time' (the lead time) is 110 days, with little variance (max lead time of 135 days and minimum of 90 days), but recently, because of a global resources upswing, lead times for earthmover tyres have increased and now average 145 days with larger variances being experienced. In some cases this has extended beyond 300 days. Industrial tyres and other non-earthmover tyres lead times have not been affected.

Orders for non-Goodmich tyres are placed with local suppliers by each individual branch manager. In most cases the supplier is in the same area and delivery times are between one and two days.

The forecasting / ordering process

There is no forecasting process. Once a month, on the day that orders are due to be placed, the general manager of XYZ sits down and decides what to order in the Goodmich range. You have been asked to take over the ordering of Goodmich tyres. The following describes this process:

The general manager uses a copy of the monthly Sales and Stock Report which shows, for each individual SKU (stock keeping unit, ie an individual tyre), and for each stocking location (each separate branch):

• Sales units for the most recent month
• Sales units for the year to date
• Sales units for the same period in the prior year
• Stock units on hand
• Units on order, but not yet received

From this information, the general manager guestimates what the quantities on today's orders will be.

Sales patterns

For all types of tyres, there has been a slow decline in the number of units sold each year for the last five years. You have discovered that sales of the Pareto A class items, which are all Goodmich earthmover tyres, appear to be very scattered and random, but on further investigation at individual customer level, the sales seem to have an element of predictability. B class items, which are mainly Goodmich industrial tyres, have relatively stable sales but with a slight rise in June, followed by a slight decline in July and August. C class items, which are mainly non-Goodmich products, are also relatively stable although they too are slowly declining.

You have managed to fit in some data gathering and analysis and among the things you have discovered is that:

1. It is the state managers who input Goodmich purchase orders quantities into the system. This is a quirk of the IT system. Once the general manager has decided on order quantities for the month, this information is sent back to the state managers and they generate their purchase order. In the past some of the quantities ordered have not always agreed with those decided by the general manager.

2. Apart from the chief financial officer (CFO) and yourself, there is no other degree qualified person in XYZ, there is not one person who has been trained in sales and all existing branch managers commenced their employment at XYZ as tyre fitters.

3. The consulting firm did not undertake a stock take, their Pareto analysis was based on all-Australia inventory data that the CFO obtained from the IT system.

Required

You have been asked by the CEO of the parent company to prepare two reports:

A. The first report, for the CEO, is to cover your inventory reduction program:

1. Describe in detail how and why the inventory rose to its present level.

2. Define your target for a reduced inventory level and provide details as to why this level is appropriate.

3. Provide a detailed, step by step action plan for your inventory reduction program. This should cover what will be done, how it will be done and who will do it.

4. Provide detailed timing for each step listed in part 3 of this report.                                                                                 

B. The second report, also for the CEO's personal review, is to cover longer term issues. This report should cover issues such as:

1. How to calculate order quantities.

2. Forecasting.

3. Achieving the Goodmich targets and bonuses

4. Maintaining inventory at the target level (set in the first report)

5. Sales and Operations Planning and any other important matters.