Ch.12 – The OM Blog by Heizer, Render, & Munson

Guest Post: How Much Inventory is There in the World?

Today’s Guest Post comes from Kelly Thomas, who is a supply chain management professional and executive at JDA Software.

Here is a simple question: “how much inventory is in the world?” The short answer is that no one knows for sure, and no one keeps track of it at a global level. It’s an interesting question though, because it gives us an understanding of how efficient the world is in turning inventory into economic output.

The Council of Supply Chain Management Professional’s annual report leverages data from the Bureau of Economic Affairs and other sources, and provides great detail on logistics, distribution, and inventory costs in the U.S. According to this report, there was $2.2 trillion in business inventory in the U.S. in 2012. Also last year, there was about $70T worth of economic output globally. The U.S. represented approximately 22% of overall output. Assuming the rest of the world is as efficient as the U.S., a simple pro-rata calculation based on economic output produces a global inventory level of $2.2T/22% = $10T.

This calculation does not account for the relative efficiency of economic activity across countries. China, for example, has twice the logistics costs of the U.S. as a percentage of economic activity or GDP. Given that the combined GDP of the BRIC countries is almost the size of the U.S. economy, and if you assume all of the BRIC countries have logistics costs similar to that of China, this would add almost another $2T to the overall inventory number, yielding $12T in global inventory. This likely understates the actual number since it also does not account for relative inefficiencies in other emerging markets (and does not include government-owned inventories).

This ballpark estimate gives us an understanding of the efficiency of economic output relative to inventory. Based on this information, economic output turns against inventory are about 6 (roughly the same as sales turns). This means there is approximately 2 months of global inventory sitting around at any one time (on an economic output basis). We can do better than 6 turns. If we were able to reduce inventories by just 10%, that would free up $1.2T in capital that could be deployed to growth activities that would benefit companies, countries, and ultimately people.

OM in the News: Wal-Mart’s Disappearing Inventory

Margaret Hancock has long considered the local Wal-Mart superstore her 1-stop shopping destination, writes BusinessWeek (April 1-7, 2013). No longer. During recent visits, the Delaware accountant says she failed to find more than a dozen basic items, including certain types of face cream, cold medicine, bandages, mouthwash, hangers, lamps and fabrics. The cosmetics section “looked like someone raided it,” said Hancock. “If it’s not on the shelf, I can’t buy it.”

Tim White, a California attorney, added that while long checkout lines irritated him, “the number-one reason we gave up on Wal-Mart was its prolonged, horrible, maddening inability to keep items in stock. The store would go weeks without products he wanted to buy, such as men’s dress shirts, which he found only in very large or small sizes and unpopular colors.”

It’s not as though the merchandise isn’t there. It’s piling up in aisles and in the back of stores because Wal-Mart doesn’t have enough bodies to restock the shelves. In the past 5 years, the retailer added 455 U.S. stores, a 13% increase, but its employee count dropped by about 20,000, or 1.4% to 1.4 million workers. A thinly spread workforce has other consequences: longer check-out lines, less help for shoppers and more disorganized stores. Last month, Wal-Mart placed last in the American Customer Satisfaction Index, the sixth year in a row the company had taken the last spot–and Bloomberg News reported that the company was “getting worse” at stocking shelves. Retailers consider labor — usually their largest controllable expense — an easy cost-cutting target. But eventually, customer service and customer satisfaction deteriorate.

Years ago, Wal-Mart supervisors drilled a message into employees’ heads: “In the door and to the floor.” That mantra now seems impossible to execute as the firm has become entangled in what one expert calls a “vicious cycle” of under-staffing. Too few workers leads to operational problems. Those problems lead to poor store sales, which lead to lower labor budgets.

Discussion questions:

1. Why can’t Wal-Mart keep its shelves fully stocked?

2. What suggestions do you have for dealing with this OM problem?

Guest Post: Zero Human Intervention in Operations (0HIO)

Dr. Bill Hardgrave is Dean of the School of Business at Auburn University and is also founder of the RFID Research Center at the U. of Arkansas.

It’s time for retailers to move to 0HIO— zero (0) Human Intervention in Operations. The concept is simple: Eliminate the human touch points in operations. Essentially, why have people do something that can be done automatically? I have seen several retailers make the same mistake in early-stage RFID—they treat RFID as a “super bar code.” They swap out bar-code equipment for RFID devices, and keep existing processes in place. In doing so, they minimize the opportunity for gain and maximize the opportunity for mistakes.

For complete inventory management, retailers must know when product is received at the store and when it moves from the back room to the sales floor. Retailers that used mobile RFID readers in place of bar-code scanners to track products experienced execution failures. That’s because store associates became busy and forgot to read products that arrived at the store. And when they couldn’t easily locate a mobile reader, they didn’t read products that were moved from the back room to the sales floor. As a result, stores had incorrect inventory counts, and they did not know where items were located. Instead, the RFID system should have been built on the premise of human touch reduction. Installing RFID portals at the receiving door and transition door from back room to sales floor would have removed the need for human intervention and ensured products were recognized and recorded.

One retailer, for example, had two full-time store associates use bar-code scanners to track the items going into and out of dressing rooms. After adopting RFID, the retailer replaced the bar-code scanners with RFID mobile devices and was disappointed to find there were no benefits. That’s because the process hadn’t changed. When the retailer installed RFID readers in the dressing rooms, the information gathered was better, and dressing-room associates were free to help customers. When evaluating existing processes, ask the question: How can I remove the requirement for human intervention at this step? (Please see RFID Journal (Feb. 19, 2013) for more details).

OM in the News: RFID for Tracking Surgical Implants

We note the increasing role of RFID (Radio Frequency ID) tags in our Process Strategy and Inventory chapters (Ch. 7, 12). Now, RFID Journal (Feb. 5, 2013) describes an exciting medical advance that will soon track surgical implants by placing the tags on implants and tools. The system, by Texas startup Innovapaedics, also includes a cloud-based server to store data and provide reporting to customers regarding the location, use and status of each instrument used during surgery, as well as devices implanted into patients.

Innovapaedics’ 3-5-year goal is to offer a “Smart Implant” solution that would include RFID tags and sensors permanently attached to implants. After an item is implanted into a patient, its RFID sensors would detect pressure and temperature changes, among other events, in order to track a patient’s healing process, as well as the device’s condition, and transmit that information to a reader. In the short-term, meanwhile, the company has developed MedEx, an RFID solution for tracking implants prior to their use within a patient, to track which items were used on that individual. The resulting data is incorporated into medical and billing records.

MedEx also enables hospitals to track surgical tools. A tag can be permanently attached to each surgical tool, and the tag’s ID number is linked to specific data about that tool in the MedEx. As a new tray of tools is created for use during a surgery, each tag is interrogated as the tool is placed into the tray and linked to that tray’s RFID number. Post-surgery, the tools are cleaned and sterilized, and are then placed in a tray once more. MedEx stores a record of which tools belong in that tray, and displays an alert if the wrong tool is placed there, or if a tool is missing. The software cannot only track the tray in which a specific tool is stored, or to which patient a particular implant has been administered, but also enable the reordering of inventory based on which implants were used.

Discussion questions:

1. Why is this an important OM advancement?

2. Describe other medical applications of RFID tags already in use–(see Chapter 5).

Guest Post: The Distribution Game– A Perfect Class Engagement Activity

Our Guest Post today comes from Dr. Chuck Munson, who is Professor of Operations Management at Washington State University.

It’s not always easy to find an activity that combines true learning with fun and competition. For more than 15 years I have been successfully using “The Distribution Game” in undergraduate supply chain management and MBA operations classes. The game was originally designed by Peter Jackson and John Muckstadt at Cornell http://people.orie.cornell.edu/~jackson/distgame.html, and it can still be downloaded for free (although it may require a modern platform conversion).

Each day for 200 days, the player must choose how many units to order for three retail locations and the supplying warehouse (so this is a multi-level inventory problem). It takes 15 days for the product to reach the warehouse from the supplier and 5 days to reach the stores from the warehouse. Demand is random. The animation is a little bit crude by today’s standards, but it’s still quite effective to see little trucks carrying products across the screen each day.

I like the game because it can be played whether or not inventory formulas have been taught. Students can try to use common sense and some can perform quite well doing so; nevertheless, they seldom beat my performance that’s completely formula-driven. Imbedded in the game are issues of safety stock, balancing setup and holding costs, lead time effects, and lumpy demand at the warehouse. We can usually get through about four games during an hour in the computer lab or with laptops in class.

Game parameters can change: I vary the demand distribution, relative holding and setup costs, and lead times. For me, the most important learning outcomes are: (1) equalize total holding and setup costs, (2) the warehouse should order in integer multiples of the combined retailer order sizes, and (3) the pipeline should be empty when time runs out.

Have fun, and consider awarding prizes to the winners!

Video Tip: A Two-Bin Kanban Inventory System at St. Clair Hospital

This 7 1/2 minute video from Pittsburgh’s St. Clair Hospital is a great tool to use when you are teaching inventory management in Chapter 12. St. Clare started with a “par level” system that often led to stock outs for nursing supplies. With the help of an industrial engineer, the hospital converted 28 supply areas over a 10 month period to a much more efficient two-bin kanban system. With the system in place, St. Clare went to zero stock outs and zero manual requisitions sent to its materials management department.

The video discusses Toyota’s kanban pull model and illustrates a realistic, interesting way that a hospital controls its inventory. It also makes the point that analysis of data is a critical first step of the process of changing any floor plan or stock area. The video closes with interviews of nurses who are happy that “everything is under budget since the new system” is in place.

Just click below to view the video.

http://www.youtube.com/watch?v=yjSwwPF5BUU

Video Tip: Inventory at Frito-Lay

If you cover the subject of Inventory Control (Ch.12), you may want to show the (8 min.) video, “Managing Inventory at Frito-Lay”. There aren’t too many more interesting products that students can relate to than potato chips…and this video goes from the farm to the truck to the plant to the truck to the store…in showing the production process. What makes it really exciting is that the whole journey often takes less than one day! We follow the inventory from the time the potatoes (12 semi-trailers full each day, at 50,000 pounds of potatoes per trailer) are loaded at a farm near each plant, unloaded, washed , sliced, seasoned, baked, bagged, boxed, loaded for delivery, shipped to supermarkets, and put on a shelf. It’s a real eye-opener to see how fresh the product at the store can be.

It’s also important for students to see that there are 4 types of inventory at Frito-Lay (and, of course, at other firms): raw materials (the potatoes, seasonings, packaging material, etc.), work-in-process, finished chips in a bag, and MRO. This may be an unusual product, in that a major raw material decays quickly, but the importance of inventory turns, W-I-P levels, and smooth production flow are all illustrated in this company’s excellent inventory management.

Jay and I really enjoyed filming this Frito-Lay series (our most recent featured company) and you will see why when you view the closing scene, filmed in my driveway. The company lent us a truck to use for the day and loaded it with hundreds of bags of chips of all brands. At the end of the day of filming our closing comments, we assumed we had to not only return the truck, but the massive quantity of chips as well. But we got to keep them! Since Jay couldn’t carry many back to Texas, we Renders ate chips for months….a big exception to my wife’s organic/healthy food house rules.

Teaching Tip: Teaching Inventory Modeling in the Real World

Our research shows that the most frequently covered topic in OM courses is Inventory Management (Ch.12). In that chapter, we do discuss the importance of record accuracy, cycle counting, and shrinkage. But what we do not discuss is the use of the numerous inventory models if inventory is only “partially observed”.

In today’s issue of Decision Line (Oct., 2010), an excellent article by Prof. Suresh Sethi, at U.Texas-Dallas, goes into the reasons for partial observation of inventory levels and then discusses how these impact modeling efforts. Here are 5 causes Suresh details:

1. Sales recorded wrong (eg, a clerk scans an item twice, when there were actually 2 different flavors of soup).

2. Misplaced inventory (eg, when items are stored dynamically, not in a fixed location). Suresh tells of a top retailer who discovered 16% of its items were misplaced.

3. Spoilage (eg, when customers tear open a package to look at the item inside, spill drinks on clothes, or scratch a car they test drive).

4. Product quality and yield (eg, when some items coming into the warehouse are unknowingly damaged).

5. Theft (eg, break-ins, employee pilferage, and customer shoplifting). The Limited, eg., recorded an inventory discrepancy of $142 million a few years ago—the equivalence of 21,000 ocean containers!

Suresh concludes, “By now it should be clear that the incomplete inventory information (i3) problem is quite common in practice, that policies in current use are neither optimal nor applicable”. He finishes the article by discussing 4 ways to classify i3 problems.

The real point worth making in class is that the models we discuss in Ch.12 depend on accurate record keeping, which may be impossible in a variety of real world companies.