Inventory Management
Your client manufactures test equipment for electronic firms. The product range is complex and has a high degree of variation. The products range from $1,000 to $25,000.
The client on average holds 150 days of inventory and would like to bring it down by half. He has asked for your help in reducing the inventory costs.
1. Background
If asked about the supply chain, the below information can be shared verbally with the interviewee:
- The test equipment manufactured by the company comprises of the following things:
- Circuit boards
- Base units
- The manufacturing of the circuit boards is outsourced. For the circuit board manufacturing, the process is as follows:
- The company does the design of the circuit board in-house. This process takes approx. 1 week.
- The design is given to the outsourced vendor for manufacturing. The company, however, is responsible for providing the raw material to the vendor. The manufacturing process takes approx. 2 weeks.
- The company manufactures the base units themselves. These base units are standard and manufactured in bulk. Hence, the lead time for the base units should be assumed to be zero.
- The company does the final assembly with the base unit & circuit boards themselves. This process takes approximately 1 week.
- The raw materials for the circuit boards can broadly be classified into two categories:
- Type 1: These are standard components, which are required in large quantity and can be ordered off-the shelf. The company purchases them from a set of distributors. The lead time for this category of components is 1 week.
- Type 2: These are custom designed components. The company provides the design of these components to the distributors who then manufactures them. The lead time for this category of components is about 6 months. The company has worked to improve this process and there is no scope of further improvement in this lead time.
- The company guarantees a 6 week delivery time to its customers after the receipt of the order.
Let the candidate assimilate this information.
2. Inventory costs
Since the case is about reduction of the inventory holding days, which are usually expressed in days of sale. A critical element to solve this case would be to understand the cost of the different components of the inventory. Also, it would be important to understand the form in which the inventory is held.
If asked, the below information can be shared verbally with the interviewee:
- The costs of the inventory are in the following ratios:
- Base units - 20%, circuit boards - 60% and assembly - 20%
- For circuit boards, the approx. cost split would be: Type 1 components - 40%, Type 2 components - 40%, Manufacturing cost - 20%
- The inventory that is held by the company is held in the form of base units & circuit boards.
- The company sells a very wide variety of test equipment. The number of combinations are over 25,000.
- The circuit boards differ greatly based on the number of functions they can perform.
- Some circuit boards are fast moving as they perform a standard set of functions. However, some are very slow moving as they are high end and perform a very wide range of functions.
- The company is a preferred manufacturer for most of its clients, as it's able to deliver both the high end as well as the standard circuit boards in a 6 week time line. The business would be significantly affected if the company eliminates the high end circuit boards.
3. Solution
I. Holding inventory in raw materials instead of circuit boards
The company should consider holding the raw materials required for the circuit boards instead of holding the manufactured circuit boards. From the time the order is placed, the company has 6 weeks to deliver it to the customer. The entire process of manufacturing of circuit boards & assembly after the order is received is 4 weeks ( 1 week circuit design, 2 weeks circuit manufacturing, 1 week assembly).
This would help eliminate the manufacturing cost of circuit boards from the inventory costs.
II. Removing the Type 1 components of circuit boards from its inventory
The Type 1 components are the standard components which only have a 1 week lead time. However, these components form 40% of the circuit board cost or 24% of the total costs 60% x 40%). The company should evaluate reducing these costs.
One way would be to procure the raw material for this category only after the receipt of the order. This would increase the time taken to manufacture from 4 weeks calculated above to 5 weeks ( 1 week circuit design, 1 week procurement of Type 1 raw material, 2 weeks circuit manufacturing, 1 week assembly). But this would still be less than the 6 week delivery time. If the company is confident about the lead times for each process, then this method would work.
Another way to do this would be to ask the circuit board manufacturer to hold the inventory for Type 1 components. This solution is likely to work if the circuit board manufacturer requires this material for its other customers also.
III. Reducing the number of configurations of circuit boards
The number of variations come from the type of functions the circuit board can perform. The company could evaluate categorizing the boards into low, medium and high end categories on the basis of their capabilities. It could then provide a circuit board from one of the three categories, but enable only the functions requested by the client.
Although this might mean providing a higher capability product to some of its customers (with some functions disabled) - but the cost reduction achieved by pooling manufacturing into three categories might offset the cost of providing a higher capability product.
4. Recommendation
The client should evaluate a combination of the following solutions in order to reduce the inventory holding costs:
- Holding the inventory in raw material instead of manufactured circuit boards
- Removing the cost of Type 1 components by either ordering just in time or by asking the circuit board manufacturer to hold this inventory
- Reducing the number of configurations of circuit boards
