“So what am I looking at?” asked the Practical Manager (PM), leaning back in his chair, looking at the colorful spreadsheet through his square-rimmed glasses.
Enthu Intern, now used to casual responses from PM, shoved his laptop closer to him.
“I did some analysis on the raw material orders we placed in last one year. In this sheet…here..I also, calculated the Economic Order Quantities for all of our raw materials, and it seems that our current ordering quantities do not comply with EOQ,” said EI in a single breath.
“Hmmm interesting,” said PM while glancing at the Excel sheet which was shaded in almost all red, reflecting the mismatch between EOQ and existing ordering quantities.
Sensing the right opening, EI jumped to his punch-line in an elevated tone, “…and we can save millions of dollars by changing our ordering quantities.” Few employees from nearby cubicles glanced in curiosity.
EI did not care much about them. He just wanted to ensure that PM listened to the remarkable detective work he was able to pull off in just two weeks after joining Electronics Giant Inc. He trailed the finance department for carrying cost numbers, followed forecasting guys to crack the annual demand projections and camped in procurement for days just to find out their ordering costs. And he was not ready to let his efforts go in vein.
“Alright,” PM finally turned his attention towards EI’s spreadsheet. “So tell me what all factors have you considered in your EOQ model.”
“I have considered the three key factors here – demand projections, ordering cost and an inventory carrying cost, I then…”
“Are there any other variables?” interrupted the PM staring blankly in the general direction of EI’s worksheet.
A little annoyed by now, EI quipped, “No Sir, the EOQ model clearly states…”
“Ok. Let me stop you right there,” PM said. “I think we need to discuss this. Let us meet this afternoon. I want you to utilize next 6 weeks here with some better work.” PM swiveled on his chair and redirected his attention to the stream of numbers on his screen.
EI stood there in an awkward state. PM had already resumed his work. He had lot of analysis to show to PM but was abruptly cut short. Frustrated, he made his way back to his desk located at the corner of the floor. He slammed his laptop and pondered upon his interaction. What did PM mean when he said “utilize next 6 weeks”. Does it mean that last 2 weeks were a waste? Was the analysis not good enough? Where did I go wrong?
EI was hired as an intern from top MBA College by Electronics Giant Inc.– a multi-billion dollar organization manufacturing electronic devices ranging from mobiles and laptops to cutting edge experimental devices like bio-chip. Electronics Giant Inc. had offices in more than two dozen countries and was expanding rapidly. No wonder it was a highly preferred employer among the students.
EI also ranked Electronics Giant highly, more so because he was really impressed with their supply chain, which was now the industry’s gold standard and a subject of many case studies. The way he saw it, he was honing his supply chain skills only to work for a company like Electronics Giant Inc. He got his opportunity after the first year when during the intern hiring season, he managed to impress the interviewers with his impeccable supply chain knowledge. And before long he was among the chosen few who would intern at their HQs over next few months.
Looking forward to his internship, which was meant to be a Litmus test for his skills in Supply Chain, EI was committed to perform and showcase his abilities at the Electronics Giant Inc.
But as his luck would have it, he ended up with a Practical Manager (PM). PM was a senior supply chain manager and had ten years of experience. He, however, seemed disinterested in guiding EI. Being incredibly busy, he often canceled his meetings with EI and provided very little insight into workings of Supply Chain at Electronics Giant.
A little let-down and out of direction, EI then tried put together a buying lot size analysis which he thought will at least bring him management’s attention. But it met the same fate as his other ideas.
Presently, he decided that he will confront PM in today’s meeting. PM shall justify his comments about the work he did. Else, he was left with no other option but to escalate the matters to the supply chain VP. Unless …unless there was some obvious flaw in his work. He again thought about EOQ model he had created. Had he considered all the variables?
“What happened dude, you look as if your girlfriend just dumped you,” a voice from his right snapped EI out of his thoughts. He found Friendly Intern (FI) smiling from ear-to-ear. FI was an intern with marketing and joined the same day as him. His broad grin subsided as EI gave a stare in response to his stale joke.
“This company is going to dogs. That’s what happened. Want to have a quick lunch before that?” EI blurted.
****
“At least she would have told me the reason why he thought it was wrong,” said EI while placing his food tray at the table. “This egg and rice preparation look appetizing,” he continued while shoving his spoon in the heap of rice. “…so anyway I am meeting him this afternoon. This will be the last straw if he doesn’t tell me what is wrong with my model.”
“Interesting,” said FI looking at the cafeteria television. A replay of yesterday’s game was on. EI wondered if FI had even listened to the whole story.
“…but you know what. I wouldn’t take it to my heart,” said FI as the game took a commercial break. “I have seen people saying all sorts of things when under pressure.”
“What is this EOQ model anyway? I’ve heard about it a couple of time in our class but never got my head around it.”
EI thought about the best way in which he can explain EOQ model to FI. Looking between his plate and partially interested FI who was still distracted by the TV, EI was struck with an idea.
“So – how many television sets would you buy in one go?”
“What?” said an astonished FI. The unusual question surely got his attention.
“Humor me. How many TV sets do you buy at a time? Say, you need a TV at home and you walk into a store, how many of them would you buy?”
“Obviously, I’d buy only one,” answered FI sheepishly.
“And how many eggs do you buy at a time?” Said EI pointing at the eggs on FI’s tray.
“Dude…what are you getting at?” asked FI who was a little bit annoyed by now.
“Common, play along, I’ll show you the EOQ connection in a minute.”
“Ummm….maybe half a dozen.”
“Why don’t you buy half a dozen TV sets then?”
“Because I am a sane person?”
“Ha Ha, very funny,” EI mocked a fake laugh. “Now answer my question.”
“Alright alright. Ok let me think – Well, a TV set lasts for say, ten years. Why should I buy even two, let alone six?”
“But even if you buy six, you are going to use them in your life-time. They are obviously not going to waste. Then, why not? Common spell it out.”
“Alright, let me think. I wouldn’t take six because I don’t want to spend a huge sum of money on something which I’ll use 10 years later.”
“Good…carry on…”
“Secondly, I don’t want to be using 10-year-old set when newer models will be in the market.”
“…and wait, there is one more – where would I keep all those units in my house? So many units are bound to block a considerable space for the next …I don’t know…fifty years.”
“Perfect…so you mentioned three things – one your cash will get strapped for a long term, two there is a risk of obsolescence and three you need to assign some storage and all this contributes to what we call inventory carrying cost. So, when you buy a television, your inventory carrying cost is so high, that you will never buy any more than one.”
“So, let me summarize- You don’t buy half a dozen TV sets because you incur high inventory carrying costs”
“Hmmm…makes sense. So buying anything involves an inventory carrying cost, be it cost of capital or storage cost. But then why should I buy anything in more than one quantity. Say…eggs.”
“Excellent…you catch-up pretty fast my friend,” said EI. “This brings us to the second major cost component. I’ll get this one as well from you. Tell me why don’t you buy one egg at a time?”
“umm…that will be a huge inconvenience for me.”
“Yes, go on…you are on the right track. Expand on inconvenience point.”
“I mean, If I buy only one egg at a time then it means that I’ll have buy one every day. Which means driving to the grocery store every day, spend time in the queue and not to mention the parking charges for my car,” said FI thoughtfully. “And…now I am beginning to see it. There are disadvantages to buying smaller quantity at a time. I’ll have to buy more frequently.”
“Excellent. And you don’t want to buy eggs more frequently even if you’d be carrying more inventories. Just like you argued in the example of television.”
“Yea true – but I’d rather have six eggs in my refrigerator than six TV sets in my storage.”
I’d rather have six eggs in my refrigerator than six TV sets in my storage.
“Awesome. …and all those costs you mentioned – the cost of parking, your inconvenience, cost of fuel to get to the store etc.- all those costs are called ordering costs.“
“So do you see now – there is a trade-off between inventory carrying costs and ordering costs. You can not minimize both of them. Think of it like a whack-a-mole. If you hammer one, the other will pop right up.”
There is a trade-off between inventory carrying costs and ordering costs. You can not minimize both of them. Think of it like a whack-a-mole. If you hammer one, the other will pop right up.
“Let me draw that for you in a table. Here,” EI pulled a paper napkin from a generous stack that FI had plucked from the food counter.
“If you buy less frequently, you’ll be saving on ordering costs, such as in the example of eggs, however, you’ll be carrying higher inventory – so in case of eggs, you’ll be carrying higher inventory.
On the other hand, if you buy more frequently, you’ll save on inventory costs, since you are carrying lower inventory, but you’ll have to incur higher ordering costs.
(INSERT A TABLE)
(INSERT A GRAPH)
And this is what EOQ model solves. At what buying quantity the total cost is minimum. We do it intuitively for eggs and television sets because it’s easy to see the trade-off, but when you consider and organization like Electronics Giant, this becomes tricky. EOQ model translates this trade-off into numbers. And then you get an optimal quantity at which the total cost is minimum.
“Wow! That is good.”
“Yes, and that is what I did for our thousands of raw materials you know. And that is what I was trying to show the PM but he doesn’t seem interested. Their existing lot sizes are off…and they can save millions just by changing them.”
“Stay put man, this is good. And let me know in case you need some help later on. Even marketing team can use it.”
“Sure absolutely…”
EI felt good after talking to FI. He was even more convinced of the accuracy of his logic. Ordering cost was correct, inventory carrying costs were calculated from industry benchmarks, and demand was taken from their forecasting team and their accuracy was almost always more than 98%. There was nothing that could go wrong. Or was it?
***
To be continued…
supplychaindetective 