Merloni-Transit Point Model

Q1: Merloni Elettrodomestici has a total of five plants each manufacturing a separate product line (stoves, refrigerators, freezers, dish washers and washing machines). These appliances are further divided into two categories, the freestanding appliances and the built-in appliances. Freestanding appliances are sold through retailers which are either located in Urban or in rural areas. Urban retailers are able to keep high inventory levels due to their operation size while rural retailers keep only a small amount of inventory. Delivery to these retailers is dependent upon the proximity of a regional warehouse and availability of stock at these regional warehouses. If the required order is available at a close regional warehouse it is usually delivered within a day but incase its not available at the regional warehouse it has to be called in from the central warehouse, which takes 2 to 6 days. 65% of Merlonis freestanding products were delivered through the regional warehouses meaning that 65% orders were delivered in a day while the rest took 2 6 days in being delivered from the central warehouse. At some occasions regional and central warehouse can be out of stock at the same time, this leads to major delays in delivery which has a greater effect on the rural retailers who keep low inventory levels. The built-in appliances are sold directly to architects and builders from the central warehouse. All the manufacturing plants have their own warehouses for raw materials and finished goods. Finished goods are frequently sent from the regional warehouses to the central warehouse depending upon the demand. Since the buyers of built-in products were builders and architects they bought in truckload sizes and for that Merloni offered a discount of 4000 lires. Furthermore, during the past few years, Merloni implemented programs that successfully shortened its production planning time and also decreased the inventory levels. With the help of ABC inventory management system and by integrating the inventory monitoring systems of all the regional warehouses with the central warehouse, Merloni had been able to bring down the inventory by 75%. The production planning time horizon was reduced from four months to three while the required lead-time to firm orders was reduced from two months to one. The current distribution system has several costs related to it. Starting with inventory costs, it can been observed that even though the inventory levels were reduced by 75%, the fact that Merloni stores inventory at 17 regional warehouses, 5 plant warehouses and 1 central warehouse, means that its inventory carrying costs must be extremely high. Related to this sort of inventory carrying is the cost of the vast infrastructure needed for such inventories. Warehouse costs, inventory handling labor costs, and insurance costs are a few significant costs related to such an inventory system. Besides these main costs, there is also the cost of having long delivery times. Although good share of customers are served within a day, the rest are served within 2-6 days. Such delays in delivery can be detrimental for the companys goodwill development with its customers. Especially for retailers in the rural areas, the delivery times can tend to be very high if a close regional warehouse is out of stock. This leads us to the next cost related to this type of a distribution system, stock out costs. Stockout costs seem to be quite high in the current scenario. There are instances when a regional warehouse is out of stock and at times even the central warehouse is found out of stock. This has led to high Stockout costs for Merloni. In contrast, there are some benefits which can be attributed to the current distribution system. Due to having a vast network of regional warehouses, Merloni has significantly controlled its delivery times. Delivery to 65% of freestanding appliance customers can be made within 24 hours. This is only possible because Merloni holds high inventory levels at each of its regional warehouses. Moving onto the cost benefit analysis of transit point system, the most important cost reduction comes from the fact that transit point eliminates the need of holding high inventories at the 17 regional warehouses. This could mean huge amounts of cost reductions for Merloni. Transit point could help reduce the operational costs of regional warehouses by reducing the need for inventory storage. These operational cost savings would be associated with reduction in space, utility, and labor usage. At the same time it is important to notice that Merloni will need to setup cross docking systems at these warehouses in place of inventory storage. Although they might offer lower operational costs, the setup

and initial management costs will offset the overall profitability of transit points. Although, transit points reduce the inventory storage costs at the regional warehouses, it fails to take into consideration factors that affect the overall inventory levels, for instance production planning lead times or production lot sizes. This means that inventory will just be transferred from the regional warehouses to the central warehouse. Low inventory at regional warehouses would mean that the central warehouse would have to hold much higher levels of safety stock in case of disruptions in the transit point system. To manage the extra inventory and handling the central warehouse will need further expansion. This again can offset the cost cuts from reducing inventory at regional warehouses. The transit point system also leads to an increase in the customer delivery times. This was also noted during the trial when customers had to be requested to wait another day or two for delivery. This increase in delivery time occurred even when Merloni was very close to the central warehouse. This might mean that applying transit point to other regions which are at a greater distance from central could lead to a great deal of increase in the delivery times. Furthermore, reducing inventory at the regional warehouses would mean that incase the central warehouse closes down (for instance in winters due to snow), deliveries and distribution throughout Italy would be disrupted. This poses a major risk for Merloni.

Question 2) As we have seen in the first question that there are many benefits of the Current system, and there are many benefits of the second question. Similarly there are many costs attatched to the two systems. But to decide which system to implement, we should be doing explicit cost analysis along with analyzing the quantitative analysis to reach a conclusion. We have Data on Roma and Cantazaro, so we can calculate the costs for the both locations which will greatly help us in our decision. So based on the cost Data Given to us for Roma and Cantanzaro we can calculate the total cost for both the current model and the Transit Point model and then we can compare to see which model is best. We have the cost data for Operating costs, Inventory costs and Short-Haul Transportation costs. Here we can assume that short-haul is the same in both models for Roma and Cantanzaro. We also have the map with the scale in exhibit 9. So we can calculate the distance and the respective transportation cost too. Distance from Roma to Febriano is 164kms (Google Maps+Exihibit9) and we can see on Exhibit 11 that a large truck will cost us .35million, and a small truck will cost us .18m. We can further assume that the total cost of inventory would reduce by 80% as was the case in Milano. The details of the calculation for Roma are given in appendix 1. We can see that the total cost of transportation under the current model for Roma is 4153 liras, but for Transit Point Model it is 3725 liras. So they can have a cost saving of 428 liras per piece in each performance cycle. This saving is substantial in the current case. We have 4 cycles per month, with1200 in average inventory, so this would mean a saving of 1200*4*428 = 2.05 million each month! Lets see the impact Catanzaro. Using the Same Exhibits we can calculate that the distance of Cantanza from Fabriano. We can see that the distance comes out to be approximately 750kms. For this distance the cost of a large truck would be 1million and of a small truck would be .55million. So based on the datas from exhibit 9, 10 and 11, and using the same method as we did in Roma, we can calculate the costs for the two methods (Appendix 2). The cost with warehouse comes out to be 10990 liras, and the cost without warehouse comes out to be 20054 liras. So in this case, if Transit Point Model is implemented, it will cost them about 9064 liras per cycle. And if we calculate the monthly impact, this would be 9064*2*780=14.14 million. So this model would not be feasible. It should be noted that in the above analysis we have used displacement, because actually distance by road might be different. If we look at the Maps and the Exhibits carefully, we realize that by adopting transit point model, two areas have been affected. One being the operating costs and the other is the transportation

costs. Roma is relatively nearer to the central warehouse so here the decrease in the operating costs was not offset by the increase in the transportation costs, but for Cantanzaro, which is about 750kms away from the central warehouse this model would not be successful. Moreover, the further a location is, the greater is the lead time.In Milano, the delivery time was 12 hours, as it is very near to the central warehouse. But as we move further away this lead times would drastically increase. This in turn would affect the customer service. Customers would be delivered late and they might even prefer a competitor who has a regional warehouse at that place. If we see the total inventory kept at the central warehouse that come out to be (44 253 units 56%), followed by Plants inventories (21 050 units 26%), and the rest of the inventory is shared between the regional Warehouses (14 330 units 18%). Already the demand for the regions is fluctuating a lot. If we adopt the Transit point model the impact of regional variations will be transferred from the regional warehouses to the Central warehouse. This will increase the requirements of safety stock at the Central Warehouse which will most probably offset the gains from the reduced regional inventory. If we see the map of Italy in appendix 3, we see that southern Italy is not connected by road. There they would have to use a combination of both road and see shipments. Again this would highly increase the lead times and can result in customer dissatisfaction. So the whole Italy cannot be satisfied with one regional warehouse. So at least two large warehouses needs to be added to implement the transit point system, one in the south and one in the north. Even with this, we would have to apply the same framework on each individual region as we did above, to see whether the cost of reduced operations is offset by the transportation cost or not. There are some other important qualitative measures that should be there when they plan to implement this system. Firstly, as it is mentioned in the case that because of heavy rainfall some areas are not accessible. So in the winter season those areas should rent a small warehouse in which they can store inventory. Otherwise delays can cause significant availability problems. Secondly as we saw in the case on Cantanzaro that we have to send partially filled truck loads. So demand should be substantial in areas where it is implemented so that full truck loads can be sent. Otherwise transportation economies would not be reaped. Thirdly as we can see that demands in particular regions is very volatile. This volatility may cause many problems. Firstly there could be many partially filled truck loads. Also planning and coordinating the transportation might become a problem if the variability is high. So for example on one day we might need 8 trucks, and on another we might need just one truck. So such problems also need to be catered. So in regions where the above problems can be tackled, and the increase in transportation costs does not exceed the gain in the operating costs this model must be implemented. Also for this new distribution system it would have to train its employees as this system demands substantial employee agility. If on a given day they are late to transmit orders then the whole system will be disrupted. So with a strong strategy, this model with be highly succesful

Appendix 1 Roma Cost of Large truck .35m Average Inventory (Exhibit 8) Demand filled by regional warehouse (per day) Order cycle Current Model (Cost in Lire per piece) Operating cost/lire/piece/order cycle Inventory costs/lire/piece/order cycle Transportation cost (10 trucks in 8 days delivering 1200 items) Total cost per piece per order cycle

1200 154.8 7.75 (1200/154.8) 961 (3605/30)*8 276 (1035/30)*8 2916 (0.35m/1200)*10 4153

8 Days

TPE Model (values in Lire on per piece basis) Operating cost/lire/piece/order cycle (8days) Inventory cost/lire/piece/order cycle Transportation cost/lire/piece/order cycle (1 small and one big truck daily for 8days) So total cost = 3725

192 (20% of 3605/30)*(8) 0 No inventory 3533 (8*(0.35+018)m/1200)

Appendix 2 Catanzaro Demand filled by regional warehouse Average daily demand filled by regional warehouse Order cycle 780 58.68 13.3 (780/58.68)

14

days Current Model (values in Lire on per piece basis) Operating cost/lire/piece/order cycle Inventory cost /lire/piece/order cycle Transportation cost (5 large and 4 small trucks in 8 days delivering 780 items) Total cost /lire/piece/order cycle Transit Point Experiment Scenario 1 (2 small trucks daily) Operating cost/lire/piece/order cycle Inventory /lire/piece/order cycle Transportation cos/lire/piece/order cycle t ( 2 small truck daily partially loaded) TOTAL COST

1551.2 (3324/30)*14 803.1333333 (1721/30)*14) 9230 ((5*1 m+4*.55m)/780) 10990

310.24 (1551*.2) 0 19744 (.55m*2*14)/780 20054

Appendix 3