Introduction

Texas Entertainment $($TE$)$ is a private distributor of electronics. TE distributes a wide range of consumer electronics including DVD players, televisions, MP$3$ players, stereos $($home and auto$),$ digital cameras, etc. They have operated out of their single distribution center in Waco, Texas since $1979.$ As most of the big box retailers of these products tend to self$-$manage their distribution channels, TE$$s customer base is dominated by small and medium sized electronic retailers. Over the years, TE has developed the reputation of providing consistent and timely service. This reputation has fueled their growth as they have secured a number of long$-$term customers.

Growing Concerns

While TE is known for its high quality customer service, it has had some recent service failures that have worried Fred Flint, the company$$s president. In fact, one of their customers since $1982$ has recently defected to a competing distributor due to TE$$s increasing inability to meet demand requirements out of inventory.

There are a few key economic trends cited by Mr$.$ Flint as contributing factors to this decrease in service. When TE began operations over four decades ago they managed and distributed approximately $45$ stock keeping units $($SKUs$)$ from a limited number of domestic manufacturers. Today, with the emergence of international producers, and the sheer variety of electronic gadgets available to consumers, TE manages and distributes over $400$ SKU$$s$.$ In an effort to reduce inventory levels, TE has increased its estimated annual cost of carrying inventory from $15\%$ of unit cost in the past to the current $30\%$ for internal measurement.

In light of these recent service disappointments, Mr$.$ Flint has requested that the inventory management team evaluate the current situation and propose possible improvements to the system. Upon discussions with key customers, Mr$.$ Flint has determined that a customer service level of $99\%$ is an appropriate target.

Current Environment and Practices

As a first step, the inventory management team decided to focus on the inventory policy and distribution flow for a representative product that could perhaps provide insight to their problems. They decided to focus on SKU# TED$10$GB$,$ which is one of their best$-$selling Blu$-$ray players. They source this product from the manufacturer$$s facility in Guadalajara, Mexico at a unit cost of $$150.$ A review of recent sales data has revealed that this item is on pace to achieve annual demand of $65,000$ units over the $250$ annual working days. Further, they have estimated that the standard deviation of daily demand is $35$ units. TE orders this product in lot sizes of $2,000$ and incurs a fixed order cost of $$4,000$ each time they place an order. A replenishment order is placed when the inventory position drops below $2,250$ units.

The supplier uses an inter$-$modal method of transportation in which the shipment is transported to the US$-$Mexican border at Laredo, Texas via truck. At Laredo, after all customs paperwork and security clearances have been completed, the shipment is transferred onto a railcar and the product is transported to the rail terminal in Houston, TX$.$ In Houston, the product is once again transferred to a truck for final delivery to the distribution center in Waco, TX$.$ The time required from placing an order until the product is in stock at the distribution center and ready for sale, averages six days with a standard deviation of three days.

Proposed Alternative

The TE inventory management group arranged a meeting with the supplier for TED$10$GB along with the $3$PL provider in order to collaborate on potential options for improving on the current distribution system. At this meeting a proposal was put forward that TE consider trying to reduce its current average lead time. In particular, the $3$PL provider believed that if TE switched from the current inter$-$modal transport method to a quicker direct truck method, TE could receive their shipments much sooner. Although the inter$-$modal transport method is less expensive, the proposed direct truck method would cut the lead time to an average of two days with an estimated one day standard deviation. However, the direct truck method would also increase the fixed order cost for TE to $$5,000.$ This was an additional $$1000$ per order.

Mr$.$ Flint was expecting an overview of the current situation along with the team$$s recommendations for improvement, the following week. The team was having trouble seeing how the reduction in lead time was worth paying the higher order cost. A tough decision had to be made.

Case Questions

$1.$ In the current environment, what are your thoughts on TE$$s current order quantity? Does this order quantity minimize total annual inventory cost? If not, what order quantity do you suggest? What are the cost implications?

$2.$ As indicated, Fred$$s goal is to meet demand $99\%$ of the time. Given their current level of safety stock, what service level are they