You were just hired as the Director of Supply Chain for a large supplier of automotive parts.After looking over various reports, you conducted an analysis of inventory.You noticed that fulfillment rates had been declining in the past several years, from 98.6 percent down to 94.3 percent- well below industry average.As you listen in meetings, you hear the salesforce is frustrated and is claiming lost sales due to the declining fulfillment rates.Oddly enough, your analysis shows that inventories have been increasing, even though there is a slight decline in sales.

As you begin to look at your reports, you notice that fulfillment rate in higher dollar value inventory items seems to be lower than the lesser value items.So, you decide to conduct an "ABC" analysis, breaking down inventory into the following categories.

A= high-value/high-margin parts

B= Mid-value/high-volume parts

C= Low-value/Low-margin and high-volume parts

Specifically, you analyze inventory levels and fulfillment rates, considering the amount the company earns in these categories (the "gross margin").The data is shocking.You notice inventory levels dropping in the A parts, while at the same time fulfillment rates are also dropping...there are persistent shortages and persistent missed orders of your most valuable parts.

Similarly, you see a slight decline inventory levels for B parts, but also a decline in fulfillment rates.

Finally, you notice that inventory levels for C parts has been ballooning, while fulfillment rates climb to well over 99%.So much so, your analysis shows that the high fulfillment rates for the C parts obscure the data.The fulfillment rate for the much more important A and B parts is much lower.

You schedule a meeting with the two purchasing people on your team.When you show them the data, you get a mixed response.One says, "Well, yeah, those A parts are expensive...we have to do everything we can to minimize inventory...those parts just can't sit around."Chuck is his name.The second sits quietly, looks at the data you've presented and says, "I haven't seen the numbers organized that way, but you're right, that doesn't look good".Her name is Cindy."Hmmm..." you think to yourself, "Chuck was awfully quick with a less than satisfactory answer."You also note Cindy took time to look at the data and study it before replying.Interesting.

You continue, focusing on the data you've prepared."So, what happens when we can't fulfill an order of an A part?"Chuck says, "The customer just finds another source.We try to avoid rush orders from our suppliers, because that costs even more."You select a single A part and say, "Okay, for example, this part has a sales price of $1,800, we pay about $1,000.How much would it cost if it was a rush order?"(You notice Cindy shifting uncomfortably, correctly sensing this meeting has a purpose she has not quite figured out.She just looks at Chuck.)

Seemingly proud he knows the numbers by heart, Chuck blurts out, "$1,200".As gently as you can, you say, "So, in order to save $1,000, we had insufficient stock to fulfill an order that would have paid us back that $1,000 and earned us a margin of $800, is that correct?"Chuck takes the proverbial bait."That's right."So you reply, "So, we are out $800 in profit, which, it seems to me, goes directly to our competitor, correct?"

You see the lightbulb go on in Cindy.But, Chuck says, "Yes, an $800 profit, but we saved $1,000."You reply, "But we sold it for $1,800, so we got our $1,000 back" to which Chuck says, "But only made $800!".At which point, Cindy says to Chuck, "I think the point being made here is we are losing profits to our competitors, which is what the salespeople have been saying."

Upon further questioning, you find out that many C parts are not critical to customer operations, so a return to industry average fulfillment rates will have no apparent impact on customer buying behavior.

After a couple of days, you prepare some recommendations.You propose to immediately increase inventory levels of A parts by 25%, increase B parts by 5% and strive to reduce inventory of C parts by 40%.You project the following trends in inventory...note these %'s are the change from the prior year (the 10% decline in inventory is a 10% decrease from Year 2.($'s in 000's)

Beginning Inventory:$47,400

Year 1:+7%

Year 2:-5%

Year 3:-10%

Year 4:-5%

Year 5:+5%

Working with your peer, the Director of Sales (who seem genuinely glad you've bee hired), you both put together revised sales projections.The Director of Sales is excited to have an advocate coming from Operations/Supply Chain...they appreciate your willingness to consider the impact on customers.She says, "I've been saying this for years, I just didn't have the data to prove my point.This is fantastic!"

Current Revenues:$632,000

Year 1:+2%

Year 2:+2.5%

Year 3:+2%

Year 4:+1%

Year 5:+.5%

In fact, the Director of Sales puts together an analysis of why margins will actually go up with this new inventory strategy.

Over the next several days, you both work together and develop the following gross margin projections:

Current Gross Margin:32.2%

Year 1:33.2%

Year 2: 33.5%

Year 3:33.7%

Year 4:33.8%

Year 5:33.9%

You both agree that these projections look reasonable...conservative even!When you do the projections, you are astounded.

You then begin to prepare a presentation to the Executive Team, who you know will only give you about 20 minutes to make your pitch.You both decide it is best to present jointly- and position the presentation as a revised supply chain strategy in support of sales and customer service.Knowing that C-level executives appreciate brevity, you both keep coming back to a two sentences to describe your proposal:

"Our analysis shows we may have an opportunity to boost sales and gross margins by making a small investment in high-dollar/low-value inventory items, while at the same time decreasing inventory levels of low-dollar/high-volume inventory items.We think we can capture both revenues and gross margin dollars that are now flowing to our competitors."

THE ASSIGNMENT:

Prepare a NPV analysis by calculating the incremental cash flows associated with this proposal.Submit your spreadsheets via Canvas.

Hints:

Calculate each change as separate items:

-Calculate the incremental cash flow associated with Inventory

-Calculate the incremental cash flow associated with Gross Margin by:

-Calculating incremental Revenues

-And applying the revised Gross Margin %

=Incremental Gross Margin

-Existing Gross Margin

=Incremental Cash Flows from Gross Margin Changes

-Calculate the total incremental cash flows

-Calculate the NPV of incremental cash flows

Key Assumption:Assume that without these proposed changes, there will be no Revenue growth, no changes in Inventory and no changes in Gross Margin.There is no incremental investment required for this project except for a minor amount of staff time.Use the Executive Team mandated discount rate of 20%.