Chapter 1, Logistics, Operations, and Supply Chain Management Video Solutions, Integral Logistics Management: Operations and Supply Chain Management Within and Across Companies,

Problem 1

Improvements in Meeting Entrepreneurial Objectives

Review the discussion of entrepreneurial objectives in four target areas (quality, costs, delivery, and flexibility) in Section 1.3.1. Your company manufactures a single product from easily obtainable components in four operations with a batch size of 5. You determine the following problems:
- Your product does not meet the demands for product quality; returns of delivered products are frequent.
- When demand is high, you regularly run into delivery difficulties. In addition to the problem of insufficient quality - which results in frequent rework - delivery difficulties are being caused mainly by poor coordination of the manufacturing departments among themselves and with the sales department. Moreover, production at the first work center is too slow, and in-house transport cannot keep up the pace. In other areas, there tend to be too many employees, particularly in sales and distribution and quality assurance.
- You think that there is a strong fluctuation of demand per period. However, you do not have the figures to back this up. You also do not know whether you can predict future demand reliably from the sales figures of past periods.

In other words, you determine a need for improvement. Discuss with your team possible measures in each of the four target areas. For each specific measure proposed, consider the amount of investments that will be required. Decide the order in which the specific measures will be realized.

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Problem 2

Entrepreneurial Objectives and ROI

The following exercise was developed in communication with Prof. Dr. Peter Mertens, Nuremberg, Germany, to whom we express many thanks.

When we looked at opportunity cost in Section 1.3.2, we mentioned that a particular objective in the four target areas (quality, costs, delivery, and flexibility) does not always support the primary entrepreneurial objective, which a company can seek to fulfill through maximum "return on investment" (ROI). For example, if investments to reduce lead time do not result in increased demand or a larger market share, then ROI decreases rather than increases.

How can this be shown more exactly, correlating the objective short lead time to factors in ROI? ROI can be expressed as follows:
$$
\begin{aligned}
\mathrm{ROI} & =\text { earnings } / \text { (investment or assets) } \\
& =\text { (revenue minus costs) } / \text { (current assets }+ \text { fixed assets). }
\end{aligned}
$$

A possible solution is based on the following line of thinking: Reduction of lead time can have the following consequences:
- It can increase the number of customer orders and thus revenue.
- It requires the elimination of bottlenecks. This can have the following consequences:
- It generally requires investments, which increases fixed assets and therefore capital costs.
- It can reduce inventories of work in order, which reduces current assets and therefore capital costs.

In this case, it is important to determine exactly whether the increase in revenue will be cancelled out by the increased costs (taking into account the increase and decrease in capital costs according to the line of thinking above). Since total assets appear in the denominator of the division, ROI decreases even when total assets increase with constant earnings.

Now, use similar arguments to try to elaborate the correlation of the following performance indicators in Section 1.4 (each corresponding to a different objective of the target areas in Section 1.3.1) to the factors in ROI;
- Scrap factor (objective: meet high demands for product quality)
- Inventory turnover (objective: low physical inventory)
- Capacity utilization (objective: high capacity utilization)
- Fill rate (objective: high fill rate)
- Delivery reliability rate (objective: high delivery reliability rate)

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Problem 3

Assessing the Economic Value Added (EVA) of Supply Chain Initiatives

Logistics managers often have problems in communicating quantitative benefits of their management decisions, which go further than reporting service level improvements and cost reductions, to the boardroom. On the other hand, financial managers have problems assessing the real contribution to enterprise value of supply chain initiatives (SCIs). Many assumptions have to be made when, for instance, calculating the economic value added (EVA) of such projects. As a result, investment decisions about SCIs use to carry a certain level of risk.

Economic value added (EVA) is a metric for representing enterprise value. EVA is positive, i.e., value is generated, when an investment activity leads to higher NOPAT than the weighted average costs of capital (WACC) invested in the assets required for generating that income.

In other words, value is only generated when the investment is expected to provide more profit than the stockholders would get by alternative investments on the market. The equation is therefore:
$E V A=N O P A T-W A C C \times$ value of fixed and current assets
Hence, the challenge is to provide transparency on the benefits and risks of the various supply chain structures and SCIs used for improving the performance of the supply chain - generally the reduction of inventory and reduction of lead time - in terms of the financial variables like EVA.
activities. From a logistics perspective, this increased the reliability of shipping and storing processes, with shorter lead times at lower costs per product. Because of lower return rates and higher product availability, the number of sold products and therefore turnover increased by $$\$ 22,980$$. The higher volume results in higher total SC cost of $$\$4,589$$ and higher taxes of $$\$ 5,517$$. From a financial perspective, the NOPAT is disproportionately higher $$(\$ 12,874)$$.
(GRAPH CANT COPY)
In addition to the perspective of the profit and loss statement, EVA integrates the changes on the balance sheet. The logistics performance improvements described above affect working capital in two dimensions. Shorter lead times reduce the cash-to-cash cycle time, representing the time capital is locked up as material in the supply chain. In addition, because costs per product could be reduced at several stages of the supply chain, the valuation of the material in the different inventory accounts is reduced, too. These relations are visible in Figure 1.7.3.1. Both effects result in reduced capital lockup of $$\$ 54,713$$. After being multiplied with the WACC of the company of $15 \%$, this value and the NOPAT effect make up the total EVA contribution of the SCI of $$\$ 21,081$$.

Consider now the following scenario: A central distribution center (CDC) located in Switzerland wants to evaluate whether it would be beneficial to change the transportation mode to the regional distribution center (DC) located in the south of Norway. Currently, transportation is by truck in order to achieve short transportation cycle times (3 days). Transportation by ship would take 7 days but is cheaper. The title of inventory is transferred as soon as the products arrive at the DC. The relevant average inventory value at the CDC is $$\$ 300,000$$ in the finished goods warehouse, plus average $$\$ 25,000$$ in-transit inventory with transportation by truck. The average in-transit inventory would double when changing the transportation to ships. At the same time, the annual transportation cost would decrease from $$\$ 20,000$$ to $$\$ 15,000$$, with payment terms toward any carrier of 60 days. The WACC of the company is $8 \%$.

What is the effect of the modal change on NOPAT and EVA after one year? Would you advise changing the transportation mode? Please also consider a sensitivity analysis in your reasoning, as the values of the initial variables can vary in practice.

Hint: As the SCVC method only calculates the change of the EVA contribution from a baseline to a changed scenario, you need to consider only values that differ between the scenarios.

Solution:
- NOPAT: $$+\$ 5,000$$ (same sales $$-\$ 5,000$$ less transportation cost)
- Average value of accounts payable: from $$\$ 3,333$$($$\$ 20,000$$ / 12 months * 2 months payment terms) to $$\$ 2,500$$
- Capital lockup: $$+\$ 25,833$$ ( $$\$ 25,000$$ higher average in-transit inventory plus $$\$ 833$$ lower accounts payable)
- EVA change: $$\$ 5,000$$-$$\$ 25,833$$ * 8 \%($ WACC) $=+$$\$ 2,933$$

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Problem 4

Rough-Cut Business Objects

Determine the process plan, the rough-cut process plan, and a possible load profile for the following product $\mathrm{P}$. If not specified differently, the operations for each (intermediate) product are the same as in Figure 1.2.3.3. The lead time at every level and for purchasing adds up to 10 time units.
- $\mathrm{P}$ is produced from one unit of components $\mathrm{A}$ and $\mathrm{B}$.
- A is produced from one unit of component C.
- B is produced from one unit of components $\mathrm{X}$ and $\mathrm{Y}$, by the same operations as for producing $\mathrm{C}$.
- $\quad \mathrm{C}$ is produced from the components $\mathrm{X}$ and $\mathrm{Z}$.
- $\mathrm{X}, \mathrm{Y}$, and $\mathrm{Z}$ are purchased components.

Apply the technique presented in Section 1.2.5, using the same rules as shown in the example but assuming that components $\mathrm{C}$ and $\mathrm{B}$ form the single item family $\mathrm{B}$.

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