CONSOLIDATED ELECTRIC: Inventory Control
Teaching Notes
1
Synopsis and Purpose
Consolidated Electric is a wholesale distributor of electrical products primarily to electrical
contractors. The company wants to design a system for inventory management of the 20,000
line-items carried in stock. A description is given in the case of the business environment and
the current inventory control system in use.
The purpose of this case is to expose students to many of the issues encountered in inventory
system design. These issues include: forecasting, replenishment decision rules, error control,
multiple item interactions, ABC analysis, and top management control. The case also asks the
student to describe how the system they design will help improve inventory management in the
company.
Discussion Questions
1.Design an inventory control system for this business. Provide the formulas that you would use
for a P System, Q system or other system you design. Compare these to the formulas currently
used. Examine the data from the Appendix to note any peculiarities in demand that your system
might encounter. What would you do about them?
2. Describe how the system you have designed will help the company meet customer-service
and cost objectives.
Analysis
One issue that needs to be considered during inventory system design is whether the system
will utilize periodic or continuous review. Periodic review should be used in order to take
advantage of purchase discounts and shipping economies. With periodic review, different items
from the same supplier can be consolidated into a single order/single shipment. Since most
product lines are reviewed on a weekly basis, this practice should be continued for control and
shipping purposes, unless a bi-weekly cycle becomes an obvious choice.
Items should be consolidated by line for ordering purposes. Thus, an entire line must be
reviewed before ordering decisions are made. The case indicates there are about 200 different
lines to consider on a weekly basis.
An inventory control system is shown in Exhibit 1. The forecasting model receives actual
demand and produces a forecast for each item on a weekly basis. The forecast should extend
through the ordering lead time plus review period for each item.
The order module accepts the forecast along with management inputs for service level and
costs. As a result, orders are calculated for each line and aggregate control information is fed
back to management prior to order placement. Orders are then placed, shipments occur from
the vendor, and disbursements are made to customers.
CONSOLIDATED ELECTRIC: Inventory Control
Teaching Notes
Before designing the forecasting module we should examine the data in Appendix 1 of the case.
A frequency distribution of the individual customer demands for seven months is shown in
Exhibit 2. The distribution indicates there are two types of customers, those who order a small
number of units and those who place very large orders. It would be very expensive to carry
safety stock for the few customers who order 50, 60, 65 or 100 units. Further examination of
Appendix 1 indicates that the same customer has ordered the 65 units on each of the four
occasions and 100 units on one occasion. A second customer has ordered 60 units on one
date and 50 units on another. If these demands occur on a predictable or known basis, perhaps
they can be scheduled in advance with the two customers and therefore be excluded from
inventory uncertainty.
The demand data also indicates that the distribution is highly non-normal. Nevertheless, the
demand over lead time may approach a normal distribution, particularly when the large orders
are excluded. The lead time in this case is about 10 to 15 days (see Appendix 1).
A forecasting system that will react to different types of demand distributions is needed.
Exponential smoothing or other techniques should be used to forecast demand and both small
item demand (Poisson) and normal distributions should be included. The forecasting model
should also handle seasonal demand and it should provide error tracking of forecasts. When a
forecast is not tracking with actual data, an exception notice should be given to the user. The
forecasting system should also detect outliers in demand when they occur and notify the user.
Finally, the forecasting system should forecast lead-time and MAD or standard deviation, as
well as demand.
The ordering module should calculate EOQ and the reorder point for each item. The EOQ
formula given in Exhibit 1 of the case can be used, but the reorder point from Exhibit 1 should
not be used. That reorder point is not related to service level or to statistical considerations.
The reorder point for normal demand should be:
where:
Reorder point
Lead time + Review period
Forecast demand over L + P periods
Safety factor
Single-period standard deviation of demand
CONSOLIDATED ELECTRIC: Inventory Control
Teaching Notes
3
Orders for each item in a line should be calculated without considering price discounts or
shipment costs (shipment weight). After calculating all orders in the line, the total order size and
weight should be accumulated. If these amounts are not sufficient to obtain a discount, an
economic analysis should be made of increased order size. Each order should be increased by
the percentage needed to reach the discount level or levels. The total cost (of ordering +
carrying + purchasing + freight) should then be compared for the EOQ and each discount level
using the line as a whole. This is preferable to the line-point procedure suggested in Exhibit 1.
After calculating the orders required for each product line, the system should supply aggregate
control information for management prior to the order placement. This information should
include, for example, total dollars ordered, total inventory levels projected, earn and turn ratios,
and service levels. The aggregate information should allow management to decide whether to
release the orders in total or not.
In terms of implementation it is clear that the ABC principle applies. The A items should,
perhaps, be put on the system first and monitored more carefully than B or C items. Also simple
reorder rules and forecasts might be used for B or C items to reduce computations.
The proposed inventory control system will help the company meet customer service and cost
objectives in several ways:
1. The system relates inventory to customer service objectives. Precise service goals can
be stated and reorder points set to achieve those goals.
2. The system relates inventory to costs and demand forecasts. It allows management to
minimize costs subject to the service goals set while reacting to forecasted demand.
3. The proposed system should save time on the part of the buyers and management. The
role of the buyer will also be changed to one of a systems manager and exception
handler rather than dealing with routine orders.
4. The system will provide more uniform decision making across product lines and across
buyers. The company will be less vulnerable to turnover of buyers.
5. The system should reduce inventory required for the same service level or alternatively it
should provide more service for the same inventory level. As a result, profits should be
improved.
Teaching Strategy
When teaching this case, I usually ask a student to describe the system he or she has
designed. I then ask several other students to describe their systems. This leads to a
discussion of good or bad features in each of the proposed systems.
After these features are described, I ask how the system will help improve inventory
management at Consolidated Electric. This leads to a discussion of the costs and benefits of an
inventory control system. In some cases questions of implementation and computerization are
also raised.
The case should take about one hour to teach. Many of the important points in management of
independent demand inventory systems can be taught by means of this case.
Teaching Notes
4
EXHIBIT 1
Inventory System
Forecasting
Module
Customer Service
Goals and Costs
Aggregate Control Info
for Top Management
Vendor
Inventory
Purchase Orders
Demand
Orders
Shipments
Sales
CONSOLIDATED ELECTRIC: Inventory Control
Teaching Notes
5
EXHIBIT 2
Demand Distribution
0
5
10
15
20
25
1 6 11 16 21 26 31 36 41 46 51 56 61 66 71 76 81 86 91 96
Order Size
Number of Orders
Series1