Hewlett Packard was founded in 1939, and has continually thrived from year to year, growing to over 50 operations worldwide presently. Around 1990 things began to change. They ran into issues they had to contend with, such as the need to find the best way to satisfy customer needs in terms of product availability. They also needed to get agreement among the various parties in the supply chain. Their inventory management plans were synchronized. In the U.S. and Western Europe the market for printers was becoming mature, although it was still developing in Eastern Europe and the Asia-Pacific region. In addition, they needed to assess which particular printer market they wanted to target, so as to maximize profits and value to shareholders.
Currently, the market consisted of 40% impact/dot matrix, 40% laser printers, and 20% inkjet printers. With dot matrix printers starting to become outdated and expected market share to drop 10% within the next few years, laser and inkjet printers would be the best alternative for HP to focus on. The key issue that Hewlett Packard will have to deal with, however, will be identifying the level of safety stock needed at their distribution centers and finding the lowest cost way to supply this amount.
There is an assortment of problems that have contributed to Hewlett Packard’s inventory/service crisis. One of these problems was a result of the considerable lead time in shipping out to Europe and Asia. Having a lead time of 4 to 5 weeks makes it extremely arduous for companies whom have a JIT system put into place. When you wish to have inventory levels of 0, but have long lead times, problems are bound to occur.
Another issue arising is HP’s system of inventory assessment. Currently they are devising a new system of safety stock analysis, because their old system was based on heuristics, and was not fully effective for the company. Due to the increasing difficulty of obtaining accurate forecasts, HP’s safety stock analysis will probably have to be revisited. It is their choice of inventory carrying costs to be used in the safety stock analysis which is the one issue that continuously comes up. Some estimates start at 12% which comes from their cost of debt plus some warehousing expenses, whereas others are at 60%, which is based on the ROI expected of new product developments. Management must be able to determine that percentage that more accurately reflects the true cost of holding inventory.
Demand uncertainties, while more controlled then past years, could have also exacerbated to the inventory/service crisis. There were three areas of concern to be addressed in this sector. The first dealt with delivery of incoming materials; whether the parts/products shipped come on time, and if the actual order was filled correctly with the right parts. Internal process uncertainties, such as process yields and machine downtimes, were another issue HP had to look over carefully. Finally, the final end demand varied too much for forecasting to be accurate enough.
This issue complicates the choice of safety stock levels since they are ultimately based on expected demand. This creates what is known as the bull-whip effect. Essentially the bull-whip increases variability at various levels of the SC making efforts to integrate efforts difficult. There are four key aspects of the bull-whip effect that HP must take into consideration: demand forecast updating, order batching, price fluctuations, and rationing and shortage gaming. These are the four major causes of bull-whip that must first be understood, so that we can counteract the effect.
The waterway distribution system could also be a potential problem for the company. Our analysis determines maximum air freight that is acceptable under different inventory holding cost assumptions. As aforementioned, there are quite a few issues which could have caused an inventory/service crisis within Hewlett Packard. Some issues, like the safety stock analysis problem are more likely to cause the crisis; however, it is most likely that a combination of all these factors contributed to the overall problem. Each issue must be examined so that some of the potential problems can be filtered out, and the real issue can be known and figured out according to HP’s policies and objectives.
Alternative courses of action:
There are three courses of action that could be implemented in an attempt to rectify the problem with satisfying demand for printers in the global economy with minimal inventory and stock out costs. The first alternative is the base case scenario. This scenario consists of HP’s normal distribution strategy, which consists of one main manufacturing plant in Vancouver who assembles everything on the printers and localizes it according to its destination. The means for distribution is by sea. The second alternative is an air freight scenario which will utilize the airline industry in HP’s shipments to Europe.
This approach reduces lead time from 4.5 weeks in the base case scenario to 1 week. All of the manufacturing and processing still occurs in the Vancouver plant. The third alternative is a generic European model to be assembled-to-order in the European DC. This approach will produce a generic product in the Vancouver facility and then ship the unfinished product to the European DC’s where the final assembling and localizing will occur.
We have three basic assumptions. First, lead time for the base case scenario will be 4.5 weeks. Second, air freight will create a lead time of 1 week; this includes actual transportation, customs clearing time, and other miscellaneous events. Third, the majority of the holding cost will be in generic European option. The calculations for all types of printers in the European market are located in Appendices 2-4.
To evaluate these three approaches, we consider holding cost for the safety stock. When comparing these costs between the three approaches for both the best case scenario of 12% inventory holding costs we get $442,300, $626,254, and $847,412, for air freight scenario, generic European model to be assembled-to-order, and base case scenario respectively. The costs for the worst case scenario of 60% inventory holding costs are $2,211,500, $3,131,272, and $4,237,062, for air freight scenario, generic European model to be assembled-to-order, and base case scenario respectively.
Necessary Supply Chain Changes:
The primary change that should be made in the supply chain management in order to implement the generic product option would be to move the finalization of the product to its respective distribution center. Due to the long shipping times involved, the factory should engineer and manufacture a base assembly at the Vancouver facility and ship them to the distribution centers abroad. At these distribution centers an inventory of localizing and finishing parts will exist; therefore, the base product can then be localized and finished at the respective distribution center according to demand patterns at that time.
Since inventory is generic, one DC can ship the generic product to another DC which can be finalized and localized quickly to satisfy the current demand to hedge the risk of stock outs in the higher demand regions. The result is that the total safety stock required at the DC is reduced by a factor of n1/2, where n is the number of different SKU’s for which the customization is being postponed. Marketing and sales figures can then be created more accurately, and seasonal trends can be compensated for more easily.
This would aid in the forecasting of demand to determine how to allocate the scarce resources to maximize profitability. Having the flexibility to better meet the changing demand of different markets should cut down on lost revenue due to stock outs. Also, the required safety stock for the distribution center will be reduced, which should cut back on inventory and holding costs. Even though these costs do not show up on the income statement, these are real costs and need to be addressed and minimized.
Recommendations and Evaluations and Conclusion:
There are a variety of different options that Hewlett Packard could use to help smooth out their supply chain. The first is air shipment. While it may provide a faster route to move the products, the big problem with air freight is that is expensive to use. Looking at appendix 5, if air freight costs per unit are less than $2.04 (assuming inventory holding cost of 12%) then the air freight is preferable to sea. The air freight costs per unit are less than $10.19 (assuming inventory holding cost of 60%) then the air freight is preferable to sea.
The next option would be to have a European factory actually producing parts and products. This would reduce the extensive lead times that are associated with shipping out of Vancouver. The other side to this situation is that with a new manufacturing factory in Europe, the concern would be that there is not sufficient volume to necessitate the need for an additional plant.
Of course, Hewlett-Packard could also always use a better forecasting method to determine demands and safety stocks needed. Obviously it has become a present problem for the company, and while they are attempting to create a method to forecast better, they are not sure they can come up with a truly effective method that would erase the uncertainties associated with demand. Because this is a difficulty, our cost allocation assumes that demand is such that the safety stock level is constant over the year. Safety stock represents the inventory level above and beyond expected demand, so assuming a constant safety stock seems reasonable.
On the flip side of a better forecasting method, you could also simply increase levels of inventory to ensure product demand is met. However, this is more of a nearsighted approach as this will just lead to increased holding costs and overall inventory costs.
Hewlett-Packard could also introduce a system of more localized distribution centers. The cost savings associated with this are hard to determine though. While you may reduce inventory and holding costs, the expenses incurred to have localized distribution centers built and maintained could very well outweigh the benefits received.
If we were Brent Cartier, we would definitely recommend that we use the air freight alternative. This was determined by comparing the numbers seen in Appendix 5. If we take a look, if the amount of air freight per unit exceeds the cost of shipping by sea per unit by less then $2.04, then airfreight will be more cost efficient. The $2.04 essentially represents differences in holding cost per unit, which is why we analyze this difference. It is important to realize however, that this is based upon a 12% inventory holding cost. If we were to base it upon 60% inventory carrying costs, the difference would be equal to $10.19. We would have to show the board of directors the calculations derived in determining the above numbers so that air freight will sell itself. The numbers speak for themselves, and the board of directors should clearly be able to see this noticeable advantage.
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