CASE ANALYSIS IN MATERIALS MANAGEMENT

New England Shipbuilding Corporation

New England Shipbuilding Corporation is one of the largest

shipyards in the United States. It builds not only various types of war
ships and supporting for the US Navy but also cargo ships for private
ship lines. A shipbuilder is basically an assembler of steel and other
components made by specialized suppliers and in the case of New
England Shipbuilding, purchased parts and materials account for more
than 60% of the sales dollars. In their past purchases, they were able
to protect themselves by incorporating price-redetermination or
escalation clauses into their contracts that permits them to increase
reasonable prices due to unanticipated fluctuations in the market that
is passed on to their customers. The company is now bidding on a $30
million order. They’re hoping to get an edge among their competitors
with the given price. The company estimated that most of the
materials (metals and metal products, machinery etc.) would amount
with a ball park figure of $20 million dollars. Walter Rogers (materials
manager) estimated that roughly $8 million will be spent for electrical
machinery and equipment of various types; $6 million for non-electrical
machinery and the balance for various types of metal parts and
products. Provided with an order not to pad his estimate to the
maximum escalation clause of 15% and not to underestimate materials
costs. The company needs the order badly and that it cannot afford to
hedge just to avoid fluctuations.

Question:

Assume that New England Shipbuilding’s costs of purchased

parts and materials follow the pattern of the BLS wholesale price
indexes for metals and metal products, electrical and non-electrical
machinery. Based on present economic conditions, what should New
England Shipbuilding include in its estimate of materials costs?

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Proposed Solution

Assuming that New England Shipyard followed the BLS wholesale

price indexes of metals and metal products, electrical and nonelectrical
machinery, based on the economic condition, surely they may have
trouble dealing with the cost of these materials. But this is New
England Shipbuilding Corporation, a well known and well established
shipyard in the US, perhaps they should take it to the next level.

They may have thought of needing the new materials but since
they needed the order badly, they should try to come up with
something to think which is “out-of-the-box”.
In this proposal, let us say that Rogers will estimate the cost of
shipbuilding based on their previous experience of building similar
ships which are nearly of the same type and size. Apart from previous
estimates the knowledge of the experts and their self made formulas
also go into this type of cost estimation. The main advantage of this
type of process is that it works fine and perhaps is very accurate for
ships which have been built previously but it would not work with the
same degree of accuracy if the shipyard receives an order which is
totally different from the type and size of ships it has been
constructing. The thing is, a shipyard relying totally on this case has
the tendency to get stereotyped and if suddenly those particular types
of ships go “out of fashion”, they would certainly be in troubled waters.
If this is the case, certainly another solution could be that the
shipyard only accepts standard orders and does not cater to “custom
made” ships. This would certainly reduce the number of clients
wanting to get their ships from such a yard, but on the other hand this
also would make the shipyard specialize in building the ships which
they offer.
One may ask, “If they would be using the same design, size and
type of ship, inevitably, they will still be dealing with the present
economic condition of the materials?”, “what about it?”. Well, in this
case they won’t be having any trouble including electrical and
nonelectrical machineries in their estimates, that is, on what will be left
and a lesser but not much of a real problem would be the metals and
metal products. This is true in the sense that if they will be spending
for the said machineries and equipments and that they will have to
worry with its fluctuations in prices, it would be better to make use of
their current machineries and equipments and rather just spend on its
repair and maintenance. Repair and maintenance shouldn’t cost as

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much $8 million to estimate if the repair would be made quarterly and

maintenance on a monthly basis for the three years to come.

Owen Electric Company

Owen Electric is a small producer of electric motors. But close control

of costs and goods marketing, it has managed to compete successfully
against such giants as General Electric and Westinghouse. Steel is
Owen Electric’s second most important commodity after copper and in
late 1958, the company steel inventory situation is far from favorable,
looking ahead, the anticipates that it will require 50 tons of steel per
month through June 30; 35 tons per month until September30; and 65
tons per month for the balance of the year 1959. Owen, like any other
purchasing agents, knows that certainly there will be a strike when the
steel contract expires July 1, 1959. Owen doubts if he can even gets on
any of his steel suppliers first-quarter 1959 rolling schedule for any
tonnage over and above what he already has as order. The company
doesn’t have any space available to store any extra steel inventories
over and above the 20 ton safety stock it hopes to accumulate during
the first quarter. However, adequate storage space could be rented for
an average cost of $1.50 per ton per month, plus $2.00 per ton to
move the steel from the warehouse to the Owen Electric Plant. In
addition, the company anticipates other modest looses as a result of
damage from extra handling, rust and so forth, which might amount to
1% of the value of the steel stored. The steel strike in 1956 lasted
about three weeks and resulted in what both steel producers and users
regarded as an inflationary wage settlement. In late 1958, the steel
company is not only faced with higher wage costs but are also feeling
the effects of much higher scrap prices. During periods of peak
demand, as much as half of this scrap must be purchased on the open
market. Owen believes that the odds strongly favor a strike, although,
of course, he is not certain how long it will last. Owen does not believe
that the strike could possibly last more than eight weeks before either
a settlement is reached voluntarily or president Eisenhower invokes
the Taft-Hartley Act. Owen guesses that if President Eisenhower
invokes the act, there would be no second strike, and labor and
management would almost certainly reach an agreement.

Questions

1. Recommend a plan of purchase and evaluate it with a Bayesian

probability analysis.
2. With the benefit of hindsight, we now know that steel production
was crippled for more than 100 days in the summer of 1959 until
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President Eisenhower finally invoked the Taft-Hartley Act forcing

the steel company employees to go back to work. However, the
composite index of steel prices remained at $0.0698 per pound
from November 1958 through 1960. Partly because of indirect
government pressure but mostly because of falling demand and
growing inroads from cheaper foreign steel. American steel
producers were not able to raise their prices above the 1959
level for more than five years thereafter.
a. How would your plan of purchase have worked during the
1959 strike?
b. Could Owen have protected himself against a steel stock out,
given the assumptions on which he based his decision?

Proposed Solution
In order to meet the monthly usage, Owen electrics buys 600 tons
of steel because it is the second most important commodity after
copper of the company. It shows that in July 1, in order to to be
protected against strike which is anticipated when the steel contracts
expire on July 1, 1959. However, it will result him to have a cost of
$157.50 per month (105*$1.50) or a total of 472 for three months.
And an additional of $210 to move the steel from the warehouse to the
Owen electric. But, the suggested plan reduces the cost of material
from $91,020 to $ 89947 having a saving of $ 1073 that can be used to
sustain that storage and delivery cost amounting to $ 682 (472+$210)
Applying the Bayesian analysis, even the estimates of $96,000
loss for 8 weeks strikes, the probability will only 10 % ( P(8)₌0.10),
thus, the expected loss would still be $ 9600 (96000 * 0.10)
If there were no strikes, there is a probability ( P(5)₌0.50),
( P(3)₌0.40), ( P(0)₌0.10),and if there is strike ( P(0)₌0), ( P(7)₌0.30),
( P(5)₌0.40), and ( P(3)₌0.30), therefore, there is a 5 % increase even
there is a strike or no strike. However, the probability of strikes is
come in 4 broad possibilities; ( P(no strike)₌0.20), ( P(3)₌0.40),
( P(6)₌0.30), ( P(8)₌0.10). due to the strike, the steel industry will
almost certainly stock with much higher prices.

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Queenstown Chemical Company

Queenstown Chemical Company is a leading producer of
specialty chemicals. Joanne Mead, Queenstown’s director of purchases,
is responsible for both raw material and finished goods inventories, in
addition to directing the company’s purchasing activities. Her biggest
single problem is managing finished goods inventories, which in the
last year have increased from $2 million dollars to $10 million. Not only
is the company running of storage space, but its cash position is
getting tight. There is no easy solution to the problem. Their customers
are aware that chemical shortages are a thing of the past, and they
insist that the company stock their needs for immediate delivery.
Customers carried 30 to 60 days inventory and insist on getting
delivery in 10 days or less. If they do not get this rapid service, they
can buy from Queenstown’s competitors, who are willing to carry
stocks for their customers. It occurs to Mead that she might try the
same approach on her suppliers and get them to carry inventories for
Queenstown. At present, the company invested $1 million in
nonproduction inventories and $6 million in raw materials. Usage of
nonproduction is about$100,000 per month and raw materials are
about $2 million per month. Queenstown uses a perpetual inventory
system. Mead believes that inventories can be reduced substantially
by requiring suppliers to carry inventories. She proposes that
Queenstown make contracts with each of its major suppliers that call
for them to maintain certain minimum stock of materials available for
immediate delivery. Meads assistant, Robert Stark, disagree with his
boss’ plan. He points out that if the cost the supplier just as much to
carry inventory as it does Queenstown. The result would be that overall
costs would be higher than they are in present. He grants that
Queenstown would probably able to persuade its suppliers to stock
without having to pay a premium. As an alternative, he suggests that
Queenstown discuss the problem with its suppliers and persuade them

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to offer lower prices. However, that this approach may not work too
well on items that are price fixed. Stark also suggests that Queenstown
might be able to reduce inventories by trying to schedule its needs for
maintenance items in advance.

Question

How would you evaluate Mead’s and Stark’s proposals? Develop

an inventory program for Queenstown?

Proposed answer:

Top heavy inventories are a giant cash vacuum that needs to be

turned off in order to free up cash for investment in revenue growth
activities. So, how can this be accomplished? One of their major
impediments to inventory reduction is the mistaken notion that just
improved inventory management is all that is required to get the job
done. The real culprits are their inefficient business processes that
cause excessive inventories to exist in the first place.
Certainly some aspects of excessive inventory investment are
the result of Inventory Control, but often their behavior is motivated by
management’s certain negative reaction to material shortages versus
periodic and less severe response to excesses. For the most part,
inventory excesses can only be significantly reduced or eliminated
when the cross-functional business processes that cause the need for
excessive inventory buffers to exist are fixed. It is futile to think
inventories can be isolated and singularly managed. Inventories are
invariably the result of how well many cross-functional business
processes really work.
Queenstown based raw material and/or finished goods inventory
stocking levels on inaccurate long term sales forecasts. The high cost
of these “bad numbers” if they aimlessly drive operations, as they
often do, depresses overall business performance. One result is that if
they use a total “push” inventory system will end up with high
inventories. An excellent method for achieving greater effectiveness
with working with their capital is to acquire materials and put them
through production so fast that inventory doesn’t have time to become
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a “liability”. Of course, this requires a well-engineered order-to-delivery

process that can have enormous benefits beyond just inventory
reduction.

A.E.D. Division

In September 1950, National Motors Corporation received a contract to

tool a large government-owned facility, in order to become a second
supplier of Hornet Engines for the US Air Force, price for the engines
was to be negotiated. Before A.E.D. could commence production of
acceptable engines which would be subject to extensive testing,
however, it had to produce two prototype engines. Until these engines
were flight tested and approved, A.E.D. could not go into full-scale
production. It was agreeable to the Air Force that A.E.D. buy crankshaft
forgings and run this forgings over its machine tools. The crankshaft
was a particularly critical component. The production control
department did not know how long it would take to pass a forging
through a complete machining cycle, but its guess was several months.
One problem that production control faced immediately was the
ordering the crankshafts needed for two prototype engines. Until in the
late 1952 the division still hadn’t finished a single crank shaft and in
May the last of the 100 forgings was scrapped. Additional forgings were
purchased and the first acceptable crankshaft was completed in
November 1952 – roughly six months behind schedule.

Questions

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1. Given no advance knowledge that the scrap rates would exceed

even the most pessimistic estimates, could A.E.D. have done
anything to prevent its crankshaft machining problems from
apparently holding up the entire program by about six months?
2. The A.E.D. case occurred in 1950. Certainly problems in
manufacturing on the threshold of new technique have, if
anything, become greater. However, companies like National
Motors now enjoy the benefit computerized material
requirements planning system. How would MRP have helped
A.E.D.? could the problem still occur if A.E.D. had had a first rate
MRP systems?

Proposed Solution

AED could have done something to prevent its crankshaft

machining problems if only they have a minimum number of forgings
from the existing supplier, since the company wanted to get its new
forging supplier approved and shipping forging as soon as possible. In
this case, the production control process is both easy and difficult to
visualize. They should’ve grasped the best way on how control and
MRP work to create a situation that is so easy to comprehend that no
formal system is needed.

The MRP could’ve helped them by always having materials on

hand when needed without carrying excess inventory. With MRP, each
change in end product demand can be instantly reflected in inventory
and production planning for each component, including those that are
several stages away from the final production process.

A problem in Order-Point control

Data on the perpetual inventory card:

Purchase
Disbursement Balance on
Date Requisition Receipts
Issued s hand
1/2 922
1/7 400 522
1/12 500
1/29 400 122
2/10 500 622
2/15 500
3/13 500 1,122
3/16 400 722
5/1 1,000 722 0
5/18 1,000 1,000
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5/19 278 722

7/12 500 400 322
8/10 500 822
10/26 600 222
10/27 500
11/18 500 722
12/12 200 522

Suppose you work for a company that controls its inventories on

a max-min basis, using perpetual inventory cards. The company is
introducing a new line of products that will result in greatly increased
usage of a particular component, you analyze the sales forecast for
this new product line and calculate that it will cause demand for the
component to rise by about 800 units per month. Naturally, you decide
to analyze the history of the component to determine what lead time
and order quantities should be. It is expected that demand for the
component will be more regular from the new product than it will be
from other products, which will continue to vary erratically as it has in
the past. The unit price F.O.B. buyer’s plant is $1 million lots of 100 to
499 pieces, 95 cents in lots of (more than 5,000 Pcs.) 500 – 999 pcs.,
92 cents of 1,000 – 4,999 pcs. And 90 cents in one more than 5,000
pcs. Normal lead time is 4 weeks, but in emergencies you can get
delivery in 2 to 3 weeks by doing a great deal of expediting.

Question

Calculate purchase quantities, safety stock, and order-point quantity,

based on the data above.

Proposed Solution

Blue Motors Corporation (A)

Blue Motors is a large auto manufacturer, and for them,

productive and inventory control is not an easy job. Plant and
equipment is the company’s biggest single asset. Control of production
parts and materials inventories is particularly difficult at the company’s
automobile assembly plants. The company cannot afford to stop its
assembly line because of supply failure, and storage space is limited.
The company could not carry more than a few days inventory of bulky
components even if it were not the least bit concerned about trying up
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too much of its working capital in inventories. Blue Motors uses

periodic ordering for all periodic parts and materials. Blue Motors stock
checkers make periodic counts of materials on hand, the stock
checkers use different review periods for different types of item. Any
item that is in critical supply is reviewed daily, regardless of its value.
Most A items are reviewed daily, B items usually are reviewed twice a
week, and C items are reviewed at least once. Until recently, all of Blue
Motors basic products have been assembled in reasonably large
quantities. The company’s newest product is what its advertising
department calls a “customized” sports car. The new product is
designed to compete with sport cars turned out by various European
manufacturers. Current plans call for assembly of the car at the
company’s main plant in Detroit. Its production volume is so low that
practically all of the components, few of which are interchangeably
with the company’s other cars, will be purchased. Suppliers of major
components have been reluctant to accept orders unless they’re
authorized to fabricate an entire year’s requirements in one production
run. Production is limited to only 15 units per day during peak demand
and will probably drop to 5 units during slack season, the company’s
normal ordering procedures for ABC items may not be applicable. The
company wants to tie up as little as of its valuable factory floor space
as possible on the new program. If an item cannot be delivered directly
to the assembly line, where there is a limited amount of space, it must
be stored in some other area of the plant, and a second handling will
be necessary. This would raise costs, particularly for high-volume
components.

Question

Recommend an ordering system for Blue Motors’ new sports car. In

making your recommendations, assume that a radiator is a typical A
item, a door handling a typical B item, and a fastener a typical C item.

Proposed Solution

Blue Motors Corporation can solve the issue if they can change
their quantity order of the components that instead of 15 units per
day, perhaps they can make it 450 units per month during peak
demand and 200 units during slack season including safety stocks.
Frequent order is not much to do the job neither care about their
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production. But in their case, the production is down to only 15 units

per day during the period of strong demand and 5 units per day during
the slow season. The thing is, doing the job for all the A, B and C’s
should be done and makes the delivery as soon as possible.

Eastern University Hospital

The director of materials management of Eastern University

Hospital, Mr. Ralph Galerneau, has a problem: despite considerable
success in cutting inventories, his storage areas are so jammed that
efficiency is being affected. The hospital is a 600-bed institution. The
situation is certain to get even worse before it gets better. The hospital
is in the midst of expansion. Purchases and withdrawals of supplies
from inventory will increase and new items will have to be added to
stocks. The new main store room for medical-surgical supplies covers
4,620 square feet. The hospital will soon be opening a new $22 million
day care center that will draw its medical-surgical supplies from the
same store facilities that serve other buildings in the hospital complex.
The materials management department also has available to it two
other warehouse facilities which are not located in the hospital premise
but are nearby. One of these facilities is rented for $354 per month and
the other for $450. However, not only this is extra storage space
limited, but it is costly to transfer materials from one storage area to
another. Total inventory of medical-surgical supplies is approximately
$100,000. Galerneau is convinced that there is very little fat in this
inventory. Galerneau would love to build a new facility with up-to-date
materials-handling equipment. The hospital’s cash position is tight and
its borrowing power is also limited. Land would be a problem even if
the hospital were willing to construct a new store building. There
simply is no convenient space available nor can additional land be
purchased easily. The hospital premises are surrounded by old,
privately owned buildings on small plots of land. Galerneau is presently
pondering whether or not he should recommend some new store
facility to the hospital’s administration and trustees. He has discovered
that repairs, maintenance and operation of the building run about
$124,000 per year. The hospital calculated depreciation on its
equipment to help determine which costs are reimbursable by Blue
Cross-Blue Shield and other agencies. Obsolescence and shrinkage are
reduced substantially as a result of the extremely close control that is
maintained over inventories. At present both order points and
purchase quantities are determined largely by judgment. Galerneau
has been considering adoption of some sort of economic ordering
procedure.
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Questions

1. Does Galerneau have sufficient information on carrying cost and

ordering cost to use EOQ formulas?
2. Suppose that Galerneau’s rough estimate of $500,000 for a new
stores building turns out to be correct and that land adjacent to
the hospital’s other buildings becomes available. How would you
go about justifying a request to the hospital’s administrator and
trustees for funds to construct the building?

Proposed Solution

The rough estimate of Galerneau is necessary to give the owner

a reasonably accurate idea of the cost to help him decide whether the
work can be undertaken as proposed or needs to be curtailed or
abandoned, depending upon the availability of funds and prospective
direct and indirect benefits. Galerneau must be in a position to know
exactly how much expenditure he is going to incur on them: From the
estimate of a work it is possible to determine what materials and in
what quantities will be required for the work so that the arrangements
to procure them can be made. The number and kind of workers of
different categories who will have to be employed to complete the
work in the specified time can be found out from the estimate that will
help in determining amount and kind of equipment needed to
complete the work.
Their estimate of work and their past experience enable them to
estimate quite closely the length of time required to complete an item
of work or the work as a whole.
Whereas the importance of knowing the probable cost needs no
emphasis, estimating materials, labor, plant and time is immensely
useful in planning and execution of any work.

Galerneau doesn’t really have any sufficient information on carrying

costs and ordering cost to make use of the EOQ. It seems that the
hospital is into a lot of those expansion investments that somehow
they would come to think of not to grant Galerneau’s request for the
said estimate. The top management might find it as an excess with the
overall operations of the company.

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Owen Electric Company (B)

Owen Electric Company controls inventories of hardware used on

its assembly line with periodic ordering. Weekly reports from stock
checkers are sent to appropriate buyers, who post them to their
records and periodically issue orders to bring stocks up to the required
balance. For example, the company uses about 10,000 pieces of a
small screw machine part each month, the buyer looks at the latest
stock report on the 15th of the month and issues an order for quantity
sufficient to balance the inventory about 15,000 pieces when it is
delivered. Thus, if the stock checker’s report indicates an inventory of
12,000 pieces and estimated usage during the 30 day lead time is
10,000 pieces, the buyer will place an order for 13,000 pieces. The unit
price of the part purchased in quantities of 5,000 to 10,000 is $0.10
but the supplier is willing to cut the price to $0.095 if he gets orders
that average 20,000 pieces. Owen Electric’s controller estimates that it
costs $10 to make each purchase, and the carrying cost of inventory is
24%.

Questions

1. Should Owen Electric take advantage of the supplier’s offer?

2. What is the company’s most economic order period if the
supplier’s price does not vary with order quantity?

Proposed Solution

The difference is not that much from 0.10 dollars to 0.095 dollars
if they order 20000 pieces when they only need 10000 pieces to 13000
pieces. True that unit prices usually are lower and the larger the order
quantity, the fewer the number of orders that must be process and the
fewer the shipments that need be handled and this reduces costs. But
in the case of Owen Electric if they going to buy 20000 pieces, it will be
too much, they will have too much stocks, so that, instead of reducing
the inventory or keep it low the result is, they will have more items to
be stored which they are not actually needed and if stocks are held
long enough, the accumulated carrying charges will exceed its value.
When many items are stored, inevitable that some of them will not be
used, will shrink, or disappear or will spoil, and the only way to prevent
is simply by not investing it in inventory. In the case of Owen Electric,
obviously the excess in 20000 pieces from the 10000 pieces needed if
they are going to accept the suppliers offer will not be use and become
obsolete.

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