ELKO, a manufacturer of lighting fixtures, has been outstanding in developing new products, but the new CEO has observed

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ELKO, a manufacturer of lighting fixtures, has been outstanding
in developing new products, but the new CEO has observed some
potential opportunities in optimizing its distribution system.
Current Distribution System
The company has 100 SKUs in its product line, all manufactured
in own plants located in the Cleveland area. For demand management
purposes, the contiguous United States was divided into 5 regions
as shown below. Each region was served by a separate distribution
center (DC) owned by ELKO. Customers (all business: retailers,
contractors, offices, etc.) placed orders with the DCs, which tried
to supply them from inventory. A DC, in turn, ordered
replenishments from the company’s plants, using a periodic review
policy with a reorder interval of six days. All DCs carried safety
inventories to ensure a CSL of 95%. The plants scheduled production
based on DC orders (i.e., no finished-goods inventory at the
plants).
ELKO used a third-party trucking company for all transportation.
On average, orders transported from the plants to the DCs cost
$0.08 per item, whereas shipments from the DC to the customers cost
$0.15 per item. Two days were necessary between the time a DC
placed an order with a plant and the time the order was put on a
truck at a plant. Further, transportation lead time of the trucking
company for shipments from the plants to the DCs was normally
distributed: 3 days on average, with 1-day standard deviation.
A detailed study of the product line had shown that there were
three basic categories of products in terms of the volume of sales:
High, Medium, and Low. Demand forecast for a representative product
in each category (Products H, M, and L) is shown in the table
below. Of the 100 products that ELKO sold, 10 were of type High, 20
of type Medium, and 70 of type Low. The holding cost incurred was
$0.05, $0.10, and $0.15 per item per day (respectively, for
products H, M and L) whether the item was in transit or in storage.
Assume the product ownership is transferred to the customer once it
leaves a DC.
Region 1
Region 2
Region 3
Region 4
Region 5
Product H
Mean
35.48
22.61
17.66
11.81
10.36
Std.Dev.
6.98
6.48
5.26
3.48
4.49
Product M
Mean
2.48
4.15
6.15
6.16
7.49
Std.Dev.
3.16
6.20
6.39
6.76
3.56
Product L
Mean
0.48
0.73
0.80
1.94
2.54
Std.Dev.
1.98
1.42
2.39
3.76
3.98
Proposed Distribution System
The task force the CEO put together came with the following
recommendation: Build a centralized distribution center (CDC) near
Chicago, close all regional distribution centers, and supply all
products to all demand regions from the new CDC.
Given that Chicago is close to Cleveland, the inbound
transportation cost from the plants to the CDC would go down to
$0.05 per unit, and the transportation lead time for shipments
between the plants and the CDC would be exactly 1 day. The CDC
would continue to follow a periodic review policy with a reorder
interval of six days, and a CSL of 95% for safety stock. Given the
increased average distance, however, the outbound transportation
cost to customers from the CDC would increase to $0.40 per
unit.
The new CDC would need an upfront investment of $2 million.
However, centralization to a single distribution center would
result in efficiencies in operations, maintenance, and other
overhead, leading to annual savings of $120,000.
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