Northcutt Bikes: the Service Department

Introduction

Several years ago, Jan Northcutt, owner of Northcutt Bikes,recognized the need to organize a separate department to deal withservice parts for the bikes her company makes. Because thecompetitive strength of her company was developed around customerresponsiveness and flexibility, she felt that creating a separatedepartment focused exclusively on aftermarket service was criticalin meeting that mission.

When she established the department, she named Ann Hill, one ofher best clerical workers at the time, to establish and man-age thedepartment. At first, the department occupied only a corner of theproduction warehouse, but now it has grown to occupy its own100,000-square-foot warehouse. The service business has also grownsignificantly, and it now represents over 15% of the total revenueof Northcutt Bikes. The exclusive mission of the service departmentis to provide parts (tires, seats, chains, etc.) to the many retailbusinesses that sell and service Northcutt Bikes.

While Ann has turned out to be a very effective manager (and nowholds the title of Director of Aftermarket Service), she stilllacks a basic understanding of materials management. To help herdevelop a more effective materials management program, she hiredMike Alexander, a recent graduate of an outstanding businessmanagement program at North Carolina State University, to fill thenewly created position of Materials Manager of AftermarketService.

The Current Situation

During the interview process, Mike got the impression that therewas a lot of opportunity for improvement at Northcutt Bikes. It wasonly after he selected his starting date and re-quested someinformation that he started to see the full extent of thechallenges that lay ahead. His first day on the job really openedhis eyes. One of the first items he had requested was a statusreport on inventory history and shipped orders. In response, thefollowing note was on his desk the first day from the warehousesupervisor, Art Demming:

We could not compile the historyyou requested, as we keep no such records. There’s just too muchstuff in here to keep a close eye on it all. Rest assured, however,that we think the inventory positions on file are accurate, as wejust completed our physical count of inventory last week. I wasable to track down a demand history for a couple of our items, andthat is attached to this memo. Welcome to the job!

Mike decided to investigate further. Although the records wereindeed difficult to track down and compile, by the end of hissecond week, he had obtained a fairly good picture of thesituation, based on an investigation of 100 parts selected atran-dom. He learned, for example, that although there was anaver-age of over 70 days’ worth of inventory (annual sales/averageinventory), the fill rate for customer orders was less than 80%,meaning that only 80% of the items requested were in inventory; theremaining orders were backordered. Unfortunately, the majority ofcustomers viewed service parts as generic and would take theirbusiness elsewhere when parts were not avail-able from NorthcuttBikes.

What really hurt was when those businesses sometimes canceledtheir entire order for parts and placed it with another partssupplier. The obvious conclusion was that while there was plenty ofinventory overall, the timing and quantities were misplaced.Increasing the inventory did not appear to be the answer, not onlybecause a large amount was already being held but also because thespace in the warehouse (built less than two years ago) hadincreased from being 45% utilized just after they moved in to itspresent utilization of over 95%.

Mike decided to start his analysis and development of solutionson the two items for which Art had already provided demand history.He felt that if he could analyze and correct any problems withthose two parts, he could expand the analysis to most of theothers. The two items on which he had history and concentrated hisinitial analysis were the FB378 Fender Bracket and the GS131 GearSprocket. Northcutt Bikes purchases the FB378 from a Braziliansource. The lead time has remained constant, at three weeks, andthe estimated cost of a purchase order for these parts is given at$35 per order. Currently Northcutt Bikes uses an order lot size of120 for the FB378 and buys the items for $5 apiece.

The GS131 part, on the other hand, is a newer prod-uct onlyrecently being offered. A machine shop in Nashville, Tennessee,produces the part for Northcutt Bikes, and it gives Northcutt Bikesa fairly reliable six -week lead time. The cost of placing an orderwith the machine shop is only about $15, and currently NorthcuttBikes orders 850 parts at a time. Northcutt Bikes buys the item for$10.75.

Following is the demand information that Art gave to Mike on hisfirst day for the FB378 and the GS131:

	FB378			GS131
			Actual		Actual
Week	Forecast	Demand		Forecast	Demand
1	30		34
2	32		44
3	35		33
4	34		39
5	35		48
6	38		30
7	36		26
8	33		45
9	37		33
10	37		30
11	36		47	10	16
12	37		40	18	27
13	38		31	30	35
14	36		38	42	52
15	36		32	55	51
16	35		49	54	44
17	37		24	52	57
18	35		41	53	59
19	37		34	53	46
20	36		24	52	62
21	34		52	53	51
22	36		41	53	60
23	37		30	54	46
24	36		37	53	58
25	36		31	54	42
26	35		45	53	57
27	36			53

Mike realized he also needed input from Ann about herperspective on the business. She indicated that she felt stronglythat with better management, Northcutt Bikes should be able to usethe existing warehouse for years to come, even with the anticipatedgrowth in business. Currently, however, she views the situation asa crisis because “we’re bursting at the seams with inventory. It’scosting us a lot of profit, yet our service level is very poor, atless than 80%. I’d like to see us maintain a 95% or better servicelevel without back orders, yet we need to be able to do that with anet reduction in total inventory. What do you think, Mike? Can wedo better?”

Questions

1.Use the available data to develop inventory policies (orderquantities and reorder points) for the FB378 and GS131. Assume thatthe holding cost is 20% of unit price.

2.Compare the inventory costs associated with your suggestedorder quantities with those of the current order quantities. Whatcan you conclude?

3.Do you think the lost customer sales should be included as acost of inventory? How would such an inclusion impact the orderingpolicies you established in question 1?