Case Study HP DeskJet

Demand and Supply Analytics OPMN B8862

Group: Anis Bayoudhi (ab3580) Fares Belghith (fb2343) Iosif Faskiotis (if2193) Michael Konstantinidis (mk3343)

Introduction
In the year 1990, Brent Cartier, a manager in the Materials Department of HP Companys Vancouver Division, was faced with a paradoxical problem of stockout and high inventory levels occurring frequently with the HP DeskJets printers. In particular, Hewlett Packard had been experiencing problems with their inventory in Europe. While the new DeskJet printer had seen much success in the US market, HP could not solve the main issue of rising inventory levels, which closely matched sales. The European Distribution Centers (DCs) were facing stock-outs as well as high inventory levels due to discrepancies in demand between the different countries, each of which required a different SKU. Senior management had expressed its concerns about the current situation of high inventory levels and low customer fill rates and the company was facing the challenge of maintaining a high level of product availability while at the same time keeping low levels of inventory.

Drivers of Uncertainty
Inventory levels worldwide were rising and were closely matching sales. Such a close match between inventory and demand could lead to backorders at the DC level, in particular in the case where products were delayed during shipment. The challenge was for HP to limit the amount of inventory of DeskJet printers, while at the same time provide a high service level to their end users. The main drivers of uncertainty in their effort to do so were the following: 1. Fluctuating Demand Demand was difficult to predict, especially in Europe, where abrupt fluctuations were being monitored. As a result, it had become a common phenomenon for some countries to remain out of stock while others were experiencing increased inventory levels. The forecasting system obviously had to be strengthened. 2. High lead time and long shipment time for Europe and Asia (4-5 weeks) Product deliveries could take anywhere from 4-5 weeks to arrive at the appropriate DC in Europe or Asia. Furthermore, it is important to take note of the additional time required for the products as they go through customs processing. 3. Commoditization of printers and hence diminishing brand loyalty The printer market was expanding drastically. The low quality printers like dot matrix were getting outdated in favor of inkjet & laser printer. With increase in demand for computers, peripherals like printers were fast becoming commodity products. In the 1990s, the US market had reached maturity; however, in Eastern Europe and Asia the market was still developing. As more and more companies began offering inkjet printers, it became more difficult to compete. The consumers (both individuals and retailers) were mainly concerned with printers that were speedy, and had good print quality. Furthermore, their buying decisions were based on cost, reliability and availability. Resellers (small or large retailers) looked for the same things, while their main goal was to maintain low inventory at their facilities, while having enough product available to the consumers wishing to purchase them. Computer

dealers were no longer an important marketing channel. Therefore, it can be concluded that brand loyalty was consistently diminishing. This raised a significant point, because HP could no longer focus on targeting their long-standing customers. HP should adopt a way to deliver good quality, low cost printers, which would be available whenever the customers required it. Due to the decreasing brand loyalty among consumers, maintaining high availability rates was crucial to HPs success. 4. Inventory Carrying Cost It is important to take note of the problem of holding costs and product depreciation. As noted, the inventory carrying costs ranged between 12% - 60%. Considering that the company wished to maintain a 98% service level to their consumers, it was necessary to come up with an annual holding cost per unit figure as well as provide estimates for their ordering costs. This information would enable the company to calculate an appropriate Economic Order Quantity (EOQ). In addition, inventory depreciation is another problem that should be accounted for. Access inventory may lead to unnecessary products taking up valuable inventory space.

Other issues
1. Lack of Cohesiveness and Communication between divisions The inventory imbalance in Europe could be attributed to a poor internal communication network. There is no indication that sales information and targets were being transferred and it almost seems as if Vancouver was manufacturing what sold best in the US. At the same time, a lack of common supply chain metrics and organizational barriers can be identified. Although the overall performance of the entire supply chain depended on the joint performance of all the channel members, the objective of each member had little to do with the entire supply chains performance and there was no performance measure for the complete supply chain. 2. Rise of Models and Options HP at the time offered a significant number of models of the DeskJet printer. This complicated the manufacturing process. As can be seen in Exhibit 4 of the case, some of them represented a very small percentage of sales in their respective markets. This raises the question of whether or not they should be sold at the first place in every region. Indeed, to meet a good service level (for example 98%), each product should be carried in enough quantity, including some safety stocks. Those safety stocks added on with the product options and may not have been worth it if the annual sales (option A) were 508 units in Europe, while another product (option AB) accounted for 189,961 units. These products might be declared as obsolete and provide more space for the ones that were actually demanded by the customers. Such a move would also relieve the DCs of unnecessary holding costs. As we will see later, strategic considerations make this decision more complicated.

3. Uncoordinated functional interests It can be assumed that HPs marketing department was making concurrent efforts to increase consumer awareness and advertise the new DeskJet printer. As a result of these efforts, sales were expected to rise. It is unclear whether or not Vancouver had taken those sales into

consideration. An objectively optimal solution might not be applied, as it would not please all the parties involved in or influencing the decision-making process. Different departments or different areas might have different objectives and may even have been incentivized by contradictory KPIs in their remuneration. And that is where lies the true complexity of the work Brent had to deliver. Some parties just care about missed sales and therefore never see inventory as a cost. On the other hand, for example, the Vancouver manufacturing plant operated on a stockless inventory principle. They had been able to successfully adopt the JIT principle, which served well for their US DC. The target inventory equals the forecasted demand plus some safety stock (for all three DCs). However, Vancouvers stockless inventory principle was not well recognized at the European and Asian DCs, because it was their concern to have enough product availability. The problem was further escalated because it seems that management was not able to come to a consensus about the most appropriate inventory approach, which caused confusion and frustration. 4. Inefficient Shipping Method At the time, HP shipped the DeskJet printers via ocean. This method of shipment had proven to be unsuitable for the company, since the associated lead-time did not allow the demand in Europe and Asia to be met in a timely manner. 5. Product Localization This included the customization of the printer so that it would meet the language and power supply needs of the particular country. This process required much time and money, as additional models were being manufactured. For the time being, the design of the manufacturing process, though very efficient and geared for high production, did not allow for any product modification once printers were tested & ready to go. Therefore, there was no provision for rapid response to ever changing market scenarios. All these issues are a piece of the problem that Brent was facing. Moreover, if the solution he would provide seemed too complicated, it would be less likely to be accepted. That could decently cause sleeping problems.

Internally Proposed Solutions

In the highly competitive market in which HP is operating, the continued success of the DeskJet printer relied on their ability to cater to the demand. Internally proposed actions that would help the company maintain a minimum level of inventory while coping with the demand in the best possible way are given bellow. 1) Safety stock analysis The team led by Dr. Corrigton aimed at conducting a safety stock analysis with the existing forecasts and some gathered data. This method could indeed provide some results if safety stocks were actually determined with a rule of thumb. Forecasts obviously presented a problem of accuracy and had high standard deviation. However, the safety stock derived from calculations has only a square root dependency on the standard deviation of the demand. Therefore, it can still help get better and more controllable results, satisfying a given service

level. The advantage of this solution is that it could give a scientific approach to the inventory management that could also satisfy the advocates of more inventory provided there was a modus vivendi on the service level. However, this method alone might not provide the best results. Yet, a safety stock calculation is inevitable in order to present a serious analysis. 2) Improve Forecasting It was particularly challenging for HP to be able to accurately forecast demand, since the market in Europe had not reached maturity yet. However, it is clear that the DeskJet printer had potential for success, as had been demonstrated in the US. Judgment-based methods (that rely on management expertise) can be quite effective when management is making decisions about internal processes or operation changes within the company. By all means, the forecasting process should be dynamic. The case does not explain how the forecasting should be done. A variety of models could be used to better determine demand data. A model that could convey the growing trend and give more weight to more recent actual sales, such as simple or double exponential smoothing, was more likely to succeed. Moreover, the US and European markets could be assumed to be similar only with a different coefficient and at different periods of time. Therefore, the growth trend that had been seen in the US could be extrapolated to the European market if the marketing specialists failed to give any explanation why it would be different. 3) Air Shipping Although this method might seem more expensive than the currently used method of shipping by ocean, setting up a direct account with a reliable air freight company would enable HP to significantly reduce their lead time to approximately 2 - 3days. By adopting this alternative, HP could continue to operate on a JIT-based replenishment strategy, since it would not run the risk of having long lead times. This would enable the company to retain its customers for future demands and after sales and service, while at the same time building on its brand name and reputation. In addition, adopting this method could eliminate the need of opening a new plant. Moreover, demand forecast 5 to 6 weeks in advance is always less accurate than a week in advance because the longer the horizon, the less data are available. Therefore, not only the inventory would be carried on less time, but also a smaller safety stock would have to be carried (a standard deviation of about 25% of the mean - as forecasting data show it might be turned into 10% of the mean or less for lead times associated to air freight, if coupled with the proper dynamic forecasting). If shipping costs data were available, we could determine if airfreight would actually make more economic sense (in addition to the aforementioned considerations) than the sea freight, studying the sign of the following expression: (AirFreight - SeaFreight) - (SeaInventory-AirInventory). If the sign is negative, then, shifting to Airfreight would be more profitable for HP. 4) More inventory This is not actually a solution. Inventory costs money and there is indeed a trade-off between inventory and service. If the costs of inventory go beyond the additional marginal profit incurred by sales no longer missed, then it does not make sense to hold this inventory, except maybe for strategic reasons involving service rates. Nevertheless, 98% service level seems pretty reasonable. It could even be lowered for the unusual products. For those specific

products, backlogging could be encouraged, for example, since those specific customers (e.g those requesting an 110V printer in Europe) might be more willing to delay their purchase. 5) Open New Plant This is the most radical change, and would require a significant capital investment. The benefits of opening a new plant in Europe, however, would include lower lead times due to the proximity of the plant to its end users and lower demand uncertainty due to the fact that the factory could easily adjust its manufacturing capacity according to the fluctuations in demand. Moreover, shipping costs could be significantly reduced. Finally, with a thorough choice of location, the production costs could actually be reduced, using Eastern European qualified but cheap workers, since at the time the wall of Berlin had fallen1. However, only a thorough NPV analysis would allow us to make a rational arbitrage between these options.

Our approach
It is very important to give a structured methodology to tackle the different problems. There are quick wins that can easily be implemented in the short term. For the longer term, further analyses must be conducted in order to arbitrate between different options. The first thing to be done is a rationalization of the inventory management, using a safety stock methodology. A quick analysis of the case data can help us determine that. Then, a 3-step analysis can be conducted to determine the best response. Step1 Forecasting: Improve the forecasting model and make it dynamic. Single or double exponential smoothing could be good first guess to modelize the demand. To get the trend, regional historical data as well as data from more mature markets (e.g. US) could help forecast it to add accuracy to the forecast, assuming the behavior is similar but delayed in time. Freight: With the support of lead time data for air shipping as well as costs, find the break-even order quantity to be indifferent between Air Freight and Sea Freight. Assume that the standard deviation of demand is the same: rigorously, the order point for air shipping is closer to the delivery date and, consequently, the forecast horizon is smaller. Therefore, standard deviation and safety stock, and therefore carried inventory, would be smaller. We need to find the quantity Q to order such that: AirFreight(Q) SeaFreight(Q) - SeaInventory(Q) + AirInventory(Q) = 0. Considered costs can be broken down to: TotalCost = Transportation + Transit + PlantInv + WhseInv The last two terms are assumed here to be the same for Air Freight or Sea Freight.
1

The case assumes we are in 1990.

Transportation cost is equal to the freight rate multiplied by the quantity ordered. However, the rate is in general a concave (sub-linear) function of the weight, being itself a linear function of the quantity. We are going to consider that we calculate this for the whole year and that this is how the contract (for discounted freight unit prices) is set. We are therefore looking for the minimum annual quantity Q such that: ( ) ( ) ( ) , where h is the unit holding cost, are respectively the rate and lead times (in days) for method i. Assuming that the carrying cost is 35% (between 12 and 60%), that the difference in lead times is 28 days and that the unit value is $650 (knowing that the average unit price is $6672), the equation becomes (approximately): Find the minimum Q such that ( ) ( )

This means that if the annual quantity is such that the unit rate (not in pounds or kilograms but in number of printers) for air is more expensive than the unit rate for sea freight by more than $19, printers should keep being shipped by sea. If it is less, then, management should consider switching to air shipping. The analysis could be redone in another time horizon, where contracts matter for the single shipment that is processed with a single order. In this case, decision is contingent on the ordering policy. The latter shall be determined in a further step. Step2: Analyze the costs incurred by the following actions: Postpone the customization of European products and/or study the possibility of standardizing the products (for the manuals for example, it could be written in several languages). Use the safety stock analysis to determine the variables to be considered (since risk pooling might lead management to consider eliminating a few options that cannot be postponed). If the contract option for freight is per order and not annual, then, given the forecasts, analyze scenarios where management is willing to satisfy a fill rate of 98% (safety stock method, whose rationalization is aforementioned) and pick the cheapest one. Step3: Consider a scenario where a new plant would be built in Europe, potentially in Eastern Germany or stable Eastern European countries, in order to reduce costs. Make an NPV calculation on it (it is an accounting problem, but the discounting factor would also be between 12% and 60% following the carrying charge) on a 3-year perspective as for the printers demand forecast (the products are
2

600,000 units were sold for $400Millons revenue in 1990

likely to evolve fast and a larger horizon would be unjustifiable), although a terminal value should be given to the finished plant that might become a new hub for other HP products destined to the European market. Compare this NPV to the best option (derived from Steps 1 and 2) equivalent NPV for the same period and arbitrate. In case results are somehow neutral, strategic considerations (positioning of HP in Europe, interests of DCs, Vancouvers ones) should prevail.

Challenges to implementation
As mentioned earlier, the main challenge was political and the communication should really be thought through in order to please the different parties involved. Other challenges would be technical and related to human resources. Was HP able to improve significantly the forecasting system with its current human resources? Moreover, the upfront capital required for the construction of a new warehouse, if that solution were to be implemented, or for the implementation of any drastic change in the supply chain is always a big challenge. 1) Improve Internal Communications Part of the forecasting implementation process would require HP to make systems changes. Such a change could take the form of a modern Enterprise Resource Planning (ERP) system, which would enable HP to fuse together functions across the various divisions in the company, give better visibility to members across all channels - including external suppliers and, finally, provide a way to have more cohesiveness through different functions of the organization. ERP would enable HP to better access their inventory levels and would also help reduce uncertainty in demand by providing more accurate forecasts. This process would also allow HP to track deliveries, making the supply chain network more efficient. 2) Postponement No matter how advanced a forecasting system is, in rapidly changing markets, sales cannot be guaranteed only through inventory stocks. The product process should be designed in a way that could mitigate the impact of poor forecasting or completely unexpected events. In the case of HP, one of the biggest problems was the need to sell the products all over the world. Multiple "localized" versions of the DeskJet were being produced, including a specific power supply (110- or 220-volt), a power cord designed to fit the outlets in a given country, and a manual written in the right language. The DeskJet printer had been originally designed so that localization would be performed at a plant in the USA. Then the localized printers would be shipped around the world to various distribution centers (DC), where they would remain in inventory until sold. While it only took a few days to get the finished printers to the USA distribution center in California, it took approximately one month for the finished printers destined for Europe and Asia to be shipped and cleared through customs in their respective countries. If demand exceeded supply at the distribution center (DC), there were costly delays in getting the proper localized versions of the printer to the right place.

In order to overcome this obstacle and reduce costs while maintaining a wide variety of localized products to meet availability requirements, HP would have to design the product and realign the manufacturing and distribution activities in such a way that the customization step leading to product variation would occur at the most efficient point in the supply chain, giving the lowest supply chain cost. The solution to this problem is postponement. The Vancouver manufacturing plant should make and ship two kinds of DeskJet printers: a) Fully localized US product. b) A generic product without power supply module and manual for the European markets for further localization. The DC would then localize the generic product quickly based on specific demand requirements for each country. The DCs would be put in charge of adding the correct manual, power supply, and plug, rather than simply holding finished-goods inventory. This technique can be characterized as risk pooling. Such a move would drastically improve the response time, as the DCs would have stock of the generic product, which could be modified as the customer orders would come through. After implementing postponement, the DCs would have the ability to meet fluctuating demand for a variety of SKUs with no unusable surplus of the "wrong" printers and a much lower risk of shortage, because storing inventory of manuals, power supplies, and plugs would be much easier than storing large boxes of finished printers. This might mean holding high levels of inventory of localized components, but since these components are much less costly compared to the finished product, there would be a significant inventory holding cost reduction. Another benefit could also be a reduction in the delivery cost. The reason for that is that now the generic printer will be sent to the distribution center as a compact size, rather than a printer already in its retail box, having a much higher volume density than before. While the decision regarding the postponement strategy is of very strategic importance to the future growth of HP, there are still some negative remarks. The staff at the DCs would have to be trained to carry out these forms of localization, potentially increasing their payroll. At the same time, changing the existing design and the processes of the supply chain would entail big capital expenditures.

Conclusions
In order to remain competitive within the Inkjet printer market, HP must adopt changes to its inventory management system. The above-mentioned recommendations will help HP reduce inventory while maintaining a desired service level to their end users. The European market must be closely studied, as the company currently runs the risk of losing a huge market, which is still in its growing stage.