SUPERCOFFEE: Reviewing the inventory management policy for coffee production

1. Context
Once Engineer Colombo achieved his MBA degree at Politecnico di Milano Graduate School of
Business in 2012, he was employed in SuperCoffee, a famous coffee producing company both for coffee
bars and households. During the first two weeks of work, Colombo began working in the production area
to learn the characteristics of the production & logistic process of the company and to reorganize (where
possible) the management procedures. In this way, as far as the many products packaged by SuperCoffee
are concerned, he learnt that the pod (compressed block of coffee) was the item of major increasing
demand. These pods were packaged on strips of paper and were used in espresso coffee machines in
households and offices alike. The Financial management considered that it was possible to achieve an
all-in yield of 20% before-tax on the pods market.
Up to that moment, however, the Sales management had not been able to exploit that potential because
there were not enough resources to hire expert salesmen and to build appropriate stocks of finished
products. Besides a turnover slightly less than 70 millions €, the last balance sheet showed that
SuperCoffee had reached its maximum credit worthiness and that the immobilize in stocks (see also
Table 1), reached the considerable amount of 10.5 millions €.
Table 1 Stocks allocation according to their typology (in millions €)
Finished product package
3.1
(inside the peripheral warehouses)
Finished product package
3.62
(inside the main warehouse)
Customs warehouse
3.46
(green coffee)
Materials for packaging and packing
0.31
(packages, tins, labels etc)
10.49

One of the most powerful way to build a leading business seemed to be through the reduction of final
product inventory. Therefore, after his first few days, Colombo began to face the problem by focusing
on the company’s procedures for production planning and controlling (PP&C) and for the management
of the unsold goods.
The PP&C system, created some years ago, concerns the packaging of a quantity equal to an economic
lot of a given product when the level of its corresponding inventory falls below the re-order point. This
crucial level corresponds to 3.5 times the average volume of sales per week, tracked on a 12-month
period. Colombo had feelings that this lots needed to be reviewed in order to take into account

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characteristics of the demand and internal cost structure. So, while updating the informative system data,
it seemed necessary to find some ways to cut down costs and reduce the huge volume stocks.

2. Products lines and factory lay-out

During his first two weeks at SuperCoffee, Colombo found out that the company produced and traded a
whole line of coffee; the in-house production consisted of 158 products. They varied in blends, roasting
temperature, processed in beans or grinded, many labels packages for domestic and international markets,
multiple formats (2.5 kg for bars, 0.25 and 0.15 kg for households and pods) and different packages (6,
12 and 24 tins). The 158 products can be grouped in 5 families: Strong, Extra, Aroma, Napoli and
America.
The majority of the space available in the factory was used as warehouse containing finished products,
ready for sale. This area was wide enough to sustain a considerable expansion of the activity volume. As
a matter of fact, only 50% of the room available was filled with products. Beside the areas for packaged
product storage, there was a warehouse for materials and an area for roasting machines and packaging
machines. Moreover, the company had customs warehouses in harbour areas for use, where the green
coffee imported by overseas countries was stocked. Due to law constraints, all the imported coffee has
to enter into the plant through the customs warehouses and is subject to duties and specific taxes, which
are called excise taxes.

3. Production process
In order to fulfil his commitment, Colombo began studying in-depth the production process and analysing
the costs related to his management.
The whole production process takes place in-house (excluding the treatment for decaffeinated products)
supervised by two employees who have been responsible for the process for 20 years: a chemist and an
engineer. Their annual salary amounted to 230,000 €.
The transformation process is divided into three macro-phases: A) moving green coffee from the customs
warehouse and blending; B) roasting; C) packaging, which is divided into two lines: one for pods and
the other one for different format tins.

A) Moving green coffee from the customs warehouse and blending

Green coffee was bought in bags or containers, separated by quality, and placed in the customs
warehouse. Periodically, the chemist and the engineer collect the required blends from the customs
warehouse (in this way the company is obliged to pay duties and excise taxes), and they bring the coffee
in the storage bin. They usually move the green coffee with delay, from the customs warehouse up to the
launch of a batch on the packaging line in order to prevent taxes and duties from occurring too early.
Therefore, the time in between the moving of raw product from the customs warehouse and the delivery
of the finished product to the warehouse is no more than a week (in this case the settling takes place in
tins and not in storage bins). In general, charges are represented by duties, which are paid at the moment

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of moving, and excise taxes that are paid when the product is sold. As a matter of fact, SuperCoffee
benefits from a special term because it is located into a region that has been granted special status. As
well as these taxes, when sold, the VAT accrues and it is paid monthly.
The blending consists of collecting predefined quantities of different green coffee qualities from a storage
bin divided up into several independent parts, and blending them into a feed hopper after an electronic
check on the beans integrity. This process aims to obtain specific blends, with different sizes.

B) Roasting
After blending, green coffee is roasted. Numerically controlled machines lead this phase. These
machines are fed by the blending storage bins, the roasting process is organized in fixed quantities called
batches, depending on different acidity level responsible for the aromatic characteristics of the coffee.
The analysis laboratory and the expertise of some tasters carry out a check by means of specific tests,
before sending the roasted coffee to the storage bins used for feeding the packaging line.

C) Packaging in tins
Packaging is organized in a completely automated process, which is fed by storage bins. It consists of a
conveyor belt and a series of machines for grinding roasted coffee (except production of beans), filling
the tins – different in size – creating a vacuum and pouring in inert gases, sealing the cap, applying the
aroma-preserving agents and its label. At the end of the process, there is a pack-filler for packing and
packaging. The process takes place two working days out of three; the production capacity, set in
expectation of a rapid growth in business volume, is higher than the current level of sales. The chemist
and the engineer carry out, on their own, all the preliminary operations before the launch of lots of tins
to fill, including the regulation of the machine for each combination of the tin size and label. After this
step, 5 employees, members of a co-operative help them. They work part-time and earn 25 € per hour.
The chemist and the engineer also check that the process works correctly, whereas the other 5 people
deal with the packing phase, putting bar-codes provided with useful information for large scale
distribution and put packages in piles on pallets to bring them to the finished product warehouses. The
experts are paid as soon as each specific batch packaging is completed.

4. Planning system based on the EOQ-ROP model

Colombo was convinced that the planning system should manage finished product inventory using the
EOQ – ROP model.
So, in order to calculate the economic lot and the reorder point for each one of the 158 packaged products
of SuperCoffee, Colombo start collecting information about the different variables. In his mind, the new
inventory management model should have been expressed in packages and calculated as follows:

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 2 ⋅ D ⋅ Co 3.5
Economic lot = Reorder point = ⋅D (1)
V ⋅i ; 52
(in packages) (in packages)

Where the following items should be included:

− D represents the annual demand, i.e. the demand for each product for 12 months, expressed in
tins packages.
− Co represents the preparation costs for each lot of tins (of a specific product), i.e. the sum of the
preparation costs of blending, of the costs related to the change of tin size, of the costs related to
the change of the label and of the costs related to order issue.
1. The blending preparation costs represent the actual staff cost for the blending phase; they
vary for each single product, depend on the chemist and the engineer salary and related to
the working time for finishing both blending and roasting processes. They are 11.5 €/unit
for Strong, 10.8 for Extra, 32.4 for Aroma, 26.2 for Napoli and 23.3 for America..
2. The costs for changing the size of tins represents the average staff costs to set-up the
process while changing the different volumes of tins; these costs are equal to the overall
set up of the machinery, divided by the average number of products of the same size,
processed on the line between a change and the other following one. Costs depend on the
chemist and the engineer annual salaries and on that they spend a whole day to set up
everything in order to change the format. On average, SuperCoffee’s packaging line
worked 170 days per year; they set the machinery nearly 35 times per year because of the
format changes. Between two changes, they dealt with nearly 10 different products for
the same volume size tins. In this way, they obtained nearly 350 different batches of coffee
and format per year. The costs of format change are calculated using the constant measure
of 85 € for all the 158 products, dividing the chemist and the engineer annual salary
(230,000 €) by the annual working days (260 days per year). Then, they share the result
over the 10 different products, of the same format, with the same launch of format.
3. The costs for changing the label represent the average staff costs to set the labelling
machine in case of label change; they are calculated with the constant measure of 117.8 €
for all the 158 products. The costs for changing the label depend on the average down
(set-up) time of the line to switch from one label to another, for tins of a given volume.
This time is equal to 30 minutes, where 20 minutes are used to set up the labelling machine
and 10 to reach the machine’s regular working, by eliminating the errors linked to the
change of the label. Since the cooperative’s workers do not have anything to do during
this step, the 30 minutes cost of break depends both on the 5 worker’s hourly rate and on
the chemist and the engineer annual salary.
4. The costs of order issue represent the average costs of administrative staff to issue the
order for filling a lot of tins. They are calculated with the constant measure of 514.3 € for
all the 158 products. The costs of order issue depend on two employees’ annual salary

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 (i.e. 180,000 €), divided by the total number of lots per year (350) and which vary for
product and tin format. The two employees have to comply with book-keeping fulfilments
concerning duties, with federal and national taxes and with other administrative activities
to run the company.
− V represents the unitary cost of production, i.e. the unitary cost of a package of tins after
packaging and packing, which is the sum of the costs of materials, of the costs of direct labour,
of the general variable costs, of the amount of general and fixed costs, of the duties and of the
excise taxes.
The costs of materials are referred to green coffee, tins, caps, aroma fixing agents, gas, label, package
materials costs. The costs of labour are referred to part-time worker costs per package, in the packaging
line; they are calculated with the standard measure of 1 € for all the 158 products. The general variable
costs are the sum of all the direct costs (excluding materials and labour) regarding a package of tins
production; they are also calculated with the standard measure of 5 € for all the 158 products. The amount
of general and fixed costs consists of the company’s general and annual fixed costs divided by the number
of packages sold during the year; this is equal to 13.1 € per package for all the 158 products. The duties
and excise taxes are actually the levy tax on imported green coffee. It varies according to the specific
coffee quality.
SuperCoffee used a form called ‘cost and price analysis’ to define the wholesale price of a package of
product. This price is equal to a unitary full cost, involving all the direct costs for the production and sale
of a given product and a quota of fixed total costs of the company (see also Table 2).

Table 2 Cost and price analysis of product (€ per package)

Strong Extra Aroma Napoli America

Wholesale price 339.90 339.90 473.90 398.70 373.90
Green coffee blend 244.20 245.60 308.90 284.20 261.20
Materials for packing 12.70 12.70 12.70 12.70 12.70
Direct labour 1.00 1.00 1.00 1.00 1.00
Duties 9.77 9.83 12.75 11.10 10.38
Excise taxes 7.33 7.37 9.35 8.40 7.82
General variable costs 5.00 5.00 5.00 5.00 5.00
General fixed costs 13.10 13.10 13.10 13.10 13.10

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 − finally, i represents the annual stock holding rate i.e. the quota value embedded into stocks (equal
to the production cost) which represents the annual stock holding costs (sum of the capital cost
and of the other holding costs). The only significant component about stock holding costs is given
by the capital cost, equal to the 9%, and defined according to the interest rate on the loan received
by SuperCoffee. The other costs (obsolescence, drops, insurance, etc.) of the stock holding costs
were quite low and amounted to 2.5% all-in.

5. Revising the planning system

Colombo decided first to correct the data regarding the economic lot and reorder point of the products
which had to be packaged during the next cycle (see table 3). As a consequence, he made use of the ‘cost
and price analysis’, the original calculations concerning the system of stock management and the real
demand data of the last year (see also table 4 and 5).

Table 3 Detail of the next production cycle (starting 20th June)

Number of
Number of Product
available
packages to th
produce (2.5 kg size) packages at 20
June
1,000 Strong 144
600 Extra 55
60 Aroma 54
120 Napoli 301
50 America 45

After calculating lots and reorder points, once again, in order to check the sensitive variation in demand
between the moment of the first draft of the procedure and the current situation, Colombo focused on the
chemist and the engineer ways to program the packaging line. He learnt that the production need
depended on the warehouse informative system, since it used to show the under-stock articles every week
(code package) as compared to the 3.5 weeks forecast margin. Since the chemist and the engineer took
two days to arrange all the machinery settings, each production schedule consisted of only one format.
They put all the kind of coffee together according to their tin format, in order to separate them by blend
and label. This is the reason why, as far as the weekly planning is concerned, they added the codes of
packages that needed to be reordered to the weekly plan while under-stock products of other formats
were delayed until the following cycle, hoping that stocks did not come to an end too early, with the aim
of covering the 3.5 weeks.

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 Despite planning by format, the process required other micro settings, in order to take into account the
change of blend and label: on average, the chemist and the engineering estimated that changing blend
took an 8 minutes set up, when they also removed tins with hybrid blends. To change the pack of labels
in the labelling machine took nearly 20 minutes unless the labels format was the same. In this case it only
takes 3 minutes.

Table 4 Summary of monthly sales (packages) for the last year and the current one (Cur)

Strong Extra Aroma Napoli America

Last Cur Last Cur Last Cur Last Cur Last Cur
Feb 128 210 51 166 79 82 163 177 10 11
Mar 136 303 52 142 82 68 180 163 34 28
Apr 233 275 74 133 151 66 198 162 44 61
May 219 463 157 213 66 38 183 256 26 55
June 284 150 127 217 33
July 343 257 96 207 35
Aug 368 179 85 186 51
Sep 230 83 61 171 16
Oct 162 72 67 205 15
Nov 246 89 103 266 26
Dec 252 181 131 257 43
Jan 114 42 39 654 22
Total 2,715 1,387 1,087 2,887 355

In the end, Colombo realized that, actually, the chemist and the engineer tried to put articles together in
order to reach a 4 weeks cycle. This step sometimes took them away from predefined economic batches.
As a matter of fact, they tried to forecast demand for each one of the products for the time in between the
launch of one lot and the other one. They took into account the initial stock available and programmed a
number of packages in order to satisfy the demand up to the following launch established for the same
format. This method was not problem-free, but the practice showed that probably it was not possible to
do better than that.

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6. Improving raw materials inventory management
Once revised the reorder policy of final products, Colombo started to think about possible improvements
for the inventory of raw materials; last year, cost of raw materials were (roughly) 100.000.000 €, with
10.000.000 € of inventory value in the balance sheet, and there were evident space for improvements.
To produce coffee, several raw materials are needed:
• Coffee beans: Costa Rican, Guatemalan, Columbian
• Vanilla beans (for coffee flavouring): Madagascar Bourbon, Mexican, Indonesian, Tahitian
• Cocoa beans (for coffee flavouring): Criollo, Forastero, Trinitario
• Solvent (for smoothing caffeine effect): methylene chloride, ethyl acetate, dichloromethane
• Packaging: foil – lined bags, plastic film, aluminum foil, cans
• Glucose (for instant coffee): liquid, syrup

Extracting the value of inventory movements in the last year, Colombo get the following picture (Table
1):

Table 5 Detail of inventory in the last two years

Item Consumption (€) Average stock (€)

Costa Rican coffee Bean 7.280.000,00 € 218.400,00 €

Guatemalan coffee bean 14.880.000,00 € 1.785.600,00 €

Columbian coffee beans 19.400.000,00 € 1.940.000,00 €

Madagascar vanilla bean 3.990.000,00 € 339.150,00 €

Mexican vanilla bean 1.160.000,00 € 46.400,00 €

Indonesian vanilla bean 5.135.000,00 € 446.745,00 €

Tahitian vanilla bean 1.520.000,00 € 53.200,00 €

Criollo cocoa beans 600.000,00 € 222.000,00 €

Forastero cocoa beans 1.650.000,00 € 214.500,00 €

Trinitario cocoa beans 925.000,00 € 231.250,00 €

Methylene chloride 3.285.000,00 € 134.685,00 €

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 Ethyl acetate 3.565.000,00 € 142.600,00 €

Dichloromethane 3.360.000,00 € 739.200,00 €

Foil – lined bags 4.050.000,00 € 149.850,00 €

Aluminum foil 2.610.000,00 € 822.150,00 €

Plastic film 555.000,00 € 194.250,00 €

Cans 1.825.000,00 € 584.000,00 €

Liquid glucose 1.425.000,00 € 256.500,00 €

Syrup 7.085.000,00 € 921.050,00 €

Coffee beans safety stocks 13.600.000,00 € 340.000,00 €

Starting from these values, Colombo is interested in identifying which inventory areas should be attacked
first in order to obtain improvements in the short term.

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Questions for analysis
You are asked to support Colombo in his analysis.
In particular, you should:

• Describe the characteristics of the SuperCoffee Production system;

• Calculate the new Inventory values (Economic Order Quantity and Reorder Point) according to
the model Colombo wants to implement;
• Analyse the model that Colombo wants to adopt. Do you think it is correct (e.g. formula, items
included, calculation made…), or would you suggest some modifications?
• Analyse the raw materials inventory data. Are you able to give Colombo some inputs about how
prioritize intervention and where to act in inventory management review for next year?

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