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Managing inventory at alko inc
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1
Operations Strategy
Case Study: Managing Inventory at ALKO Inc
Irawati Cipto – 1206186522
Dame Reiny Manalu - 1206185570 Ali Yudhi Hartanto - 1206185053
Azhar Harris – 1206185356
Magister Manajemen
Fakultas Ekonomi, Universitas Indonesia
Jakarta, 2013
2
Case Synopsis
ALKO began in 1943 in a garage workshop set up by John Williams at his
Cleveland home. In February 1948, he obtained a patent for one of his lighting
design for lighting fixtures. He decided to produce it in his workshop and tried
marketing it in the Cleveland area. The product sold well and by 1957, ALKO had
grown to a $3 million company. It’s lighting fixtures were well known for their
outstanding quality. By then, it sold a total of 5 products.
ALKO go public in 1963. Since then, ALKO has been very successful, and the
company has started distributing its products nationwide. As competition intensified
in the 1980s, ALKO introduced many new lighting fixture designs. Altough ALKO had
taken great care to ensure that product quality did not suffer, the company’s
profitability began to worsen. The problem was that margins had begun to shrink as
competition in the market intensified.
The board decided to reorganized starting at the top. Gary Fisher was hired to
reorganize and restructure the company in 1999. Fisher found a company teetering
on the edge. Fisher then analyzed that the key was in the operating performance.
Altough the company had always been outstanding at developing and producing new
products, it had historically ignored its distribution system. Fisher set up a task force
to review the company’s current distribution system.
Problems Identification
The problem identification for managing inventories at ALKO :
1) What is the annual inventory and distribution cost of the current distribution
system?
2) What are the savings that would result from following the task force
recommendation and setting up an NDC? Evaluate the savings as the
correlation coefficient of demand in any pair of regions varies from 0 to 0.5 to
1.0. Do you recommend setting up a NDC?
3) Suggest other options that Fisher should consider. Evaluate each option and
recommend a distribution system for ALKO that would be most profitable
3
Theory
Inventory is the stock of any item or resource used in an organization. An
inventory system is a set of policies and procedures that determines what inventory
levels should be maintained, when stock should be replenished and how large
orders should be.
Managing inventory types include :
a. Raw materials
b. Work in process inventory (include componet parts)
c. Finished products inventory
Inventory is created when supply exceeds the demand. The purpose of
holding inventory is to achieve economies of scale, protect suppliers from stockout
due to uneven and uncertain demand, and shelter demand variation during leadtime.
Inventory:
a. Cycle Inventory
Cycle inventory is the inventory that accrues in the supply chain as the result
of purchasing or producing larger lots than currently demanded by customers.
b. Safety Inventory
Safety inventory is created to protect against fluctuations and uncertainty in
demand, supply, and lead time. There are two major sources of uncertainty :
quantity and timing
c. Seasonal Inventory
When demand is seasonal, seasonal inventory is created to absorb uneven
rates of demand. d. In Transit Inventory
In transit inventory is a function of demand during lead time. In transit
inventory provides a safeguard during supply delivery time.
Inventory Costs:
Inventory is used to improve customer Service Level. Money invested in inventory is
an opportunity cost to company and its supply chain. The supply chain manager
needs to balance the advantage and disadvantage of both low and high inventory.
There are two major costs associated with inventory. One is holding cost and the
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other is ordering or set up cost. The primary reason for keeping inventory low is due
to the cost of holding inventory. Money invested in inventory cannot be used for
other investment. The primary reason for keeping inventory high is due to the cost of
replenishing inventory. Ordering cost or set up cost are the two major costs.
a. Managing Inventory Cost Economic Order Quantity (EOQ)
EOQ is to minimize total annual ordering cost and inventory holding cost through
ordering an optimal lot size and achieve economies of scale. The EOQ is found
by determined the minimum cost point. Making holding cost equals ordering cost
will give the optimal quantity.
SQDHQ
=2
Economic Order Quantity (EOQ) = HDS2
Q = order quantity
D = annual demand
S = cost to place an order or set up cost in manufacturing/per order
H = annual holding cost per unit
Inventory Replenishment – Reorder Point System
Reorder point system which is also known as Continuous Review System is an
inventory policy that tracks inventory position. Whenever inventory level reaches
the reorder point, an order is placed to replenish inventory. The reorder point has
two components :
(1) average demand during leadtime
(2) safety stock
Inventory Replenishment – Periodic Review System
Periodic review system is to review inventory position in a fixed time interval. The
inventory system simplifies delivery schedule because it follows a routine
replenishing cycle. A periodic review system also has two components :
5
(1) average demand during lead time plus fixed time interval
(2) safety stock
b. Improving Customer Service Level – Managing Safety Stock
There are two reasons to keep safety stock. The first reason for keeping safety
stock is to protect against demand variation. Safety stock is related to forecasting
error in demand. The second reason for keeping safety stock is to protect against
time and quantity variation from the supply side.
Case Analysis
The current distribution system at Alco :
• All production occured at 3 facilities located in the Cleveland area.
• The plants scheduled production based on DC order.
• Orders were transported from plants to the DCs in TL quantities because
order sizes tended to be large. In 1999, TL costs from the plants to DCs
averaged $0.09 per unit.
• Customer placed orders with the DCs.
• Shipment from DC to customers were LTL. LTL shipping costs from DC to
customer averaged $0.10 per unit.
• DC ordered using a periodic review policy with a reorder interval of 6 days.
• Lead time 5 days between the time a DC placed an order with a plant and the
time the order was delivered from the plant.
• Holding cost $0.15 per unit per day.
• All DCs carried safety inventories to ensure a CSL of 95%.
Alternative Distibution System for Alco :
• ALKO closed its current 5 DC.
• ALKO build a National Distribution Center (NDC) outside Chicago.
• Costs from Plant to NDC $0.05 per unit.
• Shipment cost from NDC to customer $ 0.24 per unit.
• Total replenishment for NDC still five days.
• The CLS out of NDC still continued 95%.
6
Solutions:
Summary of investment and annual cost for various options
Option Investment Annual Cost Savings from Base Case Rate of return NPV(10% )Decentralize all parts in five warehouses Base Case 960,326$ Centralize all parts at NDC 850,000$ 755,164$ 205,162$ 24.1% 1,406,777$ Centralize parts 3, 7, decentralize part 1 650,000$ 765,064$ 195,262$ 30.0% 1,497,884$
v From the demand data and given data for the current distribution system, we can
calculate annual inventory and distribution cost of the current distribution system.
The worksheet for annual inventory and distribution cost is in Appendix. After we
calculate, the annual inventory and distribution cost for current distribution system
is $960.326 (see exhibit 1)
v Then we calculate the cost for NDC. After we calculate, the cost for centralized all
parts at NDC is $755.164. So we can have saving $205.162 compare with base
cost DC (see exhibit 2).
v Another option is proposed, Centralize parts 3, 7, decentralize part 1. Total cost =
$765.064. Saving from base cost DC = $960.326 - $765.064 = $ 195.262 (see
exhibit 3).
Conclusion and Recommendation
Conclusion:
Ø Inventory is strategic importance to Supply Chain Management.
Ø Inventory is created when supply exceeds the demand. The purpose of holding
inventory is to achieve economies of scale, protect suppliers from stockout due to
uneven and uncertain demand, and shelter demand variation during leadtime.
Ø The supply chain manager needs to balance the advantage and disadvantage of
both low and high inventory. The primary reason for keeping inventory low is due
to the cost of holding inventory. Money invested in inventory cannot be used for
other investment. The primary reason for keeping inventory high is due to the
cost of replenishing inventory.
7
Ø In order to managing inventory cost, there are several ways : EOQ, Inventory
Replenishment – Reorder point system, Inventory Replenishment – periodic
review system.
Ø There are two reasons to keep safety stock. The first reason for keeping safety
stock is to protect against demand variation. Safety stock is related to forecasting
error in demand. The second reason for keeping safety stock is to protect against
time and quantity variation from the supply side.
Ø ALKO should review its current distribution system in order to reduce cost but still
maintain the CSL of 95%.
Recommendation:
Ø After analyzed the calculation for current distribution system, we recommend
ALKO to build a National Distribution Center (NDC). If we compare the cost from
current distribution system and proposal for build NDC, we can conclude that
NDC will reduce the cost of distribution system for ALKO. Ø ALKO can also make several options to reduce cost of distribution system such
as combine : centralize parts 3, 7, decentralize part 1. But however this cost for
centralize and decentralize decision still higher than centralize all parts at NDC.
Refferences:
1. Chopra, S. & Meindl, P. (2007). Supply Chain Management: Strategy, Planning & Operations, 3rd Edition, New Jersey: Pearson Prentice Hall
2. Li, L. (2007). Supply Chain Management: Concepts, Techniques & Practices,
Singapore: World Scientific Publishing Co
8
Appendix
Exhibit 1. The annual inventory and distribution cost of the current distribution system
InputsHolding cost, H = 0.15$ per unit and dayTL costs from plants to DCs = 0.09$ per unitLTL costs from DC to customers = 0.10$ per unitTL costs from plants to central whse. = 0.05$ per unitLTL cost from central whse. to cust. = 0.24$ per unitReorder Interval, T = 6 daysLead Time, L = 5 daysTarget cycle service level, CSL = 0.95Correlation Coefficient = 0
Demand data by part and region # of parts Region 1 Region 2 Region 3 Region 4 Region 5 All Regions
Part 1 Mean, R 10 35.48 22.61 17.66 11.81 3.36 90.92Part 1 SD 6.98 6.48 5.26 3.48 4.49 NAPart 3 Mean 20 2.48 4.15 6.15 6.16 7.49 26.43Part 3 SD 3.16 6.20 6.39 6.76 3.56 NAPart 7 Mean 70 0.48 0.73 0.80 1.94 2.54 6.49Part 7 SD 1.98 1.42 2.39 3.76 3.98 NA
Coefficient of variation by part and regionRegion 1 Region 2 Region 3 Region 4 Region 5 All Regions
Part 1 0.20 0.29 0.30 0.29 1.34 NAPart 3 1.27 1.49 1.04 1.10 0.48 NAPart 7 4.13 1.95 2.99 1.94 1.57 NA
Demand during reorder interval and replenishment lead timeRegion 1 Region 2 Region 3 Region 4 Region 5 All Regions
Part 1 Mean 390.28 248.71 194.26 129.91 36.96 1000.12Part 1 SD 23.15 21.49 17.45 11.54 14.89 NAPart 3 Mean 27.28 45.65 67.65 67.76 82.39 290.73Part 3 SD 10.48 20.56 21.19 22.42 11.81 NAPart 7 Mean 5.28 8.03 8.80 21.34 27.94 71.39Part 7 SD 6.57 4.71 7.93 12.47 13.20 NA
OutputsCycle stock and required safety stock by part and region
Region 1 Region 2 Region 3 Region 4 Region 5 All RegionsPart 1Cycle Inventory 106.44 67.83 52.98 35.43 10.08 272.76Part 1 SS 38.08 35.35 28.70 18.98 24.49 145.60Part 3 Cycle Inventory 7.44 12.45 18.45 18.48 22.47 79.29Part 3 SS 17.24 33.82 34.86 36.88 19.42 142.22Part 7 Cycle Inventory 1.44 2.19 2.40 5.82 7.62 19.47Part 7 SS 10.80 7.75 13.04 20.51 21.71 73.81
9
Costs per unit by region and partRegion 1 Region 2 Region 3 Region 4 Region 5 All Regions
Inventory cost 0.61$ 0.68$ 0.69$ 0.69$ 1.54$ 0.69$ Transportation cost 0.19$ 0.19$ 0.19$ 0.19$ 0.19$ 0.19$ Total cost part 1 0.80$ 0.87$ 0.88$ 0.88$ 1.73$ 0.88$ Inventory cost 1.49$ 1.67$ 1.30$ 1.35$ 0.84$ 1.26$ Transportation cost 0.19$ 0.19$ 0.19$ 0.19$ 0.19$ 0.19$ Total cost part 3 1.68$ 1.86$ 1.49$ 1.54$ 1.03$ 1.45$ Inventory cost 3.83$ 2.04$ 2.89$ 2.04$ 1.73$ 2.16$ Transportation cost 0.19$ 0.19$ 0.19$ 0.19$ 0.19$ 0.19$ Total cost part 7 4.02$ 2.23$ 3.08$ 2.23$ 1.92$ 2.35$
Total Annual Inventory and Distribution Cost # of parts Region 1 Region 2 Region 3 Region 4 Region 5 All Regions
Part 1 10 $103,729 $72,171 $56,964 $37,982 $21,260 $292,107Part 3 20 $30,463 $56,425 $66,904 $69,161 $56,259 $279,213Part 7 70 $49,246 $41,626 $63,051 $110,336 $124,747 $389,005All Parts $183,439 $170,223 $186,920 $217,479 $202,266 $960,326
10
Exhibit 2. The savings that would result from following the task force recommendation and setting up an NDC
InputsHolding cost, H = 0.15$ per unit and dayTL costs from plants to DCs = 0.09$ per unitLTL costs from DC to customers = 0.10$ per unitTL costs from plants to central whse. = 0.05$ per unitLTL cost from central whse. to cust. = 0.24$ per unitReorder Interval, T = 6.00$ daysLead Time, L = 5.00$ daysTarget cycle service level, CSL = 0.95$ Correlation Coefficient = -$
Demand data by part and region # of partsRegion 1 Region 2 Region 3 Region 4 Region 5 All Regions Central
Part 1 Mean # 35.48 22.61 17.66 11.81 3.36 90.92 90.91Part 1 SD 6.98 6.48 5.26 3.48 4.49 NA 12.27Part 3 Mean # 2.48 4.15 6.15 6.16 7.49 26.43 26.43Part 3 SD 3.16 6.20 6.39 6.76 3.56 NA 12.15Part 7 Mean # 0.48 0.73 0.80 1.94 2.54 6.49 6.49Part 7 SD 1.98 1.42 2.39 3.76 3.98 NA 6.45
Demand during reorder interval and replenishment lead timeRegion 1 Region 2 Region 3 Region 4 Region 5 All Regions Central
Part 1 Mean 390.28 248.71 194.26 129.91 36.96 1000.12 1000.01Part 1 SD 23.15 21.49 17.45 11.54 14.89 NA 40.71Part 3 Mean 27.28 45.65 67.65 67.76 82.39 290.73 290.73Part 3 SD 10.48 20.56 21.19 22.42 11.81 NA 40.30Part 7 Mean 5.28 8.03 8.80 21.34 27.94 71.39 71.39Part 7 SD 6.57 4.71 7.93 12.47 13.20 NA 21.40
OutputsCycle stock and required safety stock by part and region
Region 1 Region 2 Region 3 Region 4 Region 5 All Regions CentralPart 1Cycle Inventory 106.44 67.83 52.98 35.43 10.08 272.76 272.73Part 1 SS 38.08 35.35 28.70 18.98 24.49 145.60 66.96Part 3 Cycle Inventory 7.44 12.45 18.45 18.48 22.47 79.29 79.29Part 3 SS 17.24 33.82 34.86 36.88 19.42 142.22 66.28Part 7 Cycle Inventory 1.44 2.19 2.40 5.82 7.62 19.47 19.47Part 7 SS 10.80 7.75 13.04 20.51 21.71 73.81 35.20
Costs per unit by region and partRegion 1 Region 2 Region 3 Region 4 Region 5 All Regions Central
Inventory cost 0.61$ 0.68$ 0.69$ 0.69$ 1.54$ 0.69$ 0.56$ Transportation cost 0.19$ 0.19$ 0.19$ 0.19$ 0.19$ 0.19$ 0.29$ Total cost part 1 0.80$ 0.87$ 0.88$ 0.88$ 1.73$ 0.88$ 0.85$ Inventory cost 1.49$ 1.67$ 1.30$ 1.35$ 0.84$ 1.26$ 0.83$ Transportation cost 0.19$ 0.19$ 0.19$ 0.19$ 0.19$ 0.19$ 0.29$ Total cost part 3 1.68$ 1.86$ 1.49$ 1.54$ 1.03$ 1.45$ 1.12$ Inventory cost 3.83$ 2.04$ 2.89$ 2.04$ 1.73$ 2.16$ 1.26$ Transportation cost 0.19$ 0.19$ 0.19$ 0.19$ 0.19$ 0.19$ 0.29$ Total cost part 7 4.02$ 2.23$ 3.08$ 2.23$ 1.92$ 2.35$ 1.55$
11
Total Annual Inventory and Distribution Cost # of partsRegion 1 Region 2 Region 3 Region 4 Region 5 All Regions Central Savings
Part 1 $103,729 $72,171 $56,964 $37,982 $21,260 $292,107 $282,208 $9,899Part 3 $30,463 $56,425 $66,904 $69,161 $56,259 $279,213 $215,356 $63,857Part 7 $49,246 $41,626 $63,051 $110,336 $124,747 $389,005 $257,600 $131,405All Parts $183,439 $170,223 $186,920 $217,479 $202,266 $960,326 $755,164
Savings: $205,162
Cost Savings from Centralization as a function of the correlation coefficient and target cycle service level
All parts$205,162 0.00 0.25 0.50 0.75 1.00
0.9 $144,599 $74,213 $19,155 -$27,633 -$69,0350.91 $154,468 $80,830 $23,229 -$25,720 -$69,0350.92 $165,190 $88,019 $27,655 -$23,642 -$69,0350.93 $176,979 $95,924 $32,521 -$21,357 -$69,0350.94 $190,145 $104,752 $37,956 -$18,806 -$69,0350.95 $205,162 $114,821 $44,155 -$15,896 -$69,0350.96 $222,804 $126,651 $51,438 -$12,477 -$69,0350.97 $244,493 $141,194 $60,391 -$8,273 -$69,0350.98 $273,324 $160,526 $72,293 -$2,686 -$69,0350.99 $318,766 $190,996 $91,052 $6,121 -$69,035
Type 1 only$9,899 0.00 0.25 0.50 0.75 1.000.9 $389 -$10,751 -$19,388 -$26,701 -$33,1590.91 $1,939 -$9,716 -$18,752 -$26,403 -$33,1590.92 $3,622 -$8,591 -$18,061 -$26,079 -$33,1590.93 $5,474 -$7,355 -$17,301 -$25,722 -$33,1590.94 $7,541 -$5,974 -$16,453 -$25,324 -$33,1590.95 $9,899 -$4,399 -$15,485 -$24,871 -$33,1590.96 $12,670 -$2,548 -$14,348 -$24,337 -$33,1590.97 $16,076 -$273 -$12,950 -$23,682 -$33,1590.98 $20,603 $2,751 -$11,091 -$22,810 -$33,1590.99 $27,739 $7,517 -$8,162 -$21,437 -$33,159
Type 3 only$63,857 0.00 0.25 0.50 0.75 1.000.9 $45,492 $24,074 $7,384 -$6,776 -$19,2940.91 $48,484 $26,077 $8,616 -$6,197 -$19,2940.92 $51,736 $28,254 $9,955 -$5,569 -$19,2940.93 $55,311 $30,647 $11,427 -$4,878 -$19,2940.94 $59,304 $33,319 $13,071 -$4,107 -$19,2940.95 $63,857 $36,368 $14,947 -$3,227 -$19,2940.96 $69,207 $39,949 $17,150 -$2,193 -$19,2940.97 $75,785 $44,352 $19,858 -$922 -$19,2940.98 $84,528 $50,205 $23,458 $767 -$19,2940.99 $98,308 $59,429 $29,133 $3,430 -$19,294
Type 7 only$131,405 0.00 0.25 0.50 0.75 1.00
0.9 $98,719 $60,890 $31,159 $5,844 -$16,5820.91 $104,045 $64,469 $33,365 $6,880 -$16,5820.92 $109,832 $68,357 $35,761 $8,006 -$16,5820.93 $116,194 $72,632 $38,395 $9,243 -$16,5820.94 $123,300 $77,407 $41,338 $10,626 -$16,5820.95 $131,405 $82,852 $44,693 $12,202 -$16,5820.96 $140,927 $89,250 $48,636 $14,054 -$16,5820.97 $152,632 $97,115 $53,483 $16,331 -$16,5820.98 $168,193 $107,571 $59,926 $19,357 -$16,5820.99 $192,719 $124,050 $70,081 $24,128 -$16,582
Correlation Cofficient
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Ser
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elCorrelation Cofficiant
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Correlation Cofficient
Targ
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Correlation Cofficient
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12
Exhibit 3. Other option to be considered: building NDC while keeping the Regional DCs open
InputsHolding cost = 0.15$ per unit and dayTL costs from plants to DCs = 0.09$ per unitLTL costs from DC to customers = 0.10$ per unitTL costs from plants to central whse. = 0.05$ per unitLTL cost from central whse. to cust. = 0.24$ per unitReorder Interval = 6 daysLead Time = 5 daysTarget cycle service level = 0.95Correlation Coefficient = 0
Demand data by part and region # of partsRegion 1 Region 2 Region 3 Region 4 Region 5 All Regions
Part 1 Mean 10 35.48 22.61 17.66 11.81 3.36 90.92Part 1 SD 6.98 6.48 5.26 3.48 4.49 NAPart 3 Mean 20 2.48 4.15 6.15 6.16 7.49 26.43Part 3 SD 3.16 6.20 6.39 6.76 3.56 NAPart 7 Mean 70 0.48 0.73 0.80 1.94 2.54 6.49Part 7 SD 1.98 1.42 2.39 3.76 3.98 NA
Coefficient of variation by part and regionRegion 1 Region 2 Region 3 Region 4 Region 5 All Regions
Part 1 0.20 0.29 0.30 0.29 1.34 NAPart 3 1.27 1.49 1.04 1.10 0.48 NAPart 7 4.13 1.95 2.99 1.94 1.57 NA
Demand during reorder interval and replenishment lead timeRegion 1 Region 2 Region 3 Region 4 Region 5 Central
Part 1 Mean 390.28 248.71 194.26 129.91 36.96Part 1 SD 23.15 21.49 17.45 11.54 14.89Part 3 Mean 290.73Part 3 SD 40.30Part 7 Mean 71.39Part 7 SD 21.40
13
OutputsCycle stock and required safety stock by part and region
Region 1 Region 2 Region 3 Region 4 Region 5 CentralPart 1Cycle Stock 106.44 67.83 52.98 35.43 10.08Part 1 SS 38.08 35.35 28.70 18.98 24.49Part 3 Cycle Stock 79.29Part 3 SS 66.28Part 7 Cycle Stock 19.47Part 7 SS 35.20
Costs per unit by region and partRegion 1 Region 2 Region 3 Region 4 Region 5 Central
Inventory cost 0.61$ 0.68$ 0.69$ 0.69$ 1.54$ Transportation cost 0.19$ 0.19$ 0.19$ 0.19$ 0.19$ Total cost part 1 0.80$ 0.87$ 0.88$ 0.88$ 1.73$ Inventory cost 0.83$ Transportation cost 0.29$ Total cost part 3 1.12$ Inventory cost 1.26$ Transportation cost 0.29$ Total cost part 7 1.55$
Total Annual Inventory and Distribution Cost # of parts Region 1 Region 2 Region 3 Region 4 Region 5 Central
Part 1 10 $103,729 $72,171 $56,964 $37,982 $21,260 $0Part 3 20 $215,356Part 7 70 $257,600All Parts $103,729 $72,171 $56,964 $37,982 $21,260 $472,956
Total logistic system: $765,064Costs Savings
Benchmark: All parts in the field: $960,326 $195,262All partscentralized: $755,164 -$9,899
$765,064 0.00 0.25 0.50 0.75 1.000.9 $701,631 $760,877 $807,298 $846,772 $881,717
0.91 $711,968 $773,951 $822,516 $863,814 $900,3730.92 $723,197 $788,154 $839,049 $882,328 $920,6410.93 $735,545 $803,771 $857,228 $902,685 $942,9260.94 $749,335 $821,213 $877,530 $925,421 $967,8150.95 $765,064 $841,106 $900,686 $951,351 $996,2020.96 $783,542 $864,477 $927,890 $981,815 $1,029,5520.97 $806,259 $893,209 $961,335 $1,019,267 $1,070,5520.98 $836,457 $931,403 $1,005,794 $1,069,054 $1,125,0540.99 $884,053 $991,601 $1,075,866 $1,147,523 $1,210,956
Correlation Cofficient
Targ
et C
ycle
Ser
vice
Lev
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