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Logistic management Logistic management Document Transcript

  • IntroductionLogistics is concerned with getting the products and services where they are neededwhen they are desired. It is difficult to accomplish any marketing or manufacturingwithout logistical support. It involves the integration of information, transportation,inventory, warehousing, material handling, and packaging.The operating responsibility of logistics is the geographical repositioning of rawmaterials, work in process, and finished inventories where required at the lowest costpossibleThe formal definition of the word ‘logistics’ is: - it is the process of planning,implementing and controlling the efficient, effective flow and storage of goods,services and related information from the point of origin to the point ofconsumption for the purpose of conforming to customer requirements.Within the firm the challenge is to coordinate individual job expertise into an integratedcompetency focused on servicing customers. In most situations the desired scope ofsuch coordination transcends the individual enterprise, reaching out to includecustomers as well as material and service suppliers. Ina strategic sense, the seniorlogistics officer leads a boundary spanning initiative to facilitate effective supply chainrelationships. The excitement of contemporary logistics is found in making thecombined results of internal and external integration one of the core competencies of anenterprise. Throughout the history of mankind wars have been won and lost throughlogistical strengths and capabilities or the lack of them. Even though the generals of thepast have understood the critical role of logistics it only in the recent past that the bigorganizations have realized its role in the achievement of competitive advantage.Arth Shaw in 1915 pointed out that: the relations between the activities of demandcreation and physical supply… illustrate the existence of the 2 principles ofinterdependence and balance. Failure to co-ordinate any one of these activities with itsgroup-fellows and also with those in the other group, or undue emphasis or outlay putupon any one of these activities, it is certain to upset the equilibrium of forces whichmean efficient distribution. The physical distribution of the goods is a problem distinctfrom the creation of demand. There are many ways of defining logistics but theunderlying concept might be defined as follows: ‘Logistics is the process ofstrategically managing the procurement, movement and storage of materials, partsand finished inventory through the organization and its marketing channels insuch a way that current and future profitability are maximized through the cost-effective fulfillment of orders.’Competitive AdvantageEffective logistics management can provide a major source of competitive advantage.The bases for successes in the marketplace are numerous, but a simple model has beenbased around the three C’s – Customer, Company & Competitor. The source ofcompetitive advantage is found firstly in the ability of the organization to differentiateitself, in the eyes of the customer, from its competition and secondly by operating at alower cost and hence at greater profit. 1
  • Seeking a sustainable competitive advantage has become the concern of every managerwho realizes the marketplace and it is no longer acceptable to assume that the goodswill sell themselves. An elemental, commercial success is derived either form a costadvantage or a value advantage or, ideally both. The greater the profitability of thecompany the lesser is the production of cost. Also a value advantage gives the productan advantage over the competitive offerings. Successful companies either have aproductivity advantage or they have a value advantage or maybe a combination of thetwo.There are two main vectors of strategic direction that need to be examined: -♦ PRODUCTIVITY ADVANTAGEIn many industries there will be a competitor who will be a low cost producer and willhave greater sales volume in that sector. This is partly due to economies of scale, whichenable fixed costs to spread over a greater volume but more particularly to the impact ofthe experience curve.It is possible to identify and predict improvements in the rate of output of workers asthey become more skilled in the processes and tasks on which they work. BruceHenderson extended this concept by demonstrating that all costs, not just productioncosts, would decline at a given rate as volume increased. This cost decline applies onlyto value added, i.e. costs other than bought in supplies. Traditionally it has beensuggested that the main route to cost reduction was by gaining greater sales volume andthere can be no doubt about the close linkage between relative market share and relativecosts. However it must also be recognized that logistics management can provide amultitude of ways to increase efficiency and productivity and hence contributesignificantly to reduced unit costs.♦ VALUE ADVANTAGEIt is a cliché that customers don’t buy products they buy benefits. These benefits may beintangible i.e. they relate not to specific product features but to such things as image andreputation. Unless the product or service that we offer can be distinguished in some wayfrom its competitors there is a strong likelihood that the marketplace will view it as a‘commodity’ and so the sale will tend to go to the cheapest supplier. Valuedifferentiation can be gained in numerous ways. When a company scrutinizes marketsclosely it frequently finds that there are distinct value segments. In other words differentgroups of customers attach different levels of importance to different benefits. Theimportance of such benefit segmentation lies in the fact that often there are substantialopportunities for creating differentiated appeals for specific segments. Adding valuethrough differentiation is a powerful means of achieving a defensible advantage in themarket. Equally powerful as a means of adding value is service. Increasingly it is thecase that markets are becoming more service sensitive and this poses a challenge inmanagement of logistics. It is important to seek differentiation through means otherthan technology. A number of companies have responded to this by focusing uponservice as a means of gaining a competitive edge. Service in this context relates to theprocess of developing relationships with customers through the provision of an 2
  • augmented offer. This augmentation can take many forms including delivery service,after sales service, financial packages, technical support and so on.This matrix is a useful way of examining the options available for value andproductivity advantage: SERVICE COST & LEADER SERVICE LEADER COMMODITY COST MARKET LEADERIn commodity market situations where a company’s products are indistinguishable fromtheir competitors’ offerings the only strategy is to move towards being a cost leader ortowards being a service leader. Often the leadership route is not available. Thisparticularly will be the case in a mature market where substantial market share gains aredifficult to achieve.Cost leadership strategies have been based upon the economies of scale, gained throughgreater volume of sales. This is why market share is considered to be so important inmany industries. This cost advantage can be used strategically to assume a position ofprice leader and make it difficult for high cost competitors to survive. This costadvantage can come through effective logistics management. In many industrieslogistics cost represents such a large part of total costs that that it is possible to makemajor cost reductions through fundamentally reengineering logistics processes.The other way to come out of the commodity quadrant of the matrix is to seek a strategyof differentiation through service excellence. Customers ion all industries are seekinggreater responsiveness and reliability from suppliers; they are looking for reduced leadtimes, just-in-time delivery and value added services that help them do a better job ofserving their customers.GAINING COMPETITIVE ADVANTAGE THROUGH LOGISTICS A firm can gain competitive advantage only when it performs its strategicallyimportant activities (designing, producing, marketing delivering and supporting itsproduct) more cheaply or better than its competitors. Value chain activity disaggregates a firm into its strategically relevant activitiesin order to understand behavior of costs and existing and potential sources ofdifferentiation. They are further categorized into two types (i) Primary - inbound logistics, operation outbound logistics, marketing and sales, and service (ii) Support – infrastructure, human resource management, technology development and procurement 3
  • To gain competitive advantage over its rivals, a firm must deliver value to its customersthrough performing these activities more efficiently than its competitors or byperforming these activities in a unique way that creates greater differentiation.Logistics management has the potential to assist the firm in the achievement of both acost/productivity advantage and a value advantage. The under lying philosophy behindthe logistics concept is that of planning and coordinating the materials flow from sourceto user as an integrated system rather than, as was so often the case in the past,managing the goods flow as a series of independent activities. Thus under a logisticsmanagement regime the goal is to link the marketplace, the distribution network, themanufacturing process and the procurement activity in such a way that customers areservice at higher levels and yet at lower cost.THE MISSION OF LOGISTICS MANAGEMENTThe mission is to plan and coordinate all those activities necessary to achieve desiredlevels of delivered service and quality at lowest possible cost. Logistics must thereforebe seen as the link between the marketplace and the operating activity of the business.The scope of the logistics spans the organization, from the management of rawmaterials through to the delivery of the final product.Materials flow Suppliers Procurements Operations Distribution CustomersRequirements information flowREASONS FOR LOGISTICS TO EXISTLogistics management from this total system is the means whereby the needs ofcustomers are satisfied through the coordination of the materials and information flowsthat extend from the marketplace through the firm and its operations and beyond that tosupplies.For example for many years marketing and manufacturing have been seen as largelyseparate activities within the organization. At best they have coexisted, at worst therehas been open warfare. Manufacturing priorities and objectives have typically beenfocused on operating efficiency, achieved through long production runs, minimizedsetups, changeovers and product standardization. On the other hand marketing hassought to achieve competitive advantage through variety, high service levels andfrequent product changes.In today’s more turbulent environment there is no longer any possibility ofmanufacturing and marketing acting independently of each other. 4
  • It is now generally accepted that the need to understand and meet customer requirements is a prerequisite for survival. At the same time, in the search for improved cost competitiveness, manufacturing management has been the subject of massive renaissance. The last decade has seen the rapid introduction of flexible manufacturing systems, of new approaches to inventory based on materials requirement planning (MRP) and just in time (JIT) methods, a sustained emphasis on quality. Equally there has been a growing recognition of the critical role that procurement plays in creating and sustaining competitive advantage as part of an integrated logistics process. In this scheme of things, logistics is therefore essentially an integrative concept that seeks to develop a system wide view of the firm. It is fundamentally a planning concept that seeks to create a framework through which the needs of the manufacturing strategy and plan, which in turn links into a strategy and plan for procurement LOGISTICAL INTEGRATION Inventory FlowSuppliers Physical Manufacturing Procurement distribution support Customers Information Flow INTEGRATED LOGISTICS Logistics is viewed as the competency that links an enterprise with its customers and suppliers. Information from and about customers flows through the enterprise in the form of sales activity, forecasts and orders. As products and materials are procured, a value added inventory flow is initiated that ultimately results in ownership transfer of finished products to customers. Thus the process is viewed in terms of two inter-related efforts, inventory flow and information flow. Inventory Flow The management of logistics is concerned with the movement and storage of materials and finished products. Logistical operations start with the initial shipment of a material or component part from a supplier and are finalized when a manufactured or processed product is delivered to a customer. From the initial purchase of a material or component, the logistical process adds value By moving inventory when and where needed. Thus the material gains value at each step. 5
  • For a large manufacturer, logistical operations may consist of thousands of movements,which ultimately culminate in the delivery of the product to an industrial user,wholesaler, dealer or customer.Similarly for a retailer, logistical operations may commence with the procurement ofproducts for resale and may terminate with consumer pickup or delivery.The significant point is that regardless of the size or type of the enterprise, logistics isuseful and requires continuous management attention.In order to understand logistics it is useful to divide it into three areas.  Physical distribution  Manufacturing support  ProcurementPhysical distributionThe area of physical distribution concerns movement of a finished product to thecustomers. In physical distribution the customer is the final destination of the marketingchannel.Unless the products are delivered where and when needed, a great deal of marketingeffort can be wasted.All physical distribution systems have one feature in common: they link manufacturers,wholesalers and retailers and ensure that the product is available.Manufacturing supportThe area of manufacturing support concentrates on managing W.I.P inventory as itflows between the stages of manufacturing.A Master Production Schedule is prepared and arrangements are made for timelyavailability of materials, components, parts etc.Manufacturing support has one significant difference when compared with physicaldistribution.Physical distribution attempts to satisfy the needs of the customers while manufacturingsupport involves movement requirements that are under he control of the manufacturingenterprise.ProcurementProcurement is concerned with purchasing and arranging in-bound movement ofmaterials, parts and /or finished inventory from suppliers to manufacturing or assemblyplants, warehouses or retail stores.Procurement is also known as purchasing and buying and in some cases inboundlogistics. Procurement s concerned with availability of the desired material assortmentswhere and when needed.Within a typical enterprise, the three areas of logistics overlap. The prime concern of anintegrated logistical process is to coordinate overall value-added inventory movement.The three areas combine to provide integrated management of materials. 6
  • Information flowInformation flow identifies specific locations within a logistical system that haverequirements. Information also integrates the three operating areas. The primaryobjective of developing and specifying requirements is to plan and executeintegrated logistical operations. Within individual logistics areas, differentmovement requirements exist with respect to size of order, availability ofinventory, and urgency of movement. The primary objective of informationsharing is to reconcile these differences.Logistical information involves two major types of flows: 1. Coordination flows 2. Operation flows1. Planning and coordination flowsCoordination is the backbone of the overall information system. Coordinationresults in plans specifying:  Strategic objectives Strategic objectives detail the nature and location of customers, which are matched to the required products and services to be performed.  Capacity constraints Capacity constraints coordinate internal and external manufacturing requirements. Capacity constraints identify limitations, barriers, within basic manufacturing capabilities and determine appropriate outsource requirements.  Logistical requirements Logistics requirements specify the work that distribution facilities, equipment and labour must perform to implement the capacity plan.  Inventory deployments Inventory deployments are the interfaces between planning/coordination and operations that detail the timing and composition of where inventory will be positioned.  Manufacturing requirements Manufacturing plans are derived from logistical requirements and typically result in inventory deployment.  Procurements requirements 7
  • Procurements requirements schedule material and components for inbound shipment to support manufacturing requirements. In retailing and wholesaling situations, procurements involve manufacturing requirements.  Forecasting Forecasting utilizes historical data, current activity levels, and planning assumptions to predict future activity levels. Logistical forecasting is generally concerned with relatively short –term predictions. The overall purpose of information planning/coordination flow is to integrate specific activities within a firm and to facilitate overall integrated performance. 2. Operational flows The second aspect of information requirements is concerned with directing operations to receive, process, and ship inventory as required supporting customer and purchasing orders. Operational requirements deal with  Order management  Order processing  Distribution operations  Inventory management  Transportation and shipping  ProcurementDifferences between Supply chain management and Logistics management. 1. Supply chain management is a broader concept whereas Logistics management is a narrower concept. 2. The concept of Supply chain management is relatively new whereas the concept of Logistics management is relatively old. 3. Supply chain management is an extension of Logistics management. 4. Logistics management is primarily concerned with optimizing flows within the organization whilst supply chain management recognizes that internal integration by itself is not sufficient. 5. Logistics is essentially a planning orientation and framework that seeks to create a single plan for the flow of product and information through a business. Supply chain management builds upon this framework and seeks to achieve linkage and co-ordination between processes of the other entities in the pipeline, i.e. suppliers and customers, and the organization itself. 6. The focus of Supply chain management is upon the management of relationships in order to achieve a more profitable outcome for all parties in the chain where as the focus of Logistics management is upon the management of resources within the organization. 8
  • Traditional PerspectiveTraditionally most organizations have viewed themselves as entities that existindependently from others and indeed need to compete with them in order to survive.However such a philosophy can be self-defeating idf it leads to unwillingness tocorporate in order to compete. Behind this seemingly paradoxical concept is the idea ofsupply chain integration.Definition“Supply chain management is the management of upstream and downstreamrelationships with suppliers and customers to deliver superior customer value at lesscost to the supply chain as a whole.”ExplanationThe supply chain is the network of organizations that are involved through upstreamand downstream linkages, in the different processes and activities that produce value inthe form of products and services in the hands of ultimate consumer. Thus for examplea shirt manufacturer is a part of a supply chain that extends upstream through theweavers of fabrics to the manufacturers of fibres, and downstream through distributorsand retailers to the final consumer. Each of these organizations in the chain aredependent upon each other by definition and yet and yet paradoxically by tradition donot co-orporate with each other.Clearly this trend has many implications for logistics management, not the least beingthe challenge of integrating and coordinating the flow of materials from a multitude ofsuppliers, often offshore, and similarly managing the distribution of the finished productby way of multiple intermediaries.OriginIn the past it was often the case that relationships with suppliers and downstreamcustomers (such as distributors or retailers) were adversarial rather than co-operative. Itis still the case today that some companies will seek to achieve cost reductions or profitimprovements at the expense of their supply chain partners. Companies such as these donot realize that simply transferring costs upstream or downstream does not make themany more competitive. The reason for this is that ultimately all costs their way to thefinal marketplace to be reflected in the price paid by the end user. The leading- edgecompanies recognize the fallacy of this convectional approach and instead seek to makethe supply chain as a whole more competitive through the value it adds and the coststhat it reduces overall. They have not realized that the real competition is not companyagainst but rather supply chain against supply chain.Figure 1 suggests that there is in effect an evolution of integration from the stage 1position of complete isolation from the other business functions. An example would bewhere production or purchasing does their own thing in complete isolation from theother business functions. An example would be where production seeks to optimize itsunit costs of manufacture by long production runs without regard for the build-up of the 9
  • finished goods inventory and heedless of the impact it will have on the need forwarehousing space and the impact on working capital.Stage 2 companies have recognized the need for at least a limited degree of integrationbetween adjacent functions, e.g. distribution and inventory management or purchasingand materials control. The natural next step to stage 3 requires the establishment andimplementation of an ‘and-to-end’ planning framework that will be fully described laterin this book.Stage 4 represents true supply chain integration in that the concept of linkage and co-ordination that is achieved in stage 3 is now extended upstream to suppliers anddownstream to customers.Relationship buildingIt is apparent that supply chain management involves a significant change from thetraditional arm-length, even adversarial, relationships that so often typifiedbuyer/supplier relationships in the past. The focus of supply chain management is onco-operation and trust and the recognition that properly managed ‘the whole can begreater than sum of its part’s.Thus the focus of supply chain management is upon the management of relationships inorder to achieve a more profitable outcome for all parties in the chain. This brings withit some significant challenges since there may be occasions when the narrow self-interest of one of the parties has to be subsumed for the benefit of the chain as a whole.Whilst the phrase ‘supply chain management’ is now widely used, it could be arguedthat it should really be termed ‘demand chain management’ to reflect the fact that thechain should be driven by the market, not by suppliers. Equally the word ‘chain’ shouldbe replaced by ‘net work’ since there will normally be multiple suppliers and, indeed,suppliers to supplier as well as multiple customers and customers’ customers to beincluded in the total system.Figure 2 illustrates this idea of the firm being at the centre of a network of suppliers andcustomers.Extending this idea it has been suggested that a supply chain could more accurately bedefined as:“A network of connected and interdependent organizations mutually and co-operativelyworking together to control, manage and improve the flow of materials and informationfrom suppliers to end users.” Integrated log cycleNetwork design 10
  • Customer serviceSCM - Dist channelsSupply Network Management Or Demand Network ManagementThe Phrase ‘Supply Chain Management’ is widely used. It is a management ofupstream and downstream of relationships with suppliers and customers to deliversuperior customer value at less cost to the supply chain as a whole.So supply chain management focuses on the management of relationships in order toachieve a more profitable outcome for all parties in the chain. It is argued that it shouldreally be ‘Demand Chain Management’ as a chain should be driven by the market, andnot by suppliers. So also the word ‘chain’ should be replaced by ‘network’. Since therewill normally be multiple suppliers and, indeed, suppliers to suppliers as well asmultiple customers and customers’ customers to be included in the total system.S = Supplier; SS = Suppliers’ Supplier;C = Customer; CC = Customers’ Customer TRANSPORTATIONTransport FunctionalityTransportation is one of the most visible elements of logistics operations.Transportation provides 2 major functions: product movement & product storage.Product MovementWhether the product is in the form of materials, components, assemblies, work-in-process, or finished goods, transportation is necessary to move it to the next stage of themanufacturing process or physically closer to the ultimate consumer. A primarytransportation function of product movement is moving up and down the value chain.Since transportation utilizes temporal, financial, and environmental resources, it isimportant that items be moved only when it truly enhances the product value.Transportation involves the use of temporal resources because product is inaccessibleduring the transportation process. Such product, commonly referred to as in-transitinventory, is becoming a significant consideration as a variety of supply chain strategiessuch as just – in – time and quick response practices reduce manufacturing anddistribution center inventories.Transportation uses financial resources because internal expenditures are necessary forprivate fleets or external expenditures are required for commercial or publictransportation.Transportation uses environment resources both directly and indirectly.In direct terms, it is one of the largest consumers of energy (fuel and oil) in thedomestic United States economy. In fact, it accounts for close to 67% of all domestic oiluse. 11
  • Indirectly, transportation creates environmental expense through congestion, airpollution and noise pollution.The major objective is to move product from an origin location to a prescribeddestination while minimizing temporal, financial and environmental resource costs.Loss and damage expenses must also be minimized. At the same time the movementmust take place in such a manner that meets customer demands regarding deliveryperformance and shipment information availability.Product Storage:A less common transportation function is temporary storage. Vehicles make ratherexpensive storage facilities. However, if the in-transit product requires storage but willbe moved again shortly (e.g. in a few days), the cost of unloading and reloading theproduct in a warehouse may exceed the per-daily charge of storage in the transportationvehicle.In circumstances where warehouse space is limited, utilizing transportation vehiclesmay be a viable option.One method involves loading on the vehicle and then having it take an indirect route toits destination. This is desirable when the origin or destination warehouse has limitedstorage capacity.A second method to achieve temporary product storage is diversion. This occurs whenan original shipment destination is changed while the delivery is in transit.E.g. suppose a product is initially scheduled to be shipped from Chicago to LosAngeles. However, if during the delivery process, it is determined that San Francisco isin greater need of the product or has available storage capacity; the product could bedelivered to the alternative destination of San Francisco.In short, although product storage in transportation vehicles can be costly, it may bejustified from a total cost or performance perspective when loading or unloading costs,capacity constraints, or the ability to extend lead times are considered.PrinciplesThere are two fundamental principles guiding transportation management andoperations. They are economy of scale and economy of distance.Economy of scale refers to the characteristic that transportation cost per unit of weightdecreases when the size of the shipment increases.E.g. truckload shipments cost less per pound than less-than-truckload shipments. It isalso generally true that larger capacity transportation vehicles such as rail or water areless expensive per unit of weight than smaller capacity vehicles like motor or air.Transportation economies of scale exist because fixed expenses associated with movinga load can be spread over the load’s weight. The fixed expenses include administrativecosts of taking the order; time to position the vehicle for loading or unloading, invoicing 12
  • and equipment cost. These costs are fixed because they do not vary with shipmentvolume.E.g. suppose the cost to administer a shipment is $ 10.00. Then the 1-pound shipmenthas a per unit of weight cost of $10.00, while the 1,000 pound shipment has a per unitof weight cost of $0.01. Thus, it can be said that an economy of scale exists for the1000-pound shipment.Economy of distance refers to the characteristic that transportation cost per unit ofdistance decreases as distance increases.e.g. a shipment of 800 miles will cost less than two shipments (of the same combinedweight) of 400 miles. Transportation economy of distance is also referred to a setapering principle since rates or charges taper with distance. The rationale of distanceeconomies is similar to that for economies of scale.Longer distances allow the fixed expenses to be spread over more miles, resulting inlower overall per mile charge.These principles are important considerations when evaluating alternative transportationstrategies or operating practices. The objective is to maximize the size of the load andthe distance that is shipped while still meeting customer service expectations.Transport InfrastructureTransportation infrastructure consists of the rights-of-ways, vehicles, and carrierorganizations that offer transportation services on a for-hire or internal basis. The natureof the infrastructure also determines a variety of legal and economic characteristics foreach mode or multimodal system. A mode identifies the basic transportation method orform.Modal CharacteristicsRAIL NETWORKSince olden times, railroads have handled the largest number of ton-miles. As a result ofthe early establishment of a comprehensive rail network connecting almost all the citiesand towns, railways dominated the intercity freight tonnage till World War II and insome cases of Europe, Asia and Africa they even connected the countries. This earlysuperiority enabled railways to transport large shipments very economically.Railroads have come a long way, as we can see by just the US figures that 54.0% ofintercity transport in 1947 was by Railways, 39.2% in 1958, 36.4 % in 1980 and almost37% in 1992. The period from 1950-1970 saw a tremendous decline in use of railways.The capability to efficiently transport large tonnage over long distances is the mainreason railroads continue to handle significant intercity tonnage and revenue. Railroadoperations incur high fixed costs because of expensive equipment, right-of-way(railroads must maintain their own track), switching yards, and terminals. However, railexperiences relatively low operating costs. The replacement of steam by diesel powerreduced the railroads’ variable cost per ton-mile, and electrification offers potential for 13
  • more reductions. New labor agreements have reduced workforce requirements, furtherdecreasing variable costsThese days’ rail transport only focuses on transporting specific products, which arebest, suited to the requirement. Greatest railroad tonnage comes from raw materialextractive industries located at considerable distances. Despite problems, Rail fixed-variable costs are still superior for long distances. Railroads basically concentrate on thecontainer traffic and are becoming more responsive of the customer needs, emphasizingbulk industries and heavy manufacturing.They have expanded their intermodal operations through alliances and motor carrierownership. Railroads are even concentrating on development of special equipment.There are unit trains which are entire train carrying the same commodity, which arebulk products such as coal or grain. Unit trains are faster, less expensive to operate andquick as it can bypass rail yards and go direct to the product’s destination.There are also various different types, such as articulated cars for extended Rail chassis,double-stack railcars, have 2 levels of containers, thereby doubling the capacity of eachcar. It also reduces chances of damage because of their design. These technologies haveare being applied by railroads to reduce weight, increase carrying capacity, andfacilitate interchange.After a major decline till 1970, Railroads have emerged as a major mode of transportonce again since the early 80’s because of revitalization of rail network. Evidencesuggests that Rail network will be used extensively once again in the 1990’s and early21st century.MOTOR CARRIERSHighway transportation has increased rapidly since the end of World War II. This isbecause Motor carrier industry results from door-to-door operating flexibility and speedof intercity movement. They are even flexible because they can operate on each andevery kind of roadways.In comparison to railroads, motor carriers have relatively small fixed investments interminal facilities and operate on publicly maintained highways. Although the cost oflicense fees, user fees, and tolls are considerable, these expenses are directly related tothe number of over-the-road units and miles operated.The variable cost per mile for motor carriers is high because a separate power unit anddriver are required for each trailer or combination of tandem trailers. Laborrequirements are also high because of driver safety restrictions and the need forsubstantial dock labor. Motor carriers are best suited to handle small shipments movingshort distances.The characteristics of motor carriers favor manufacturing and distributive trades, shortdistances, and high-value products. Motor carriers have made significant inroads intorail traffic for medium and light manufacturing. This is also because of deliveryflexibility, tat they have captured a major chunk of the market. In short, the prospect formaintaining a stable market share in highway transport remains bright. 14
  • This industry even has a few problems, and one of the primary difficulties relate toincreasing cost to replace equipment, maintenance, driver wages, and platform and dockwages. Although accelerating, labor rates influence all modes of transport; motorcarriers are more labor-intensive, which causes higher wages to be a major concern.One more threat for hire-motor carrier industry is over-the-road transportation byshipper-owned trucks or by specialized carriers under contract to perform transportservices for shippers.Since 1980, the industry segments have become more definitive since deregulation, andinclude truckload (TL), less than truckload (LTL), and specialty carriers. TL segmentincludes loads over 15,000 pounds that generally do not require intermediate stops forconsolidation. LTL segment of the industry loads less than 15,000 pounds that generallyrequires stops at intermediate terminals for consolidation. Because of terminal costs andrelatively higher marketing expenses, LTL experiences a higher percentage of fixedcosts then TL.These characteristics have caused extensive industry consolidation, since deregulationhas resulted in small number of relatively large carriers worldwide.Specialty carriers include package haulers such as Federal Express and United ParcelService. These firms focus on specific requirements of the market or product. It is quiteapparent that highway transportation will continue to function as the backbone oflogistical operations for the foreseeable future.WATER TRANSPORTIt is the oldest mode of transportation. First it was the sailing vessels, which wasreplaced by steamboats in early 1800’s and by diesel power in the 1920’s.Domestic water transportation – involves the Great Lakes, canals, and navigable rivers.In every country, fewer system miles exist for inland water than any othertransportation mode. The main advantage of water transportation is the capacity to move extremely largeshipments. Water transport employs 2 types of vessels. Deep-water vessels, which aregenerally designed for Ocean and Great Lakes use, & are restricted to deep-water portsfor access. In contrast, diesel-towed barges, which generally operate on rivers andcanals, have considerably more flexibility.Water transport ranks between rail and motor carrier in the fixed cost aspect. Althoughwater carriers must develop and operate their own terminals, the right-of-way isdeveloped and maintained by the government and results in moderate fixed costs ascompared to railways and highways.The main disadvantage of water transport is the limited range of operation and speed.Unless the origin and destination are adjacent, supplement haul by rail or truck isrequired. The capability to carry very high cargo at an extremely low variable costplaces this mode of transport in demand when low freight rates are desired and speed oftransit is a secondary consideration. 15
  • But, water transport on the other hand isn’t all that flexible. Labour restrictions onloading and unloading at docks create operational problems and tend to reduce thepotential range of available traffic. Also, a highly competitive situation has developedbetween railroads and inland water carriers in areas where parallel routes exist.Great lakes are concentrating towards transportation of bulk products while Deep-watervessels transport a significant high volume of non-bulk items. Containerized cargofacilitates vessel loading and unloading and enhances intermodal capability byincreasing the efficiency of cargo transfer between highway, rail and water.Inland and great lakes will continue to be a viable option in future logistical systemswhile the slow passage of inland river transport can provide a form of warehousing intransit integrated into overall system design.PIPELINESSurprisingly, Pipelines are also one of the major form of transportation mediumthroughout the world. In 1989, in USA over 53% of all crude and petroleum ton-milemovements were through Pipelines.In addition to Petroleum, other important product transported by pipeline is the naturalgas. Pipelines are owned and operated privately in most of the countries and many gascompanies act as both gas distributors and contract transportation providers. Pipelinesare also utilized for transport of manufacturing chemicals, pulverized dry bulk materialssuch as cement, flour via hydraulic suspension, and sewage and water within cities andmunicipalities.Pipelines are very unique in nature compared to other types of transport, such as; theyoperate on 24-hour basis, seven days a week, and are limited by commodity changeoverand maintenance. Unlike other modes, there is no empty “Container” or “vehicle” thatmust be returned.Pipelines have highest fixed cost and lowest variable cost among transport modes. Highfixed costs result from right-of-way, construction and requirements for control stations,and pumping capacity. Since pipelines are not labour-intensive, the variable operatingcost is extremely low once the pipeline has been constructed. An obvious disadvantageof these pipelines is that they are not flexible and are limited with respect tocommodities that can be transported.Experiments regarding transport of solid products are still going on. Coal slurrypipelines are proving to be economical over long distances but it concernsenvironmentalists, as it requires massive quantities of water.AIR TRANSPORTAir transport is the newest and the least utilized mode of transport. Its major advantagebeing its speed, which is accompanied by high costs. A coast-to-coast shipment via airrequires only a few hours contrast to days taken by other mean of transportation. Thehigh cost of transport can be traded off for high speed, which allows other elements oflogistical design, such as warehousing, inventory to be reduced or eliminated. But still 16
  • air transport remains more of a potential opportunity than a reality because it is verymuch under utilized.The high cost of jet aircraft, coupled with erratic nature of freight demand, has limitedthe assignment of dedicated planes to all-freight operations. However premium carriersprovide planes dedicated for freight operations. This premium service started off withdocuments and has moved onto large parcels, which is an ideal service for firms with alarge number of high-value products and time-sensitive service requirements.The fixed cost of air transport is low as compared to rails, water and pipeline. In fact,air transport ranks second only to highway with respect to low fixed cost. Airways andairports are maintained by public funds and terminals are by local communities. Thefixed costs of airfreight are associated with aircraft purchase and the requirement forspecialized handling systems and cargo containers. But the air freight variable cost isextremely high as a result of fuel, maintenance, and labour intensity of both in-flightand ground crews.Since they require wide-open space, airports are generally not integrated with othermeans of transport. However more “all freight” airports are being developed so as toreduce conflict with passenger operations.No particular commodity dominates the traffic carried by airfreight operations. Theseoperations are carried more on emergency basis than routine basis. Firms usually utilizescheduled or non-scheduled air cargo movements when the situation justifies high cost.Products with greatest potential for regular air movements are those having high valueor extremely perishable. When the marketing period for an item is extremely limited, airtransport comes into the picture, as it may be the only practical method for logisticaloperations.Transportation Hidden CostsThe physical distribution component of a major project, including transportation of rawmaterials, project materials, machinery and equipment and such infrastructure facilitiesas roads, vehicles etc., usually accounts for 20 to 30% of the total capital cost.The general scarcity of various goods, unpredictable nature of the economy andeconomic behavior on the part of the business community and the bureaucracy in Indiamake it all the more necessary for one to plan well ahead. In fact, planning oftransportation and infrastructure must be done well ahead of general planning, so thatresources spent on other parts of the project do not result in in - fructuous expenditure.In developed countries, these facilities are already available in abundance or areprovided for well in advance. In developing countries, action is generally initiated onlyafter the project has been partially put through or when it becomes totally inescapable todo so.On the other hand, because of lack of these facilities, such problems are faced evenduring construction.Eg. Trucks get stuck in muddy roads, work sites remain unapproachable, and seriousvehicular accidents are caused near the project areas. 17
  • In developing countries, for the supervision of construction of a building, usually noqualified individual is appointed for the co ordination and planning of transportationinfrastructure, which forms a major fraction of the total cost of a project running intocrores.For a major project, the average total cost to the economy of a project costing Rs. 100crores which is delayed by one year from the date of targeted completion is 39% morethan the original budgeted cost on account of the following:1. The rate of interest on capital may be taken at nearly 12%.2. The profit on income per year about 12%3. The cost of depreciation on account of obsolescence or rusting without running of the plant at 5%.4. The cost of escalation of the project cost at 10%.The cost of delay in the completion of the project would therefore be roughly aboutRs.11 lakhs per day or Rs. 3.25 crores per month. It would be worthwhile to educatesenior executives to recognize these facts, for this aspect of the project is usuallyignored by project authorities.Project authorities do not hold themselves responsible for the transportation bottlenecksand resulting delays. These delays are due to non-receipt of equipment, machinery, rawmaterials etc. and these delays generally run into months. Due to such delays, theproject suffers heavy losses, which occur because of congestion in the ports, trafficjams, railway restrictions etc. Therefore, it is financially more practical to obtain criticalequipment, machinery and raw materials, critical not from the point of view ofavailability in the market but critical form the standpoint of transportation bottlenecks-so that the likely delays are avoided.A proper transportation planning of materials, therefore, may well save a project as wellas the economy form the ill effects of wasteful expenditure. At the same time it wouldhelp speed up production.Transportation Cost ElementsFollowing are the essential elements of transportation to be taken into account:1. Transport Mode – The most critical decision is the selection of appropriate modeof transport. This fixes two basic elements of distribution function:a) Transit time or time lapse between production and sale;b) Level of transportation costs.There is an inverse relationship between transit time and transport cost – the lower thetransit time, the higher the transport cost. However, a decision that takes into accountonly one cost factor cannot be justified. An evaluation of the effect of transit time onother costs must also be considered. Unsold production represents a high cost, and thelonger the transit time, the higher the level of unsold production.2. Inventory Costs – A first class service to clients often requires immediate delivery and, hence a higher level of inventory at the market centre. Economy, on the other hand, calls for minimum inventory. The level of output held in stock is dictated by- 18
  • a) Transit time: If the time lapse between production and sale is longer, the level of inventory becomes higher.b) Sales pattern: If the pattern of sales is erratic, higher inventory levels are caused.c) Production pattern: If the production pattern is erratic, higher inventory levels have to be maintained to prevent stock –outs.Assuming that the sales and production patterns are largely fixed, the importantvariable, which can influence stock, levels in transit time. As transit time is reduced, thelevel of static stock can be reduced with accompanying stock reduction.3. Transit Capital – Capital can be released by changing the proportion of the total output in transit. This can be done by adjusting the transit time. As transit time is reduced, the quantity of goods in transit can be decreased with an associated reduction in transit inventory costs. By realizing the capital cost of transit inventory and goods in transit, capital commitments can be reduced, and more capital can be available for other purposes.4. Obsolescence - When a slow or erratic mode of transport is employed, a higher level of inventory is necessary to ensure continuous, prompt delivery to the customer. However, when designs change rapidly, obsolescence reduces the market value of the products in store. Rapid advances in technology bring about swifter technical obsolescence. Any goods in the pipeline realize a lower figure when new models are introduced by a company or it’s competitors. Air distribution can overcome this problem, and the effect of such obsolescence can be minimized.5. Packaging – The nature of packaging of a product is often determined by the mode of it’s transport. E.g. Because of the dry conditions of carriage, short transit times and minimum handling, air cargo generally requires much less packaging than other forms of long distance transport. Goods dispatched by air may require only a dust cover or even no cover at all. In some cases, savings on the packaging of sophisticated products may more than pay for the actual transport charges. Less packaging may lead to other advantages too. These include lower unpacking costs and lower chargeable weight for freight.6. Insurance – Insurance risks are based on transit time as well as the possibility of damages en route. With faster transit times, skillful handling, substantial reduction in damage and greater security in transit, insurance premiums tend to fall substantially.7. Breakages – Cost of breakages is an important factor in any cost benefit analysis. Because breakages may be indemnified by insurance companies, the true cost of damage to cargos can easily be overlooked. In the first place, the vulnerability of various products sent by different modes is reflected in the insurance premium. To high premiums must be added the clerical work involved in establishing claims, making replacements and the loss of customer’s goodwill. The replacements themselves will be subject to the same hazards and premiums will require further documentation. Therefore, only that mode of transport must be selected which substantially reduces real damage in transit. This calls for a selection of the routes which are more direct and which avoid transshipment. Handling equipment must also be more sophisticated. Containers can be used by shippers for door-to-door transportation, thereby avoiding all handling of goods by the carrier. 19
  • 8. Pilferage – Many expensive administrative problems associated with breakages also apply to pilferage. This problem is reduced for example, when door-to-door containers are used, a fact which is again reflected in lower insurance rates.9. Deterioration – In many surface cargos, deterioration may be avoided only by complicated and expensive packing to counteract mechanical shock, exposure to weather or unfavorable temperature etc. Some cannot be stored at all, except at great expense, and others deteriorate slowly. Deterioration can be costly in terms of packing, stock losses and expensive conditioning in store. It can only shut the door on many distant markets. A high speed of transport and the frequency of services can overcome many of these problems.10. Transport Costs – Transport can be divided into 3 phases: (i) Delivery to docks, airport or railway station. (ii) Transport from one terminal to another. (iii) Delivery from the terminal to the consignee’s place. In the cost-benefit analysis of the turnaround time of a company’s delivery and collection vehicles, their man hour costs can be significant. Some customers may find this item to be more costly than the cost of the major journey.Transport Elements:Whether the movement of material and equipment is by rail, sea, air or road, adequatefacilities for their free flow to and from the factory must be ensured. The factors whichaffect progress at the construction stage, and production and dispatches aftercommission, have been discussed in the following paragraphs:1) Terminal Facilities:Terminal facilities are usually grudgingly provided. One reason for this is that any delayor any in convenience caused to truck operators is not a loss to the project. It is treatedas a loss to the carrier. In some cases, this may be true. However, this usual incidence ofstoppage or regulation of the production process can be minimized, if not eliminated.Often extreme stinginess is expressed in planning for these facilities, which includestorage space, and loading and unloading arrangements in a suitable area. If the storagespace is not adequate or if the traffic is exceptionally heavy, production suffersinevitably. Since transport requirements of each project are different and depend on itslocation, physical availability of infrastructure, etc, it is not advisable to prescribe oneuniform scale of terminal facilities. They must be worked out for an individual projecton the basis of its own specific requirements.Storage, loading and unloading facilities, good quality roads, which are usablethroughout the whole year, and suitably, designed yard for railway wagons have to beplanned as a part of terminal facilities. It is also essential to pay special attention to themaintenance of loading and unloading equipment, the design, location, length, heightand other features of loading and unloading platforms, etc., and the maintenance ofcirculating area and roads where heavy vehicles ply. 20
  • The overall savings in transport rates would more than justify the expenditure incurredon the provision of additional facilities. This ahs not been recognized by the planners ofindividual projects.For rail movement, not only sufficient number of loading lines, but also sufficientnumber of marshalling, examination and holding lines must be planned for. These linesmust be suitably connected with one another to ensure smooth shunting operations. Theconfiguration of lines (yard designs) is more important than the number of lines in theyard, for the requirements of prime mover (shunting engines) can also be cut down by asuitable design of yard.2) Vehicles:An important feature of movement of finished products of major projects is the type ofvehicle used for movement. The vehicle dimensions, capacity. Type and its specialcharacteristics, if any, have to be examined with the reference to the quality andquantity of goods to b moved. In case of sea transport---- the size, speed and the type ofship, in case of road movement---- capacity, moving dimensions and speed of the trucksand in case of rail movement---- the capacity, type and general availability of wagonsmust be closely examined.Planned movement on any section must be taken into account utilisation of the existingsectional capacity, the expected general growth in traffic on the section, and thepossible future identifiable streams of new traffic. If movement on a saturated section isinevitable, line capacity of the section must be increased.3) Prime Movers:The motive power utilized for the internal handling of vehicles and transportation todestinations is another important component of the total movement system. In the caseof rail movement, locomotives required for the shunting and marshalling of wagonswithin the plant must be of such weight, horsepower and performance characteristics aswill match the specific tasks of shunting and reception and dispatch of wagons. In caseof road movement, suitable design and layout of conveyors and mechanical loaders canreduce the drudgery of manual labour and make pre-despatch and post-receipt handlingoperations more efficient.4) Routes And Sectional Capacity:Another important aspect of transport planning is the routes for streams of traffic, viz.,roadways, railways, waterways and airways. The routes or pathways must haveadequate capacities. Generally speaking, because of lack of understanding of thetransportation subject, executives take it for granted that capacity of routes is unlimited.A very important but invisible component of movement activity is sectional capacity,which is dependant on permissible sectional speed and other characteristics of a section.In turn, sectional speed depends on the geometrics of the road (track, sea route, roadsurface, carriage way, gradients and curves, etc.). 21
  • Over a section of railways or roadways between two stations A and B, only a limitednumber of wagons, trucks or vehicles can be pushed through, depending on theavailability of terminal facilities to handle these vehicles, the facilities to enablevehicles to move on the section, and availability of sufficient number of vehicles.Unless sufficient capacity is developed on each of the different routes to move thevehicles, the additional number of vehicles provided would not necessarily lead tohigher levels of transport availability. On the contrary, movement may become moresluggish.5) Transit Time:The relative locations of a plant and the customers or suppliers determine largely thetransit time for raw materials, spare parts and finished products. Transit time generallynever receives adequate attention in the panning of major projects. There is a generalimpression that, if need be, transit time can be drastically cut at any time by air-lifting aconsignment. Apart from the fact that the neglect of transportation planning leads to anoverall higher cost of transportation, in practice, reduction in transit time actuallyachieved may not justify the heavy cost of air transport. Rough estimates of transit timefrom unreliable sources are generally utilized for planning movements of goods.Although more detailed information sources may be readily available. It is essentialtherefore, that executives understand clearly the difference between:(a) Normal transit time under normal conditions;(b) Normal transit time under abnormal conditions;(c) Optimal transit time;(d) Most optimistic transit time(e) Most pessimistic transit time; and(f) Desirable transit time. Because the importance of transit time is not adequately recognized, it is notrealistically provided for. Major projects suffer from the heavy delays even before thecommencement of construction because of the non-availability of constructionequipment and machinery in time. The existing bottlenecks in the fields oftransportation are almost always ignored. Construction schedules, inventories,warehousing facilities, order processing or production schedules, etc., are generallyplanned without the recognition of the inevitable delays that flow from thesebottlenecks.6) Weigh Bridge:Another usually neglected aspect of industrial transportation activity is the factoryweigh bridge. Weigh bridges ion factories are generally inaccurate, if not actually out oforder. It is seldom appreciated that the losses continuously occurring on this singlepiece of factory equipment and general inefficiency, which results from its ineffectiveand inefficient management, can be easily avoided by proper advance planning.Executives ignore the usual traffic jams at factory gates slow down receipts anddispatches, which, in turn, indirectly affect output. The relative advantages of varioustypes of weigh bridges must be properly appreciated by executives, and a weigh bridgewhich will handle the anticipated volume of traffic expeditiously must be selected.7) Distribution pattern 22
  • The pattern of movement of the finished produced by road or rail must be plannedproperly. For example, when the requirements of the number of rail wagons are to beworked out, it is not sufficient to take the average lead or distance for the whole countryfor calculating fleet requirements. it is also not sufficient to use the figure of theexisting average lead of general goods ,or even that pertaining to a specific commodity.However, when it comes to actually transport, because of imprecise pre-planning, themanufacturer wants the commodity carrier to transport goods to anywhere andeverywhere n the country. This presents a problem. The manufacturer providesinformation to the common carrier about the quantity o goods to b e marketed. Butdetailed information must be supplied to the carrier so that the carrier can plan themovement in entirety.8) Nature of productAnother aspect, which is often disregarded by project managements as well as commoncarrier, is the variability arising out of the specialized nature of products to be moved.The generally low level of sophistication in transport planning in the country had madeit difficult for the planners to appreciate the fact that transport capacity is influenced bythe nature of goods, their packing and other specialized requirements, such as specialhandling equipment.etc.Freight Rate StructureFreight rates of any mode of transport are based on the following principles:1. Freight should the actual cost of transport operation. The actual cost of operation depends on the following factors:a) Fixed costs - Freight should cover interest on capital, depreciation, registration and insurance expenses of a vehicle, if applicable, general upkeep of the vehicle, administration overheads, and expenditure on other fixed facilities, etc.b) Semi-fixed costs - Freight should cover the salary of the driver, cleaner, conductor and miscellaneous maintenance expenses, which vary partially with the running of the vehicle.c) Vehicle Utilization - A transporter is interested in getting maximum mileage out of his vehicle by moving it at top speed to cover the distance in as short a time as possible. i. If the consignments loaded or the route covered is not conducive, the transporter would quote a higher freight rates. ii. Higher freight rates are also quoted when vehicles are detained at terminals either for certain formalities, terminal congestion in busy ports or at factory gates, or while waiting for loading or unloading operations. Terminal detentions are invariably accounted for in the freight rates themselves, but they are normally not noticed at all.iii. Freight rates are quoted higher if there an expectation of obtaining a return trip with a load or if considerable empty movement of vehicles is involved after unloading. 23
  • iv. Vehicle Utilization is affected by the nature of goods. Hazardous goods that are likely to cause damage to the other consignments or the vehicle itself attract higher freight rates. v. Consignments, which can be loaded less by weight in a vehicle, attract higher unit freight rate since they yield poor utilization of the vehicle.2. Traffic Bearing Capacity:An age-old consideration for the freight rates is the doctrine of “what traffic can bear.”Transportation adds place utility to goods, for it makes them marketable at anotherplace. However, after the addition of the cost of transport, the price of goods should bestill attractive to the buyer.3. Public Use:Freight rates all over the world are governed on human grounds that items of public useshould be made available to the common man at the cheapest rate. For example,foodgrains and salt are carried at rock-bottom prices, sometimes even at those, which donot cover the actual cost of operation.4. Government Policies:Freight rates are often framed on the basis of government objectives, which aim atserving certain points – such as promotion of certain type of trade, development ofcertain industries, etc. In such cases, freight rates are either depressed to promote theparticular traffic or hiked to discourage particular traffic.5. Reasonable Profit:The transporter must provide for a reasonable profit after covering the cost ofoperations and capital investment. This margin must give not only return of investmentbut also compensate him for the entrepreneurial time and effort he puts in, but alsoprovide sufficient funds for future development of his enterprise.IntermodalChartROAD TRANSPORTRoad transport forms an essential part of any transport activity, whether rail, sea or air.It is essential as a supplementary and complementary mode of transport to completemovement by other modes of transport. Eg. From one terminal i.e. the railway stationthe goods have to be carried to the destination like an area by road.Road transport offers certain advantages like i. Door to door service to customers which neither rail nor neither sea nor air transport can offer. ii. On per unit basis, the cost of making a road is 1/6th that of laying a railway line.iii. Capital investment in case of railways is much less then railways designed to carry equivalent quantum of traffic. 24
  • iv. Road transport provides employment to six million persons (two million direct and four million indirect)There are negative points also to be viewed like: i. As much as 6200 crores are collected in dues but only 10% of this revenue is used for development of roads, which a disadvantage as road transport is till not well organized. ii. Road transport industry is not come of age in India, as there are very few companies, which own the entire fleet of trucks. Single vehicle owners operate most of the road transport.There is a system of associates, who pool in their vehicles and other resources and sharethe benefits of vehicle contribution. The associates operate from different cities. Anassociate in one city, say, Mumbai, watches the interest of his counterpart in Delhi.Together they operate as a team. They minimize expenses on the maintenance of abranch office at the out-station and yet give the identity of a single branch operator.Problems in Road Transport:Road transport faces a number of problems. This is evident from the following facts:1) There is an occasional storage of diesel fuel in the country.2) Vehicle availability in the country has been problematic. With the recent entry of a number of manufacturers, the situation has improved to some extent.3) The cost of components and accessories, such as tyres and batteries, has escalated tremendously.4) The Octroi and police check posts are to many, resulting in heavy detention to road vehicles.5) The present Motor Vehicle Act regulating the issue of licenses and permits and movement of vehicles is very restrictive. It was decades ago to control and regulate traffic. The current requirements of traffic are for development. There are persistent demands from various transport associations for suitable amendments of the Motor Vehicle act. But they do not seem to receive due attention.6) Conditions on Indian road are very bad and hazardous. They tend to reduce speed of vehicles, which leads to wastage of natural transport capacity.7) Roadside maintenance and service facilities have not developed though found necessary.8) The system of national, zonal and state permits restricts free growth of road transport but the system has to be followed.Transportation Network Design OptionsClassical economists neglected the importance of facility, location and overall networkdesign Economists, when originally discussed supply – demand relationships, facility,location and transportation cost differentials were assumed to be non existent or equalamong competitors.  The number, size, geographical relationship of the facilities are used to perform logistics operation directly affect customer service capabilities and cost.  Network design – primary responsibility of logistics.  Typical logistics facilities are manufacturing plants, warehouses, gross dock operations and retail stores. 25
  •  Determining (i) How many of each facility are required (ii) Their geographic location (iii) The work to be performed at each is a significant part of network design. In specific situations facility operations may be outsourced to service specialists. No matter who does the actual work, all facilities must be managed as an integral part of a firm’s logistical network. You have a network for internal customers, external customers as well as suppliers. Suppliers should be made to understand what their commitment is and follow it. You have to co-exist with your suppliers and share information with them. Network design must take into account geographical location because a great deal of variation exists between different geographical markets. If you set up your base in a place where your demand is high then after a while the demand shifts and come from another location, then again you are in a dilemma.In a dynamic, competitive environment• Product assortment• Customer supplies• Manufacturing requirementsAll of the above are constantly changing. However re-location of all logistics facilitiesat one time is inconceivable. Relocation or redesign of specific facilities is possible.Over a period of time, all facilities should be evaluated, to determine if their location isdesirable.Selection of a superior location network can provide the first step.Your network of facilities forms a structure from which logistical operations areperformed. Your network should incorporate transportation and information. Specificwork tasks related to network design are processing customer orders, management ofinventory, material handling.LOGISTICS PLANNING PROCESSTo match the changing environment in the logistics due to the changes in the markets,competitors, suppliers and technology, there is a need for a systematic planning anddesign methodology to formally include the relevant consideration and effectivelyevaluate the alternatives.MethodologyThe logistics relational and operating environment is constantly changing. Even for theestablished industries, a firms markets, demands, costs and service requirements changerapidly in response to the customer and competitive behavior. Just as no ideal logisticalsystem is suitable for all enterprises the method for identifying and evaluatingalternative logistics strategies can vary extensively. However there is a general processapplicable to most logistics design and analysis situations. The process can besegmented into three phases: problem definition and planning, data collection and 26
  • analysis, and recommendations and implementation. The following discussion describeseach phase and illustrates the types of issues encountered.PHASE I: PROBLEM DEFNITION AND PLANNINGPhase 1 of logistics system design and planning provides the foundation for the entireproject. A thorough and well-documented problem definition and plan are essential toall that follows.1. Feasibility AssessmentThe process of evaluating the need and desirability for change is referred to asfeasibility assessment and it includes the activities of situational analysis, supportinglogic development, and cost benefit estimation. The objective of doing so is tounderstand the environment, process, and performance characteristics of the currentsystem and to determine future estimation.a) Situational analysis: The purpose of the situational analysis id to provide seniormanagement with the best possible understanding of the strengths and weaknesses ofthe existing logistics capabilities for both current and future environment. Thesituational analysis is the performance of measures and characteristics that describe thecurrent logistics environment through:  Internal review: Internal review is necessary to develop a clear understanding of existing logistics by covering the overall logistics process as well as each logistics function with respect to its stated objectives and its capabilities to meet those objectives. It profiles historical performance, data availability, strategies, operation and tactical policies and practices. All major resources such as workforce, equipment, facilities, relationships and information are examined. The comprehensive review attempts to identify the opportunities that might motivate or justify logistics system redesign or refinement. Assessment must consider the process (physical and information flows through the value – added chain), decisions (logic and criteria currently used for value chain management), and key measures for each major logistics activity. These measurements focus on the key performance indicators and the firm’s ability to measure them.  Market assessment & competitive evaluation: the objective is to document and formalize customer perceptions and desires with regard to the changes in the firm’s logistical capabilities. It’s the review of the trends and service demands required by customers by the use of interviews with the selected customers or through customer5 surveys. The assessment focuses on the external relationships with the suppliers, customers (wholesalers and retailers) and consumers (final consumer). The assessment not only considers trends in requirements and processes but also the enterprise and the competitor’s capabilities.  Technology Assessment: it focuses on the application and capabilities of the key logistics technologies, including transportation, storage, material handling, packaging, and information processing. The assessment considers the firm’s capabilities in terms of current technologies and the potential for applying new technologies. The objective of the assessment is to identify advancements that 27
  • can provide effective trade – offs with other logistics resources such as transportation and inventory.b) Supporting logic development: The second feasibility assessment task isdevelopment of a supporting logic to integrate the findings of the internal review,external assessment and technology study. Supporting logic development builds onthis comprehensive review in three ways  First - supporting logic development forces a critical review of the potential opportunities for logistics improvements and a determination of whether additional investigation is justified, using logistics principles such as tapering principle, principle of inventory aggregation. The resulting benefits or costs should be clearly identified.  Second - it critically evaluates current procedures and practices using comprehensive, factual analysis and evaluation that isn’t influenced by opinion and thus help in identifying areas with improvement potential which in turn provides a foundation to determine the need for strategic adjustment. The deliverables of this evaluation process include classification of planning and evaluation issues prioritized into primary and secondary categories across short and long range planning horizons.  Third - the process of developing supporting logic should include clear statements of potential redesign alternatives such as  Definition of current procedures and systems  Identification of the most likely system design alternatives based on leading industry and competitive practices  Suggestion of innovative approaches based on new theory and technologiesThe alternatives along with being practical should also challenge the existingpractices. Flow diagrams and /or outline illustrating the basic concepts associatedwith each alternative are constructed, which frame opportunities for flexible logisticspractices, clearly outline value added and information flow requirements and providea comprehensive overview of the options. A recommended procedure requires themanager responsible for evaluating the logistical strategy to develop a logicalstrategy to develop a logical statement and justification of potential benefits.Using customer service concept and logistics integration logic and methodology,the manager should commit to paper the most attractive strategy alternatives.c) Cost benefit estimate: The final feasibility assessment is a preplanning estimate ofthe potential benefits of performing a logistics analysis and implementing therecommendation. Benefits should be categorized in terms of:  Service improvements - It includes results that enhance availability, quality or capability. Improved sciences increase loyalty of existing customers and may also attract business.  Cost reduction - Cost reduction benefits may be observed in two forms:First, they may occur as a result of a one time reduction in financial or managerialresources required to operate the existing system for e.g. Reduction in capitaldeployed for inventory and other distribution related assets 28
  • Second, cost reductions may be found in the form of out - of - pocket or variable expenses. For e.g. new technologies for material handling and information processing often reduce variable cost by allowing more efficient procedures and operations.  Cost prevention - Cost prevention reduces involvement in programs and operations experiencing cost increases. Any cost prevention justification is based on an estimate of future conditions and therefore is vulnerable to some error for e.g. many material – handling and information technology upgrades are at least partially justified through financial analysis of the implications of future labor availability and wage levels. In the final analysis, the decision to undertake in – depth planning will depend on how convincing the supporting logic is, how believable estimated benefits are, and whether estimated benefits offer sufficient return on investment to justify organizational and operational change. These potential benefits must be balances against the out 0- of pocket cost required to complete the process.2. Project Planning: Logistics system complexity requires that any effort to identifyand evaluate strategic or tactical alternatives must be planned thoroughly to provide asound basis for change. Project planning involves five specific items:a) Statement of objectives: The statement of objectives documents the cost and serviceexpectations for the logistics systems revisions. It’s essential that they be statedspecifically and in terms of measurable factors. The objective fine market or industrysegments, the time frame for revisions, and specific service levels. For e.g., desireddelivery of 98 percent of all orders within 48 hours after the order is placed, minimalcustomer shipments from secondary distribution centers, back – orders held for amaximum of five days, etc. specific definitions of these objectives direct system designefforts to ache9ice explicit performance levels. Total system cost can then bedetermined.b) Statement of constraints: The second project planning consideration concernsdesign constraints. On the basis of the situational analysis, it’s expected that seniormanagement will place restrictions on the scope of permissible system modificationsdepending on the specific circumstances of individual firms. But constraints can affectthe overall planning process for e.g. one restriction common to distribution systemdesign concerns the network of manufacturing facilities and their product mixassortment which the management often holds constant for logistical system redesign asthere are large financial investments in existing production facilities. The purpose ofdeveloping a statement of constraints is to have a well-defined starting point and overallperspective for the planning effort. The statement of constraints defines specificorganizational elements, buildings, systems, procedures, and/or practices to be retainedfrom the existing logistical system.c) Measurement standards: Such standards direct the project by identifying the coststructures and performance penalties and by providing a means to ass’s success. 29
  • Management must stipulate guidelines for each category as a prerequisite to formulationof a plan. It is important that the standards adequately reflect total system performancerather than a limited, sub optimal focus on logistics functions. Once formulated, suchstandards must be held constant throughout system development. An importantmeasurement requirement is to quantify a list of assumptions that underlie or providethe logic supporting the standards. Measurement standards should include definitions ofhow cost components such as transportation are calculated and also relevant customerservice measures and method of calculation must also be included.d) Analysis procedures: Analysis techniques range from simple manual methods toelaborate computerized decision support tools. For e.g., models incorporatingoptimization ort simulation algorithms for evaluating and comparing alternativelogistics warehouse networks. Once the project objectives and constraints are defined,planning must identify alternative solution techniques and select the best approach.Selection an analysis technique must consider the information necessary to evaluate theproject issues and optionse) Project work plan: On the basis of feasibility assessment, objectives, constraints andanalysis technique, a project work plan must be determined and the resources and timerequired for completion identified. The alternatives and opportunities specified duringthe feasibility assessment provide the basis for determining the scope of the study. Inturn the scope determines the completion time. One of the most common errors instrategic planning is to undere4stimate the time required to complete a specificassignment. Overruns require financial expenditures and reduce project credibility.There are a number of PC – based software packages available to structure projects,guide resource allocation, and measure progress.PHASE II: DATA COLLECTION AND ANALYSISOnce the feasibility assessment and project plan are completed, phase 2 focuses on datacollection and analysis. This includes activities to (1) define assumptions and collectdata, and (2) analyze alternatives1) ASSUMPTIONS AND DATA COLLECTION:This activity builds on the feasibility assessment and project plan to develop detailedplanning assumptions and identify data collection requirements. Specific tasks are asfollowsa) Define analysis approach and techniques: The most common techniques areanalytical, simulation and optimizationThe analytical approach uses standard numerical methods, such as those availablethrough spreadsheets, to evaluate each logistics alternative. For e.g., spreadsheetavailability have increases the use of analytical tools for distribution applicationsA simulation approach can be likened to a “wind tunnel” for testing logisticsalternatives. Simulation is widely used, particularly when significant uncertainty isinvolved. The testing environment can be physical (a model material handling systemthat physically illustrates product flow in a scaled down environment) or numerical(such as a computer model of a material handling environment that illustrates product 30
  • flow on a computer screen) current software makes simulation one of the most costeffective approaches foe dynamically evaluating logistics alternativesOptimization uses linear or mathematical programming to evaluate alternatives andselect the best one. Because of its powerful capabilities, optimization is usedextensively for evaluating logistics network alternatives such as the number andlocation of the distribution centers.b) Define and review assumptions: Assumptions definition and review build on thesituation analysis, project objectives, constraints and measurements standards. Forplanning purposes, the assumption defines the key operating characteristics, variablesand economies of current and alternative systems. Assumptions generally fall into threeclasses:Business assumptions - They define the characteristics of the general environmentincluding relevant market, consumer, and product trends and competitive actions,within which an alternative logistics plan must operate. They are generally outside theability of the firm to change.Management assumptions define the physical and economic characteristics of thecurrent or alternative logistics environment and are generally within the firm’s ability tochange or refine. Typical assumptions include a definition of alternative distributionfacilities, transport modes, logistics processes and fixed and variable costs.Analysis assumption defines the constraints and limitations that must be included to fitthe problem to the analysis technique. These assumptions frequently concern problemsize, degree of analysis detail and solution methodology.The elements of assumption categories are as follows BUSINESS ASSUMPTIONS 1. Scope: Definition of business units and product lines to be included 2. Alternatives: Range of options that can be considered 3. Market Trends: Nature and magnitude of change in market preferences and buying patterns 4. Product Trends: Nature and magnitude of change in market preferences and buying patterns particularly with respect to package size and packaging. 5. Competitive actions: Competitive logistics strengths, weaknesses and strategies. MANAGEMENT ASSUMPTIONSMarkets: Demand patterns by market area, product and shipment sizeDistribution Facilities: Locations, operating policies, economic characteristics andperformance history of current and potential distribution facilities.Transportation: Transportation rates for movement between potential and existingdistribution facilities and customersInventory: Inventory levels and operating policies for each distribution facility 31
  • ANALYSIS ASSUMPTION 1. Product Groups: Detailed product information aggregated to fit within the scopeof analysis 1. Technique. 2. Market Areas: Customer demand grouped to aggregate market areas to fit thescope of analysis techniquesc) Identify data resources: The process of data collection begins with afeasibility assessment. A fairly detailed specification of data is required to formulateor fit the analytical technique. For situations when data are extremely difficult tocollect or when the necessary level of accuracy is unknown, sensitivity analysis canbe used to identify data collection requirements. For e.g. an initial analysis may becompleted using transportation costs estimated with distance – based regressions. Thetypes of data required in a logistical design n study can be divided into three classes:business assumptions, management assumptions and analysis assumptions. Themajority of data required in a logistical study can be obtained from internal records.Although considerable searching may be needed, most information is generallyavailable. - The first major data category is sales and customer orders. The annual sales forecast and percentage of sales by month, as well as seasonality patterns are necessary for determining logistics volume and activity levels. Historical samples of customer order invoices are also needed to determine shipping patterns by market and shipment size. The combination of aggregate measures of demand and detailed order profiles of projects the requirements that the logistics system must be capable of satisfying. Specific customer data are also required to consider the cost and time associated with moving the products across distance. Customers and markets ate often aggregated by location, type, size, order frequency, growth rate, and special logistical services to reduce analysis complexity. - For integrated channel analysis, its necessary to identify and track the costs associated with manufacturing and purchasing. It’s often necessary to consider the number and location of plants, product mix, production schedules and seasonality. Identification of policies and costs associated with inventory transfer, reordering, and warehouse processing, inventory control rules and product allocation procedures. For each of the current and the potential warehouse, the operating costs, capacities, product mix, storage levels and service capabilities should be established. - Transportation data requirementsTransportation data requirements include the number and type of modes utilized,modal selection criteria, rates and transit times, and shipping rules and policies.For most logistics analysis applications, a select amount of future market data isuseful for evaluating future scenarios. Although the management may be able toprepare a consolidated sales forecast it is difficult to prepare a market-by-marketprojection of sales. There can be two solutions to this problem.1. Usage of demographic projections that correlate highly with sales can help thecompany to estimate future demand levels and hence determine future logisticsrequirements. Secondary data published by various government agencies can alsoprovide a data bank of environmental information 32
  • 2. Keeping a watch on the competitors strategies and capabilities by documenting competitive logistical system designs and flows can be helpful in providing competitive benchmarks that compare customer service capabilities, distribution networks and operating capabilities. d) Collect Data Once the data sources have been identified the company can start assembly of required data and conversion of that data to an appropriate format for the analysis tool. To avoid errors like overlooking data that does not reflect major components of logistical activity or collection of data from a misrepresentative time period, the data collection process should be properly documented. e) Collect Validation Data The objective of validation is to increase management credibility regarding the analysis process and to ensure that the results of the analysis accurately reflect reality. It is important to ensure that a through investigation is conducted into analytical results based on data that might not accurately reflect the past.2) ANALYSIS The analyst uses the technique and data from the previous activity to evaluate logistics strategic and tactical alternatives. The process of analysis includesa) Define analysis questionsThis involves defining specific analysis questions concerning alternatives and the rangeof acceptable uncertainty. The questions build on research objectives and constraints byidentifying specific operating policies and parameters. For e.g.: In the case of inventoryanalysis questions might focus on alternative service and uncertainty levels.b) Complete and validate baseline analysisThe second task completes the baseline analysis of the current logistics environmentusing the appropriate method or tools. Results are compared with validation datacollected previously to determine the degree of fit between historical and analyticalfindings. The comparison should focus on identifying significant differences,determining sources of possible errors and identifying and correcting them. c) Complete alternative analysisAn evaluation of systems alternatives should be accomplished either manually orelectronically to determine the relevant performance characteristics of each alternative.d) Complete sensitivity analysisIn this phase uncontrollable factors like demand, factor cost or competitive actions arevaried to assess the ability of potential alternatives to operate under a variety ofconditions. Sensitivity analysis in conjunction with an assessment of potential scenarioprobabilities is then used in a decision tree to select the best alternative.PHASE III - RECOMMENDATIONS & IMPLEMENTATIONSPhase III operationalize planning and design efforts by making specific managementrecommendations and developing implementation plans. 33
  • a) RecommendationsAlternative and sensitivity analysis results are reviewed to determine recommendationsto management. There are four steps in this part of the phase namely: - 1. Identify the Best Alternative Performance characteristics and conditions for each alternative must be compared to identify the two or three best options. The decision tree analysis should identify the best alternative i.e.: The one that meets the desired service objectives at the minimum total cost. 2. Evaluate Costs and Benefits A Cost Benefit analysis compares the alternatives for a base period and then projects comparative operations across a particular planning horizon. Potential benefits such as cost reduction; service improvement and cost prevention are identified and quantified. In other words when evaluating the potential of a particular logistical strategy an analysis comparing present cost and service capabilities with projected conditions must be completed for each alternative. 3. Develop a Risk Appraisal Risk Appraisal considers the probability that the planning environment will match the assumptions. It also considers the potential hazards related to system changeover. Risk related to adoption of a selected alternative can be quantified using sensitivity analysis. For e.g.: Assumptions can be varied and the resulting influence on system performance for each alternative can be determined. The end result of a risk appraisal provides a financial evaluation of the downside risk if the planning assumptions fail to materialize. Risks related to system changeover such as unanticipated delays, a series of contingency plans etc can also be quantified and a series of contingency plans could be tested to determine their possible impact. 4. Develop Presentation The final step in this procedure is a presentation to the management / submission of a report that identifies specific operating and strategic changes, provides qualitative reasons for suggesting these changes and then quantitatively justifies the changes in terms of service, expenses, asset utilization or productivity improvements.b) ImplementationThe actual plan or design implementation is the final process activity. An adequateimplementation procedure is the only means to obtain a tangible return from theplanning process. This broadly includes four phases. 1. Define Implementation Plan The implementation plan has to be defined in terms of the individual events, their sequence and their dependencies. The planning process may initially develop at a macro level. But it must ultimately be refined to provide individual assignment responsibility and accountability. Plan dependencies identify the interrelationships between events and thus define the completion sequence. 2. Schedule Implementation 34
  • The implementation plan is scheduled based on the assignments identified in the previous stage. The schedule must allow adequate time for acquiring facilities and equipment, negotiating agreements, developing procedures and training. 3. Define Acceptance Criteria The criteria for evaluating the success of the plan are then developed. The Acceptance Criteria should focus on service improvements, cost reduction, improved asset utilization and enhanced quality. Although the acceptance criteria may focus on the area / function which was the main focus for the Plan, it should also take a broad perspective that focuses on total logistics system performance rather than the performance of an individual function. 4. Implement The final task is actual implementation of the plan or design. Implementation must include adequate controls to ensure that performance occurs on schedule and that acceptance criteria are carefully monitored.PLANNING THE INVENTORY RESOURCESPlanning is extremely important when it comes to inventory resources. The lack ofplanning can be costly to the firm either because of the carrying and financing costs ofexcess inventory or the lost sales from inadequate inventory. The inventoryrequirements to support production and marketing should be incorporated into thefirm’s planning process in an orderly fashion.The production sideEvery product is made up of a specified list of components. The planner must realizethe different mix of components in each finished product. Each item maintained ininventory will have a cost. This cost may be based on volume purchases, lead time foran order, historical agreements or other factors. Each component can be assigned avalue. Once the mix is known and each component has been assigned a value, theplanner can calculate the materials cost.The marketing sideThe second step in inventory planning involves a forecast of unit requirements duringthe future period. The marketing department should also provide pricing information sothat higher profit items can receive more attention.Inventory databaseAn important component of inventory planning involves access to an inventorydatabase. It is a structured framework that contains the information needed toeffectively manage all items of inventory, from raw materials to finished goods. Thisinformation includes the classification and amount of inventories, demand for the items,cost to the firm for each item, ordering costs, carrying costs and other data.The task of inventory planning can be highly complex. At the same time it rests onfundamental principles. In doing so we must understand and determine the optimal lotsize that has to be ordered. The EOQ (economic order quantity) refers to the optimalorder size that will result in the lowest total of order and carrying costs and ordering 35
  • costs. By calculating the economic order quantity the firm attempts to determine theorder size that will minimize the total inventory costs.An examination of the two curves reveals that the carrying cost curve is linear i.e. morethe inventory held in any period, greater will be the cost of holding it. Ordering costcurve on the other hand is different. The ordering costs decrease with an increase inorder sizes. The point where the holding cost curve i.e. the carrying cost curve and theordering cost curve meet, represent the least total cost which is incidentally theeconomic order quantity or optimum quantity.The EOQ can be calculated with the help of a mathematical formula. Followingassumptions are implied in the calculation:1. Constant or uniform demand- although the EOQ model assumes constant demand, demand may vary from day to day. If demand is not known in advance- the model must be modified through the inclusion of safe stock.2. Constant unit price- the EOQ model assumes that the purchase price per unit of material will remain unaltered irrespective of the order offered by the suppliers to include variable costs resulting from quantity discounts, the total costs in the EOQ model can be redefined.3. Constant carrying costs- unit carrying costs may very substantially as the size of the inventory rises, perhaps decreasing because of economies of scale or storage efficiency or increasing as storage space runs out and new warehouses have to be rented.4. Constant ordering cost- this assumption is generally valid. However any violation in this respect can be accommodated by modifying the EOQ model in a manner similar to the one used for variable unit price.5. Instantaneous delivery- if delivery is not instantaneous, which is generally the case; the original EOQ model must be modified through the inclusion of a safe stock.6. Independent orders- if multiple orders result in cost saving by reducing paper work and the transportation cost, the original EOQ model must be further modified. While this modification is somewhat complicated, special EOQ models have been developed to deal with it. These assumptions have been pointed out to illustrate the limitations of the basicEOQ model and the ways in which it can be easily modified to compensate for them. The formula for the EOQ model is: 2 M Co S Cc Where M = is the annual demand Co is the cost of ordering Cc is the inventory carrying cost S = is the unit price of an item.Limitations of the EOQ formula-1. Erratic changes usages- the formula presumes the usage of materials is both predictable and evenly distributed. When this is not the case, the formula becomes useless.2. Faulty basic information- order cost varies from commodity to commodity and the carrying cost can vary with the company’s opportunity cost of capital. Thus the 36
  • assumption that the ordering cost and the carrying cost remains constant is faulty and hence EOQ calculations are not correct.3. Costly calculations: the calculation required to find out EOQ is extremely time consuming. More elaborate formulae are even more expensive. In many cases, the cost of estimating the cost of possession and acquisition and calculating EOQ exceeds the savings made by buying that quantity.4. No formula is a substitute for common sense- sometimes the EOQ may suggest that we order a particular commodity every week (six-year supply) based on the assumption that we need it at the same rate for the next six years. However we have to order it in the quantities according to our judgement. Some items can be ordered every week; some can be ordered monthly, depends on how feasible it is for the firm.5. EOQ ordering must be tempered with judgement- Sometimes guidelines provide a conflict in ordering. Where an order strategy conflicts with an operational goal, order strategy restrictions should be developed to permit honouring the goal.Quantity discounts: In the EOQ analysis, it has been assumed that material prices andtransportation costs were constant factors for the range of order quantities considered.In practice, some situations occur in which the delivered unit cost of a materialdecreases significantly if a slightly larger quantity than the originally computed EOQ ispurchased. Quantity discounts, freight rate schedules and price increases may createsuch situations. These additional variables can also be included in the formula.Determining ordering pointIn the EOQ model, the leas time for the procurement material is assumed to be zero.Consequently the ordering point for replenishment of stock occurs when the level ofinventory drops down to zero. In view of instant replenishment of stock, the level ofinventory jumps to the original level from zero level. This is well illustrated in thefollowing diagram:However, in real life situations, one never encounters a zero lead-time. There is alwaysa time lag from the date of placing an order for materials and the date on which thematerials are received. As a result, the ordering level is always at the level higher thanzero. If the firm orders the goods when the inventory level reaches the reorder point, thefirm will never run out of goods. The decision on how much stock to hold is generallyreferred to as “Order point problem” that is how low should the inventory be depletedbefore it is reordered.The two factors that determine the appropriate order point are the: a) Procurement or delivery time stock (inventory needed during the lead time) and; b) The safety stock, which is the minimum level of inventory that is held as a protection against shortages. Reorder point = Normal consumption + safety stock during lead-time.In summary, the efficiency of the replenishment system affects how much delivery timeis needed. 37
  • Determination of level of safety stock involves a basic trade-off between the risk ofstock-out, resulting in possible customer dissatisfaction and lost sales, and the increasedcosts associated with carrying additional inventory. The following diagram representsthis better: Reorder level = (Average daily usage rate) x (Lead time in days)Safety stockWhen the wage rate and/or lead-time vary, then the reorder level should naturally be ata level high enough to cater to the production needs during then procurement period andalso to provide some measure of safety for at least partially neutralizing the degree ofuncertainty.How much should the magnitude of safe stock be?It depends on the degree of uncertainty surrounding the usage rate and lead-time. It ispossible to a certain extent of to quantify the values that usage rate and lead-time cantake along with the corresponding ‘chances of occurrences’ known as ‘probabilities’.These probabilities can be ascertained based on the previous experiences and thejudgmental ability of executives. Based on the above values and estimated stock outcosts and carrying costs of inventory it is possible to work out the total cost associatedwith different levels of safety stock. Higher the quantity of safety stock, the lower willbe the stock-out cost and the higher will be the incidence of carrying costs. Thus thereorder level will call for a trade-off between stock out costs and carrying cost. Thereorder level will be such that the total stock out cost and the carrying cost will be at itsminimum.Cost of carrying inventoryCarrying material in inventory is expensive. A number of studies indicated that theannual cost of carrying a production inventory averaged approximately 25% of thevalue of the inventory. The escalating and volatile cost of money has escalated theannual inventory carrying cost to a figure between 25% - 35% of the value of theinventory. The following five elements make up this cost: 1) Opportunity cost (12% -20%) 2) Insurance cost (2% – 4%) 3) Property taxes (1% - 3%) 4) Storage costs (1%- 3%) 5) Obsolescence and deterioration (4% - 10%) Total carrying cost (20% - 40%)Let us briefly look into these costs:Opportunity cost of invested fundsWhen a firm uses money to buy production material and keeps it in the inventory, itsimply has this much less cash to spend for other purposes. Money invested in externalsecurities or in productive equipment earns a return for the company. Thus it is logicalto charge all money invested in inventory an amount equal to that it could earnelsewhere in the company. This is the opportunity cost associated with inventoryinvestment.Insurance cost 38
  • Most firms insure the assets against possible losses from fire and other forms ofdamage.Property taxesThis is levied on the assessed value of a firm’s assets, the greater the inventory value,the greater the asset value and consequently the higher the firm’s tax bill.Storage costsThe warehouse is depreciated every year over the length of its life. This cost can becharged against the inventory occupying the space.Obsolescence and deteriorationIn most inventory operations, a certain percentage of the stock spoils, is damaged, ispilfered, or eventually becomes obsolete. A certain number always takes place even ifthey are handled with utmost care.Generally speaking, this group of carrying costs rises and falls nearly proportionately tothe rise and fall of the inventory level.Moreover, the inventory level is directly proportional to the quantity in which theordered material is delivered. Hence costs of carrying inventory vary nearly directlywith the size of the delivery quantity. This relationship is illustrated as follows:(Carrying Cost per year) = (Average inventory value) x (Inventory carrying cost as a % of inventory value)Origin purchaseBuyer incurs the freight cost and product risk when the product is in transit.EOQ EXTENSIONS:While the EOQ formulation is relatively straightforward, there are some other factorsthat must be considered in actual application. The most important and persistentproblems are those related to various adjustments necessary to take advantage of socialpurpose situations and utilization characteristics.1. Volume transportation rate: In the EOQ formulation, there was no considerationfor the impact of transportation cost on order quantity. The transportation cost from theorigin to the inventory depot is incurred by the seller. However if the ownership istransferred at the origin, the impact of the transportation rates on the total cost must beconsidered when determining the order quantity. As a general rule, greater the quantity,lesser will be the volume transportation rate because many sellers tend to give adiscount when the goods are bought in a larger size (both by the truck and rail). Thus allother things being equal, an enterprise will want to buy goods in large quantities tomaximize transportation economies. Such quantity may be larger than the actualquantity determined by EOQ. Increasing the size of the order has a two fold impacton the inventory: • It increases the inventory carrying cost • It provides better transportation economies. Finally, two factors regarding inventory cost under costs of origin purchase are: 39
  • • The transit inventory is a part of the enterprise’s average inventory and therefore subjected to an appropriate charge. • The transportation cost should be added to the price of the goods purchased to assess the value of the goods tied up in inventory. Thus the inventory carrying cost should be assessed on the combined cost of the item and transportation.2. Quantity DiscountsPurchase quantity discounts represent an EOQ extension. If the discount at anyassociated quantity is sufficient to offset the added cost of maintenance less the reducedcost of ordering, then the quantity discount offers a viable alternative. It should be notedthat quantity discounts and volume transportation rates each effect later purchasequantities. However, this does not mean that the lowest total cost purchase will alwaysbe a large quantity.EOQ Adjustments A variety of special situations can occur that will require adjustments to basic EOQ model. Some of them are: • Production lot size (most economical quantity from manufacturing perspective) • Multiple item purchase. This describes situations when more than one product is bought concurrently, so that quantity and transportation discounts must consider the impact of the product combinations. • Limited capital (limited capital – budget limitations for total inventory investment) • Private trucking (influences order quantity since it represent a fixed cost once the decision is made to replenish the product.) If the enterprise decides to use its own truck, it should fill the truck regardless of the value calculated by the EOQ. Transporting a half empty truck does not make any sense. Inventory Related Definitions This includes definitions related to an inventory management policy. 1) INVENTORY POLICY: It consists of guidelines concerning what to purchase or manufacture when to take action and in what quantity. It also deals with the inventory positioning and placements in plants and distribution centers. E.g some plants may maintain stock at a plant and hence postpone the inventory positioning. The second inventory policy element concerns inventory management strategy. One approach is to manage inventory at each distribution center independently. The other extreme deals with inventory interdependence across distribution sites by managing inventory centrally. Centralized inventory management requires more coordination and communication. (2) Service level: It defines the performance objectives that the inventory function must be capable of achieving. It can be defined in terms of the following: (a) Order cycle time: the time taken to complete from the time of placing the order to the payment for the goods received. It can also be defined as the elapsed time between the release of a purchase order by a customer and the receipt of the corresponding shipment. 40
  • (b) Case fill rate: it can be defined as the percentage of cases or units ordered that can be shipped as 4requested. For e.g. 95% case fill rate indicates that on an average, 95 cases out of 100 could be filled from available stock. The remaining 5 will be back ordered or deleted. (c) Line fill rate: % of order lines that could be filled completely. Each time on an order is a request for an individual product, so an order may have multiple lines. E.g. if a customer order is received requesting 80 units of product A and 20 units of product B, the order is of 100 cases and 2 lines. If there are 75 units of product A available and all 20 of product B, the case fill would be 95% (75+20)/ (80+20) and the line fill rate would be 50%. (d) Order fill: it is a % of customer orders that could be filled completely. In the above example, the order could not be filled completely filled, so the resulting order fill would be zero.The inventory function is a major element of the logistics process that must beintegrated in order to meet the service objectives. To improve service level, once canincrease the inventory. Other approaches would be faster transportation modes, betterinformation mgmt, or alternative sources of supply.Average inventory: this consists of the materials, components, WIP and finishedproducts typically stocked in logistical facilities. Average inventories include cycle,safety stock and in transit inventory components.Cycle inventory: it is also known as base stock. It can be defined as the % of theinventory that results from the replenishment process. Cycle inventory can also be saidto result when in order to reduce unit purchase costs (or increase production efficiency),the number of units purchased (or produced) inventory from to which the lot size isapplied. It may be more economical to order the product in a large size than to order itin small batches. At the beginning of a performance cycle, the stock level is at themaximum level. However daily customer demands stock to be withdrawn from theinventory until it reaches zero. Prior t this, a replenishment order must be given. Theamount ordered for replenishment is called the order quantity. The average inventoryheld as a result of the order process is referred to as base stock, which is also called asthe lot size stock. Usually the base stock equals to one half of the order quantity.Safety stock inventory: It has been explained on pg 6Transit inventory: this represents the stock that is either moving or awaiting movementin transportation vehicles. This portion of the total inventory is also known as pipelineinventory. It can also be defined as the materials moving forward but not yet received. Itis necessary to achieve order replenishment. Transit inventory represents real assetsand must be paid for even though it is not accessible or usable. There has typically beena high degree of uncertainty associated with transit inventory because shippers wereunable to determine where a transport was located or when it was likely to arrive. Whilesatellite communications have somewhat reduced this uncertainty.Shippers bill have limited accessibility to such information. Increased focus on smallerorder quantities, more frequent order cycles and just in time strategies have resulted intransit inventory becoming a larger percentage of the total inventory assets. As a result, 41
  • greater attention is paid to reducing the amount of transit inventory and its associateduncertainty. Formulating inventory policy Inventory turnover is a widely used performance measure that reflects the liquidity of a firm’s inventory and the speed with which inventory is converted into sales. This indicates the number of times the inventory is sold or turned over during a stated period. Inventory turnover ratio = Cost of goods sold Average inventory value e.g, if the firm’s annual cost of goods sold = Rs.5, 00,000 and its average inventory value = Rs.50,000, the inventory turns over 10 times. If the cost of goods sold rises to Rs.10, 00,000 and the value of the inventory remains as it is, the turnover ratio jumps to 20. Inventory turnover is related to actual sales. Hence high inventory levels are not penalized if the sales are very high and low inventory levels are not rewarded, if the sales are low. If the inventory turnover is high, it means that the inventory is kept in stock for a less period of time and hence it is more liquid. The cash flow needed to finance the inventory also decreases as the number of inventory turnover increases. A high level of sluggish inventory amounts to unnecessary tie-up of funds, reduced profits and increased costs. If these inventories are written off, it will adversely affect the Working capital and liquidity position of the firm. However, if the inventory level is maintained at a very low level (inventory turnover high), then it may result into frequent stock outs, which means the firm replenishes its inventory in small lot sizes. This may be costly to the firm.Elements of logistics ManagementInventory planning methods use a common information base to co-ordinate inventoryrequirements across multiple locations or stages in the value added chain. Planningactivities may occur at the plant warehouse level to coordinate inventory allocation anddelivery to multiple distribution centers. Planning may also occur to coordinateinventory requirements across multiple channel partners such as manufacturers andretailers.Two inventory planning methods are: a) Fair share Allocation b) Distribution requirement planning.Fair share AllocationIt is a simplified inventory management planning method that provides each distributionfacility with an equitable or ‘Fair share’ of available inventory from a common sourcesuch as a plant warehouse.Example of a fair share allocation Plant warehouse Inventory 600 units. 42
  • Distribution center 1 Distribution center 2 Distribution center 3 ___________________ _____________________ _____________________ Inventory 50 units Inventory 100 units Inventory 75 units Daily use 10 units Daily use 50 units Daily use 75unitsThe above figure illustrates the network structure, current inventory levels and dailyrequirements of three distribution centers served by a common plant warehouse. Usingfair share allocation rules, the inventory planner determines the amount of inventorythat can be allocated to each district center from the available inventory at the plantwarehouse. For this example assume that it is desirable to retain 100 units at the plantwarehouse, hence 500 units are available for allocation.FormulaDS =Where,DS = common days supply for distribution center inventory.Aj = inventory units to be allocated from plant warehouse.Ij = inventory in units for distribution center ‘j’Dj = daily demand for distribution center j.n = number of distribution centers.In this example, DS = 500 + (50+100+75) 10 + 50 +15 = 500 + 225 75 = 9.67 daysHence the fair share allocation indicates that each distribution center should be broughtup to 9.67 days of stock. The amount to be allocated to each distribution center isdetermined by:Aj = (DS – Ij ) x Dj DjAj = amount allocated to distribution center ‘j’.Ds = days’ supply that each distribution center is brought up to Ij and Dj are as above.The amount allocated to distribution center 1 in this case:A1 = (9.67 – 50/10) x 10 = (4.67) x 10 = 46.7 ~ 47 units.However fair share allocation does not consider site-specific factors such as differencesin performance cycle time, EOQ, safety stock requirements.SKU (Stock keeping unit – it is a specific item purchased by the customer includingcolour and size uniqueness.)Distribution requirement planning (DRP) 43
  • It is a more sophisticated approach that considers multiple distribution stages and thecharacteristics of each stage. It is a logical extension of MRP, although there is onefundamental difference between the two. • MRP is determined by a production schedule that is defined and controlled by the enterprise. On the other hand, DRP is guided by customer demand, which is not controllable by the enterprise. • So, while MRP generally operates in a dependent demand situation, DRP operates in an independent environment where uncertain customer demand determines inventory requirements. The manufacturing requirements planning component coordinates the scheduling and integration of materials into finished goods. • MRP controls inventory until manufacturing or assembly is complete. DRP then takes coordination responsibility once finished goods are received in the plant warehouse. The fundamental DRP planning is the schedule, which coordinates requirements across the planning horizon. There is a schedule for each SKU and each distribution facility. Schedules for the same SKU are integrated to determine the overall requirements for replenishment facilities such as the plant warehouse. The schedules are developed using weekly time increments known as ‘buckets’. The schedule reports current on-hand balance, safety stock, performance cycle length and EOQ.Distinction between DRP and MRPDIFFERENCE BETWEEN MRP AND DRP MRP DRPGuiding factor Guided by production Guided by customer demand schedulesControl of the firm Under control of the firm Not under control of the firmDemand situation Operates in dependant Operates in independent demand situation demand situationArea of operation Coordinates scheduling and Coordinates demand betweenand coordination integration of materials into outlets and supply sources finished goodsStage of Controls inventory until Controls and coordinatesfunctioning manufacturing and assembly inventory after manufacturing is complete. and assembly of finished goods 44
  • The figure below shows the areas of functioning of MRP and DRP. MRP plans theprocurement of raw materials as per their requirements, right from the first stage till thefinal assembly.After the goods have been manufactured, DRP plans the distribution of finished goodsfrom the plant warehouse to the wholesalers and retailers till it reaches the customer.The integrated model seeks to combine these two areas. Taking intoconsideration the requirements of both MRP and DRP, it provides integratedplanning. 45
  • CUSTOMERSDISTRIBUTION DISTRIBUTION DISTRIBUTION DISTRIBUTION CENTER CENTER CENTER CENTER DISTRIBUTION DISTRIBUTION CENTER CENTER REGIONAL REGIONAL WAREHOUSE WAREHOUSE PLANT WAREHOUSE FINAL ASSMEBLY (MANUFACTURING) SUB ASSEMBLY B SUB ASSEMBLY C SUB ASSEMBLY D SUB ASSEMBLY A PART C PART D PART E PART A PART B RAW MATERIALS 46
  • DRP Benefits And Constraints An inventory management system such as DRP offers a number of benefits for management. The major organizational beneficiaries include marketing and logistics.The major marketing benefits are: • Improved service levels that increase on time deliveries and decrease customer complaints. • Improved and more effective promotional and new product introduction plans. • Improved ability to anticipate shortages so that marketing efforts are not expended on products with low stock. • Improved inventory coordination with other enterprise functions, since DRP facilitates a common set of planning numbers. • Enhanced ability to offer customers a coordinated inventory management service.The major logistics benefits are: • Reduced distribution center freight costs resulting from coordinated shipments. • Reduced inventory levels, since DRP can accurately determine what product is needed and when. • Decreased warehouse space requirements because of inventory reductions. • Reduced customer freight costs as a result of fewer back orders. • Improved inventory viability and coordination between logistics and manufacturing. • Enhanced budgeting capitability, since DRP can effectively simulate inventory and transportation requirements under multiple planning scenarios.The constraints of DRP are: • Inventory planning systems require accurate and coordinated forecasts for each distribution center. The forecast is necessary to direct the flow of goods through the distribution channel. To the extent that this level of forecast accuracy is possible, inventory-planning systems operate well. However, this requires forecasts for each distribution center and SKU as well as adequate lead-time to allow product movement. However there are 3 potential sources for error exist. The forecast itself may be wrong, it may have predicted demand at the wrong location, or it may have been predicted demand at the wrong time. • Inventory planning requires consistent and reliable performance cycles for movement between the distribution centers. While variable performance cycles can be accommodated through safety lead times, performance cycle uncertainty reduces planning system effectiveness. • Integrated planning is subject to system nervousness and frequent rescheduling, because of production breakdowns and delivery delays. The system nervousness leads to fluctuations in capacity utilization, rescheduling cost, and confusion in deliveries. This is intensified by the volatile operating environment characteristic of distribution. Uncertainties such as supply transportation performance cycles and vendor delivery reliability can cause an extremely nervous DRP system. • DRP is not the universal solution for inventory management. 47
  • Question 16Logistical Organization And Development: 3 Stages Of EvolutionPrior to the 1950s,functions now accepted as logistics were generally viewed asfacilitating or support work. Organizational responsibility for logistics was dispersedthroughout the firm. This fragmentation often meant that aspects of logistical work wereperformed without cross-functional coordination, often resulting in duplication andwaste information was frequently distorted or delayed and lines of authority andresponsibility were typically blurred. Managers recognizing the need for total costcontrol began to reorganize and combine logistics functions into a single managerialgroup. Structuring logistics as an integrated organization first appeared in the 1950s. The motivation behind functional aggregation was the belief that groupinglogistics functions into a single organization would increase the likelihood ofintegration. The paradigm (model) was that functional proximity would facilitateimproved understanding of how decisions and procedures in one area affectperformance in other areas. The belief was that eventually all functions would begin towork as a single group focused on total system performance. This integration paradigm,based on organizational proximity, prevailed throughout a thirty-five year period.However, by the mid 1980s, it was becoming increasingly clear that the paradigm offunctional aggregation might not, in final analysis, offer the best approach to achieveintegrated logistics. For many firms, the ink had barely dried on what appeared to be theperfect logistics organization, when new and far more pervasive rethinking of whatconstituted the ideal structure emerged. Almost overnight, the emphasis shifted from function to process. Firms began toexamine the role logistical competency could play in the overall process of creatingcustomer value. This ushered in new thinking regarding how to best achieve logisticalperformance. To a significant degree, the focus on process reduced the pressure toaggregate functions into all encompassing organization units. The critical questionbecame not how to organize individual functions but rather how to best manage theoverall logistical process. The challenges and opportunities of functional disaggregationand information driven integration began to emerge. The mission of logistics is to position inventory when and where it isrequired to facilitate profitable sales. This supportive work must be performedaround the clock and typically throughout the world, which means that logistics needsto be an integral part of all processes. The ideal structure for logistics would be anorganization that performs essential work as part of the processes it supports whileachieving the synergism of cross functional integration. Information technology introduced the potential of electronic integration ascontrasted to physically combining logistics functions. Using information technology tocoordinate or orchestrate integrated performance allows the responsibility for workitself to be distributed throughout the overall organization. Integration requires thatlogistics combine with other areas such as marketing and manufacturing. For example,rather than focusing on how to relate transportation and inventory, the real challenge isto integrate inventory, transportation, new product development, flexible manufacturingand customer service. in order to achieve overall organizational integration, a firm mustcombine a wide variety of capabilities into new organizational units. This means thatthe traditional single function department must be assimilated in a process. Suchassimilation often requires the traditional organizational structure be dissaggregated andthen recombined in new and unique ways in one sense, such a functional disaggregationmay appear to come full circle back to the early days of fragmented single-functiondepartments. However, the critical differences in the emerging organization model are 48
  • widespread availability of unbridled information. The new organization format ischaracterized by an extremely different culture concerning how information is managedand shared. Understanding the organizational development process permits logisticsmanagers to evaluate the firm’s current state of organization and plan changes that canbe accommodated.FIG: LOGISTICS ORGANIZATION DEVELOPMENT CYCLEStages of functional organizationFigure illustrates a traditional organizational structure with dispersed logisticalfunctions.. the initial belief was that integrated performance would be facilitated bygrouping logistical functions normally spread throughout the traditional organizationinto a single command and control structure.. It was felt that these functions would bebetter managed, trade-offs better analyzed, and least-Total cost solutions betteridentified if all logistics work was integrated into one organization. In order foroperational integration to occur, managers had to believe that performance could beimproved.Without this belief, they would continue To emphasize structure as opposed tomanagement practice.While the idea of functional integration is logical and appeals to common sense, it is notalways supported by other unit managers. It is natural that any attempt to repositionmanagement authority and responsibility will meet resistance. Many logisticsexecutives can provide examples of how attempts to reorganize were met with rivalry 49
  • and mistrust--- not to mention accusations of empire building. Traditionally, inorganizational structures, financial budgets follow operational responsibility. Likewise,power, visibility, and compensation result from managing large head counts andsubstantial budgets. Logistical reorganization, therefore, was typically seen as a way forlogistical managers to gain power, visibility and compensation at the expense of othermangers. This also was ample reason for other managers to protect their power byresisting logistics functional integration. As a result, unified logistical organizationsfaces considerable resistance. But in an increasing number of firms, benefits weresufficient to empower reorganization. The resulting evolution typically involved threestages of functional aggregation.STAGE 1 ORGANIZATIONThe initial attempt at grouping logistical activities emerged during the late 1950s andearly 1960s. Organizations with even a minimal degree of formal unification emergedonly after senior management became committed to the belief that improvedperformance would result. The typical evolutionary pattern was for two or morelogistics functions to be operationally grouped without significant change in the overallorganization hierarchy. Such initial aggregation Occurred at both the staff and linelevels of organization.. Seldom were organization Units engaged in purchasing andphysical distribution integrated during this initial development stage.Figure illustrates a typical stage 1 organization. Although completely separate, physicaldistribution and material management units serve to aggregate related functions. As thepotential of integrated logistics developed recognition within an enterprise, one or twoclusters of unified operations emerged. In the marketing area, the cluster typicallycentered around customer service. In the manufacturing area, concentration was usuallyon inbound materials or parts procurement.. However, with few exceptions, mosttraditional departments were not changed and the organization hierarchy was not alteredsignificantly. For the most part, stage 1 organizational change involved groupingfunctions within the traditional domains of marketing and manufacturing. The notable 50
  • deficiency of stage 1 organization was a failure to focus direct responsibility forinventory.For example, initial physical distribution organizations typically controlledwarehousing, transportation and order processing. Few stage 1 organizations had directresponsibility to manage trade-offs between transportation and finished inventorydeployment.STAGE 2 ORGANIZATIONAs the overall enterprise gained operational experience with unified logistics and costbenefits, a second stage of organization began to evolve. Figure illustrates stage 2,which began to emerge in the late 1960s and early 1970s. The significant feature ofstage 2 was that logistics was singled out and elevated to a position of higherorganizational authority and responsibility. The motivation was simple: Positioninglogistics at a higher organization level increased the likelihood of strategic impact.Independent status allowed logistics to be managed as a core competency. A likelycandidate for elevated status was physical distribution in firms where customer serviceperformance was critical to overall success. The grocery manufacturing business was anexample where materials management often increased in operational authority andresponsibility because inbound materials and production was a major portion of productcosts. Thus the focal group that was elevated to higher organizational prominence in thestage 2 organizations typically depended on the nature of the enterprise’s primarybusiness. The example in the figure illustrates a situation wherein physical distributionwas restructured and elevated.In order to establish stage 2 organizations, it was necessary to reassign functions andposition the newly created organization at a higher level within the overall enterprisestructure. In the stage 2 organization, the concept of a fully integrated logistics unit wasnot achieved. Rather, integration was focused on either physical distribution or 51
  • materials management. This failure to synthesize logistical management into anintegrated system was due in part to a preoccupation with the performance of specificfunctions, such as order processing or purchasing, which were perceived as essential totraditional operations. A second limiting factor to total integration was the lack of cross– functional logistical information systems.. As a general rule, organizationalintegration reflected the information systems capability of the firm.A significant point about the stage 2 organizations is that integrated physicaldistribution and/or materials management began to gain acceptance among financial,manufacturing, and marketing counterparts. The other corporate officers viewed theseintegrated organization as something more than purely reactive efforts aimed at costreduction or containment. In the stage 2 organizations, it was common for the integratedunit to become a primary contributor to business strategy. The stage 2 organization isreadily observable in industry today and may well remain the most adopted approach tologistical facilitation.STAGE 3 ORGANIZATIONStage 3 organizations emerged in the 1980s the logistical renaissance began. Thisorganizational structure sought to unify all logistical functions and operations under asingle senior manager. Stage 3 organizations, having the comprehensive nature, wereand continue to be rare. However, the trend at the stage 3 level of organizationstructuring is clearly to group as many logistical planning and operational functions aspractical under single authority and responsibility. The goal is the strategic managementof all materials and finished product movement and storage to the maximum benefit ofthe enterprise.The rapid development of logistical information systems provided an impetus for stage3 organizations. Information Technology became available to plan and operate systemsthat fully integrated logistical operations. Several aspects of the stage 3 organizationsjustify further discussion.First, each area of logistics – purchasing, manufacturing support and physicaldistribution is structured as a separate line organization. The lines of authority andresponsibility directly enabled each bundle of supportive services to be performed 52
  • within the overall integrated logistical effort. Since areas of operational responsibilityare well defined, it is possible to establish manufacturing support as an operational unitsimilar to purchasing and physical distribution. Each of these units is operationally self-sufficient. Therefore, each can maintain the flexibility to accommodate critical servicesrequired by its respective operational area. In addition, since overall logistical activitiescan be planned and coordinated on an integrated basis, operational synergies betweenareas can be exploited.Second, five capabilities grouped under logistical support are positioned as operationalservices. This common service orientation is the mechanism to integrate overalllogistical operations. It is important to stress that logistical support is not a stafforganization. Rather, the group manages the day-to-day logistics work, which isstructured with matrix accountability for direct liaisons between physical distribution,manufacturing support, and purchasing operations.Third, logistical resource planning embraces the full potential of managementinformation to plan and coordinate operations. Order processing triggers the logisticalsystem into operation and generates the integrated database required for control.Logistical resource planning facilitates integration. The plans are based onproduct/market forecasting, order processing, inventory status, and capacity strategy todetermine overall requirements for any planning period. On the basis of identifiedrequirements, the planning unit operationalizes manufacturing by coordinatingproduction scheduling, capacity planning, and materials requirement planning. Finally, overall planning and controllership exist at the highest level of the stage3 organization. These two efforts serve to facilitate integration. The planning group isconcerned with long-range strategic positioning and is responsible for logistical systemquality improvement and reengineering. The logistical controller is concerned withmeasurement of cost and customer service performance and with provision ofinformation for managerial decision-making. The development of procedures forlogistical controllership is one of the most critical areas of integrated logisticaladministration. The need for careful measurement is a direct result of the increasedemphasis placed on customer service performance. The measurement task is extremelyimportant because of te large operating and capital dollar expenditures involved inlogistics.The stage 3 logistical organization approach offers a single logic to guide the efficientapplication of financial and human resources from material sourcing to customerdelivery. As such a stage 3 organization, stage 3 logistical positions a firm to managetrade-offs between purchasing, manufacturing support, and physical distribution.STAGE FOUR: A SHIFT IN EMPHASIS FROM FUNCTION TO PROCESS.Interdependent of functional aggregation or disaggregation it is clear that organizationsare struggling to position their operating capabilities to better support oriented processmanagement. Mckinsey Consultants, frank Ostroff and Doug Smith proposedarchitecture to illustrate how functional hierarchical vertical organization to transition tobecome a process oriented horizontal model.The concept of 21st century organization is envisioned as the result of three factors:development of a highly involved work environment with self directed work teams(SDWT) as a vehicle to empower employees to generate maximum performance;second, improved productivity that results from managing processes rather thanfunctions (this notion has always rested at the core of integrated logistics) and third, therapid sharing of adequate information that allows all facets of organization to beintegrated. 53
  • The essence for the argument for radical restructuring is that the traditional evolutionaryconcept of organization change is not sufficient to stimulate major breakthroughs inservice or productivity. Rather, traditional change shifts the balance of centralizationand decentralization or realigns operating structure between customers’ territories orproducts without any serious redesign of the basic work process. Because suchrestructuring typically assumes that functional organizations will continue to performthe basic work, little or no difference in actual practice results. In essence, companiesare refocusing old business practices rather than designing new, more efficientprocesses.The challenges of managing logistics as a process are three fold. First all effort must befocused on value added to the customer. an activity exists and is justified only to theextent that it contributes to customer value. Therefore, a logistical commitment must bemotivated by a belief that customers desire a specific activity to be performed.Logistical managers must develop the capacity to rethink externally. Second, organizinglogistics as part of process requires that all skills necessary to complete the work beavailable regardless or functional organization. Organizational grouping on the basis ofselected functions can artificially separate natural workflows and create bottlenecks.When horizontal structures are put in place, critical skills need to be put into position toensure that required work is accomplished. Finally, work performed in a processcontext should stimulate synergism. With systems integration, the design of work as aprocess means that overall organizational trade-offs is structured to achieve maximumoutput for minimum input investment.The radical changes proposed by the shift from functional to process orientation havemixed messages for managers involved in logistics. On the positive side, generaladoption of a process orientation builds on the basic principles of systems integration.At the core of integrated logistics is a commitment to functional excellence in thecontext of contribution to process performance. A general shift in managing logistics asa process means that it will be positioned as a central contributor to all initiatives thatfocus on new product development, customer order generation, fulfillment and delivery.The overall trend of process integration expands the operational potential and impact oflogistics.STAGE 5: BEYOND STRUCTURE: VIRTUALITY AND ORGANIZATIONALTRANSPARENCYIt is highly unlikely that the attention being given to process will end management ‘squest for the ideal logistical organization. While several different scenarios concerningthe organization of the future are technologically feasible, one of the most intriguing isspeculationThat formal hierarchical command and control organization structure will be replacedwith an informal electronic network often referred to as a virtual organization. Theword virtual implies an underlying existence without formal recognition. In otherwords, a virtual organization, whether it is a total enterprise or a specific corecompetency, would exist as a provider of integrated performance but not as anidentifiable unit of in terms of the formal organization structure of their membershipcritical activities in an integrated fashion. These work teams could be transparent interms of the formal organization structure of their membership. In other words, formalorganization charts may not be related to actual workflow. In fact, logisticsorganizations of the future could not be characterized by functional disaggregationthroughout the organization in an attempt to focus on workflow rather than structure. 54
  • THE NEED FOR INTEGRATIONIntegration is required not just within the organization but integration upstream withsuppliers and distributors and customers. This integration is logistical rather than“vertical”; in other words we do not imply ownership or domination of the supply chainbut rather that there is a greater emphasis on the linkage of organizations throughinformation. The whole nature of logistics management has been dramatically changed by theinformation technology revolution. Information systems have now become the drivingforce pressurizing companies to reconsider their relationships with customers as well assuppliers. It is no longer possible to manage the business as if it were in a vacuum withno interconnections with other organizations.By process integration we mean collaborative working between buyers and suppliers,joint product development, common systems and shared information. For somecompanies such ideas are yet unthinkable and yet the signs are clearly pointing to afuture where it will be the extent and quality of supply chain, integration that willdetermine market place performance. However in many industries the concept of process integration is increasinglyaccepted. For e.g. Over the last decade there has been a significant change in the waymany car manufacturers in Western Europe have changed from fragmented, transactionfocused businesses to highly integrated and relation ship based supply chains.Question 17LOCATION APPLICATIONSPlant and distribution center location is a common problem faced by logistics managers.Increased production economics of scale and reduced transportation cost have focusedattention on distribution centres.In recent years, location analysis has been further extended to include logistics channeldesign as a result of global sourcing and marketing decisions. Global operationsincrease logistics channel decision complexity, design alternatives and related logisticscost.LOCATION DECISIONSLocation decision focus on selecting the number and location of distribution centres.Typical management questions:-  How many distribution centers should the firm use and where should they be located?  What customers or market areas should be serviced from each distribution center?  Which product lines should be produced or stopped at each plant or distribution center?  What logistics channels should be used to source material and serve international markets?  What combination of public and private distribution facilities should be used?LOCATION ANALYSIS TECHNIQUESLocation analysis problems are very complex and data intense. Complexities are createdbecause of the number of locations multiplied by the alternative location sitesmultiplied by the stocking strategies for each location. Data intensity is created becausethe analysis requires detailed demand and transportation information. The techniquesused are: 55
  •  Analytic techniques  Optimization or linear programming techniques  Simulation techniquesAnalytic techniques: they generally describe methods that identify the center of gravityof logistics geography. A center of gravity method is appropriate for locating a singledistribution plant or center. A number of methods both mathematical and nonmathematical can be applied to a problem of a single location. The cost and complexityof the technique is to be matched to the difficulty of the problem.In the following example technique employed is evolved from analytic geometry.The model is based on Cartesian co-ordinates, where the horizontal axis is labeled asthe x-axis, and the vertical axis is labeled as the y-axis. The figure below illustrates sucha coordinate system.Any given point in the quadrant can be identified with reference to x and y coordinates.Taken together, these co-ordinates define unique points. The figure below illustrates thex and y co-ordinates of Detroit, Michigan, Columbus, Ohio. The co-ordinates forDetroit are 3.5 and 3. the co-ordinates of Columbus are 3.8 and 2. the x and y co-ordinate system can be used to calculate the distance between any two points on theplane using the Pythagoras theorem.By use of this basic system of orientation, it is possible to replicate the geographicmarket area in which the distribution centre is to be located.This method to solve the location problem determines the ideal co-ordinate position ofthe distribution warehouse on the basis of distance, weight or a combination of both.The computation is a weighted average of the distance, weight or combined factors,with the warehouse location as the dependent variable. The algebric solution may useeither the weighted average x and y co-ordinate or the median location. The medianlocation uses the coordinate location with half the demand on each side. The formulaeof this calculation depend on the independent variables expressed in the locationmeasure. The problem is in a manner such that identical service standards exist for allpotential distribution warehouse locations. The objectives are to minimizetransportation cost.Transportation cost are a function of time, weight and distance. Historically, inmathematical techniques it is not possible to consider all the factors together. The 4solution methods that consider combination of factors are:-ton – center solutionmile – center solutionton – mile center solutiontime – ton – mile center solutionTon – center solution: the location point represents the center of gravity or movementin market area. The assumption is that the center of movement represents the least costlocation. In Ton – center solution only weight is given consideration. All demandlocations are plotted on the co-ordinate plane and identified by subscripts. To expresstonnage requirements to each demand center, annual tonnage is reduced to standardunits. Once each demand location is defined and the total units load to each demandcenter are known, the best warehouse location can be determined.The location solution is found by adding the products of location and deliveryfrequency to each demand center from the x- co-ordinate and dividing the total number 56
  • of units. The process is requested from the y co-ordinate. The result is a location interms of x and y for the distribution warehouse. The final location solution indicates thepoint that provides the balance of weight between destinations over a specific period.X,Y= unknown co-ordinate values of the warehouse.Xn,Yn= delivery locations, designated by the appropriate script.Fn= annual tonnage to each destination, expressed as standard trailors.Mile – center solution: this determines the geographical point that minimizes thecombined distance to all demand centers. The assumption underlying the solution is thatdelivery costs are solely a function of distance. Therefore, if distance is minimized aleast cost location is determined. The basic deficiency of this omission of weight andtime considerations.The mile center solution cannot be determined by solving for the weighted average co-ordinate location along each dimension. It requires a iterative process to detmine anincreasingly improved warehouse location. This optimum location is determined byutilizing the general formula for the length of a straight line between two points.The procedure:The solution uses initial X and Y co-ordinates to initiate an iterative process that refinesthe previous mile – center warehouse X,Y location co-ordinates. The location problemis solved when the incremental charges in the co-ordinates are within the acceptablerange of the initial or previous values.Example: initial values of X and Y are 30 and 40 respectively. The location solution isobtained by using these values to determine the new warehouse co-ordinates.New values X=36 and Y=43. The new values indicate a shift, therefore the procedure isnot complete For next iteration the most recent values are used X=36 and Y=43. If theiteration results in values X=36 and Y=43 then the difference is minimal or zero, theproblem is optimized.Tolerance range= +/- 1 mile on X and Y co-ordinates.Therefore 4 square mile area.Xk,Yk= co-ordinate values of the warehouse for iteration k.Xi,Yi= demand point, designated by the appropriate subscript.di= distance between each demand point (Xi,Yi) and warehouse location for iteration k.Ton –Mile – Center Solution: it combines the variables of weight and distance inselecting warehouse locations. This solution considers the frequency of delivery to eachdestination in when selecting a warehouse location. This solution also requires aniterative process since the distance between demand point and warehouse is included.Where Yk,Xk= co-ordinate values of the warehouse for iteration k.Xi,Yi= demand pint designated by the appropriate subscript.Fi= annual tonnage to each demand point, expressed as standard.di= distance between each demand point (Xi,Yi) and warehouse location for iteration k. 57
  • Time – Ton – Mile – Center Solution: it includes all factors influenced by cost. Costsare a function of time weight and distance. The warehouse site derived as a product ofthis solution is a least cost location. The procedure for selecting the solution is iterativebecause time and distance factors are differentiated from a given ware house location.Xk,Yk= unknown co-ordinate value of a warehouseFi= annual tonnage to each location expressed as a standard trailers, identified by theappropriate subscript.Mi= delivery location differentiated in terms of miles per minute from the initialwarehouse location to each new location until the iterative process is complete.Mi considers both distance and time to all demand points from the warehouse locationfor each iteration. Mi=dn =distance tn timeFACILITIES LOCATION DECISIONSPlant location decisionsManager’s goal when locating facilities and allocating capacity should be to maximizethe overall profitability of the resulting supply chain network. The followinginformation must be available before the design decision can be madeLocation of supply sources and marketsLocation of potential facilities sitesDemand forecast by marketFacility, labor, and material cost by siteTransportation cost between each pair of sitesInventory cost by site as well as function of quantityThe fundamental trade off managers space when making facilities decision is betweenthe cost of the number, location and type of facility(efficiency) and the level ofresponsiveness that these facilities provide the company’s customers (Internal as well asExternal)A firm’s competitive strategy has a significant impact on network design decisionswithin the supply chain. Firms focusing on cost leadership will tend to find the lowestcost location for their manufacturing facilities even if that means locating very far fromthe market they serve.Firms focusing on responsiveness will tend to locate facilities closer to the market andmay select high-cost location if this choice allows the firm to react quickly to changingmarket needs.Global supply chain networks can best support their strategic objectives with facilitiesin different countries playing different roles. For example, Nike has production facilitieslocated in many countries in Asia. He facilities in China and Indonesia focus on costand produce the mass-market, lower-priced shoes for Nike. In contrast, facilities inKorea and Taiwan focus on responsiveness and produce the higher-priced new designs.The differentiation allows Nike to satisfy a wide variety of demands in the mostprofitable manner.The following is the classification of possible roles for various facilities in a globalsupply chain network. 58
  • Offshore facility-low cost facility for export production: - an offshore facility servesthe role of being a low-cost supply source for markets located outside the country wherethe facility is located. The location selected for an offshore facility should have lowlabor and other costs to facilitate low-cost production.Source facility- low cost facility for global production: - A source facility also haslow cost as its primary objective, but its strategic role is broader than that of an offshore facility. A source is often a primary source of product for the entire globalnetwork. Source facilities tend to be located in places where production costs arerelatively low, infrastructure is well developed, and skilled workforce is available.Server-facility – regional production facility: - A server facility’s objective is tosupply the market where it is located. A server facility is built because of tax incentives,local content requirement, tariff barriers, or high logistics costs to supply the regionfrom elsewhere.Contributor facility- regional production facility with development skills.: - Acontributor facility serves the market where it is located but also assumes responsibilityfor product customization, process improvements, product modification or productdevelopment.Outpost facility- regional production facility built to gain local skill: - An outpostfacility is located primarily to obtain access to knowledge or skills that may exist withina certain region.. Given its location, it also plays a role of server facility. The primaryobjective remains one of being a source of knowledge and skills for the entire network.Lead facility – facility that leads in development and process technologies: a leadfacility creates new products, processes, and technologies for the entire network. Leadfacilities are located in areas with good access to a skilled workforce and technologicalresources.Focused attention on Distribution Center due to increased production, economy of scaleand reduced transportation cost.Technology wise:Characteristics of available production technologies have a significant impact onnetwork design decisions. If production technology displays significant economies ofscale, few high capacity locations are most effective. This is the case in the manufactureof computer chips, in which factories require a very large investment. As a result, mostcompanies build few chip production facilities, and each one they build has a very largecapacity.In contrast, if facilities have lower fixed costs, many local facilities are preferredbecause this helps lower transportation costs. For example, bottling plants for coca colado not have a very high fixed cost. To reduce transportation cost, coca cola sets upmany bottling plants all over the world, each serving its local market.Flexibility of production technology affects the degree of consolidation that can beachieved in the network. If the production technology is very inflexible and productrequirements vary from one country to another, a firm has to set up local facilities toserve the market in each country. Conversely, if the technology is flexible, it becomeseasier to consolidate manufacturing in a few large facilities. Transportation wise: 59
  • The fundamental trade-off for transportation is between the cost oftransporting a given product (efficiency) and the speed with which that product istransported (responsiveness)Transportation has a large impact on both responsiveness and efficiency. Fastertransportation, whether in form of different modes of transportation or differentamounts being transported, allows a supply chain to be more responsive but reduces itsefficiency. The type of transportation a company uses also affects the inventory andfacility locations in the supply chain. For example: Dell flies components from Asiabecause doing so allows the company to lower the level of inventory it holds. Clearly,such a practice increases responsiveness but decreases transportation efficiency becauseit is more costly than transporting parts by ship. The role of transportation in a company’s competitive strategy figures prominentlywhen the company is considering the target customer’s needs. If a firm’s competitivestrategy targets customers that demand a very high level of responsiveness and thatcustomer is willing to pay for this responsiveness then a firm can use transportation asone driver for making the supply chain more responsive. The opposite is true as well. Ifa company’s competitive strategy targets customers whose main decision criterion isprice, then the company can use transportation to lower the cost of the product at theexpense of responsiveness.As a company may use both inventory and transportation to increase responsiveness orefficiency, the optimal decision for the company often means finding the right balancebetween the two.Also,The companies can gain economies of scale when a product is manufactured or storedin only one location; this centralization increases efficiency however the cost reductioncomes only at the expense of responsiveness, as many of a company’s customer maybelocated far from the production facility. The opposite is also true. Locating facilitiesclose to customers increases the number of facilities needed and consequently reducesthe efficiency. However, if the customer demands and is willing to pay for theresponsiveness that having numerous facilities adds, then this facilities decision helpsmeet the company’s competitive strategy goals.There are also many instances, in which the pricing schedule yield economies of scale,with prices decreasing as lot size is increased. This form of pricing is very common inbusiness to business transactions. A discount is lot size based if the pricing scheduleoffers discounts based on quantity orders in a single lot. A discount is volume based ifthe discount is based on the total quantity purchased over a giver period, regardless ofthe number of lots purchased over a given over that period. Two commonly useddiscount based schemes areAll units quantity discountsMarginal unit quantity unit discount or multi block tariffs.Companies must also decide what a facility’s capacity to perform its intended functionor functions will be. A large amount of excess capacity allows the facility to be veryflexible and to respond to wide swings in the demands placed on it. Excess capacity,however costs money and therefore can decrease efficiency. A facility with little excesscapacity will likely be more efficient per unit of product it produces then one with a lotof unused capacity. The high utilization capacity will, however , have difficultyresponding to demand fluctuations. Therefore, a company must take a balanced tradeoff to determine the right amount of capacity to have at each of its facilities. 60
  • Typical decisions of location decisionsDeciding where a company will locate its facilities constitutes a large part of the designof the supply chain. A basic trade off here is whether to centralize to gain economies ofscale or decentralize to become more responsive by being closer to the customer.Companies must also consider a host of issues related to various characteristics of thelocal areas in which the facility may be situated. These include: -  Macro economic factors  Strategic factors  Quality of workers  Cost of workers  Cost of facilities  Availability of Infrastructure  Proximity to customers and the rest of the network  Tax effectsDistribution centers- how many and where??????????When deciding upon locational decision a manager basically decides upon suppliers,plants, ware houses and markets. There may also be other facilities such as superstockists, consolidation centers or transit points. SUPPLIERS PLANTS WAREHOUSES MARKETSBesides locating the facilities a manager must also decide how market may be allocatedto ware houses and how ware houses will be allocated to plants. The allocation decisioncan be altered on a regular basis as different costs change and markets evolve. Whendesigning the network, both location and allocation decisions are made jointly.In some cases, companies want to design supply chain networks, in which a market issupplied from only one factory. This is commonly known as the capacitated plantlocation model with single sources. Companies may impose this constraint because itlower the complexity of coordinating the network and requires less flexibility from eachFacility.A much more general form of the plant location model needs t be considered if theentire supply chain network from the supplier to the customer must be designed.Consider a supply chain in which suppliers send materials to factories that supply warehouses that supply markets. Location and capacity allocation decision has to be madefor both factories and ware houses. Multiple ware houses may be used to satisfydemand at a market, the multiple factories may be used to replenish warehouses.Supply chain design decision should be evaluated for a variety of future scenarios thatreflect the underlying uncertainty. Accountings for uncertainty relieve the managers to 61
  • built extra capacity in to supply chain network and make the available capacity moreflexible in terms of the markets that can be served. If capacity is flexible, demand canbe reallocated within the supply chain network to react best to changing demand, prices,costs, and / or exchange rates. If capacity is inflexible, production cannot be changed inresponse to change in condition. The presence of flexibility thus increases potentialprofits.Customer / market- to be served from each distribution center.Firms must consider the response time customers desire when designing their supplychain methods. Firms that target customers who can tolerate a large response andrequire few locations and can focus on increasing the capacity of each location. Incontrast, firms that customers who value short response time need to locate close tothem. These firms must have many facilities, with each location having low capacity.First, a decrease in the response time customers desire increases the number of facilitiesrequired in the network.For example customers are unlikely to come to a convenient store if they have to travela long distance to get there. It is thus best for a convenient store chain to have manystores distributed in an area so that most people have convenience stores close to them.In contrast, customers shop for larger amount at super market and are willing to travellonger distances to get to one. Thus, super market chains tend to have stores that aremuch larger tan convenient stores and not as densely distributed.If a firm is delivering product to customers, use of rapid means of transportation allowsit to build fewer facilities and still provide a short response time. However, this optionincreases transportation cost. Moreover, there are many situations in which the presenceof a facility close to a customer is important. For example a coffee shop is likely toattract customers who live or work nearby. No faster mode of transport can serve as asubstitute and be used to attract customers that are far away.Use of logistics channel- for material sources: The procurement cycle occurs at the manufacturer/supplier interface andincludes all processes necessary to ensure that materials are available for manufacturingto occur according to schedule. During the procurement cycle, the manufacturer ordersthe components from suppliers that replenish the component inventories. Therelationship is quite similar to that between a distributor and manufacturer, with onesignificant difference: whereas retailer or distributor orders are triggered by uncertaincustomer demand, component orders can be determined precisely once themanufacturer has decided what the production schedule will be. Component orders aredependent on the production schedule. Of course, if a supplier’s lead times are long, thesupplier has to produce to forecast because the manufacturer’s production schedule maynot be fixed that far in advance.In practice, there are several tiers of suppliers, each producing a component for the nexttier. A similar cycle would then flow back from one stage to the next. The processes areshown as belowPROCUREMENT CYCLE 62
  • Order based on manufacturer’s production Receiving at schedule or manufacturer Component manufacturing Supplier and transporting and/or production shipping schedulingA firm can vary supply of product by controlling a combination of the following twofactors:Production capacityInventoryThe objective is to maximize profits. Some of the specific approach to managingcapacity and inventory are listed below:Time flexibility of workforce so as to comfortably utilize the idle or unused spaceUse of seasonal workforce so as to meet the sudden shoot in demand and not loose onthe revenue thus generated.Use of subcontracting so as to acquire an economical way since it works out to becheaper.Use of dual facilities- dedicated and flexible so as to produce at a relatively steady ratewith fluctuations being absorbed by the flexible facility.Designing product flexibility into the production processes, modification in layout, soas to meet the sudden demand as well as effectively extract the best possible from allthe resources in an accommodating and flexible manner.Managing inventory:’Using common components across multiple products, which would facilitate arelatively constant overall demand.Build inventory of high demand or predictable demand products, which helps insynchronization of supply and demand making the utmost and optimum use of seasonaland off seasonal advantage. Use of Public and Private distribution facilities: 63
  • His aspect involves a two-fold considerationFrom the transportation point of viewFrom the warehousing point of viewAs can be clearly understood, transportation involves either owning the means oftransport or appointing an agency for transport commonly known as outsourcing oftransportation service. This has to be analyzed considering the long-term benefits, thecost-benefits, the responsive benefit, and efficiency, comparing the estimated results inboth the cases – owned as well as outsourced. Again if the lead time is high, thelocation facility if at a greater proximity to the suppliers, and if the cost structure issuitable to the company the company shall go ahead to establish its own infrastructureto increase the transportation efficiency. This is mostly the case with companies thatpractice just in time method and is affiliated to a reduced inventory system. Similarly,the reason not many companies owning is its involves huge capital investment,increased complications, increased labour and the like.Companies now a day also design their own shapes in the trucks and other means oftransport so as to accommodate maximum in the limited possible space.A warehouse, may be, privately owned and operated by company making its owngoods. Commonly known as private warehouse. A warehouse may be owned andoperated by another organization, including a government agency, and only used by acompany on certain terms and conditions. Commonly known as public ware house.Irrespective of whether a warehouse is privately or publicly owned, the followingfactors have to be taken into account to work out the cost of storage:Interest on the cost of buying the siteInterest on the cost of furnitureCost of repairs and maintenanceDepreciation on building and equipmentInsuranceIf productivity (or efficient use) of the warehouse can be increased by 20% there is anequivalent reduction in costs per unit handled and processed.There are fixed costs in the shape of the cost of space per square meter or per cubicmeter, which have to be borne, whether or not the warehousing is operating.Maximum efficiency is obtained by processing a larger number of units through thewarehouse space. The larger the number of processed units, the lower the cost per unit.There is nothing as a better or the best option but both have their sets of advantages anddisadvantages and a company should critically evaluate all the expenses related andaccordingly decide the better and the most suitable option for itself.However it is always advised to use a perfect blend of both, private as well as publicwarehouses. Also, private warehouses need not be owned, they can be rented or leasedwith or without equipment.Product lines – produced at plants, stocked at distribution centers:Q.17Product lines- production and Distribution CentresThe tour material in this fig delineates the areas of material handling function and itstour of duties. Typically, material is handled at the following stages. 64
  • 1. Raw material is transported from the vendor to the warehouse of the production unit. It is received by trucks, by rail wagon or even by ship. At the warehouse, the handling of material takes place, and a system is required to be evolved. Thereafter, the material is stored. 2. At the time the material is required for production process, it is again handled. It is retrieved and transferred or fed in to the production process. 3. During the production process too, the material is handled in many ways. After the material has been finally processed and turned in to a finished product, the finished product is handled and loaded for dispatch by a given mode of transport to a warehouse or to a dealer. 4. Sometimes, the finished product is packed and directly loaded on to the transport to vehicle. 5. Sometimes, the material produced at the end of a production process is not the final finished product but only an intermediate finished product. This intermediate product is required to be handled and stored to be retrieved again, whenever required for finishing. 6. Sometimes, the semi-finished product is required to be sent out of the production unit to another manufacturer. This would require the physical transport of this intermediate product to the other production unit. In this case, the product may again be transported back to the production unit for final processing or storage before dispatch 7. Sometimes, the semi-finished product may be finished in another processing plant and loaded and dispatched from there. Finishing Work at Another unit Receipt Customer DealerVendor Productio Despatch Storage Storage Warehouse Transport n unit Transport Temporary Storage of semi- finished Product 8. Assuming that the product has been stored in its final finished form, it has to be handled before dispatch from the production centre. 9. The goods may be dispatched straight to he customer, in which case the handling of the product is done by the customer himself as a one-time job. If dispatches to the customer are regular feature and if specialized handling of 65
  • goods at the time of delivery is required, suitable arrangements will have to be made to ensure that handling is good. 10. Sometimes the goods are sent to a retailer or a dealer. In this case, the quantity of goods dispatched may be larger. If the dispatches are regular and in large quantities specialized handling may be required. Accordingly, the necessary arrangements will have to be made. 11. The goods may be dispatched to a field warehouse of the company, or to a public warehouse, or to the warehouse of a stockiest or distributor. In this case, they are required to be stored suitably for sometime before they are despatched to a customer, retailer, or dealer, as the case may be. The alternative requires the handling of the finished product during its retrieval and despatch to a proper destination. At the destination the product is handled again.TOTAL COST ANALYSIS APPROACHThe concept of total cost analysisMany problems at the operational level in logistics management because all the impactsof specific decisions, both direct and indirect, are not taken into account throughout thecorporate system. Too often decisions touch in one area can lead to unfortunate resultsin the other areas, change in policy on minimum order value, for example, mayinfluence customer ordering patterns and lead to additional costs. Similarly changes inproduction schedules that aim to improve production efficiency may lead to fluctuationsin finished stock availability and thus affect customer service.A. The problems associated with identifying with total system impact ofdistribution policies are immense. By its very nature logistics cuts across traditionalcompany organization functions with cost impacts on most of those functions.B. Conventional accounting systems do not usually assist in the identification ofthese company wide impacts frequently absorbing logistics related costs in other costelements. The cost of processing orders for eg. is an amalgam of specific costs incurred indifferent functional areas of the business which generally prove extremely difficult tobring together. Figure (1.1) outlines the various cost elements involved in the complete orderprocessing cycle, each of these elements having a fixed and variable cost componentwhich will lead to a different total cost per order. Order placement and communication. 66
  • Order Entry Credit Check Documentation Order Pricing Delivery Invoicing and CollectionFig. (1.1)Stages in the order-to-collection cycleC. Accounting practice for budgeting and standard-setting has touched to result in acompartmentalization of company accounts; thus budgets tend to be set on a functionalbasis. The trouble in that policy costs do not usually configure themselves within thesense water tight boundaries. It is the nature of logistics that, like a stone thrown into apond, the effects of specific policies spread beyond their immediate area of impact.(2) A. A further feature of logistics decisions which contributes to the complexity ofgenerating appropriate cost information is that they are usually taken against thebenchmark of an existing system.The purpose of total cost analysis in this context is to identify the change in costsbrought about by these decisions. Cost must therefore be viewed in incremental terms –the change to the system. Thus the addition of an extra warehouse to the distributionnetwork will bring about cost changes in transport, inventory investment andcommunications.It is the incremental cost difference between the two options which is the relevantaccounting information for decisions making in this case. 67
  • Fig. (1.2) shows how total logistics costs can be influenced by the additional, or removal, of a depot from the system.Y Total distribution costs Trunking costs Inventory costs Outlet costs Local DeliveryCosts costs Order Processing costs 0 Number of outlets X Fig (1.2) The total costs of a distribution network To understand the demand of measuring logistics, it is necessary to review traditional accounting methods in terms of analysis requirements and to identify costs relevant to integral logistical systems. PUBLIC ACCOUNTING PRACTICE 68
  • Logistical functions are on integral part of the two main financial reports ofbusiness – the balance sheet and the profit and the loss statements (P& L). However, theprimary deficiency in determining logistical costing and analysis in the method bywhich standardized accounting costs are identified classified and reported.The first problem results from the fact that accounting practice aggregates costs on astandard or natural account basis rather than on an activity basis. The process ofclassification and assignment helps but does not satisfy the requirements for total – costanalysis. In reality, many expenses associated with logistical performance cut acrossorganizational units. For eg. – efforts to reduce inventory will reduce inventory carryingcost, but they may also lead to more back orders, which would increase totaltransportation cost. The result is deficient data for integrated performance measurement.In order to design and evaluate logistical operations, it is necessary to identify costsassociated with performing specific activities or tasks, such as the warehouse expensesfor a specific SKU (stock keeping unit). This means that the individual logisticalactivities must be identified and that costs be allocated or assigned.An overlapping deficiency of accounting involves the traditional methods of reportingtransportation expenditures. It remains a standard practice in retail accounting to deductfreight from gross margin figure. In part, it seems to be based on the belief thatmanagers can do little about inbound freight. However, the problem extends beyondwhere freight is accounted for and reported. In many purchasing situations, freight isnot reported at all as a specific cost. Many products are purchased on a delivered pricebasis, which includes transportation cost.A final deficiency in traditional accounting practice is the failure to specify and assigninventory cost.Full costs associated with the maintenance of the inventory such as insurance and taxes,are not identified and assigned, thereby resulting in an understatement or obscurity inreporting inventory cost. For eg.- If a brand manager is not held responsible for hisbrand’s inventory carrying cost, he is not motivated to reduce inventory levels.The financial burden for assets committed to material, WIP and finished goodsinventory is not identified, measured, and separated from other forms of capital expenseincurred by the enterprise.LOGISTICS ACTIVITY – BASED COSTINGActivity based costing seeks to relate all relevant expenses to the value adding activitiesperformed. For eg.- costs are assigned to a customer or product to reflect all relevantactivity costs independent of when and where they occur.The fundamental concept of activity-based costing is that expenses need to be assignedto the activity that consumes a resource rather than to an organization or budget unit.For eg.- Two products, produced in the same manufacturing facility, may requiredifferent assembly and handling procedures. One product may need an assembly orpackaging operation that requires additional equipment or labor. If total labor andequipment costs are allocated to the products on the basis of sales units produced, thenboth items will be charged for the additional assembly and packaging operationsrequired by only one of them. This unjustly reduces the profitability of the simplifiedproduct by forcing that product to pay for the operations it does not need. In a 69
  • manufacturing sense, identifying and assigning cost factors means that a specificproduct will be fully assigned its fair share of all overhead and operating costs.In the case of logistics, the key event is a customer order and the related activities andrelevant costs that reflect the work required to fulfill the order. Logistical activitiesbased costing must provide managers the insights needed to determine if a specificcustomer, order, product or service is profitable. This requires matching specificrevenue with specific costs.Effective costing requires identification of he specific expenses to include in an analysisframework.A second concern is to specify the relevant cost time frame.Finally, costs must be allocated or assigned to specific factors that are relevant toassembly alternative actions.The guiding criteria for effective logistical activity-based costing are relevancy andconsistency. Relevancy is important in the sense that the cost assignments helpmanagers to better understand the major factors affecting logistics expenses.Consistency is important in terms of comparing related activities over time. Thesecriteria help in the decision making process where logistical activities are concerned.(5) Cost IdentificationTo have a representative presentation, all costs associated with the performance of alogistics function should be included in the activity-based cost classification. The total costs associated with forecasting and order management,transportation, inventory, warehousing and packaging must be isolated. Typicallogistics costs can be categorized as:Direct CostsIndirect CostsOverheadsa) Direct or Operational CostsThose expenses specifically caused by the performance of logistics work. Such costs arenot difficult to identify.The direct costs of transportation, warehousing, material handling , and some aspects oforder processing and inventory can be extracted from traditional cost accounts. For eg.-the transportation costs for an individual truckload order can be directly attributed to aspecific order. Likewise, only minor difficulty is experienced in isolating the directadministration cost of logistical operations.b) Indirect ExpensesThese expenses are more difficult to isolate. Costs associated with indirect factors areexperienced on a more or less fixed basis as a result of allocation of resources tologistical operations. For eg., the cost of capital invested in real estate, transportationequipment, and inventory – just a few areas within the capital structures of logistics –must be identified to arrive at a comprehension total cost.The manner by which indirect costs are attributed to logistics activities is determined bymanagerial judgments. For eg.- how should the indirect costs, such as equipment,associated with a warehouse be allocated to the customer order shipped from thatwarehouse? One approach is to allocate the overhead costs on the basis of the averagecost per unit. 70
  • b) i) All capital allocated to the logistical system represents a scarce commodity.Therefore all expenses paid to support capital investment in logistic operations arerelevant to logistical activity-based costs .The judgments applied in arriving at cost ofcapital will greatly influence logistical system design. Thus, procedures and standardsused to calculate indirect logistical costs are critical. They are also essential forpotential outsourcing.c) OverheadsA final costing allocation is overhead. An enterprise incurs considerable expenses onbehalf of all organizational units, such as for lighting and heat in various facilities.Judgement is required to determine how and to what extent various types of overheadshould be allocated to specific activities.One method is to directly assign total corporate overhead on a uniform basis to alloperational units.At the other extreme, some firms withhold all overhead allocations to avoid distortingthe ability to measure direct and indirect logistical activity-based costs.From the viewpoint of effective logistical activity-based costing, it is sound practice notto allocate any overhead cost that cannot be directly assigned to a logistical activity.A general rule to follow is that a specific cost should not be assigned to logisticalfactors unless it is under the managerial control of the logistical organization. Becauseof subjective cost allocation, enterprise in the same industry will report vastly differentlogistical expenses. It is important to realize that such cost differentials may have nodirect relationship to the actual efficiency of logistical operations.Cost Time FrameA basic concern in logistical activity based costing is to identify the period of time overwhich costs are accumulated for measurement.(1) Generally accepted accounting principles call for accrual methods to relaterevenues and expenditures to the actual time period during problems can be associatedwith establishing logistical activity-based costs. Expenses associated with raw material procurement through finished productdistribution and almost all other logistical product distribution and almost all otherlogistical operating costs are incurred in anticipation of future transactions, makingaccrual methods difficult to administer.(2) To overcome the time problem, accountants attempt to break costs into twogroups: a) Costs assigned to a specific product and, b) Costs associated with the passage of time.This classification is an attempt made to match appropriate product and time periodcosts to specific periods of revenue generation.(3) From a logistical perspective, a great many of the expenses associated withprocurement and manufacturing support can be assigned and absorbed into directproduct cost. Thus, because they can be assigned to a specific product, inventories arevalued on the basis of fully allocated cost. 71
  • Such practices can significantly influence logistical system design, dependingon the characteristics of the business.(4) In situations where a considerable period of time elapses between productionand sales, such as in highly seasonal businesses, significant costs of maintaininginventory and performing logistical operations may not be associated with revenuegeneration. Unless this potential mismatch is clearly understood and accommodated in theassignment process, logistics can be significantly mismeasured.(7) Cost Formatting (1) The typical way to format activity-based costs is to assign expenses tothe event being managed, for eg.- if the object of analysis is a customer order, then allcosts that result from the associated performance cycle contribute to the total activitycost. Typical units of analysis in logistical activity-based costing are customer orders,channels, products and value added services.In addition to activity-based costing, management may wish to format financial reportsregarding operational measurement and control. Logistical expenses can be presented ina number of ways for managerial use.Three common ways are:-Functional Grouping,Allocated Grouping andFixed–Variance Grouping.Functional GroupingTo format costs byFunctional grouping-requires that all expenditures for direct and indirect logisticalservices performed for a specified operating time be formatted and reported by masterand sub-account classification for comparison of one or more operating periods.No standard format of activity costs or functional groupings is available that fits theneeds of all enterprises.(i) Logistical functional cost statements must be designed to facilitate controlwithin each unique environment.(ii) It is important to identify as many cost accounting categories as practical and todevelop a coding system that will facilitate assignment to three cost accounts.(iii) Effective total-cost groupings can be maintained over time only if appropriatecoding to reclassify material accounts into functional groups in incorporated in the basiclogistics information system.Allocated cost formatting or groupingi) This consists of assigning overall logistical experiences to a measure of physicalperformance, for eg.- Total logistical cost can be generated on a per ton, per hundredweight, per product, per order, or per line-item basis, or on some other physical measurethat is useful for comparative analysis of operating results.ii) While important for assigning overall expenses to physical performance measures,this grouping typically has limited use outside logistics management.Fixed-Variance Grouping 72
  • i) This is the most useful for identifying the logistics cost implications of current oralternate operating practices.ii) This method of formatting consists of assigning costs as either fixed or variable toappropriate the magnitude of change in operating expenditure that will result fromdifferent volumes of logistical throughput.iii)Costs that do not directly vary with volume are classified as fixed. In the short run,these expenses fixed even if volume were reduced to zero.iv) Costs influenced by volume are classified as variable for eg.- the cost of a deliverytruck is fixed: if the truck costs $40,000 to purchase , the firm is charged $40,000whether the truck is used for 1 or 1,000 deliveries.However, gasoline to operate the truck is variable total gasoline costs depend on howfrequently the truck is driven.The use of fixed and variable cost formatting offers a convenient way to handleexpenses in logistical system design models.TOTAL COST PRESENTATIONFor purposes of implementing and presenting logistical total-cost analysis, it is commonpractice to focus on INVENTORY and TRANSPORTATION as the two main networkdesign factors.a) Both inventory and transportation expenses can be defined in a formatsufficiently broad to include activity and functional cost relationships for relatedlogistical components. For eg.- communication costs that are associated with order processing and withexpenditures required for warehouse storage and material handling can be classifiedunder the inventory umbrella.2) In terms of inventory, total cost includes all expenses related to inventorycarrying cost and customer ordering. A Inventory carrying cost includes taxes ,storage, capital, insurance andobsolescence. B The cost of ordering includes the full expense of inventory control,order preparation, communications, update activities and managerial supervision.3) The total cost of transportation includes for-hire transport expenses andaccessorial charges plus costs related to the hazards incurred with the various modes,legal forms of transport, and associated administrative expenses. If privatetransportation is used, accounts direct, indirect, and overhead costs.4) A brief summary of the total cost of logistical activities is presented in Fig. 2(Table). Classification of costs in terms of inventory or transportation highlights thebasic trade offs that determine the cost justification for logistical network design.5) The basic logic for focusing on transportation and inventory as key factors thatthey logistical operations. A Transportation deals with the geographic (spatial) dimensions oflogistical operations by positioning product where the customer wants to purchase it. B Inventory involves the rate at which capital assets are used (temporal)to meet customer requirements by having product available WHEN the customer wantsto purchase. 73
  • 6) A second justification for focusing on transportation and inventory is that thesetwo factors include 80 to 90 percent of overall logistics expenses for the typical firm.7) The columns on the right side of Fig. 2 (Table) reflect potential activities thatmay be used to segment costs for managerial review. For eg.- an ordering cost can be assigned to a specific order, or it may begrouped by customer. If the objective is to determine the expenses associated with any specific level ofde-aggregated activity, it is essential to assign specific costs to the actual targets orevents. For eg.- if the de-aggregated activity is the ordering cost for one specificproduct, the actual expenses for that product alone must be identified.As noted earlier, the extension of total costs to an activity based format may not meetpublic accounting precision. The purpose of activity based costing is to give managers abetter perspective of the total cost, associated with performance of a specific activity.Total Costs Classified by Inventory and TransportationACTIVITY-Based AssignmentsCustomer Order Product Value-added ServiceINVENTORY- related costsInventory carrying cost (ICC):TaxStorageCapitalInsuranceObsolescenceOrdering:CommunicationProcessing, including materialhandling and packagingUpdate activities, includingreceiving and date-processingINVENTORY CONTROLManagementTRANSPORTATION- related costsDirect:RatesAccessorial chargesIndirct, liability not protected by carrierManagerial: 74
  • Location Analysis Data Requirements: The primary analysis data requirements aredefinitions of markets, products, network, customer demand, transportation rates, andvariable and fixed costs.Market definition:Location analysis requires that demand be classified or assigned to a geographic area.The combination of geographic areas constitutes a logistics service area. Such an areamay be a country or a global region. The demand for each customer is assigned to oneof the market areas. The selection of the market definition method is an extremelyimportant element of the system design procedure.A number of market definition structures have been developed. The most useful forlogistics modeling are: County, Standard metropolitan statistical area (SMSA) and ZIPor postal codesThe major issues for selecting a market definition concern the number of areas requiredto provide accurate results. While more market detail increases accuracy, it alsoincreases analysis efforts. Research indicates that approximately 200 markets offer aneffective trade-off between accuracy and analysis effort.Product definition: Although individual product flows can be considered whenperforming a location analysis, it is usually not necessary to use such detail. Individualitems –especially those with similar distribution characteristics, production sites, andchannel arrangements – are grouped or simplify the analysis.Network definition The network definition specifies the channel members, institutionsand possible locations to be included in the analysis. Specific issues concern thecombinations of suppliers, production, locations, distribution centers or channelmember alternatives. While using a more comprehensive definition reduces the chanceof suboptimising logistics system performance, total channel location analysis increasescomplexity. Location analysts must evaluate the trade offs between increasing analysiscomplexity and improved potential for total supply chain optimization.Market demand: Market demand defines the shipment volume in each geographic areadefined as a market specifically location analysis is based on the relative productvolume shipped to each market area. While the volume may pertain to the number ofunits or cases shipped to each market, most location analyses are based on weight sincetransportation cost is strongly influenced by the amount of weight being moved. Marketdemand utilized in the analysis may also be based on historical shipments or anticipatedvolume if substantial changes are expected.Transportation rates: Inbound and outbound transportation rates are a major datarequirement for location analysis. Rates must be provided for shipments betweenexisting and potential distribution channel members and markets. in addition , ratesmust be developed for each shipment size and each transportation link betweendistribution centers and markets. it is common for location analysis to require in excessof a million individual rates. Because of the large number rates are commonlydeveloped using regressions or are retrieved from diskettes provided by most carriers.Variable and fixed costs: The final location analysis data requirements are the variableand fixed costs associated with operating distribution facilities. Variable costs includeexpenses related to labour, energy. Utilities and materials. in general, variable expenses 75
  • are a function of throughput. Fixed cost includes expenses related to facilities,equipment and supervisory management. Within a relevant distribution facilityoperating range, fixed costs remain relatively constant. While variable and fixed costdifference by geography is typically not substantial there are minor locationalconsiderations that should be included to ensure analysis accuracy. the majordifferences result from locational peculiarities in wage rates, energy cost, land valuesand taxes.Conclusion: substantial logistics planning emphasis is placed on location analysis. inthe past distribution networks were relatively stable, so it was unnecessary for firms tocompete system analyses regularly. However the dynamics of alternative distributionchannel options, changing logistics cost structures and availability of third partyservices require that logistics networks be evaluated and refined more frequently today.It is common for firms to perform evaluations annually or monthly.Total cost-analysis:The basic integrative concept in logistical network design is total cost. An exampleillustrated a total cost justification for using high cost airfreight. The basic thesis wasthat in situations where the speed and dependability of air delivery would permit othercosts (such as warehousing and inventory) to be reduced or eliminated, high costpremium transportation would be justified by achievement of lower total cost. Totalcost could be reduced by careful integration of logistical activities.The basic concept of total cost is simple and complements the notion of designinglogistics as an integrated performance system. The main problem in operationalizingtotal cost is that traditional accounting practice for classifying and reporting criticalexpenses does not typically provide adequate logistics metrics.Public accounting practice:The two main financial reports of business enterprises are the balance sheet and theprofit and loss statements (P&L). The purpose of the balance sheet is to summarizeassets and liabilities and to indicate the net worth of ownership. The P&L statementreflects the revenue costs associated with the specific operations over a specific periodof time. As the name profit and loss implies, its purpose is to determine the financialsuccess of operations.These two are mainly suited for investors, taxation and auditing purposes and not forlogistical purposes  The first problem results from the fact that accounting practices aggregates cost on a standard or natural account basis rather on activity basis. The practice of grouping expenses into natural accounts such as salaries, rent, utilities and depreciation fails to identify or assign the operations responsibility .In reality many expenses, associated with logistical performance cut across organizational units. For example efforts to reduce inventory will reduce inventory-carrying costs, but they may lead to back-orders, which would increase the total transportation cost.  The practice of classifying the costs on a natural basis also creates a problem in activity-based cost analysis. In order to design and evaluate logistical operations it is necessary to identify costs associated with performing specific activities or tasks, such as the warehousing expenses for a specific SKU. This means that the individual logistics must be allocated or assigned. 76
  •  Transportation expenses- Freight is not accounted for. Many products are purchased on a delivery price basis, which includes transportation cost.  Failure to assign inventory costs  Finances committed to Raw materials, WIP, Finished goods not carefully separated from other capital expenses.Activity-Based Costing:Activity-based costing seeks to relate all relevant expenses to the value adding activitiesperformed. For example, costs are assigned to a customer or product to reflect allrelevant activity cost independent of when and where they occur. The fundamentalconcept of activity-based costing is that expenses need to be assigned to the activity thatconsumes a resource rather than to an organizational or budget unit. For example, 2products produced in the same manufacturing facility, may require different assemblingand handling procedures. One product may need an assembly or packaging operationsthat requires additional equipment or labor. If total equipment and labor costs areallocated to the products on the basis of sales or units produced than both items will becharged for the additional assembly and packaging operations required by only one ofthem.In case of logistics, the key event is a customer order and related activities and relevantcosts that reflect the work required to fulfill the order In other words, logistical activity-based costing must provide managers the insights needed to determine if a specificcustomer, product, order, or service is profitable. This requires matching specificrevenue with specific costs. The guiding criteria for effective logistical activity-basedcosting are relevancy and consistency. Relevancy is important in the sense that the costsassignment helps managers to better understand the major factors affecting logisticsexpenses. Consistency is important in terms of comparing related activities over time.In the final analysis, a logistical costing system has to make sense only to the managerswho are using it as a guide to decision making.(I) Cost Identification:All costs associated with the performance of logistics function should be in the activity-based classification. The total cost associated with fore casting and order management,transportation, inventory, warehousing, packaging must be isolated. Typical logisticscosts can be categorized under two headings – direct and indirect costs, cost of capitaland overheads.a) Direct Costs:These costs are those expenses specifically caused by the performance of logisticswork. Such costs are difficult to identify. For example, the transportation costs for anindividual truckload order can be directly attributed to a specific order. Likewise onlyminor difficulty is experienced in isolating the direct administration cost of logisticaloperations. 77
  • b) Indirect Costs:These are more difficult to isolate. For example, the cost of capital invested in realestate, transportation equipment, and inventory- just a few of the areas within the capitalstructure of logistics- must be identified to arrive at a comprehensive total cost. Themanner by which total costs are attributed to logistics activities are determined bymanagerial judgments. One approach is to allocate the overhead cost on the basis of theaverage cost per unit.All expense paid to support capital investment in logistical operations are relevant toactivity-based costs. The judgment applied in arriving at cost of capital will greatlyinfluence logistical system design. Thus procedures and standards used to calculateindirect logistical costs are critical. They are also essential for potential outsourcing.c) Cost of Capital :Capital investment Expenses for logistical activities are relevant to logistical activity-based costs. Cost of such capital also needs to be included in your logistical cost.d) OverheadAn enterprise incurs considerable expenses on behalf of all organizational units, such asfor light and heat in various facilities. Judgement is required to determine how and towhat extent various types of overhead should be allocated to specific activities. Onemethod is to directly assign total corporate overhead on a uniform basis to alloperational units. At the other extreme, some firms withhold all overhead allocations toavoid distorting the ability to measure direct and indirect logistical activity- based costs.(II) Cost Time FrameA basic concern in logistical activity-based costing is to identify the period of time overwhich costs are accumulated for measurement. Accounting principles call for accrualmethods to relate revenues and expenditure to the actual time period during whichservices are performed. Expenses associated to raw material procurement throughfinished product distribution and almost all other logistical operating costs are incurredin anticipation of future transactions, making accrual methods difficult to administer.To overcome the time problem, accountants attempt to break costs into 2 groups- costsassigned to a specific product and costs associated with the passage of time. Using thisclassification an attempt is made to match the appropriate product and time period coststo specific periods of revenue generation. From a logistical perspective, a great many ofthe expenses associated with procurement and manufacturing support can be assignedand absorbed into direct product cost. In situations where a considerable period of time elapses betweenproduction and sales, such as in highly seasonal businesses, significant costs ofmaintaining inventory and performing logistical operations may not be associated withrevenue generation.(III) Cost Formatting 78
  • The typical way to format activity-based costs is to assign expenses to the event beingmanaged. For example, the object of analysis is a customer order, than all costs thatresult from the associated performance cycle contribute to the total activity cost.Typical units of analysis in logical activity- based costing are customer orders,channels, products and value added services. The cost analysis will vary depending onwhich analysis unit is selected for observation Logistical expenses can be presented in anumber of ways for managerial use. Three common ways are• Functional grouping,• Allocated grouping, and• Fixed variance grouping.A) Functional Grouping:To format costs by functional grouping requires that all expenditures for direct andindirect logistical services performed for a specified operating time be formatted andreported by master and sub account classifications. Thus ,a total cost statement can beconstructed for comparison of one or more operating periods .It is important to identifyas many cost accounting categories as practical and to develop a coding system that willfacilitate assignments to these cost accounts.B) Allocated Costs Grouping:This consists of assigning overall logistical expenditures to a measure of physicalperformance. For example, total logistical cost can be generated on a per ton, perproduct, per order, or on some other physical measure that is useful for comparativeanalysis of operating results.C) Fixed Variance Grouping:This is the most useful for identifying the logistics cost implications of current oralternative operating practices. This method of formatting consists of assigning costs aseither fixed or variable to approximate the magnitude of change in operatingexpenditure that will result from different volumes of logistical throughput. Costs thatdo not directly vary with volume are classified as fixed. In the short run, these expenseswould remain if volume were reduced to zero. Costs influenced by volume areclassified as variable. For example, the cost of a delivery truck is fixed, howevergasoline to operate the truck is variable.Total Cost Presentation:It is the common practice to focus on inventory and transportation as the two mainnetwork design factors, which are sufficiently broad to include activity and functionalcost relationships.In terms of inventory, total cost includes all expenses related to inventory carrying costand customer ordering. Inventory carrying cost includes all taxes, storage; capital, 79
  • insurance and obsolescence .The cost of ordering includes the full expense of inventorycontrol, order preparation, communications, update activities and managerialsupervision.The total cost of transportation includes for – hire transport expenses and accessoriescharges plus costs related to the hazards incurred with the various modes, legal forms oftransport, and associated administrative expenses.The basic logic for focusing on transportation and inventory, as key factors are that theyrepresent the spatial and temporal dimensions of logistical operations. Transportationdeals with the geographical (spatial) dimensions of logistical operations by positioningthe product where the customer wants to purchase. Inventory involves the rate at whichcapital assets are used (temporal) to meet customer requirements by having productavailable when the customer wants to purchase.Logistical MeasurementThe combination of slower economic growth and increased competition has forcedfirms in every industry to concentrate on efficient and effective deployment of logisticalresources. On result of these efforts has been the emergence of a new corporate positiondevoted to logistical controllership. The logistics controller is concerned withcontinuous measurement of a firm’s performance. In order to carry out the measurementprocess controllership focuses on the assessment of resource deployment and goalattainment.Dimensions of Performance MeasurementSubstantial effort has been expended to improve the quality of information that logisticsmanagers have at their disposal to measure, compare and guide logistical performance.In most firms old reporting formats need to be redesigned to take advantage of newcomputer based control systems. In place of traditional status and trend reports, today’smanagers require flexible and on demand ad hock report.ObjectivesThe three objectives for developing and implementing performance measurementsystems include monitoring, controlling and directing logistics operations.Monitoring measures track historical logistics system performance for reporting tomanagement and customers. Typical monitoring measures include service level andlogistic cost components.Controlling measures track ongoing performance and are used to refine a logisticsprocess in order to bring it into compliance when it exceeds control standards. Anexample of a control application is transportation damage tracking. If a system is inplace to periodically report product damage, logistics management can identify thecause and adjust the packaging of loading process as needed. 80
  • Directing measures are designed to motivate personnel. Typical examples include payfor performance practices used to encourage warehouse of transportation personnel toachieve higher levels of productivity. Specifically consider warehouse material handlersof delivery drivers who are paid for eight hours of work based on standard productionrates. If the material handlers can complete the assigned tasks in less than the allottedtime, they are allowed personal or unassigned time. On the other hand if they requiremore than the allotted time, the disincentive is that they are not compensated for theadditional time. In some cases employees are actually given a bonus when the task iscompleted in less than the allotted time. When such directed measures are used it isimportant that both positive and negative performance be measured.For example the completion of an assigned task such as order selection in less than thestandard time must be traded off against increased errors or damage.Typical Logistics Activity Based Measures 1. Order Entry time per order 2. Delivery time per order 3. Order selection time per order 4. Inquiry time per order 5. Order entry time per customer 6. Order selection time per customerdelivery time per customer] 7. Order selection time per product 8. Delivery time per productPerspectiveThe appropriate management perspective must be evaluated and determined. Thecontinuum of possibilities ranges from all activity based measures to entirely processbased measures.Activity based measures focus on individual tasks required to process and ship orders.Examples include customer orders entered, cases received from suppliers, cases shippedto customers. These measures record the level of activity and in some instances thelevel of productivity.While activity based measures focus on the efficiency and effectiveness of primarywork efforts they do not usually measure the performance of the overall process ofsatisfying customers. For example order takers who are judged on the number of callsper hour may be rated high with respect to activity based measurement may do poorlyin the overall satisfaction process because they fail to take the time to listen carefully tocustomers. For this reason it is important that some performance measures taken anoverall process perspective. 81
  • Process based measures consider the customer satisfaction delivered by the entiresupply chain. They examine total performance cycle time or total service quality, bothof which measure the collective effectiveness of all activities required to satisfycustomers. Today’s firms are paying more attention on process measures while tryingnot to sub optimize individual activities. The Perfect Order is an increasingly commonprocess measure.Internal Performance MeasurementInternal performance measures focus on comparing activities and processes to previousoperations and/or goals. For example, customer service might be compared to lastperiod’s actual performance as well as to this period’s goal. Research suggests thatlogistics performance measures can generally be classified into these categories: 1. Cost. 2. Customer service. 3. Productivity. 4. Asset management. 5. Quality.COST: The most direct reflection of logistics performance is the actual cost incurred toaccomplish specific operating objectives. Logistics cost performance is typicallymeasured in terms of rupees, as a percentage of sales, or as a cost per unit of volume.CUSTOMER SERVICE: These measures examine a firm’s relative ability to satisfycustomers.PRODUCTIVITY MEASURES: It is unclear whether it is the most important or evennecessarily a critical measure of performance for all systems.Productivity is a relationship (usually a ratio or an index) between output (goods/orservices) produced and quantities of inputs (resources) utilized by the system to producethat output. Thus it is a very simple concept. If a system has clearly measurable outputsand identifiable, measurable inputs that can be matched to the appropriate outputs,productivity measurement is routine. However, it can be difficult and frustrating if (1)outputs are hard to measure and input utilization is difficult to match up for a givenperiod of time, (2) input and output mix or type constantly changes, or (3) data aredifficult to obtain or unavailable.There are 3 types of productivity measures: - 1. Static: - if all the output and input in a given system are included in the productivity equation, it would be a total factor static productivity ratio. It is considered static because it is based on only one measurement. 2. Dynamic: - It is completed across time. If outputs and inputs in a system compare static productivity ratios from one period to another, the result is a dynamic productivity index, for example: 82
  • Outputs 1994/inputs 1994 Outputs 1990/inputs 19943. Surrogate: - This represents factors that are not typically included in the concepts ofproductivity but are highly correlated with it (customer satisfaction, profits,effectiveness, quality, efficiency, etc.). Most managers operationalize productivity inthis manner.ASSET MEASUREMENT: Focuses on the utilization of capital investments infacilities and equipment as well as working capital application to inventory to achievelogistics goals. Logistics facilities, equipment, and inventory can represent a substantialsegment of a firm’s assets. In the case of wholesalers, the amount exceeds 90 %. Itmeasures focus on how fast liquid assets such as inventory ‘turnover’ as well as howwell fixed assets generates return on investments.QUALITY: Quality measures, which are the most process-oriented evaluations, aredesigned to determine the effectiveness of a series of activities rather than an individualactivity. However quality is usually difficult to measure because of its broad scope.A contemporary measurement concept that is increasing in interest is ’the perfectorder’. Delivery of the perfect order is the ultimate measure of quality in logisticsoperations, that is, the perfect order concerns the effectiveness of the overall integratedlogistical firm performance rather than individual functions. It measures whether anorder processes smoothly through every step – order entry, credit clearance, inventoryavailability, accurate picking, on-time delivery, correct invoicing and payment withoutdeducting- of the order management process without fault, be it expediting, exceptionprocessing, or manual intervention.The perfect order represents ideal performance. From an operational perspective amulti-industry consortium defines the perfect order as one that meets all the followingstandards 1. Complete delivery of all items requested 2. Delivery to customer’s request date with one-day tolerance 3. Complete and accurate documentation supporting the order, including packing slips, bills of lading and invoices and 4. Perfect condition that is faultlessly installed, correct configuration, customer- ready with no damage.However there are many roadblocks to achieving such a level of success. Today the bestlogistics organizations report achieving a 55 to 60 perfected perfect order performance,while most organizations report less than 20 per percent.External Performance MeasurementWhile internal measures are important for detailed organizational monitoring, externalperformance measures are also necessary to monitor, understand and maintain a focusedcustomer perspective and to gain innovative insights from other industries. The topicsof customer perception measurement and best practice benchmarking, which addressthese requirements, are discussed and illustrated below. 83
  • Customer Perception MeasurementTo succeed in any activities of business one has to always cater to and satisfy the needsof the customer. To do so, it is essential for one to know how the customer thinks inorder to meet his needs in a more satisfying manner. Therefore, an importantcomponent of leading edge logistical performance is the regular measurement ofcustomer perceptions. Such measures can be obtained through surveys or by systematicorder follow up. These surveys can be company - or industry – sponsored.Such surveys ask questions regarding the firm’s and the competitor’s performance ingeneral or for a specific order in particular. Most of the surveys incorporatesmeasurement of customer perceptions regarding availability, performance-cycle time,information availability, problem resolution and product support. The survey may bedeveloped and administered by the firm itself or by consultants, delivery agents orindustry organizations.ConclusionInternal performance measures focus on the activities required to serve customers.Measurement of these activities, as well as comparison with goals and standards, isnecessary to improve performance and motivate and reward employees. Costmeasurement is the minimum component of any performance measurement system.More sophisticated firms incorporate customer service, asset management andproductivity measurement. While such measures generally monitor internal processefficiency, they do not examine external process effectiveness very well, particularlyfrom the customer’s viewpoint. The quality measures applied today by the mostsophisticated logistics organizations offer such an external perspective. While theindividual internal measures discussed above offer a broad performance evaluation,they do not provide an integrated point of view. For example many customers desirehigh performance regarding both service and quality.Best Practice Benchmarking:Benchmarking is a critical aspect of comprehensive performance measurement. Manycompanies are adopting benchmarking as a technique to compare their operations tothose of both competitors and leading firms in related and non-related industries.Benchmarking is also used in important strategic areas as a tool to calibrate logisticsoperations.Most of the firms use the following types of Benchmarking tools: 1. Published Logistics Data: This method uses existing data that are published in various periodicals and university researchers. This method of data is easily obtainable and is cheaper to obtain. But the information got in this means is normally too general and may not be tailor-made for the firm’s exact problems. Since this information is available in public, it does not offer a real competitive advantage. 2. Benchmark against noncompetitive firms: In this method a noncompetitive firm in the related industry is benchmarked. This is done by studying and 84
  • reviewing the other firms’ measures, practices and processes to develop insights that will improve performance. The firm that is chosen to benchmark might be in the same industry but will be operating in a different market. 3. Alliance of Organisations: In this method, an alliance is formed between two organizations that systematically share benchmark data on a regular basis. These kinds of alliances require more effort to maintain but usually provide substantially better information than the preceding two methods.Strategic FactorsThe key strategic factor to consider during the make-versus-buy decision isperformance capability. The decision to outsource involves evaluating which supplieris the most capable of performing the service at a best practice level. This requires anevaluation of potential outsource services in terms of their contribution to a firms coreand noncore activities. Typically a firm will not want to run the risk of diluting corecompetencies by having external firms perform isolated, highly sensitive activities.Once a firm has isolated those activities that are “core supportive” the balance ofrequired activities or the noncore requirements become outsource candidates.The most difficult step for most firms is to identify which activities are critical corecapabilities. The outsourcing decision should not be limited to asset investment.Instead, it must center on capabilities provided or achieved through the assetinvestment. If the capabilities achieved by performing activities internally do notextend an enterprise’s core competencies, then such activities should be outsourced.The desirability of outsourcing is based in part on the benefits of specialization. Ifrequired service can be improved or an enterprise can reduce its overall investment oroperating requirements, then outsourcing is an attractive alternative.Make-versus-buy decisions involve trade-off analysis among economic and strategicfactors. A large portion of such analysis examines cost to service elements.Outsourcing is easily justified if visible costs decrease and service improves, as long asother economic and strategic requirements are satisfied. Specialization can result ineconomies of scale enabling simultaneous achievement of reduced cost and improvedservice.Economic FactorsOliver Williamson examined economic factors in terms of transaction costs. Thesecosts are those expenses associated with performing a specific activity. Thefundamental Williamson proposition was that free market allocation would result in abalance of internal sourcing and outsourcing that would minimize the transaction cost.Outsourcing creates a situation where external firms can behave opportunistically at theexpense of their customer. Service provider withholding poor performance informationto ensure its operational success. Such information withholding could result in a majorproblem for the service provider’s customers.If only a few companies exist with capability to perform the required logistics service,One that approximates monopoly power replaces the ideal free or competitive market.This situation is further complicated if the requested logistics service require transaction 85
  • specific assets such as dedicated trucks, buildings or wok forces. In the event ofcancellation, such customized assets may not be easily transferred to other customers.Transaction cost analysis suggests that logistics activities be performed internally if thetransaction costs are lower than expenses associated with outsourcing. Internal costsare usually lower when (1) only a few potential third-party suppliers are available foroutsourcing, (2) transaction- specific assets are required, or (3) various suppliers of suchservices are in a position to take advantage of the transaction setting. The trade-offs depend on which party is best positioned to achieve i.e. besteconomies of scale. For example, when considering outsourcing or owning awarehouse, volume is a critical factor. Suppose the product requiring storage followsan erratic demand pattern. On average, 25000 units need to be stored to meet monthlyrequirements. However, peak storage demand requires 50,000 units, while the lowestpoint of seasonality requires only 5,000. If a privately owned warehouse is used, it musthave the capacity to hold 50,000 units. When demand justifies only 5,000 units storage,the warehouse would be operating at approximately 10 percent of capacity (5000/50000= 10percent capacity). Under such utilization, fixed, overhead, labour and managerialexpenses would be spread over so few units that the cost per unit would be very high. On the other hand, outsourcing to a public warehouse could result in standardper unit cost that is independent of month-to-month storage requirements. When outsourcing is outsourced, customer typically negotiates a rate thatrequires it to pay only for space used. Therefore, the price is the same per unit whetherthe firm stores 5,000 or 50,000 units. If the price per square foot is $1.50 and a unittakes up 2 square fees, the total charge per unit is $3.00, regardless of the total no ofunits stored. The level of rate typically charged would reflect average utilization ascontrasted to either a minimum or maximum. Alternative opportunity cost of capital is one such expense involved inoutsourcing. A private trucking fleet requires substantial equipment investment. Tofully evaluate outsourcing, an enterprise should consider alternative uses of the capitalthat would be invested in a private fleet of trucks. For example, the same amount ofmoney could be used to increase manufacturing capacity, improve logistics facilities, orexpand other aspects of the business. The enterprise must determine which types ofinvestment offer the best long-term advantage.Another consideration is cost associated with obsolescence. Firm’s investment intechnologies, which can become obsolete before the enterprise can fully amortize thecost. In such case, technology may not have paid for itself in productivity andefficiency before it must be replaced. Outsourcing logistics activities means that thirdparty service provider is responsible for technology investments, and this reduces therisk of obsolescence. Because of high volume usage, service providers will amortizecost of technology investment before they become obsolete. Furthermore the serviceprovider is forced to update technology, to maintain attractiveness to their customerbase.Final important consideration in outsourcing is related to labour. When moving frominternal to external performance of logistic, the labour requirements and managementresponsibilities of the customer will be reduced or shifted to service supplier. This shiftaffects cost like early retirement, layoffs, reassignment morale, productivity unionizationand retaining. And while moving to logistical service in-house from a third partyprovider, hiring, training, internal labour shifts and implementation time are the keyconsiderations that may serve to limit flexibility 86