15Sourcing Decisions in a Supply ChainPowerPoint p

15
Sourcing Decisions in a Supply Chain
PowerPoint presentation to accompany
Chopra and Meindl Supply Chain Management, 5e
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Copyright ©2013 Pearson Education, Inc. publishing as Prentice
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Learning Objectives
Understand the role of sourcing in a supply chain
Discuss factors that affect the decision to outsource a supply

chain function
Identify dimensions of supplier performance that affect total
cost
Structure successful auctions and negotiations
Describe the impact of risk sharing on supplier performance and
information distortion
Design a tailored supplier portfolio
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The Role of Sourcing
in a Supply Chain
Sourcing is the set of business processes required to purchase
goods and services
Outsourcing
Offshoring
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in a Supply Chain
Outsourcing questions
Will the third party increase the supply chain surplus relative to
performing the activity in-house?
How much of the increase in surplus does the firm get to keep?
To what extent do risks grow upon outsourcing?

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in a Supply Chain
Figure 15-1
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Supplier Scoring and Assessment
Supplier performance should be compared on the basis of the
supplier’s impact on total cost
There are several other factors besides purchase pri ce that
influence total cost
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Supplier Selection
Identify one or more appropriate suppliers
Contract should account for all factors that affect supply chain

performance
Should be designed to increase supply chain profits in a way
that benefits both the supplier and the buyer
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Design Collaboration
About 80% of the cost of a product is determined during design
Suppliers should be actively involved at this stage
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Procurement
A supplier sends product in response to orders placed by the
buyer
Orders placed and delivered on schedule at the lowest possible
overall cost
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Sourcing Planning and Analysis

Analyze spending across various suppliers and component
categories
Identify opportunities for decreasing the total cost
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Cost of Goods Sold
Cost of goods sold (COGS) represents well over 50 percent of
sales for most major manufacturers
Purchased parts a much higher fraction than in the past
Companies have reduced vertical integration and outsourced
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Benefits of Effective
Sourcing Decisions
Better economies of scale through aggregated
More efficient procurement transactions
Design collaboration can result in products that are easier to
manufacture and distribute
Good procurement processes can facilitate coordination with
suppliers
Appropriate supplier contracts can allow for the sharing of risk
Firms can achieve a lower purchase price by increasing
competition through the use of auctions

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In-House or Outsource
Increase supply chain surplus through
Capacity aggregation
Inventory aggregation
Transportation aggregation by transportation intermediaries
Transportation aggregation by storage intermediaries
Warehousing aggregation
Procurement aggregation
Information aggregation
Receivables aggregation
Relationship aggregation
Lower costs and higher quality
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Factors Influencing Growth of Surplus by a Third Party
Scale
Large scale it is unlikely that a third party can achieve further
scale economies and increase the surplus
Uncertainty
If requirements are highly variable over time, third party can
increase the surplus through aggregation
Specificity of assets
If assets required are specific to a firm, a third party is unlikely

to increase the surplus
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Factors Influencing Growth of Surplus by a Third
PartySpecificity of Assets Involved in FunctionLowHighFirm
scaleLow High growth in surplusLow to medium growth in
surplusHigh Low growth in surplusNo growth in surplus unless
cost of capital is lower for third partyDemand uncertainty for
firmLow Low to medium growth in surplusLow growth in
surplusHigh High growth in surplusLow to medium growth in
surplus
Table 15-1
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Risks of Using a Third Party
The process is broken
Underestimation of the cost of coordination
Reduced customer/supplier contact
Loss of internal capability and growth in third-party power
Leakage of sensitive data and information
Ineffective contracts
Loss of supply chain visibility
Negative reputational impact

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Third- and Fourth-Party
Logistics Providers
Third-party logistics (3PL) providers performs one or more of
the logistics activities relating to the flow of product,
information, and funds that could be performed by the firm
itself
A 4PL (fourth-party logistics) designs, builds and runs the
entire supply chain process
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Third- and Fourth-Party
Logistics ProvidersService CategoryBasic ServiceSome Specific
Value-Added ServicesTransportationInbound, outbound by ship,
truck, rail, airTendering, track/trace, mode conversion,
dispatch, freight pay, contract managementWarehousingStorage,
facilities managementCross-dock, in-transit merge, pool
distribution across firms, pick/pack, kitting, inventory control,
labeling, order fulfillment, home delivery of catalog
ordersInformation technologyProvide and maintain advanced
information/computer systemsTransportation management
systems, warehousing management, network modeling and site
selection, freight bill payment, automated broker interfaces,
end-to-end matching, forecasting, EDI, worldwide track and

trace, global visibilityReverse logisticsHandle reverse
flowsRecycling, used-asset disposition, customer returns,
returnable container management, repair/refurbishOther 3PL
servicesBrokering, freight forwarding, purchase-order
management, order taking, loss and damage claims, freight bill
audits, consulting, time-definite deliveryInternationalCusto ms
brokering, port services, export crating, consolidationSpecial
skills/handlingHazardous materials, temperature controlled,
package/parcel delivery, food-grade facilities/equipment, bulk
Table 15-2
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Using Total Cost to
Score and Assess SuppliersPerformance CategoryCategory
ComponentsQuantifiable?Supplier priceLabor, material,
overhead, local taxes, and compliance costsYesSupplier
termsNet payment terms, delivery frequency, minimum lot size,
quantity discountsYesDelivery costsAll transportation costs
from source to destination, packaging costsYesInventory
costsSupplier inventory, including raw material, in process and
finished goods, in-transit inventory, finished goods inventory in
supply chainYesWarehousing costWarehousing and material
handling costs to support additional inventoryYesQuality
costsCost of inspection, rework, product
returnsYesReputationReputation impact of quality
problemsNoOther costsExchange rate trends, taxes,
dutiesYesSupportManagement overhead and administrative
supportDifficultSupplier capabilitiesReplenishment lead time,
on-time performance, flexibility, information coordination
capability, design coordination capability, supplier viabilityTo

some extent
Table 15-3
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Comparing Suppliers
Based on Total Cost
Annual material cost = 1,000 x 52 x 1 = $52,000
Average cycle inventory = 2,000/2 = 1,000
Annual cost of holding cycle
inventory = 1,000 x 1 x 0.25 = $250
Standard deviation of ddlt =
Safety inventory required
with current supplier =
Annual cost of holding safety
inventory = 1,787 x 1 x 0.25 = $447
Annual cost of using current
supplier = 52,000 + 250 + 447 = $52,697
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Annual material cost = 1,000 x 52 x 0.97 = $50,440
Average cycle inventory = 8,000/2 = 4,000
Annual cost of holding cycle
inventory = 4,000 x 0.97 x 0.25 = $970
Standard deviation of ddlt =
Safety inventory required
with current supplier =
Annual cost of holding safety
inventory = 6,690 x 0.97 x 0.25 = $1,622
Annual cost of using current
supplier = 50,440 + 970 + 1,622 = $53,032
Comparing Suppliers
Based on Total Cost
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Supplier Selection –
Auctions and Negotiations
Supplier selection can be performed through competitive bids,
reverse auctions, and direct negotiations
Supplier evaluation is based on total cost of using a supplier
Auctions:
Sealed-bid first-price auctions
English auctions
Dutch auctions
Second-price (Vickery) auctions
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Factors influence the performance of an auction
Is the supplier’s cost structure private (not affected by factors
that are common to other bidders)?
Are suppliers symmetric or asymmetric; that is, ex ante, are
they expected to have similar cost structures?
Do suppliers have all the information they need to estimate their
cost structure?
Does the buyer specify a maximum price it is willing to pay for
the supply chain?
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Collusion among bidders
Second-price auctions are particularly vulnerable
Can be avoided with any first-price auction
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Basic Principles of Negotiation
The difference between the values of the buyer and seller is the
bargaining surplus
The goal of each negotiating party is to capture as much of the
bargaining surplus as possible
Have a clear idea of your own value and as good an estimate of
the third party’s value as possible
Look for a fair outcome based on equally or equitably dividing
the bargaining surplus
A win-win outcome
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Contracts, Risk Sharing, and
Supply Chain Performance
How will the contract affect the firm’s profits and total supply
chain profits?
Will the incentives in the contract introduce any information
distortion?
How will the contract influence supplier performance along key
performance measures?
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Contracts for Product Availability and Supply Chain Profits
Independent actions taken by two parties in a supply chain often
result in profits that are lower than those that could be achieved
if the supply chain were to coordinate its actions
Three contracts that increase overall profits by making the
supplier share some of the buyer’s demand uncertainty are
Buyback or returns contracts
Revenue-sharing contracts
Quantity flexibility contracts
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Buyback Contracts
Allows a retailer to return unsold inventory up to a specified
amount at an agreed upon price
The manufacturer specifies a wholesale price c and a buyback
price b
The manufacturer can salvage $sM for any units that the retailer
returns
The manufacturer has a cost of v per unit produced and the
retail price is p
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Buyback ContractsWholesale Price cBuyback Price bOptimal
Order Size for Music StoreExpected Profit for Music
StoreExpected Returns to SupplierExpected Profit for
SupplierExpected Supply Chain Profit$5$0 1,000$3,803
120$4,000$7,803$5$2 1,096$4,090
174$4,035$8,125$5$3 1,170$4,286
223$4,009$8,295$6$0 924$2,841
86$4,620$7,461$6$2 1,000$3,043
120$4,761$7,804$6$4 1,129$3,346
195$4,865$8,211$7$0 843$1,957
57$5,056$7,013$7$4 1,000$2,282
120$5,521$7,803$7$6 1,202$2,619 247$5,732$8,351
Table 15-4
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Buyback Contracts
Holding-cost subsidies
Manufacturers pay retailers a certain amount for every unit held
in inventory over a given period
Encourage retailers to order more
Price support
Manufacturers share the risk of product becoming obsolete
Guarantee that in the event they drop prices they will lower
prices for all current inventories
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Revenue-Sharing Contracts
Manufacturer charges the retailer a low wholesale price c and
shares a fraction f of the retailer’s revenue
Allows both the manufacturer and retailer to increase their
profits
Results in lower retailer effort
Requires an information infrastructure
Information distortion results in excess inventory in the supply
chain and a greater mismatch of supply and demand
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Revenue-Sharing Contracts
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Revenue-Sharing ContractsWholesale Price cRevenue-Sharing
Fraction fOptimal Order Size for Music StoreExpected
Overstock at Music StoreExpected Profit for Music
StoreExpected Profit for SupplierExpected Supply Chain
Profit$10.30 1,320342$5,526$2,934$8,460$10.45
1,273302$4,064$4,367$8,431$10.60
1,202247$2,619$5,732$8,350$20.30
1,170223$4,286$4,009$8,295$20.45
1,105179$2,881$5,269$8,150$20.60
1,000120$1,521$6,282$7,803
Table 15-5
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Quantity Flexibility Contracts
Allows the buyer to modify the order (within limits) after
observing demand
Better matching of supply and demand
Increased overall supply chain profits if the supplier has
flexible capacity
Lower levels of information distortion than either buyback
contracts or revenue sharing contracts
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Quantity Flexibility ContractsabWholesale Price cOrder Size
OExpected Purchase by RetailerExpected Sale by
RetailerExpected Profits for RetailerExpected Profits for
SupplierExpected Supply Chain Profit0.000.00$51,000
1,000880$3,803$4,000$7,8030.050.05$51,017
1,014966$4,038$4,004$8,4160.200.20$51,047
1,023967$4,558$3,858$8,4160.000.00$6924
924838$2,841$4,620$7,4610.200.20$61,000
1,000955$3,547$4,800$8,3470.300.30$61,021
1,006979$3,752$4,711$8,4630.000.00$7843
843786$1,957$5,056$7,0130.200.20$7947
972936$2,560$5,666$8,2260.400.40$71,000
1,000987$2,873$5,600$8,473
Table 15-6
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Contracts to Coordinate
Supply Chain Costs
Differences in costs at the buyer and supplier can lead to
decisions that increase total supply chain costs
A quantity discount contract may encourage the buyer to

purchase a larger quantity which would result in lower total
supply chain costs
Quantity discounts lead to information distortion because of
order batching
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Contracts to Increase Agent Effort
In many supply chains, agents act on behalf of a principal and
the agents’ efforts affect the reward for the principal
A two-part tariff offers the right incentives for the dealer to
exert the appropriate amount of effort
Threshold contracts increase information distortion
Offer threshold incentives over a rolling horizon
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Contracts to Induce
Performance Improvement
A buyer may want performance improvement from a supplier
who otherwise would have little incentive to do so
A shared-savings contract provides the supplier with a fraction
of the savings that result from performance improvement
Effective in aligning supplier and buyer incentives when the
supplier is required to improve performance and most of the

benefits of improvement accrue to the buyer
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Design Collaboration
50-70% of spending at a manufacturer comes from procurement
80% of the cost of a purchased part is fixed in the design phase
Design collaboration with suppliers can result in reduced cost,
improved quality, and decreased time to market
Design for logistics, design for manufacturability
Modular, adjustable, dimensional customization
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The Procurement Process
The process in which the supplier sends product in response to
orders placed by the buyer
Main categories of purchased goods
Direct materials
Indirect materials
Procurement process for direct materials should be designed to
ensure that components are available in the right place, in the
right quantity, and at the right time
Focus for indirect materials should be on reducing transaction
cost

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Differences Between Direct
and Indirect MaterialsDirect MaterialsIndirect
MaterialsUseProductionMaintenance, repair, and support
operationsAccountingCost of goods soldSelling, general, and
administrative expenses (SG&A)Impact on productionAny delay
will delay productionLess direct impactProcessing cost relative
to value of transactionLowHighNumber of transactionsLowHigh
Table 15-7
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Product Categorization
Figure 15-2
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Designing a Sourcing Portfolio: Tailored Sourcing

Options with regard to whom and where to source from
Produce in-house or outsource to a third party
Will the source be cost efficient or responsive
Onshoring, near-shoring, and offshoring
Tailor supplier portfolio based on a variety of product and
market characteristics
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Designing a Sourcing Portfolio: Tailored SourcingResponsive
SourceLow-Cost SourceProduct life cycleEarly phaseMature
phaseDemand volatilityHighLowDemand
volumeLowHighProduct valueHighLowRate of product
obsolescenceHighLowDesired qualityHighLow to
mediumEngineering/design supportHighLow
Table 15-8
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Designing a Sourcing Portfolio: Tailored SourcingOnshore
Near-shoreOffshoreRate of innovation/product
varietyHighMedium to HighLowDemand volatilityHighMedium
to HighLowLabor contentLowMedium to HighHighVolume or
weight-to-value ratioHighHighLowImpact of supply chain
disruptionHighMedium to HighLowInventory costsHighMedium
to HighLowEngineering/management supportHighHighLow

Table 15-9
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Risk Management in Sourcing
Inability to meet demand on time
An increase in procurement costs
Loss of intellectual property
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Making Sourcing
Decisions in Practice
Use multifunction teams
Ensure appropriate coordination across regions and business
units
Always evaluate the total cost of ownership
Build long-term relationships with key suppliers
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Summary of Learning Objectives
Understand the role of sourcing in a supply chain
Discuss factors that affect the decision to outsource a supply
chain function
Identify dimensions of supplier performance that affect total
cost
Structure successful auctions and negotiations
Describe the impact of risk sharing on supplier performance and
information distortion
Design a tailored supplier portfolio
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All rights reserved. No part of this publication may be
reproduced, stored in a retrieval system, or transmitted, in any
form or by any means, electronic, mechanical, photocopying,
recording, or otherwise, without the prior written permission of
the publisher.
Printed in the United States of America.
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2×3002 +1,0002 ×12 =1,086.28

2´300
2
+1,000
2
´1
2
=1,086.28
NORMSINV(0.95)×1,086.28 =1,787
NORMSINV(0.95)´1,086.28=1,787
6×3002 +1,0002 ×42 = 4,066.94
6´300
2
+1,000
2
´4
2
=4,066.94
NORMSINV(0.95)×4,066.94 = 6,690
NORMSINV(0.95)´4,066.94=6,690
Expected manufacturing profit =O * (c – v) – (b – sM )
Expected manufacturing profit =O*(c–v)–(b–s
M
)

× expected overstock at retailer
´ expected overstock at retailer
CSL* = probability (demand ≤O*) =
Cu
Cu +Co
=
(1– f )p – c
(1– f )p – sR
CSL*=probability (demand £O*)=
C
u
C
u
+C
o
=
(1–f)p–c
(1–f)p–s
R
Expected manufacturers profits = (c – v)O *
Expected manufacturers profits=(c–v)O*
+ fp(O * – expected overstock at retailer)
+fp(O*– expected overstock at retailer)

Expected retailer profit
Expected retailer profit
+sR × expected overstock at retailer – cO *
+s
R
´ expected overstock at retailer–cO*
= (1– f )p(O * – expected overstock at retailer)
=(1–f)p(O*– expected overstock at retailer)
Expected quantity purchased by retailer, QR
Expected quantity purchased by retailer, Q
R
= qF(q)+Q 1– F(Q)⎡ ⎣ ⎤ ⎦
=qF(q)+Q1–F(Q)
é
ë
ù
û
+µ Fs
Q – µ

σ
⎛
⎝
⎜
⎞
⎠
⎟ – Fs
q– µ
σ
⎛
⎝
⎜
⎞
⎠
⎟
⎡
⎣
⎢
⎤
⎦
⎥
+mF

s
Q–m
s
æ
è
ç
ö
ø
÷
–F
s
q–m
s
æ
è
ç
ö
ø
÷
é
ë
ê
ù
û
ú
= –σ fs
Q – µ
σ
⎛
⎝
⎜

⎞
⎠
⎟ – fs
q– µ
σ
⎛
⎝
⎜
⎞
⎠
⎟
⎡
⎣
⎢
⎤
⎦
⎥
=–sf
s
Q–m
s
æ
è
ç
ö

ø
÷
–f
s
q–m
s
æ
è
ç
ö
ø
÷
é
ë
ê
ù
û
ú
Expected quantity sold by retailer, DR
Expected quantity sold by retailer, D
R
= Q 1– F(Q)⎡ ⎣ ⎤ ⎦
=Q1–F(Q)
é
ë
ù
û
+µFs

Q – µ
σ
⎛
⎝
⎜
⎞
⎠
⎟ –σ fs
q– µ
σ
⎛
⎝
⎜
⎞
⎠
⎟
+mF
s
Q–m
s
æ
è
ç
ö
ø
÷

–sf
s
q–m
s
æ
è
ç
ö
ø
÷
Expected quantity overstock
at manufacturer
Expected quantity overstock
at manufacturer
Expected retailer profit = DR × p+ QR – DR( )sR – QR ×c
Expected retailer profit=D
R
´p+Q
R
–D
R
( )
s
R
–Q
R
´c
Expected manufacturer profit = QR ×c+ Q – QR( )sM – Q×v

Expected manufacturer profit =Q
R
´c+Q–Q
R
( )
s
M
–Q´v
= QR – DR
=Q
R
–D
R
14
Transportation in a Supply Chain
PowerPoint presentation to accompany
Chopra and Meindl Supply Chain Management, 5e
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Learning Objectives
Understand the role of transportation in a supply chain
Evaluate the strengths and weaknesses of different modes of
transportation
Discuss the role of infrastructure and policies in transportation
Identify the relative strengths and weaknesses of various
transportation network design options
Identify trade-offs that shippers need to consider when
designing a transportation network
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The Role of Transportation
in a Supply Chain
Movement of product from one location to another
Products rarely produced and consumed in the same location
Significant cost component

Shipper requires the movement of the product
Carrier moves or transports the product
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Modes of Transportation and their Performance Characteristics
Air
Package carriers
Truck
Rail
Water
Pipeline
Intermodal
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Notes:
Modes of Transportation and their Performance
CharacteristicsModeFreight Value
($ billions)
in 2002Freight Tons (billions)
in 2002Freight
Ton-Miles (millions)
in 2002Value Added to GNP

(billion $)
in 2009Air (includes truck and air) 563 6 13 61.9Truck
9,075 11,712 1,515 113.1Rail 392 1,979
1,372 30.8Water 673 1,668 485 14.3Pipeline
896 3,529 688 12.0Multimodal 1,121 229
233
Table 14-1
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Notes:
Air
Cost components
Fixed infrastructure and equipment
Labor and fuel
Variable – passenger/cargo
Key issues
Location/number of hubs
Fleet assignment
Maintenance schedules
Crew scheduling
Prices and availability
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Notes:
Package Carriers
Small packages up to about 150 pounds
Expensive
Rapid and reliable delivery
Small and time-sensitive shipments
Provide other value-added services
Consolidation of shipments a key factor
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Truck
Significant fraction of the goods moved
Truckload (TL)
Low fixed cost
Imbalance between flows
Less than truckload (LTL)
Small lots
Hub and spoke system
May take longer than TL
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Notes:
Rail
Move commodities over large distances
High fixed costs in equipment and facilities
Scheduled to maximize utilization
Transportation time can be long
Trains ‘built’ not scheduled
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Notes:
Water
Limited to certain geographic areas
Ocean, inland waterway system, coastal waters
Very large loads at very low cost
Slowest
Dominant in global trade
Containers
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Pipeline

High fixed cost
Primarily for crude petroleum, refined petroleum products,
natural gas
Best for large and stable flows
Pricing structure encourages use for predicable component of
demand
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Intermodal
Use of more than one mode of transportation to move a
shipment
Grown considerably with increased use of containers
May be the only option for global trade
More convenient for shippers – one entity
Key issue – exchange of information to facilitate transfer
between different modes
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Transportation Infrastructure
and Policies
Governments generally take full responsibility or played a
significant role in building and managing infrastructure
elements
Without a monopoly, deregulation and market forces help create

an effective industry structure
Pricing should reflect the marginal impact on the cost to society
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Transportation Infrastructure
and Policies
Figure 14-1
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Hall.
14-‹#›
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Design Options for a
Transportation Network
When designing a transportation network
Should transportation be direct or through an intermediate site?
Should the intermediate site stock product or only serve as a
cross-docking location?
Should each delivery route supply a single destination or
multiple destinations (milk run)?
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Hall.
15
Notes:
Direct Shipment Network
to Single Destination
Figure 14-2
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Hall.
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Direct Shipping with Milk Runs
Figure 14-3
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All Shipments via Intermediate Distribution Center with Storage
Figure 14-4
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All Shipments via Intermediate Transit Point with Cross-
Docking
Suppliers send their shipments to an intermediate transit point
They are cross-docked and sent to buyer locations without
storing them
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Shipping via DC Using Milk Runs
Figure 14-5
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Tailored NetworkNetwork StructureProsConsDirect shippingNo
intermediate warehouse
Simple to coordinateHigh inventories (due to large lot size)
Significant receiving expenseDirect shipping with milk
runsLower transportation costs for small lots Lower
inventoriesIncreased coordination complexityAll shipments via
central DC with inventory storageLower inbound transportation
cost through consolidationIncreased inventory cost Increased
handling at DCAll shipments via central DC with cross-

dockLow inventory requirement
Lower transportation cost through
consolidationIncreased coordination complexityShipping via DC
using milk runsLower outbound transportation cost for small
lotsFurther increase in coordination complexityTailored
networkTransportation choice best matches needs of individual
product and storeHighest coordination complexity
Table 14-2
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Selecting a Transportation Network
Eight stores, four supply sources
Truck capacity = 40,000 units
Cost $1,000 per load, $100 per delivery
Holding cost = $0.20/year
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Annual sales = 960,000/store Direct shipping
Batch size shipped from each
supplier to each store = 40,000 units
Number of shipments/yr from
each supplier to each store = 960,000/40,000 = 24
Annual trucking cost

for direct network = 24 x 1,100 x 4 x 8 = $844,800
Average inventory at each
store for each product = 40,000/2 = 20,000 units
Annual inventory cost
for direct network = 20,000 x 0.2 x 4 x 8 = $128,000
Total annual cost of
direct network = $844,800 + $128,000 = $972,800
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Hall.
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Annual sales = 960,000/store Milk runs
supplier to each store = 40,000/2 = 20,000 units
Transportation cost per shipment
per store (two stores/truck) = 1,000/2 + 100 = $600
for direct network = 48 x 600 x 4 x 8 = $921,600
direct network = $921,600 + $64,000 = $985,600
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Annual sales = 120,000/store Direct shipping
supplier to each store = 40,000 units
for direct network = 3 x 1,100 x 4 x 8 = $105,600
direct network = $105,600 + $128,000 = $233,600
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Annual sales = 120,000/store Milk runs
supplier to each store = 40,000/4 = 10,000 units
Transportation cost per shipment
per store (two stores/truck) = 1,000/4 + 100 = $350
for direct network = 12 x 350 x 4 x 8 = $134,400

direct network = $134,400 + $32,000 = $166,400
14-‹#›
Hall.
14-‹#›
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Trade-offs in Transportation Design
Transportation and inventory cost trade-off
Choice of transportation mode
Inventory aggregation
Transportation cost and responsiveness trade-off
14-‹#›
Hall.
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Trade-offs in Transportation DesignModeCycle InventorySafety
InventoryIn-Transit CostTransportation TimeTransportation
CostRail55525TL44433LTL33344Package11161Air22252Water
66616
Table 14-3
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Trade-offs When Selecting Transportation Mode
Demand = 120,000 motors, Cost = $120/motor,
Weight = 10 lbs/motor, Lot size = 3,000,
Safety stock = 50% ddltCarrierRange of Quantity Shipped
(cwt)Shipping Cost ($/cwt)AM Railroad 200+6.50Northeast
Trucking 100+7.50Golden Freightways 50–1508.00Golden
Freightways 150–2506.00Golden Freightways 250+4.00
Table 14-4
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Trade-offs When Selecting Transportation Mode
Cycle inventory = Q/2 = 2,000/2 = 1,000 motors
Safety inventory = L/2 days of demand
= (6/2)(120,000/365) = 986 motors
In-transit inventory = 120,000(5/365) = 1,644 motors
Total average inventory = 1,000 + 986 + 1,644
= 3,630 motors
Annual holding cost
using AM Rail = 3,630 x $30 = $108,900
Annual transportation
cost using AM Rail = 120,000 x 0.65 = $78,000
The total annual cost for
inventory and transportation
using AM Rail = $186,900
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Trade-offs When Selecting Transportation ModeAlternativeLot
Size (Motors)Transpor-
tation
CostCycle InventorySafety InventoryIn-Transit
InventoryInventory CostTotal CostAM Rail 2,000$78,000
1,000986 1,644$108,900$186,900Northeast
1,000$90,000 500658 986$64,320$154,320Golden
500$96,000 250658 986$56,820$152,820Golden
1,500$96,000 750658 986$71,820$167,820Golden
2,500$86,400 1,250658 986$86,820$173,220Golden
3,000$80,000 1,500658 986$94,320$174,320Golden (old
proposal) 4,000$72,000 2,000658
986$109,320$181,320Golden (new proposal)
4,000$67,000 2,000658 986$109,320$176,820
Table 14-5
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Hall.
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Tradeoffs When
Aggregating Inventory
Highval – weekly demand μH = 2, σH = 5, weight = 0.1 lbs,
cost = $200
Lowval – weekly demand μL = 20, σL = 5, weight = 0.04 lbs,
cost = $30
CSL = 0.997, holding cost = 25%, L = 1 week, T = 4 weeks
UPS lead time = 1 week, $0.66 + 0.26x

FedEx lead time = overnight, $5.53 + 0.53x
Option A. Keep the current structure but replenish inventory
once a week rather than once every four weeks
Option B. Eliminate inventories in the territories, aggregate all
inventories in a finished-goods warehouse at Madison, and
replenish the warehouse once a week
14-‹#›
Hall.
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Hall.
Tradeoffs When
HighMed inventory costs (current scenario, HighVal)
All 24 territories, HighVal inventory = 24 x 34.7 = 832.8 units
14-‹#›
Hall.
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Tradeoffs When
HighMed inventory costs (current scenario, LowVal)
All 24 territories, LowVal inventory = 24 x 70.7 = 1696.8 units

14-‹#›
Hall.
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Tradeoffs When
Annual inventory
holding cost
for HighMed = (average HighVal inventory x $200
+ average LowVal inventory x $30) x 0.25
= (832.8 x $200 + 169.8 x $30) x 0.25
= $54,366 ($54,395 without rounding)
14-‹#›
Hall.
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Tradeoffs When
HighMed transportation cost (current scenario)
Average weight of each replenishment order
= 0.1QH + 0.04QL = 0.1 x 8 + 0.04 x 80 = 4 pounds
Shipping cost per replenishment order
= $0.66 + 0.26 x 4 = $1.70
Annual transportation cost = $1.70 x 13 x 24 = $530
HighMed total cost (current scenario)
Annual inventory and transportation cost at HighMed
= inventory cost + transportation cost
= $54,366 + $530 = $54,896

14-‹#›
Hall.
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Tradeoffs When
Aggregating InventoryCurrent ScenarioOption AOption
BNumber of stocking locations24241.2 unitsReorder interval4
weeks1 week1 weekHighVal cycle inventory96 units24 units24
unitsHighVal safety inventory737.3 units466.3 units95.2
unitsHighVal inventory833.3 units490.3 units119.2
unitsLowVal cycle inventory960 units240 units240 unitsLowVal
safety inventory737.3 units466.3 units95.2 unitsLowVal
inventory1,697.3 units706.3 units335.2 unitsAnnual inventory
cost$54,395$29,813$8,473Shipment
typeReplenishmentReplenishmentCustomer orderShipment size8
HighVal + 80 LowVal2 HighVal + 20 LowVal1 HighVal + 10
LowValShipment weight4 lbs. 1 lb.0.5 lb.Annual transport
cost$530$1,148$13,464Total annual
cost$54,926$30,961$22,938
Table 14-6
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Hall.
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Tradeoffs When
Average weight of each customer order
= 0.1 x 0.5 + 0.04 x 5 = 0.25 pounds
Shipping cost per customer order

= $5.53 + 0.53 x 0.25 = $5.66
Number of customer orders per territory per week = 4
Total customer orders per year = 4 x 24 x 52 = 4
Annual transportation cost = 4,992 x $5.66 = $28,255
Total annual cost = inventory cost + transportation cost
= $8,474 + $28,255 = $36,729
14-‹#›
Hall.
14-‹#›
Hall.
Tradeoffs When
Aggregating InventoryAggregate DisaggregateTransport
costLow HighDemand uncertaintyHighLowHolding
costHighLowCustomer order sizeLargeSmall
Table 14-7
14-‹#›
Hall.
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Trade-off Between Transportation Cost and Responsiveness
Steel shipments LTL = $100 + 0.01x
MondayTuesdayWednesdayThursdayFridaySaturdaySundayWee
k 119,97017,47011,31626,19220,2638,38125,377Week
239,1712,15820,63323,37024,10019,60318,442
Table 14-8
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Hall.
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Hall.
Trade-off Between Transportation Cost and
ResponsivenessTwo-Day ResponseThree-Day ResponseFour-
Day ResponseDayDemandQuantity ShippedCost ($)Quantity
ShippedCost ($)Quantity ShippedCost
($)119,97019,970299.7000217,47017,470274.7037,440474.4003
11,31611,316213.16048,756586.56426,19226,192361.9237,5084
75.080520,26320,263302.630068,3818,381183.8128,644386.445
4,836648.36725,37725,377353.7700839,17139,171491.7164,548
745.48092,1582,158121.58066,706767.061020,63320,633306.33
22,791327.9101123,37023,370333.70001224,10024,100341.004
7,70574.7068,103781.031319,60319,603296.03001418,44218,44
2284.4238,045480.4538,045480.45$4,164.463,464.463,264.46
Table 14-9
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Hall.
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Hall.
Tailored Transportation
The use of different transportation networks and modes based
on customer and product characteristics
Factors affecting tailoring
Customer density and distance
Customer size
Product demand and value
14-‹#›

Hall.
14-‹#›
Hall.
Tailored TransportationShort DistanceMedium DistanceLong
DistanceHigh densityPrivate fleet with milk runsCross-dock
with milk runsCross-dock with milk runsMedium densityThird-
party milk runsLTL carrierLTL or package carrierLow
densityThird-party milk runs or LTL carrierLTL or package
carrierPackage carrier
Table 14-10
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Hall.
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Hall.
Tailored Transportation
Table 14-11Product TypeHigh ValueLow ValueHigh
demandDisaggregate cycle inventory. Aggregate safety
inventory. Inexpensive mode of transportation for replenishing
cycle inventory and fast mode when using safety
inventory.Disaggregate all inventories and use inexpensive
mode of transportation for replenishment.Low
demandAggregate all inventories. If needed, use fast mode of
transportation for filling customer orders.Aggregate only safety
inventory. Use inexpensive mode of transportation for
replenishing cycle inventory.
14-‹#›
Hall.
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Hall.
Role of IT in Transportation
The complexity of transportation decisions demands use of IT
systems
IT software can assist in:
Identification of optimal routes by minimi zing costs subject to
delivery constraints
Optimal fleet utilization
GPS applications
14-‹#›
Hall.
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Hall.
Risk Management in Transportation
Three main risks to be considered in transportation are
Risk that the shipment is delayed
Risk of disruptions
Risk of hazardous material
Risk mitigation strategies
Decrease the probability of disruptions
Alternative routings
In case of hazardous materials the use of modified containers,
low-risk transportation models, modification of physical and
chemical properties can prove to be effective
14-‹#›
Hall.
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Hall.
Making Transportation
Decisions in Practice
Align transportation strategy with competitive strategy
Consider both in-house and outsourced transportation
Use technology to improve transportation performance
Design flexibility into the transportation network
14-‹#›
Hall.
14-‹#›
Hall.
Summary of Learning Objectives
Understand the role of transportation in a supply chain
Evaluate the strengths and weaknesses of different modes of
transportation
Discuss the role of infrastructure and policies in transportation
Identify the relative strengths and weaknesses of various
transportation network design options
Identify trade-offs that shippers need to consider when
designing a transportation network
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Hall.
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Hall.
All rights reserved. No part of this publication may be
reproduced, stored in a retrieval system, or transmitted, in any

form or by any means, electronic, mechanical, photocopying,
recording, or otherwise, without the prior written permission of
the publisher.
Printed in the United States of America.
14-‹#›
Hall.
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Hall.
Average lot size, QH = expected demand during T weeks
=TµH = 4 × 2 = 8 units
Safety inventory, ssH = F
–1(CSL) ×σT+L = F
–1(CSL) × T + L ×σH
= F–1(0.997) × 4 +1× 5 = 30.7 units
Total HighVal inventory = QH / 2 + ssH = (8 / 2) + 30.7 = 34.7
units
Average lot size, Q
H
= expected demand during T weeks
=Tm
H
=4´2=8 units
Safety inventory, ss
H
=F
–1
(CSL)´s

T+L
=F
–1
(CSL)´T+L´s
H
=F
–1
(0.997)´4+1´5=30.7 units
Total HighVal inventory =Q
H
/2+ss
H
=(8/2)+30.7=34.7 units
Average lot size, QL = expected demand during T weeks
=TµH = 4 × 20 = 80 units
Safety inventory, ssL = F
–1(CSL) ×σT+L = F
–1(CSL) × T + L ×σL
= F–1(0.997) × 4 +1× 5 = 30.7 units
Total LowVal inventory = QL / 2 + ssL = (80 / 2) + 30.7 = 70.7
units
Average lot size, Q
L
= expected demand during T weeks
=Tm
H
=4´20=80 units
Safety inventory, ss
L
=F

–1
(CSL)´s
T+L
=F
–1
(CSL)´T+L´s
L
=F
–1
(0.997)´4+1´5=30.7 units
Total LowVal inventory =Q
L
/2+ss
L
=(80/2)+30.7=70.7 units

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