Optimization-Based Procurement for Transportation Services Calice and Sheffi, 2003

Three Economies of Transportation  Economies of Scale  Economies of density  Economies of Scope  Hub-and-Spoke  Southwest model

Steps of transportation procurement  Bid preparation  Bid execution  Bid analysis and assignment

Cost of carriers  Line-haul cost  Connection to follow-on loads (dwell + deadhaul)  Connection cost uncertainty  Carriers should be concerned more with economies of scope than economies of scale

 Problems with traditional bidding system  Interdependency of lanes is ignores – cost hedging  Cannot consider other factors; e.g., requirements such as minimum volume for preferred carriers.

 Implications  Shippers should design the bid such that it enhances carrier efficiencies and lower bid prices.

 A Solution  Let carriers submit conditional bids (package bids) – Lanes can be overlapped  Shippers solve an optimization model to determine the assignments to carriers.

 Results  Less uncertainty for carriers  Lower bid prices by carriers  Lower transportation cost for shippers  Both shippers and carriers benefit  SCM cost reduced  Potential Savings  Table 1

The optimization model can also incorporate or consider:  Min/Max carriers  Favoring incumbents  Back up carriers  Threshold volume  Performance factors

Discussion Questions  1.When does it make sense to use optimization?  2.Who should create package bids?  3.What business constraints should shippers consider?  4.What performance factor should a shipper consider?  5.Can bidding be used to collaborate across shippers?