CHAPTER 2: Logistics

Overview of logistics Logistics of business is big and important The logistical value proposition The work of logistics Logistical operations Logistics integration objectives Logistical operating arrangements Flexible structure Supply chain synchronization

What is logistics? Logistics is the design and administration of systems to control movement and geographical positioning of raw materials, work-in-process, and finished inventories at the lowest total cost.

Logistics has risen to a key position in the global economy Postwar U.S. (1945-1995) Global leader in distribution and logistics, as a direct result of World War II Rise of EEC and Asia (1980-2000) Both regions became major exporters and distributors e-Commerce (1998-Present) Global logistics capability almost everywhere

Table 2.1- U.S. logistics cost, 1980-2010 in five year intervals ($B) Nominal GDP ($T) Inventory Cost Transportation Cost Administrative Cost Total Logistics Cost Logistics % of GDP 1980 2.80 220 214 17 451 16.1 1985 4.22 227 274 20 521 12.3 1990 5.80 283 351 25 659 11.4 1995 7.40 302 441 30 773 10.4 2000 9.82 374 594 39 1007 10.3 2005 12.43 395 739 46 1180 9.5 2010 14.60 396 769 47 1212 8.3 Source: Adapted from Rosalyn Wilson, 22nd Annual “State of Logistics Report” Council of Supply Chain Management Professionals and Penske: Oak Brook, IL, 2011.

The cost of logistics

Logistics will continue its renaissance in the future Information technologies will automate many of the traditionally manual logistical functions: Automated port and rail operations RFID tagging of materials Advanced technologies for warehousing and inventory operations Removal of trade barriers will continue to expand global trade and logistics

Goal of logistics management To satisfy customer expectations for delivery of products (or services) while minimizing the total cost Managers must support the requirements for procurement, manufacturing and customer accommodation supply chain operations

Logistics costs trends from Table 2.1 Transportation Costs relative to the Total Cost of Logistics have gone up Because of fuel prices and movement of manufacturing to Asia Inventory Costs relative to the Total Cost of Logistics have gone down Adoption of JIT and Lean practices have reduced these Administrative Costs relative to the Total Cost of Logistics have stayed the same

Logistical value proposition Logistical value proposition consists of a commitment to key customer expectations and requirements at a minimum cost The two elements of this value proposition are Service and Cost Minimization Firms must make appropriate tradeoffs between service and cost for each of their key customers

Service benefits are created by logistical performance in 3 areas Availability involves having inventory to consistently meet customer material or product requirements Operational performance deals with the time required to deliver a customer’s order Key metrics for this area involve delivery speed and consistency Service reliability involves the quality attributes of logistics Key to quality is accurate measurement of availability and operational performance over time

Basic logistical service may not fit all customers Basic logistics service describes the level of service a firm provides all established customers However, some customers require unique or special value-added services Managers must realize that customers are different and that services provided must be matched to accommodate unique requirements and purchase potential

Cost minimization using the total cost logistics model Traditional Cost Logistics Model Total Cost Logistics Model Focused on achieving the lowest possible cost for each individual function of logistics For example, Transport the material the cheapest way possible Expected lowest cost based on decisions that were cheapest for individual functions Ignored the impact of cost decisions across logistics functions Focused on achieving the lowest total cost across each function of logistics A cost decision in one function should consider impact to costs of all other logistics functions For example, Transporting material the cheapest way is slower than other choices. This requires an increase in storage cost to hold the material longer Would it still be a lower cost to use the cheapest mode of transport?

Different perspectives on cost minimization Traditional Cost Logistics Model Total Cost Logistics Model Minimize order processing cost + Minimize inventory cost + Minimize transportation cost + Minimize warehousing, materials handling and packaging cost + Minimize facility cost __________________________ Lowest logistics cost Minimize (order processing + inventory + transportation + warehousing, materials handling and packaging + facility) cost _________________________ Lowest total logistics cost

Example of evaluating alternatives to find lowest total cost Compare two alternative shipping carriers to move a shipment of electronic chips Value of shipment = $25,000.00 Faster shipping is generally more expensive than slower shipping Carrier 1 costs $250 to ship Carrier 2 costs $20 more but delivers 1 day faster Product in transit is a form of inventory Holding costs for shipment is 40% of value per year No other cost differences across remaining logistics functions 15

Example of evaluating alternatives to find lowest total cost Traditional Cost Method Minimize transportation cost Compare 1st carrier at $250 vs. 2nd carrier at $270 Decision is to use 1st Carrier to save $20 Total Cost Method Minimize total of transportation and inventory cost Compare 1st carrier at $250 + $27.40 = $277.40 vs. 2nd carrier at $270 Decision is to use 2nd Carrier since it is a lower total cost Daily cost of holding product = x /365 Annual holding cost Product value = (.40 x $25,000)/ 365 = $27.40

Logistics includes these major functions of work Order Processing Inventory Transportation Warehousing, Materials Handling, and Packaging Integrated through a network of facilities E.g. warehouses and distribution centers

Integrated logistics framework Goal is to achieve customer satisfaction at the lowest Total Cost Decisions in one functional area will impact cost of all others We integrate the logistical functions into a coherent framework starting with the customer (Order processing) and ending with the customer (Transportation and Delivery)

The five functions of logistical work are interrelated Figure 2.1 Integrated Logistics

Order processing Order processing is the transmission of customer requirements to the supply chain Accurate information is needed to achieve superior logistical performance Responsive supply chains require accurate and timely information about customer purchase behavior Fast information flow enables improved work balancing

Inventory Inventory requirements of a firm are directly linked to the facility network and the desired level of customer service Inventory strategy seeks to achieve the desired customer service with the minimum inventory commitment Inventory strategy is based on a combination of Core customer segmentation Product profitability Transportation integration Time-based performance Competitive performance

Transportation Transportation is the operational area that geographically moves and positions inventory There are three basic ways to satisfy transportation requirements Operate a private fleet of equipment Contract with dedicated transport specialists Engage carriers that provide different transportation services as needed on a per shipment basis

Warehousing, materials handling and packaging These work activities are integral parts of other logistical functions Inventory typically needs to be warehoused at selected times during the logistics process Transportation vehicles require materials handling for efficient loading and unloading Individual products are most efficiently handled when packaged together into shipping cartons Effective integration of these functions facilitates the speed and overall ease of product flow throughout the logistical system

Facilities network The number, size and geographical relationship of facilities used to perform logistical operations directly impacts customer service capability and cost Types of facilities in the logistics network include Manufacturing plants, warehouses, cross-dock operations and retail stores

The scope of integrated logistical operations Figure 2.2 Logistical Integration

Inventory flow Managers must be concerned with the movement and storage of inventory in 3 major forms Materials Work-in-process Finished products Logistical operations should add value by moving inventory when and where needed Materials and components gain value at each step of their transformation into finished inventory

The 3 areas of the value-added logistic process Customer relationship management is the movement of finished product to customers Manufacturing production concentrates on managing work-in-process inventory as it flows between stages of manufacturing Procurement is concerned with purchasing and arranging inbound movement of materials, parts, and/or finished inventory from suppliers into manufacturing or assembly plants, warehouses or retail stores

Information flow Information flow identifies specific locations within a logistical system that have requirements Information also integrates the three operating areas Information facilitates coordination of planning and control of day-to-day operations Logistical information has two major components Planning / coordination information Operational information needed to complete work

Logistical integration requires achieving six objectives simultaneously Responsiveness Variance reduction Inventory reduction Shipment consolidation Quality Life cycle support

Logistical operating arrangements All logistical arrangements share two common characteristics They are designed to manage inventory The range of logistics alternatives is limited by available technology Three widely utilized structures are Echelon (traditional) is a linear flow from origin to destination through buffers or warehouses/distribution centers Direct is designed to ship products directly to customer’s destination from one or a limited number of centrally located inventories Combined is a combination of Echelon and Direct, depending on the product, market, or customer

Figure 2.3 - Echelon structured logistics

Figure 2.4 - Combined echelon and direct delivery

Flexible structures are programs to service customers using alternatives Flexible operations are preplanned contingency strategies to prevent logistical failures For example, a warehouse is out of an item so a contingency policy assigns the total order to another warehouse The structure appears the same as a combined arrangement, but with the ability to change the logistical structure to suit the service need Different approaches for different situations Very common with “factory-less” companies like Nike and Best Buy

Example situations for flexible logistics structure The customer-specified delivery facility might be near a point of equal logistics cost or equal delivery time from two different logistics facilities The size of a customer’s order creates improved logistical efficiency if serviced through an alternative channel arrangement Decision to use a selective inventory stocking strategy Agreements between firms to move selected shipments outside the established echeloned or direct arrangements

Figure 2.5 - Flexible echeloned and direct delivery

Supply chain synchronization Supply chain synchronization is the operational integration of multiple firms across a supply chain Seeks to coordinate the flow of materials, products and information between supply chain partners to reduce duplication of effort Seeks to reengineer internal operations of individual firms to leverage overall supply chain capability

The logistics performance cycle is the basic unit of supply chain design and operational control The performance cycle represents elements of work necessary to complete the logistics related to customer accommodation, manufacturing or procurement A performance cycle consists of the following elements Nodes Links Inventory Base stock Safety stock Input and output requirements

Figure 2.6 - Logistical performance cycles Input and output requirements are not illustrated

Performance cycle uncertainty Major objective of logistics in all areas is to reduce performance cycle uncertainty Operational variance is randomly introduced during the cycle through The structure of the performance cycle itself Operating conditions The quality of logistical operations

Figure 2.8 Performance Cycle Uncertainty Total time to complete the customer delivery cycle is based on each task within the cycle Figure 2.8 Performance Cycle Uncertainty

Ways to improve performance cycle times EDI (Electronic Data Interchange) or Internet order management and tracking RFID or Bar code material tracking Automated inventory management Automated order selection and picking Communication with customers to determine their needs Communication with suppliers to determine their capabilities

Performance cycle synchronization seeks to achieve planned time performance Delayed or faster performance at any point along the supply chain results in potential disruption of operations Once consistent operations are achieved, managers can focus on reducing the time to complete the performance cycle to a minimum