Logistics & Supply Chain Management, MBA II...

Logistics & Supply Chain Management, MBA II Semester

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Prepared by K.Swapna, Assistant Professor, Dept of MBA, CMRCET

LECTURE NOTES

On

LOGISTICS AND SUPPLY CHAIN

MANAGEMENT

MBA II semester R 18 syllabus

Prepared by

K. SWAPNA

ASSISTANT PROFESSOR, DEPT. OF MBA

CMRCET


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UNIT – I

LOGISTICS AND COMPETITIVE STRATEGY


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1. WHAT IS SUPPLY CHAIN?

A supply chain consists of all parties involved, directly or indirectly, in fulfilling a

customer

request. The supply chain includes not only the manufacturer and suppliers, but also

transporters, warehouses, retailers, and even customers themselves. Within each

organization, such as a manufacturer, the supply chain includes all functions involved in

receiving and filling a customer request. These functions include, but are not limited to,

new product development, marketing, operations, distribution, finance, and customer

service.

A supply chain is dynamic and involves the constant flow of information, product, and

funds between different stages. Eg. In the figure below, Unilever provides the availability

and pricing of the products to the customers through its advertisements (Information

flow). The customer pays for the product (Product flow). Big bazaar obtains its products

from Unilever (Product flow)


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WHAT IS BUSINESS LOGISTICS?

It is the part of the supply chain process that plans, implements and controls the efficient,

effective flow and storage of goods, service and other related information from point of

use or consumption in order to meet customer requirements.

1.2.SUPPLY CHAIN STAGES:

A supply chain is dynamic and involves the constant flow of information, products and

funds

between different stages.

As shown in figure 2, a typical supply chain may involve a variety of stages. These

supply chain

stages include

o Customers

o Retailers

o Wholesalers/Distributors

o Manufacturers

o Suppliers (Component or Raw Material)

Figure 2: Supply Chain Stages

SUPPLY CHAIN MANAGEMENT Supply chain management (SCM) is the term used

to describe the management of the flow of materials, information, and funds across the

entire supply chain, from suppliers to component producers to final assemblers to

distribution (warehouses and retailers), and ultimately to the consumer

In fact, it often includes after-sales service and returns or recycling. Traditionally,

marketing, distribution, planning, manufacturing, and the purchasing organizations along

the supply chain operated independently. These organizations have their own objectives

and these are oftenconflicting. Therefore, there is a need for a mechanism through which

these different functions can be integrated together.


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Supply chain management is a strategy through which such integration can be achieved.

Supplychain management is typically viewed to lie between fully vertically integrated

firms, where the entire material flow is owned by a single firm and those where each

channel member operates independently. Therefore coordination between the various

players in the chain is the key in its effective management.

IMPORTANCE OF SUPPLY CHAIN

SCM plays a vital role in organization activities and an essential element to operational

efficiency which can be applied to customer satisfaction and company‗s success. It is just

like the backbone of an organization which manages the critical issues of the business

organization such as rapid growth of multinational corporations, global expansion and

environmental concerns which indirectly or dramatically affects the corporate strategy.

Other benefits and importance of supply chain management are:

Reduces inventory costs

Provides better medium for information sharing between partners

Improves customer satisfaction as well as service

Maintains better trust between partners

Provides efficient manufacturing strategy

Improve process integration

Improves bottom line (by decreasing the use of fixed assets in the supply

chain)

Increase cash flow

Improves quality and gives higher profit margin

OBJECTIVES OF SUPPLY CHAIN

Supply chain management is concerned with the efficient integration of suppliers,

factories,

warehouses and stores so that merchandise is produced and distributed:

In the right quantities

To the right locations

At the right time

In order to

Minimize total system cost

Satisfy customer service requirements

-face global competition

Improve standardization

DRIVERS OF SUPPLY CHAIN The major drivers of supply chain performance consist of

three logistical drivers & three crossfunctional drivers as shown in figure


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FACILITY

Facility is the actual physical locations in the supply chain network where products are

stored,assembled or fabricated. The two major types of facilities are:

• Production sites(factories)

• Storage sites(warehouses)

Factories can be built to accommodate one of the two approaches to manufacturing:

Product Focus: A factory that takes a product focus performs the range of different

operations required to make a given product line from fabrication of different product

parts to assembly of these parts.

Functional focus: A functional focus approach concentrates on performing just a

few operations such as only making a select group of parts or doing only

assembly.

Warehousing uses three main approaches:


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Stock keeping unit(SKU) storage: In this approach all of a given type of product is

storedtogether.

Job lot storage: In this approach all the different products related to the needs of a

certain type of customer or related to the needs of a particular job are stored

together.

Crossdocking: In this approach, product is not actually warehoused in the facility,

insteadthe facility is used to house a process where trucks from suppliers arrive

and unload largequantities of different products. These large lots are then broken

down into smaller lots.Smaller lots of different products are recombined according

to the needs of the day and quickly loaded onto outbound trucks that deliver the

product to their final destination.So the fundamental trade-off that managers face

when making facilities decision between the cost of the number, location & type

of facilities(efficiency) & the level of responsiveness that these facilities provide

the company‗s customer.

INVENTORY

Inventory encompasses all the raw materials, work in process, and finished goods within

a supply chain. Changing inventory policies can dramatically alter the supply chain‗s

efficiency &responsiveness.

There are three basic decisions to make regarding the creation and holding of inventory:

Cycle Inventory: This is the amount of inventory needed to satisfy demand for the

product in the period between purchases of the product.

Safety Inventory: inventory that is held as a buffer against uncertainty. If demand

forecasting could be done with perfect accuracy, then the only inventory that

would be needed would be cycle inventory.

Seasonal Inventory: This is inventory that is built up in anticipation of predictable

increases in demand that occur at certain times of the year.

GAINING COMPETITIVE ADVANTAGE THROUGH LOGISTICS

A firm can gain competitive advantage only when it performs its strategically important

activities (designing, producing, marketing delivering and supporting its product) more

cheaply or better than its competitors.

Value chain activity disaggregates a firm into its strategically relevant activities in order

to understand behavior of costs and existing and potential sources of differentiation. 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


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TRANSPORTATION

Transportation entails moving inventory from point to point in the supply chain.

Transportation can take the form of many combinations of modes & routes, each with its

own performance characteristics. There are six basic modes of transport that a company

can choose from:

•Ship which is very cost efficient but also the slowest mode of transport. It is limited to

use between locations that are situated nest to navigable waterways & facilities such as

harbor & canals.

• Rails which is also very cost efficient but can be slow. This mode is also restricted to

use between locations that are served by rail lines.

• Pipelines can be very efficient but are restricted to commodities that are liquid or gases

such as water, oil & natural gas.

• Trucks are a relatively quick & very flexible mode of transport. Trucks can go almost

anywhere. The cost of this mode is prone to fluctuations though, as the cost of fuel

fluctuates and the condition of road varies.

• Airplanes are a very fast mode of transport and are very responsive. This mode is also

very expensive mode & is somewhat limited by the availability of appropriate airport

facilities.

• Electronic transport is the fastest mode of transport and it is very flexible & cost

efficient. However , it can be only be used for movement of certain types of products

such as electric energy, data, & products composed of data such as music, pictures &

text.

CROSS-FUNCTIONAL DRIVERS:

• Information

• Sourcing

• Pricing

INFORMATION

Information serves as the connection between various stages of a supply chain, allowing

them to coordinate & maximize total supply chain profitability. It is also crucial to the

daily operations of each stage in a supply chain for e.g a production scheduling system.

Information is used for the following purpose in a supply chain:

1. Coordinating daily activities related to the functioning of other supply chain drivers:

facility, inventory & transportation.

2. Forecasting & planning to anticipate& meet future demands. Available information is

used to make tactical forecasts to guide the setting of monthly & quarterly production

schedules & time table

3. Enabling technologies: many technologies exist to share & analyze information in the

supply chain. Managers must decide which technologies to use & how to integrate these

technologies into their companies like internet, ERP, RFID.


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SOURCING

Sourcing is the set of business processes required to purchase goods & services.

Managers must first decide which tasks will be outsourced & those that will be performed

within the firm.

Components of sourcing decisions

• In-House or outsource: The most significant sourcing decision for a firm is whether to

perform a task in-house or outsource it to a third party. This decision should be driven in

part by its impact on the total supply chain profitability.

• Supplier selection: It must be decided on the number of suppliers they will have for a

particular activity. The must then identify the criteria along which suppliers will be

evaluated & how they will be selected like through direct negotiations or resort to an

auction.

PRICING

Pricing determines how much a firm will charge for goods & services that it makes

available in the supply chain. Pricing affects the behavior of the buyer of the good or

services, thus affecting supply chain performance, for example, if a transportation

company varies its charges based on the lead time provided by the customers, it s very

likely that customers who value efficiency will order early & customers who value

responsiveness will be willing to wait & order just before they need a product

transported. This directly affects the supply chain in terms of the level of responsiveness

required as well as the demand profile that the supply chain attempts to serve.

Pricing is also a lever that can be used to match supply & demand.

Components of Pricing Decisions:

• Fixed Price versus Menu pricing: A firm must decide whether it will charge a fixed

price for its supply chain activities or have a menu with prices that vary with some other

attribute, such as response time or location of delivery.

• Everyday low pricing versus High-Low pricing: Company‗s supply chain achieves the

balance between responsiveness & efficiency that best meets the needs of the company

competitive strategy.

LOGISTICS / SUPPLY CHAIN STRATEGY

Strategy is the process whereby plans are formulated for positioning the firm to meet its

objectives.

Strategy formulation begins with defining a corporate strategy. This involves:

Assessing needs, strengths, and weaknesses of the 4 major components:

customers

suppliers

competitors

the company itself

"Visioning" where counter -intuitive, unheard of, and unconventional strategies

are considered.


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Corporate strategies are converted to more specific strategies for the various functional

areas of the firm such as logistics.

Supply chain management strategy relates to procurement, transportation, storage and

delivery. – e.g. Never use more than 1 supplier for every input AND

– e.g. Never expedite orders just because they are late

Selecting a good logistics or supply chain strategy requires much of the same creative

processes as developing a good corporate strategy. Innovative approaches to

logistics/supply chain strategy can give a competitive advantage.

The objectives of logistics strategy are:

- Minimize cost

- Minimize investment

- Maximize customer service

A proactive logistics strategy begins with business goals and customer service

requirements. These have been referred to as attack ‗strategies to meet competition. The

remainder of the logistics system can be derived from these attack strategies.

Each link in the logistics system is planned and balanced with each other in an integrated

Logistics planning process as shown in figure below. Design of the management and

control system completes the planning cycle.

Designing the effective logistics customer service strategies requires no particular

program or technique. It is simply the product of a sharp mind. Once the logistics service

strategy is formulated, the task is then to meet it. This involves among selecting

alternative courses of action. Such selection is amenable to various concepts and

techniques for analysis.

Logistics Planning Process


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SIX CONCEPTS FOR LOGISTICS STRATEGY FORMULATION

1. Total cost concept: Tradeoff conflicting costs at optimum

2. Differentiated distribution: Not all products should be provided the same level of

customer service

3. Mixed strategy: A pure strategy has higher costs than a mixed strategy

4. Postponement: Delay formation of the final product as long as possible

5. Shipment consolidation: Smaller shipment sizes have disproportionately higher

transportation costs than larger ones

6. Product standardization: Avoid product variety since it adds to inventory


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LOGISTICS-INTEGRATED SUPPLY CHAINS


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LOGISTICS / SUPPLY CHAIN PLANNING:

LEVELS OF PLANNING

Logistics planning attempts to answer the questions of what, when and how it takes place

at three levels: Strategic, tactical and operational. The major difference between them is

the time horizon for the planning. Strategic Planning is considered long range, where

time horizon is longer than one year. Tactical planning involves an intermediate time

horizon, usually less than a year. Operational planning is short range decision making,

with decisions frequently made on an hourly or daily basis.

The concern is how to move the product effectively and efficiently through the

strategically planned logistics channel. Selected examples of typical problems with these

planning time horizons are shown in the below figure

Each planning level requires a different perspective. Because of its long term horizon,

strategic planning works with data that are incomplete and imprecise. At the other end of

the spectrum, operational planning works with very accurate data and the methods of

planning should be able to handle a great deal of these data and still find reasonable

plans.


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MAJOR PLANNING AREAS

Logistics planning tackles four major problem areas:

Customer Service Goals:

More than any other factor, the level of logistics consumer service provided dramatically

affects system design. Low levels of service allow centralized inventories at few

locations and the use of less expensive forms of transportation. High service levels

generally require the opposite. However when service levels are pressed to their upper

limits, logistics costs will rise at a rate disproportionate to the service level. Therefore the

first concern in logistics strategic planning must be the proper setting of customer service

levels.

Facility Location Strategy:

The geographic placement of the stocking points and the sourcing points creates an

outline for the logistics plan. Fixing the number, location and size of the facilities and

allocating market demand to them determine the paths through which products are

directed to the market place. The proper scope for the facility location problem is to

include all product movements and associated costs as they take place from plant, vendor

or port locations through the immediate stocking points and on to customer locations.

Finding lowest cost assignments or alternatively the maximum profit assignments is the

essence of facility location strategy.

Inventory Decisions

Inventory decisions refer to the way which the inventory is managed.

Transport Decisions

Transport decisions can involve mode selection, shipment size and routing and

scheduling. These decisions are influenced by the proximity of the warehouses to the

customers and plants, which in turn influence warehouse location. Inventory levels also

respond to transport decisions through shipment size.

WHEN TO PLAN?

No distribution network currently exists. There has been no re-evaluation in 5 years. When costs are changing rapidly, especially transport & inventory. When markets have shifted. When current distribution economics encourage shifts. When there has been a major policy shift in logistics such as in price,

customer service, or investment level


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SELECTING PROPER CHANNEL STRATEGY

Selecting the proper channel design greatly affects the effectiveness and efficiency of the

supplychain. Fundamentally, two strategies are followed – Supply to Stock and Supply to

order. A Supply to stock strategy is one where the supply channel is set up for maximum

efficiency. That is inventories are used to achieve good economies by allowing

economical production runs, purchasing in quantity, batch order processing and

transporting in large shipment sizes. Safety stocks are maintained to realize high levels of

product availability. Demand is usually met from inventories, but careful control holds

inventory levels to a minimum. A Supply to order strategy is one where the supply

channel is set up for maximum responsiveness. The channel characteristics are excess

capacity, quick changeovers, short lead times, flexible processing, premium

transportation and single order processing. Postponement strategies are used to delay the

creation of product variety as long and as far down the supply channel as possible. The

cost associated with responsiveness is offset by minimization of finished goods

inventories.

TYPES OF LOGISTICS

Return Logistics (Reverse Logistics): In order to increase the sales as well as the market

share, many companies advertise that their goods will perform well over a period of time.

The customer is, therefore, led to believe that in case he buys the product of that

company, he is assured of satisfactory performance of the product. But at the same time,

it is very much obvious that the company cannot assure the satisfactory performance of

each and every of its product which is sold in the market. Few of the products sold may

not perform as advertised over the specific period of time. Such products need to be

brought back by the company to confirm good customer service. Multination Companies

(MNCs) to protect their market image and to stall its competitors from grabbing its

customers, recall immediately the defective or substandard product from the market.

Product recall is a critical competency resulting from increasingly rigid quality standards

product expiration dating responsibility for hazardous consequences The company has,

therefore, to take into account the defective goods that would be returned while framing

the total logistical system network and calculating the total cost of such a system of

network. Incorporating the goods returned in the total logistical systems network and cost

is called as Return Logistics. Return Logistics requirement‗ also result from the

increasing number of laws prohibiting random scrapping and disposal on one hand, while

encouraging recycling of waste such as beverage containers, packaging materials, etc.

The most significant aspect of return logistical operation is the need for maximum control

when a potential health liability exists. E.g.: a contaminated drug in the market is

extremely dangerous and the company has to recall all the stock of contaminated drug.


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Military Logistics

Military logistics is the art and science of planning and carrying out the movement and

Maintenance of military forces. In its most comprehensive sense, it is those aspects or

military operations that deal with: Design, development, acquisition, storage, distribution,

maintenance, evacuation, and disposition of material, evacuation, and hospitalization of

personnel, acquisition or construction, maintenance, operation, and disposition of

facilities.

Third Party Logistics (3PL)

3PL, Third Party Logistics describes businesses that provide one or many of a variety of

logistics related services. Types of services would include public warehousing, contract

warehousing, transportation management, distribution management, freight

consolidation. A 3PL provider may take over all receiving, storage, value added,

shipping, and transportation responsibilities for aclient and conduct them in the 3PL‗s

warehouse using the 3PLs equipment and employees or may manage one or all of these

functions in the clients facility using the clients equipment, or anything combination of

the above. 3PL can be defined as the ―Business of proposing physical distribution

reforms to a client and undertaking comprehensive physical distribution services.

Third party logistics (3PL), a new business model for physical distribution, originated in

the U.K. & became highly popular in U.S. in the 1990s. 3PL providers offer innovative

alternatives to clients in the form of comprehensive logistics services. Because 3PL

requires that providers have intimate access to the corporate strategy of their clients,

relationships are based long term contracts as a rule

The growing demand for 3PL can be attributed to both demand,& supply side factors. (1)

faced with deregulation & growing competition, transport companies are seeking new

business opportunities, & (2) clients are seeking to outsource their logistics operations cut

costs & focus management resources on core businesses.

Fourth Party Logistics

Traditionally, suppliers and big corporations have been meeting the demands by

increased inventory, speedier transportation solutions posting on-site service engineers

and many times employing a third party service provider. Today they need to meet

increased levels of services due to e-procurement, complete supply visibility, virtual

inventory management and requisite integrating technology. Now corporations are

outsourcing their entire set of supply chain process from a single design, make and run

integrated comprehensive supply chain solutions. This evolution in supply chain

outsourcing is called Fourth Party Logistics – the aim being to provide maximum overall

benefit. Thus a fourth party logistics provider is a supply chain integrator that assembles

and manages the resources, capabilities and technology of its own organization with

those of complementary service provider to deliver a comprehensive supply chain

solution. It leverages the competencies of third party logistics providers and business

process managers to deliver a supply chain solution through a centralized point of

contact. As the fourth party logistics provider caters to multiple clients, the investment is

spread across clients-thus taking the advantage of economies of scale.


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Inbound Logistics

Creation of value in a conversion process heavily depends on availability of inputs on

time. Making available these inputs on time at point of use at minimum cost is the

essence of Inbound Logistics. All the activities of a procurement performance cycle come

under the scope of Inbound Logistics. Scope of Inbound Logistics covers transportation

during procurement operation, storage, handling if any and overall management of

inventory of inputs. Several activities or tasks are required to facilitate an orderly flow of

materials, parts or finished inventory into a Manufacturing complex. They are sourcing,

order placement and expediting, transportation, receiving and storage. Overall,

procurement operations are called inbound logistics. Inbound logistics have potential

avenues for reducing systems costs. Delivery time, size of shipment, method of transport

& value of products involved are different from those of physical distribution cycles.

Normally delivery is large as a low cost transportation mode is chosen. As the value of

inventory is low, size of shipment is large & transit inventory costs are low.

Outbound Logistics

Value added goods are to be made available in the market for customers to perceive

value. Finished goods are to be distributed through the network of warehouses and supply

lines to reach the consumer through retailer shops in the market. During conversion value

is added to the raw materials and as a result value of the inventory in this case is very

high unlike inputs. Now the size of shipment, modes of transport and delivery time is

different as compared to inputs. Activities of shipment, distribution performance cycle

come under the scope of Outbound Logistics. They are order management, transportation,

warehousing, packaging, handling etc.

LOGISTICS ACTIVITIES

Transportation

Warehousing and storage

Industrial packaging

Materials handling

Inventory control

Order fulfillment

Demand forecasting

Production

Planning/scheduling

Procurement

Customer service

Facility location

Return goods handlin

Parts and service support

Salvage and scrap disposal


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The 6 Models Of Supply Chains Solutions:

The way you manage your supply chain connection has a direct bearing on your business

performance in terms of product cost, working capital requirements, service perception

by customers, speed to market and other factors that influence your competitiveness in

the marketplace.

An organization's supply chain strategy is shaped by four key elements, including:

The industry framework

Your unique value proposition

Internal supply chain processes

Managerial focus

There are six main supply chain models that almost all businesses adopt. These can be

grouped into main categories:

Supply chain models that are oriented to efficiency

Supply chain models that are oriented to responsiveness


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Supply chain models oriented to efficiency.

In industries where the value proposition is oriented to metrics such as high relevance of

asset utilization, low cost, and total cost, the end-to-end efficiency is given high priority.

Examples of such industries include steel, cement, paper, low-cost fashion, and

commodity manufacturing in general. Three supply chain models fall under this category:

The ''efficient'' supply chain model

This model is best suited to industries that exist in highly competitive markets with

several producers, and customers who may not readily appreciate their different value

propositions. These are usually commoditized businesses where production is scheduled

based on expected sales for the length of the production cycle and competition is almost

solely based on price. The steel and cement industries fall under this category.

The key objective of the efficient supply chain model is that managers should focus on

maximizing end-to-end efficiency including high rates of asset utilization in a bid to

lower costs.

The ''fast'' supply chain model

This supply chain model is best suited for companies that manufacture trendy products

with short lifecycles. Consumers are mostly concerned with how fast the manufacturer

updates their product portfolios to keep up with fashion trends.

Companies that adopt the fast supply chain model focus on shortening the time from idea

to market and maximizing the levels of forecast accuracy so as to reduce market

mediation cost.

The ''continuous-flow'' model

This model is ideal for industries with high demand stability. The manufacturing

processes in a continuous-flow model are designed to generate a regular cadence of

product and information flow. This supply chain model is suited for mature industries

with little variation in the customer demand profile.

Competitive positioning for this model involves offering a continuous-replenishment

system that ensures high service levels and low inventory levels at customers' facilities.

Supply chains oriented to responsiveness

In industries that are characterized by high demand uncertainty and where market

mediation costs is the top priority, supply chain models that are oriented to

responsiveness are usually employed. These include:


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The "agile" supply chain model

The agile supply chain model is ideal for companies that manufacture products under

unique specifications by their customers. This model is mostly used in industries

characterized by unpredictable demand. The model uses a make-to-order decoupling

point that involves manufacturing an item after receiving customers' purchase orders.

To ensure agility in the supply chain, managers focus on having the ability for excess

capacity and designing manufacturing processes that are capable of the smallest possible

batches.

The "custom-configured" model

This model is ideal where products with multiple and potentially unlimited product

configurations are required. It features a high degree of correlation between asset cost

and the total cost. Product configurations is usually accomplished during the assembly

process where different product parts are assembled according to a customer's

specifications.

The custom-configured model combines the continuous-flow supply chain model and an

agile supply chain where the processes before configuration of the product are managed

under the continuous-flow model while downstream processes operate as an agile supply

chain.

The "flexible" supply chain model

This supply chain model is best suited for industries that are characterized by high

demand peaks followed by extended periods of low demand. This model is characterized

by high adaptability with capability to reconfigure internal manufacturing processes so as

to meet specific customer needs or solve customer problems.

For this supply chain model to be successful, the management should focus on ensuring

ample flexibility with emphasis on rapid response capability, having extra capacity of

critical resources, possessing adequate technical strengths, and developing a process flow

that is quickly reconfigurable.


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UNIT – II

MEASURING LOGISTICS COSTS AND

PERFORMANCE


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The concept of Total Cost analysis:

Purpose

How can the logistic management contribute to the customer value of a firm? This is a

central question in modern Logistic and Supply Chain Management concepts. Martin

Christopher states, ―that there is no escaping the fact that the customer in today‘s

marketplace is more demanding, not just of product quality, but also of service.‖

Ultimately the success or failure of any business will be determined by the level of

customer value that it delivers in its markets .

In the following, the concept of customer value and the total cost of ownership is outlined

in more detail. On the one hand, we will see, that the logistic management can play a

major part for improving the customer value and the competitive advantage of a firm. On

the other hand, the logistic manager has a practical framework for analyzing the logistic

system and to derive the proper strategies and actions.

Objectives

The concept of customer value focuses on customer satisfaction. Customer satisfaction is

accomplished by providing value to the customer ‗beyond‘ price, especially with clients

in a business-to-business setting. Customer satisfaction occurs when businesses

successfully fulfill their obligations on all components of the marketing mix: product,

price, promotion and place. The place component represents the manufacturer‘s

expenditure for customer service, which can be thought of as the output of the logistics

system. There are at least four reasons why companies should focus on customer service.

Satisfied customers are typically loyal and make repeat purchases.

It can be up to five times as costly to attract a new customer as it is to keep an old one.

Customers who decide to defect are very likely to share their dissatisfaction with others.

It is more profitable to sell more to existing customers than it is to find new customers for

this same level of sales increase.

The general ratio for customer value is as follows:

Customer value = Quality * Service / Cost * Time.

Each of the four constituent elements can briefly be defined as follows.

Quality: The functionality, performance and technical specification of the offer. Quality

includes all non-price attributes, both product and customer service.

Service: The availability, support and commitment provided to the customer.

Cost: The customer‘s transaction costs including price and life cycle costs.

Time: The time taken to respond to customer requirements, e.g. delivery

lead times.


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The idea behind customer value is, that the customers are interested in obtaining quality

at a good price. They use product and service attributes to evaluate the expected benefits.

In summary, the customer buys not only on price but rather on value.

The ratio for customer value shows, that Logistics management is almost unique in its

ability to impact both the numerator and the denominator significantly.

It is important to know, that the cost element of the customer value ratio is not only the

purchasing price. This is the point, where the concept of ‗Total cost of ownership‘ is put

in place. You can see in the following figure, that the selling or purchasing price is only

the ‗visible‘ part of the iceberg whereas below the surface of the water are all the costs

which have a significant influence not only on the profit margin but on the economic

benefit in general.

The basic principle of total cost analysis is that managers should consider the total cost of

all logistics activities instead of trying to reduce the cost of individual logistics activities

so that real cost savings can be realized. Otherwise, cost reductions in one logistics

activity can lead to cost increases in others, and this may result in increased total costs.

Total cost analysis can be expanded to include all of the costs of ownership, not just those

related to logistics. With total cost analysis, the goal is to compare the costs of doing

business with the firm to those of doing business with a competitor and to show the

customer the financial benefits associated with the firm‘s higher service performance. For

example, it is necessary to convert fill rates, lead times and on-time performance that are

better than those of competitors to an inventory turn advantage and therefore lower

carrying costs per unit. Rather than telling customers that the firm provides better on time

delivery performance than competitors, that its fill rates are better and its lead time is

shorter, management needs to show the customer how this performance affects its

inventory investment. For example, if an item costs the customer $100 and the

customer‘s inventory carrying cost is 36%, the cost associated with one inventory turn is

$36. By dividing this number by the inventory turns actually achieved, it is possible to

calculate the cost on a per unit basis. If the firm‘s better service results in 12 inventory

turns for the customer compared to six turns for a competitor‘s product, the inventory

carrying cost per unit would be $3 ($36 ÷ 12) versus $6 (36 ÷ 6) for the competitor. The

$3 per unit savings can be used to justify a price premium over that competitor .

Characteristics – Customer Value

Based on the idea that value beyond price leads to higher sales figures, higher profit

margins and higher shareholder value.

Value equals quality relative to price.

Quality includes all non-price attributes, both product and customer service.

Quality, price and value are relative.


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Relatively easy to obtain these measures.

Fails to measure the financial impact of providing higher levels of customer value.

Characteristics – Total Cost of Ownership

Total cost analysis can be defined as minimizing the total costs of logistics including

transportation, warehousing, inventory, order processing, information systems,

purchasing and production-related lot quantity costs, while achieving a given customer

service level.

Total cost analysis can be used to show the performance of logistics internally as well as

externally.

Reducing the total costs associated with logistics represents value creation for the

company.

Does not consider revenue implications of logistics related service.

More time consuming since it has to be done on an individual customer basis.

Requires access to cost information.

Perpetuates the ‗myth‘ that logistics is simply a cost that must be reduced.

Implementation Notes – Customer Value

Each of the four elements (Quality, Service, Cost, Time) requires a continuous

programme of improvement, innovation and investment to ensure continued competitive

advantage.

The customer value can not be defined by single functional business departments, but

need a general management board for defining a sound ‗mission‘.

Implementation Notes – Total Cost of Ownership

The ultimate goal should not be to reduce one entity‘s costs simply by shifting them to

another firm. The goal should be to reduce total costs for the supply chaiz.

The Total Cost of Ownership concept is a core tool for system evaluation in general

(Vendor selection, Logistic system and process audit, etc.).

Use the Total Cost Analysis for considering the change of costs from the actual (As-Is

state) to the future system (To-Be state).

Logistic managers should base their analysis on it for getting and improving their

attendance on TOP management level.

Martin Christopher defined already a simple procedure in year 1988 for linking the costs

according to different customer segments

Define the customer service segment and their service needs

Identify the factors that produce variations in the costs of service (e.g. Delivery

characteristics, product mix, etc.).


25


Identify the actual difference in the provision of service to individual customers (e.g. E.g.

Direct delivery, merchandising support, special packs etc.).

Identify specific resources used to support customer segment (e.g. direct delivery,

merchandising support, special packs etc.).

Identify specific resources used to support customer segments (E.g. People, computers,

warehouses, inventory etc.).

Attribute costs by customer type.

LOGISTICS AND THE BOTTOM LINE Today‘s turbulent business environment has produced an ever greater awareness amongst

managers of the financial dimension of decision making. ‗The bottom line‘ has become

the driving force which, perhaps erroneously, determines the direction of the company. In

some cases this has led to a limiting, and potentially dangerous, focus on the short term.

Hence we find that investment in brands, in R&D and in capacity may well be curtailed if

there is no prospect of an immediate payback. Just as powerful an influence on decision

making and management horizons is cash flow. Strong positive cash flow has become as

much a desired goal of management as profit.

The third financial dimension to decision making is resource utilization and specifically

the use of fixed and working capital. The pressure in most organizations is to improve the

productivity of capital – ‗to make the assets sweat‘. In this regard it is usual to utilize the

concept of return on investment (ROI). Return on investment is the ratio between the net

profit and the capital that was employed to produce that profit, thus:


26


It will be seen that ROI is the product of two ratios: the first, profit/sales, being

commonly referred to as the margin and the second, sales/capital employed, termed

capital turnover or asset turn. Thus to gain improvement on ROI one or other, or both, of

these ratios must increase. Typically many companies will focus their main attention on

the margin in their attempt to drive up ROI, yet it can often be more effective to use the

leverage of improved capital turnover to boost ROI. For example, many successful

retailers have long since recognized that very small net margins can lead to excellent ROI

if the productivity of capital is high, e.g. limited inventory, high sales per square foot,

premises that are leased rather than owned and so on.

Figure illustrates the opportunities that exist for boosting ROI through either achieving

better margins or higher assets turns or both. Each ‗iso-curve‘ reflects the different ways

the same ROI can be achieved through specific margin/asset turn combination. The

challenge to logistics management is to find ways of moving the iso-curve to the right.

The impact of margin and asset turn on ROI


27


The ways in which logistics management can impact on ROI are many and varied. Figure

3.2 highlights the major elements determining ROI and the potential for improvement

through more effective logistics management.

Logistics impact on ROI

Logistics and the balance sheet As well as its impact on operating income (revenue less costs) logistics can affect the

balance sheet of the business in a number of ways. In today‘s financially-oriented

business environment improving the shape of the balance sheet through better use of

resources has become a priority.

Once again better logistics management has the power to transform performance in this

crucial area. Figure 3.3 summarizes the major elements of the balance sheet and links to


28


each of the relevant logistics management components. By examining each element of

the balance sheet in turn it will be seen how logistics variables can influence its final

shape.

Logistics management and the balance sheet

Cash and receivables

This component of current assets is crucial to the liquidity of the business. In recent years

its importance has been recognized as more companies become squeezed for cash. It is

not always recognized however that logistics variables have a direct impact on this part of

the balance sheet. For example, the shorter the order cycle time, from when the customer

places the order to when the goods are delivered, the sooner the invoice can be issued.

Likewise the order completion rate can affect the cash flow if the invoice is not issued

until after the goods are despatched. One of the less obvious logistics variables affecting

cash and receivables is invoice accuracy. If the customer finds that his invoice is

inaccurate he is unlikely to pay and the payment lead time will be extended until the

problem is rectified.

Inventories

Fifty per cent or more of a company‘s current assets will often be tied up in inventory.

Logistics is concerned with all inventory within the business from raw materials,

subassembly or bought-in components, through work-in-progress to finished goods. The

company‘s policies on inventory levels and stock locations will clearly influence the size


29


of total inventory. Also influential will be the extent to which inventory levels are

monitored and managed, and beyond that the extent to which strategies are in operation

that minimize the need for inventory.

Property, plant and equipment

The logistics system of any business will usually be a heavy user of fixed assets. The

plant, depots and warehouses that form the logistics network, if valued realistically on a

replacement basis, will represent a substantial part of total capacity employed (assuming

that they are owned rather than rented or leased). Materials handling equipment, vehicles

and other equipment involved in storage and transport can also add considerably to the

total sum of fixed assets. Many companies have outsourced the physical distribution of

their products partly to move assets off their balance sheet. Warehouses, for example,

with their associated storage and handling equipment represent a sizeable investment and

the question should be asked: ‗Is this the most effective way to deploy our assets?‘

Current liabilities The current liabilities of the business are debts that must be paid in cash within a

specified period of time. From the logistics point of view the key elements are accounts

payable for bought-in materials, components, etc. This is an area where a greater

integration of purchasing with operations management can yield dividends. The

traditional concepts of economic order quantities can often lead to excessive levels of

raw materials inventory as those quantities may not reflect actual manufacturing or

distribution requirements. The phasing of supplies to match the total logistics

requirements of the system can be achieved through the twin techniques of materials

requirement planning (MRP) and distribution requirements planning (DRP). If premature

commitment of materials can be minimized this should lead to an improved position on

current liabilities.

Debt/equity

Whilst the balance between debt and equity has many ramifications for the financial

management of the total business it is worth reflecting on the impact of alternative

logistics strategies. More companies are leasing plant facilities and equipment and thus

converting a fixed asset into a continuing expense. The growing use of ‗third-party‘

suppliers for warehousing and transport instead of owning and managing these facilities

in-house is a parallel development. These changes obviously affect the funding

requirements of the business. They may also affect the means whereby that funding is

achieved, i.e. through debt rather than equity.

The ratio of debt to equity, usually referred to as ‗gearing‘ or ‗leverage‘, will influence

the return on equity and will also have implications for cash flow in terms of interest

payments and debt repayment.

LOGISTICS AND SHAREHOLDER VALUE

One of the key measures of corporate performance today is shareholder value. In other

words, what is the company worth to its owners? Increasingly senior management within

the business is being driven by the goal of enhancing shareholder value. There are a


30


number of complex issues involved in actually calculating shareholder value but at its

simplest it is determined by the net present value of future cash flows. These cash flows

may themselves be defined as:

Net operating income

Less: Taxes

Less: Working capital investment

Less : Fixed capital investment

= After-tax free cash flow

More recently there has been a further development in that the concept of economic value

added (EVA) has become widely used and linked to the creation of shareholder value.

The term EVA originated with the consulting firm Stern Stewart,2 although its origins go

back to the economist Alfred Marshall who, over 100 years ago, developed the

concept of ‗economic income‘. Essentially EVA is the difference between operating

income after taxes less the true cost of capital employed to generate those profits.

Thus:

Economic value added (EVA)

= Profit after tax – True cost of capital employed

It will be apparent that it is possible for a company to generate a negative EVA. In other

words, the cost of capital employed is greater than the profit after tax. The impact of a

negative EVA, particularly if sustained over a period of time, is to erode shareholder

value. Equally improvements in EVA will lead to an enhancement of shareholder value.

If the net present value of expected future EVAs were to be calculated this would

generate a measure of wealth known as market value added (MVA), which is a true

measure of what the business is worth to its shareholders. A simple definition of MVA is:

Stock price × Issued shares less Book value of total capital invested = Market value

added and, as we have already noted, MVA = Net present value of expected future EVA

Clearly, it will be recognized that there are a number of significant connections between

logistics performance and shareholder value. Not only the impact that logistics service

can have upon net operating income (profit) but also the impact on capital efficiency

(asset turn). Many companies have come to realize the effect that lengthy pipelines and

highly capital-intensive logistics facilities can have on EVA and hence shareholder value.

As a result they have focused on finding ways in which pipelines can be shortened and,

consequently, working capital requirements reduced. At the same time they have looked

again at their fixed capital deployment of distribution facilities and vehicle fleets and

in many cases have moved these assets off the balance sheet through the use of third-

party logistics service providers. The drivers of shareholder value The five basic drivers

of enhanced shareholder value are shown in Figure. They are revenue growth, operating

cost reduction, fixed capital efficiency, working capital efficiency and tax minimization.

All five of these drivers are directly and indirectly affected by logistics management and

supply chain strategy.


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The drivers of shareholder value

Revenue growth

The critical linkage here is the impact that logistics service can have on sales volume and

customer retention. Whilst it is not generally possible to calculate the exact correlation

between service and sales there have been many studies that have indicated a positive

causality. It can also be argued that superior logistics service (in terms of reliability and

responsiveness) can strengthen the likelihood that customers will remain loyal to a

supplier. it was suggested that higher levels of customer retention lead to greater sales.

Typically this occurs because satisfied customers are more likely to place a greater

proportion of their purchases with that supplier.

Operating cost reduction

The potential for operating cost reduction through logistics and supply chain management

is considerable. Because a large proportion of cost in a typical business are driven by

logistics decisions and the quality of supply chain relationships, it is not surprising that in

the search for enhanced margins many companies are taking a new look at the way

they manage the supply chain. It is not just the transportation, storage, handling and order

processing costs within the business that need to be considered. Rather a total pipeline

view of costs on a true ‗end-to-end‘ basis should be taken. Often the upstream logistics

costs can represent a significant proportion of total supply chain costs embedded in the

final product. There is also a growing recognition that time compression in the supply


32


chain not only enhances customer service but can also reduce costs through the reduction

of non-value-adding activities.

Fixed capital efficiency

Logistics by its very nature tends to be fixed asset ‗intensive‘. Trucks, distribution

centres and automated handling systems involve considerable investment and,

consequently, will often depress return on investment. In conventional multi-echelon

distribution systems, it is not unusual to find factory warehouses, regional distribution

centres and local depots, all of which represent significant fixed investment. One of the

main drivers behind the growth of the third-party logistics service sector has been the

desire to reduce fixed asset investment. At the same time the trend to lease rather than

buy has accelerated. Decisions to rationalize distribution networks and production

facilities are increasingly being driven by the realization that the true cost of financing

that capital investment is sometimes greater than the return it generates.

Working capital efficiency

Supply chain strategy and logistics management are fundamentally linked to the working

capital requirement within the business. Long pipelines by definition generate more

inventory; order fill and invoice accuracy directly impact accounts receivable and

procurement policies also affect cash flow. Working capital requirements can be

dramatically reduced through time compression in the pipeline and subsequently

reduced order-to-cash cycle times. Surprisingly few companies know the true length of

the pipeline for the products they sell. The ‗cash-to-cash‘ cycle time (i.e. the elapsed time

from procurement of materials/components through to sale of the finished product) can

be six months or longer in many manufacturing industries. By focusing on eliminating

non-value-adding time in the supply chain, dramatic reduction in working capital can be

achieved. So many companies have lived with low inventory turns for so long that they

assume that it is a feature of their industry and that nothing can be done. They are also

possibly not motivated to give working capital reduction a higher priority because an

unrealistically low cost of capital is being employed.

Tax minimization

In today‘s increasingly global economy organizations have choices as to where they can

locate their assets and activities. Because tax regimes are different country by country,

location decisions can have an important impact on after-tax free cash flow. It is not just

corporate taxes on profits that are affected, but also property tax and excise duty on fuel.

Customs regulations, tariffs and quotas become further considerations, as do rules and

regulation on transfer pricing. For large global companies with production facilities in

many different countries and with dispersed distribution centres and multiple markets,

supply chain decisions can significantly affect the total tax bill and hence shareholder

value. The role of cash flow in creating shareholder value There is general agreement

with the view of Warren Buffet3 that ultimately the value of a business to its owners is

determined by the net present value of the free cash flow occurring from its operations

over its lifetime. Thus the challenge to managers seeking to enhance shareholder value is


33


to identify strategies that can directly or indirectly affect free cash flow. Srivastava et al.4

have suggested that the value of any strategy is inherently driven by:

1. An acceleration of cash flows because risk and time adjustments reduce the value of

later cash flows;

2. An increase in the level of cash flows (e.g. higher revenues and/or lower costs,

working capital and fixed investment);

3. A reduction in risk associated with cash flows (e.g. through reduction in both volatility

and vulnerability of future cash flows) and hence, indirectly, the firm‘s cost of capital;

and

4. The residual value of the business (long-term value can be enhanced, for example, by

increasing the size of the customer base). In effect, what Srivastava. are suggesting is

that strategies should be evaluated in terms of how they either enhance or accelerate cash

flow. Those strategic objectives can be graphically expressed as a cumulative distribution

of free cash flow over time (see Figure) with the objective of building a greater

cumulative cash flow, sooner. Obviously the sooner cash is received and the greater the

amount then the greater will be the net present value of those cash flows.

Principles of logistics costing It will be apparent from the previous comments that the problem of developing an

appropriate logistics-oriented costing system is primarily one of focus. That is the ability

to focus upon the output of the distribution system, in essence the provision of customer

service, and to identify the unique costs associated with that output. Traditional

accounting methods lack this focus, mainly because they were designed with something

else in mind. One of the basic principles of logistics costing, it has been argued, is that

the system should mirror the materials flow, i.e. it should be capable of identifying the

costs that result from providing customer service in the marketplace. A second principle

is that it should be capable of enabling separate cost and revenue analyses to be made by

customer type and by market segment or distribution channel. This latter requirement

emerges because of the dangers inherent in dealing solely with averages, e.g. the average

cost per delivery, since they can often conceal substantial variations either side of the

mean

Logistics missions that cut across functional boundaries


34


operationalize these principles requires an ‗output‘ orientation to costing. In other words,

we must first define the desired outputs of the logistics system and then seek to identify

the costs associated with providing those outputs. A useful concept here is the idea of

‗mission‘. In the context of logistics, a mission is a set of customer service goals to be

achieved by the system within a specific product/market context.

Missions can be defined in terms of the type of market served, by which products and

within what constraints of service and cost. A mission by its very nature cuts across

traditional company lines. Figure illustrates the concept and demonstrates the difference

between an ‗output‘ orientation based upon missions and the ‗input‘ orientation based

upon functions. The successful achievement of defined mission goals involves inputs

from a large number of functional areas and activity centers within the firm. Thus an

effective logistics costing system must seek to determine the total systems cost of

meeting desired logistic objectives (the ‗output‘ of the system) and the costs of the

various inputs involved in meeting these outputs. Interest has been growing in an

approach to this problem, known as ‗mission costing‘.

Figure illustrates how three distribution missions may make a differential impact upon

activity centre/functional area costs and, in so doing, provide a logical basis for costing

within the company. As a cost or budgeting method, mission costing is the reverse of

traditional techniques: under this scheme a functional budget is determined now by the

demands of the missions it serves. Thus in Figure 3.9 the cost per mission is identified

horizontally and from this the functional budgets may be determined by summing

vertically.

Given that the logic of mission costing is sound, how might it be made to work in

practice? This approach requires firstly that the activity centres associated with a

particular distribution mission be identified, e.g. transport, warehousing, inventory, etc.,

and secondly that the incremental costs for each activity centre incurred as a result of

undertaking that mission must be isolated. Incremental costs are used because it is

important not to take into account ‗sunk‘ costs or costs that would still be incurred even if

the mission were abandoned. We can make use of the idea of ‗attributable costs to

operationalize the concept:

Attributable cost is a cost per unit that could be avoided if a product or function were

discontinued entirely without changing the supporting organization structure


35


The programme budget (£’000)

In determining the costs of an activity centre, e.g. transport, attributable to a specific

mission, the question should be asked: ‗What costs would we avoid if this

customer/segment/channel were no longer serviced?‘ These avoidable costs are the true

incremental costs of servicing the customer/segment/channel. Often they will be

substantially lower than the average cost because so many distribution costs are fixed

and/or shared. For example, a vehicle leaves a depot in London to make deliveries in

Nottingham and Leeds. If those customers in Nottingham were abandoned, but those in

Leeds retained, what would be the difference in the total cost of transport? The answer

would be –not very much, since Leeds is further north from London than Nottingham.

However, if the customers in Leeds were dropped, but not those in Nottingham, there

would be a greater saving of costs because of the reduction in miles travelled. This

approach becomes particularly powerful when combined with a customer revenue

analysis, because even customers with low sales off take may still be profitable in

incremental costs terms if not on an average cost basis. In other words the company

would be worse off if those customers were abandoned. Such insights as this can be

gained by extending the mission costing concept to produce profitability analyses for

customers, market segments or distribution channels. The term ‗customer profitability

accounting‘describes any attempt to relate the revenue produced by a customer, market

segment or distribution channel to the costs of servicing that customer/segment/channel.


36


The cost of holding inventory, there are many costs incurred in the total logistics process

of converting customer orders into cash. However, one of the largest cost elements is also

the one that is perhaps least well accounted for and that is inventory. Is it probably the

case that many managers are unaware of what the true cost of holding inventory actually

is. If all the costs that arise as a result of holding inventory are fully accounted for, then

the real holding cost of inventory is probably in the region of 25 per cent per annum of

the book value of the inventory.

The reason this figure is as high as it is is that there are a number of costs to be included.

The largest cost element will normally be the cost of capital. The cost of capital

comprises the cost to the company of debt and the cost of equity. It is usual to use the

weighted cost of capital to reflect this. Hence, even though the cost of borrowed money

might be low, the expectation of shareholders as to the return they are looking for from

the equity investment could be high.

The other costs that need to be included in the inventory holding cost are the costs of

storage and handling, obsolescence, deterioration and pilferage, as well as insurance and

all the administrative costs associated with the management of the inventory

Customer profitability analysis

One of the basic questions that conventional accounting procedures have difficulty

answering is: ‗How profitable is this customer compared to another?‘ Usually customer

profitability is only calculated at the level of gross profit – in other words the net sales

revenue generated by the customer in a period, less the cost of goods sold for the actual

product mix purchased. However, there are still many other costs to take into account

before the real profitability of an individual customer can be exposed. The same is true if

we seek to identify the relative profitability of different market segments or distribution

channels.


37


The significance of these costs that occur as a result of servicing customers can be

profound in terms of how logistics strategies should be developed. Firstly, customer

profitability analysis will often reveal a proportion of customers who make a negative

contribution, as in Figure The reason for this is very simply that the costs of servicing

a customer can vary considerably – even between two customers who may make

equivalent purchases from us.

Customer profitability

analysis

If we think of all the

costs that a company incurs

from when it captures

an order from a customer

to when it collects the payment, is will be apparent that the total figure could be quite

high. It will also very likely be the case that there will be significant differences in these

costs customer by customer. At the same time, different customers will order a different

mix of products so the gross margin that they generate will differ. As Table highlights,

there are many costs that need to be identified if customer profitability is to be accurately

measured.


38


The customer profit and loss account

The best measure of customer profitability is to ask the question: ‗What costs would I

avoid and what revenues would I lose if I lost this customer?‘ This is the concept of

‗avoidable‘ costs and incremental revenue. Using this principle helps circumvent the

problems that arise when fixed costs are allocated against individual customers.


39


What sort of costs should be taken into account in this type of analysis? Figure presents a

basic model that seeks to identify only those customer- related costs that are avoidable

(i.e. if the customer did not exist, these costs would not be incurred).

The starting point is the gross sales value of the order from which is then subtracted the

discounts that are given on that order to the customer. This leaves the net sales value

from which must be taken the direct production costs or cost of goods sold. Indirect costs

are not allocated unless they are fully attributable to that customer. The same principle

applies to sales and marketing costs as attempts to allocate indirect costs, such as national

advertising, can only be done on an arbitrary and usually misleading basis. The

attributable distribution costs can then be assigned to give customer gross contribution.

Finally any other customer-related costs, such as trade credit, returns, etc., are subtracted

to give a net.

Customer profitability analysis: a basic model


40



41


Contribution to overheads and profit: Often the figure that emerges as the ‗bottom line‘

can be revealing as shown, in Table.

Table Analysis of revenue and cost for a specific custome


42


In this case a gross contribution of £70,000 becomes a net contribution of £56,400 as

soon as the costs unique to this customer are taken into account. If the analysis were to be

extended by attempting to allocate overheads (a step not to be advised because of the

problems usually associated with such allocation), what might at first seem to be a

profitable customer could be deemed to be the reverse. However, as long as the net

contribution is positive and there is no ‗opportunity cost‘ in servicing that customer the

company would be better off with the business than without it.

The value of this type of exercise can be substantial. The information could be used,

firstly, when the next sales contract is negotiated and, secondly, as the basis for sales and

marketing strategy in directing effort away from less profitable types of account towards

more profitable business. More importantly it can point the way to alternative strategies

for managing customers with high servicing costs. Ideally we require all our customers to

be profitable in the medium to long term and where customers currently are profitable we

should seek to build and extend that profitability further


43


Customer profitability matrix

Figure represents a simple categorization of customers along two dimensions: their total

net sales value during the period and their costto- serve. The suggestion is that there

could be a benefit in developing customer-specific solutions depending upon which box

of the matrix they fall into. Possible strategies for each of the quadrants are suggested

below.

Build

These customers are relatively cheap to service but their net sales value is low. Can

volume be increased without a proportionate increase in the costs of service? Can our

sales team be directed to seek to influence these customers‘ purchases towards a more

profitable sales mix?

Danger zone

These customers should be looked at very carefully. Is there any medium to long-term

prospect either of improving net sales value or of reducing the costs of service? Is there a

strategic reason for keeping them? Do we need them for their volume even if their profit

contribution is low?

Cost engineer

These customers could be more profitable if the costs of servicing them could be reduced.

Is there any scope for increasing drop sizes? Can deliveries be consolidated? If new

accounts in the same geographic area were developed would it make delivery more

economic? Is there a cheaper way of gathering orders from these customers, e.g. the

Internet.

Protect

The high net sales value customers who are relatively cheap to service are worth their

weight in gold. The strategy for these customers should be to seek relationships which

make the customer less likely to want to look for alternative suppliers. At the same time

we should constantly seek opportunities to develop the volume of business that we do

with them whilst keeping strict control of costs. Ideally the organization should seek to

develop an accounting system that would routinely collect and analyze data on customer

profitability.

Unfortunately most accounting systems are product focused rather than customer

focused. Likewise cost reporting is traditionally on a functional basis rather than a

customer basis. So, for example, we know the costs of the transport function as a whole

or the costs of making a particular product but what we do not know are the costs of

delivering a specific mix of product to a particular customer. There is a pressing need for

companies to move towards a system of accounting for customers and marketing as well

as accounting for products. As has often been observed, it is customers who make profits,

not products


44


DIRECT PRODUCT PROFITABILITY

An application of logistics cost analysis that has gained widespread acceptance,

particularly in the retail industry, is a technique known as direct product profitability – or

more simply ‗DPP‘. In essence it is somewhat analogous to customer profitability

analysis in that it attempts to identify all the costs that attach to a product or an order as

it moves through the distribution channel. The idea behind DPP is that in many

transactions the customer will incur costs other than the immediate purchase price of the

product.

Often this is termed the total cost of ownership. Sometimes these costs will be hidden and

often they can be substantial – certainly big enough to reduce or even eliminate net profit

on a particular item. For the supplier it is important to understand DPP inasmuch as his

ability to be a low-cost supplier is clearly influenced by the costs that are incurred as that

product moves through his logistics system.

Similarly, as distributors and retailers are now very much more conscious of an item‘s

DPP, it is to the advantage of the supplier equally to understand the cost drivers that

impact upon DPP so as to seek to influence it favorably.

Table describes the steps to be followed in moving from a crude gross margin measure to

a more precise DPP.

Table Direct product profit (DPP)

The importance to the supplier of DPP is based on the proposition that a key objective of

customer service strategy is ‗to reduce the customer‘s costs of ownership‘. In other words

the supplier should be looking at his products and asking the question: ‗How can I

favorably influence the DPP of my customers by changing either the characteristics of the


45


products I sell, or the way I distribute them?‘From pack design onwards there are a

number of elements that the manufacturer or supplier may be able to vary in order to

influence DPP/square meter in a positive way, for example, changing the case size,

increasing the delivery frequency, direct store deliveries, etc.

Cost drivers and activity-based costing As we indicated earlier in this chapter there is a growing dissatisfaction with

conventional cost accounting, particularly as it relates to logistics management.

Essentially these problems can be summarized as follows:

● There is a general ignorance of the true costs of servicing different

customer types/channels/market segments.

● Costs are captured at too high a level of aggregation.

● Full cost allocation still reigns supreme.

● Conventional accounting systems are functional in their orientation

rather than output oriented.

● Companies understand product costs but not customer costs.

The common theme that links these points is that we seem to suffer in business from a

lack of visibility of costs as they are incurred through the logistics pipeline. Ideally what

logistics management requires is a means of capturing costs as products and orders flow

towards the customer.

To overcome this problem it is necessary to change radically the basis of cost accounting

away from the notion that all expenses must be allocated (often on an arbitrary basis) to

individual units (such as products) and, instead, to separate the expenses and match them

to the activities that consume the resources. One approach that can help overcome this

problem is ‗activity-based costing‘. The key to activity-based costing (ABC) is to seek

out the ‗cost drivers‘ along the logistics pipeline that cause costs because they consume

resources. Thus, for example, if we are concerned to assign the costs of order picking to

orders then in the past this may have been achieved by calculating an average cost per

order. In fact an activity-based approach might suggest that it is the number of lines on an

order that consume the order picking resource and hence should instead be seen as the

cost driver. Table 3.4 contrasts the ABC approach with the traditional method. The

advantage of using activity-based costing is that it enables each customer‘s unique

characteristics in terms of ordering behaviour and distribution requirements to be

separately accounted for. Once the cost attached to each level of activity is identified (e.g.

cost per line item picked, cost per delivery, etc.) then a clearer picture of the true cost-to

serve will emerge. Whilst ABC is still strictly a cost allocation method it uses a more

logical basis for that allocation than traditional methods.


46


ACTIVITY-BASED COSTING VS TRADITIONAL COST BASES

There are certain parallels between activity-based costing and the idea of mission costing

introduced earlier in this chapter. Essentially mission costing seeks to identify the unique

costs that are generated as a result of specific logistics/customer service strategies aimed

at targeted market segments. The aim is to establish a better matching of the service

needs of the various markets that the company addresses with the inevitably limited

resources of the company. There is little point in committing incremental costs where the

incremental benefits do not justify the expenditure.

There are four stages in the implementation of an effective mission costing process:

1. Define the customer service segment: Use the methodology to identify the different

service needs of different customer types. The basic principle is that because not all

customers share the same service requirements and characteristics they should be treated

differently.

2. Identify the factors that produce variations in the cost of service: This step

involves the determination of the service elements that will directly or indirectly impact

upon the costs of service, e.g. the product mix, the delivery characteristics such as drop

size and frequency or incidence of direct deliveries, merchandising support, special

packs and so on.

3. Identify the specific resources used to support customer segments: This is the point

at which the principles of activity-based costing and mission costing coincide. The basic

tenet of ABC is that the activities that generate cost should be defined and the specific


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cost drivers involved identified. These may be the number of lines on an order, the people

involved, the inventory support or the delivery frequency.

4. Attribute activity costs by customer type or segment Using the principle of

‗avoidability‘ the incremental costs incurred through the application of a specific

resource to meeting service needs are attributed to customers. It must be emphasized that

this is not cost allocation but cost attribution. In other words it is because customers use

resources that the appropriate share of cost is attributed to them. Clearly to make this

work there is a prerequisite that the cost coding system in the business be restructured.

In other words, the coding system must be capable of gathering costs as they are incurred

by customers from the point of order generation through to final delivery, invoicing and

collection. The basic purpose of logistics cost analysis is to provide managers with

reliable information that will enable a better allocation of resources to be achieved. Given

that logistics management, as we have observed, ultimately is concerned to meet

customer service requirements in the most cost-effective way, then it is essential that

those responsible have the most accurate and meaningful data possible.


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UNIT-3

Logistics and Supply chain relationships


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Benchmarking the logistics process

Benchmarking generally refers to the process of measuring one‘s performance against a

set of pre-established standards by the world or your competitors present in the same

business process as you. It is essentially aimed at improving the business and operational

practices that your company is already following, and refining those practices after

carrying a thorough comparison with that of your competitors. Thus, the benchmarking

activity is driven by a desire to enhance operational capability, to lower costs and

improve service.

Benchmarking, with regards to logistics, has the same meaning as it is the main

constituent of any supply chain. Benchmarking in logistics involves evaluating the

amount of time that a product takes to reach its ultimate customer; expediting the flow of

material within a supply chain; monitoring the storage, and shipping operations; and

checking the cost effectiveness of logistics operations.

The following areas of logistics may require benchmarking:

1. Loading/ offloading;

2. Warehousing;

3. Transportation;

4. Value added services;

5. Packaging

All these factors are crucial in logistics, and needs to be evaluated against the standard

practices to remove any financial loopholes or human error. Effective logistics require

managing the aforementioned areas, and making necessary improvements after checking

them through performance measurement tools.

Importance

In times of economic hardship, it has become increasingly challenging for logistics

companies to maintain their performance, and costs together. The ever increasing fuel

prices have also doubled the freight rates which is affecting their business tremendously.


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Through benchmarking, you may identify areas that are taking more than what should be

invested, or doesn‘t have all the necessary resources. Remember, more than anything,

time and money is crucial in logistics.

Thus, by reducing the amount of time and money, you can have a valuable competitive

advantage over your competitors. For example, if they take 6-10 hours to deliver a

product, you can take less than 4 hours to do the same job.

Also through this assessment, you‘ll be able to discover new opportunities that can be

helpful in improving the quality of your services, and handling processes at each step.

MAPPING THE SUPPLY CHAIN PROCESSES

On a mission to improve supply chain management within an organization. Mapping out your

processes is an inexpensive way to make great strides and improvement

An evolving but seismic shift is occurring – you are increasingly operating in a world where the

supply chain must manage goods (and services) not sitting in a distribution center but constantly

in motion, requiring a whole new level of visibility systems, synchronization techniques, and

(most importantly) management skill sets. Supply chain value mapping defines how to arrive at

the desired outcomes in a supply chain. It commonly encompasses an analysis of manufacturing;

origin sourcing; vendor compliance and standardization; transportation; and the financial that

maximize economic profitability (e.g., capital and fixed-asset utilization, day sales outstanding,

days of inventory on hand, and the cash-to-cash conversion cycle). In short, every critical

business function and process should be analyzed. This analysis starts with a ―whiteboard

session‖ that involves all the key decision makers within the organization. For example, the

decision maker in finance (e.g., CFO or controller) should be on hand to baseline key financial

data that drives shareholder wealth and value. Changes to a supply chain should positively

impact the cost of goods sold, purchases outstanding, day sales outstanding, inventory turnover

and operating ratio, and, ultimately, a company‘s economic profitability.

Supply chain map is the path to improvements:

Supply chain mapping is the first step in creating an ―outcome-driven supply chain.‖ The process

identifies the change that will differentiate an organization from its competition, serve a client

base with a prosperous value proposition, reduce internal cost, and drive profitability. We get

started with mapping your supply chain at its most basic level, it is the series of steps and

persons involved with every stage of your operation. It encompasses your suppliers, their

procurement of material and works, all the way down through your distribution network until it

reaches the final customers. One basic technique of supply chain management, which is greatly

underutilized by many businesses, is the mapping and drawing of your supply chain and

production processes. As a company grows and expands, often the supply chain becomes a

tangled network. By drawing out your operation on paper or in a ―whiteboard‖ session, you can


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visualize and understand your problems. Incorporating everyone in the process makes it easy to

identify areas of concern and will help alleviate waste.

When we talk supply chain mapping, we are really talking about uncovering new opportunities

to improve supply chains. With UPS, you enter into a collaborative process where our expertise

and your supply chain combine. Our goal is to help you reduce cost, improve service, or address

particular problems. Through this exploration, our trained logistics experts pinpoint the ―quick

fixes‖ that can immediately be implemented; as well as, ascertain longer term initiatives and

solutions that align with your overall global supply chain.

Process mapping provides a visualization of all the steps needed to procure and produce

materials, deliver a product, and understand potential problem areas. Just like conventional maps,

your process design should have a start and end point, with different sections outlining various

stages along the way. Here are the basic steps to creating such an outline:

Draw out your suppliers: What does it take to purchase and receive items? We include critical

information such as lead times and minimum stock orders. If you have had any problems in the

past (late deliveries, incorrect deliveries etcetera), we include these on the map as well. This will

help you get a better sense for what you‘re dealing with, and how to avoid future problems.

Do not forget the receiving end: Are there any issues that may arise during the receipt of ordered

goods. For example, you may have identified that improper orders are common with an

individual supplier; as a result, you should ensure your receiving function has a process for

checking the order before the supplier‘s truck leaves the warehouse.

Where do the finished goods go; Do you spend a lot of time moving inventory? Does your

material or finished goods inventory move to one place, only to be moved again the next day?

Mapping out these processes allows for better visualization of where there is wasted time and

energy. Remember, where there‘s waste, there‘s lost money.

Continue this mapping process through your own internal processes. Once you have this on

paper, you can see the process as a whole, and should initiate employee input. Employees may

notice missing items or have suggestions to improve the overall process. Your process map will

make your complex systems visible and allow our experts to help you identify non-value added

or redundant activities. You, and your UPS experts will begin the process analysis by examining

the time, cost, resources, and people involved in each step of each process. The goal is to…

Identify non-value added processes and steps Identify the steps that consume the most time or

resources Identify processes that take too long or vary greatly in time Identify points of delay and

other pinch points Estimate the value added by each step and judge the value against the cost

Consider the reasons for problems and how to improve specific activities or processes

You can also use the map for trial and error. Try shifting processes around on paper to see if you

can calculate and anticipate future results. The map should include all problem areas, which

should be addressed as a team. It thus becomes easier to target and eliminate such issues. Unlike

manufacturing plants, which run in scheduled shifts, supply chains never stop. They run in

constant motion as multiple channel members harvest and create raw materials, and then move


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these raw materials to manufacturers—who then create products and move those products to

markets, where customers buy, consume, return, and dispose of them. The supply chain begins

with the conception of a product and terminates when the product‘s life ends. So, remember:

map, draw and visualize your operation. It‘s a great way to improve your processes, increase

share holder value, and reach your goals.

Supply Chain Benchmarking

Process and Methodology

Supply chain operations within an organization should be constantly reviewed to identify

where improvements can be made. One method is to perform a series of benchmarking

tests for price, quality, design, efficiency, and cost effectiveness.

In general, companies perform two types of benchmarking: results benchmarking, which

focuses on quantitative performance measures, and best practices benchmarking, which

focuses on how well processes are executed. The results of both styles of benchmarking

are best used together because results benchmarking only provides a basis for ranking a

company, not a strategy to improve its performance. Successful supply chain

benchmarking incorporates all of the elements in the global supply chain and focuses on

product specifications, operational performance, management practices, and software

solutions. Although supply chain benchmarking involves three major elements—the

supplier, the distributor, and the interface of the two—customer satisfaction should be the

primary motivation for establishing a benchmarking program.

Defining the Scope of Supply Chain Benchmarking:

A company can have multiple supply chains operating within its global supply chain.1

Organizations should therefore think at the metric level and identify the products,

channels, and geographies for which data can reasonably be combined.

Benefits of Successful Benchmarking: In addition to providing useful comparisons with

other companies, supply chain benchmarking can identify:

Performance improvements

Interdependencies and relationships between

Key performance indicators (kpis)

Better business tradeoffs

Opportunities for cross-industry best practices

Baseline information for goal setting, prioritization

and ongoing performance measurements


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A Step-by-Step Process for the Quantitative Comparison of Supply Chain Metrics

1. Determine the scope of the inquiry (e.g., planning, procurement, manufacturing, and

logistics)

2. Select a set of supply chain KPIs to measure and compare

3. Identify a peer group of companies

4. Agree on measurements and targets that can reach the site and process levels

5. Develop reporting templates and determine the timing of measurement (e.g., daily,

weekly, etc.)

6. Plan the implementation approach

7. Obtain stakeholder buy-in for benchmarking and its benefits

8. Identify tools and resources for data collection

9. Collect and validate data

10. Analyze and interpret results

11. Develop an action plan

12. Track execution of action

Supply chain benchmarks of standard processes Another way to approach supply chain benchmarking is to look deeper into traditional

supply chain processes.

Planning (demand management, materials planning, and production scheduling) Many

planning KPIs are available, but companies must determine the indicators that are truly

important to their organizations‘ operational performance.

Examples include cash-to-cash cycle time, inventory carrying costs, days inventory

outstanding, finished goods inventory turn rate, cost of goods sold as a percentage of

revenue, forecast accuracy, number of full-time equivalents (FTEs) for the supply chain

planning function per $1 billion in revenue, production schedule adherence, total

expediting of costs to execute the production plan, value-added productivity per

employee, and return on assets.

Procurement (sourcing strategy development, supplier selection and contract

management, order management, and supplier appraisal and development) Examples of

KPIs benchmarked for procurement include total cost of the procurement cycle per

purchase order or per $1,000 in purchases, rate of annual raw material inventory turns,

average supplier lead time in days, days payable, number of FTEs for the procurement

cycle per $1 billion in purchases, and the percentage of purchases made via an electronic

marketplace.

Manufacturing (production scheduling, production, and performing maintenance)

Common manufacturing KPIs include finished product first-pass yield (FPY), percentage

of defective parts per million (DPMO), and scrap and rework costs as a percentage of

sales and quantities shipped per employee. Other KPIs benchmarked for product

manufacturing are manufacturing cycle time, actual production rate as a percentage of


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maximum capable production rate, annual work-in-process (WIP) inventory turn rate,

unplanned machine downtime as a percentage of scheduled run time, warranty costs (i.e.,

repair and replacement) as a percentage of sales, and labor turnover rate as a percentage

of the workforce.

Logistics (logistics strategy, planning for inbound material flow, warehousing, outbound

transportation, and managing returns and reverse logistics) Standard KPIs for product

delivery include order fill rate, pick-to-ship cycle times for customer orders, total cost of

outbound transportation process per $1,000 in revenue, number of FTEs required to

operate outbound transportation per $1 billion in revenue, the percentage of sales order

line items not fulfilled due to stock-outs, the percentage of full-load trailer/container

capacity used per shipment, and the percentage of orders expedited. Examples of KPIs

for logistics/warehousing as a whole include total logistics costs as a percentage of

revenue, freight costs as a percentage of revenue, the percentage of sales orders delivered

on time, the number of FTEs for the logistics function per $1 billion in revenue, and the

ratio of premium freight charges to total freight charges


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UNIT-IV

SOURCING, TRANSPORTING AND PRICING

PRODUCTS


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Definition of the Council of Logistics Management (CLM)

Logistics is the process of planning, implementing, and controlling the efficient, cost-

effective flow and storage of raw materials, in-process inventory, finished goods and

related information from point of origin to point of consumption for the purpose of

conforming to customer requirements.

The mission of logistics is to get the right goods or services to the right place, at the right

time, and in the desired condition, while making the greatest contribution to the firm.

Customer Service standards set the level of output and degree of readiness to which the

logistics system must respond. Logistics costs increase in proportion to the level of

customer service provided. Setting very high service requirements can force logistics

costs to exceedingly high levels.

Transportation and inventories are the primary cost-absorbing logistics activities.

Experience has shown that each will represent one-half to two-thirds of total logistics

costs.

It is Transportation that adds place value to the products and services, whereas Inventory

adds time value. Transportation is essential because no modern firm can operate without

providing for the movement of its raw materials and/or finished products

Inventories are essential to logistics management because it is usually not possible or

practical to provide instant production or sure delivery times to the customers. They serve

as buffers between supply and demand so that needed product availability may be

maintained for customers while providing flexibility for production and logistics to seek

more efficient methods for manufacturing and distributing the products

Logistics is about creating value – value for customers and suppliers of the firm, and

value for the firm‘s stakeholders. Value in logistics is expressed in terms of time and

place.

Products and services have no value unless they are in the possession of the customers

when (time) and where (place) they wish to consume them.

Logistics revolves around a primary decision triangle of Location, Inventory, and

Transportation, with Customer Service being the result of these decisions.

Customer Service Goals

Low levels of service allow centralized inventories at few locations and the use of less

expensive forms of transport. High service levels generally require just the opposite.


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However, when service levels are pressed to their upper limits, logistics costs rise at a

rate disproportionate to the service level.

Customer service broadly includes inventory availability, speed of delivery, and order

filling speed and accuracy. The cost associated with these factors increase at a higher rate

as customer service levels is raised.

Reformulating the logistics strategy is usually needed when service levels are changed

due to competitive forces, policy revisions, or arbitrary service goals different from those

on which the logistics strategy was based originally.

Facility Location Strategy

The geographic placement of the stocking points and their sourcing points create an

outline for the logistics plan. Fixing the number, location, and size of the facilities and

assigning market demand to them determines the path through which products are

directed to the market place. The proper scope for the facility location problem is to

include all product movements and associated costs as they take place from plant, vendor,

or port location through the intermediate stocking points and to the customer locations.

Assigning customer demand to be served directly from plants, vendors, or ports, or

directing it through selected stocking points, affect total distribution costs.

Finding the lowest cost assignments, or alternatively the maximum profit assignments is

the essence of facility location strategy.

Inventory Decisions

Refer to the manner in which inventories are managed. Allocating (pushing) inventories

to the stocking points versus pulling them into stocking points through inventory

replenishment rules represents two strategies.

Selective location of various items in the product line in plant, regional or field

warehouses or managing inventory levels by various methods or inventory control are

others.

Transportation Decisions

Transport decisions can involve mode selection, shipment size, and routing or scheduling.

These decisions are influenced by the proximity of warehouses to customers and plants,

which in turn, influence warehouse location. Inventory levels also respond to transport

decisions through shipment size.

Customer service levels, facility location, inventory, and transportation are major

planning areas because of the impact that decisions in these areas have on the

profitability, cash flow, and return on investment of the firm.


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Another way to look at logistics planning problem is to view it in the abstract as a

network of links and nodes, as shown in.

The links of the network represent the movement of goods between various inventory

storage points. These storage points – retail stores, warehouses, factories, or vendors –

are the nodes. There may be several links between any pair of nodes, to represent

alternative forms of transportation service, different routes, and different products. Nodes

represent points where the flow of inventories is temporarily stopped, for example, at a

warehouse, before moving onto a retail store and to the final customer.

In addition there is a flow of information flows. Information is derived from sales

revenues, product costs, inventory levels, warehouse utilization, forecasts, transportation

rates and the like. Links in the information network usually consists of the mail or

electronic methods for transmitting information from one geographical point to another.

Nodes are the data collection and processing points, such as a clerk who handles order

processing and prepares bills of laden or computer that updates inventory records.

A major difference in the network is that product mainly flows ―down‖ the distribution

channel (toward the final customer), whereas information mainly, but not entirely, flows

―up‖ the channel (toward raw material sources).

Product Characteristics

Logistics costs are sensitive to such characteristics as product weight, volume (cube),

value, and risk. In the logistics channel, these characteristics can be altered through

package design or finished state of the product during shipment and storage. For

example, shipping a product in a knocked-down form can considerably affect the weight-

bulk ratio of the product and the associated transportation and storage costs.

A firm producing high valued goods (such as machine tools and computers) with logistics

costs being a fraction of total costs will likely give little attention to the optimality of

logistics strategy. However, when logistics costs are high, as they can be in the case of

packaged industrial chemicals and food products, logistics strategy is a key concer

Classifying Products

Consumer Products are those that are directed to ultimate consumers. A three-fold

consumer classification has been suggested Convenience Products are those goods and

services that consumers purchase frequently, immediately, and with limited comparative

shopping. Typical products are banking services, tobacco items, and many foodstuffs.

These products generally require wide distribution through many outlets. Distribution

costs are typically high but more than justified by the increased sales potential that is

brought about by this wide and extensive distribution. Customer service levels are

expressed in terms of product availability and accessibility.

(Examples are vending machines for Pepsi-cola etc., and telephone kiosks all over the

place).


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Shopping Products are those for which customers are willing to seek and compare:

shopping many locations, comparing price and quality, performance, and making a

purchase only after careful deliberation. Typical products in this category are fashion

clothes, automobiles, and home furnishings. Because of the customer‘s willingness to

shop around, the number of stocking points I substantially reduced as compared with

convenience goods and services. Distribution costs for such suppliers are somewhat

lower than convenience goods. Specialty Products are those for which buyers are willing

to expend a substantial effort and often to wait a significant amount of time in order to

require them. Buyers seek out particular types and brands of goods and services.

Examples can be almost any type of good ranging from fine foods to custom made

automobiles or a service such as management consultancy advice. Because buyers insist

on particular brands, distribution is centralized and customer service levels are not as

high as for convenience and shopping products. Physical distribution costs can be the

lowest of any product category. Because of this, many firms will attempt to create a

brand preference for their product line

Industrial Products are those that are directed to individuals or organizations that use

them to produce other goods or services. Their classification is quite different from

consumer products.

Traditionally, industrial goods and services have been classified according to the extent

to which they enter the production process. For example, there are goods that are part of

the finished product, such as raw materials and component parts; there are goods that are

used in the manufacturing process, such as buildings and equipment; and there are goods

that do not enter the process directly, such as supplies and business services. Although

this classification is valuable in preparing a selling strategy, it is not clear if it is useful in

planning a physical distribution strategy.

Industrial buyers do not seem to show preferences for different service levels for different

product classes. This simply means that traditional product classification for industrial

products may not be useful for identifying typical logistics channels, as is the

classification of consumer products.

The Product Life Cycle

Products do not generate their maximum sales volume immediately after being

introduced, nor do they maintain their peak sales volume indefinitely. The physical

distribution strategy differs for each stage. During the introductory stage, the strategy is a

cautious one, with stocking restricted to relatively few locations. Product availability is

limited.

If the product receives market acceptance, sales are likely to increase rapidly. Physical

distribution is particularly difficult at this stage. Often there is not much of a sales history


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that can guide inventory levels at stocking points or even the number of stocking points

to use.

The growth stage may be fairly short, followed by a longer stage called maturity. Sales

growth is slow or stabilized at a peak level. The product volume is no longer undergoing

rapid change, and therefore can be assimilated into the distribution pattern of similar

existing products. At this time the product has its widest distribution. Many stocking

points are used with good control over product availability throughout the market place.

Eventually the sales volume declines for most products as a result of technological

change, competition, or waning consumer interest. To maintain efficient distribution,

patterns of product movement and inventory deployment have to be adjusted. The

number of stocking points is likely to be decreased and the product stocking reduced to

fewer, and more centralized location.

The 80 –20 Curve

The product line of a typical firm is made up of individual products at different stages of

their respective life cycles and with different degrees of sales success. At any point in

time, this creates a product phenomenon known as the 80- 20 curve.

The bulk of the sales are generated from relatively few products in the product line and

from the principle known as Pareto´s law. That is, 80 percent of a firm‘s sales are

generated by 20 percent of the product line items. Each category of items could be

distributed differently. For example, A items might receive wide geographical

distribution through many warehouses and high levels of stock availability, where C

items might be distributed from a single stocking point (e.g. the plant) with lower total

stocking levels than for A items. B items would have an intermediate distribution strategy

where a few regional warehouses are used.

Product Characteristics

The most important characteristics of the product that can influence logistics strategy are

the attributes of the product itself – weight, volume, value, perishability, flammability,

and substitutability. When observed in various combinations, they are an indication of the

need for warehousing, inventories, materials handling, and order processing. Weight–

Bulk Ratio The ratio of weight to bulk (volume) is a particularly meaningful measure, as

transportation and storage costs are directly related to them. Products that are dense, i.e.

have a high weight-bulk ratio (rolled steel, printed materials, and canned foods) show

good utilization of transportation equipment and storage facilities, with the costs of both

tending to be low. However, for products with low density (inflated beach balls, boats,

potato chips, and lamp shades), the bulk capacity of transportation equipment is not fully

realized before the weight-carrying limit is reached. Also the handling and space costs,

which are weight-based, tend to be high relative to the product‘s sales price.


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Value-Weight Ratio Storage costs are particularly sensitive to value. When value is

expressed as a ratio to weight, some of the obvious cost trade-offs emerge that are useful

in planning the logistics system.

Products that have low value-weight ratios (coal ore, and sand) have low storage costs

but high movement costs as a percentage of their sales price.

Inventory carrying costs are computed as a percentage of the product‘s value. Low

product value means low storage cost because inventory-carrying cost is the dominant

factor in storage cost.

Transportation costs on the other hand, are pegged to weight. When the value of the

product is low, transportation costs represent a high proportion of the sales value.

High value- weight ratio products (electronic equipment, jewelry, and musical

instruments) show the opposite pattern with higher storage and lower transport costs.

If the product has a high value-weight ratio, minimize the amount of inventory

maintained is a typical reaction.

Risk Characteristics Product risk characteristics refer to such patterns as perishability,

flammability, value, tendency to explode, and ease of being stolen. When a product

shows high risk in one or more of these features, it simply forces more restrictions on the

distribution system. Both transport and storage costs are higher in absolute dollars and as

a percentage of the sales price.

Logistics Customer Service

Customers view the offerings of any company in terms of price, quality, and service, and

they respond with their patronage. Logistics customer service for many firms is the speed

and dependability with which items ordered by customers can be made available.

Transportation Fundamentals

Transportation usually represents the most important single element in logistics costs in

most firms. Freight movement has been observed to absorb between one-third and two

thirds of total logistics costs.

Service Choices and Their Characteristics

The user of transportation has a wide range of services at his disposal, all revolving

around the five basic modes water, rail, truck, air, and pipeline).

Transportation service may be viewed in terms of characteristics that are basic to all

services: price, average transit time, transit time variability, and loss and damage


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Price (cost) of transport service to a shipper is simply the line-haul rate for transporting

goods plus any accessorial or terminal charges for additional services.

Transit time and Variability Average delivery time and delivery time variability rank at

the top as important transportation performance characteristics.

Delivery (transit) time is usually referred to as the average time it takes for a shipment to

move from its point of origin to its destination.

For purposes of comparing carrier performance, it is best to measure transit time door to

door, even if more than one mode is involved.

Variability refers to the usual differences that occur between shipments by various

modes.

Transit time variability is a measure of uncertainty in carrier performance.

Single-Service Choices

Rail the railroad is basically a long hauler and slow mover of raw materials (coal, lumber,

chemicals) and of low valued manufactured products (food, paper, and wood products)

and prefers to move shipment sizes of at least a full carload.

Truck trucking is a transportation service of semi finished and finished products.

Trucking moves freight with smaller average shipment sizes than rail. The inherent

advantage of trucking is its door-to-door service such that no loading and unloading is

required between origin and destination.

Air Air-service dependability can be rated as good under normal operating conditions,

and air transport has a distinct advantage in terms of loss and damage.

Water transportation is limited in scope for several reasons. Domestic water service is

confined to the inland waterway system, which requires shippers to be located on the

waterways or to use another transportation mode in combination with water. Availability

and dependability of water service are greatly influenced by weather.

Pipeline to date, pipeline transportation offers a very limited range of services and

capabilities. The most economically feasible products to move by pipeline are crude oil

and refined petroleum products. However, there is some experimentation with moving

solid products suspended in liquids, called ‖slurry‖, or containing the solid products in

cylinders that in turn move in a liquid. Product movement by pipeline is very slow, only

about 3 or 4 miles per hour. This slowness is tempered by the fact that products move 24

hours a day and 7 days a week. Cost of service, average transit time (speed), and transit-

time variability (dependability) can serve as the basis for modal choice.


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Vehicle Routing

Because transportation costs typically range between 1/3 and 2/3 of total logistics costs,

improving efficiency through the maximum utilization of transportation equipment and

personnel is a major concern. The length of time that goods are in transit reflects on the

number of shipments that can be made with a vehicle within a given period of time and

on the total transportation costs for all shipments. To reduce transportation costs and also

to improve customer service, finding the best paths that a vehicle should follow through a

network of roads, rail lines, shipping lanes, or air navigational routes that will minimize

time or distance is a frequent decision problem.

Although there are many variations of routing problems, they can be reduced to a few

basic types. There is the problem of finding a path through a network where the origin

point is different from the destination point.

There is a similar problem where there are multiple origin and destination points. And

there is the problem of routing when origin and destination points are the same. Separate

and Single Origin and Destination Points Perhaps the simplest and most straight forward

of routing a vehicle through a network is the shortest route method.

Multiple Origin and Destination

When there are multiple source points that may serve multiple destination points, there is

a problem off assigning destinations to sources as well as finding the best routes between

them. This problem occurs when there is more than one vender, plant or warehouse to

serve more than one customer for the same product. It is further complicated when the

source points are restricted in amount of total customer demand that can be supplied from

each location. This type of problem is frequently solved by a special class of linear

programming algorithm known as the transportation method.

Vehicle Routing and Scheduling

This is an extension of the vehicle routing problem. More realistic restrictions are now

included such as:

1. Each stop may have a volume to be picked out as well as delivered.

2. Multiple vehicles may be used having different capacity limitations to both weight and

cube.

3. A maximum total driving time is allowed on a route before a rest period of at least 8

hours.

4. Stops may permit pickup and/or deliveries at certain times of the day (called time

windows).

5. Pickup may be permitted on route only after deliveries are made.

6. Drivers may be allowed to take short rests or lunch breaks at certain times of the day.

These restrictions add a great deal of complexity to the problem and make it very difficult

to find an optimal solution. However good solution can be found using heuristic

procedures.


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Inventory Strategy

The Storage and Handling System

In contrast with transportation, storage and handling of product takes place primarily at

the nodal points in the supply chain network. Storage has been referred to as

transportation at zero miles per hour. The costs of warehousing and materials-handling

activities absorb 26 percent of a firm‘s logistics dollar.

Need for a Storage System

If demand for a firm‘s products were known for sure and products could be supplied

instantaneously to meet the demand, theoretically, storage would not be required since no

inventories would be held. However, it is neither practical nor economical to operate a

firm in this manner since demand usually cannot be predicted exactly.

Even to approach perfect supply and demand coordination, production would have to be

instantly responsive, and transportation would have to be perfectly reliable with zero

delivery time. This is not available to a firm at any reasonable cost. Therefore, firms use

inventories to improve supply-demand coordination and lower overall costs.

It follows that maintaining inventories produces the need for warehousing and handling

as well; storage becomes an economic convenience rather than a necessity.

The costs of warehousing and materials handling are justified because they can be traded

off with transportation and production-purchasing costs. That is, by warehousing some

inventory, a firm can often lower production costs through economical production lot

sizing and sequencing.

By this means, a firm avoids the wide fluctuations in output levels due to uncertainties

and variations in demand patterns. Also, the warehousing of these inventories can lead to

lower transportation costs through the shipment of larger, more economical quantities.

Storage System Functions

The storage system can be separated into two important functions:

- Inventory holding (storage)

- Materials handling

Materials handling refers to those activities of loading and unloading, moving the product

to and from various locations within the warehouse, and order picking. Storage is simply

the accumulation of inventory for a period of time. Different locations in the warehouse

are chosen, depending on the purpose of storage


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UNIT-5

MANAGING GLOBAL LOGISTICS AND

GLOBAL SUPPLY CHAINS


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Global Supply Chain Operations

Global Business Environment

To date, our world market is dominated mostly by many well established global brands.

Over the last three decades, there have been a steady trend of global market convergence

– the tendency that indigenous markets start converge on a set of similar products or

services across the world. The end-result of the global market convergence is that

companies have succeeded on their products or services now have the whole wide world

to embrace for their marketing as well as sourcing.

The rationale of global market convergence lies partially in the irreversible growth of

global mass media including Internet, TVs, radios, news papers and movies, through

which our planet has become truly a small global village. Everybody knows what

everybody else is doing, and everyone wants the same thing if it is perceived any good. It

also lies in the rise of emerging economic powers led by BRICs (Brazil, Russia, India and

China), which has significantly improved the living standard and the affordability of

millions if not billions of people.

For organizations and their supply chains, the logic of going global is also clearly

recognizable from economic perspective. They are merely seeking growth opportunities

by expanding their markets to wherever there are more potentials for profit- making; and

to wherever resources are cheaper in order to reduce the overall supply chain costs. Inter-

organizational collaborations in technological frontier and market presences in the

predominantly non-homogeneous markets can also be the strong drivers behind the scene.

One can also observe from a more theoretical perspective that the trends of globalization

from Adam Smith‘s law of ―division of labour‖. A global supply chain is destined to be

stronger than a local supply chain because it takes the advantage of the International

Division of Labour. Surely, the specialization and cooperation in the global scenario

yields higher level of economy than that of any local supply chains. Thus the growth of

global supply chain tends to give rise to the need for more coordination between the

specialized activities along the supply chain in the global scale.

As the newly appointed Harvard Business School dean professor Nitin Nohria said ―If the

20th century is American‘s century, then the 21st century is definitely going to be the

global century.‖ The shift of economic and political powers around world is all too

visible and has become much more dynamic and complex. But, one thing is certain that

there will be significantly and increasingly more participation of diverse industries from

all around the world into the global supply chain network; hence bringing in the

influences from many emerging economies around the world. Their roles in the globally

stretched network of multinational supply chains are going to be pivotal and will lead

towards a profoundly changed competitive landscape.


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In such a global stage there are a number of key characteristics that global supply chains

must recognize before they can steer through:

• Borderless: National borders are no longer the limits for supply chain

development in terms of sourcing, marketing, manufacturing and delivering. This

borderless phenomenon is much beyond the visible material flows of the globalised

supply chain. It is equally strongly manifested in terms of invisible dimensions

of global development such as brands, services, technological collaboration and

financing. Evidently, the national borders are far less constrictive than they used to be.

Arguable this is perhaps the result of technology development, regional and bilateral

trade agreements, and the facilitation or world organizations such as WTO, WB, GATT,

OECD, OPEC and so on.

• Cyber-connected: The global business environment is no longer a cluster of many

indigenous independent local markets, but rather it emerged as an inter-connected single

market through predominantly and growingly important cyber connections. For this

reason, the inter-connection of our global business environment is almost ―invisible‖,

spontaneous and less controllable and surely irreversible. Globally stretched

multinational supply chains would not be possible or even comprehensible without cyber-

technology allowing large amounts of data to be transferred incredibly quickly and

reliably.

• Deregulated: Trade barriers around the world has been demolished or at least

significantly lowered. Economic and free-trade zones around the world have promoted

open and fair competition and created, albeit never perfect, a level playing field on the

global stage. Deregulation simplifies and removes the rules and regulations that constrain

the operation of market forces. It has targeted more at the international trading and

aiming for stimulating global economic growth. The typical deregulated regions are

European Union, North America Free Trade Agreement zone; Associations of Southeast

Asian Nations group and so on. Deregulation reduces government control over how

business is done thus moving towards laissez-fair and free market system.

• Environmental Consciousness: Last decade has witnessed the growing concerns

on the negative impact of business and economic development on the natural

environment. The global movement towards green and more eco sustainable business

strategies plays an important role in today‘s global supply chain development. This is

also driven by the actions of lawmakers and regulatory agencies, such as the

Environmental Protection Agency (EPA). Governments of leading economies are

increasingly involved in promoting greening activities in business, and formalize more

legislation and regulation to place upon firms in the future. Carbon footprint is now a key

performance measure of the sustainability for many global supply chains.


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• Social Responsibility: Along with that is a wider socio-economic impact. Fair

trade and business ethics become increasingly the key measures on business‘s social

responsibility, and the key factors for business decision making. Social pressure strikes at

the heart of a company‘s brand in the mind of the consumer. A significant group of

consumers have begun making their purchasing decisions based on the supply chain‘s

ethical standard and social responsibility. Global corporate citizenship and social

responsibility forms yet another important business environmental factor that can make

or break a business.

Strategic Challenges Under such a changing global business environment, what are the new strategic and

operational challenges? At a macro level, there are at least five key strategic challenges

that will have the long term and overall impact on the architecture as well the

management process of the global supply chains. Those strategic challenges tend to be

interrelated intricately and dynamically with one another. The magnitude of those

challenges varies from industry to industry; and from time to time.

Market dimension

Continuing demand volatility across the world market that hampered many supplychains‘

ability to manage the responsiveness effectively. Demand fluctuation at the consumer

market level poses a serious challenge to the assets configuration of supply chain,

capacity synchronization, and lead-time management. More often than not it triggers the

‗bullwhip effect‘ throughout the supply chain resulting in higher operating cost and

unsatisfactory delivery of products and services.

The root causes of the demand volatility in the global market are usually unpredictable

and even less controllable. Economic climate plays a key role in overall consumer

demand. The recent worldwide economic downturn has made many global supply chains

over-capacitated, at least for a considerable period of time. Geo-political instability

around the world has also contributed to the market volatility to certain industries.

Technology development and product innovation constantly creates as well as destroys

the markets often in a speed much faster than the supply chain can possibly adapt.

Emerging economies around the world are aggressively churning out products and

services that rival the incumbent supply chains in terms of quality and price, which lead

to huge swings of market sentiment.


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Recent research shows that customer loyalty has significantly decreased over the last

decade, adding to the concerns of market volatility. The development of internet based

distribution channels and other mobile marketing medias has made it incredibly easier for

consumers to switch their usual brands. Many products are becoming more and more

commoditized, with multiple competitors offering very similar features. With increased

market transparency, many B2B and end customers simply shop for the lowest price,

overlooking their loyalty to particular suppliers or products. A lack of robust forecasting

and planning tools may have contributed to the problem, as companies and their suppliers

frequently find themselves scrambling to meet unexpected changes in demand.

Technology dimension

Technology and the level of the sophistication in applying the technology for competitive

advantages have long been recognised as the key strategic challenges in supply chain

management. This is even more so, when we are now talking about the supply chain

development in a global stage. The key strategic challenges in the technological

dimension are threefold.

The first is the development lead-time challenge. The lead-time from innovative ideas to

testing, prototyping, manufacturing, and marketing has been significantly shortened. This

is partially due to the much widened global collaboration on technological development

and subsequent commercialisation and dissemination. The globally evolved technology

development systems have created a new breed of elite group as the world technology

leaders across different industries. They capture the first mover advantages and made the

entry barriers for new comers almost impossible to overtake. No doubt, there is a

strategic challenge that global supply chain must create an ever ready architecture that

can quickly embrace the new ideas and capitalise it in the market place.

The second challenge comes from its disruptive power. Harvard Business School

professor Clayton Christensen published his book The Innovator‘s Dilemma in May

1997, in which he expounded on what he defined as the disruptive technology. The basic

message he tried to put across was that when new technologies causes great firms to fail,

managers face the dilemma. Evidently, not all new technologies are sustaining to

business, often they are competency-destroying. The product or service developed

through applying new innovative technologies may not be so much appreciated by the

consumers. Consumers often are often not so eager to buy the ideas. They may not be so

convinced that the value the technology created or the costs it added in. If you wait for

other companies to test the market first, then you run a high risk of losing the first mover

advantage and losing the market leadership. That‘s the dilemma and that‘s the challenge.


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The third challenge lies in the supply chain network. The innovative ideas and new

technologies usually emerge from a supplier or a contractor in the supply chain network.

To convince the whole supply chain of the value adding or cost reduction is not

guaranteed. Each supplier and contractor will have its own value stream and will make

technology adoption decisions based on the needs of its own customers. Innovative ideas

that come up from subcontractors may be stifled due to the supply chain‘s inability to

coordinate value contribution between individual members and the whole supply chain.

The cost and profit structures in the value network can also limit the attractiveness of an

innovation. If profit margins are low, the emphasis will be on cost cutting across proven

technologies, rather than taking the risk of the new technologies.

Finally from the technology evolution perspective, technology destroys as readily as it

creates. The development of digital photography has literally destroyed the photo film

manufacturing industries including many well known brands; LCD and Plasma

technology also smashed the TV Tube (traditional screen component) manufacturing

industry overnight. This increased risk of technology disruption at the industrial scale is

lot more formidable than the innovative dilemma Prof Christenson was talking about in

his book. Nevertheless, there are some helpful supply chain strategies that can better

prepare them for the eventuality.

Resource dimension

From resource based perspective, global supply chain development is both motivated by

dinging new resources around world and by make better use of its own already acquired

resources to yield economic outputs. It comes as no surprises that one of the key strategic

challenges in global supply chain development is about resource deployment. The term

resource in this context means any strategically important resources, including financial

resource, workforce resource, intellectual resource, natural material resources,

infrastructure and asset related resources, and so forth.

Stretching supply chains‘ downstream tentacles around the world opens the door for

making good (more efficient) use of internal resources, i.e. the same level of resources

can now be used to satisfy much wider and bigger market in terms of volume, variety,

quality and functions. However the internal resource or competence based strategy will

also face more severe challenges on the global stage than in its own local or regional

market. The challenges are not necessarily just from the indigenous market, but more

likely they come from equally competitive incumbent multinationals and possible

emerging ones alike. Also more menacingly the internal based advantages can evaporate

anytime when global business environment subjects fundamental changes.


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Stretching the sourcing-end (supply side) of supply chain to the global market is a great

strategy to acquire scarce resources, or any resources at a much lowered cost. The

productivity and operational efficiency oriented strategy is often no match to the

procurement focused strategy in measures of reducing the total supply chain cost. No

wonder many multinationals are actively debating on sourcing their workforce, materials

and energy from overseas locations in order to significantly reduce the operation cost,

which will then lead to more competitive market offerings. This resource sourcing

strategy has been the prime drive for the surge of off-shoring and outsourcing activities

all over the world. However many long- term and short-term impacts of outsourcing and

off-shoring are difficult to be fully understood from the outset, if at all possible. Thus it

forms a key strategic challenge in global supply chain development.

Time dimension

Most of the key global supply chain challenges are time related, and it appears to be that

they are becoming even more time related than ever before. Given that everything else is

equal; the differences on time could make or break a supply chain. When the new market

opportunity emerges it is usually the one who gets into the market first reaps the biggest

advantages. Competitions on many new electronic consumer products is largely about

who developed it first and become the industry leader. From the internal supply chain

perspective, the cost and core competences are all largely measured against time.

Inventory cost increase, if the materials do not move on quick enough; supply chain

responsiveness is can be significantly influenced by the lead-time and throughput time.

Indeed, one of the key supply chain management subject areas is about agility and

responsiveness. That is basically defined as how fast the supply chain can respond to the

unexpected and often quite sudden changes in market demand. Understandably, in the

increasingly fast moving global market place, developing and implementing an agile

supply chain strategy makes sense. However, the tough challenges are usually not on

making the decisions as to whether should the supply chain be agile or not. They are

more on balancing the ‗cost to serve‘. In order to maintain a nimble footed business

model, the supply chain may have to upgrade its facilities with investment, having higher

than usual production and service capacities, or having high level of inventories. Then the

question is would the resultant agility pay for the heightened supply chain costs. There is

no fixed answer to this question, and it remains as a key challenge to supply chain

managers.

The time measures on many operational issues have also been the major challenges for

supply chain managers. Customer lead-time, i.e. from customer order to product delivery,

is one of those challenges. Toyota claims that they can produce a customer specified

vehicle with a fortnight – the shortest lead-time in the auto industry. This adds huge value

to the supply chain in terms of customer satisfaction, cost reduction, efficiency and


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productivity. But it could be a huge challenge, when the customers are all over the world

and the productions sites and distribution logistics facilities are not well established.

All the challenges in the three dimensions are, of course, interrelated and even

interdependent with each other. A supply chain strategist must have a sound system view

to understand the intricate relations of all factors in the whole supply chain and over the

projection of long-term. Those strategic challenges have undoubtedly given rise to the

risk level of global supply chain development. It came as little surprise that the supply

chain risk management, which will be discussed later in this book, is now one of the hot

topics discussed in the academia and business circle alike.

How Global Supply Chains Responded Knowing the challenges is one thing perhaps to begin with, but learning about how to

face up to the challenges is quite another. Despite the plethora of literatures on supply

chain management, there are still no universally agreed ―one size fit all‖ recipes for

managers to prescribe in order to survive the challenges. Academic and empirical studies

show there are at least five common approaches that supply chains have survived the

global challenges.

Collaboration

―If you cannot beat them, you better join them.‖ A great deal of global supply chain

management activities are not necessarily about competing against one another, rather it

is more about collaboration and partnering. Inter-firm collaboration in supply chain

management context is simply defined as working together to achieve a common goal.

The content of collaboration varies from project to project and from business to business.

It may be a research and development collaboration which is aiming perhaps for a

technological advancement or a new product design; or it could be a logistics operational

collaboration where the aim is to reduce logistics lead-time and cost; it could also be

marketing collaboration where the aim is to penetrate the market and increase sales. So,

the collaboration is usually mentioned when there is an area or a project the activities of

the collaboration can be associated with. The parties that involved in the collaboration are

often referred to as the partners or collaborative partners. There are a number of obvious

reasons why collaboration is one of the most favourite supply chain management

approaches.

• Sharing resources: collaboration between two firms helps to share the

complementary resources between them, thus avoiding unnecessary duplication of the

costly resources such as capital-intensive equipment, service and maintenance facilities,

and distribution networks and so on. Information, knowledge and intellectual resources

are also very common resources that are shared during the collaboration.

• Achieve synergy: collaboration of the two partnering firms will usually result in

what is called ‗synergy.‘ Synergy, in general, may be defined as two or more things


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functioning together to produce a result not independently obtainable. That is, if elements

A and B are combined, the result is greater than the expected arithmetic sum A+B. In the

context business collaboration or partnering, synergy is about creating additional business

value that neither can achieve individually.

• Risk sharing: a properly constructed collaboration can help to mitigate the

company‘s market and supply risk significantly for both parties. Risk is the negative but

uncertain impact on business, which is normally beyond control. By collaborating on

investment and marketing, the negative impact of the supply chain risks can be borne by

both parties and thus shared and halved.

• Innovation: collaboration in technology development and R&D partnering is

particularly effective way to advance their competitive advantages through innovation in

the technological frontier. The logic behind is perhaps that when people from different

business working to gather, they start blend their knowhow and experience together,

sparkling new innovative ideas. In most of innovation training programmes one can

always recognise one of steps of generating innovative ideas is to have brain storming

across a multi- functional team.

Supply chain integration

The nature of a supply chain is that it is usually a network which consists of a number of

participating firms as its member. For a global supply chain the network stretches many

parts of the world, and the participating member firms of the network can be an

independent company in any country around the world. Supply chains are therefore

voluntarily formed ‗organisations‘ with fickle loyalties and often antagonistic relations in

between the member firms. Communication and visibility along the supply chain are

usually poor. In other words, supply chains are not born integrated.

Supply chain integration therefore can be defined as the close internal and external

coordination across the supply chain operations and processes under the shared vision

and value amongst the participating members. Usually, a well integrated supply chain

will exhibit high visibility, lower inventory, high capacity utilisation, short lead-time, and

high product quality (low defect rate). Therefore, managing supply chain integration has

become one of the most common supply chain management approaches that can stand up

to the global challenges.

However, there is no supply chain that is strictly 100% integrated, nor any one that is

strictly 0% integrated. It is about how much the supply chain is integrated from a focal

company‘s point of view. To illustrate this degree of difference in supply chain

integration, Frohlich and Westbrook (2001) suggested a concept of ‗Arc of Integration‘

(Figure 3). A wider arc represents a higher degree of integration which covers larger

extent of the supply chain, and a narrow one for a smaller extent. The issue about supply

integration is particularly important when the supply chain is formed by the members

around the globe.


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Arc of integration

Divergent product portfolio

A conventional wisdom says that ‗don‘t put all your eggs in one basket.‘ It also makes

sense in formulating a global supply chain development strategy. Translated into business

management terminology, the wisdom is very similar to the ‗divergent product portfolio‘

strategy. Then it may make even more sense when the global market becomes the stage

for the supply chain. Two key characteristics of global market are volatility and diversity.

Develop divergent product portfolio will make the supply chain more capable of

satisfying the divergent demand of the world market. Many leading multinational

organisations have already been the firm believer of this strategy. They have developed a

wide range of product or even business sector portfolio to cater for the market needs.

Virgin Group, General Electric, British Aerospace are just some well know examples.

The divergent product portfolio strategy can also significantly mitigate the market risks

that brought forth by the nature of global market volatility. If one product is not doing

well, the supply chain can still be stabilised by others that do well. The shock of one

single market at a particular time will not derail the overall business. In a long run,

occasional market instabilities will ease off with each other. So, the divergent portfolio

works like a shock absorber and risk mitigating tool.

Develop the ―blue ocean strategy‖


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Instead of going for the ‗head-on‘ competition in the already contested ‗red sea‘ a much

more effective approach is to create a new market place in the ‗blue ocean‘, which makes

the competition irrelevant. This is an innovative strategic approach developed by Prof.

Cham Kim and Renee Mauborgne in 2005, and published in their joint authored book

―Blue Ocean Strategy‖. In the book, the authors contend that while most companies

compete within such red oceans, this strategy is increasingly unlikely to create profitable

growth in the future.

Based on a study of 150 strategic moves in many globally active supply chains over the

last thirty years, Kim and Mauborgne argue that developing the ‗blue ocean strategy‘ (as

they coined it) has already been proven an effective response to the global challenges for

many supply chains. Tomorrow‘s leading supply chains will succeed not by battling

competitors, but by creating ‗blue ocean‘ of uncontested market space that is ripe for

growth. They have proved that one can face up to the challenges most effectively without

actually doing so. Creating new market space is actually a lot easier than you think if you

know how.

Pursuing world class excellence:

To weather the global challenges and to achieve long lasting business success often calls

for one fundamental feat and that feat is world class excellence. Almost all known world

leading supply chains in all industrial sectors have somehow demonstrated that they have

just been excellent in a multitude of performance measures. The world class excellence

defines the highest business performance at a global level that stand the test of time. Only

the very few leading edge organisations around the world truly deserve this title. But the

title is not just a title. It is the fitness status that ultimately separates the business winners

from losers.

To become a world class supply chain one need to excel in four dimensions. The first

dimension is the operational excellence. All world class supply chain must have

optimised operations measured in productivity, efficiency, cost effectiveness, quality, and

high standard of customer service and customer satisfaction. The second dimension is the

strategic fit. All world class supply chains must also ensure that excellent operations fit to

the supply chain‘s strategic objective and stakeholder‘s interests; and the internal

resources fit to the external market needs. The third dimension is the capability to adapt.

Would class supply chains must be dynamic and able to adapt into to new business

environment in order to sustain the success. The fourth dimension is the unique voice. All

world class supply chains needs to develop its own unique signature practices that render

positive market results. Such internally unique practice coupled with positive market

result is called unique voice. This dimension goes beyond benchmarking on best-

practices; it creates best-practices


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2.4 Current Trends in Global SCM

Many reliable management researches and surveys conducted in recent years have come

to a broad consensus that some significant development trends are shaping and moving

today‘s global supply chains. The following trends are mainly based on and adapted from

the PRTM 2010 Survey results with the author‘s own interpretation and analysis to

facilitate student learning.

Trend 1: Supply chain volatility and market uncertainty is on the rise.

Research survey shows that continued demand volatility in most of global markets is a

major concern to the executives of supply chains. Significantly more than any other

challenges to supply chain flexibility, more than 74% of the surveyed respondents ticked

the demand volatility and poor forecasting accuracy as the increasing major challenges to

supply chain flexibility. Apparently, few companies have strategies in place for managing

volatility in the years ahead let along implementing it. The lack of flexibility to cope with

the demand change is increasingly a management shortfall. In the path of economic

recovery, this shortfall could well be the trigger for bullwhip effect.

The fast development of cyber market and mobile media has given rise to the market

visibility leading to high level of market transparency. B2B customers and consumers

have found it a lot easier to shop for alternative lower price or better value. The switching

cost is evaporated rapidly, and so is the customer loyalty, which adds salt to the injury.

The only known approaches to deal with the trend of increased volatility are improving

forecasting accuracy and planning for flexible capacity throughout the supply chain. Best

performing companies tends to improve supply chain responsiveness through improving

visibilities across all supply chain partners. On the downstream side, companies are now

focusing more on deepening collaboration with key customers to reduce unanticipated

changes.

Trend 2: Market growth depends increasingly on global customers and supplier networks

The research survey has shown a positive growing trend in international customers and

international suppliers in more international locations. As a result, more than 85% of

companies expect the complexity of their supply chains to grow significantly at least for

the coming year. The immediate implication of this trend is that the supply chain will

have to produce higher number of products or variants to fulfil the customer expectations,

albeit this may vary slightly for different geographical regions. In the main, the pattern of

global supply chain is going to be more complex in terms of new customer locations,

market diversity, product variants, and demand volatility.

On the supply side, the trends indicated that a more dynamic supply networks stretching

far and wide globally. Managing those suppliers, developing them and integrating them

become more a critical challenge than ever before. Nearly 30% of respondents expect the


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in-house manufacturing facilities will decline and to be replaced by outsourced and off-

shored international contractors. Similarly nearly 30% of respondents expected a decline

in the number of strategic suppliers to the OEM (original equipment manufacturer) in

order to achieve more closely integrate the supply chain for higher collaborated value

adding. This will result in more consolidated supply base. This is more evident in North

America and Europe, but significantly less so in Asia where expansion of supply network

is more of the case.

Trend 4: Risk management involves end-to-end supply chain

To date, risk has become an increasingly critical management challenge across the global

supply chains. According to the research survey participants, new demands from their

customers have played a key role in this development. Dealing with cost pressures of

their own, many customers have increased their efforts in asset management and have

started shifting supply chain risks, such as inventory holding risks, upstream to their

suppliers. This approach, however, merely shifts risks from one part of the supply chain

to another but not reduces it for the whole supply chain. In fact, between 65% and 75%

respondents believe that supply chain risks can only be most effectively mitigated by the

end-to-end supply chain approaches. These end-to-end supply chain practices include

advanced inventory management, joint production and material resource planning,

improved delivery to customers and so forth.

Leading companies are taking an end-to-end approach in managing risk at each node of

the supply chain. To keep the supply chain as lean as possible, they are taking a more

active role in demand planning, which ensures they order only the amount of material

needed to fill firm orders. Firms are also limiting the complexity of products that receive

late-stage customisation. Leading companies mitigate inventory-related risks by shifting

the responsibility for holding inventory to their suppliers and, furthermore, by making

sure finished product is shipped immediately to customers after production.

Trend 5: More emphasis on supply chain integration and empowerment

Little can be achieved without appropriate management approaches that truly integrated

across all functions throughout the supply chain and empowered them to take bold action.

However, approximately 30% mention the lack of integration between supply chain

functions like product development and manufacturing. Integrated supply chain

management across all key functions still seen to be a myth, with many procurement and

manufacturing executives making silo optimisation decisions. Nearly one-fourth of

survey respondents point to their organisations‘ inability to make concerted actions and

coordinated planning to respond to the external challenges. This could be a surprise to

many that would believe after so much has been talked by so many for so long on the

supply chain integration, little has been achieved in practice.


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Whilst almost all the survey participating companies have supply chain department, many

of them failed to empower their supply chain managers to take leading roles in business

transformation. Leading companies understand that breakthrough improvements are not

possible unless the decisions made are optimal for all supply chain functions. For this

reason, they have already taken steps to integrate and empower their supply chain as a

single resource under one joint responsibility. These firms are making sure the

organisation has a strong end-to-end optimization, and are integrating supply chain

partners up and downstream.

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