1. ELEMENTS OF LOGISTICS MANAGEMENT WHAT IS LOGISTICS? Logistics is concerned with getting the products and services where they are needed and when they are desired. It is difficult to accomplish any marketing or manufacturing without logistical support. It involves the integration of information, transportation, inventory, warehousing, material handling, and packaging. The operating responsibility of logistics is the geographical repositioning of raw materials, work in process, and finished inventories where required at the lowest cost possible. The formal definition of the word ‘logistics’ as per the perception of Council of Logistics Management is the process of planning, implementing and controlling the efficient, effective flow and storage of goods, services and related information from the point of origin to the point of consumption for the purpose of conforming to customer requirements. Mission of logistics is providing a means by which customer satisfaction is achieved. Art of moving, lodging and supplying troops, supplies and equipment is logistics. Concept of logistics has moved into business to move, lodge and supply inputs and outputs. Logistics is practiced for ages since organized activity began. Without logistics support no activity can be performed to meet defined goal. The current challenge is to perform logistics scientifically in order to optimize benefits to the organization. Logistics is a planning function of management. Logistics function is concerned with taking products and services where they are needed and when they are needed. Logistics ensures that the required inputs [what] to a value adding process made available, where they are needed, when they are needed and in quantities [how much] they are needed. It also ensures that the outputs of value adding process are made available where they are needed when they needed and in the quantities [how much?] they are needed.
are the the are
There are many ways of defining logistics but the underlying concept might be defined as follows: ‘Logistics is the process of strategically managing the procurement, movement and storage of materials, parts and finished inventory through the organization and its marketing channels in such a way that current and future profitability are maximized through the costeffective fulfillment of orders.’ GENESIS OF MODERN LOGISTICS Several Modern Management concepts are born or refined in the crucible of II World War. You may remember several OR techniques like Value Analysis & PERT/CPM have their origin in the II World War. Resources come under pressure in a war, like no other time and one is expected to deliver results in spite of all odds. These trying situations forced the military planners to evolve solutions to their problems. After the war these concepts traveled to business where resource crunch is usual. In business there is no enemy, but there are competitors who pose threat to the organizations survival. Field Marshall Rommel’s words that ‘………before they are fought, battles are won or lost by quartermasters’ speak about the importance of logistics. 1
There are several examples where battles are lost due to long & ineffective supply lines. Logistics received great importance in military planning and subsequently became a very important management function in the course of last 40 years. Logistical management includes the design and administration of systems to control the flow of material, work in process and finished inventory to support business unit strategy
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OVERVIEW OF LOGISTICS FUNCTION Logistical History of India: India was a maritime power since about 300 BC, trading with several countries of the world bringing prosperity home. Traders of Surat brought riches to the country by extensive maritime trade. Like many of our excellent practices, logistical efficiency also faded away over a period of time. Some important logistical feats in history: 1. Berlin Airlift – 1945: A study in logistics. When the city of Berlin was blockaded by Soviets and all supply lines were cut off, Americans planned and executed a major logistics operation to feed the city from air. 2. Indians in the Gulf countries – 1991: 1n 1991, when gulf war broke out, Indian Government evacuated thousands of Indians from the gulf countries and brought them home in a massive exercise employing Indian airlines planes. 3. Operation Overlord-1945: Allies’ invasion of Europe and subsequent victory In II World War. 4. American war of Independence Keeping 12,000 soldiers armed and fed from England was a big task; British lost the American war of independence due to bad logistics. What causes bad logistics? a. Infrastructure: Bad roads, inefficient railways, poor communication lines, and congestion in the ports. b. Taxation: e.g. Octroi c. Information: Inadequate information d. Management: Poor management decisions
IMPORTANCE OF LOGISTICS Logistics is the bed rock of trade and business.
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Without selling and or buying there can be no trade and business. Buying and or selling takes place only when goods are physically moved into and or away from the market.
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Take away logistical support trade and business will collapse
1. Leads to customer satisfaction through superior customer service. Organizational objectives of P[Productivity],Q [Quality],C [Cost],D [Delivery],E [Employee Morale],F [Flexibility],S [Safety],H [Health],E [Environment] are set to meet customer expectations of Q,C,D. Q, C, S, H, E are parts of must be quality that a customer expects. Logistics addresses D, F objectives which lead to customer satisfaction through superior customer service 2. Integrates logistical activities In conventional management environment, various activities of logistics work in isolation under different management functions. Each pocket trying to sub optimize its objectives at the cost of overall organizational objectives. Purchasing trying to purchase at minimum price at the cost of what is needed by operations. Operations 3
produce large quantities at minimum production cost ignoring demand leading to doom inventory. Logistics function of management brings all such functions under one umbrella pulling down inter departmental barriers. 3. Competitive edge: In the fiercely competitive environment logistics provides the edge. Due to technological revolution most of the products are moving into commodity markets. In a commodity market where price is controlled by competition, where there is no product differentiation in terms of quality parameters like performance & reliability, where brands are almost irrelevant, competitive edge is that of availability of product and service in terms of time, place and quantity. 4. Logistics wins or loses wars • British lost American war of independence due to poor logistics • Rommel was beaten in the desert by superior logistics of Allies 5. Supports critical functions like operations and marketing Strong logistics support enables a company to move towards JUST IN TIME production system for survival in a highly competitive market a) Interface with marketing These days marketing a product is increasingly on the strength of availability and flexibility as we discussed earlier. Stronger emphasis is on the last of four Ps of marketing [product, price, promotion and place]. Logistics provides the interface between production function and marketing function. Marketing is trying to sell the product in the market place. Logistics makes the product accessible to marketing by acting as interface between the function that produces it and the function that makes the consumer buy it. This interface is gaining importance due to following changes that are sweeping the market making many companies adopt JUST IN TIME production system. a. change in the customer: demanding, knowledgeable, conscious of rights, lacking in brand loyalty, changes preferences very fast, expects very high degree of service b. many products are moving towards commodities market: product differentiation in terms of quality of performance is vanishing and brands are losing their magic. As a result of above we find that availability is an important determinant of purchasing decision. 6. Logistical costs: For individual businesses logistics expenditures are 5% to 35% of sales depending on type of business, geographical areas of operation, weight/value ratios of products and materials. This is an expensive operation. Improvement in the efficiency of logistics function yields savings as well as customer satisfaction
WHY SHOULD WE LEARN LOGISTICS? HOW OR WHY DOES LOGISTICS BECOME IMPORTANT FOR MANAGEMENT STUDENTS? 1. Impact on cost of creating and delivering of product to the customer 2. provides competitive edge to business 3. crucial to survival and prosperity in global trade and business 4. many products have short life cycles 5. more & more logistics experts are going up the hierarchical ladder 6. leads to the concept of supply chain management 7. Logistics is important in the Indian market due to the sweeping changes, which are taking place. a. Competition: Internal as well as external 4
b. Shift from seller’s market to buyer’s market c. Changing customer d. Expanding business, growing exports e. Corporate mangements’ Shift towards modern management concepts like Lean management, Just In Time, Total Quality Management etc.,
IMPORTANCE OF LOGISTICS MANAGEMENT IN INDIA I. Liberalization and opening our door to competition II. Global business has long supply & distribution lines III. Changing Indian customer, aware, demanding and less brand loyal IV. Competition ensures that product differentiation in terms of quality is difficult V. Product life cycles are shrinking VI. Our markets are shifting from sellers’ to buyers’ VII. Many consumer products are moving into commodities market VIII. India is a large country. Large distances separate production and consumption centers. Essential commodities have to travel from Food Corporation warehouses to consumers through PDS. IX. Logistics performance has not been impressive X. Fruits and vegetables are grown at various places but do not enjoy access to market
WHAT ARE THE OPERATIONAL OBJECTIVES OF LOGISTICS? 1. Rapid response F-flexibility objective of an organization: Some companies measure this as response time to customer’s order. On an average how much time do we need to fulfill one particular type of customer’s order in a year? This is a measure of Rapid response Logistics should ensure that the supplier is able to respond to the change in the demand very fast. Entire production should change from traditional push system to pull system to facilitate rapid response. Instead of stocking the goods and supplying on demand, orders are executed on shipment to shipment basis. Information Technology plays an important role here as an enabler. IT helps management in producing and delivering goods when the consumer needs them. This results into reduction of inventory and exposes all operational deficiencies. Now the management resolves these deficiencies and slashes down costs. [Concept of SMED and KANBAN as practiced by JIT companies in Japan or elsewhere] 2. Minimum variance D-delivery objective of an organization, this can be measured as ‘On Time Delivery’ or OTD. If 100 deliveries are made in a month/quarter/year how many reached as per the commitment made to the customer? This percentage is OTD. Any event that disrupts a system is variance. Logistics operations are disrupted by events like delays due to obstacles in information flow, traffic snarls, acts of god, wrong dispatches, damage in transit. Traditional approach is to keep safety stocks and transport the goods by high cost mode. The cost of this approach is huge. Logistics is expected to minimize these events, thereby minimize and improve on On Time Delivery. 3. Minimum inventory This is component of cost objective of a company. Inventory is associated with a huge baggage of costs. It is termed as a necessary evil. Objective of minimum inventory is measured as Inventory Turns or Inventory Turnover Ratio. Americans call 5
this measure as turn velocity. Logistics management reduces these turns without sacrificing customer satisfaction. Lower turns ensure effective utilization of assets devoted to stock. [Concept of single piece flow as practiced by JIT companies in Japan or elsewhere]. Logistical management should keep the overall well being of a company in view and fix a minimum inventory level without trying to minimize the inventory level as an isolated objective 4. Movement consolidation Transportation is the biggest contributor to logistics cost. Transportation cost depends on product type, size, weight, distance to be transported etc. for transporting small shipments just in time [reduction in inventory costs] expensive transport modes are used which again tend to hike the costs. Movement consolidation is planning several such small shipments together [of different types of shipments] by integrating interests of several players in the supply chain. Generally, large shipment size and long distances reduce transportation cost per unit. Movement consolidation shall result into reduction in transportation costs. 5. Quality If the quality of product fails logistics will have to ship the product out of customers premises and repeat the logistics operation again. This adds to costs and customer dissatisfaction. Hence logistics should contribute to TQM initiative of management. In fact, commitment to TQM has made the managements world over wake up to the significance of logistics function. Logistics can play a significant role in total quality improvement by improving the quality of logistics performance continuously and continually. 6. Life cycle support [cradle to cradle logistical support- produce, pack (cradle) and repack(cradle)] Logistics function is expected to provide life cycle support to the product after sale. This includes a. After sales service: the service support needed by the product once it is sold during its life cycle b. Reverse logistics [concept Oct’03] or Product recall as a result of - rigid quality standards [critical in case of contaminated products which can cause environmental hazard] - transit damage [leaking containers containing hazardous material] - product expiration dating - rigid laws prohibiting unscientific disposal of items associated with product [packaging] - Rigid laws making recycling mandatory - Erroneous order processing by supplier - Reverse logistics is an important component of logistics planning
INFORMATION SYSTEMS - Internal & External Information flow
NETWOR K DESIGN - Suppliers, operations, warehouses
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WARE HOUSING - Storage, Handling, Packing & Distribution
LOGISTICS FUNCTIONS
INVENTORY - When to order? How much to order? Just In Time
TRANSPORTATION - Water, Road, Rail, Pipeline & Air
LOGISTICAL FUNCTIONS [components elements of logistics]
of
logistics
or
1. Information management Management is appreciating importance of information as an element of logistics of late, now. The role of information is vital in order processing. Quality of information is critical as error in composition of information requirement creates potential disturbance in the supply chain. Incorrect order processing due to erroneous information will result into product recall and reshipment if the sales opportunity still exists. Faster and quality information flow from customer to processor results into cost effective logistics. Forecasting and order management are two areas of logistical work dependent on information. Forecasting is an effort to estimate future requirements to position inventory or assets devoted to inventory. As forecasting becomes unreliable in a fast changing environment, control strategies like JIT, Quick Response and Continuous Replenishment came into being. Now it is the task of the logistics function to use information technology to strengthen operation control and forecasting to the best advantage of the organization. Leading firms typically have information systems capable of monitoring logistical performance on a real time basis giving them the capability to identify potential operational breakdowns and take corrective actions prior to customer service failure. 7
In situations where timely corrective action is not possible, customers can be notified in advance and thereby taking the surprise out of forthcoming service failures 2. Inventory control Keeping the stock levels in such a position, so that neither stock out nor stock piling takes place is Inventory control. While formulating inventory policies find out 20% of the products marketed that account for 80% of the profit. 3. Transportation Transportation is the most visible of all elements of logistics and high contributor to logistics expenditure. Costs of transportation are mainly as follows a. Movement costs: money paid for moving material across geographical terrain b. Preservation costs: money spent on preserving the material during transit c. Cost of idle asset: inventory is unavailable for conversion during transit. This results into costs for organization d. Administration costs: money spent on administration Transportation is accomplished in three ways a. One’s own fleet – private carriage b. Contract with specialists on long term basis – contract carriage c. Contract on individual shipment basis – common carriage Expectations from transportation service are a. minimum cost – transportation costs are explained earlier b. Speed: speed of transport means the speed with which goods reach the destination. c. Consistency: consistency in speed is achieving the same speed over a long period of time. Consistency reflects on the reliability of carrier. Any unexpected variance can play havoc with logistics. Modern information technology has made continuous tracking of consignments possible. This takes the element of surprise out. IT has helped logistics managers to seek out ways and means to improve speed and consistency. What is becoming important is a combination of speed and consistency. Requirement of speed depends on type of industry. In some situations speed may not be important. Then transportation service offering high speed increases cost. So logistics managers have to strike a balance between service and cost. Three important aspects of transportation are facility location, transportation cost and consistency. Design of logistics system should consider total costs rather than elemental cost of transportation 4. Warehousing Warehousing is holding material before dispatch after it is produced. Although warehousing is conventionally considered to be a storage facility, it plays a much higher role from logistics viewpoint. It is perceived to be a switching facility rather than a storage facility. Warehouse ownership can be private, public or third party contract. Warehouse provides economic and service benefits to the logistical system. Economic benefits are Movement Processing/Postponement & stock piling.
Consolidation,
Break-bulk,
Cross-dock,
Service benefits are spot stocking, assortment, mixing & production support 5. Material handling Material handling covers receiving, moving, storing, dispatching activities. It has an 8
impact on cost [capital as well as running], quality and safety. One of the principles of material handling is minimum movement. Commonly used material handling equipment are forklifts, EOT Cranes, hoists, pulley blocks, trolleys, railroad cars, conveyers, ropes and slings etc. 6. Packaging Packaging is done to make handling and transporting cost effective. It protects the product in transit and handling. Packing is expected to facilitate lifting and moving by providing easy access to forks or hooks. Packing is also expected to display universal symbols and other instructions for handling. Eg. pallets and containers, wooden boxes, wrapping etc. Types of packaging: consumer packaging and industrial packaging Consumer packaging - There is no focus on logistics. Importance is given to marketing appeal and packaging the finished product. Industrial packaging importance is given to logistics considerations handling and moving. Individual parts are packed in cartons or bags and grouped together as master cartons. Master cartons are grouped into units for handling. This concept leads to unitization and subsequently to containerization.
SOME IMPORTANT CONCEPTS 1. Logistics Management and Supply Chain Management……… Development of Logistics and Supply Chain Management Concept a. 1950 – 1960: Importance of examining costs and benefits in physically moving the goods to customers came into focus in post war1950s. We have seen earlier that concept of logistics was born in the crucible of warfare and came into business after the end of II world war. Idea of total system cost emerged during this period. Analyses of trade off situations between costs of several activities, selection of modes of transport keeping total system cost in mind are fallout of this concept. It can be understood that selection of water as a mode of transport gives low transportation cost that will result into high transit inventory adversely affecting total system cost. Initially outbound logistics was in focus as value of the finished goods inventory is high.
I N
V1
Procurement V3 V2 I N V
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Inbound F W3 Market Finished O R3Goods R4Stores R5 Logistics
R6
V4
Receiving stores
V5 INBOUND LOGISTICS
I N
I N V
Operation
F O
Inbound Logistics
PROCUREMENT
OUTBOUND LOGISTICS
I N V
I N
OPERATION
Finished Goods Stores F O
I N
W1
W2
I N V
W3
DISTRIBUTION
F O
I N
F O
R1
R2
R3
R4
R5
R6
I N V
Market
A new management function called Physical Distribution Management emerged integrating various activities on the outbound side like transportation, warehousing, packaging, customer service etc. Advent of electronic era of 1960s made information a strong component of physical distribution management. Inbound logistics was still considered to be a concern of vendors and did not receive the attention of management. 10
b. In 1970s strengthened by IT, physical distribution management started looking into some aspects of financial management subsystems. Monitoring and planning for efficient completion of cash cycle became attached to physical distribution management. Around the same time importance of inbound logistics was appreciated. c. In 1980s physical distribution management function came to be called logistics management encompassing inbound and outbound logistics. During this time this function started looking closely into logistical operations adopting modern concepts like TQM & TPM to logistical operations. d. 1990: This concept expanded, all up stream and down stream organizations and activities were brought closer for mutual cooperation in order to gain benefits of QCD. This idea of external integration is Supply Chain Management. Definition: the management of upstream and down stream relationships with suppliers and customers to deliver superior customer value at less cost to the supply chain as a whole. Supply Chain Management looks beyond the confines of organizations to deliver value to the end user at minimum cost. Supply chain is visualized as a pipeline through which products from raw materials stage to the end user. Supply Chain Management is ensuring that this flow is smooth and quick. Henry Ford visualized the importance of this flow in early 1990s and expanded his business to cover raw materials, their deposits, forests, plantations and even transportation activities like shipping lines. His business interests extended beyond the frontiers. This diverse expanse of business gave him final control on the supply chain but became nonviable due to labor problems and unwieldy bureaucracy. He realized that smaller independent organizations were more efficient and cost effective in delivering value and shifted his focus to a network of competent dealers. Idea of supply chain management Supply Chain Management aims at breaking down organizational barriers a] to share sales information on ‘real time’ basis that reduces inventories and need for safety stocks. This is called supply chain compression resulting into inventory reduction and larger inventory turns. Dell Computers considered to be leaders in computers business have recorded 50 inventory turns in 1997, IV Q, whereas Compaq could manage only 10 turns. b] Smoothen the flow of information both ways [orders reaching the suppliers, and products reaching the that results into reduced delivery time or reduction of lead-time resulting into shortened cash-flow cycle particulars Logistics management Supply chain management Scope Inbound logistics, in process All players in the supply chain inventory [movement from from raw material source to one plant to another], finished product consumer, outbound logistics vendors, their vendors, supplier organization[shipper], Warehouses, service providers, customers, their customers How this is By internal integration of By external integration of created in logistics functions handled by roles of various players in the business? various management supply chain. functions within organization Main Logistics cost reduction by Supply chain profitability by objective integrating resources across value creation. the pipeline definition Logistics is the process of Management of upstream strategically managing and down stream 11
Origin focus
procurement and storage of material , part and finished inventory [and related information flow] through organization and its marketing channels in such a way that current and future profits are maximized through cost effective fulfillment of order A very old concept in military planning. L/M tries to take the product to the consumer at minimum logistical cost. Hence it is supply driven.
relationships with suppliers and customers to deliver superior customer value at less cost to the supply chain as a whole.
As a logical extension of logistics management SCM focuses on value creation in the supply chain. Hence this is customer focused or demand driven.
2. Business functions of logistics I] Business logistics is planning, implementing and controlling efficient & effective flow and storage of goods, efficient & effective flow services, and related information from point of origin to point of use or consumption in order to meet customer requirements. a. Food and agricultural products: We are familiar with warehouses owned by Food Corporation of India. The government in these warehouses stores huge quantities of procured food grains. These stocks are subsequently moved to outlets of Public Distribution System. This is a logistical operation by Govt. of India in Agricultural Products Sector b. Raw materials and finished engineering, chemical, pharmaceutical goods. c. Consumer durable goods: Logistical Management is receiving attention in industry as many consumer durable products are moving into commodities market. II] Business logistics plays the role of facilitator for trade and business. It makes business happen. 3. Logistical mission Mission of logistics is to achieve business objectives by delivering desired quality of service at the lowest total cost. This is nothing other than delivering QCD expectations of the customer by planning logistical operations at minimum cost. This can also be called creating customer value at minimum cost. The illustration below shows that
Transportation
Warehouse
M/H Customer service goals [QCD] At market type A
290
Customer service goals [QCD] At market type B
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Customer service goals [QCD] At market type C
Functional Inputs to Logistical Management Logistical mission cuts across functional lines to achieve business objectives at minimum cost. Logistical mission is a set of goals to be achieved at a particular type of market for a particular type of product. Naturally this is responsive to competition. Hence logistical mission is to achieve above goals at minimum system cost. Focus is on mission rather than on isolated functions. Mission of logistics is providing a means by which customer satisfaction is achieved. 4. Role of planning in logistics management • Role of planning is central to logistics management • Mission of logistics management is to plan and coordinate all those activities necessary to achieve desired levels of service and quality at lowest possible cost. • Logistics is fundamentally a planning concept that seeks to create a frame work through which needs of the market place can be translated into a manufacturing strategy and plan • Logistics makes one plan, integrating various resources of the organization that replaces traditional concept of planning in pockets 5. Logistics interface with marketing Interface is a common wall or surface between two objects, concepts or functions. It can also be common area/areas of performance or interest. Outbound logistics plays an important role in selling the product of the company as it moves the product through the distribution system to the customer. Hence it is called the other half of marketing. In several instances making the product available at the right time at the right place itself is the key to successful selling. A student of management very well knows four Ps of marketing. We have already seen the role of logistics as far as ‘Place’ is concerned. It is quite interesting to see the interface with respect to other Ps as well. Price: Logistics enables marketing to quote a competitive price by providing discount opportunities on account of Transportation cost savings. Logistics Manager can plan the size of the consignment confirming to the most economical schedules published by transportation service providers to save transportation costs. If order size matches with the favored size the benefits are substantial. Logistics Management has to balance inventories to tackle anticipated price-triggered sales. Product: Inputs of logistics manager are quite important as far as the size and shape of the product are concerned. Size and shape of the product can make logistics nightmarish, thereby adding huge amount of costs. Weight/volume ratio plays very important role in deciding economics of logistics. The story of Gillette is well known logistical circle. The low weight, unwieldy floor display proved to be a very expensive logistical operation. While consumer packaging provides sales push in a retailers shop, it can make industrial packaging difficult due to its shape and ability to protect the contents. Product and its packaging is a common area from the point of view of logistics. Promotion: Logistics Management is required to manage inventory needed to match sales triggered by promotional activities in the market. Marketing Management & Logistics Management need to work closely in deciding promotional strategies for the 13
product. Promotional strategies may be push or pull type. Logistical problems may be faced in either or both, but being aware takes the punch away from the blow! Place: Marketing decision to distribute the product directly to retailers or through wholesalers has a great impact on logistical operations. Demand placed by wholesalers is more streamlined as compared to retailers. Logistical management of retailers’ demand often requires time sensitive transportation methods which are expensive. In addition to the four Ps, customer service is another area where marketing & logistical mangements have to work closely to effectively beat the competition. 6. Inbound & outbound logistics 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. A procurement cycle is shown below. 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 time 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. As the price of products is lower, trade off between cost of maintaining inventory in transit and low cost transport exists to the benefit of the organization. Inbound logistics
Sourcing
Receiving
Order placement & expediting
Transportation
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 retailers’ shops in the market. During conversion value is added to the raw materials and as a result value of the inventory in 14
this case is very high unlike inputs. Now the size of shipment, modes of transport and delivery time are different as compared to inputs. Activities of distribution performance cycle come under the scope of Outbound Logistics. They are order management, transportation, warehousing, packaging, handling etc. 7. Importance of 3Cs – competitive advantage by effective logistics management [Logistics and Supply Chain Management by Martin Christopher, Page # 5,] The three Cs in business are Company, Customer and Competition. All the three “C” are vital for healthy business and prosperous economy. Buying decision is always triggered by a need a consumer is experiencing due to the stress he is under. Customer is attracted by value when he is about to make a buying decision. Competitors in business continuously add value to their products in order to be ahead in the competition. Any supplier organization or Company tries to be better than the Competition by utilizing their assets efficiently and effectively. Ref. Fig.12 The Supplier Company tries to differentiate her products in terms of functional quality and product cost. Competition has ensured that technology and human skills are almost same everywhere. Hence product differentiation in terms of functional quality and product cost is nearly impossible. But a great opportunity exists for the Supplier Company to differentiate her products by service and logistics cost by superior logistics. When this happens customer sees better value in the products of Supplier Company as compared to competition.
Importance of 3Cs
Value
“C” customers Look for value, benefit at lowest price
“C” company By effective utilization of assets tries to create and offer value to customers
Value
“C” competitor By effective utilization of assets tries to create and offer value to customers
Cost differentials
8. Logistics overview and its implications a. Birth and development of logistics in post war business since 1950. [Refer our earlier notes] b. External integration of supply chain and concept of Supply Chain management………… 1990 c. Elements of Logistical Management function d. Scope of Logistical Management e. Significance of logistics in Business Management, the time and place a. Overall goal of Logistical Management function 15
9. Different attributes of logistics management and need of coordination of different organizational departments with that of logistics Attributes of Logistics Management [what makes Logistics Management distinct from other departments?] 1. Functions of logistics are spread across various stages of value chain. 2. Provides interface between marketing and customers, marketing and operations, operations and supplier 3. Provides competitive edge to business in the current environment 4. Handles flow of information and materials. 5. Large avenue for cost reduction. Need of coordination of different organizational departments with that of logistics The above features show the complexity and scope of logistics management. For such a management function to function effectively various pieces of jigsaw puzzle should fall at correct places which requires coordination of all functional departments. If we want to solve a jigsaw puzzle, we need to have the complete picture on the box. In the absence of this picture solving the puzzle becomes impossible. Overall coordination of different organizational departments can provide the complete picture. This requires integration of all functions of logistics. If a firm does not consistently satisfy time and place requirement it has nothing to sell in the market, it is simply out of business. Good logistics alone can enable organizations to do business. To enjoy full benefits of logistics, full range of functional work must be performed on an integrated basis. Excellence in each aspect of functional work is relevant only when it is viewed in terms improving overall efficiency and effectiveness of integrated logistics. This requires that the functional work of logistics be integrated to achieve business unit goals.
Concept of Integration in Logistics Operation What is the concept of Integration in Logistics Operation? In order to perform various functions of logistics in coordinated fashion bringing all functions of logistics under one operational command is important. Performance of these functions in an isolated fashion is detrimental to the objectives organization. Performance in isolation loses sight of overall picture. It is like trying to solve a jigsaw puzzle without complete picture before you. What do we integrate? Information flow, inventory flow, procurement, operations support, physical distribution. Concept of Integration in Logistics Operation
Inventory flow Custom er
Physical distribution
Manufacturing support
Suppliers Procurement
Information flow
If we view the above graphic we see all internal logistical operations in an organization. We also see their close relationship with each other and the need to perform them in an orchestrated fashion. 16
Value added role of Logistics Different types of economic utilities like form utility, place and time utility and possession utility add value to a product. In other words make product attractive and trigger purchase. a) Form Utility is given by Production to a product when conversion process is held. Logistics also adds form utility when warehousing activities like mixing, assembling, processing postponement or unpacking take place. b) Place and Time Utility is given by logistics functions when a product is moved to a needed place on time to serve the customer c) Possession Utility: Marketing creates Possession Utility by promoting the product by advertising and or by any other means. But logistics finally possession by customer happen Elements of logistics Management Inventory planning methods use a common information base to co-ordinate inventory requirements across multiple locations or stages in the value added chain. Planning activities may occur at the plant warehouse level to coordinate inventory allocation and delivery to multiple distribution centers. Planning may also occur to coordinate inventory requirements across multiple channel partners such as manufacturers and retailers. Two inventory planning methods are: a) Fair share Allocation b) Distribution requirement planning. Fair share Allocation It is a simplified inventory management planning method that provides each distribution facility with an equitable or ‘Fair share’ of available inventory from a common source such as a plant warehouse. Example of a fair share allocation Plant warehouse Inventory 600 units.
Distribution center 1
Distribution center 2
Distribution center 3
___________________ Inventory 50 units Daily use 10 units
_____________________ Inventory 100 units Daily use 50 units
_____________________ Inventory 75 units Daily use 75units
The above figure illustrates the network structure, current inventory levels and daily requirements of three distribution centers served by a common plant warehouse. Using fair share allocation rules, the inventory planner determines the amount of inventory that can be allocated to each district center from the available inventory at the plant warehouse. For this example assume that it is desirable to retain 100 units at the plant warehouse, hence 500 units are available for allocation. 17
Formula DS = Where, DS = common days supply for distribution center inventory. Aj = inventory units to be allocated from plant warehouse. Ij = inventory in units for distribution center ‘j’ Dj = daily demand for distribution center j. n = number of distribution centers. In this example, DS = 500 + (50+100+75) 10 + 50 +15 = 500 + 225 75 = 9.67 days Hence the fair share allocation indicates that each distribution center should be brought up to 9.67 days of stock. The amount to be allocated to each distribution center is determined by: Aj = (DS – Ij ) x Dj Dj Aj = amount allocated to distribution center ‘j’. Ds = days’ supply that each distribution center is brought up to Ij and Dj are as above. The amount allocated to distribution center 1 in this case: A1 = (9.67 – 50/10) x 10 = (4.67) x 10 = 46.7 ~ 47 units. However fair share allocation does not consider site-specific factors such as differences in performance cycle time, EOQ, safety stock requirements. SKU (Stock keeping unit – it is a specific item purchased by the customer including colour and size uniqueness.)
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Role of value added Logistics
LOGISTICS Place & Time Utility
PRODUCTION Form Utility
MARKETING Possession Utility
ACHIEVING LOGISTICS COMPETENCY. Logistics is the process of strategically managing the procurement, movement and storage of materials, parts and finished goodsinventory(and the related information flows) through organisation and its marketing channels in such a way that current & future profitabilty is maximised through the cost effective fullfillment of orders. In order to achieve logistics competency following aspects are to be tacklses: 1) The inbound logistics: • Locating suppliers • Selection of suppliers • Suppliers warehouse • In-bound transportation • Involving suppliers from the beginning as partners 2) Operations: • Superior technology and advanced process • Automation • Scheduling & planning • Response to quick changes in demand/product cahnge • Re-engineering • Internal- storage/transpor • JIT, KAIZAN? • ERP • Value engineering • Packaging 3) Outbound logistics: • Finished product- storage • Selection of distributors/ dealers 19
• • • 4. • • • • 5. • • • • • • • All
Distribution channel selection Transportation Inventory(finished goods) Customer service Delivery should be as per the schedule Provide excellent service support by way of appointing servicing agents Availability of original spare parts Value-added services Logistics costing Activity – based costing Transportation costs Inventory holding costs New product development costs Sales/distribution/marketing costs Sales promotions/advertising costs Operational costs the above activites are to be coordinated
Example Maruti cars:
IN - BOUND ENGINE CARBURETOR STEERING ASSAY CHASSIS SHEET METAL ELECTRICAL FITTINGS TYRES BEARINGS FANS METERS PAINTING
-
FROM JAPAN SUZUKI LOCAL SUPPLIERS LOCAL SUPPLIERS MARUTI MARUTI LOCAL SUPPLIERS MRF SKF LOCAL SUPPLIERS LOCAL SUPPLIERS MARUTI
OUT BOUND DHL GATTI RAIWAYS EXPORT DELHI DISTRIBUTOR
COURIER COURIER LONG DISTANCE SEA ROAD
Factory • Cars moves on rails, each assembly line is called “line” where right from the chasis assembly is done • Road test & performance testing is done for each car • Strict quality control/quality assurance • 6-5 implementation(not more than 5 cars should go for re-work- existing 25 cars out of 1500 cars/day) Customer services • Delivery as per schedule • Excellent service support by way of appointing servicing agents like service in mumbai/pune doing sale & servicing 20
• •
Availability of original spare parts Value added services
21
2. LOGISTICS MANAGEMENT? “Logistic is the process of planning, implementing and controlling the efficient, effective flow of goods storage of goods, services and related information from the point of origin to the point of consumption for the purpose of conforming to customer requirements” Logistics exists to satisfy customer requirements by facilitating relevant manufacturing and marketing operation. The main responsibility of logistic is the geographical positioning of raw materials, work in process and finished inventories at the lowest possible cost. Creating logistics value is costly. Logistics accounts for one of the highest costs of doing business. Logistics expenditure normally ranges from 5% to 35% of sales depending on the type of business. Thus logistics even though very important for any business success is expensive.
VARIOUS DEFINITIONS OF LOGISTICS MANAGEMENT Logistic management encompasses all materials flows management, from the inflow of purchased materials into works (i.e. materials planning of raw materials components and other products, transport of materials from suppliers to works, receiving and inspection and storage of materials) materials flow through manufacturing processes (i.e. materials issues and materials handling) and material (flow to customers (physical distribution (Refer fig.1 for these relationships) Schmidt describes logistics management as: “The management (i.e. the planning, execution and control) of all factors that affect the material flow and the information about it, seen from the perspective of customer’s requirements for the purpose of achieving a high reliability, a high degree of completeness and a short delivery time” Institute of purchasing and supply define logistics as: “Logistics is the concept which seeks provide for the management and co-ordination of the activities within the supply chain from sourcing and acquisition through production, where appropriate, and on through distribution channels to the customer. The goal of logistics is the creation of competitive advantages through the simultaneous achievement of high customer service levels, optimum investment and value for money.” According to Bowersox and Closs: “Logistics management includes the design and administration of systems to control the flow of materials work in progress and finished inventory to support business unit strategy” From the above definitions, we conclude that-(1) Logistics management is the function of managing the total flow of materials which includes movement of raw materials from suppliers, in process within the firm, and movement of finished goods to the customer. (2) Logistics management covers both physical flow of products as well as information flow covering reports and documentation relating to goods movement. 22
(3) Logistics management evolves procedures that meet customer service at the minimum cost. (4) Logistic management achieves cost reduction by speeding the flow of materials, work-in-progress and finished products.
23
Funtions of Logistics Managers 1. Receiving of materials, counting and storing. 2. In-plant progress checking and up to date information. 3. Contact person for customers. 4. Arranging in-bound and out bound transportation of materials . 5. Quality assurance. 6. Packing & Dispatching.
MISSION STATEMENT "Mission of Logistics management is to plan and coordinate all those activities necessary to achieve, desired levels of delivered service and quality at lowest possible cost.” 1. Logistics: We aim at the timely movement of materials to the specified destinations at the minimum cost, every time & at all the time." 2. Blue - Dart: "Meeting perceived and actual expectations of both - our customers & fellow Blue - Darters, in the most cost - effective manner by eliminating waste, duplication and defects in the shorte5t possible time, continuously." 3. GATI: "We deliver anything any where. To provide a single window solutions to the customers covering from courier to cargo across the world, with service offering suiting customer needs, on a time frame" 4. Radhakrishna Foodland {P} Ltd. - McDonald's Distribution Partner: "To ensure that all McDonald's restaurants are supplied without interruption, products conforming to acceptable standards at lowest LOCAL COSTS to the system" 5. Parle Products Pvt. Ltd: "Parle Products Limited will strive to provide constantly nutritious and quality food products to meet consumer's satisfaction by using quality materials. And by adopting appropriate process. To facilitate above we will strive to continuously train our employees and to provide them an open and participative environment."
Achieving Logistics competency (How to be 1 UP in the market?) Logistics is a process of strategically managing the procurement, movement and storage of materials, parts and finished goods inventory ( and the related information flows ) and its marketing channels in such a way that current & future profitability are maximized through the cost effective fulfillment of orders . In order to achieve logistics competencey following aspects are to be tackles :1.
The In-bound Logistics : . Locating suppliers (finding out) . Selection of suppliers . Suppliers Warehouses . In-bound transportation 24
. Involving suppliers from the begning – as partners 2.
Operations : . Superior technology & advanced process (cutting edge technology ) . Automation . Scheduling & planning . Response to Quick – changes in demand / product – change / R&D . Re-engineering . Internal – Storage / transport . Inventory holdings – stores / Work in progress / finished goods . JIT , KAIZAN ? . ERP . Value Engineering . Packaging 3. Outbound Logistics : . Finished product – storage / Bonded store location . Selection of distributors / dealers . . Distribution channels selection . . Distribution Process (transported by road) . Transportation (own vehicle) . Inventory (finished goods) 4. Customer Service : 1. Delivery as per schedule 2. Provide excellent service support by way of appointing service agents (sales & Service) 3. Availability of original spare parts . 4. Value - added services. 5.
Logistics coasting : 1. Activity – Based coasting . 2. Transportation coast . 3. Inventory holding coast . 4. New product development coast . 5. Sales / Distribution / Marketing coast . 6. Sales / Promotion Advertising coast . 7. Operational coast . All the above activities are to be co-ordinated In Short 1. Logistics Network Design. 2. Information flow of Network. 3. Transportation coast. 4. Inventory coast. 5. Warehouses, Material handling & Packaging. 6. Marketing / Distribution. 7. Service support activities.
EXAMPLE 1. Maruti car : In – Bound 25
Engine Carburetor Steering Assay Chasis Sheet Metal Electric Fittings Tyres Bearings Fans Meters Painting
-
From Japan Suzuki Local Suppliers Local Suppliers Maruti Maruti Local Suppliers MRF SKF Local Suppliers Local Suppliers Maruti
Out – Bound DHL Gatti Railways Export Delhi Distributor
- Courier (special trolley Trucks) - “ “ “ - Long Distance - Sea - Road
Factory . Cars move on RAILS , each assembly line is called “LINE” where right from chasis thewhole assembly is done. . Road test and performance testing is done for each car. . All tools are Hydraulic and hence no extra pressure on any nut or bolt. . Strict Quality control / Quality Assurance . 6-5 implementation (not more than 5 cars should go for re-work – exsisting 25 cars out of about 1500 cars / day. Customer Services
1. Delivery as per schedule, (Since 6- σ is under implementation car is taken not to get Non-conforming report. 2. Excellent service support by way of appointing servicing agents (sales & services) like Sai service in Mumbai / Pune doing sales & servicing. 3. avalibility of original spare parts. 4. Value – added service (take packing & forwarding). Logistics & Marketing Interface There are 4 – Ps in the marketing viz. 1. Price 2. Promotion 3. Product 4. Place 5. and 5th addition factor is PSYCHOLOGY
26
1.
Price refer to the time, efforts and money a customer expends to get a product or service from the standpoint of the selling firm price is the amount of money o firm receives for its products and services. The should cover . Fixed costs . Variable costs . Some margine of profit (Role of logistics) By proper scheduling, planning, and better utilization of transport etc prices can be reduced (eg:- items from China like computer, mobile). Examples :
1. 2. 3. 4.
Godrej has sub-contracted out-bound logistics to DHL / ELBEE etc. Voltas also has done the same. Camline’s pencil packing at a private factory in Umargaon. HMT Tumkar / ranibug units – Assembly is done by ancillary units in various states.They do not manufacture straps & cases being low skilled operations as compared to producing components. 5. Call-Centres of foreign companies in India. 2. 3.
Promotion : Needed to (1) Educate customers (2) Attract customers (3) Making product more visible (4) Offer discount to customers i.e. surf/Arial or Pilsbery Atta (some gifts). Product : A product is the SUMof the attributes that the customer buys.
Logistics takes the responsibility for protecting product attributes through the supply chain. It also covers packing. . Potato wafers packing (Rs.10 for about 30 chips) . Cots – wool packing for glass items or instruments. . Product features like more comfort in car (AC, Stereo. Telephone, Safety devices)
4. Place : Warehouse location, transport to various retail counters in TIME, quick
replacement of stocks etc are the aspects. Examples 1. Bread distribution 2. Egg distribution 3. Dabbewala distribution 4. Flowerwala distribution 5. Milk distribution / Curd distribution 6. Amul chocolates 7 other products 7. Madecines distribution 8. Watches distribution 9. Some provision distribution – Toothpaste, Cosmetics oils, etc.
A product should be available at a right place at the Right- time, at the RightQuantity, Right-Quality & Right Price.
5. Psychology : This is new dimension to the 4P’s advocated by the marketing Gurus. The psychology of the customers at Different levels or say of different 27
NICHE groups is to be understood in order to create the required impact of the advertisement or promotion activities. Example If Price is reduced – psychological factor is . Since product is not selling the company has reduced price, but the case may be different we have done cost reduction 7 productivity improvement & desire to pass benefits to the customers. The importance of 3-C’s in Logistics The 3-C’s in Logistics & there relationship with each other are as follow :CUSTOMERS
VALUE
VALUE
COST DIFFERENTIALS ASSETS & UTILISATION
ASSETS & UTILISATION
COMPANY
COMPETITOR
The source of competitive advantages is initially found in the ability of the organization to differentiate itself in the EYES of the customer . From its competition . By operating at a lower cost . Greater profit due to above In today’s Global competitive market a product will not sell itself either . Based on its BRAND image . Based on its success today COMMERCIAL SUCCESSES can be derived from either : COST advantage VALUE advantage BOTH 1.
or or
Cost Advantage
Cost Advantage can be gained by productivity improvements or increasing the sales & market share. The expenses or costs are distributed over the sales volume & the more the sales – lesser are the cost (cost per unit). All costs will decline at a given rate as volume of sales increased . Cost in the logistics can be reduced by 28
a) b) c) These savings
Saving in transportation costs – outward inward Saving in operating costs Saving in post production costs viz. warehousing, distribution etc. can be passed on to customers.
Example 1. Cost of Arial and Surf came down. 2. Cost of TV / DVD recently came down (DVD 1 Lacs to Rs.30,000) 3. Cost of gold plating on Watches came down due to change in processing viz . Instesd of chemical processing called electronic – present technology is physicalo vapour defisution (cost / straps from Rs.180 to Rs.50 for gold plating). 2.
Value Advantage
“Customer don’t buy product – they buy BENEFITS Hence number of advertisements tell us about what that product can deliver in addition to its basic function. Example : Surf / Arial not only washes clothes but REMOVE STAINS . Ayush Shampoo – not only acts as cleaning agents but strengthen hair. . Watch not only shows time but also has features like Date, Day, stop-watch function etc. . Some cars – more LEG space etc. Therefor companies manufacture number of models for Niche market i.e. requirement of a section of people. Example . Maruti – 800 -General Public . Maruti – Zen -For slightly more comfort requirement . Maruti Esteem -High class people . Maruti Omni / Van -Specific use Marrayes Value Advantage is gained by 1) Delivery service 2) After sales-service 3) Financial package 4) Technical support (say upgrading of computers) For value advantage a customer will be ready even to PAY MORE TO BRIEF 1. CUSTOMER 2. COMPETITOR 3. COMPANY
3C’s in logistics -Needs benefits from the products in addition to its primary function at the same cost or even paying slightly more. -Always tring to be ONE-UP & hence requires productivity and cost improvements. -Assets / Facilities utilization -Having a cutting edge Better Technology Process / R&D
EXAMPLES 29
1. Fridge a) Double door b) Auto defrosting c) Front door water outlet etc. 2.
3.
TVS are tooled up with a) DVD / CVD Connections b) Multi – channels c) Act as computers
Telephones with a) caller identification b) Storage of some phone numbers c) Hand set d) Call waiting features e) Call transfer etc. 4. TITAN Watches a) Titan show rooms – general class b) Tanishq show rooms : exclusive costly watches & jewellery.
Competitive Advantage Effective logistics management can provide a major source of competitive advantage. The bases for successes in the marketplace are numerous, but a simple model has been based around the three C’s – Customer, Company & Competitor. The source of competitive advantage is found firstly in the ability of the organization to differentiate itself, in the eyes of the customer, from its competition and secondly by operating at a lower cost and hence at greater profit. Seeking a sustainable competitive advantage has become the concern of every manager who realizes the marketplace and it is no longer acceptable to assume that the goods will sell themselves. An elemental, commercial success is derived either form a cost advantage or a value advantage or, ideally both. The greater the profitability of the company the lesser is the production of cost. Also a value advantage gives the product an advantage over the competitive offerings. Successful companies either have a productivity advantage or they have a value advantage or maybe a combination of the two. There are two main vectors of strategic direction that need to be examined: ♦
PRODUCTIVITY ADVANTAGE
In many industries there will be a competitor who will be a low cost producer and will have greater sales volume in that sector. This is partly due to economies of scale, which enable fixed costs to spread over a greater volume but more particularly to the impact of the experience curve. It is possible to identify and predict improvements in the rate of output of workers as they become more skilled in the processes and tasks on which they work. Bruce Henderson extended this concept by demonstrating that all costs, not just production costs, would decline at a given rate as volume increased. This cost decline applies 30
only to value added, i.e. costs other than bought in supplies. Traditionally it has been suggested that the main route to cost reduction was by gaining greater sales volume and there can be no doubt about the close linkage between relative market share and relative costs. However it must also be recognized that logistics management can provide a multitude of ways to increase efficiency and productivity and hence contribute significantly to reduced unit costs.
♦
VALUE ADVANTAGE
It is a cliché that customers don’t buy products they buy benefits. These benefits may be intangible i.e. they relate not to specific product features but to such things as image and reputation. Unless the product or service that we offer can be distinguished in some way from its competitors there is a strong likelihood that the marketplace will view it as a ‘commodity’ and so the sale will tend to go to the cheapest supplier. Value differentiation can be gained in numerous ways. When a company scrutinizes markets closely it frequently finds that there are distinct value segments. In other words different groups of customers attach different levels of importance to different benefits. The importance of such benefit segmentation lies in the fact that often there are substantial opportunities for creating differentiated appeals for specific segments. Adding value through differentiation is a powerful means of achieving a defensible advantage in the market. Equally powerful as a means of adding value is service. Increasingly it is the case that markets are becoming more service sensitive and this poses a challenge in management of logistics. It is important to seek differentiation through means other than technology. A number of companies have responded to this by focusing upon service as a means of gaining a competitive edge. Service in this context relates to the process of developing relationships with customers through the provision of an augmented offer. This augmentation can take many forms including delivery service, after sales service, financial packages, technical support and so on. This matrix is a useful way of examining the options available for value and productivity advantage: SERVICE LEADER
COST & SERVICE LEADER
COMMODITY MARKET
COST LEADER
In commodity market situations where a company’s products are indistinguishable from their competitors’ offerings the only strategy is to move towards being a cost leader or towards being a service leader. Often the leadership route is not available. This particularly will be the case in a mature market where substantial market share gains are difficult to achieve. Cost leadership strategies have been based upon the economies of scale, gained through greater volume of sales. This is why market share is considered to be so important in many industries. This cost advantage can be used strategically to assume a position of price leader and make it difficult for high cost competitors to 31
survive. This cost advantage can come through effective logistics management. In many industries logistics cost represents such a large part of total costs that that it is possible to make major cost reductions through fundamentally reengineering logistics processes. The other way to come out of the commodity quadrant of the matrix is to seek a strategy of differentiation through service excellence. Customers ion all industries are seeking greater responsiveness and reliability from suppliers; they are looking for reduced lead times, just-in-time delivery and value added services that help them do a better job of serving their customers. 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 development and procurement
resource
management,
technology
To gain competitive advantage over its rivals, a firm must deliver value to its customers through performing these activities more efficiently than its competitors or by performing these activities in a unique way that creates greater differentiation.
Logistics management has the potential to assist the firm in the achievement of both a cost/productivity advantage and a value advantage. The under lying philosophy behind the logistics concept is that of planning and coordinating the materials flow from source to user as an integrated system rather than, as was so often the case in the past, managing the goods flow as a series of independent activities. Thus under a logistics management regime the goal is to link the marketplace, the distribution network, the manufacturing process and the procurement activity in such a way that customers are service at higher levels and yet at lower cost. THE MISSION OF LOGISTICS MANAGEMENT The mission is to plan and coordinate all those activities necessary to achieve desired levels of delivered service and quality at lowest possible cost. Logistics must therefore be seen as the link between the marketplace and the operating activity of the business. The scope of the logistics spans the organization, from the management of raw materials through to the delivery of the final product. Materials flow
Suppliers
Procurements
Operations
Distribution
Requirements information flow 32
Customers
REASONS FOR LOGISTICS TO EXIST Logistics management from this total system is the means whereby the needs of customers are satisfied through the coordination of the materials and information flows that extend from the marketplace through the firm and its operations and beyond that to supplies. For example for many years marketing and manufacturing have been seen as largely separate activities within the organization. At best they have coexisted, at worst there has been open warfare. Manufacturing priorities and objectives have typically been focused on operating efficiency, achieved through long production runs, minimized setups, changeovers and product standardization. On the other hand marketing has sought to achieve competitive advantage through variety, high service levels and frequent product changes. In today’s more turbulent environment there is no longer any possibility of manufacturing and marketing acting independently of each other. It is now generally accepted that the need to understand and meet customer requirements is a prerequisite for survival. At the same time, in the search for improved cost competitiveness, manufacturing management has been the subject of massive renaissance. The last decade has seen the rapid introduction of flexible manufacturing systems, of new approaches to inventory based on materials requirement planning (MRP) and just in time (JIT) methods, a sustained emphasis on quality. Equally there has been a growing recognition of the critical role that procurement plays in creating and sustaining competitive advantage as part of an integrated logistics process. In this scheme of things, logistics is therefore essentially an integrative concept that seeks to develop a system wide view of the firm. It is fundamentally a planning concept that seeks to create a framework through which the needs of the manufacturing strategy and plan, which in turn links into a strategy and plan for procurement
3. LOGISTICS SYSTEM
INFORMATION
1. OPERATIVE LEVEL The lowest level of pyramid refers to transactions and enquiries. Examples of this activities are order enquiries, order processing, stock – status checks, Bill of lading preparation and Transportation – rate. Only implemented guidelines are given they follow guidelines. Since there are diverse people therefore extension of information is more . 2. SUPERVISORY LEVEL Information of this nature is used by the supervisory staff . Say, warehouse – supervisor’s must exercise control over space utilization inventory and Labour 33
Productivity in order – billing operations. They prepare shift plan, they keep assembly ready . A truck –fleet manager must have the necessary people, equipment and spare –parts to accomplish the transportation mission and schedule deliveries . 3. MIDDLE MANAGEMENT LEVEL Here middle management level is concurred with evaluation of inventory control limits , supplier evaluation, Carriers selection, planning for seasonal space and transportation needs etc are termed as Tactical Planning . They decide and supervisor follows. What is the ROL, which inventory control system to follows. What should be the buffer stock of an item. 4. TOP MANAGEMENT LEVEL Strategic Planning & Long Term Planning are the areas where top management works . There activities involve – setting of goals, policies and objectives, deciding on the overall logistical structure and determining the resources needed for the supply – distribution task . all policies , goals, next three years what to produce , supplier selection .
Following 4 primary activities take place within the logistic information system :-
1. Data flow from external sources . 2. Processing and storage of information within the firm . 3. Communication of data for storage and processing to the decision maker in the form of reports. 4. Communication of decision to customers and their feedback . 1. External Information System A sound external logistics Information system is based on enlisting the cooperation of customers and providing adequate and relevant information for advance planning, operation and control of Logistics activities . Co-ordinations is required both, both within and outside the organization for the planning & control of logistics and other functions of management . The SOURCE of information are the customers themselves and information can be collected through the sales staff . Information on the following aspects is collected : A] B] C] D]
Order pattern of customers Material handling system available Re-order point of the customers Ordering procedure of the customers
Following information is desirable from various internal department for the external information system . A] Purchasing – Components, customers requirements B] Production – Product preference, product performance, packing etc. C] Marketing – Sales structure, sales promotion efforts, man power, competitor’s 34
activities etc . D] Finance and Control – Sales statistics credit rating, financial capacity etc . E] Physical Distribution – Sales statistics, inventory control, Warehouse location, material handling system etc . 2. Internal Information System Information flow within the organization is termed on internal information system. Following department- wise information is needed : A] Purchasing : i) Total logistics costs of purchasing from different supplier and supply points . ii) Routing instruction for in-bound materials and suppliers . iii) Status of in-bound materials & suppliers. iv) Names, addresses etc . v) Delivery request dead lines vi) Supplier prices & price discounts vii) Alternate sources of supply & process etc . B] i) ii) iii) iv) v) vi) vii)
Production Warehouse capacity for raw materials & finished products . Production quantities & planning product. Warehouse material handling system . Delivery requirements. Status of inbound supplies . Logistical innovations Production capacity & scheduling etc .
C] Marketing i) Logistical costs of alternate levels of customers service, say number of warehouses nearer to customer . ii) Performance in meeting customer service standards viz. quantity, quality, timely delivery etc. iii) Competition ‘logistics costs . iv) Customer complaints v) Sales cost (salary, facilities, expenses) vi) Prices & price adjustments (discounts) vii) Special customer requirements – viz. special feature color, design etc . D i) ii) iii) iv) v) vi)
Finance Budget for physical distribution costs Various costs estimate Capital investment requirements Freight Bill - auditing Credit procedure Financial performance etc. (profits)
E] i) ii) iii) iv)
Service agencies Rate adjustments Request for quotation for requirements Freight rates Carrier rates, service 7 availability etc .
LOGISTICS INFORMATION SYSTEM DESIGN 35
Following 4 major considerations for designing the LSi)
The decision to be made in the organization at each level of management ii) The requirements of the system – the input requirements & sources, volume, quality of data, manner in which data to be collected. iii) The Requirements of control over the system – operation for the system, no. of copies to whom information to be sent etc. iv) Input & Output Data – Identify points of collection of data, design formats, arrange data entry & prepare various reports for various depots .
Principles of Logistics Information (1) Availability Logistics information should be readily and consistently available . Rapid availability is necessary to respond to customers and improve management decisions. e.g. order and inventory status. (2) Accuracy Accuracy is defined as the degree to which LIS reports match actual physical count for status. Logistics information must reflects both current status and periodic activity for measures such as customer orders and inventory levels. (3) Timeliness Information should be timely provide quick management feedback .Timeliness refers to the delay between when an activity occurs and when the activity is visible in the information system . Timely information reduces uncertainty and identifies problems, thus reducing inventory requirements increasing decision accuracy . (4) Flexibility It should be flexible for both customers and company .One wants invoices for all his retail store and another wants one invoice for all retail stores . (5) Appointment format Logistics information should be appropriately formatted so that they contain the right information in the right form and in the right orders . (6) Exceptional If there is large order all of a sudden, product having little or no inventory, delayed shipments, decreased in operating productivity, LIS should take care of all this factors . Types of Information System i)
External Information system
36
A sound external logistic information system is based on enlisting the co-operation of customers and providing educate and relevant information for advanced planning, operation and control of logistics activities . The source of data for the external information system for customers service are no doubt the customers themselves, and information can be collected from them through the sales staff . (ii)
Internal Information system
Made up of the elements of the information flow within an organization .It is between the department of purchasing, production, marketing, finance, etc on several important issues .The internal information system covers, data processing, data analysis, and completion of control reports are of various types – status reports, exemption report and summary reports on the basis of which decision may be made by respective managers in the organization. Advantages (i)
(ii)
Lower inventory caring costs, more efficient replenishment, more accurate forecast, more on time delivery, fewer documentation errors, avoiding the purchase of unnecessary equipment, etc . Its ability to better plan and control traffic management .
Disadvantages Inflexibility to change, difficulty of integrating old and new systems, higher cost, estimation of system capability etc. Expectation of the company from LIS is to high ! some company things that using logistics information system will solve all the logistics problems they have faced .
ACTIVITIES OF THE LOGISTICS FUNCTIONS Logistics function consists of following sets of activities: (1) Order processing. Though this activity does not contribute much to total costs, yet it is treated important because of its contribution to lead time.
(2) Transportation Management. Transportation involves---
• • • • • •
Firm’s own transport (if goods are to be collected) Hiring of transport (if services of external firm are to be used) Routing and load planning. Selection of the most suitable of transport (i.e. rail, road, sea or air). Packaging needed (i.e. loose, pallets or special). Documentation required (especially if goods are arriving from overseas.) 37
(3) Inventory management. Inventories require to be maintained to take care of needs between the time of demand and time of supply. Inventory management involved decisions concerning.
• • •
Buffer stocks. Lead time. Replenishment of stocks.
(4) Warehousing. Is concerned with management of space to hold inventories and it involves such problems as:
• • • • •
Site selection. Space determination. Layout and design. Receipts and issues and storage. Preservation.
(5) Materials handling is concerned with movement of product at the stocking point and it involves such decision as :
• • •
Smoothening of materials flow. Selection of materials handling equipment. Maintenance of materials handling equipment.
(6) Packaging is concerned with design of packing of the product that ensures damage free movement of the product and is conducive to efficient handling and storage.
(7) Acquisition is concerned with sourcing, planning and ordering of the product in
order to ensure its availability in the right quantity, at the right time, at the right place and at the right cost. Acquisition, however, dose not includes other purchasing activities such as price negotiation, vendor rating etc.
(8) Product scheduling is concerned with preparation of aggregate quantities to be produced in accordance with demands, actual as well as projected. Product scheduling, however, dose not include day-to-day detailed scheduling carried out by production planner.
(9) Information system is a must for the successful implementation of logistics function. Database on customer location, sales volume, inventory levels, lead times etc. must be maintained. IMPROVING EFFECTIVESS OF LOGISTICS MANGEMENT: Five pillars to the effective logistics are: (i) Logistical network, (ii) Transport (iii) information, (iv) Inventory and (v) Warehousing, materials handling and packaging. 38
(1) Logistical network include facilities such as manufacturing, warehouse, dealers and retail stores. The larger the geographical spread, the more complex the film’s logistical network. Superior logistical network, based on systematic analysis and determination of number of each type of facilities, their geographical location, specific work allocations etc. can be a very big competitive tool. (2) Information. Accurate forecasting and good order management are essential for the systematic inventory management JIT and Contingency Replenishment (CR) and quick response (QR) to the customer. Timely information thus is the key to the logistical performance. Modern information technology, in the form of both hardware (faxes, mobile phones, e-mail) and software (Enterprise Resource Planning) have removed the deficiencies in information. (3) Transport. Cost, speed and reliability are key determinants of the effectiveness, whether it is a war or business. Since time is the essence, quality of transport performance becomes the critical factor. Further, as speed and cost of transport are inter-related, careful selection of the transport becomes essential for optimum cost. For example, faster transport costs mean more money but reduce inventories and improve customer service. (4) Inventory management. Good inventory management system must be put into place to achieve desired customer service with minimum inventory investment. Inventory policies must be carefully devised. Excessive inventories hide deficiencies (e.g. deficiencies of logistics network, poor quality of suppliers, interior purchase order management etc.) while too low inventories cause delay in order execution, slow response and deficient customer service. Selective treatment based on following principles generally lead to effective inventory management: • Enough quantity of high profit high volume products, demanded by the core customer, may be carried in stock while or negligible inventory may be kept of lowprofit-low volume products purchased by a fringe of customers. • Core customers may be serviced by fast reliable air service while orders of other customers may be dispatched by surface transport. • Commitment to deliver product rapidly and timely (say within the declared period) must be preceded by enhanced capabilities of logistic network. • Commitment of rapid and consistent delivery should be intended to gain customer service advantage and to neutralize the strength that a competitor enjoys. (5) Warehousing, materials handling and packaging. The choice and location of the warehouse should be with a view to get closer to the core customers. Materials handling within the warehouse should be planned to ensure safe and speedy receipt, movement, storage and packaging of customer’s requirements. SUMMARY Logistics management is the management of all factors that affect the materials flow and the information about it, seen from the perspective of customer requirement, for the purpose of achieving a high delivery, a high reliability, a high degree of completeness and a short delivery time. Logistics functions include following: (i) (ii)
Order processing Transport management 39
(iii) (iv) (v) (vi) (vii) (viii)
Inventory management Warehousing Materials handling Packaging Production scheduling Information system
Some examples of the Logistics decisions taken by the OrganizationsA manufacturer of large molded plastic water tanks has transport costs as a significant portion of the product cost. The is due to the fact that the weight based capacity of the trucks are underutilized by the large volume tanks. In order to build a competitive edge by reducing the product cost attempts are being made to change the product design in which the lid is a separate piece. It enables small size tanks to go into the large sized ones, resulting in the reduction of the transportation cost. Since at present the results of the research are uncertain, a location decision has been taken to manufacture the products in products in four regions regions rather then at one place. A few cement manufacturers are modifying their production structure in response to the non-availability of covered railway wagons. Cement has been sent to the distribution centers in the granulated forms so that the open wagons can be used. Fine grinding is being done prior to the secondary distribution. Packaging decisions to whether cement should be transported in bulk or in a jute bag or HDPE bags are also under consideration. A two wheeler manufacturer is re-examining its distribution network design as well as its warehouse location to ensure better response to satisfy customer requirements and lower total product cost by cost by optimizing on cost relating to primary distribution, secondary distribution, warehouse operations and sales tax. A manufacturer of sponge iron in western India is deciding on a movement plan for both its incoming raw materials and outgoing finished products. The significant issues are the transportation mode choice, shipment size and stocking levels especially since water, rail and road are possible alternatives. The issues are more complicated since the port serving the plant is minor one with limitations of vessel draft and movement being inhibited during the monsoon. Possibilities of cost saving by coordinating inbound and outbound movement add another dimension to the problems. Certain pharmaceuticals and chemical industries could examine their production planning with respect to their production batch size by considering the profile of orders from the dealers, thereby optimizing on set up costs, work-in-process inventory cost and finished goods inventory cost. In such industries choices can also be made regarding transportation of some products in liquid, paste or powder form. There are implications on transportation costs, conversion energy costs and packing costs. Functions of logistics managers: 1) 2) 3) 4) 5)
Receiving of materials, counting and storing. Implant progress , checking and up to date information Contact person for customer Arranging inbound and outbound transportation of materials. Quality assurance 40
6) Packing and dispatching Achieving logistics competency It is the process of strategically managing the procurement, movement and storage of materials, parts, and finished goods inventory (and the related information flows) through the organization and its marketing channels in such a way that current and future profitability is maximized through cost effective fulfillment of orders. 1) INBOUND LOGISTICS: i) locating suppliers ii) selection of suppliers iii) suppliers warehouses iv) inbound transportation v) involving suppliers from the beginning as a partner 2) 3) OPERATIONS : i) superior technology and advanced process(cutting edge technology) ii) automation iii) scheduling and planning iv) response to quick-changes in demand/product:change/R&d v) re-engineering vi) internal-storage/transport vii) inventory holdings-stores/work in progress/finished goods viii) JIT, Kaizen? ix) ERP x) Value engineering xi) Packaging 4) OUTBOUND LOGISTICS i) finished product-storage/bonded store location ii) selection of distributors/dealers iii) distribution of channel selection iv) distribution process v) transportation vi) inventory(finished goods) 5) CUSTOMER SERVICE i) delivery should be as per schedule ii) provide excellent service support by way of appointing service agents( sales and service) iii) availability of original spare parts iv) value added services 6) LOGISTICS COSTING i) activity based costing ii) transportation costs iii) inventory holding costs iv) new product development costs v) sales/distribution/marketing costs 41
vi) sales promotion/advertising cost vii) operational costs All the above activities are to be co-ordinated Factory 1) Cars move on rails, each assembly line is called LINE where right from the chaise the whole assembly is done. 2) Road test and performance testing is done for each car. 3) All tools are hydraulic and hence no extra pressure on any nut or bolt. 4) Strict quality control/quality assurance 5) Six-five implementation ( not more than 5 cars should go for re-work existing 25 cars out above 1500 cars a day) CUSTOMER SERVICE 1) delivery as per schedule 2) excellent support by way of appointing servicing agents like sales service in Mumbai and Pune doing sales and servicing 3) availability of original spare parts 4) value added services (taking packaging and forwarding) LOGISTICS AND MARKETING INTERFACE There are 4 P’s in the marketing viz 1) Price 2) Place 3) Product 4) Promotion 5) And the 5th additional factor is PSYCHOLOGY 1) PRICE refers to the time, effort and money a customer expends to get a product or service from the stand point of the selling firm price is the amount of money a firm receives for his product and services. The price should cover: i) fixed cost ii) variable cost iii) Some margin of profit. By proper scheduling, planning and better utilization of transport etc. prices can be Reduced Eg. Godrej has subcontracted outbound logistics to DHL/LB etc Voltas has also done the same Camlin pencils packing at a private factory in Umargaon HMT tumkur / Ranibaug units- assembly is done by ancillary units in various states. They don’t manufacture straps and cases being low skilled operation as compared to producing components. Callcentres of foreign companies in India. 2) PROMOTION : needed to educate the customers, attract customers making product more visible , offer discounts to customers that is surf/Arial or Pillsbury aata. 3) PRODUCT: a product is a sum of attributes that a customer buys. Logistics takes the responsibility of protecting product attributes through supply chain also covering packaging i) Potato wafer packing: Rs 10 for about 30 chips. 42
ii) iii)
Cots-wool packing for glass items or instruments Product features like more comfort in car ( AC , Stereo , telephone, safety devices ) 4) PLACE : Warehouse location , transportation to various retail counters in time , quick replenishment of stocks are the aspects. Eg. i) Bread distribution ii) Egg distribution iii) Dabawala distribution iv) Flowerwala distribution v) Milk distribution vi) Curd distribution vii) Amul chocolates and other products viii) Medicine distribution ix) Watches distribution x) Some provision distribution-toothpaste, cosmetics, oils etc A product should be available at the right place at the right time at the right quantity at the right quality with the right price. 5) PSYCHOLOGY: This is the new dimension to the 4-P”s advocated by the marketing gurus. The psychology of the customers at different levels or say of different NICHE groups is to be understood in order to create the required impact of the advertisement or promotion activities. Example If the price is reduced – Psychological factor is. Since the product is not sold by the company which has a reduced price, but the case may be different we have done cost reduction & productivity improvements & desire to pass the benefits to the customers. THE IMPORTANCE OF 3-C”S IN LOGISTICS THE 3 C’S in logistics and the relationships with each other are as follows. The source of competitive advantages is initially found in the ability of the organization. They differentiate itself in the”EYES” of the customer. a) from its competition b) by operating at a lower cost c) Greater profit due to above In today’s global competitive market a product will not sell itself either. a) Based on its Brand image b) Based in its success today COMMERCIAL SUCCESS CAN BE DERIVCED FROM EITHER A) B)
COST ADVANTAGE VALUE ADVANTAGE BOTH
OR OR
1) COST ADVANTAGE 43
Cost advantage can be gained by productivity of improvements or increasing the sales & marketing shares. The expense or costs are distributed over the sales volume & the more the sales-less is the costs (cost per unit) All costs will decline at the given rate as volume of sales increased. Costs in the logistics cab be reduced by 1) Savings in transportation costs 2) Savings in operating costs 3) Saving in Post production costs viz .warehousing, distribution etc. These savings can be passed on to Customers . Example: 1) Cost of Aerial & surf came down 2) Costs of TV/DVD recently came down (d v d = 1 Lacs to 30,000). 3) Costs of gold plating on watched came down due to change in processing a) Instead of chemical processing called ELECTRONICS PRESENT TECHNOLOGY is physical vapour defisution. 4) costs of wrist watches are competitive and nearly fixed 5) Cost of computers has come down 6) Cost of air conditioners came down from 1 lacs to 30000 for a 1.5 tone A/c 2) VALUE ADVANTAGE “CUSTOMERS DON’T BUY PRODUCTS – THE BUY BENEFITS”. Hence number of advertisements tells us about what that product can deliver in addition to its basic function. Example: Surf /Arial not only wash clothes but Removes stains. 1) Ayush shampoo – not only acts as cleaning agents but strengthen hair. 2) Watch not only shows time but also has features like Date, Day
-800 for General public -Zen “ slightly more comfort requirement -Esteem for high class people -Omni/ van for specific uses
For value advantage is gained by 1) Delivery service 2) After Sales service 3) Financial Package 4) Technical support For value advantage a customer will be ready even to Pay More To Brief 1) CUSTOMER -Needs benefits from the the products in addition to its primary function at the same cost or even paying slightly more 2) COMPETITOR - Always trying to be ONE UP & hence requires productivity and costs improvements. 3) COMPANY - ASSETS/FACILITIES UTILIZATION Having a cutting edge technology process/ R& D Examples 1) Fridge 44
A) Double door B) Front door water outlet C) Auto Defrosting. 2) TVS are tooled up with a) DVD / CVD CONNECTIONS b) Multi channels c) Act as computers 3) TELEPHONES WITH A) CALLER IDENTIFICATION B) STORAGE CAPACITY OF SOME PHONE NUMBERS C) HAND SET D) CALL WAITING FEATURES E) CALL TRANSFER 4) TITAN Watches 1) Titan show rooms - General class 2) Tanishq show rooms: Exclusive costly watches & Jewellery.
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LOGISTICAL INTEGRATION Inventory Flow
Suppl iers
Physical distribution
Manufacturing support
Procurement
Customers Information Flow
INTEGRATED LOGISTICS Logistics is viewed as the competency that links an enterprise with its customers and suppliers. Information from and about customers flows through the enterprise in the form of sales activity, forecasts and orders. As products and materials are procured, a value added inventory flow is initiated that ultimately results in ownership transfer of finished products to customers. Thus the process is viewed in terms of two inter-related efforts, inventory flow and information flow. Inventory Flow The management of logistics is concerned with the movement and storage of materials and finished products. Logistical operations start with the initial shipment of a material or component part from a supplier and are finalized when a manufactured or processed product is delivered to a customer. From the initial purchase of a material or component, the logistical process adds value By moving inventory when and where needed. Thus the material gains value at each step. For a large manufacturer, logistical operations may consist of thousands of movements, which ultimately culminate in the delivery of the product to an industrial user, wholesaler, dealer or customer. Similarly for a retailer, logistical operations may commence with the procurement of products for resale and may terminate with consumer pickup or delivery. The significant point is that regardless of the size or type of the enterprise, logistics is useful and requires continuous management attention. In order to understand logistics it is useful to divide it into three areas. Physical distribution Manufacturing support Procurement
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Physical distribution The area of physical distribution concerns movement of a finished product to the customers. In physical distribution the customer is the final destination of the marketing channel. Unless the products are delivered where and when needed, a great deal of marketing effort can be wasted. All physical distribution systems have one feature in common: they link manufacturers, wholesalers and retailers and ensure that the product is available.
Manufacturing support The area of manufacturing support concentrates on managing W.I.P inventory as it flows between the stages of manufacturing. A Master Production Schedule is prepared and arrangements are made for timely availability of materials, components, parts etc. Manufacturing support has one significant difference when compared with physical distribution. Physical distribution attempts to satisfy the needs of the customers while manufacturing support involves movement requirements that are under he control of the manufacturing enterprise.
Procurement Procurement is concerned with purchasing and arranging in-bound movement of materials, parts and /or finished inventory from suppliers to manufacturing or assembly plants, warehouses or retail stores. Procurement is also known as purchasing and buying and in some cases inbound logistics. Procurement s concerned with availability of the desired material assortments where and when needed. Within a typical enterprise, the three areas of logistics overlap. The prime concern of an integrated logistical process is to coordinate overall valueadded inventory movement. The three areas combine to provide integrated management of materials. Information flow Information flow identifies specific locations within a logistical system that have requirements. Information also integrates the three operating areas. The primary objective of developing and specifying requirements is to plan and execute integrated logistical operations. Within individual logistics areas, different movement requirements exist with respect to size of order, availability of inventory, and urgency of movement. The primary objective of information sharing is to reconcile these differences. Logistical information involves two major types of flows: 1. Coordination flows 2. Operation flows 47
1. Planning and coordination flows Coordination is the backbone of the Coordination results in plans specifying:
overall
information
system.
Strategic objectives Strategic objectives detail the nature and location of customers, which are matched to the required products and services to be performed. Capacity constraints Capacity constraints coordinate internal and external manufacturing requirements. Capacity constraints identify limitations, barriers, within basic manufacturing capabilities and determine appropriate outsource requirements. Logistical requirements Logistics requirements specify the work that distribution facilities, equipment and labour must perform to implement the capacity plan. Inventory deployments Inventory deployments are the interfaces between planning/coordination and operations that detail the timing and composition of where inventory will be positioned. Manufacturing requirements Manufacturing plans are derived from typically result in inventory deployment.
logistical
requirements
and
Procurements requirements Procurements requirements schedule material and components for inbound shipment to support manufacturing requirements. In retailing and wholesaling situations, procurements involve manufacturing requirements. Forecasting Forecasting utilizes historical data, current activity levels, and planning assumptions to predict future activity levels. Logistical forecasting is generally concerned with relatively short –term predictions. The overall purpose of information planning/coordination flow is to integrate specific activities within a firm and to facilitate overall integrated performance. 2. Operational flows The second aspect of information requirements is concerned with directing operations to receive, process, and ship inventory as required supporting customer and purchasing orders. Operational requirements deal with Order management Order processing Distribution operations 48
Inventory management Transportation and shipping Procurement
Differences between Supply chain management and Logistics management. 1. Supply chain management is a broader concept whereas Logistics management is a narrower concept. 2. The concept of Supply chain management is relatively new whereas the concept of Logistics management is relatively old. 3. Supply chain management is an extension of Logistics management. 4. Logistics management is primarily concerned with optimizing flows within the organization whilst supply chain management recognizes that internal integration by itself is not sufficient. 5. Logistics is essentially a planning orientation and framework that seeks to create a single plan for the flow of product and information through a business. Supply chain management builds upon this framework and seeks to achieve linkage and co-ordination between processes of the other entities in the pipeline, i.e. suppliers and customers, and the organization itself. 6. The focus of Supply chain management is upon the management of relationships in order to achieve a more profitable outcome for all parties in the chain where as the focus of Logistics management is upon the management of resources within the organization.
Traditional Perspective Traditionally most organizations have viewed themselves as entities that exist independently from others and indeed need to compete with them in order to survive. However such a philosophy can be self-defeating idf it leads to unwillingness to corporate in order to compete. Behind this seemingly paradoxical concept is the idea of supply chain integration. Definition “ Supply chain management is the management of upstream and downstream relationships with suppliers and customers to deliver superior customer value at less cost to the supply chain as a whole.” Explanation The supply chain is the network of organizations that are involved through upstream and downstream linkages, in the different processes and activities that produce value in the form of products and services in the hands of ultimate consumer. Thus for example a shirt manufacturer is a part of a supply chain that extends upstream through the weavers of fabrics to the manufacturers of fibres, and downstream through distributors and retailers to the final consumer. Each of these organizations in the chain are dependent upon each other by definition and yet and yet paradoxically by tradition do not co-orporate with each other. 49
Clearly this trend has many implications for logistics management, not the least being the challenge of integrating and coordinating the flow of materials from a multitude of suppliers, often offshore, and similarly managing the distribution of the finished product by way of multiple intermediaries. Origin In the past it was often the case that relationships with suppliers and downstream customers (such as distributors or retailers) were adversarial rather than co-operative. It is still the case today that some companies will seek to achieve cost reductions or profit improvements at the expense of their supply chain partners. Companies such as these do not realize that simply transferring costs upstream or downstream does not make them any more competitive. The reason for this is that ultimately all costs their way to the final marketplace to be reflected in the price paid by the end user. The leading- edge companies recognize the fallacy of this convectional approach and instead seek to make the supply chain as a whole more competitive through the value it adds and the costs that it reduces overall. They have not realized that the real competition is not company against but rather supply chain against supply chain. Figure 1 suggests that there is in effect an evolution of integration from the stage 1 position of complete isolation from the other business functions. An example would be where production or purchasing does their own thing in complete isolation from the other business functions. An example would be where production seeks to optimize its unit costs of manufacture by long production runs without regard for the build-up of the finished goods inventory and heedless of the impact it will have on the need for warehousing space and the impact on working capital. Stage 2 companies have recognized the need for at least a limited degree of integration between adjacent functions, e.g. distribution and inventory management or purchasing and materials control. The natural next step to stage 3 requires the establishment and implementation of an ‘and-to-end’ planning framework that will be fully described later in this book. Stage 4 represents true supply chain integration in that the concept of linkage and coordination that is achieved in stage 3 is now extended upstream to suppliers and downstream to customers. Relationship building It is apparent that supply chain management involves a significant change from the traditional arm-length, even adversarial, relationships that so often typified buyer/supplier relationships in the past. The focus of supply chain management is on co-operation and trust and the recognition that properly managed ‘the whole can be greater than sum of its part’s. Thus the focus of supply chain management is upon the management of relationships in order to achieve a more profitable outcome for all parties in the chain. This brings with it some significant challenges since there may be occasions when the narrow self-interest of one of the parties has to be subsumed for the benefit of the chain as a whole. 50
Whilst the phrase ‘supply chain management’ is now widely used, it could be argued that it should really be termed ‘demand chain management’ to reflect the fact that the chain should be driven by the market, not by suppliers. Equally the word ‘chain’ should be replaced by ‘net work’ since there will normally be multiple suppliers and, indeed, suppliers to supplier as well as multiple customers and customers’ customers to be included in the total system. Figure 2 illustrates this idea of the firm being at the centre of a network of suppliers and customers. Extending this idea it has been suggested that a supply chain could more accurately be defined as: “A network of connected and interdependent organizations mutually and co-operatively working together to control, manage and improve the flow of materials and information from suppliers to end users.” Supply Network Management Or Demand Network Management The Phrase ‘Supply Chain Management’ is widely used. It is a management of upstream and downstream of relationships with suppliers and customers to deliver superior customer value at less cost to the supply chain as a whole. So supply chain management focuses on the management of relationships in order to achieve a more profitable outcome for all parties in the chain. It is argued that it should really be ‘Demand Chain Management’ as a chain should be driven by the market, and not by suppliers. So also the word ‘chain’ should be replaced by ‘network’. Since there will normally be multiple suppliers and, indeed, suppliers to suppliers as well as multiple customers and customers’ customers to be included in the total system. S = Supplier; C = Customer;
SS = Suppliers’ Supplier; CC = Customers’ Customer
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4. CUSTOMER SERVICE INTRODUCTION TO CUSTOMER SERVICE: No discussion of outbound logistics systems would be considered complete without the inclusion of customer service. Having the right product, at the right in the right quantity, without damage or loss, to the right customer is an underlying principle of logistics systems that recognizes the importance of customer service. Customer service is often the key link between logistics and marketing. If the logistics system, particularly outbound logistics, is not functioning properly and a customer does not receive a delivery as promised, the company could lose future sales. Even though manufacturing can produce a good product at the right cost, and marketing can sell it; if logistics does not deliver it when and where promised, the customer will be dissatisfied.
WHAT IS CUSTOMER SERVICE? The role of customer service is to provide time and place utility' in the transfer of goods and services between buyer and seller. Put another way, there is no value in the product or service until it is in the hands of the customer or consumer. Definition: Customer service as an activity: This level treats customer service as a particular task that a firm must accomplish to satisfy the customers needs. Order processing, billing and invoicing, product return, and claims handling are all typical examples of this level of customer handling. Customer service departments which basically handle customer problems and complain also represent this level of Customer service. Customer Service as performance measures: The focus upon performance measures for customer service is very important because it provides a method for evaluating how well the logistics system is functioning. Over time such measures provide benchmarks to gauge improvement which is especially important when a firm is trying to implement a continuous improvement program. But this level of involvement is not sufficient. Customer Service as philosophy: In this level entirely consistent with many firms’ contemporary management. Rather than narrowly viewing customer service performance measures, this interpretation involves that pervades the entire firm and all of its activities.
the view of customer service is emphasis on quality and quality as an activity or as a set of a dedication to customer service
Thus, the concept of customer service as a philosophy of management ensures an environment of customer-focused thinking in all aspects of managing the firm.
CUSTOMER SERVICE – EXPECTATION (THE 7 R’S) 52
The “seven R’s rule” offers a simple description of how integrated logistics creates customer service. The seven R’s mean having the Right product, in the Right quantity, in the Right condition, at the Right place, at the Right time, for the Right consumer and at the Right cost. Any breakdown in the seven R’s disrupts the flow of product and leads to poor customer service. Firms that routinely deliver the seven R’s add value for customers and create a competitive advantage for themselves.
CUSTOMER SERVICE – IMPORTANCE Customer service defines the effectiveness of integrated logistics in the channel of distribution. A 98 percent in stock level means that the desired product is available to the customer when required 98 percent of the time. This also means that the firm accepts a 2 percent stock out level. Integrated logistics activities determine stock availability, which may in turn determine whether the firm loses a customer or loses a sale, two major factors in customer service cost. To, increase availability of the product from 95 percent to 98 percent and improve customer service levels, a manufacturer may choose air transportation over trucks. For distances over 500 miles, air is usually faster than roads in getting the product on the shelves. Shorter transit time means lower inventory levels. The question must be asked, though: do lower inventories, improved customer service, and lower warehousing costs offset the increased transportation cost? Air transportation costs more than motor transportation, so the cost savings may not offset the increase in transportation costs. Customer service costs may be difficult to measure, so trade off may also be difficult to analyze. By analyzing the cost tradeoffs, the manufacturer can determine. For example, that a 3 percent increase in product availability costs too much in additional transportation, inventory or other integrated logistics expenses. Keep in kind that improvements in customer service can often be made while also lowering other costs. Other factors besides transportation and inventory costs should be considered in setting the customer service mix.
CUSTOMER SERVICE - ELEMENTS Customer service has multifunctional interest for a company; but, from the point of view of the logistics function, we can view customer service as having four traditional dimensions: time, dependability, communications and convenience. (1) Time: The time factor is usually order cycle time, particularly from the perspective of the seller looking at customer service. On the other hand, the buyer usually refers to the time dimension as the lead-time, or the replenishment time. Regardless of the perspective or the terminology, several basic components or variables affect the time factor. (2) Dependability: To some customers, dependability can be more important than lead-time. The customer can minimize its inventory level if lead-time is fixed. That is, a customer that knows with 100 percent assurance that lead time is ten days could adjust its inventory levels to correspond to the average demand (usage) during the ten days and would have no need for safety stock to guard against stock outs resulting from fluctuating lead times. 53
Cycle time: Lead-time dependability then directly affects the customer's inventory and stock out costs. Providing a dependable, lead-time reduces some of the uncertainty a customer faces. A seller, who can assure the customer of a given level of lead-time, plus some tolerance, distinctly differentiates its product from that of its competitor. The seller that provides a dependable lead-time permits the buyer to minimize the total cost of inventory, stock outs, order processing, and production scheduling. Safe delivery: An order's safe delivery is the ultimate goal of any logistics system. As was noted earlier, the logistics function is the culmination of the selling function. If goods arrive damaged or are lost, the customer cannot use the goods as intended. A shipment containing damaged goods aggravates several customer cost centersinventory, production, and marketing. Correct Orders: Finally, dependability embraces the correct filling of orders. A customer who has been anxiously awaiting the arrival of an urgently needed shipment may discover upon receiving the shipment that the seller made an error in filling the order. The customer who has not received what was requested may face potential lost sales or production. (3) Communications: The two logistics activities vital to order filling are the communication of customer order information to the order filling area and the actual process of picking out of inventory the items ordered. In the order information stage, the use of EDI or Internet-enabled communications can reduce errors in transferring order information from the order to the warehouse receipt. The seller should simplify product identification such as product codes in order to reduce order picker errors. (4) Convenience: Convenience is another way of saying that the logistics service level must be flexible. From the logistics operations stand point, having one or a few standard service levels that apply to all customers would be ideal; but this assumes that all customers' logistics requirements are homogeneous. In reality, this is not the situation. For example, one customer may require the seller to palletize and ship all shipments by rail; another may register a truck delivery only, with no palletization; still others may request special delivery times. Basically, logistics requirements differ with regard to packaging, the mode and carrier the customer requires, routing, and delivery times. Convenience recognizes customers' different requirements. Martin Christopher proposes the following: Ideally organizations should establish standards and monitor performance across a range of customer service measures. For example, using the pre-transaction, transaction and post-transaction framework, the following measures provide valuable indicators of performance: Pre-transaction: • Stock availability • Target delivery dates • Response time to queries Transaction: • Order fill rate • On-time delivery 54
• • •
Back-orders by age. Shipment delays Product substitutions
Post-transaction: • First call fix rate • Customer complaints • Return/claims • Invoice errors • Service availability PERFORMANCE MEASURES FOR CUSTOMER SERVICE There are four TRADITIONAL dimensions of customer service from a logistics perspective. They are: • Time • Dependability • Convenience • And communication These are essential considerations in developing a sound and effective customer service program. They also provide a basis for setting standards of performance for customer service in the logistics area. Now however, the standards have been changed as per the needs of the customer. They have become customer oriented as compared the previous (traditional) seller oriented standards. They NEW BASIS of customer service performance measures are: • • • • •
Orders Orders Orders Orders Orders
received on time received complete received damage free filled accurately billed accurately
There was a problem with the traditional form of customer service performance measures because they looked after the performance of only pre-shipment. So any problems that took place during the delivery of the good that could cause problems and dissatisfaction to the customer were not catered to. And thus the seller using the traditional method of measurement would not have any basis upon which to evaluate the magnitude and extent of the problem. The current method (new method) focusing on the measurement at the delivery level not only provides a database to make an evaluation but also more importantly provide early warnings of problems as they are developing. For example: if the standard delivery for on time delivery is 98% and it slips during a given month to 95% an investigation may show that a carrier is not following instructions or even that the buyer is at fault by not being ready to accept the shipments. It is very difficult / demanding today for suppliers to take up on time delivery measures. This is because supplying goods on time is more important today than it has ever been in the past and it is going to be even more crucial in the future. This is because companies are now focusing on new methods of inventory control such as just in time. In this method of inventory management, the goods have to be supplied 55
EXACTLY when they are needed or said they are going to be supplied. Suppliers today book their warehouses and other store deliveries on the outbound side of logistics based on the time that the companies give them. Their production schedules could get messed up if the goods are not supplied on time. Hence on time delivery performance measures are very difficult and very important today. Extremely good companies today are not using only one measure of performance, but they are using several standards to measure their performance simultaneously. Using many measures of customer service make it even more difficult to have high levels of customer service (it is more difficult to have good levels of customer service when you are using more than one measure of performance). For example: if a company is only using one of the following: • 95% of orders delivered on time • 93% of the orders filled completely • 97% of the orders delivered damage free If the company only sets targets on achieving one of the above standards, it would be challenging but possible. For example, if the company sets out to achieve 95% of the orders delivered on time, then they would have to focus on all the activities on achieving that required performance. But for a company to try and achieve all the three performance levels simultaneously for every order and to attain a perfect order level like 95% would be difficult. Thus is short, if a company takes only one measure for evaluating customer service levels, it will have a higher chance of doing well and having a good customer service level. Whereas if it takes up more than one standard then there are chances of the company not doing as well in terms of the customer service level, as the company would have to focus attention on various parameters which would be difficult. Also the number of perfect orders, if the company takes up more than one performance measure, would be less because the number of parameters that the order could “not be perfect” would be higher.
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IMPLEMENTING CUSTOMER SERVICE STANDARDS • Setting standards: This highlights the key for successfully developing and implementing customer service standards. The first point is to be careful of adopting easily achievable performance standards; such standards may be too low to be of practical value. While setting and adhering to a meaningful standard should help to differentiate your firm from the competition, setting standards at unrealistically low levels will not help to establish a competitive advantage. • Levels of Quality: Secondly, some current management philosophies such as emphasis on total quality or on creation of perfect order are very critical of any acceptable quality level set below 100 %. This does not mean that a firm can achieve 100% performance at all times, for the use of 100% represents an attitude more than a measurement. From a practical viewpoint, however, establishing a desired quality level that is less than 100 will generally limit, rather than encourage superior performance. • Communication with customers: Thirdly, the firm should develop customer service policies and standards through customer consultation. After adopting the standards, the firm should formally communicate them to customers. Certain firms prefer to keep silent about their customer service standards and avoid letting their customers know their exact policies and performance targets. The best approach, however, is to communicate these policies and standards to customers very openly. • Control of Customer Service: Fourth, the firm should develop procedures to measure, monitor and control the customer service quality called for by the firm's performance measures and standards. Using techniques such as statistical process control (SPC), obtaining feedback and taking corrective action are essential to success. When customer service standards are ineffective, the firm should not hesitate to amend or discontinue them as appropriate.
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5. FORECASTING INTRODUCTION: Demand Forecasting: A major component of demand management is forecasting the amount of product that will be purchased by customers or end users. The sales forecast is then integrated with the production schedule activities. The various steps involved in this are: 1. To develop a twelve-month forecast of demand by month using an appropriate sales forecasting method. 2. To review this forecast (by brand and product managers) and recommend relevant changes 3. To develop aggregate production schedules for the next twelve-month period and to allocate specific production requirements to various manufacturing facilities. 4. Logistics function assumes responsibility for scheduling production on a short term basis in order to co-ordinate demand for finished product with the timing and availability of needed production inputs.
PURPOSE OF FORECASTING: Forecasting involves predicting the future. Forecasting allows logistics managers to be proactive rather than reactive. The forecasting process affects every area of logistics in some way or the other. i.e., conducting or developing forecasts, providing information to be used in forecasting or receiving forecasting results and implementing necessary actions. It attempts to predict the future using either qualitative or quantitative methods or combinations or both. It primarily helps in logistics decision making. Reasons for forecasting are: • • • • • • •
Increasing customer satisfaction Reducing stock outs Lowering safety stock needs Scheduling production efficiently Reducing product obsolescence costs Managing pricing and promotion in a better way Improving shipping
The various types of forecasts are: 1. Demand Forecast 2. Supply Forecast 3. Price Forecast Demand forecast involves determining the firms demand for an item. This includes current and projected demand, inventory status and lead times. 58
Supply forecast involves collection of data about current suppliers and producers, aggregate projected supply situation and technological and political trends which might affect supply. Price forecast is based on information gathered and analyzed about demand and supply. It provides a prediction of short-term and long-term prices and the underlying reasons for those trends.
Further, forecasts can be classified as: • • •
Short-term forecast Intermediate-term forecast Long term forecast
Long-Term forecasts usually cover more than three years and are used for strategic or long term planning. Intermediate-Term forecasts usually range from one to three years and address budgeting issues and sales plans. Short-Term forecasts are most important for the operational logistics planning process. They project demand into the next several months up to one year or slightly more than one year.
FORECASTING PROCESS: FORECASTING PROCESS
Nature of Demand
Forecast Components
A- NATURE OF DEMAND: • •
Dependant demand Independent demand
Dependant Demand: • Vertical dependant demand characterized by sequence of purchasing and manufacturing. Such as number of tyres used for assembly of automobiles. • Horizontal dependant demand occurs in a situation where an attachment, promotion item or operator’s manual is included with each item shipped. For example, forecast for tennis balls would depend on tennis rackets. 59
• In horizontal demand, the item demanded is not required to complete the manufacturing process but may be needed to complete the marketing process. • The estimated demand for an item is determined using forecast, inventory and requirement planning. • Once purchasing or manufacturing plan for the base items is determined, the requirement of the components/attachments can be easily calculated directly and no separate forecasting is done separately. For example, demand of tyres linked with demand of automobiles or demand for tennis balls linked with that of tennis rackets. • Hence, it is not necessary to forecast the demand of dependant item since it can be derived directly from the forecast of base item. Independent Demand: • Not related to the demand of another item. For example, the demand for refrigerator is probably not related to the demand of milk. •
Hence, independents demand items must not be forecast individually.
B- FORECAST COMPONENTS: •
The forecast is generally a monthly or weekly figure for each SKU.
•
The forecast is generally composed of 6 components; -Base demand -Seasonal factors -Trends -Cyclic factors -Promotions -Irregular quantities
Base demand = average sales level, and other components are indexes or factors. Ft = (Bt X St X T X Ct X Pt) + L Where, Ft = forecast quantity for period ‘t’ Bt = Base level demand St = seasonality factor for period ‘t’ T = trend component quantity increase or decrease per time period Ct = cyclic factor for period ‘t’ Pt = promotional factor for period ‘t’ L = irregular or random quantity A word of Caution: all forecast may not include all the components.
Characteristics of Forecast Components: 1. Base demand: 60
•
Forecast based on average demand over an extended time.
•
Forecast for items have no seasonality, trend, cyclic, or promotional components.
• It is the quantity that is left after the remaining components have been removed. 2. Seasonal component: • Usually upward and downward movement in depend pattern, usually on annual basis. For example demand for woollen blankets is at its peak during winter months and at its lowest during summer. The above seasonality refers to consumer retail level; the seasonality at wholesale level precedes consumer demand by approximately one quarter. • The seasonality factor or index has an average value of 1.0 for all periods and individual monthly seasonal factors can range from o to 12. • An individual seasonality factor of 1.2 indicates that sales are projected at 20% above an average period. 3. Trend component: • Long range general movement in periodic sales over an extended period of time. This trend can be positive, negative or neutral in direction. A positive trend indicates increasing sales across time. •
The trend direction may change number of times over the entire product life cycle.
• Increases or decreases in trend are dependant on changes in overall population of consumer patterns. For instance, a reduction in birth rate implies that a reduction in the demand for disposable diapers will follow. •
The trend value greater than 1.0 indicates that periodic demand is increasing.
The trend component influences the base demand in the succeeding time periods as under: B = Bt X T Where, B = base demand in period t + 1 Bt = base demand in period ‘t’ T = periodic trend index 4. Cyclic component: • Swings in demand pattern lasting more than a year. It is also known as business cycles which may be either upward or downward. • Traditionally, economies swing from recession to expansion every 3 years to five years. A typical example: demand for housing and the resulting demand for major appliances. 61
5. Promotional Component: • Demand swings initiated by the firms marketing activities such as advertising schemes or promotions. • Sales increase during promotion as the customers take advantage of promotion, thus leading to liquidation of inventories. • Promotions can be either the deals offered to the consumers or deals offered to the traders (wholesalers/retailers). • Promotions, if offered regularly and at the same time each year will resemble a seasonal component. • The firm to a large extent can control its timing and magnitude. 6. Irregular component: • Random or unpredictable quantities that do not fit within the other categories, hence impossible to detect. • Objective is to minimize the magnitude of the random component by tracking and predicting the other components.
VARIOUS TECHNIQUES OF FORECASTING: 1. Time Series Techniques: Time Series techniques are statistical methods using historical sales data that contain relatively clear and stable relationships and trends. Time-series analysis is used to identify; • systematic variations in the data resulting from seasonality, • cyclic patterns, • trends, and • the growth rates of these trends. Once individual forecast components are identified time-series techniques assume that the future will be similar to the past. This implies that existing demand patterns will continue into the future. The assumption is often reasonably correct in the short term. Thus, these techniques are most appropriate for short-range forecasting. However, unless the demand patterns are reasonably stable, techniques do not always produce accurate forecasts. When the rate of growth or the trend changes significantly, the demand pattern experiences a turning point. Since time-series techniques use historical demand patterns and weighted averages of data points, they are typically not sensitive to turning points. As a result, other approaches must be integrated to determine when turning points will likely occur. Time-series techniques include a variety of methods that analyze the pattern and movement of historical data. On the basis of specific recurring characteristics, techniques of varying sophistication can be used. Four time-series techniques are discussed in order of increasing complexity. They are moving average, exponential smoothing, extended smoothing and adaptive smoothing. i. Moving Average: Moving average forecasting uses an average of the most recent period's sales. The average may contain any number of previous time periods, although one, three, four, and twelve-period averages are common. A one-period moving average results in next period's forecast being projected by last period's sales. A twelve-period moving average, such as monthly, uses the average of the 62
last twelve periods. Each time a new period of actual data becomes available, it replaces the oldest time period's data. Thus the number of time periods included in the average is held constant. E.g. of moving average: Years 1 2 3 4 5 6
Demand 280 288 265 285 302
3 yearly average
moving
277.67 282.67 287.33
The forecast for the 4th year as per the demand based on the previous years is calculated as follows; 4th year forecast = 280 + 288 + 265 = 277.67 Ans 3 ii. Exponential Smoothing Analysis/curve: This is another time series forecasting technique where the forecast for the next period is calculated as ‘weighted average’ of all previous values. It is based on the principle that the most recent values is the most important for predicting the future value. Also, it presumes that values prior to the current value are also relevant but in a declining importance as we go back in time. We have the equation as follows; 1 Y t+1 = ayt + (1-a) Y1t Where, Y1t+1 = new demand forecast Y1t = old demand based on moving average yt = old demand (actual value) a = something constant, such that 0< a < 1 (a lies between 0 and 1), generally a = 0.2 e.g. Month s Dema nd
1
2
3
4
5
6
7
213
201
198
207
220
232
?
Using exponential smoothing analysis, t+1=7 Therefore, t = 6 Substituting in the above formula we get, 63
Y17 = ay6 + (1-a) Y16 = 0.2 X 232 + (1-0.2) X 208.33 = 46.4 + 0.8 X 208.33 = 46.4 + 166.66 = 213.06 Ans Calculation of Y16 = 207 + 220 + 232 = 208.33 3 iii.Regression Analysis: Regression is derived from the word ‘to regress’, which means to go in past. Statistics meaning of regression analysis is to collect the past available data and analyze them for the future strategies. The general regression model is given by; Y= a + bx + ui Where, Y = dependent variable x = independent variable ui = un-explanatory terms For simple regression analysis we assume ui = 0 Therefore, the model becomes; Y = a + bx ; r2 Where, r2 = explanatory power of the model. It explains whether the model is good or bad. Significance of Y = a + bx ; r2 • If sign of b is positive, which implies that y is directly proportional to x • If sign of b is negative then it implies that y is inversely proportional to x • Value of r2 lies between 0 and 1, i.e. 0 < r2 < 1 e.g.: If r2 = 0.9 = 90% which implies that 90% of variations in Y is explained by x and the remaining 10% is due to ui Note: • If r2 is greater than and equal to 0.8 then the model is a good one • If r2 is greater than and equal to 0.6 and is less than 0.8 then the model is an average one. • If r2 is less than 0.6 then the model is a poor one. Multiple regression analysis: A multiple regression model in ‘n’ variables is given by; Y= a + b1x1 + b2x2 + ……….bn-1 xn-1 Where, a = constant b1, b2……bn-1 = regression co-efficient x1, x2……xn-1 = independent variable Y = dependant variable. 64
APPROACHES TO FORECASTING: 1. Top-Down Approach: The top-down or decomposition approach, as develops a nation level SKU forecast and then spreads the volume across locations on the basis of historical sales patterns. As an example, suppose the aggregate monthly forecast for the entire country is 10,000 units. Assume that the firm uses four distribution centers to service the demand with a historical split of 40, 30, 20, and 10 percent, respectively. In this situation, forecasts for individual distribution centers are projected to be 4000, 3,000, 2000 and 1000 respectively. Forecast management must select the best approach for each particular situation. The top-down approach is centralized and appropriate for stable demand situations or when the demand levels are changing uniformly throughout tile market. For example, when demand levels are increasing 10 percent uniformly across all markets, the use of the top-down approach facilitates development of new detailed forecasts since all changes are relative. 2. Bottom-Up Approach: On the other hand the bottom-up approach is decentralized since each distribution center forecast is developed independently. As a result, each forecast can more accurately track and consider demand fluctuations within specific markets. However, the bottom-up approach requires more detailed record keeping and makes it more difficult to incorporate systematic demand factors such as the impact of a major promotion. While forecast management does not have to accept one alternative at the expense of the other, an acceptable combination must be selected. The correct Combination must trade off the detail tracking of the bottom-up approach with the data manipulation ease of the top-down approach.
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6. TRANSPORTATION MANAGEMENT Introduction Transportation plays a key role in economic success by allowing for the safe and efficient distribution of goods and services throughout the supply chain. Transportation links the various integrated logistics activities. Without transportation, the integrated logistics system breaks down. Some view transportation as the glue that holds the entire system together. Without the transportation link raw material cannot flow into the warehouses and plants, nor can be finished product flow out of the plant to field warehouses and finally to the customer. Transportation physically moves products from where they are produced to where they are needed. This movement across space or distance adds value to products. This value added is often referred to as place utility. Time Utility is created by warehousing and storing products until they are needed. Transportation is also a factor in time utility, it determines how fast and how consistently a product moves from one point to another. This is known as time-intransit and consistency of services respectively. If a product is not available at the precise time it is needed, there may be expensive repercussions, such as lost sales, customer dissatisfaction, and production downtime, when the product is being used in the manufacturing process. Transportation Ryder Integrated Logistics and United Parcel Services (UPS) have achieved successes because they are able to provide consistent time-in-transit and thus increase the time and place utility of their customer products.
Transportation Functionality Transport functionality provides two major functions. Product Movement and Product Storage. Product Movement Where the product is in the form of materials, components, assemblies, work-inprogress or finished goods, transportation is necessary to move it to the next stage of the manufacturing process or physically closer to the ultimate customer. A primary transportation function is product movement up and down, the value chain since transportation utilizes Temporal (time), financial and environmental resources, it is important that items be moved only when it truly enhances product value. The major objective of transportations to move product from an origin location to a prescribed destination while minimizing temporal, financial and environmental resource costs, loss and damage expenses must also be minimized. Product Storage 66
A less common function is 'temporary Storage’. Vehicles make rather expensive storage facilities. However, if the in-transit product requires storage but will be moved again shortly (say in few days), the cost of unloading and reloading the product in a warehouse may exceed the per day charge of storage in the transportation vehicle. In circumstances where warehouse space is limited utilizing transportation vehicles may be a viable option. 1) One method may be involving loading product on the vehicle and then have it to take a circuitous route or indirect route to its destination. 2) Another method is by way of diversion. This occurs when an original shipment destination is changed while the delivery is in transit. Principles: There are 2 fundamental principles guiding transportation management: 1) Economy of scale 2) Economy of distance 1) Economy of scale This refers to the characteristics that transportation cost per unit of weight decreases when the size of the shipment increases. It is also generally true that larger capacity transportation vehicles such as rail or water are less expensive per unit of weight than smaller capacity vehicles like truck and tempo. Transportation economies of scale exist because fixed expenses associated with moving and loading can be spread over the loads weight. The more the load, the lesser will be cost per unit weight. The fixed expenses include administrative cost of taking the transportation order; time to position the vehicle for loading and unloading, invoicing and equipment cost. 2) Economy of distance Refers to the characteristic that transportation cost per unit of distance decreases as distance increases. These principles are important considerations when evaluating alternative transportation strategies or operating practices. The objective is to maximize the size of the load and the distance that it is shipped while still meeting customer service expectations. Participants in transportation Decisions: 1) Shipper 2) Carrier 3) Consignee 4) Public 5) Government
Modes of transportation There are five major modes of freight transportation, airlines, motor carriers, pipelines, railroads and water carriers. Each of these modes has distinct characteristics that give them advantage over the others. Which mode is the best depends on the freight hauled cost, speed, reliability, capacity, length of haul and flexibility. 67
Airlines Airlines are the fastest terminal-to-terminal mode of transportation. That is the primary advantage. They specialize in time sensitive movement of documents, perishable items, technical instruments, medical supplies and high valued products. Also air transportation has the highest percentage of revenues coming from passenger travel. While airlines are important for some freight movement, their primary business has traditionally been passenger travel. Airfreight services cost more than other modes, primarily due to their speed. Air carriers provide terminal-toterminal service, meaning that direct delivery to a consumer's door is the rarest of exceptions. Airlines are reasonably reliable. While weather related flight delays might disrupt service, the disrupted service is often still the fastest than the next fastest mode, the motor carrier. The airlines, speed advantage is most apparent for hauls over 500 miles. For trips less than 500 miles, motor carriers can often outperform airlines door-to-door. Airlines transport small volume shipments rather than large volumes, and packaged products rather than heavy bulk commodities. The physical configuration and cost of air service also limit the variety of products shipped by air. Measured by weight airlines transport very little freight. The percentage of total freight dollars shipped by air is relatively small although the revenue growth rate is promising. As customer service expectations increase, so does the demand for shorter transit times. As a result, many shippers have turned to air transportation Most airline costs change over a short period of time and depend on output making airlines predominantly variable cost carriers. When the initial cost of the air fleet is significant these fixed costs are spread over the long useful life of the aircraft. Terminals represent a major fixed cost in other modes, but airline terminals are publicly owned facilities for which the airlines pay user fees. The significant start-up costs associated with an airline limit the number of competitors creating an oligopolistic market structure, with only a few large carriers. Motor carriers (Road) Motor carriers are the most flexible mode of transportation. This means better direct access to motor carriage for more shippers and final consumers. Motor carriers compete with airlines for higher valued products as well as time-sensitive products (electronics perishable etc,) within a 500 miles radius. Motor carriage ranks as the second fastest mode of transportation, with the additional advantages of door-to-door flexibility and broad geographic coverage. Because trailers vary in length, temperature control and form motor carriers can carry a variety of products. In fact, they can carry almost anything. As industry saying 'if it got there, a truck brought it' rings very nearly true. Motor carrier rates are high compared with all other modes but air. They also face gross weight and length restrictions, as well as other legal limits. Motor carriers are susceptible to delays because of bad weather or traffic congestion. Almost, motor carriers are not well suited to handle extremely heavy bulky products because the trailer is not properly constructed to ship such significant weight efficiently even when permit allow the legal restriction to be lifted. Pipelines Pipelines are unique mode of transportation. They are fixed in place, and the product moves through them. This limits the type of products they can transport but 68
within these limits they can move more tons under a single shipment than any other mode of transportation (30,000 to 25,00,000 tons). They can transport product only in a liquid or gaseous state. Petroleum is the number one product moved by pipelines. Pipelines are cost effective where large quantities of liquid products need to be transported. Pipelines offer one advantage that none of the other modes can offer. A pipeline is a continuous flow mode. When the pipeline is full the product flows to the destination immediately and continues to do so almost without fail. Pipelines are the most dependable mode of delivery unaffected by external factors like weather. However, pipeline transportation is slow, rigid in terms of routes and product types and limited to terminal-to-terminal service. A pipeline's average speed is usually between two and five miles per hour. Pipelines can rarely deliver the product to the consumer's door and the origin and destination of the mode are fixed-unless household water and gas lines are taken into account. Many pipelines are built by private entities for private use. Different types of liquid can be shipped through a pipeline at the same time separated by a batching plug. A batching plug is a mechanism designed to allow for continuous flow through the pipeline while maintaining the integrity of each individual product. Pipeline costs are predominantly fixed. Pipelines must build their own right-of-way, an extremely expensive undertaking. Pipelines most often move large quantities of a liquid product from a fixed origin to a fixed destination. The construction of a pipeline becomes cost effective only when the high initial fixed cost can be spread over enough volume to keep the unit transportation cost competitive with other modes. Railroads Railroads transport a significant amount of domestic freight. Railroads haul highdensity low-valued freight over long distances at rates lower than trucking and air, but higher than water and pipeline. Products hauled include coal, stone, sand, metals, grain and automobiles. Their primary competitors include domestic water carriers for large bulk products and motor products for higher valued goods. Railroads can handle a wide variety of goods but generally have not. They lack flexibility and high-speed delivery in their standard operation. Historically, railroads have been unreliable due to poor scheduling, a substandard infrastructure and unreliable equipment. Railroads argue that their assets are older because they must commit considerable resources to build their own right of way. Rail companies have attempted to improve their reputation for customer service by updating old equipment, installing current technologies and implementing customer-oriented strategies. Like other modes, railroads are classified by annual sales figures. Railroads operate in an oligopoly, with a limited number of interdependent competitors. Fixed costs are high compared with air, water and motor carriage. The higher percentage of fixed costs stems from ownership and construction of the right-of-way. Rail transportation has benefited from significant level of international inter modal freight, which currently provides the industry with its highest growth and profits. Water Carriers Water carriers dominate international transportation because of their cost structure and ability to transport large volumes. Their significant modal market share is derived from these international operations. Advantage of water transport includes long haul capabilities-particularly for low-valued products such as coal, stone, grain and ores-at low rates. They can and do haul a broad range of products from ores and grains to Christmas toys. Since water carriers haul a wide variety of commodities, they operate a variety of ships. Tankers primarily carry liquid products like petroleum and crude oil. Measuring over 1.500 feet long and 200 feet wide, these vessels are some of the largest on the ocean. Bulk carriers are constructed to haul commodities like coal, iron 69
ore, or agricultural products. Furthermore, significant growth in container ships shows the impact containerization has had on water carriage. Standardized containers are loaded, placed on container ships, and shipped across the ocean to their destination. A standard container measures either 8' by'8 by 20' or 8' by 8 by 40'.One twenty-foot container is referred to as one twenty-foot equivalent unit (TEU). A forty foot container is two TEUs. Water carriers compete heavily with railroads along certain routes and with pipelines for the movement of some products, particularly petroleum. Water carriers cost structure and volume levels are such that they can charge very low rates. Water carriers are relatively slow, unreliable and suffer from a high degree of variability in delivery schedules. Two main types of for-hire carriers make up the deep-water industry. Liners have fixed sailing times and fixed routes, while tramps sail when they reach capacity. Since liners must sail at a specific time, they are not always filled to capacity. Tramps are usually the better choice when service dates and times are not critical, and liners the better choice when these criteria are critical. Water carriers operate in an oligopoly due to the large initial investment, which tends to limit the number of carriers. However, over the life of the ship, variable cost dominates. The initial cost of the ship is significant, but the volume transported over the useful life of the ship is so large that the cost per unit is relatively low. Mode Comparison- Dominant Traffic MODE Rail
% SHARE 40%
Road/ Highway Water
30%
Pipeline Air
10% 5%
15 %
NATURE OF TRAFFIC Agricultural products, ores, coal, heavy machines, etc. Medium & Light manufacturing distribution Mining, cement chemicals, agricultural products, heavy machinery, etc. Petroleum products, chemicals, gas Emergency requirements of any material, small lots
Cost Structure for Each Mode MODE Rail Road
FIXED COSTS High Low capital
Water Pipeline Air
High/ medium Highest Medium
VARIABLE COSTS Low Mediumfuel, maintenance Low Low Highfuel human operation
Relative operating Characteristics OP. CHARTS Speed Availability
RAIL
ROAD
WATER
PIPELINE
AIR
3 2
2 1
4 4
5 5
1 3
70
Dependabi lity Capability Frequency Total score
3
2
4
1
5
2 4 14
3 2 10
1 5 18
5 1 17
4 3 16
SCALE: 1 TO 5; 1 IS BETTER Classification of carriers Common carriers The basic foundation of the public transport and system is the common carrier. They have the right to transport any material within a specified zone. (Trucks and tempos). Contract Carriers Contract carriers provide transport services for selected customers. The basis for contract is an agreement between a carrier and a shipper for a specified transportation service at a previously agreed cost. Private Carriers A private carrier consists of a firm providing its own transportation. They are 'not for hire'. Specialized carriers a) Oil tankers b) Trailers to carry container (8 ft. high, 20 or 40 ft. length & 8 ft.wide) loads and special products material. c) Special closed trucks/tempos. d) Parcel services-blue dart, Fed-ex. Etc. Value Added Services These are as follows: a) Electronic tracking b) Advanced label imaging system (bar code) c) Delivery confirmation service d) On-call pick up service e) Packaging and forwarding, etc.
Transportation Documents a) Bill of lading It is the basic document utilized in purchasing transport services. It serves as a receipt and documents commodities and quantities shipped for this reason accurate description and count are essential. In case of loss damage or delay, the bill of lading is the basis for damage claims. The designated individual or buyer on a bill of lading is the only bona-fide recipient of the goods, a carrier is responsible for proper delivery according to instructions contained in the document in effect, and title is transferred with completion of delivery.
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The bill of lading specifies terms and conditions of carrier liability and documents responsibility for all possible causes of loss. Or damage except those defined as acts of GOD (flood, earthquake. etc.) b) Freight bill The freight bill represents a carrier's method of charging for transportation services performed. It is developed using information contained in the bill of lading. The freight bill may be either pre-paid or collect. c) Shipping manifest The shipping manifest lists individual stops or consignees when multiple shipments are placed. The objective of the manifest is to provide a single documentation that defines the content of the total load without requiring the review of individual bill of lading.
Transportation Cost Structures (1) Fixed cost (2) variable cost (3) joint cost (4) common cost Fixed cost. Certain costs are constant regardless of the firm's activity. Example of this would include the capital invested in railroad, tracks, airplanes, or tractors. A variable cost changes as output changes. If a tractor is driven more miles, certain costs increase proportionately. Fuel costs, wages, maintenance costs and tire replacement depend on output. As miles increases so do these costs. Fuel usage for airlines varies with the number of flights as week as the distance traveled. To determine if a cost is variable consider what happens if operations shut down. The costs that disappear are variable and these that continue are fixed. All cost in the long run are variable. For instance, a locomotive is eventually no longer useable and must be replaced. For the twenty-five year life of the locomotive the cost is fixed. When a new locomotive is purchased to replace it, the cost changes, it is no longer fixed. However once the new engine is placed, it too will have a useful life of many years. The cost again becomes fixed. For most decisions do not reach beyond its useful life. The benefits of increased volume accrue more to high fixed cost carriers than to high variable costs carriers seek volume to spread the fixed costs over more units greatly increasing profits. A joint cost occurs when the production of one product or service requires or offers the production of another product or service. For example, a railroad moves goods from New York to Los Angeles. It now has engines available in Los Angeles to provide back-haul service to New York or additional transportation from Los Angeles. The cost of placing the train in Los Angeles is a joint cost with the New York to LA run and whatever run follows it. Fixed and variable costs can also be joint costs. All modes incur joint costs to some extent. Common cost cannot be directly associated with a product or activity. Since this creates confusion we normally assign activities percentage of these common costs. For instance a tractor traveling from Dallas to Chicago with three shipments breaks down and requires $5000 in repairs. How much of this repair cost should be allocated to the three different shipments? It is based on space used, weight or both? That’s the 72
problem with common costs. In transportation common costs are significant and are found in all modes. Airlines are variable cost mode because they do not own the right of way. Governmental entities own the large airports the federal government operates the airways and airlines pay fees for the privilege of using them. In keeping with the definition of variable costs airlines pay take off and landing fees only when they take off and land. Other large variable costs include fuel, wages and maintenance. Major fixed costs are the airplanes and salaries. Due to their type of operations airlines have many common costs since they normally move freight in a single airplane for multiple customers. Motor carriers like airlines; do not own the way or path of travel. They are variable cost carriers. Some estimate that 90 percent of the motor carrier industry's cost is variable. They pay user fees (taxes etc.) to offset the road maintenance costs. Other major variable costs are fuel, driver wages, and equipment maintenance. The major fixed costs are the terminals and equipment. LL carriers have many common costs because of the number of shipments in a single trailer. TL carriers have few common costs because the trailer is filled with product from a single shipper. Pipelines are categorized as heavy fixed cost carriers. They own their right of way and their terminals. In fact because of computerization, this mode is also classified as very capital intensive. This leads to lower wages and maintenance costs. Because pipelines move a variety of liquid products, they have significant common costs. Railroads are fixed cost carriers because they own their equipment and tracks. Economic of scale arise from increased volume which allow per unit costs to be kept low by spreading fixed costs over more units. A significant portion of railroad cost is common because all traffic share replacement costs. Water carriers are variable cost carriers because they do not own the waterways. They ways are not free. Channels must be maintained in major rivers and ports. In the United States, the U.S. Army Corps of Engineers dredges the channels. Water carrier’s major variable costs are labor, fuel and maintenance. Like railroads, significant portion of their costs are common because multiple shipments often share a vessel. Transportation Hidden Costs The physical distribution component of a major project, including transportation of raw materials, project materials, machinery and equipment and such infrastructure facilities as roads, vehicles etc., usually accounts for 20 to 30% of the total capital cost. The general scarcity of various goods, unpredictable nature of the economy and economic behavior on the part of the business community and the bureaucracy in India make it all the more necessary for one to plan well ahead. In fact, planning of transportation and infrastructure must be done well ahead of general planning, so that resources spent on other parts of the project do not result in in - fructuous expenditure. In developed countries, these facilities are already available in abundance or are provided for well in advance. In developing countries, action is generally initiated only after the project has been partially put through or when it becomes totally inescapable to do so. 73
On the other hand, because of lack of these facilities, such problems are faced even during construction. Eg. Trucks get stuck in muddy roads, work sites remain unapproachable, and serious vehicular accidents are caused near the project areas. In developing countries, for the supervision of construction of a building, usually no qualified individual is appointed for the co ordination and planning of transportation infrastructure, which forms a major fraction of the total cost of a project running into crores. For a major project, the average total cost to the economy of a project costing Rs. 100 crores which is delayed by one year from the date of targeted completion is 39% more than the original budgeted cost on account of the following: 1. The rate of interest on capital may be taken at nearly 12%. 2. The profit on income per year about 12% 3. The cost of depreciation on account of obsolescence or rusting without running of the plant at 5%. 4. The cost of escalation of the project cost at 10%. The cost of delay in the completion of the project would therefore be roughly about Rs.11 lakhs per day or Rs. 3.25 crores per month. It would be worthwhile to educate senior executives to recognize these facts, for this aspect of the project is usually ignored by project authorities. Project authorities do not hold themselves responsible for the transportation bottlenecks and resulting delays. These delays are due to non-receipt of equipment, machinery, raw materials etc. and these delays generally run into months. Due to such delays, the project suffers heavy losses, which occur because of congestion in the ports, traffic jams, railway restrictions etc. Therefore, it is financially more practical to obtain critical equipment, machinery and raw materials, critical not from the point of view of availability in the market but critical form the standpoint of transportation bottlenecks- so that the likely delays are avoided. A proper transportation planning of materials, therefore, may well save a project as well as the economy form the ill effects of wasteful expenditure. At the same time it would help speed up production. Transportation Cost Elements Following are the essential elements of transportation to be taken into account: 1. Transport Mode – The most critical decision is the selection of appropriate mode of transport. This fixes two basic elements of distribution function: a) Transit time or time lapse between production and sale; b) Level of transportation costs. There is an inverse relationship between transit time and transport cost – the lower the transit time, the higher the transport cost. However, a decision that takes into account only one cost factor cannot be justified. An evaluation of the effect of transit time on other costs must also be considered. Unsold production represents a high cost, and the longer the transit time, the higher the level of unsold production. 74
2. Inventory Costs – A first class service to clients often requires immediate delivery and, hence a higher level of inventory at the market centre. Economy, on the other hand, calls for minimum inventory. The level of output held in stock is dictated bya) Transit time: If the time lapse between production and sale is longer, the level of inventory becomes higher. b) Sales pattern: If the pattern of sales is erratic, higher inventory levels are caused. c) Production pattern: If the production pattern is erratic, higher inventory levels have to be maintained to prevent stock –outs. Assuming that the sales and production patterns are largely fixed, the important variable, which can influence stock, levels in transit time. As transit time is reduced, the level of static stock can be reduced with accompanying stock reduction. 3. Transit Capital – Capital can be released by changing the proportion of the total output in transit. This can be done by adjusting the transit time. As transit time is reduced, the quantity of goods in transit can be decreased with an associated reduction in transit inventory costs. By realizing the capital cost of transit inventory and goods in transit, capital commitments can be reduced, and more capital can be available for other purposes. 4. Obsolescence - When a slow or erratic mode of transport is employed, a higher level of inventory is necessary to ensure continuous, prompt delivery to the customer. However, when designs change rapidly, obsolescence reduces the market value of the products in store. Rapid advances in technology bring about swifter technical obsolescence. Any goods in the pipeline realize a lower figure when new models are introduced by a company or it’s competitors. Air distribution can overcome this problem, and the effect of such obsolescence can be minimized. 5. Packaging – The nature of packaging of a product is often determined by the mode of it’s transport. E.g. Because of the dry conditions of carriage, short transit times and minimum handling, air cargo generally requires much less packaging than other forms of long distance transport. Goods dispatched by air may require only a dust cover or even no cover at all. In some cases, savings on the packaging of sophisticated products may more than pay for the actual transport charges. Less packaging may lead to other advantages too. These include lower unpacking costs and lower chargeable weight for freight. 6. Insurance – Insurance risks are based on transit time as well as the possibility of damages en route. With faster transit times, skillful handling, substantial reduction in damage and greater security in transit, insurance premiums tend to fall substantially. 7. Breakages – Cost of breakages is an important factor in any cost benefit analysis. Because breakages may be indemnified by insurance companies, the true cost of damage to cargos can easily be overlooked. In the first place, the vulnerability of various products sent by different modes is reflected in the insurance premium. To high premiums must be added the clerical work involved in establishing claims, making replacements and the loss of customer’s goodwill. The replacements themselves will be subject to the same hazards and premiums will require further documentation. Therefore, only that mode of transport must be selected which substantially reduces real damage in transit. This calls for a selection of the routes which are more direct and which avoid transshipment. Handling equipment must also be more sophisticated. Containers can be used by shippers for door-to-door transportation, thereby avoiding all handling of goods by the carrier. 75
8. Pilferage – Many expensive administrative problems associated with breakages also apply to pilferage. This problem is reduced for example, when door-to-door containers are used, a fact which is again reflected in lower insurance rates. 9. Deterioration – In many surface cargos, deterioration may be avoided only by complicated and expensive packing to counteract mechanical shock, exposure to weather or unfavorable temperature etc. Some cannot be stored at all, except at great expense, and others deteriorate slowly. Deterioration can be costly in terms of packing, stock losses and expensive conditioning in store. It can only shut the door on many distant markets. A high speed of transport and the frequency of services can overcome many of these problems. 10.
Transport Costs – Transport can be divided into 3 phases:
(i) Delivery to docks, airport or railway station. (ii) Transport from one terminal to another. (iii) Delivery from the terminal to the consignee’s place. In the cost-benefit analysis of the turnaround time of a company’s delivery and collection vehicles, their man hour costs can be significant. Some customers may find this item to be more costly than the cost of the major journey.
Transport Elements: Whether the movement of material and equipment is by rail, sea, air or road, adequate facilities for their free flow to and from the factory must be ensured. The factors which affect progress at the construction stage, and production and dispatches after commission, have been discussed in the following paragraphs: 1) Terminal Facilities: Terminal facilities are usually grudgingly provided. One reason for this is that any delay or any in convenience caused to truck operators is not a loss to the project. It is treated as a loss to the carrier. In some cases, this may be true. However, this usual incidence of stoppage or regulation of the production process can be minimized, if not eliminated. Often extreme stinginess is expressed in planning for these facilities, which include storage space, and loading and unloading arrangements in a suitable area. If the storage space is not adequate or if the traffic is exceptionally heavy, production suffers inevitably. Since transport requirements of each project are different and depend on its location, physical availability of infrastructure, etc, it is not advisable to prescribe one uniform scale of terminal facilities. They must be worked out for an individual project on the basis of its own specific requirements. Storage, loading and unloading facilities, good quality roads, which are usable throughout the whole year, and suitably, designed yard for railway wagons have to be planned as a part of terminal facilities. It is also essential to pay special attention to the maintenance of loading and unloading equipment, the design, location, length, height and other features of loading and unloading platforms, etc., and the maintenance of circulating area and roads where heavy vehicles ply. 76
The overall savings in transport rates would more than justify the expenditure incurred on the provision of additional facilities. This ahs not been recognized by the planners of individual projects. For rail movement, not only sufficient number of loading lines, but also sufficient number of marshalling, examination and holding lines must be planned for. These lines must be suitably connected with one another to ensure smooth shunting operations. The configuration of lines (yard designs) is more important than the number of lines in the yard, for the requirements of prime mover (shunting engines) can also be cut down by a suitable design of yard. 2) Vehicles: An important feature of movement of finished products of major projects is the type of vehicle used for movement. The vehicle dimensions, capacity. Type and its special characteristics, if any, have to be examined with the reference to the quality and quantity of goods to b moved. In case of sea transport---- the size, speed and the type of ship, in case of road movement---- capacity, moving dimensions and speed of the trucks and in case of rail movement---- the capacity, type and general availability of wagons must be closely examined. Planned movement on any section must be taken into account utilisation of the existing sectional capacity, the expected general growth in traffic on the section, and the possible future identifiable streams of new traffic. If movement on a saturated section is inevitable, line capacity of the section must be increased. 3) Prime Movers: The motive power utilized for the internal handling of vehicles and transportation to destinations is another important component of the total movement system. In the case of rail movement, locomotives required for the shunting and marshalling of wagons within the plant must be of such weight, horsepower and performance characteristics as will match the specific tasks of shunting and reception and dispatch of wagons. In case of road movement, suitable design and layout of conveyors and mechanical loaders can reduce the drudgery of manual labour and make predespatch and post-receipt handling operations more efficient. 4) Routes And Sectional Capacity: Another important aspect of transport planning is the routes for streams of traffic, viz., roadways, railways, waterways and airways. The routes or pathways must have adequate capacities. Generally speaking, because of lack of understanding of the transportation subject, executives take it for granted that capacity of routes is unlimited. A very important but invisible component of movement activity is sectional capacity, which is dependant on permissible sectional speed and other characteristics of a section. In turn, sectional speed depends on the geometrics of the road (track, sea route, road surface, carriage way, gradients and curves, etc.). Over a section of railways or roadways between two stations A and B, only a limited number of wagons, trucks or vehicles can be pushed through, depending on the availability of terminal facilities to handle these vehicles, the facilities to enable vehicles to move on the section, and availability of sufficient number of vehicles. 77
Unless sufficient capacity is developed on each of the different routes to move the vehicles, the additional number of vehicles provided would not necessarily lead to higher levels of transport availability. On the contrary, movement may become more sluggish. 5) Transit Time: The relative locations of a plant and the customers or suppliers determine largely the transit time for raw materials, spare parts and finished products. Transit time generally never receives adequate attention in the panning of major projects. There is a general impression that, if need be, transit time can be drastically cut at any time by air-lifting a consignment. Apart from the fact that the neglect of transportation planning leads to an overall higher cost of transportation, in practice, reduction in transit time actually achieved may not justify the heavy cost of air transport. Rough estimates of transit time from unreliable sources are generally utilized for planning movements of goods. Although more detailed information sources may be readily available. It is essential therefore, that executives understand clearly the difference between: (a) Normal transit time under normal conditions; (b)Normal transit time under abnormal conditions; (c) Optimal transit time; (d)Most optimistic transit time (e) Most pessimistic transit time; and (f) Desirable transit time. Because the importance of transit time is not adequately recognized, it is not realistically provided for. Major projects suffer from the heavy delays even before the commencement of construction because of the non-availability of construction equipment and machinery in time. The existing bottlenecks in the fields of transportation are almost always ignored. Construction schedules, inventories, warehousing facilities, order processing or production schedules, etc., are generally planned without the recognition of the inevitable delays that flow from these bottlenecks. 6) Weigh Bridge: Another usually neglected aspect of industrial transportation activity is the factory weigh bridge. Weigh bridges ion factories are generally inaccurate, if not actually out of order. It is seldom appreciated that the losses continuously occurring on this single piece of factory equipment and general inefficiency, which results from its ineffective and inefficient management, can be easily avoided by proper advance planning. Executives ignore the usual traffic jams at factory gates slow down receipts and dispatches, which, in turn, indirectly affect output. The relative advantages of various types of weigh bridges must be properly appreciated by executives, and a weigh bridge which will handle the anticipated volume of traffic expeditiously must be selected. 7) Distribution pattern The pattern of movement of the finished produced by road or rail must be planned properly. For example, when the requirements of the number of rail wagons are to be worked out, it is not sufficient to take the average lead or distance for the whole country for calculating fleet requirements. it is also not sufficient to use the figure of 78
the existing average lead of general goods ,or even that pertaining to a specific commodity. However, when it comes to actually transport, because of imprecise pre-planning, the manufacturer wants the commodity carrier to transport goods to anywhere and everywhere n the country. This presents a problem. The manufacturer provides information to the common carrier about the quantity o goods to b \e marketed. But detailed information must be supplied to the carrier so that the carrier can plan the movement in entirety. 8) Nature of product Another aspect, which is often disregarded by project managements as well as common carrier, is the variability arising out of the specialized nature of products to be moved. The generally low level of sophistication in transport planning in the country had made it difficult for the planners to appreciate the fact that transport capacity is influenced by the nature of goods, their packing and other specialized requirements, such as special handling equipment.etc. Freight Rate Structure Freight rates of any mode of transport are based on the following principles: 1. Freight should the actual cost of transport operation. The actual cost of operation depends on the following factors: a) Fixed costs - Freight should cover interest on capital, depreciation, registration and insurance expenses of a vehicle, if applicable, general upkeep of the vehicle, administration overheads, and expenditure on other fixed facilities, etc. b) Semi-fixed costs - Freight should cover the salary of the driver, cleaner, conductor and miscellaneous maintenance expenses, which vary partially with the running of the vehicle. c) Vehicle Utilization - A transporter is interested in getting maximum mileage out of his vehicle by moving it at top speed to cover the distance in as short a time as possible. i. If the consignments loaded or the route covered is not conducive, the transporter would quote a higher freight rates. ii. Higher freight rates are also quoted when vehicles are detained at terminals either for certain formalities, terminal congestion in busy ports or at factory gates, or while waiting for loading or unloading operations. Terminal detentions are invariably accounted for in the freight rates themselves, but they are normally not noticed at all. iii. Freight rates are quoted higher if there an expectation of obtaining a return trip with a load or if considerable empty movement of vehicles is involved after unloading. iv. Vehicle Utilization is affected by the nature of goods. Hazardous goods that are likely to cause damage to the other consignments or the vehicle itself attract higher freight rates. v. Consignments, which can be loaded less by weight in a vehicle, attract higher unit freight rate since they yield poor utilization of the vehicle. 79
2. Traffic Bearing Capacity: An age-old consideration for the freight rates is the doctrine of “what traffic can bear.” Transportation adds place utility to goods, for it makes them marketable at another place. However, after the addition of the cost of transport, the price of goods should be still attractive to the buyer. 3. Public Use: Freight rates all over the world are governed on human grounds that items of public use should be made available to the common man at the cheapest rate. For example, foodgrains and salt are carried at rock-bottom prices, sometimes even at those, which do not cover the actual cost of operation. 4. Government Policies: Freight rates are often framed on the basis of government objectives, which aim at serving certain points – such as promotion of certain type of trade, development of certain industries, etc. In such cases, freight rates are either depressed to promote the particular traffic or hiked to discourage particular traffic. 5. Reasonable Profit: The transporter must provide for a reasonable profit after covering the cost of operations and capital investment. This margin must give not only return of investment but also compensate him for the entrepreneurial time and effort he puts in, but also provide sufficient funds for future development of his enterprise. ROAD TRANSPORT Road transport forms an air. It is essential as a complete movement by railway station the goods
essential part of any transport activity, whether rail, sea or supplementary and complementary mode of transport to other modes of transport. Eg. From one terminal i.e. the have to be carried to the destination like an area by road.
Road transport offers certain advantages like i. Door to door service to customers which neither rail nor neither sea nor air transport can offer. ii. On per unit basis, the cost of making a road is 1/6th that of laying a railway line. iii. Capital investment in case of railways is much less then railways designed to carry equivalent quantum of traffic. iv. Road transport provides employment to six million persons (two million direct and four million indirect) There are negative points also to be viewed like: i. As much as 6200 crores are collected in dues but only used for development of roads, which a disadvantage as well organized. ii. Road transport industry is not come of age in India, companies, which own the entire fleet of trucks. Single most of the road transport.
10% of this revenue is road transport is till not as there are very few vehicle owners operate
There is a system of associates, who pool in their vehicles and other resources and share the benefits of vehicle contribution. The associates operate from different cities. 80
An associate in one city, say, Mumbai, watches the interest of his counterpart in Delhi. Together they operate as a team. They minimize expenses on the maintenance of a branch office at the out-station and yet give the identity of a single branch operator.
Problems in Road Transport: Road transport faces a number of problems. This is evident from the following facts: 1) There is an occasional storage of diesel fuel in the country. 2) Vehicle availability in the country has been problematic. With the recent entry of a number of manufacturers, the situation has improved to some extent. 3) The cost of components and accessories, such as tyres and batteries, has escalated tremendously. 4) The Octroi and police check posts are to many, resulting in heavy detention to road vehicles. 5) The present Motor Vehicle Act regulating the issue of licenses and permits and movement of vehicles is very restrictive. It was decades ago to control and regulate traffic. The current requirements of traffic are for development. There are persistent demands from various transport associations for suitable amendments of the Motor Vehicle act. But they do not seem to receive due attention. 6) Conditions on Indian road are very bad and hazardous. They tend to reduce speed of vehicles, which leads to wastage of natural transport capacity. 7) Roadside maintenance and service facilities have not developed though found necessary. 8) The system of national, zonal and state permits restricts free growth of road transport but the system has to be followed.
Factors influencing Transportation Costs and Pricing In general factors influencing transportation costs/pricing can be grouped into two major categories: product related factors and market related factors. Many factors related to a products characteristic influenced the cost/pricing of transportation. They can be grouped into the following categories: 1) 2) 3) 4)
Density Stow ability Ease or difficulty of handling Liability
Density refers to a product's weight to volume ratio. Items such as steel, canned Foods, building products and bulk paper goods have high weight to volume ratios. They are relatively heavy given their size. On the other hand products such as electronics clothing, luggage and toys have low weight to volume ratios and thus are relatively lightweight given their size. In general, low-density products-those with low weight to volume ratios-tend to cost more to transport on a per pound (kilo) basis than high-density products. Stow ability is the degree to which a product can fill the available space in a transport vehicle. For example, grain ore, and petroleum products in bulk have excellent stow ability because they can completely fill the container (e.g. railcar, tank, truck, pipeline) in which they are transported. Other items such as automobiles, machinery, livestock and people do not have good stow ability or cube utilization. A product's stow ability depends on its size, shape, fragility, and other physical characteristics. 81
Related to stow ability is the ease or difficulty or handling the product. Difficult to handle items are more costly to transport. Products that are uniform in their physical characteristics (e.g. raw materials and items in cartons, cans, or drums) or that can be manipulated with materials handling equipments requires less handling expenses and are therefore less costly to transport. Liability is an important concern. Products that have high value to weight ratios are easily damaged and are subject to higher rates of theft or pilferage, cost more to transport. Where the transportation carrier assumes greater liability (e.g. with compute, jewelry and home entertainment products) higher price will be charged to transport the product. Other factors, which vary in importance depending on the product category, are the products hazardous characteristics and the need for strong and rigid protective packaging. These factors are particularly important in the chemical and plastic industries.
Market-Related Factors In addition to product characteristics, important market related factors affect transportation cost/pricing. The most significant are: 1) Degree of intra-mode and inter-mode competition. 2) Location of markets, which determines the distance goods, must be transported. 3) Nature and extent of government regulation of transportation carriers 4) Balance or Imbalance of freight traffic into and out of a market 5) Seasonality of product movement 6) Whether the product domestically or internationally Customer service is a vital component of logistics management. Which each activity of logistics management contributes to the level of service a company provides to its customers, the import of transportation on customer service is one of the most significant. The most important transportation service characteristics affecting customer service levels are: -Dependability consistency of service -Time and transit -Market coverage- the ability to provide door-to-door service -Flexibility- handling of a variety of products and meeting the special needs of shippers -Loss and damage performance -Ability of the carrier to provide more than basic transportation service i.e. (to become part of shippers over all marketing and logistics programs) Each mode of transport- motor, rail, air, water and pipeline- has varying service capability. Service Choices And Performance Characteristics The user of transportation has a wide range of services as his or her disposal all revolving around the five basic modes, the variety is almost limitless (1) The five modes maybe used in combination (2) Agencies, associations and brokers maybe 82
used for their indirect services (3) A single transportation mode maybe used exclusively. From among this plethora of service choices, the user must select a service or service combination that provide the best balance between the quality of service provided and the cost of the service. The task of service choice is not as forbidding as it sounds because the circumstances surrounding a particular shipping situation often reduce the choice to only a few reasonable service possibilities. To aid in solving the problem of transportation service choice, transportation service maybe viewed in terms of characteristics that are basic to all services. These criteria are: (1) Cost of service (2) Average delivery time (3) Transit time variability (4) Loss and Damage. It is presumed that the service is available and can be supplied with a frequency that makes it attractive as a possible service choice. Cost of service: The cost of service is simply the line-haul cost for transporting goods plus any accessorial or terminal charges for additional service provided. In the case for- hire service, the rate charged for the movement of goods between two points plus any additional charges, such as pick-up at origin, delivery at destination, insurance or the cost of preparing the goods for shipment makes up the total cost of service. When the shipper owns the service, the cost of service is an allocation of the relevant costs to the shipment in question. Relevant costs include such items as fuel, labor maintenance, depreciation of equipment and administrative costs. Cost comparisons for the purpose of transportation-service selection must be made on the basis of actual charges that reflect the specific commodity being shipped, the distance and direction of the movement and any special handling required. Delivery Time and Variability: There are many factors to be considered when selecting a transportation service. Repeated surveys have shown that average delivery time and delivery time variability rank at the top in importance. Delivery time is usually referred to as the average time it takes for a shipment to move from its point of origin to its destination. The different modes of transportation vary as to whether they provide direct connection between the origin and destination points, for example, shipments move on air carriers between airports and on water carriers between harbors. But for purposes of comparing carriers performance, it is best to measure delivery time 'door-to-door' even if more than one mode is involved. Although the major movement of shipment may be by rail, local pickup and delivery is often by truck if no rail sidings are available at the shipment origin and destination points. Variability refers to the normal differences that occur between shipments by the various modes. All shipments having the same origin and destination points and moved on the same mode are not necessarily in transit for the same length of time due to the effects of weather, traffic congestion, number of stop offs, and difference in time to consolidate shipments. Transit-time variability is a measure of the uncertainty in carrier performance. In recent years there has been renewed interest in the idea of coordinating the service of more than one transportation mode. The major feature of coordination is the free exchange of equipment between modes. For example, a truck trailer is carried abroad an airplane or a rail car is hauled by a water carrier. Such equipment interchange creates transportation services that are not available to a shipper using single transportation mode. Coordinated services are usually a compromise between the services offered by the cooperating carriers individually. That is, cost and performance characteristics rank between those of the participating carriers. There are ten possible co-ordinate services: 83
(1) Rail-truck (2) Rail-water (3) Rail-air (4) Rail-pipeline (5) Truck-air (6) Truck-water (7) Truck-pipeline (8) Water-pipeline (9) Water-air (10) Air-pipeline. Not all of these combinations are practical. Some that are feasible have gained little acceptance. Only rail truck called 'piggyback' has seen widespread use. Truck-water combinations, refereed to as 'fishy-back’, are gaining acceptance especially in the international movement of high-valued goods. To a much lesser extent truck-air and rail-water combinations are feasible but they have seen limited use. TOFC. Trailer on flatcar or piggyback refers to transporting truck trailers on rail board flatcars, usually over long distances than trucks normally haul. TOFC is blending of the convenience and flexibility of trucking with the long haul economy of rail. The cost is less than for trucking alone and has permitted trucking to extend its range. Likewise, rail has been able to share in some traffic that normally would move by truck alone. The shipper benefits from the convenience of door-to-door service over long distances at reasonable rates. These features have made piggyback the most popular coordinated service. Piggyback (TOFC/COFC) In piggyback service, a motor carrier trailer or a container is placed on a rail flatcar and transported from one terminal to another. Axles can be placed under the containers so a truck can deliver them. At the terminal facilities, motor carriers perform the pickup and delivery functions. Piggyback service thus combines the low movement with the flexibility and convenience of truck movement. Since 1976 shippers have increased their use of piggyback service by 200 percent. In 1994 there were 8.1million inter-modal shipments with 1995 and 1996 shipments approximating the same levels. Truck and rail partnerships to support inter modalism such as the one begun in 1989 between the Santa Fe railroad and J.B.Hunt Transport Services are relatively common. The railroad carriers freight on the long haul and the trucking company picks up and delivers between the customer and railroad.77% of inter-modal users agree that such alliances have a positive impact on transportation options available to them. In India Konkan Railway has started this typed service. Roadrailers. An innovative inter-modal concept was introduced in the late 1970s.Roadrailers or trailer trains as they are sometime called, combine motor and rail transport in a single piece of equipment. The road railer resembles a conventional motor carrier trailer. However the trailer has both rubber truck tires and steel rail wheels. Over highways tractor power units transport the trailers in the normal way, but instead of placing the trailer on a flatcar for rail movement, the wheels of the trailer are retracted and the trailer rides directly on the rail tracks. The advantages of this inter-modal form of transport are that rail flatcars are not required and that the switching time to change wheels on the trailer is less than loading and unloading the trailer from the flatcar. The major disadvantages of roadrailers are the added weighted of the rail wheels, which reduces fuel efficiency and results in higher movement costs in addition to the higher cost of the equipment. The disadvantages have tended to out-weight the advantages resulting in very low usage of this Inter-modal option. If technology improvements can reduce the cost of this transport option, usage is likely to increase. Miscellaneous inter-modal issues. Any other inter-modal combinations are possible. In international commerce for example the dominant modes of transportation are air and water. Both include Inter-modal movements through the use of containers and truck trailers. Combinations of air-sea, air-rail, truck-sea and rail-sea are used globally. As an example 'By shipping cargo by ocean from Japan to Seattle, then transferring it to a direct flight to Europe from Seattle-Tacoma Airport. Asian exporters 84
reap substantial benefits. They can cut their transit times from 30 days for all water service to about 14 days and slash freight costs by up to 5 % compared with all services.
Third Party Logistics Service Providers This sector is growing very rapidly. With the increasing emphasis on supply chain management, more companies are exploring the third party option. For some firms dealing with one third party firm who will handle all or most of their freight offers a number of advantages, including the management of information by the third party, freeing the company from day-to-day interactions with carriers, and having the third party oversee hundreds or even thousands of shipments. Third parties have administered activities such as freight payment and dedicated contract carriage for many years. However, additional transportation and logistics activities are being outsourced. In some instances, some companies have outsourced large parts of their logistics operations to their parties. Brokers, freight forwarders, shipper, associations, Inter-modal marketing companies and third party logistics service providers can be available shipping options for a firm in the same way that the give basic modes and Inter-modal combinations can. The logistics executive must determine the optimal combination of transport alternatives for his or her company. In addition to the preceding alternatives many companies find that other transport forms can be used to distribute their products. Small package carriers and parcel post are important transporters of many time sensitive products. These companies use a combination of transport modes, especially air. The U.S. domestic airfreight market consists of 60% express, 25% passenger carriers and 15% mail. The growth rate in this sector has been robust, averaging about 10% a year.
TRANSPORTATION NETWORK DESIGN OPTIONS: Transportation Network Design Options Classical economists neglected the importance of facility, location and overall network design Economists, when originally discussed supply – demand relationships, facility, location and transportation cost differentials were assumed to be non existent or equal among competitors.
The number, size, geographical relationship of the facilities are used to perform logistics operation directly affect customer service capabilities and cost. Network design – primary responsibility of logistics. Typical logistics facilities are manufacturing plants, warehouses, gross dock operations and retail stores.
The design of a transportation network affects the performance of a supply chain. This is because a supply chain establishes an infrastructure within which operational decision regarding scheduling and routing are made. A well-designed transportation network is very essential for an organization. It allows the supply chain to achieve the desired degree of responsiveness at a low. A) DIRECT SHIPMENT NETWORK: The retail stores chain network options for the direct shipment network. As the name suggests, the retail stores chain network structures its transportation network in such a way that the shipment of goods and materials come directly from the suppliers to the retail stores. 85
In direct shipment network, the path or the route which each shipment has to take is specified. The duty of the supply chain manager in this case is only to decide on the quantity of goods that has to be sent to the retail stores and then, depending on the type and quantity of goods, he has to decide on the mode of transportation. Here the supply chain manager has to strike a balance. In other words, if be decides to reduce the number of trips of transportation to minimize transportation cost, then he has to decide on larger inventories at a retail stores. But maintaining large inventories have their disadvantages as well. Again to keep the inventory level minimum at the retail stores, there will be more number of trips by trucks to the retail stores. This will increase the cost of transportation. Hence, the supply chain manager has to decide in a judicious manner between inventory cost and transportation cost. B) DIRECT SHIPPING WITH MILK RUNS: A milk run is a route in which a truck either delivers product from a single supplier to multiple retailers or goes from multiple supplier to a single retailer. Hence, in direct shipping with milk runs, a supplier delivers directly to multiple retail stores on a truck, or a truck picks up deliveries from many suppliers destined for the same retail stores. When using this opinion, a supply chain manager has to decide on the routing of each milk run. This is because if a supplier has to deliver to multiple retail stores, the supply chain manager has to decide which retail stores are to be given priority and accordingly the routes have to be decided. Similar decision about the route has to taken by the supply chain manager when many suppliers have to be contacted by the truck to take deliver of goods meant for the same retail store. Direct shipment of goods to the destinations provides the benefits of eliminating the need of having intermediate warehouses. Further the milk runs help to lower the transportation costs by consolidating shipments to multiple stores on a single truck. For example if replenishment to each retail store is considered on a direct shipment basis, it may happen that the lot size dispatched to that retail store may be small and the truck will not be loaded to its full capacity. However, if milk runs are used instead, the deliveries to multiple stores can be profitably, consolidated on to a single truck. This will result in the better utilization of the truck and also helps to reduce cost. For example, Toyota uses milk runs from suppliers to support its Just-in-Time (JIT) manufacturing system in both Japan and the United State. However in Japan, Toyota has many of its assembly plants located close together and thus uses milk runs from a single supplier for many plants. Again in the United State, Toyota uses milk runs from many suppliers to its assembly plant in Kentucky. C) ALL SHIPMENTS VIA CENTRAL DISTRIBUTION CENTRE: In this transportation network, the suppliers do not send the shipment of goods directly to the retail stores. The retail chain divides the stores by geographical region. Each region bas Central Distribution Center. The supplier sends the goods to the various central distribution centers. The Central Distribution Centre, in turn sends the goods to the retail stores as per the requirement. The Central Distribution Centre is an extra large between the suppliers and the retailers. It can play two different roles. First role is to store inventory and the second role is to serve as a transfer location. The presence of a distribution center helps to reduce supply chain cost when suppliers are located far from the retail stores and the transportation cost are high. Cross Docking of goods and products is taken advantages of when there are large shipments on the inbound side and on the outbound side, goods and products have to be sent to retail outlets replenishment lots. A major benefit of cross docking of products is that little inventory has to be held at the central distribution center and the products flow faster in the supply chain. Cross docking also saves handling costs, because the product does not have to be moved in to and out of storage at the central 86
distribution center. LOCATION APPLICATIONS Plant and distribution center location is a common problem faced by logistics managers. Increased production economics of scale and reduced transportation cost have focused attention on distribution centres. In recent years, location analysis has been further extended to include logistics channel design as a result of global sourcing and marketing decisions. Global operations increase logistics channel decision complexity, design alternatives and related logistics cost. LOCATION DECISIONS Location decision focus on selecting the number and location of distribution centres. Typical management questions: How many distribution centers should the firm use and where should they be located? What customers or market areas should be serviced from each distribution center? Which product lines should be produced or stopped at each plant or distribution center? What logistics channels should be used to source material and serve international markets? What combination of public and private distribution facilities should be used? LOCATION ANALYSIS TECHNIQUES Location analysis problems are very complex and data intense. Complexities are created because of the number of locations multiplied by the alternative location sites multiplied by the stocking strategies for each location. Data intensity is created because the analysis requires detailed demand and transportation information. The techniques used are: Analytic techniques Optimization or linear programming techniques Simulation techniques Analytic techniques: they generally describe methods that identify the center of gravity of logistics geography. A center of gravity method is appropriate for locating a single distribution plant or center. A number of methods both mathematical and non mathematical can be applied to a problem of a single location. The cost and complexity of the technique is to be matched to the difficulty of the problem. In the following example technique employed is evolved from analytic geometry. The model is based on Cartesian co-ordinates, where the horizontal axis is labeled as the x-axis, and the vertical axis is labeled as the y-axis. The figure below illustrates such a coordinate system. Any given point in the quadrant can be identified with reference to x and y coordinates. Taken together, these co-ordinates define unique points. The figure below illustrates the x and y co-ordinates of Detroit, Michigan, Columbus, Ohio. The co-ordinates for Detroit are 3.5 and 3. the co-ordinates of Columbus are 3.8 and 2. the x and y co-ordinate system can be used to calculate the distance between any two points on the plane using the Pythagoras theorem.
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By use of this basic system of orientation, it is possible to replicate the geographic market area in which the distribution centre is to be located. This method to solve the location problem determines the ideal co-ordinate position of the distribution warehouse on the basis of distance, weight or a combination of both. The computation is a weighted average of the distance, weight or combined factors, with the warehouse location as the dependent variable. The algebric solution may use either the weighted average x and y co-ordinate or the median location. The median location uses the coordinate location with half the demand on each side. The formulae of this calculation depend on the independent variables expressed in the location measure. The problem is in a manner such that identical service standards exist for all potential distribution warehouse locations. The objectives are to minimize transportation cost.
FACILITIES LOCATION DECISIONS Plant location decisions Manager’s goal when locating facilities and allocating capacity should be to maximize the overall profitability of the resulting supply chain network. The following information must be available before the design decision can be made Location of supply sources and markets Location of potential facilities sites Demand forecast by market Facility, labor, and material cost by site Transportation cost between each pair of sites Inventory cost by site as well as function of quantity The fundamental trade off managers space when making facilities decision is between the cost of the number, location and type of facility(efficiency) and the level of responsiveness that these facilities provide the company’s customers (Internal as well as External) A firm’s competitive strategy has a significant impact on network design decisions within the supply chain. Firms focusing on cost leadership will tend to find the lowest cost location for their manufacturing facilities even if that means locating very far from the market they serve. Firms focusing on responsiveness will tend to locate facilities closer to the market and may select high-cost location if this choice allows the firm to react quickly to changing market needs. Global supply chain networks can best support their strategic objectives with facilities in different countries playing different roles. For example, Nike has production facilities located in many countries in Asia. He facilities in China and Indonesia focus on cost and produce the mass-market, lower-priced shoes for Nike. In contrast, facilities in Korea and Taiwan focus on responsiveness and produce the higher-priced new designs. The differentiation allows Nike to satisfy a wide variety of demands in the most profitable manner. The following is the classification of possible roles for various facilities in a global supply chain network. Offshore facility-low cost facility for export production: - an offshore facility serves the role of being a low-cost supply source for markets located outside the country where the facility is located. The location selected for an offshore facility should have low labor and other costs to facilitate low-cost production. 88
Source facility- low cost facility for global production: - A source facility also has low cost as its primary objective, but its strategic role is broader than that of an off shore facility. A source is often a primary source of product for the entire global network. Source facilities tend to be located in places where production costs are relatively low, infrastructure is well developed, and skilled workforce is available. Server-facility – regional production facility: - A server facility’s objective is to supply the market where it is located. A server facility is built because of tax incentives, local content requirement, tariff barriers, or high logistics costs to supply the region from elsewhere. Contributor facility- regional production facility with development skills.: - A contributor facility serves the market where it is located but also assumes responsibility for product customization, process improvements, product modification or product development. Outpost facility- regional production facility built to gain local skill: - An outpost facility is located primarily to obtain access to knowledge or skills that may exist within a certain region.. Given its location, it also plays a role of server facility. The primary objective remains one of being a source of knowledge and skills for the entire network. Lead facility – facility that leads in development and process technologies: a lead facility creates new products, processes, and technologies for the entire network. Lead facilities are located in areas with good access to a skilled workforce and technological resources. Focused attention on Distribution Center due to increased production, economy of scale and reduced transportation cost. Technology wise: Characteristics of available production technologies have a significant impact on network design decisions. If production technology displays significant economies of scale, few high capacity locations are most effective. This is the case in the manufacture of computer chips, in which factories require a very large investment. As a result, most companies build few chip production facilities, and each one they build has a very large capacity. In contrast, if facilities have lower fixed costs, many local facilities are preferred because this helps lower transportation costs. For example, bottling plants for coca cola do not have a very high fixed cost. To reduce transportation cost, coca cola sets up many bottling plants all over the world, each serving its local market. Flexibility of production technology affects the degree of consolidation that can be achieved in the network. If the production technology is very inflexible and product requirements vary from one country to another, a firm has to set up local facilities to serve the market in each country. Conversely, if the technology is flexible, it becomes easier to consolidate manufacturing in a few large facilities. Transportation wise: The fundamental trade-off for transportation is between the cost of transporting a given product (efficiency) and the speed with which that product is transported (responsiveness) Transportation has a large impact on both responsiveness and efficiency. Faster transportation, whether in form of different modes of transportation or different amounts being transported, allows a supply chain to be more responsive but reduces its efficiency. The type of transportation a company uses also affects the inventory 89
and facility locations in the supply chain. For example: Dell flies components from Asia because doing so allows the company to lower the level of inventory it holds. Clearly, such a practice increases responsiveness but decreases transportation efficiency because it is more costly than transporting parts by ship. The role of transportation in a company’s competitive strategy figures prominently when the company is considering the target customer’s needs. If a firm’s competitive strategy targets customers that demand a very high level of responsiveness and that customer is willing to pay for this responsiveness then a firm can use transportation as one driver for making the supply chain more responsive. The opposite is true as well. If a company’s competitive strategy targets customers whose main decision criterion is price, then the company can use transportation to lower the cost of the product at the expense of responsiveness. As a company may use both inventory and transportation to increase responsiveness or efficiency, the optimal decision for the company often means finding the right balance between the two. Also, The companies can gain economies of scale when a product is manufactured or stored in only one location; this centralization increases efficiency however the cost reduction comes only at the expense of responsiveness, as many of a company’s customer maybe located far from the production facility. The opposite is also true. Locating facilities close to customers increases the number of facilities needed and consequently reduces the efficiency. However, if the customer demands and is willing to pay for the responsiveness that having numerous facilities adds, then this facilities decision helps meet the company’s competitive strategy goals. There are also many instances, in which the pricing schedule yield economies of scale, with prices decreasing as lot size is increased. This form of pricing is very common in business to business transactions. A discount is lot size based if the pricing schedule offers discounts based on quantity orders in a single lot. A discount is volume based if the discount is based on the total quantity purchased over a giver period, regardless of the number of lots purchased over a given over that period. Two commonly used discount based schemes are All units quantity discounts
Marginal unit quantity unit discount or multi block tariffs. Companies must also decide what a facility’s capacity to perform its intended function or functions will be. A large amount of excess capacity allows the facility to be very flexible and to respond to wide swings in the demands placed on it. Excess capacity, however costs money and therefore can decrease efficiency. A facility with little excess capacity will likely be more efficient per unit of product it produces then one with a lot of unused capacity. The high utilization capacity will, however , have difficulty responding to demand fluctuations. Therefore, a company must take a balanced trade off to determine the right amount of capacity to have at each of its facilities. Typical decisions of location decisions Deciding where a company will locate its facilities constitutes a large part of the design of the supply chain. A basic trade off here is whether to centralize to gain economies of scale or decentralize to become more responsive by being closer to the customer. Companies must also consider a host of issues related to various characteristics of the local areas in which the facility may be situated. These include: Macro economic factors Strategic factors Quality of workers 90
Cost of workers Cost of facilities Availability of Infrastructure Proximity to customers and the rest of the network Tax effects
Distribution centers- how many and where?????????? When deciding upon locational decision a manager basically decides upon suppliers, plants, ware houses and markets. There may also be other facilities such as super stockists, consolidation centers or transit points. SUPPLIERS
PLANTS
WAREHOUSES
MARKETS
Besides locating the facilities a manager must also decide how market may be allocated to ware houses and how ware houses will be allocated to plants. The allocation decision can be altered on a regular basis as different costs change and markets evolve. When designing the network, both location and allocation decisions are made jointly. In some cases, companies want to design supply chain networks, in which a market is supplied from only one factory. This is commonly known as the capacitated plant location model with single sources. Companies may impose this constraint because it lower the complexity of coordinating the network and requires less flexibility from each Facility. A much more general form of the plant location model needs t be considered if the entire supply chain network from the supplier to the customer must be designed. Consider a supply chain in which suppliers send materials to factories that supply ware houses that supply markets. Location and capacity allocation decision has to be made for both factories and ware houses. Multiple ware houses may be used to satisfy demand at a market, the multiple factories may be used to replenish warehouses. Supply chain design decision should be evaluated for a variety of future scenarios that reflect the underlying uncertainty. Accounting for uncertainty relieve the managers to built extra capacity in to supply chain network and make the available capacity more flexible in terms of the markets that can be served. If capacity is flexible, demand can be reallocated within the supply chain network to react best to changing demand, prices, costs, and / or exchange rates. If capacity is inflexible, production cannot be changed in response to change in condition. The presence of flexibility thus increases potential profits. Customer / market- to be served from each distribution center. Firms must consider the response time customers desire when designing their supply chain methods. Firms that target customers who can tolerate a large response and require few locations and can focus on increasing the capacity of each location. In contrast, firms that customers who value short response time need to locate close to 91
them. these firms must have many facilities, with each location having low capacity. First, a decrease in the response time customers desire increases the number of facilities required in the network. For example customers are unlikely to come to a convenient store if they have to travel a long distance to get there. It is thus best for a convenient store chain to have many stores distributed in an area so that most people have convenience stores close to them. In contrast, customers shop for larger amount at super market and are willing to travel longer distances to get to one. Thus, super market chains tend to have stores that are much larger tan convenient stores and not as densely distributed. If a firm is delivering product to customers, use of rapid means of transportation allows it to build fewer facilities and still provide a short response time. However, this option increases transportation cost. Moreover, there are many situations in which the presence of a facility close to a customer is important. For example a coffee shop is likely to attract customers who live or work nearby. No faster mode of transport can serve as a substitute and be used to attract customers that are far away.
Use of logistics channel- for material sources: The procurement cycle occurs at the manufacturer/supplier interface and includes all processes necessary to ensure that materials are available for manufacturing to occur according to schedule. During the procurement cycle, the manufacturer orders the components from suppliers that replenish the component inventories. The relationship is quite similar to that between a distributor and manufacturer, with one significant difference: whereas retailer or distributor orders are triggered by uncertain customer demand, component orders can be determined precisely once the manufacturer has decided what the production schedule will be. Component orders are dependent on the production schedule. Of course, if a supplier’s lead times are long, the supplier has to produce to forecast because the manufacturer’s production schedule may not be fixed that far in advance. In practice, there are several tiers of suppliers, each producing a component for the next tier. A similar cycle would then flow back from one stage to the next. The processes are shown as below PROCUREMENT CYCLE
Order based on manufacturer’s production schedule or supplier’s stocking needs.
Receiving at manufacturer
Supplier production scheduling
Component manufacturing and transporting and/or shipping
A firm can vary supply of product by controlling a combination of the following two factors: Production capacity Inventory 92
The objective is to maximize profits. Some of the specific approach to managing capacity and inventory are listed below: Time flexibility of workforce so as to comfortably utilize the idle or unused space Use of seasonal workforce so as to meet the sudden shoot in demand and not loose on the revenue thus generated. Use of subcontracting so as to acquire an economical way since it works out to be cheaper. Use of dual facilities- dedicated and flexible so as to produce at a relatively steady rate with fluctuations being absorbed by the flexible facility. Designing product flexibility into the production processes, modification in layout, so as to meet the sudden demand as well as effectively extract the best possible from all the resources in an accommodating and flexible manner. Managing inventory:’ Using common components across multiple products, which would facilitate a relatively constant overall demand. Build inventory of high demand or predictable demand products, which helps in synchronization of supply and demand making the utmost and optimum use of seasonal and off seasonal advantage. Use of Public and Private distribution facilities: His aspect involves a two-fold consideration From the transportation point of view From the warehousing point of view As can be clearly understood, transportation involves either owning the means of transport or appointing an agency for transport commonly known as outsourcing of transportation service. This has to be analyzed considering the long-term benefits, the cost-benefits, the responsive benefit, and efficiency, comparing the estimated results in both the cases – owned as well as outsourced. Again if the lead time is high, the location facility if at a greater proximity to the suppliers, and if the cost structure is suitable to the company the company shall go ahead to establish its own infrastructure to increase the transportation efficiency. This is mostly the case with companies that practice just in time method and is affiliated to a reduced inventory system. Similarly, the reason not many companies owning is its involves huge capital investment, increased complications, increased labour and the like. Companies now a days also design their own shapes in the trucks and other means of transport so as to accommodate maximum in the limited possible space. A warehouse, may be, privately owned and operated by company making its own goods. Commonly known as private warehouse. A warehouse may be owned and operated by another organization, including a government agency, and only used by a company on certain terms and conditions. Commonly known as public ware house. Irrespective of whether a warehouse is privately or publicly owned, the following factors have to be taken into account to work out the cost of storage: Interest on the cost of buying the site Interest on the cost of furniture Cost of repairs and maintenance Depreciation on building and equipment Insurance 93
If productivity (or efficient use) of the warehouse can be increased by 20% there is an equivalent reduction in costs per unit handled and processed. There are fixed costs in the shape of the cost of space per square meter or per cubic meter, which have to be borne, whether or not the warehousing is operating. Maximum efficiency is obtained by processing a larger number of units through the warehouse space. The larger the number of processed units, the lower the cost per unit. There is nothing as a better or the best option but both have their sets of advantages and disadvantages and a company should critically evaluate all the expenses related and accordingly decide the better and the most suitable option for itself. However it is always advised to use a perfect blend of both, private as well as public warehouses. Also, private warehouses need not be owned, they can be rented or leased with or without equipment. Product lines – produced at plants, stocked at distribution centers: Product lines- production and Distribution Centres The tour material in this fig delineates the areas of material handling function and its tour of duties. Typically, material is handled at the following stages. 1. Raw material is transported from the vendor to the warehouse of the production unit. It is received by trucks, by rail wagon or even by ship. At the warehouse, the handling of material takes place, and a system is required to be evolved. Thereafter, the material is stored. 2. At the time the material is required for production process, it is again handled. It is retrieved and transferred or fed in to the production process. 3. During the production process too, the material is handled in many ways. After the material has been finally processed and turned in to a finished product, the finished product is handled and loaded for despatch by a given mode of transport to a warehouse or to a dealer. 4. Sometimes, the finished product is packed and directly loaded on to the transport to vehicle. 5. Sometimes, the material produced at the end of a production process is not the final finished product but only an intermediate finished product. This intermediate product is required to be handled and stored to be retrieved again, whenever required for finishing. 6. Sometimes, the semi-finished product is required to be sent out of the production unit to another manufacturer. This would require the physical transport of this intermediate product to the other production unit. In this case, the product may again be transported back to the production unit for final processing or storage before despatch 7. Sometimes, the semi-finished product may be finished in another processing plant and loaded and despatched from there.
Finishing Work at Another Vendor
Receipt Transport
Storage
Producti on unit
Storage
94
Despatch Transport
Customer Dealer Warehouse
Temporar y Storage of semifinished
8. Assuming that the product has been stored in its final finished form, it has to be handled before despatch from the production centre. 9. The goods may be despatched straight to he customer, in which case the handling of the product is done by the customer himself as a one-time job. If despatches to the customer are regular feature and if specialised handling of goods at the time of delivery is required, suitable arrangements will have to be made to ensure that handling is good. 10. Sometimes the goods are sent to a retailer or a dealer. In this case, the quantity of goods despatched may be larger. If the despatches are regular and in large quantities specialised handling may be required. Accordingly, the necessary arrangements will have to be made. 11. The goods may be despatched to a field warehouse of the company, or to a public warehouse, or to the warehouse of a stockist or distributor. In this case, they are required to be stored suitably for sometime before they are despatched to a customer, retailer, or dealer, as the case may be. The alternative requires the handling of the finished product during its retrieval and despatch to a proper destination. At the destination the product is handled again.
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7. WAREHOUSE MANAGEMENT INTRODUCTION Warehouse can play a key role in the integrated logistics strategy and its building and maintaining good relationships between supply chain partners. Warehousing affects customer service stock-out rates and firm’s sales and marketing success. A warehouse smoothens out market supply and demand fluctuations. When supply exceeds demand, a demand warehouse stores products in anticipation of customers requirements when Demand exceeds supply the warehouse can speed product movement to the customer by performing additional services like marking prices, packaging products or final assy. Etc Warehousing can be defined as a location with adequate facilities where volume shipments are received from production centre, which are then broken down in to particular order and shipped onwards to the customer. Warehousing is an integral part of any logistics system. The warehouse is a link between producer and customer. Out-bound warehouse help consumers buy on demand without a nearby production plant warehousing cost are about10% of total integrated logistics costs for most companies.
TYPES OF WAREHOUSES 1. Private warehousing 2. Public warehousing 3. Contract warehousing 1. PRIVATE WAREHOUSING A firm producing or owning the goods owns private warehouses. The goods are stored until they are delivered to a retail outlet or sold. Potential advantage of using a private warehouse is the ability to maintain physical control over the facility, which allows managers to address loss, damage, and theft. When not in use they can rent in out. The construction and maintenance of private warehousing can be extremely costly. All the expenses have to be carefully analyzed and evaluated. These are: i. ii. iii. iv. v. vi. vii.
Fixed expenses and building and land acquisition costs which are high; Expenses incurred on ensuring that warehouses are properly equipped with material-handling equipment like conveyors, fork lifts, hand trucks, racks and bins, and dock levelers; The costs of salaries of staff required for peak activity periods which can be very high since retrenchment during slack periods may not be possible; Extra payment to be made for work on Saturday and Sundays and holidays; Janitor and other services charges are required to be taken into account; The office and record-keeping equipment necessary for successful warehousing operations has to be budgeted for; To this must be added the cost of such item as fuel, air-conditioning, power, and light; 96
viii.
The cost of maintaining insurance records and of the premiums paid for fire, theft, and also for workmen’s compensation.
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ADVANTAGES OF PRIVATE WAREHOUSING The advantages and disadvantages of private warehousing as against those of public warehousing are: i. ii. iii.
Private warehousing offers better control over the movement and storage of products as required by the management from time to time; There is less likelihood of error in the case of private warehousing since the company’s products are handled by its own employees who are able to identify the products of their own company better; If there is sufficient volume of goods to be warehoused, the costs of private warehousing compares favourably with that of public warehousing. But private warehouse may not be expected to be packed upto the brim all the while. Therefore the costs of private warehousing per unit may actually higher.
2. PUBLIC WAREHOUSING A public warehouse rents space to individuals or firm needing storage, some provide wide array of srevices including packaging, labelling, testing, inventory, maintenance, local delivery, data processing and pricing. All the foregoing cost factors operate in public warehousing as well. But in public warehousing, the expenses are distributed over several other consignments of other clients. In most instances therefore the net result is lower cost for each. Warehousing has become a highly specialised service and a public warehouseman can render better srevice with greater flexibility for the user. A company running a private warehouse will have to compare costs incurred with the total figure for the complete service through public warehousing.
ADVANTAGES OF PUBLIC WAREHOUSING i. ii. iii. iv. v. vi.
It is generally less expensive and more efficient; Public warehouses are usually strategically located and immediately available; Public warehousing is sufficiently flexible to meet most space requirements, for several plans are available for the requirement of different users; Fixed costs of a warehouse are distributed among many users. Therefore the overall cost of warehousing per unit works out to a lower figure; Public warehousing facilities can be given up as soon as necessary without any additional liability on the part of the user; The costs of public warehousing can be easily and exactly ascertained, and the user pays only for the space and services he use.
3. CONTRACT WAREHOUSING Contract warehousing is a specialized form of public warehousing. In addition to warehousing activities such warehousing provides a combination of integrated logistics services. Thus allowing the leasing firm to concentrate on its specialty. They provide customized services. (Value-added services)
FUNCTION OF WAREHOUSE Warehouses are basically intermediate storage points in the logistics system where raw material, work in process, finished goods and good in transit are held for varying duration of times for a variety of purposes. The warehousing 98
functionality today is much more than the traditional function of storage. The following are main function that warehousing serves today: •
CONSOLIDATION: this helps to provide for the customer requirement of a combination of products from different supply or manufacturing sources. Instead of transporting the products as small shipments from different sources, it would be more economical to have a consolidation warehouse. This warehouse will receive these products from various sources and consolidate these into shipments, which are economical for transportation or as required by the customers. PLANT A
PLANT B PLANT C
•
CONSOLIDATION WAREHOUSE
A
B
C
BREAK BULK: as the name suggest, the warehouse in this case serves the purpose of receiving bulk shipments through economical long distance transportation and breaking of these into small shipments for local delivery. This enables transportation economies with combination of long distance bulk transportation, break bulk warehousing, and short distance small shipments in place of long distance small shipments. CUSTOMER A PLANT A
BREAK
CUSTOMER B
BULK CUSTOMER C
BREAK BULK •
CROSS DOCKING: this type of facility enables receipt of full shipments from a number of suppliers, generally manufacturers, and direct distribution to different customers without storage. As soon as the shipments are received, these are allocated to the respective customers and are moved across to the vehicle for the onwards shipments to the respective customers at these facilities. Smaller shipments accompanying these full shipments are moved to the temporary storage in these facilities awaiting shipments to the respective customers along with other full shipments. CUSTOMER A
Company A/ Plant A Company B / Plant B
DISTRIBUTION CENTRE
Company C/ Plant C
CUSTOMER B
CUSTOMER C 99
CROSS DOCKING •
PRODUCT MIXING: products of different types are received from different manufacturing plants or sources in full shipment sizes. These products are mixed at these warehouses into right combination for the relevant customers as per their requirements. Some products which are commonly required inmost product mixtures, are kept in constant storage at these warehouses and continuously provided for the product mixture shipments requiring these.
PLANT A PLANT B
WARE HOUSE TRANSIT MIXING POINT
PLANT C
PRODUCT D
PRODUCT MIXING
A
CUSTOMER W B C D
A
CUSTOMER X B C D
A
CUSTOMER Y B C D
A
CUSTOMER W B C D
•
STOCK PILING: this function of warehousing is related to seasonal manufacturing or demand. In the case of seasonal manufacturing, certain raw materials are available during short periods of the year. Hence, manufacturing is possible only during these periods of availability, while the demand is full year around. This requires stockpiling of the products manufactured from these raw materials. Am example is mango pulp processing. On the other hand, certain products like woolens are required seasonally, but are produced throughout the year, and thus need to be stockpiled as such.
•
POSTPONEMENT: this functionality of warehousing enables postponement of commitment of products t o customers until orders are received from them. This is utilized by manufacturers or distributors for storing products ready up to packaging stage. These products are packaged and labeled for the particular customer only on receipt of the order.
•
POSITIONING: this permits positioning products or materials at strategic warehouses near to the customers. These items are stored at the warehouse until ordered by the customers when these can be provided to the customers in the shortest lead-time. This function of warehousing is utilized for higher service levels to customers for critical items and during increased marketing activists and promotions.
•
ASSORTMENT: assortment warehouse store a variety of products for satisfying the variety requirements of customers. For example, retailers may demand different brands of the same product in small quantities rather than larger quantities of the single brand.
•
DECOUPLING: during manufacturing, operation lead-times may differ in order to enable production economies. Thus, the batch size and the lead-time of production 100
•
may differ in consecutive operations. This decoupling of operations requires intermediate storage of materials required for the subsequent operation. SAFETY STOKING: in order to cater to contingencies like stock outs, transportation delays, receipt of defective or damaged goods, and strikes, safety stocks have to be maintained. This ensures that, on the inbound side production stoppages do not occur, and, on the outbound side customers are fulfilled on time.
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SQUARE ROOT LAW WITH EXAMPLE In their aggressive effort to take cost out of logistics network, firms are searching for new ways to reduce levels of inventory without adversely effecting customer service. A currently popular approach is to consolidate inventories into fewer stoking location in order to reduce aggregate inventories and their associated cost. Correspondingly, this strategy requires the involvement of capable transportation and information resources to see that customer service is held at existing levels and is even improved whenever possible. Square root law: The square root law helps determine the extent to which inventories may be reduced through such strategy. Assuming the total customer demand remains the same, the SRL estimates the extent to which aggregate inventory needs will change as a firm increases or reduces the number of stocking location. In general, the greater the number of stoking locations, the greater the amount of inventory needed to maintain customer service levels. Conversely, as inventories are consolidated into fewer stocking locations, aggregate inventory levels will decrease. The extent to which these changes will occur is understood through application of the square root law. The square root law states that: “ the total safety stock inventories in the future number of facilities can be approximated by multiplying the total amount of inventory at existing facilities by the square root of the number of future facilities divided by number of existing facilities.” Therefore X2 = X1
N2 N1
Where: N1= number of existing facilities N2= number of future facilities X1= total inventory in existing facility X2= total inventory in future facilty EXAMPLE: A company presently distributing 40000 units of product to its customer from eight facility location throughout India is located at A, B, C, D, E, F, G and H. the company is evaluating an opportunity to consolidate its operations into two facilities. Using SRL find the total amount of inventory in the two future facility. Solution: N2 X2 = X1 N1 Here, X1= 40000 N1= 8 N2= 2 Therefore, X2= 40000 2 8 102
X2= 40000*1/2 X2= 20000
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The Number of Warehouses: The number of warehouses is another decision parameter impacting a number of cost variables and customer service. If customer service is taken in cost terms as cost of customer dissatisfaction, the number of warehouses will affect transportation, inventory, warehousing and customer dissatisfaction costs. Transportation costs initially decreases with increasing number of warehouses. This is due to the transportation economies obtained by having large-volume long-range transportation from consolidation warehouses and short-range small-volume transportation from break-bulk warehouses. However, as the number of warehouses increases beyond a certain value, the transportation cost starts increasing due to large number of transportation trips in –between the larger numbers of warehouses. Inventory costs continuously increases with the increasing number of warehouses because the increased space available needs to be utilized and firms increase the commitment of inventory at these warehouses beyond those actually needed. Transit inventory costs continuously decrease with the increased number of warehouses due to the shorter transportation times between the larger number of warehouses. The warehousing costs increase with more warehouses due to the maintenance and facility costs associated with each warehouse. For the same space, a single warehouse incurs less warehousing cost than two warehouses. The increasing number of warehousing leads to increasing customer service levels, thus, decreasing customer dissatisfaction cost. Warehouse Location Warehousing is important to the firms since it improves service and reduces co9st improvements in service are gained through rapid response to customer requests (time utility), which is a, primary factor leading to increased sales. The location decision regarding warehouses is affected by manufacturing plant, and, customer and market locations. A traditional classification by Edgar Hoover classifies warehouse locations as market-positioned, manufacturing-positioned, or intermediatelypositioned. Market-positioned warehouses Market-positioned warehouses are located near to the customers and markets (point of product consumption) with the objective of serving them. These generally have a large variety and low volume of items to service local requirements. Such warehouses reduce cost by providing place utility. A Market-positioned warehouses functions as a collection point for the products of distant firms with the resulting accumulations of product serving as the supply source for retail inventory replenishment. This approach allows large and cost-effective shipments from the manufacturer with lower-cost, local transportation providing service to individual retailers. Market-positioned warehouses may be owned by the firm or the retailer (private warehouses), or they may be an independent business providing warehouse service for profit (public). Manufacturing Positioned Warehouse Manufacturing positioned warehouse are located near to the manufacturing facilities in order to support manufacturing on the inbound side and to facilitate assortmentcreation and shipping on the outbound side. Improve customer services and 104
manufacturing support achieved through type of warehouse which acts as the collection point for products needed in filling customer orders and material needed for manufacturing. Intermediately- Positioned Warehouse Intermediately- positioned warehouse are those located between manufacturing and market-position warehouses. These help in consolidation of assortments for shipments from different manufacturing facilities. A firm may have many manufacturing plant located, for economic reasons, near the sources of raw material. Under these conditions the cost-effective warehouse may be at some intermediate point. A few of the factors governing the warehouse locations are: • availability of services; • land cost; • availability of transport linkages for example, to a rail siding; • availability of utilities of water and power; • taxes and insurance cost; • expansion space availability; • And soil strength and lay off land for drainage.
WAREHOUSE LAYOUT AND DESIGN To understand layout and design, some background information on a typical warehouse’s base space requirements is necessary. This discussion of space requirements relates quite closely to the discussion of basic warehouse operations. Before looking specifically at eh types of space a firm needs, we comment briefly about determining how much space a firm requires. This first step in determining warehouse space requirements is to develop a demand forecast for a company’s products. This means preparing an estimate in units for a relevant sales period (usually thirty days) by product category. Then the company will need to determine each item’s order quantity, usually including some allowance for safety stock. The next step is to convert the units into cubic footage requirements, which may need to include pallets and which usually include an allowance of 10 to 15 percent for growth over the relevant period. At this point, the company has an estimate of basic storage space requirements. To this the company must add space needs for aisles and other needs such as lavatories and meeting rooms. Warehouse commonly devotes one-third of their total space to non-storage functions. Many companies make these spaces decision through computer simulation. The computer can consider a vast number of variables and can help product more requirements good software packages are available. One additional warehouse space requirements provides an interface with the transportation part of the logistics system- receiving and shipping. While this can be operate, efficiency usually requires two separate areas. In considering these space needs a firm must choose whether to use the dock area outside the building or to unload goods out of the vehicle directly into the warehouse. The firm has to allow or turnaround space and possibly for equipment and pallet storage. Also important are areas for staging goods before transportation and for unitizing consolidated shipments. In addition this area may need space for checking counting and inspecting. The volume and frequency of the throughput are critical in determining receiving and hipping space needs. Another space requirements in physical distribution warehouses is for order packing and assembly. The amount of space these functions need depends upon 105
order volume and the product’s name along with the materials-handling equipment. This area’s layout is critical to efficient operations and customer service. A third type of space is the actual storage space. In a warehouse, a firm must use the full volume of the cubic storage space as efficiently as possible. A firm can derive the amount of storage space from the analysis described earlier in this section and it will largest single area in the warehouse. As with the order picking area, a firm has to consider storage area layout in detail. We cover this topic in a subsequent section. Finally a firm must consider three additional types of space. First, many physical distribution warehouses have space for recouping- that is, an area to salvage undamaged parts of damaged cartoons. Second administrative and clerical staff generally require office space. Finally, rest rooms and, employee cafeteria, utilities and locker rooms require miscellaneous space. The amount of space these last three categories require depends upon a number of variables. For example, the average amount of damaged merchandise and the feasibility of repacking undamaged merchandise determine recouping space needs. The space requirement for a cafeteria and locker rooms depend on the number of employees.
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LAYOUT AND DESIGN PRINCIPLES While the discussion thus far has delineated a typical warehouse’s various space needs, we need to consider layout in more details. We first consider some general layout design principles and then examine layout in the context of the space category previously. The most commonly accepted warehouse design and layout principles are as follows: First, use a one story facility wherever possible, since it usually provides more usable space per investment dollar and usually it is less expensive to construct. Second, use straight-line or direct flow of goods into and out of the warehouses, to avoid backtracking. A third principle is to use efficient materials handling equipment and operations. The next section explores materials-handling fundamentals. Among other benefits, materials-handling equipment improves efficiency in operations. A fourth principle is to use an effective storage plan on the warehouse. In other words, the firm must place goods in the warehouse in such a way to maximize warehouse operations and avoid inefficiencies. Stated simply, we are trying to utilize existing space as completely and effectively as possible while providing both adequate accessibility and protection for the goods we are storing. The fifth principle of good layout is to minimize aisle space within the constraints that the size, type, and turning radius of materials-handling equipment impose. We must also consider the products and the constraints they impose. A sixth principle is to make maximum use of the building’s height-that is to utilize the building’s cubic capacity effectively. This usually requires integration with materials handling. Though vehicles capable of maneuvering in small aisles and stacking higher than conventional materials can be very expensive, such equipment offers potentially large overall systems savings because using height costs works best when items are regularly shaped and easily handled, when order selection is the middle stage of activity and when product moves in high volumes with few the . A company should not make warehousing decisions once and\d then take them for granted; rather, the company should monitor productivity regularly during warehouse operations. While monitoring methods vary widely, the company should set goals and standards for cost and order-handling efficiency and then measure actual performance in a n attempt to optimize the warehouse’s productivity. By improving productivity, a company can improve its resources uses increase cash flow, profits and return on investment; and provide its customer with better service. To begin a productivity program, a company should divide warehouse operations into functional areas and measures each areas productivity, utilization and performance, focusing on improvements in labor, equipment and making comparisons with standards if they exist. Repeating measurements can show relative trends. There is no single measure of warehouse productivity, but the method the company chooses must have the following attributes validity, coverage, comparability, completeness, usefulness, compatibility and cost effectiveness.
VALUE ADDING The warehouse serves several value adding roles in a logistics system. Companies will sometimes face less than truckload (LTL) shipments of raw material and finished goods. Shipping goods long; distances at LTL rates is more costly than shipping at full truckload or carload rates. By moving the LTL amounts relatively short distances to or from a warehouse. Warehousing can allow a firm to consolidate smaller shipments into large shipment: (a car load or truckload) with significant transportation savings. 107
For the inbound logistics system the warehouse would consolidate different suppliers LTI shipments and ship a volume shipment (TL) to the firm’ plant. For the outbound logistics system the warehouse would receive a consolidated volume shipment from various plants and ship LTL shipments to different markets. A second warehousing function may be customer order product mixing. Companies frequently turn out a product line that contains thousands of “different” products if we consider, color, size shape and other variations. When planning orders, customers often want a product line mixture- for example, five dozen, four cup coffee pots, six dozen ten cup coffee pots with blue trim and ten dozen red trim and three dozen blue salad bowl sets. Because companies often produce items at different plants, a company that did not warehouse goods would have to fill orders from several locations causing differing arrival times and opportunity for mix-ups therefore a product mixing warehouse for a multiple product line leads to efficient order filling. By developing new mixing warehouses near dense urban areas, firms can make pickups and deliveries in smaller vehicles and schedule these activities at more optimum times to avoid congestion. In addition to product mixing for customer orders, companies sing raw materials or semi finished goods(e.g. auto manufacturer) company move carloads of terms mixed from a physical supply warehouse to plant. This strategy not only reduces transportation costs from consolidation but also allows the company to avoid using the plant as a warehouse. This strategy will become increasingly popular as increased fuel expenses raise transport costs and firm increase the use of sophisticated strategies such as materials requirements planning (MRP) or just in time (JIT) system. Cross -Docking is an operation that facilitates the product mixing function. In cross docking operations products from different suppliers arrive in truckload lots but instead of being placed into storage for later picking they are moved across the warehouse area waiting trucks for movement to particular customers. The incoming materials are picked from the delivering truck from temporary storage locations to fill a specific order and moved across the deck to a truck destined for the customer. The whole process is completed in a matter of hours. Excess product and small items are stored temporarily to await scheduled deliveries and to permit sorting of inbound loads of mixed products. A third warehouses functions is to provide service. The importance of customer service is obvious. Having goods available in a warehouse when a customer places an order, particularly if the warehouse is in reasonable proximity to the customer usually leads to customer satisfaction and enhances future sales. Service may also be a factor for physical supply warehouses. However, production schedules, which a firm makes in advance, are easier to service than customers while customers demands is often uncertain physical supply stock outs costs sometimes seem infinite. A fourth warehousing functions is protection against contingencies such as transportation delays vendors stock outs or strikes. A potential trucker’s strike will generally cause buyers to stock larger inventories than usual; for example this particular function is very important for physical supply warehouse in that a delay in the delivery of raw material can delay the production of finished goods. However, contingencies also occur with physical distribution warehouses- for example, goods damaged in transit can affect inventory levels and order filling. A fifth warehousing function is to smooth operations or decouple successive stages in the manufacturing process. Seasonal demand and the need for a production run along enough to ensure reasonable cost quality are examples of smoothing- that is preventing operations under overtime conditions at low production levels. In effect, this balancing strategy always a company to reduce its manufacturing capacity investment. 108
As we can see warehouse functions can make important contributions to logistics systems and company operation. However, we must also view warehousing in a tradeoff context; that is warehousing’s contribution to profit must be greater than its cost.
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8. MATERIAL HANDLING Definition of material handling “Material handling is defined as the art and science of moving, storing of substances in a form.”
packaging and
Other definitions include: a) Creation of time and place utility b) Movement and storage of material at the lowest possible cost through the use of proper methods and equipments. c) Lifting, shifting and placing of material which effect in a saving in money, time and place. d) Art and science of conveying, elevating, packaging and storing of materials.
SCOPE OF MATERIALS HANDLING The scope of materials handling activity within an organization depends on the type of product manufactured, the size of organization, the value of the product and the value of the activity being performed and the relative importance of materials handling to the enterprise. There are three perspectives about materials handling viz: a) The traditional point of view. b) Plant wide – concern for overall flow of materials. c) The system point of view. In the traditional point of view of materials handling, the emphasis is on the movement of materials from one location to another within the confines of the individual plant. The concern is to find the best way to move the materials from one place to another within the planrt. Plant wide concern focuses the attention on the overall flow of materials in the plant. The main concern is te hinter-relationship between all the handling problems and the possibility of establishing an overall materials handling plan. The systems point of view of material handling requires visualization of material handling problems, the physical distribution activities, and all closely related functions as one, an all – encompassing system. This point of view involves a much broader considerations of materials handling activities involving the movement of material from all sources of supply (vendors), all handling activities witin and around the plant and the activities involved in the distribution of finished goods to all customers of thr firm.
IMPORTANCE OF MATERIAL HANDLING 1. Efficient materials handling is important to manufacturing operations. Materials sent by vendors must be unloaded, moved through inspections and production operations to stores and finally to the shipping departments. This movements donot add value to the product but, they do add to the cost. 110
2. materials handling analysis is a subset to plant layout and materials handling are all part of design of a production facility and can hardly be treated as separate. Materials handling system and plant, enhance effectiveness of each other. A good plant layout enables an operation to use the most effective handling method. Efficient operation of appropriate materials handling methods reduces costs and enables maximum capabilities to be derived from a given production facility.
OBJECTIVES OF MATERIALS HANDLING Even though the best solution to the materials handling problem, is no handling, it is hardly practicable in the manufacturing process. Hence, the main objective of materials handling is to reduce the number of handling equipments and reducing the distances through which the materials are handled. Other objectives of materials handling are: 1. lower unit materials handling costs. 2. reduction in the manufacturing cycle time through faster movements of materials and by reducing the distance through which the materials are moved. Reduction in manufacturing cycle time results in reduced work in progress inventory costs. 3. contribution towards a better control of the flow of materials through the manufacturing facility. 4. improved working conditions and the greater safety in the movement of materials. 5. contribute to better quality by avoiding damage to products by inefficient handling. 6. increases storage capacity through better utilisation of storage areas. 7. higher productivity at lower manufacturing cost.
MATERIAL HANDLING PRINCIPLES Certain principles have evolved to guide facility layout to ensure efficient handling of materials. Although, there are no hard and fast rules, they do provide effective guidelines for the efficient movement of materials in most facility layouts. Principle 1: Materials should move through the facility in direct flow pattern, minimizing zigzagging or backtracking. Principle 2: Related production processes should be arranged to provide for direct material flows. Principle 3: Mechanized materials handling devices should be designed and located so that human effort is minimized. Principle 4: Heavy and bulk materials should be moved the shortest distance during processing. Principle 5: The number of times each material is handled should be minimized. 111
Principle 6: Systems flexibility should allow for unexpected breakdowns of materials handling equipments, changes in production system technology, etc. Principle 7: Mobile equipments should carry full loads all the times. These seven principles can be summarized as follows: 1. Eliminate Handling: If not, make the handling distance as short as possible. 2. Keep Moving: If not, reduce the time spent at the terminal points of a route as short as possible. 3. Use simple patterns of material flow (the simplest path is a straight line path of flow which minimizes the handling distance between two points). If not, reduce backtracking, crossovers and other congestion producing patterns as much as possible. 4. Carry pay loads both ways: If not, minimize the time spent in ‘transport empty’ by speed changes and route locations. 5. Carry full loads: If not, consider increasing the size of unit loads, decreasing carrying capacity, lowering speed, or acquiring more versatile equipment. 6. Use Gravity: if not, try to find another source of power that is reliable and inexpensive. In addition to the above guidelines, there are certain other very important aspects of materials handling, such as the following: a. Materials handling consideration should include the movement of men, machine, tools and information. b. The flow system must support the objectives of receiving, sorting, inspecting, inventorying, accounting, packaging and assembling. Since the consideration and objectives do conflict, it is essential to take a systems decision followed by delicate diplomacy to establish a material movement plan that meets service requirement without subordinating safety and economy.
MATERIAL HANDLING COSTS The costs of materials handling arise from two sources: 1. the cost of owning and maintaining equipment. 2. the cost of operating the system. While the costs of owning the equipment are generally known since entries are available in the books of accounts, the cost of operating the handling system are hard to pin down as records are not generally maintained. Every effort has to be made to reduce materials handling costs, particularly because they do not add any value to a product. The product will not be worth any more toi the consumer simply because it was moved, but it will still cost the consumer more. How to reduce handling costs? 112
There are three fundamental ways of minimizing the costs: a) eliminating the handling itself whenever and wherever possible. b) Mechanizing, largely by conveyors and power driven trucks, whatever handling still remains. c) Making the necessary handling more efficient. Primary requisite for any action to be taken towards minimizing handling costs is to have a record maintained for them. It is here that majority of the companies are not doing the right thing.
Factors affecting the selection of materials handling equipments The selection of materials handling equipments requires consideration of and attaining of proper balance between the following factors: i. ii. iii.
Production problem. The capabilities of the handling equipment available. The human element involved.
The ultimate aim is to arrive at the lowest cost per unit of materials handled. (i) The production problem factors are: a. Volume of the production t obe attained. b. Class of materials to be handled. c. The layout of plant and building facilities. For example: the handling equipment which can be economically justified for the manufacture of 1000 TV sets per day would be entirely different from the handling equipment needed in a plant manufacturing 20 steam turbine generators I na year as the production rate, weight and class of materials needed are different. (ii) Capabilities of the handling equipments available are: a. Adaptability: The load carrying and movement characteristics of the equipment should fit the material-handling problem. b. Flexibility: Wherever possible, the equipment should have the flexibility to handle more than one material, class or size. c. Load Capacity: Equipment selected should have enough load-carrying characteristics to do the job effectively. d. Power: The equipment should have enough power available to do this job. e. Speed: The speed of movement of the handling equipment should be as high as possible, within the limits of production process and plant safety. f. Space Requirements: The required to install or operate materials handling equipment is also an important consideration. g. Supervision required: The degree of automation in the handling equipment decides the amount of supervision required. h. Ease of maintenance: Equipment selected should be capable of easy maintenance at reasonable cost. 113
i. Environment: Equipment selected must conform to any environmental regulations. j. Cost: The cost of the equipment (capital investment) is an obvious factor in the selection. The various kinds of costs to be considered in addition to the initial purchase price of the handling equipment are: a. Operating Costs b. Installation Costs c. Maintenance Costs d. Power Requirements e. Insurance Requirements f. Space Cost g. Depreciation Cost h. Salvage Value i. Time Value of money invested j. Opportunity Cost (iii) The human elements/factors cannot be overlooked in the selection of materials handling equipment. They are: a. The capabilities of the available manpower to operate the equipment. b. Safety of personnel (those who operate it or come in contact with it)
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TYPES OF MATERIAL HANDLING SYSTEMS The materials handling systems can be classified according to the type of handling equipment used, type of material handled and the methods, need or functions performed. The Classifications are: 1. Equipment oriented systems depending upon the type of equipment used. They are: a) b) c) d) e) f)
Overhead Systems Conveyor Systems Tractor Transfer Systems Fork-lift Truck and Pallet Truck Systems Industrial Truck Systems Underground Systems
2. Material oriented systems consisting of the following types: a) Unit handling Systems b) Bulk Handling Systems c) Liquid handling Systems 3. Method oriented systems can be of the following types: a) Manual Systems b) Mechanized or automated Systems c) Job-Shop Handling Systems d) Mass Production Handling Systems 4. Function oriented Systems: a) Transportation systems b) Conveying Systems c) Transferring Systems d) Elevating Systems The materials handling equipments are classified into four basic types, viz. conveyors, cranes and hoists, trucks and auxiliary equipment.
TYPES OF MATERIALS HANDLING SYSTEMS 1. CONVEYORS These are gravity or powered devices, commonly used for moving loads from point to point over fixed paths. The various types of conveyors are: a) Belt Conveyor: Motor driven belt, usually made of rubberized fabric or metal fabric on a rigid frame. b) Chain Conveyor: Motor driven chain that drags materials along a metal slide base. c) Roller conveyor: Boxes, large parts or unit lands roll on top of a series of rollers mounted on a rigid frame. 115
d) Pneumatic Conveyor: high volume of air flows through a tube, carrying materials along with the airflow. The other types of conveyors are bucket conveyor, screw conveyor, pipeline conveyor, vibratory conveyor, trolley conveyor, and chute or gravity conveyors. Advantages of conveyors are that they do not require operators, will move a large volume of products and inexpensive to operate. 2. CRANES, ELEVATORS AND HOISTS These are overloaded devices used for moving various loads intermittently between points within an area, fixed by supporting and binding rails. a) Cranes are devices mounted on overhead rails or ground level wheels or rails. They lift, swing and transport large and heavy materials. Examples are Gantry Crane, Jib Crane and Electrically Operated Overhead Crane (EOTC). b) Elevators are a type of cranes that lift materials usually between floors of buildings. c) Hoists are devices, which move materials vertically and horizontally in a limited area. Examples are Air Hoists, electric hoists and chain hoists. 3.
INDUSTRIAL TRUCKS
These devices are used for moving mixed or uniform loads intermittently over variable paths. They are electric, diesel, gasoline or liquefied petroleum, gas powered vehicles equipped with beds, forks, arms or other holding devices. Examples are forklift trucks, pallet trucks, tractor with trailers, hand trucks and power trolleys. 4.
AUXILIARY EQUIPMENTS
These are devices or attachments used with handling equipment to make their use more effective and versatile. Examples are ramps, positioners, pallets, containers and turn-tables.
MISCELLANEOUS HANDLING EQUIPMENTS 1.
Pipe Lines, which are closed tubes that transport liquids by means of pumps or gravity.
2.
Automatic transfer devices, which automatically grasp materials, hold them firmly while operations are being performed and move them to other locations.
3.
Automated guided vehicle (AGV) Systems: These devices do not require operations and provide a great deal of flexibility in the paths they travel and the functions they perform and the AGVs are controlled by signals sent through the wires embedded in the floor or inductive tape on the floor surface. A remote control computer is needed to control the movement of AGVs.
4.
Industrial Robots: a robot is a mechanism that has a movable armlike projection with a gripper on the end that can perform a variety of 116
functions with the control that can be reprogrammed and hence they are very versatile. The process design and the principles of efficient materials handling provide the framework for selecting specific materials handling devices as the core of the materials handling system. Each of the handling devices has its own unique characteristics and advantages and disadvantages.
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9. INVENTORY CONTROL Inventory is any stock of economic resources that is stored for future us e it is commonly used to store materials, in process, packing materials, spares etc, stocked in order to meet respected demand or distribution in the future. Although inventory of any materials is an idle resource, in the sense it is not meant for immediate use. It is necessary to maintain some inventories for the smooth functioning of the organization. Inventories are essential: 1. For adequate customer service. 2. To take advantage of price discounts by bulk purchasing. 3. To make possible economics in transportation and clearing & forwarding charges. 4. To maintain service stocks while replacement stocks are in transit. 5. To serve as a buffer in case of shop rejections and delayed deliveries. 6. To maintain smooth supply chain. Demerits of excess inventory 1. Lock up of capital. 2. Cost involved in carrying inventory, storage place, personnel, records etc. 3. Risk of deterioration. 4. Risk of obsolescence- model changes. 5. Changes in price- if low, or loss. Inventory control and its advantages 1. Keeping investment low 2. Ensures timely availability. 3. Allows full advantage of economics. 4. Reduces stock out chances. Types and examples of inventories: Several types of inventories are maintained by the organizations. Some of the major inventories are 1. Raw materials Inventory 2. Finished goods Inventory 3. Semi finished goods Inventory 4. Spare parts and supplies Inventory Some specific examples of Inventory are: a. Items on shelves of departments and food stores. b. Unused telephone numbers the phone company is holding c. Cash on hand and bank reserves. d. Blood in blood banks. e. Standby pilots and stewardesses employed by the air lines. f. Empty space in warehouse for incoming shipments.
Inventory functions The following is the list of the major reasons for maintaining an Inventory a) Protect against irregular demand: Inventories are kept to meet fluctuating demand. For example, blood is stored in blood banks in quantities, sufficient to meet the needs of major accidents b) Protect against irregular supply: a strike by the suppliers employees is one reason why deliveries may not reach on time. Lacks of materials at supplier’s level, strikes in transportation network are other possible reasons for delays in supply. Inventory is used as buffer that can be used until late deliveries arrive. 118
c) Protection against inflation: Inventories are often kept as a hedge against inflation. In this case inventories are building up in anticipation of price increase. This speculative practice is common in commodity markets. d) Benefits of large quantities: purchasing quantities of an item often entities the buyer to a discount. Similarly in case of manufacturing large production lots, the utilization of make efficient automotive equipment can be justified by reducing the per unit manufacturing cost. e) Saving the ordering cost: ordering in large quantities reduces the number of time the order must be placed and processed. Since the fixed cost is associated with placing each order, the fewer one places an order, the lower the total cost of ordering will be. f) Other reasons: Inventories are kept for several other reasons; an Inventory may improve the bargaining power of firm with a supplier (or with its own employees) by making the company less dependent on them. Inventories are also kept so that machine can be shut down for overhands. An Inventory of labor is maintained to meet fluctuating production demands in order to reduce hiring, firing and training costs
THE STRUCTURE OF THE INVENTORY SYSTEM The Inventory system involves a cyclical process, which is assumed to run over several, periods, whose major characteristics are: a) Inventory level: an item is stocked in a warehouse, store, or any other storage area. This stock continues an Inventory. The size of the Inventory is called the Inventory level (or Inventory on hand). b) Depletion: the Inventory is depleted as demand occurs. Assume that one starts with an Inventory of 100 units. As time passes the Inventory is reduced. The rate of demand can be constant (e.g. three units on the first day and seven on the second). A constant demand reduces the Inventory leveling equal steps. c) Reordering: to rebuild an inventory, the item is replenished periodically. When the inventory level is reduced to a certain level called the reorder point, a replenishment order is placed. The time between reordering and receiving is called lead-time. d) Replenishment, shortages and surpluses: in most basic inventory models, it is assumed that the reordering is scheduled so that the replenishment will arrive exactly when the inventory level reaches zero. Such an assumption holds if the demand is constant. However, if the demand fluctuates and the lead-time varies, the shipment may arrive either before or after the stock is completely depleted, that is the depletion and replenishment does not coincide. In such a case as surplus or shortage will occur. If the shipment arrives after depletion, then the demand cannot be met and shortage will occur. When the shipment arrive prior depletion, an inventory level larger than zero or surplus exists. e) Safety stock; shortages can be eliminated or reduced by deliberately building up a safety stock. It is the extra inventory held against the possibility of stock out. f) The average inventory: the balance of inventory on hand, in case of constant demand, it is about half the maximum inventory. g) Basic inventory decisions: the major decisions the management makes in the inventory area are: How much to order at one time (what order quantity should be) When to order this quantity (what the reorder point should be) 119
Should safety stock be build up? How large should it be?
INVENTORY CARRYING COSTS Inventory carrying costs refers to the cost of handling stocks. The following elements constitute the Inventory carrying costs a) Capital cost is an important item in determining the cost of carrying inventory. Capital cost is either the cost of borrowing capital or the cost of diverting companies’ funds to invest in inventories. The former means the interest rate the later implies the foregone opportunity cost. There are thus two methods of determining capital cost. The first method is to use the bank lending rate, if the money were to be borrowed. The other method is to consider the opportunity cost of the money (the return that the money will yield if invested elsewhere). b) Storage cost: includes cost of storage (i.e. annual rent or depreciation), cost of preservation (i.e. rust preventive oils and greases), cost of record keeping, and cost of periodic/ annual stock verification etc. Depreciation of the stores building can be located under separate schedules of the balance sheet and is usually given for the total area. Having obtained the total figure, as a part of it (ratio of stores building and the total area) could be considered to calculate the storage space cost. Some of the elements of the storage cost are fixed and hence are to be incurred irrespective of the inventory volume. A certain amount of space is made available and must be lighted, and maintained. Wages of the personnel can never be curtailed even when their workload is reduced. Similarly no saving can result if space released is significant and even if it is substantial it is just not possible to anticipate what savings will accrue to the company. One may therefore question the validity of using the storage cost as a control tool when most of the elements of this cost are fixed. The solution lies in considering only the variable expenses, those, which increase or reduce with rise or fall in inventory investment. c) Deterioration and obsolescence: deterioration is the loss from reduction in the inventory value due to one or more of the following reasons: The part/item/material may have limited shelf life and hence may deteriorate if stored for a long time, e.g. rubber parts may crack after approximate six months life, and for example, ammonia sheets may spoil if stocked beyond three months. Many a time s stock are built up without knowledge of deterioration and this is exactly what happened at one of the leading companies in India. A certain item was found to be sufficient for the next 10 to 12 years, while the life of the item was hardly five years. Yet, another company had more or less similar problem. It used to import potting compound, its shipment time being 3 months. It was generally found that the compound lost its functional property because of its short life. The company therefore decided to get the shipment by air, the quantity just enough to meet immediate requirement of the item. The items also deteriorate when the storage conditions are inadequate, unsatisfactory or both. Some of the parts may also get damp, dried up, or spoiled Deterioration can also result from poor handling of the stores. Some of the fragile items may collide with other and break. This process of deterioration, thus, reduces the value of the stocks and they may not be now worth the value recorded in the accounts book. An adjustment has to be made to avoid fictitious stock values to appear in the financial documents. This is done by writing of the certain amount (equal to the difference between the values of the items 120
as per accounts books minus the value to be realized from the disposal of such items) at the time of preparation of financial statements. T is this amount – the amount written off – that is to be considered to compute deterioration as an element of carrying cost. Obsolescence is the loss from reduction in inventory value of the items/ components that are rendered unusable by the company due to changes in design or due to developments in the field. The risk of Obsolescence varies from industry to industry and is obviously greater in those industries where modifications are frequent and new developments are regular. The problem is still severe in industries producing fashion goods. That is why many progressive business firms tend to get rid of their surplus stocks which otherwise would become obsolete by some sort of periodic action such as clearance sales etc. d) Insurance cost: inventories, like other assets, are covered by insurance cost is thus the premium paid or payable to cover the company against loss due to unforeseen acts such as fire, theft etc. PROCUREMENT COST: Procurement cost is also called ordering cost, replenishment cost or recumbent cost is the cost incurred to replenish the stock of an item. It is in fact, the cost incurred at different stages of the procurement function & is obtained by dividing the cost of activities like requisitioning order writing, orders follow up, receiving and inspection, records keeping, and bill payment per period by the number of orders processed during the period. Procurement cost, therefore, represents average cost to be expended to place an order and execute the delivery once. Basic elements of procurement cost are as under: (a) Paper work cost: The procurement function is built around paper work since all orders, small or big, need paper work. Purchasing function sets out with paper work (materials requisitions) pushes through paper work (enquiry forms, purchase order forms, goods receipt notes, inspection notes stores receipt notes) and ends up with paper work (cheques to pay suppliers invoices). The requirements of this paper work vary directly with the order frequency and its cost is considered as one of the elements of procurement cost. (b) Postage cost: Postage cost is the cost expended to mail documents necessary to the business transaction. Purchase orders are sent to authorize vendors to supply the goods, delivery schedules are mailed communicate immediate as well as future requirements, amendments to purchase orders are issued to alter \ modify quantity, price or other terms, goods inspection notes: are posted to acknowledge receipts of materials & inform inspection results, discrepancy notes are sent to highlight shortage in the quantities received, cheques are dispatched to settle suppliers bills etc. Postage cost is also incurred for the exchange of statement of accounts; debit notes credit notes & other documents required in the transaction. (c) Follow up cost; Follow up cost is the function of seeing that the suppliers affect deliveries on time. The Follow up function nowadays has become the foremost function of the buyers. Vendors be it small manufacturers, traders or a supplier at a distance takes little initiative in delivering the goods on time. Major portion time of the buyers, therefore, is spent in purchase follow up; pre delivery follow up & shortage chasing. Telephones, trunk calls, telegrams & telex are the aids commonly used by the buyers for the pre-delivery follow up as well as for shortage chasing. The costs on such communication Medias is yet another major element of procurement cost. 121
(d) Costs of visits to the vendors plants: Follow up with the vendors at times requires visits by purchase personnel & therefore costs of such visits are considered towards procurement cost. (e) Expediting cost: Follow up with the vendors enables buyers to secure advance information of expected delays. Pre-delivery follow up enables buyer: To make alternates arrangements (i.e. request other suppliers for early delivery). To decide expedited routing of goods from suppliers. For the single-source items, the buyers in the event of delaying may have no choice but to dire expedited routing of goods. The difference between the expedited routing costs and order routing costs, if borne by the buyer too forms a part of procurement cost. (f) Operating cost of vehicles; Vehicles are employed for collection & delivery of materials from / and to the vendors, collection materials from transporters / railways godown etc. The operating cost of such vehicles should be considered (if the vehicle is exclusively used by the materials department for buying materials for local market, to chase vendors and / or to bring goods to the plant). As yet another element procurement cost. (g) Inspection & testing: Inspection & testing costs include cost of destructive test. Too frequent purchases increase inspection costs. (h) Administrative costs; Purchase is a major function & it requires performance of number of activities. Indents are to inform the purchase department of the impending need, inquiries are floated, quotations received, rates are compared, terms of payment are looked into and then an order is placed suppliers whose terms are attractive, progress on the order is reviewed and follow up with supplier done wherever necessary materials on arrival are checked for quantity & inspected for quality suppliers invoices are received, verified and paid for. All these activities add – up into big expenses, the salaries being the main expense. Other related expenses of these activities are indirect wages, gratuity, bonus ESIC provident fund, depreciation on office equipment etc.
SELECTIVE CONTROL: Selective control means variations in method of control from item to item based on selection basis. The criterion used for the purpose may be cost of item, critically, lead to consumption, procurement difficulties, or something else. Various classifications are employed render selective treatment to different types of materials, each classification emphasizes in of particular aspect. For example, ABC analysis emphasizes usage value (i.e. consumption of items in terms of money), VED analysis considers critically, HML employs prize criterion and SDE analysis is based on procurement difficulties. Selective control can be divided into 8 types as per table: Classification Criterion employed Usage value (i.e. consumption 1. ABC analysis. per period x prize per unit). 2. HML analysis High-Medium- Unit price (i.e. it doesn’t take Low). consumption into account). 3. VED analysis Vital-Essential- Critically of the item (i.e. loss of Desirable). production). 4. SDE analysis (Scarce-DifficultProcurement difficulties. Easy). 122
5. GOLF analysis (GovernmentOrdinary-local-Foreign). 6. SOS analysis (Seasonal-OFFSeasonal). 7. FSN analysis (Fast-Slow-Non Moving). 8. XYZ analysis.
Source of procurement. Seasonality. Issue from stores. Inventory investment.
ABC ANALYSIS ABC analysis underlines a very important principle ‘vital few trivial many’. Statistics reveal that just a handful of items account for bulk of annual expenditure on materials. These few items are called ‘A’ items, therefore hold the key to business. Are numerous in numbers but their contribution is less significant. ABC analysis thus tends segregate all items into three categories: A, B and C on the basis of their annual usage. The categorizations made enables us top ay the right amount of attention as merited by the items. A-items: It is usually found that hardly 5 to 10 % of the total items account for 70 to 75% of total money spent on the materials. This items required detailed and rigid control and need to be stock in smaller quantities. These items should be procured frequently, the quantity occasion being small. A healthy approach, however, would be to enter into contract with the manufacturer of this items and have their supply in stagger lots according to pre determine programme of the buyer. This however will be possible when the demand is steady. Alternatively, the inventory can be at minimum by frequent ordering. B-items: This item are generally 10 to 15 % of the total items and represent 10 to 15 % of the total expenditure on the materials. These are intermediate items. The control on this item need not be as detail and as rigid as apply to A items C- items: These are numerous (as many as 70 to 80% of the total items), inexpensive (represent hardly 5 to 10% of total annual expenditure on materials), and hence insignificant (do not required loose control) items. The procurement policy of these items is exactly the reverse of A items. Items should be procured infrequently and in sufficient quantities. This enables the buyer to avail price discount and reduce workload of the concern department. Conducting ABC Analysis To conduct ABC Analysis, following 6 steps are necessary: 1) Prepare the list of the items and estimate their annual consumption (units) 2) Determine unit price (or cost) of each item 3) Multiply each annual consumption by its unit price (or cost) to obtain its annual consumption in rupees (annual usage) 4) Arrange items I ascending order of their annual usage starting with the highest annual usage down to the smallest usage 5) Calculate cumulative annual usages and express the same as cumulative usage % so express the number of items into cumulative item percentages 6) Plot cumulative usage percentage against cumulative item percentages and segregate the item to A, B, C categories 123
ABC Analysis can be applied almost to all aspects of material management such as: (a) Purchasing, (b) receiving, (c) inspecting, (d) store keeping and (e) issue of store, (f) verification of bills, (g) inventory control and, (h) value analysis etc. Purpose of A-B-C Analysis: - To separate the pre dominant few from vast majority of items whose annual consumption is very low - To avoid wasteful expenditure - To give selective control - For better purchase policy to give maximum attention to A items - For better pre-design and pre purchase analysis - Effective value analysis - Realistic marker research - Development of reliable source of supply and - Better follow up A B C Very tight control on inventoryModerate control Loose control Only exact requirement to beMore or less procured requirement
exact
On estimated usage
Posting of individual issues in Individual posting Collective posting stores card Continuous check on production schedule and aBroad check Hardly any check revision of delivery deals Low safety stock. BiVery low safety stock if Fairly large safety monthly ordering or possible non at all stock by Ordering Quarterly Regular expediting and follow No follow up Some follow up up & reduction in lead time necessary Desirable Very strict consumptionPast consumption is consumption comes control used as basis with less attention Accurate material planning needed with respect toPast consumption is the Rough estimate forecasts. Data base shouldbase be accurate & up to date Concerted effort of costModerate attempts areAnnual review reduction. enough suffices
HML ANALYSIS . H-M-L Analysis is similar to ABC analysis, except for the difference that instead of usage price criterion is used. The items under this analysis are classified into three groups, which are called high, medium and low. To classify, the items are listed in the descending order of Unit price: the management for deciding the three categories then fixes the cut of lines. For example, the management may decide that all items of unit. Price above RS.1000 will be category, and those having unit price between Rs100 to Rs.1000 will be of 'M' category, and having unit price below RS.100 will be of 'L' category. 124
HML analysis helps to # Assess storage and security requirements e.g. high priced items like bearings, worm wheels, etc. (required to be kept in cupboards). # To keep control over consumption at the departmental head level e.g. indents of high medium priced items are authorized by the departmental head after careful scrutiny of the consumption figures. # Determine the frequency of stock verification, e.g. high priced items are checked more frequently than low priced items. # To evolve buying policies to control purchases. e.g. excess supply than the order quantity may be accepted for 'H' and 'M' groups While it may be accepted for 'L' group. # to delegate authorities to different buyers to make petty cash purchases, e. g 'H' and 'M' . may be purchased by senior buyers and ‘L’ items by junior buyers
VED Analysis VED analysis represents classification of items based on criticality. The analysis classifies the items into three groups called Vital, Essential and desirable. Vital category encompasses those items for want of which production would come to a hault. Essential group includes items whose stock out cost is very high and desirable group comprises of items, which do not cost any immediate loss of productions. The stock out of these items entail nominal expenditure and cause major disruptions for a short duration. VED analysis is best suited for spare inventory. Infact it is advantageous to use more than 1 method. E.g. ABC & VED analysis together would be helpful would be helpful for inventory control of spares.
SDE - ANALYSIS SD E analysis is based on problems of procurement namely: # Non-availability # scarcity # longer lead time # Geographical location of suppliers and # Reliability of suppliers etc, S-D-E analysis classifies the items into three groups called 'Scares', 'Difficult' and 'Easy. The information so developed is then used to decide purchasing strategies. 'Scarce' classification comprises of items which are in short supply, imported or Chanalised through government agencies. Such items are best to procure once a year in lieu of effort and expenditure involved in the procedure for import. 'Difficult' classification includes those items, which are available indigenously but are not easy to procure. Also items which come from far off distance and for which reliable sources do not exist fall into this category. Even the items, which are difficult to, manufacture and only one or two manufacturers are available belong to this group. Supplies of such items require several months of advance notice. 'Easy' classification covers those items, which are readily available. Items produced to commercial standards, items where supply exceeds demand and others which are locally available fall into this group. The S-D-E analysis is employed by the purchase department: 125
(i) To decide on the method of buying. E.g. Forward buying method may be followed for some of the items in the 'Scare' group, scheduled buying and contract buying for Easy group. (ii) To fix responsibility of buyers. E.g. senior buyers may be given the responsibility of 'S' and 'D' groups while items in 'E' group may be handled by junior buyers or even directly by storekeeper.
G-NG-LF ANALYSIS / GOLF ANALYSIS The G-NG-LF analysis (or GOLF analysis) like S-D-F analysis is based on the nature of the suppliers, which determine quality, lead-time, and terms of payment, continuity or otherwise of supply and administrative work involved. The analysis classifies the items into four groups namely G, NG, L and F. 'G' group covers items procured from 'Government' suppliers such as the STC, the MMTC and the public sector undertakings. Transactions with this category of suppliers involve long lead-time and payments in advance or against delivery. 'NG' (0 in GOLF analysis) group comprises of items procured from 'Non-Government (or Ordinal Suppliers. Transactions with this category of suppliers involve moderate delivery time, end availability of credit, usually n the range of 30 to 45 day. 'L' group contains items bought from 'Local supplier the items bought from local suppliers are those which are cash purchase or purchased on blank orders. . 'F' group contain those items, which are purchased from 'Foreign suppliers'. The transactions will such suppliers, . # Involve a lot of Administrative and procedural work. # Require initial clearance from government agencies such as DGTD. # Necessitate search-of foreign suppliers. # Require opening of letter of credit. . # Require making of arrangement for shipping and port clearance.
S-OS ANALYSIS S-OS analysis is based on seasonality or otherwise of the items. The analysis classifies the item into two groups: SOS (I.e. seasonal) and OS (off -seasonal). The analysis identifies items, which are: (i) Seasonal items are available only for a limited period. For example, agriculture products like raw mangoes, raw material for cigarette and paper industries, etc, are available for a limited time am therefore such items are procured to last the full year. (ii) Seasonal but are available throughout the year. Their prices however, are lower during the harvest time. The quantity of such items requires to be fixed after comparing the cost saving due to lower prices against higher cost of carrying inventories. (iii) Non-seasonal items whose quantity is decided on different considerations.
F-S-N ANALYSIS F-S-N analysis is based on the consumption figures of the items. The items under this analysis are classified into three groups: F (Fast moving), S (Slow moving) and N (Non moving). 126
To conduct the analysis, the last date of receipt or the last date of issue whichever is later is taken into account and the period usually in terms of number of months that has elapsed since the last movement is recorded. Such an analysis helps to identify: (i) Active items which require to be reviewed regularly. (ii) Surplus items whose stocks are higher than their rate of consumption and (iii) Non moving items which are not being consumed. The last two categories are reviewed further to decide on disposal action to deplete their stocks and thereby release company's productive capital. Further detailed analysis is made of the third category in regard to their year-wise stocks and the items can be sub-classified. As non-moving for 2 years, 3 years, 5 years and so on.
X-Y-Z ANALYSIS X-Y-Z Analysis is based on value of the stocks on hand (i.e. inventory investment). Item whose inventory values are high are called X items while those whose inventory values are low are called Z items, Y items are those, which have moderate inventory stocks. Usually X-Y-Z analysis is used in conjunction with either ABC analysis or HML analysis. X-Y-Z analysis when combined with ABC analysis is used as under. Class Of Items
A
B
C
X
Efforts to be made Effort to be made Steps to be taken to reduce stock to convert them to Y dispose off surplus Z category category stocks
Y
Efforts to be made * to convert to Z category
Z
*
Control may be further tightened
Stock levels may be * reviewed twice a year
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TYPES OF EOQ MODELS There are different EOQ models. The most classical model was first proposed by Wilson in 1928 is popularly known as EOQ (economic order quantity) model or Wilson lot size formula. BASIC (Wilson) EOQ model with infinite replenishment rate. Assumptions underlying the EOQ model: 1. The demand of the item occurs uniformly over the period at the known rate. 2. The replenishment of the stock is instantaneous. 3. The time that elapses between the placing a replenishment order and receiving the item into stock, called lead-time is zero. 4. The price per unit is fixed and is independent of the order size. 5. The cost of placing an order and process the delivery is fixed and does not vary with the size. 6. The inventory carrying charges vary directly and linearly with the size of the inventory as is expressed as a percentage of average of average inventory investment. 7. The item can be produced in quantities desired there being no restriction of any kind. 8. The item is fairly long shelf life, there being no fear of deterioration or spoilage. Nowadays an EOQ technique is not much in use because an open order with delivery schedule can be placed on a supplier for all future periods. This keeps down the purchasing cost. With the availability of computer links (networking techniques/email etc) between the buyer and the supplier there is no need to physically raise a purchase order, avoiding major purchasing cost. At the same time computer helps in ensuring Just in time inventory. Limitations of EOQ The assumption listed above may not come true in real life situations, thus limiting the use of model. Price of material may not come remain same through out the year. Availability of materials is another constraint material will have to be purchased at the time at which is available. There can be delay in real situation in placing orders since many times the calculated EOQ is an inconvenient number and some time is wasted in taking decision for rounding off this number. In real situations suppliers receive n irregular. Availability of materials is another constraint material will have to be purchased at the time at which is available. There can be delays in real situation in placing orders since many times the calculated E.O.Q. is inconvenient number & some time is wasted in taking decision for rounding off this number. In real situations suppliers receive an irregular stream of orders since the use of E.O.Q. usually leads to orders at random points. If suppliers are allowing discounts & if quantities are purchased above a particular level, the discount will also have to be taken into consideration for fixing the ordering quantity. Also purchasing costs are nowadays reduced to a great extent because of computer links between buyer & seller. So in practice purchasing cost & inventory carrying cost are not exactly opposite to each other. Often the inventory carrying cost 128
& purchasing cost cannot be identified accurately & sometimes cannot be even identified properly.
Replenishment systems: One of the jobs of the materials department is to ensure uninterrupted supply of materials to the production department. To accomplish this task, the materials department has to monitor the stock levels and place orders regularly. Two questions that arise are-when to place and order? And what quantities to order? Two main systems are followed for the same 1) Fixed order quantity system 2) Fixed order interval system Each system has certain conditions, which govern the circumstances of its use.
Fixed order quantity system (Q-System of Inventory):
Here the quantity to be ordered is worked out as the economic order quantity (EOQ), and the minimum stock level is also worked out. When the stock in hand reaches this level, an order is placed for a quantity equals to the EOQ.
Features of fixed-order-quantity system: a) Reorder quantity is always the same, which is equal to the EOQ. b) The time interval between the orders varies. c) Reordering is done when the stock in hand is equal to safety stock plus the leadtime consumption (This is known as the reorder level). d) Average inventory is equal to safety stock + Q/2 e) Maximum inventory will be equal to safety stock + Q f) Minimum inventory equals the safety stock. g) This system is normally used for items of lower value where orders are placed infrequently and the lead-time average consumption etc is fairly constant. To operate this system it is necessary to post the receipts and issues on the material card and a book stock worked out regularly. The reorder level is normally shown on the top right hand corner of the card, so that when the book stock comes down to this level an order can be initiated. To simplify this system many firms use a two-bin system- one is the main bin and the other a reserve bin. The stock in reserve bin equals the reorder level. When the main bin is empty it indicates an order has to be placed for the said item. Important formulae: Fixed order quantity system: Reorder level = safety stock + lead time consumption Reorder quantity = Q Maximum inventory = Q + safety stock Minimum inventory = safety stock Average inventory = Q/2 + safety stock Total cost of ordering = number of orders * cost per order = Annual consumption * cost per order 129
Cost of carrying inventory = avg. inventory * cost per unit * inventory carrying cost. Total cost of managing the inventory = cost of ordering + cost of carrying.
Fixed order interval system (P - System of Inventory) Under this system the stock in hand is reviewed at periodic intervals and an order is placed for which vary with the stock in hand, The review period is decided by the management and the consumption during this review period, and lead time consumption is worked out. The quantity ordered is decided depending on the stock in hand, so that the ordered quantity and the stock in hand will take care of the requirements till the next review period plus the lead time consumption plus the safety stock Features of fixed – order- interval system: 1) The interval between two orders is fixed. 2) The maximum level (basic parameters of the system) is equal to review period consumption. Lead time consumption + safety stock 3) Reorder quantity equals the maximum level (as worked out above ) minus the stock in hand plus stock on order 4) Average inventory equals safety stock+ lead time consumption 2 5) Maximum inventory equals safety stock + Lead-time consumption 6) This system is used for high consumption value items (A category) needing a strict control. Reestablishment where large number of items are produced and a continuous sale is made as to follow such a system. Important Formulae: Maximum level (basic parameters) = Review period consumption+ lead time consumption + Safety stock Re-order Quantity = Max Level- (stock in hand + Stock on order) Maximum Inventory = safety Stock + lead time Consumption Average inventory = safety stock + lead-time consumption 2 Total cost of managing the inventory= cost of ordering + cost of carrying. Problem based on fixed order interval system: the monthly consumption of a unit costing Rs. 400. the order cost is Rs.36, and the inventory carrying cost is 1.5% per month. If the rev period = lead time = one month and the safety stock maintained is half the review period. 1) Fix the necessary parameters to operate a fixed order Interval system 2) What will be reorder quantity if the stock during he first reviews of 650 units 3) What will be the reorder quantity if the stock during the second review is 200 units and also it is given that the order placed earlier has not yet been received. Given Review period = lead time = 1 month Review period consumption = lead time consumption = 400 units Safety stock = half a month's consumption = 200 Necessary parameters (maximum level) = review period consumption + 130
lead time consumption + safety stock = 400 + 400 + 200 = 1000 units During the first review, the reorder quantity = maximum level - stock in hand = 100 - 650 = 350 units During the second review, the above ordered quantity is still not received, Hence Re-order quantity = maximum level - (stock in hand + stock on order) = 100 - (200 + 350) = 1000 - 550 = 450 units
Factors that influence the level of Safety stock: a) Category of Item: In case of A category items where a better control is exercised it may not be required to keeps a high level of safety stock. In addition to this a high level of safety stock and high value consumption item will also increase the inventory carrying costs. b) Lead-time: Normally longer the lead-time more is the chances of fluctuation and hence more is the requirement of safety stock. c) Number of suppliers: In case there are a number of suppliers available for an item, it is not necessary to keep a high level of safety stock as any stock out situation can be handles easily from alternate sources of supplies. d) Criticality of an item: Safety stock for critical items needs to be high E.g. in case of packing materials the safety stock need to be high as stock out in packing material will affect the delivery of finished goods to the customer, but in case of lubricants where lubrication can be delayed safely by a few days a lower safety stock can be maintained. e) Availability of substitutes: Lesser safety stock can be kept for items where substitutes are available easily. f) Possibility make the item in-house: If it is possible to make an item in-house at a short notice on case of emergency. A lower safety stock will suffice. g) Risk of obsolescence or deterioration: It is better to have lower safety stock for items where the cost of deterioration is higher than the cost of no stock situation. h) Space restrictions: Restrictions in the storage space is another factor influencing the safety stock levels. i) Stock out cost / management policy: The cost of stock out and the management's decision to allow stoppage of production due to no stock situation (depending upon the market and company's financial conditions) also influence the decision on the safety stock levels.
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Service level The amount of safety stock needed to determine by the service level desired by their company. The service level id probably that amount of inventory on had during lead time is sufficient to meet expected demand - that is the probability that a stock out will not occur, a service level of 90% means that there ids a 90 probability that demand will be met during lead time Service level (SL) is the ratio of the no. The units delivered without the delay to the no. Of units demanded No. Of units delivered without delay SL= -----------------------------------------------No. Of units demanded No. Of units demanded - No. Of units short SL= --------------------------------------------------------No. Of units demanded Preferred time span for calculation is 1 year SL Range: 0 < SL < 1 i.e. SL = 0 means complete Delivery failure SL = 1 means 100% Service ( No Shortages) SL is expressed as a %. No. of order periods when stocks were zero i) Percentage of stock-outs = SL = ---------------------------------------------------------X 100 Total No. of order periods This is indicative of the probability of being out of stock while awaiting a supplier's delivery and is, therefore independent of the order size. No. of working days in which stocks were zero ii) Percentage of stock-outs = SL = --------------------------------------------------------- X 100 . Total No. of working days This ratio is a measure of the probability of being out of stock during the year. No. of units iii) Percentage of stock-outs = SL = ------------------------------------ X 100 No. of units demanded This ratio would show the average potential sale lost. Another method to determine Service Level is by considering the lower stocking cost (or under stocking) and the overstocking cost. Under-stocking cost (Ku), merely the loss one could incur if the item was not available (missed deliveries, lost sales, dissatisfied customers and production bottlenecks).
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Overstocking Cost (Ko) is not only the inventory carrying costs but may include other factors like opportunity cost (ties up funds) Ku SL = ------K u + Ko Service Level is a target specified by management defined in terms of a. Order Cycle Time b. Cash fill rate c. Line fill rate d. Order fill rte e. Any combination of these a) Order Cycle Time (Performance Cycle of Lead Time): The performance cycle is the elapsed time between the release of a purchase order by a customer and the receipt of the corresponding shipment. b) Case fill rate: It defines percentage of cases or units ordered that can be shipped or requested e.g. 'a 95% case fill rate indicates that, on average, 95 cases out of 100 could be filled from available stock. The remaining 5 cases would be back - ordered or deleted. c) Line fill rate: It is the percentage of order lines that could be filled completely. Each line on an order is a request for an individual product. So at order may have multiple lines e.g. when a customer order is received requesting 80 units of Product A and 20 units of Product B, the order contains 100 cases and two lines. If there are only 75 units of Product A available and all 20 of product a, the case fill would be 955 [ 75 + 20) I (80 + 20)) and the Line fill would be 50% d) Order fill rate: It is the percentage of customer orders that could be filled completely. In the example above, the order could not be completely filled, so the resulting order fill would be zero. The inventory function is a major element of the logistics process that must be integrated to meet service objectives. While a traditional approach is achieving a higher service level is to increase inventory, other approaches include use of faster transportation modes, better information management to reduce uncertainty, alternative sources of supply. While it is the task of overall logistics management to meet the prescribed service objectives Inventory management plays a particular key role. Inventory Policy: Inventory policy consists of guidelines concerning • What to purchase or manufacture • When to take action. • In what quantity It also includes decisions regarding inventory positioning and placement at plants & at distribution centers. e.g. • Some firms may decide to postpone inventory positioning by maintaining stock at the plant. • Other firms may choose to place more products in local distribution centers i.e. nearer to market Another inventory policy element concerns inventory management strategy. One approach is to manage inventory at each distribution centre independently. 133
Other approach is to manage inventory centrally. This requires more coordination & communication. Average Inventory: Average inventory consists of the materials, components, work in process and finished products typically stocked in logistical facilities. From a policy viewpoint, the appropriate level of average inventories includes: a. Cycle inventory or base stock or Lost size stock b. Safety Stock Inventory c. Transit Inventory a) Cycle inventory or base stock or Lot size stock is the portion of average inventory that results from replenishment process. At the beginning of a performance cycle, stock is at a maximum level. Daily customer demands "draw off' (consumes) inventory until the- stock level reaches zero. Prior to this, a replenishment order is initiated so that stock will arrive before a stock-out occurs. The replenishment order must be initiated when available inventory is greater than or equal to the customer demand during the performance cycle time. The amount ordered for replenishment is called the order quantity. The average inventory held as a result of the order process is referred to as Base Stock. Considering only the order quantity: Order Quantity Cycle inventory or base stock or Lot size stock = -------------------2 b) Safety Stock Inventory: The second part of Average Inventory is the stock held to protect transit the impact of uncertainty on each facility. This portion of inventory is called safety stock. It is used only at the end of replenishment cycles when uncertainty has caused higher than expected demand or longer than expected performance cycle times. Order Quantity Average Inventory = ------------------- + Safety Stock 2 Safety Stock Inventory is created by placing an order sooner that typically needed. The replenishment order most likely will arrive ahead of time protecting against there uncertainties. 1) Demand 2) Lead time & 3) Supply c) Transit Inventory or pipeline Inventory: It is the stock that is either moving or awaiting movement in transportation vehicles. Transit Inventory is necessary to achieve order replenishment. From a logistics management perspective, transit inventory introduces two sources of complexity into the supp\y chain. . a) b)
It represents real assets and must be paid for even though it is not accessible or usable. There has typically been a high degree of uncertainty associated with transit inventory because shippers were unable to determine where a transport vehicle was located or when it was likely to arrive. .
Increased focus on small order amounts, more frequent order cycles. JIT Strategies have resulted in transit Inventory becoming a larger percentage of total inventory assets. 134
Ownership of Transit Inventory • If transferred at destination: It is not owned by consignee. • If transferred at origin: It owned by consignee.
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PLANNING THE INVENTORY RESOURCES Planning is extremely important when it comes to inventory resources. The lack of planning can be costly to the firm either because of the carrying and financing costs of excess inventory or the lost sales from inadequate inventory. The inventory requirements to support production and marketing should be incorporated into the firm’s planning process in an orderly fashion. The production side Every product is made up of a specified list of components. The planner must realize the different mix of components in each finished product. Each item maintained in inventory will have a cost. This cost may be based on volume purchases, lead time for an order, historical agreements or other factors. Each component can be assigned a value. Once the mix is known and each component has been assigned a value, the planner can calculate the materials cost. The marketing side The second step in inventory planning involves a forecast of unit requirements during the future period. The marketing department should also provide pricing information so that higher profit items can receive more attention. Inventory database An important component of inventory planning involves access to an inventory database. It is a structured framework that contains the information needed to effectively manage all items of inventory, from raw materials to finished goods. This information includes the classification and amount of inventories, demand for the items, cost to the firm for each item, ordering costs, carrying costs and other data. The task of inventory planning can be highly complex. At the same time it rests on fundamental principles. In doing so we must understand and determine the optimal lot size that has to be ordered. The EOQ (economic order quantity) refers to the optimal order size that will result in the lowest total of order and carrying costs and ordering costs. By calculating the economic order quantity the firm attempts to determine the order size that will minimize the total inventory costs. An examination of the two curves reveals that the carrying cost curve is linear i.e. more the inventory held in any period, greater will be the cost of holding it. Ordering cost curve on the other hand is different. The ordering costs decrease with an increase in order sizes. The point where the holding cost curve i.e. the carrying cost curve and the ordering cost curve meet, represent the least total cost which is incidentally the economic order quantity or optimum quantity. The EOQ can be calculated with the help of a mathematical formula. Following assumptions are implied in the calculation: 1. Constant or uniform demand- although the EOQ model assumes constant demand, demand may vary from day to day. If demand is not known in advance- the model must be modified through the inclusion of safe stock. 2. Constant unit price- the EOQ model assumes that the purchase price per unit of material will remain unaltered irrespective of the order offered by the suppliers to include variable costs resulting from quantity discounts, the total costs in the EOQ model can be redefined. 136
3. Constant carrying costs- unit carrying costs may very substantially as the size of the inventory rises, perhaps decreasing because of economies of scale or storage efficiency or increasing as storage space runs out and new warehouses have to be rented. 4. Constant ordering cost- this assumption is generally valid. However any violation in this respect can be accommodated by modifying the EOQ model in a manner similar to the one used for variable unit price. 5. Instantaneous delivery- if delivery is not instantaneous, which is generally the case; the original EOQ model must be modified through the inclusion of a safe stock. 6. Independent orders- if multiple orders result in cost saving by reducing paper work and the transportation cost, the original EOQ model must be further modified. While this modification is somewhat complicated, special EOQ models have been developed to deal with it. These assumptions have been pointed out to illustrate the limitations of the basic EOQ model and the ways in which it can be easily modified to compensate for them. The formula for the EOQ model is: 2 M Co S Cc Where M = is the annual demand Co is the cost of ordering Cc is the inventory carrying cost S = is the unit price of an item. Limitations of the EOQ formula1. Erratic changes usages- the formula presumes the usage of materials is both predictable and evenly distributed. When this is not the case, the formula becomes useless. 2. Faulty basic information- order cost varies from commodity to commodity and the carrying cost can vary with the company’s opportunity cost of capital. Thus the assumption that the ordering cost and the carrying cost remains constant is faulty and hence EOQ calculations are not correct. 3. Costly calculations: the calculation required to find out EOQ is extremely time consuming. More elaborate formulae are even more expensive. In many cases, the cost of estimating the cost of possession and acquisition and calculating EOQ exceeds the savings made by buying that quantity. 4. No formula is a substitute for common sense - sometimes the EOQ may suggest that we order a particular commodity every week (six-year supply) based on the assumption that we need it at the same rate for the next six years. However we have to order it in the quantities according to our judgement. Some items can be ordered every week; some can be ordered monthly, depends on how feasible it is for the firm. 5. EOQ ordering must be tempered with judgement - Sometimes guidelines provide a conflict in ordering. Where an order strategy conflicts with an operational goal, order strategy restrictions should be developed to permit honouring the goal. Quantity discounts: In the EOQ analysis, it has been assumed that material prices and transportation costs were constant factors for the range of order quantities considered. In practice, some situations occur in which the delivered unit cost of a material decreases significantly if a slightly larger quantity than the originally computed EOQ is purchased. Quantity discounts, freight rate schedules and price 137
increases may create such situations. These additional variables can also be included in the formula. Determining ordering point In the EOQ model, the leas time for the procurement material is assumed to be zero. Consequently the ordering point for replenishment of stock occurs when the level of inventory drops down to zero. In view of instant replenishment of stock, the level of inventory jumps to the original level from zero level. This is well illustrated in the following diagram: However, in real life situations, one never encounters a zero lead-time. There is always a time lag from the date of placing an order for materials and the date on which the materials are received. As a result, the ordering level is always at the level higher than zero. If the firm orders the goods when the inventory level reaches the reorder point, the firm will never run out of goods. The decision on how much stock to hold is generally referred to as “Order point problem” that is how low should the inventory be depleted before it is reordered. The two factors that determine the appropriate order point are the: a) Procurement or delivery time stock (inventory needed during the lead time) and; b) The safety stock, which is the minimum level of inventory that is held as a protection against shortages. Reorder point = Normal consumption + safety stock during lead-time.
In summary, the efficiency of the replenishment system affects how much delivery time is needed. Determination of level of safety stock involves a basic trade-off between the risk of stock-out, resulting in possible customer dissatisfaction and lost sales, and the increased costs associated with carrying additional inventory. The following diagram represents this better: Reorder level = (Average daily usage rate) x (Lead time in days)
Safety stock When the wage rate and/or lead-time vary, then the reorder level should naturally be at a level high enough to cater to the production needs during then procurement period and also to provide some measure of safety for at least partially neutralizing the degree of uncertainty. How much should the magnitude of safe stock be? It depends on the degree of uncertainty surrounding the usage rate and lead-time. It is possible to a certain extent of to quantify the values that usage rate and lead-time can take along with the corresponding ‘chances of occurrences’ known as ‘probabilities’. These probabilities can be ascertained based on the previous experiences and the judgmental ability of executives. Based on the above values and estimated stock out costs and carrying costs of inventory it is possible to work out the total cost associated with different levels of safety stock. Higher the quantity of safety stock, the lower will be the stock-out cost and the higher will be the incidence of 138
carrying costs. Thus the reorder level will call for a trade-off between stock out costs and carrying cost. The reorder level will be such that the total stock out cost and the carrying cost will be at its minimum. Cost of carrying inventory Carrying material in inventory is expensive. A number of studies indicated that annual cost of carrying a production inventory averaged approximately 25% of value of the inventory. The escalating and volatile cost of money has escalated annual inventory carrying cost to a figure between 25% - 35% of the value of inventory. The following five elements make up this cost: 1) Opportunity cost (12% -20%) 2) Insurance cost (2% – 4%) 3) Property taxes (1% - 3%) 4) Storage costs (1%- 3%) 5) Obsolescence and deterioration (4% - 10%) Total carrying cost (20% - 40%) Let us briefly look into these costs:
the the the the
Opportunity cost of invested funds When a firm uses money to buy production material and keeps it in the inventory, it simply has this much less cash to spend for other purposes. Money invested in external securities or in productive equipment earns a return for the company. Thus it is logical to charge all money invested in inventory an amount equal to that it could earn elsewhere in the company. This is the opportunity cost associated with inventory investment. Insurance cost Most firms insure the assets against possible losses from fire and other forms of damage. Property taxes This is levied on the assessed value of a firm’s assets, the greater the inventory value, the greater the asset value and consequently the higher the firm’s tax bill. Storage costs The warehouse is depreciated every year over the length of its life. This cost can be charged against the inventory occupying the space. Obsolescence and deterioration In most inventory operations, a certain percentage of the stock spoils, is damaged, is pilfered, or eventually becomes obsolete. A certain number always takes place even if they are handled with utmost care. Generally speaking, this group of carrying costs rises and falls nearly proportionately to the rise and fall of the inventory level. Moreover, the inventory level is directly proportional to the quantity in which the ordered material is delivered. Hence costs of carrying inventory vary nearly directly with the size of the delivery quantity. This relationship is illustrated as follows: (Carrying Cost per year) = (Average inventory value) x (Inventory carrying cost as a % of inventory value) Origin purchase 139
Buyer incurs the freight cost and product risk when the product is in transit. EOQ EXTENSIONS: While the EOQ formulation is relatively straightforward, there are some other factors that must be considered in actual application. The most important and persistent problems are those related to various adjustments necessary to take advantage of social purpose situations and utilization characteristics. 1. Volume transportation rate: In the EOQ formulation, there was no consideration for the impact of transportation cost on order quantity. The transportation cost from the origin to the inventory depot is incurred by the seller. However if the ownership is transferred at the origin, the impact of the transportation rates on the total cost must be considered when determining the order quantity. As a general rule, greater the quantity, lesser will be the volume transportation rate because many sellers tend to give a discount when the goods are bought in a larger size (both by the truck and rail). Thus all other things being equal, an enterprise will want to buy goods in large quantities to maximize transportation economies. Such quantity may be larger than the actual quantity determined by EOQ. Increasing the size of the order has a two fold impact on the inventory: • It increases the inventory carrying cost • It provides better transportation economies. Finally, two factors regarding inventory cost under costs of origin purchase are: • The transit inventory is a part of the enterprise’s average inventory and therefore subjected to an appropriate charge. • The transportation cost should be added to the price of the goods purchased to assess the value of the goods tied up in inventory. Thus the inventory carrying cost should be assessed on the combined cost of the item and transportation.
2. Quantity Discounts Purchase quantity discounts represent an EOQ extension. If the discount at any associated quantity is sufficient to offset the added cost of maintenance less the reduced cost of ordering, then the quantity discount offers a viable alternative. It should be noted that quantity discounts and volume transportation rates each effect later purchase quantities. However, this does not mean that the lowest total cost purchase will always be a large quantity. EOQ Adjustments A variety of special situations can occur that will require adjustments to basic EOQ model. Some of them are: • Production lot size (most economical quantity from manufacturing perspective) • Multiple item purchase. This describes situations when more than one product is bought concurrently, so that quantity and transportation discounts must consider the impact of the product combinations. • Limited capital (limited capital – budget limitations for total inventory investment) 140
•
Private trucking (influences order quantity since it represent a fixed cost once the decision is made to replenish the product.) If the enterprise decides to use its own truck, it should fill the truck regardless of the value calculated by the EOQ. Transporting a half empty truck does not make any sense. Inventory Related Definitions This includes definitions related to an inventory management policy. 1) INVENTORY POLICY: It consists of guidelines concerning what to purchase or manufacture, when to take action and in what quantity. It also deals with the inventory positioning and placements in plants and distribution centers. E.g some plants may maintain stock at a plant and hence postpone the inventory positioning. The second inventory policy element concerns inventory management strategy. One approach is to manage inventory at each distribution center independently. The other extreme deals with inventory interdependence across distribution sites by managing inventory centrally. Centralized inventory management requires more coordination and communication. (2) Service level: It defines the performance objectives that the inventory function mustr be capable of achieving. It can be defined in terms of the following: (a) Order cycle time: the time taken to complete from the time of placing the order to the payment for the goods received. It can also be defined as the elapsed time between the release of a purchase order by a customer and the receipt of the corresponding shipment. (b)Case fill rate: it can be defined as the percentage of cases or units ordered that can be shipped as 4requested. For e.g. 95% case fill rate indicates that on an average, 95 cases out of 100 could be filled from available stock. The remaining 5 will be back ordered or deleted. (c) Line fill rate: % of order lines that could be filled completely. Each time on an order is a request for an individual product, so an order may have multiple lines. E.g. if a customer order is received requesting 80 units of product A and 20 units of product B, the order is of 100 cases and 2 lines. If there are 75 units of product A available and all 20 of product B, the case fill would be 95% (75+20)/ (80+20) and the line fill rate would be 50%. (d)Order fill: it is a % of customer orders that could be filled completely. In the above example, the order could not be filled completely filled, so the resulting order fill would be zero. The inventory function is a major element of the logistics process that must be integrated in order to meet the service objectives. To improve service level, once can increase the inventory. Other approaches would be faster transportation modes, better information mgmt, or alternative sources of supply. Average inventory: this consists of the materials, components, WIP and finished products typically stocked in logistical facilities. Average inventories include cycle, safety stock and in transit inventory components. Cycle inventory: it is also known as base stock. It can be defined as the % of the inventory that results from the replenishment process. Cycle inventory can also be said to result when in order to reduce unit purchase costs (or increase production efficiency), the number of units purchased (or produced) inventory from to which the lot size is applied. It may be more economical to order the product in a large size than to order it in small batches. At the beginning of a performance cycle, the stock level is at the maximum level. However daily customer demands stock to be withdrawn from 141
the inventory until it reaches zero. Prior t this, a replenishment order must be given. The amount ordered for replenishment is called the order quantity. The average inventory held as a result of the order process is referred to as base stock, which is also called as the lot size stock. Usually the base stock equals to one half of the order quantity. Transit inventory: this represents the stock that is either moving or awaiting movement in transportation vehicles. This portion of the total inventory is also known as pipeline inventory. It can also be defined as the materials moving forward but not yet received. It is necessary to achieve order replenishment. Transit inventory represents real assets and must be paid for even though it is not accessible or usable. There has typically been a high degree of uncertainty associated with transit inventory because shippers were unable to determine where a transport was located or when it was likely to arrive. While satellite communications have somewhat reduced this uncertainty. Shippers bill have limited accessibility to such information. Increased focus on smaller order quantities, more frequent order cycles and just in time strategies have resulted in transit inventory becoming a larger percentage of the total inventory assets. As a result, greater attention is paid to reducing the amount of transit inventory and its associated uncertainty. Formulating inventory policy Inventory turnover is a widely used performance measure that reflects the liquidity of a firm’s inventory and the speed with which inventory is converted into sales. This indicates the number of times the inventory is sold or turned over during a stated period. Inventory turnover ratio = Cost of goods sold Average inventory value e.g, if the firm’s annual cost of goods sold = Rs.5,00,000 and its average inventory value = Rs.50,000, the inventory turns over 10 times. If the cost of goods sold rises to Rs.10, 00,000 and the value of the inventory remains as it is, the turnover ratio jumps to 20. Inventory turnover is related to actual sales. Hence high inventory levels are not penalized if the sales are very high and low inventory levels are not rewarded, if the sales are low. If the inventory turnover is high, it means that the inventory is kept in stock for a less period of time and hence it is more liquid. The cash flow needed to finance the inventory also decreases as the number of inventory turnover increases. A high level of sluggish inventory amounts to unnecessary tie-up of funds, reduced profits and increased costs. If these inventories are written off, it will adversely affect the Working capital and liquidity position of the firm. However, if the inventory level is maintained at a very low level (inventory turnover high), then it may result into frequent stock outs, which means the firm replenishes its inventory in small lot sizes. This may be costly to the firm.
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JUST -IN-TIME & KANBAN INTRODUCTION: JIT is a management philosophy developed in Japan which has been applied in practice since the early 1970s in many Japanese in Toyota & was perfected by Mr. Taiichi Ohno as a mean of meeting consumer demands with minimum delays A: There are strong cultural aspects associated with the emergence of JIT in Japan. The Japanese work ethic involves the following concepts: 1. 2. 3. 4. 5.
Workers are highly motivated to seek constant improvement (Kaizen, Pokayoke etc) Companies focus on 'group efforts' Work itself takes precedence over leisure. Employees tend to remain in one company There exists a high degree of group consciousness and sense of equality among the Japanese. The Japanese are a homogeneous race", where individual differences are not exploited.
B: JIT has a high degree of cultural aspects imbedded in it’s demit. Some of the cultural characteristics may be related to JIT are as follows. 1. JIT management allows an organization to meet consumer demand, regardless of the level of demand. This is made possible through the use of “pull system”. 2. The degree of time lapse between material arrivals processing and assembly of the final product for consumers is minimized by JIT production technique. Production lead time minimization is possibly the result of Japanese cultural emphasis on “speed and efficiency”. 3. JIT allows a greater amount of space and time between operations within plant 4. Element for successful implementation of JIT programmes a. b. c. d. e. f. g. h. i. j.
Management commitment Fostering a sense of employee ownership Provision of awareness & education of JIT including SQC, TQM etc Knowing needs of individuals by survey by Studding customers TPM-preventive maintenance total productive maintenance Simplifying process &eliminating wastes Documenting all activities &results Automation processes. Planning & developing item frames & establishing & employment responsibilities for implementation k. Questioning all activities
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THE" KANBAN" SYSTEM 1. Introduction The word "Kanban"
in Japanese means "a single" it is usually a card or tag employment work in process parts. There are two types of Kanbans which are used as a tool in the JIT production system. The "withdrawal" Kanban is used to indicate the type and amount of product which the next process should withdraw from the preceding process. The "production ordering" Kanban specifies the type & quantity of product which the next process may produce. 2. The Functions of Kanbans: The functions of Kanbans are two fold (i) they are used as a means for production control and (ii) for process improvement. The role played by the Kanban in process improvement includes improving the operations used in the reducing inventory costs 3. Circumstances for Kanban: 1. Sub-assay & final assay are carried out in separate plants or at distance, which would not permit moving a product “one at a time” for practical reason. 2. Change- over times between feeding &using operations involve a great amount of times this will create line-imbalance. 3. There are a different no. of different works-cells, which must share a piece of equipments. The Kanbans becomes important int his situation for linking the m/c with the various work-cells 4. The use of m/s which is responsible for work-cell rather than risking the requirement of a high degree to link the m/c to a work-cell to be used separately and avoids it becoming an indispensable part of a work-cell. 5. The existence of problems such as low quality work and bottlenecks or other problems, which may impair the steady flow of operations. 4. Rules Kanban operation: in order to maintain smooth flow of production following rules is to followed: 1. Parts from a downstream process should be obtained from preceding process in the quality, type & timing, as described in the Kanban, following steps are important: a. The Kanban must always be attached to the product. b. Withdrawal of a product should never occur unless a Kanban is attached c. The number of withdrawals should never… 2. The parts should be produced corresponding to the information provided on the Kanban. From this, a. Production should never exceed the no. of Kanbans b. When manufacturing involves different kinds of parts, the quantity & sequences of their processing should be followed as specified in the preceding operation 3. If no Kanban is attached to the product, there should not be any production. 4. In the event than defective items are produced, they should not be transferred to the subsequent process. 5. It should be assured that only 100% quality parts are placed in the containers available for use 6. The no of Kanbans used in the product process should be minimized to prevent build-up inventory 7. The product process can be streamlined & slowly Kanban can be reduced. 5. Lead Time & Cycle Time Reduction a. Waiting time b. Moving time c. Queuing time d. M/C setup time e. Running Time
6. Implementing the Kanban System a. Obstacles 144
i. Habitual practice of producing continuously. ii. Modifications in the production schedule and product mix are frequently required. iii. Unbalanced rates for consumption b. Training of operators c. Desire of operators attitude d. Implementation procedure-simple 7. Combination of JIT, Kanban, MRP, Customization is needed to take advantage of all the 3 systems.
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INVENTORY CONTROL NUMERICALS 1) The annual demand for an item is 3200 units. The unit cost is Rs. 6/- and inventory carrying rate is 25% Per annum. If the cost of one procurement is Rs. 150 find EOQ, No. of orders per year, time between two consecutive orders & optimal cost 2) A firm uses an economic order quantity system for replenishment of one of its stock item. The item demand is 18000 units per annum, the cost of placing an order is Rs. 300/- and the firm uses an inventory carrying rate of 30% per annum. The cost of an item is Rs. 16/- per unit find What would be the optimum no. of orders per annum If for administrative convenience an order is placed only once in two months, how much extra cost does the firm incur? At the end of the year it was noticed that true cost of placing an order was Rs. 600/- per order. How much firm loses in the year due to this error in cost? 3) An air craft use high utensils bolts at an approximately constant rate of 50,000 numbers per order. The bolts cost Rs. 20/- each and the purchase department estimated the cost a Rs. 200/- to place an order, the opportunity cost on working capital is 20% per year. No shortage is allowed. How frequently the orders be placed and what is the economic order quantity? If an order could be executed only once in two months, the ordering quantity would be higher than the optimal quantity. What would be the percentage change in the total relevant cost? The company finds, to its error that the cost of placing an order was Rs. 500/- and carrying cost was 15% per year and not the earlier data, how much the company losing per year on inventory, due to imperfection cost information If the entire requirement is to be bought in a single order, what should be the justifiable unit price of the company? Determine what should be the companyُ s policy for this component. 4) A company uses an EOQ system of stock replenishment for one of its item purchased from external Supplier. The rate of consumption is nearly constant with a known demand of 36,000 units of inventory of inventory per annum. The cost of ordering is estimated as Rs. 600/- per order and the company uses an inventory carrying rate of 30% per annum. The items cost is Rs. 16/- per unit. Find the optimal no. of orders to be placed per year and the annual cost of operating the system If for the administration convenience, it is decided to order only once a quarter, how much extra cost will the company incur per annum? If the entire requirement has to be bought in a single order, what should be the justifiable unit price? The supplier offers the following price schedule for lot purchases. Should the company avail this opportunity and if so, what should be the optimum ordering policy and he benefit that will accrue?
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LOT SIZE 1-2499 2500-5999 6000-11999 12000 & above
PRICE PER UNIT (Rs.) 16.00 15.20 14.50 14.00
5) A company uses an EOQ system of stock replenishment for one of its item purchased from external Supplier. The rate of consumption is nearly constant with a known demand of 36,000 units of inventory of inventory per annum. The cost of ordering is estimated as Rs. 360/- per order and the company uses an inventory carrying rate of 24% per annum. The items cost is Rs. 12/- per unit. Find the optimal no. of orders to be placed per year and the annual cost of operating the system If for the administration convenience, it is decided to order only once a quarter, how much extra cost will the company incur per annum? If the entire requirement has to be bought in a single order, what should be the justifiable unit price? At the end of the year it was noticed that true cost of placing an order was Rs. 500/- per order. How much firm loses in the year due to this error in cost? The supplier offers the following price schedule for lot purchases. Should the company avail this opportunity and if so, what should be the optimum ordering policy and he benefit that will accrue? LOT SIZE 1-2499 2500-5999 6000-11999 12000-23999 24000 & over
PRICE PER UNIT (Rs.) 12.00 11.40 10.60 10.30 10.00
6) A chemical factory has nearly uniform consumption of a chemical at estimated as 60,000 kg. per annum. The factory follows an EOQ system. The cost of placing an order is estimated at Rs. 500/- , the inventory carrying cost is 30% per annum. The item cost is Rs. 8/- per kg. find EOQ, No. of orders per year, time between two consecutive orders & optimal cost As the chemicals is of a hazardous nature and the factory has no proper large storage facility, it is decided for reasons of safety, that orders will be placed once a fortnight, there by reducing the inventory holdings. How much extra cost would the company incur a a result of this policy? The supplier offers the following price schedule for lot purchases. Should the company avail this opportunity and if so, what should be the optimum ordering policy and he benefit that will accrue? LOT SIZE Upto 9999 10000-19999 20000-29999 30000 & above
PRICE PER UNIT (Rs.) 8.00 7.60 7.40 7.30 147
7) Monthly consumption of item having unit price of Re. 1 has been estimated at 300 units. The inventory carrying cost and procurement cost for the company have been computed to be 18% and Rs. 36/- per order respectively. Stock records shows that this item can normally be procured within a period of one month. If the company adheres to the policy of two safety stock for all items calculate reorder qnty, min. level, max. Level, reorder level & average inventory 8) The average monthly consumption for an item is 300 units and the normal lead time is one month. If the maximum consumption has been up to 370 units per month and maximum lead time is 1.5 month, what should be the buffer stock for an item? 9)
The following information is provided:
ANNUAL USAGE = 24000 units ORDERING COST = Rs. 120/- per order CARRING COST = 20% PRICE PER ITEM = Rs. 20/LEAD TIME =10 days 1 YEAR =240 working days Find EOQ, no. of orders per year In the past two years, the usage rate has gone as high as 140 nits per day. For a reordering system based on the inventory level, what safety stock is required to protect against this higher usage rate? What should be the reordering point at this safety stock level? What should be the carrying cost of the company?
10.
LOGISTICS ORGANIZATION
Organizing Integrated Logistics While quality and customer service became the focus of top management in the 1990s, speed, and supply chain management are becoming key competitive issues in the recent years (i.e., 2000 onwards). To be competitive in the global market, a firm must be able to implement the strategies, plans and programs to deliver adequate levels of quality and service that are acceptable to the customers. Logistics play a vital role in that process. A study in USA highlighted the importance of quality programs in the area of logistics. It identified several barriers to instituting high quality program in logistics management. The top. six barriers identified were related to employees or organisational issues. These barriers are as follows: (i) Changing the corporate culture; (ii) Establishing a common vision throughout the organisation; (iii) Establishing employee ownership in the quality process; (iv) Gaining top management commitment; (v) Changing management process; (vi) Training and educating employees. 148
The role of individual employees and logistics departments are especially crucial in strategic logistics management.
ENVIRONMENTAL FACTORS AFFECTING LOGISTICS MANAGEMENT The factors affecting the logistics executives are: (j) economic uncertainty, (ii) inflation, (iii) product and energy shortages, (iv) environmentalism, (v) green marketing, (vi) regulatory restrictions, and (vii) increasing customer demands and expectations. developed but no single "ideal" structure is appropriate for all firms. Alternative organisational structures have to be evaluated and an effective organisation structure has to be developed. Because of the increasing difficulty in managing the logistics activities it is necessary to organise logistics within the firm and to measure its effectiveness. Effective integrated logistics organisation is very important to the firm. Many types of organisational structures have been developed but no single "ideal" structure is appropriate for all firms. Alternative organisational structures have to be evaluated and an effective organisation structure has to be developed.
IMPORTANCE ORGANISATION
OF
AN
EFFECTIVE
LOGISTICS
A firm's strategic management process includes an effective and efficient logistics organisation. The problem and challenges that organisations face primarily lie in systems, structure. mission. people. corporate-culture and reward structure rather than in strategic decision making. The manner in which these strategic resources interact to create a synergetic system is critical to the success of the organisation. In traditional organisations, logistics functions were scattered throughout the firm with no single executive, department or division responsible for managing the entire distribution process. Integrated logistics management concept requires an organisationaI structure that combines the activities of logistics under a single, highlevel executive. The present trend is to integrate many logistics functions under one top-ranking corporate executive. The logistics executives exercise control over logistics activities such as: (i) transportation, (ii) warehousing (iii) inventory control, (iv) order processing and (v) purchasing and procurement. In general, logistics executive's span of control has been expanded to include transportation, warehousing, inventories, order processing, packaging, materials handling, forecasting and planning and purchasing. Coordination of the various logistics activities is crucial to the efficient functioning and effectiveness of the organisation.
STAGES OF DEVELOPMENT OF ORGANISATIONAL STRUCTURE IN INTEGRATED LOGISTICS Stage 1: There is no integrated logistics department. The activities are fragmented into functional areas such as: (a) marketing, (b) finance/accounting, (c) manufacturing and (d) management services. In such organisational structures, integrated activities cannot reach their full potential in providing a competent edge. For example, transportation is divided between marketing and manufacturing (responsible 149
for purchasing and material handling). These departments may independently contract transport carriers to their respective needs of inbound shipment of materials and for outbound shipment of finished goods to warehouses, retail outlets or final consumers. If one entity controls transportation, then inbound movements can be matched with outbound movements, thereby balancing traffic flows and increasing transport carriers utilisation and productivity. Stage 2: This stage recognises the physical distribution function in the firm and the need to manage the same under a single entity (i.e., person, department or function). A separate distribution department is enac:ted to carry out functions such as: (a) warehouse operations, (b) outbound traffic. (c) international traffic, (d) carrier selection, (e) private carriers, (j) warehouse site selection, (g) packaging and (It) distribution planning In stage 2 integrated logistics organisation, the management tends to be transaction driven. The focus is on reducing the number of transport carriers, eliminating obsolete inventory, improving utilisation of transport vehicles and levelling out workloads Stage 3: A stage 3 integrated logistics organisation takes over functions of order processing, customer service, inventory control and in bound traffic in addition to its functions in stage 2 organisational structure. The distribution manager is given a new title as "logistics manager". The distribution manager, in addition to focusing on transactions (in stage 2), pursues budgets in stage 3. The distribution manager is responsible for developing the change process, rewarding good performance, consolidating the integrated logistics organisation and implementing integrated logistics measures. A stage 3 integrated logistics organisation can result in savings upto 15 per cent of integrated logistics costs over a stage 2 organisation. Stage 4: At this stage, the integrated logistics becomes a separate functional area headed by an integrated logistics manager, contributing to high-level strategic decisions. The additional functions added to the functions of logistics manager of stage 3 structure are: (i) demand forecasting, (ii) salvage/scrap disposal, (iii) purchasing, (iv) materials handling, (v) parts/ service support and (vi) logistics planning. At this stage the integrated logistics manager balances cost and service, develops better information, improves cooperation with the functional areas of the firm and begins to roll over plans and budgets. A 10 to 15 per cent cost improvement over stage 3 can be achieved. Stage 5: At this stage, integrated logistics organisational structure becomes the integrated logistics matrix environment. In the matrix structure, integrated logistics becomes part of the "management seryices". It helps to coordinate the flows of products into, through and out of the firm. The integrated logistics manager links integrated logistics to marketing, finance/accounting and manufacturing.
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Exhibit 9. 1 illustrates Organisational Structure.
the
Integrated
Integrated Logistics Matrix Organisational Structure Integrated Marketing Finance/ Logistics Accounting Activities " International and Transportation Budgets domestic outbound, carrier selection, private carriage Field warehouse Facility Budgets operations
Logistics
Matrix
Manufacturing-
International domestic
and
inbound, inplant, carrier selection, private carriage Raw material, work-inprocess and finished goods, warehouse operations, plant and warehouse location
Structure
and location
Inventory
Finished goods, parts Budgets and
Raw material, work-inprocess and goods, parts and support, purchasing
service support
Field warehouse Budgets systems, Handling packaging Communicatio Order processing, Budgets ns demand & Information forecasting Material
finished service
Inplant and warehouse systems, packaging Production scheduling
GENERIC LOGISTICS STRATEGIES The organisational strategies used by manufacturers are: (i) process-based strategy, (ii) market-based strategy and (iii) channel-based strategy which are briefly described below: Process-based Strategy is concerned with managing a broad group of logistics activities as a value-added chain. It emphasizes achievement of efficiency from managing purchasing, manufacturing scheduling and physical distribution as an integrated system. Market-based strategy is concerned with managing a limited group of logistics activities across a multi division business or across multiple business units. The logistics organization which follows this strategy seeks to (a) to make joint product shipments to customers on behalf 151
of different business units or product groups and ( b) to facilitate sales and logistical coordination by a single order-invoice. Channel-based strategy focuses on managing logistics activities performed jointly in combination with dealers and distributors. The channel orientation places a great deal of attention on external control. Logistics co-ordination: Co-ordination of the various logistics activities can be achieved in several ways. The basic systems are usually structured through a combination of: (i) strategic versus operational structure, (ii) centralised versus decentralised structure, (iii) Line versus staff structure. Strategic versus operational structure: refers to the level at which logistics activities arc positioned within the firm. Strategically it is important to determine the position of logistics in the corporate hierarchy relative to other activities such as marketing, manufacturing and finance/ accounting. Operational structure of the various logistics activities such as warehousing, inventory control, order processing, transportation is also equally important. Centralised Versus Decentralised: The term centralized distribution can reflect a system in which logistics activities are administered at a central location (a corporate head quarters), centrally programming activities such as order processing, traffic, or inventory control can result in substantial cost savings due to economics of scale. Decentralization of logistics activities can be effective for some firms. Decentralization can lead to higher levels of customer service. Line and Staff: Logistics activities can be line, staff or some combination of both. Logistics as a line activity is comparable to sales or production in that employees are "doing things" that is, performing various tasks. When this is done, one individual is made responsible for doing the distribution job. In this staff organisation, the line activities such as order processing, traffic and warehousing are assigned to a logistics vice president or to production, marketing, or finance/accounting. The various staff activities assist and coordinate the line functions. The combination of line and staff activities joins these two organizational types, thus eliminating the shortcomings inherent in the system where line and staff activities arc not coordinated.
Components of an Optimal Logistics Organisation Factors contributing to organisational effectiveness can be summarised as: (i) organisational characteristics, (ii) environmental characteristics, (iii) employee characteristics and (iv) managerial policies and practices. Organisational Characteristics: Structure and technology are major components of a firm's organisational characteristics. Structure refers to the relationships that exist between various functional areas: interfunctional (marketing, finance, operations, manufacturing, logistics) or intrafunctional (warehousing, traffic, purchasing, customer service). Examples of structural variables are decentralisation, specialisation, formalisation, span of control, organisation size and work unit size.
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Environmental characteristics: The effectiveness of the organisation is influenced by factors internal and external to the firm. Internal factors which are controllable are known as organisational climate (referred to as corporate culture sometimes). External factors, sometimes referred to as uncontrollable elements include the political and legal, economic, cultural and social and competitive environments. Employee characteristics: Employers are the keys to effective organisations. The ability of individuals to carryout their respective job responsibilities ultimately determines the overall effectiveness of any organisation. Managerial Policies and Practices: Policies at the macro level (entire firm) determine the overall goal structure of the firm. Policies at the micro (departmental) level influence the individual goals of the various corporate functions such as warehousing, traffic, order processing and customer service. Macro and micro policies in turn.affect the procedures and practices of the organisation. The planning, coordinating and facilitating of goal-directed activities - which determine organisational effectiveness - depend on the policies and practices by the firm at the macro and micro levels. The factors which can aid the logistics executive in improving the effectiveness of the organisation are: (i) strategic: goal setting, (Ii) resource acquisition and utilization, (iii) performance environment, (iv) communication process, (v) leadership and decision making, and (vi) organisational adaptation and innovation.
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These factors are briefly discussed in the following paragraphs. (i) Strategic goal setting: Strategic goal setting involves the establishment of two clearly defined goals: (i) the overall goal or goals of firm and (ii) goals of the individual employee, Both sets of goals must be compatible and aimed at maximising firm employee effectiveness. (ii) Resource acquisition and utilization: Resource acquisition and utilisation includes the use of human and financial resources as well as technology to maximise the achievement of corporate goals and objectives. For example, this requires properly trained and experienced persons operating the firm's private truck fleet using proper storage and retrieval systems for the company's ware houses, using proper storage and retrieval systems in the warehouses, keeping inventories and having capital to take advantage of forward buying opportunities. (iii) Performance environment: This is concerned with having the proper organisational climate to motivate employees to maximise their effectiveness and subsequently, the effectiveness of the overall logistics function. The strategies which can develop a goaloriented performance include: (a) proper employee selection and placement, (b) training and development programs, (c) task design and (d) performance evaluation combined with a reward structure that promotes goal oriented behaviour. (iv) Communication process: Communication is one of the most important factors that influence logistic effectiveness in any organisation. Good communication facilitates effective transmission of logistics policies and procedures throughout the firm. It also provides feed back of information concerning the success or failures of the logistics policies and procedures. The communication flows can be downward, upward or horizontal within the logistics area. (v) Leadership and decision making: The quality of leadership and decisionmaking expertise of the senior logistics executives are as important as effective communication. The effectiveness of the logistics organisation will be high if the top logistics executive is a highly capable individual who makes thoughtful, logical and consistent decisions. (vi) Organisational adaptation and innovation: This is an important attribute of effective organizations. The environment surrounding the logistics activity must be constantly monitored. Logistics must adapt to changing conditions and innovate to continue to provide an optimal "cost-service mix" to the firm and its markets. For example, the changes in environmental conditions include changes in transport regulations, service requirement of customers, degree of competition in the firm's target markets, economic or financial shifts in the market place and technological advancements in distribution area. Stability and continuity are essential to an effective organisation. It must have a unique offering which it can deliver to the market and provide value to customers.
DEVELOPMENT ORGANISATION
OF
AN
OPTIMAL
LOGISTICS
There are a variety of good organisational designs for a firm and over time, a firm may have to modify its designs to reflect environmental and corporate changes. The development of a new logistics organizational unit or restructuring an existing one requires the following tools or stages: (i) Determine corporate strategy and objectives (ii) Organise functions in a manner compatible with the corporate structure 154
(iii) Define the functions for which the logistics executive is accountable (iv) Know his or her (i.e.. logistics manager's) management style (v) Organise for flexibility (vi) Know the available support systems vii) Understand the plan for allocation of human resource so that it complements the objectives of both the individual and the organisation. These steps are discussed briefly in the following paragraphs. (i) Corporate objectives: Overall corporate objectives and strategy provide a long-term direction to logistics activities. Each functional component of the firm such as finance, marketing, production and logistics are guided by the corporate objectives and strategies. Logistics executives need to understand their role in carrying out corporate strategy. ii) Corporate structure: The overall corporate structure affects the specific organisational structure of the logistics activity. But logistics is increasingly being centralized. In consumer goods companies, logistics will typically report to marketing group. In industrial goods producing firms logistics will report to manufacturing/operations administration. Often, logistics is a separate organizational activity reporting directly to the CEO in firms manufacturing both consumer and industrial goods. (iii) Functional responsibilities: The major functional responsibilities of logistics are: (i) transportation, (ii) warehousing, (iii) inventory control, (iv) order processing, (v) packaging and (vi) purchasing and procurement. It is important that most of the logistics functions are placed under a single department or division. This will allow the firm to implement the concepts of integrated logistics management and total cost trade-offs. The typical responsibilities of logistics in most organisations include outbound transportation, intra-firm transportation, warehousing, inbound transportation materials handling and inventory management. Since these are basic logistics functions, they must be administered by a senior logistics executive. Two functions which are important for carrying out the logistics mission but for which logistics often does not have responsibility are: (i) sales forecasting and ii) international distribution. (iv) Management style: The management style of the senior logistics executive may bring significant changes in personnel, employee morale, and productivity. The style or personality of the senior logistics executive and to some extent of his or her lower level managers influence the attitudes, motivation, work ethic and productivity of employees at all levels of the organisation. The performance of two identical organizational structures can be at significantly different levels of efficiency, productivity and profitability. The success of a firm's logistics mission depends on the management style and this is the reason for equal effectiveness of different organisational structures. (v) Flexibility: It is necessary for any logistics organisation to be able to adapt to changes. Unadaptable and unresponsive organizations become ineffective over a period of time. The logistics organisation must accept the changes and respond to them in ways that are beneficial to the firm. (vi) Support systems: Support systems are essential for logistics systems. The logistics .. organisation (i.e.. the logistics department or division) is supported by a good management information system (MIS). Other support systems include legal services, computer systems, administrative services and financial/accounting services. 155
(vii) Human resource considerations: The most vital component of an effective logistics organisation is "people" because it is the people who ultimately determine how well the firm operates. Employees' skills and abilities, wage scales, training programs, selection and retention procedures and other employee related policies are crucial to the structuring or restructuring of a logistics organisation. An organisation to be successful, it is necessary to have a logistics manager who will lead productive and efficient employees. Successful organizations are those that blend the optimal combination of organizational structure, planning process, people and management style. Logistical Organization And Development: 3 Stages Of Evolution Prior to the 1950s,functions now accepted as logistics were generally viewed as facilitating or support work. Organizational responsibility for logistics was dispersed throughout the firm. This fragmentation often meant that aspects of logistical work were performed without cross-functional coordination, often resulting in duplication and waste information was frequently distorted or delayed and lines of authority and responsibility were typically blurred. Managers recognizing the need for total cost control began to reorganize and combine logistics functions into a single managerial group. Structuring logistics as an integrated organization first appeared in the 1950s. The motivation behind functional aggregation was the belief that grouping logistics functions into a single organization would increase the likelihood of integration. The paradigm (model) was that functional proximity would facilitate improved understanding of how decisions and procedures in one area affect performance in other areas. The belief was that eventually all functions would begin to work as a single group focused on total system performance. This integration paradigm, based on organizational proximity, prevailed throughout a thirty-five year period. However, by the mid 1980s, it was becoming increasingly clear that the paradigm of functional aggregation might not, in final analysis, offer the best approach to achieve integrated logistics. For many firms, the ink had barely dried on what appeared to be the perfect logistics organization, when new and far more pervasive rethinking of what constituted the ideal structure emerged. Almost overnight, the emphasis shifted from function to process. Firms began to examine the role logistical competency could play in the overall process of creating customer value. This ushered in new thinking regarding how to best achieve logistical performance. To a significant degree, the focus on process reduced the pressure to aggregate functions into all encompassing organization units. The critical question became not how to organize individual functions but rather how to best manage the overall logistical process. The challenges and opportunities of functional disaggregation and information driven integration began to emerge. The mission of logistics is to position inventory when and where it is required to facilitate profitable sales. This supportive work must be performed around the clock and typically throughout the world, which means that logistics needs to be an integral part of all processes. The ideal structure for logistics would be an organization that performs essential work as part of the processes it supports while achieving the synergism of cross functional integration. Information technology introduced the potential of electronic integration as contrasted to physically combining logistics functions. Using information technology to coordinate or orchestrate integrated performance allows the responsibility for work itself to be distributed throughout the overall organization. Integration requires that logistics combine with other areas such as marketing and manufacturing. For example, rather than focusing on how to relate transportation and inventory, the real challenge is to integrate inventory, transportation, new product development, flexible 156
manufacturing and customer service. in order to achieve overall organizational integration, a firm must combine a wide variety of capabilities into new organizational units. This means that the traditional single function department must be assimilated in a process. Such assimilation often requires the traditional organizational structure be dissaggregated and then recombined in new and unique ways in one sense, such a functional disaggregation may appear to come full circle back to the early days of fragmented single-function departments. However, the critical differences in the emerging organization model are widespread availability of unbridled information. The new organization format is characterized by an extremely different culture concerning how information is managed and shared. Understanding the organizational development process permits logistics managers to evaluate the firm’s current state of organization and plan changes that can be accommodated.
FIG: LOGISTICS ORGANIZATION DEVELOPMENT CYCLE
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Stages of functional organization
Figure illustrates a traditional organizational structure with dispersed logistical functions.. the initial belief was that integrated performance would be facilitated by grouping logistical functions normally spread throughout the traditional organization into a single command and control structure.. It was felt that these functions would be better managed, trade-offs better analyzed, and least-Total cost solutions better identified if all logistics work was integrated into one organization. In order for operational integration to occur, managers had to believe that performance could be improved. Without this belief, they would continue To emphasize structure as opposed to management practice. While the idea of functional integration is logical and appeals to common sense, it is not always supported by other unit managers. It is natural that any attempt to reposition management authority and responsibility will meet resistance. Many logistics executives can provide examples of how attempts to reorganize were met with rivalry and mistrust--- not to mention accusations of empire building. Traditionally, in organizational structures, financial budgets follow operational responsibility. Likewise, power, visibility, and compensation result from managing large head counts and substantial budgets. Logistical reorganization, therefore, was typically seen as a way for logistical managers to gain power, visibility and compensation at the expense of other mangers. This also was ample reason for other managers to protect their power by resisting logistics functional integration. As a result, unified logistical organizations faces considerable resistance. But in an increasing number of firms, benefits were sufficient to empower reorganization. The resulting evolution typically involved three stages of functional aggregation. STAGE 1 ORGANIZATION
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The initial attempt at grouping logistical activities emerged during the late 1950s and early 1960s. Organizations with even a minimal degree of formal unification emerged only after senior management became committed to the belief that improved performance would result. The typical evolutionary pattern was for two or more logistics functions to be operationally grouped without significant change in the overall organization hierarchy. Such initial aggregation Occurred at both the staff and line levels of organization.. Seldom were organization Units engaged in purchasing and physical distribution integrated during this initial development stage. Figure illustrates a typical stage 1 organization. Although completely separate, physical distribution and material management units serve to aggregate related functions. As the potential of integrated logistics developed recognition within an enterprise, one or two clusters of unified operations emerged. In the marketing area, the cluster typically centered around customer service. In the manufacturing area, concentration was usually on inbound materials or parts procurement.. However, with few exceptions, most traditional departments were not changed and the organization hierarchy was not altered significantly. For the most part, stage 1 organizational change involved grouping functions within the traditional domains of marketing and manufacturing. The notable deficiency of stage 1 organization was a failure to focus direct responsibility for inventory. For example, initial physical distribution organizations typically controlled warehousing, transportation and order processing. Few stage 1 organizations had direct responsibility to manage trade-offs between transportation and finished inventory deployment. STAGE 2 ORGANIZATION
As the overall enterprise gained operational experience with unified logistics and cost benefits, a second stage of organization began to evolve. Figure illustrates stage 2, which began to emerge in the late 1960s and early 1970s. The significant feature of stage 2 was that logistics was singled out and elevated To a position of higher organizational authority and responsibility. The motivation was simple: Positioning logistics at a higher organization level increased the likelihood of strategic impact. Independent status allowed logistics to be managed as a core competency. A likely 159
candidate for elevated status was physical distribution in firms where customer service performance was critical to overall success. The grocery manufacturing business was an example where materials management often increased in operational authority and responsibility because inbound materials and production were a major portion of product costs. Thus the focal group that was elevated to higher organizational prominence in the stage 2 organizations typically depended on the nature of the enterprise’s primary business. The example in the figure illustrates a situation wherein physical distribution was restructured and elevated. In order to establish a stage 2 organization, it was necessary to reassign functions and position th newly created organization at a higher level within the overall enterprise structure. In the stage 2 organization, the concept of a fully integrated logistics unit was not achieved. Rather, integration was focused on either physical distribution or materials management. This failure to synthesize logistical management into an integrated system was due in part to a preoccupation with the performance of specific functions, such as order processing or purchasing, which were perceived as essential to traditional operations. A second limiting factor to total integration was the lack of cross – functional logistical information systems.. As a general rule, organizational integration reflected the information systems capability of the firm. A significant point about the stage 2 organization is that integrated physical distribution and/or materials management began to gain acceptance among financial, manufacturing, and marketing counterparts. The other corporate officers viewed these integrated organization as something more than purely reactive efforts aimed at cost reduction or containment. In the stage 2 organizations, it was common for the integrated unit to become a primary contributor to business strategy. The stage 2 organization is readily observable in industry today and may well remain the most adopted approach to logistical facilitation. STAGE 3 ORGANIZATION
Stage 3 organizations emerged in the 1980s the logistical renaissance began. This organizational structure sought to unify all logistical functions and operations under a single senior manager. Stage 3 organizations, having the comprehensive nature, were and continue to be rare. However, the trend at the stage 3 level of organization structuring is clearly to group as many logistical planning and operational functions as practical under single authority and responsibility. The goal is the strategic management of all materials and finished product movement and storage to the maximum benefit of the enterprise. 160
The rapid development of logistical information systems provided an impetus for stage 3 organizations. Information Technology became available to plan and operate systems that fully integrated logistical operations. Several aspects of the stage 3 organizations justify further discussion. First, each area of logistics – purchasing, manufacturing support and physical distribution is structured as a separate line organization. The lines of authority and responsibility directly enabled each bundle of supportive services to be performed within the overall integrated logistical effort. Since areas of operational responsibility are well defined, it is possible to establish manufacturing support as an operational unit similar to purchasing and physical distribution. Each of these units is operationally self-sufficient. Therefore, each can maintain the flexibility to accommodate critical services required by its respective operational area. In addition, since overall logistical activities can be planned and coordinated on an integrated basis, operational synergies between areas can be exploited. Second, five capabilities grouped under logistical support are positioned as operational services. This common service orientation is the mechanism to integrate overall logistical operations. It is important to stress that logistical support is not a staff organization. Rather, the group manages the day-to-day logistics work, which is structured with matrix accountability for direct liaisons between physical distribution, manufacturing support, and purchasing operations. Third, logistical resource planning embraces the full potential of management information to plan and coordinate operations. Order processing triggers the logistical system into operation and generates the integrated database required for control. Logistical resource planning facilitates integration. The plans are based on product/market forecasting, order processing, inventory status, and capacity strategy to determine overall requirements for any planning period. On the basis of identified requirements, the planning unit operationalizes manufacturing by coordinating production scheduling, capacity planning, and materials requirement planning. Finally, overall planning and controllership exist at the highest level of the stage 3 organization. These two efforts serve to facilitate integration. The planning group is concerned with long-range strategic positioning and is responsible for logistical system quality improvement and reengineering. The logistical controller is concerned with measurement of cost and customer service performance and with provision of information for managerial decision-making. The development of procedures for logistical controllership is one of the most critical areas of integrated logistical administration. The need for careful measurement is a direct result of the increased emphasis placed on customer service performance. The measurement task is extremely important because of te large operating and capital dollar expenditures involved in logistics. The stage 3 logistical organization approach offers a single logic to guide the efficient application of financial and human resources from material sourcing to customer delivery. As such a stage 3 organization, stage 3 logistical positions a firm to manage trade-offs between purchasing, manufacturing support, and physical distribution. STAGE FOUR: A SHIFT IN EMPHASIS FROM FUNCTION TO PROCESS. Interdependent of functional aggregation or disaggregation it is clear that organizations are struggling to position their operating capabilities to better support oriented process management. Mckinsey Consultants, frank Ostroff and Doug Smith proposed architecture to illustrate how functional hierarchical vertical organization to transition to become a process oriented horizontal model. The concept of 21st century organization is envisioned as the result of three factors: development of a highly involved work environment with self directed work teams (SDWT) as a vehicle to empower employees to generate maximum performance; second, improved productivity that results from managing processes rather than 161
functions (this notion has always rested at the core of integrated logistics) and third, the rapid sharing of adequate information that allows all facets of organization to be integrated. The essence for the argument for radical restructuring is that the traditional evolutionary concept of organization change is not sufficient to stimulate major breakthroughs in service or productivity. Rather, traditional change shifts the balance of centralization and decentralization or realigns operating structure between customers’ territories or products without any serious redesign of the basic work process. Because such restructuring typically assumes that functional organizations will continue to perform the basic work, little or no difference in actual practice results. In essence, companies are refocusing old business practices rather than designing new, more efficient processes. The challenges of managing logistics as a process are three fold. First all effort must be focused on value added to the customer. an activity exists and is justified only to the extent that it contributes to customer value. Therefore, a logistical commitment must be motivated by a belief that customers desire a specific activity to be performed. Logistical managers must develop the capacity to rethink externally. Second, organizing logistics as part of process requires that all skills necessary to complete the work be available regardless or functional organization. Organizational grouping on the basis of selected functions can artificially separate natural workflows and create bottlenecks. When horizontal structures are put in place, critical skills need to be put into position to ensure that required work is accomplished. Finally, work performed in a process context should stimulate synergism. With systems integration, the design of work as a process means that overall organizational trade-offs are structured to achieve maximum output for minimum input investment. The radical changes proposed by the shift from functional to process orientation have mixed messages for managers involved in logistics. On the positive side, general adoption of a process orientation builds on the basic principles of systems integration. At the core of integrated logistics is a commitment to functional excellence in the context of contribution to process performance. A general shift in managing logistics as a process means that it will be positioned as a central contributor to all initiatives that focus on new product development, customer order generation, fulfillment and delivery. The overall trend of process integration expands the operational potential and impact of logistics. STAGE 5: BEYOND TRANSPARENCY
STRUCTURE:
VIRTUALITY
AND
ORGANIZATIONAL
It is highly unlikely that the attention being given to process will end management ‘s quest for the ideal logistical organization. While several different scenarios concerning the organization of the future are technologically feasible, one of the most intriguing is speculation That formal hierarchical command and control organization structure will be replaced with an informal electronic network often referred to as a virtual organization. The word virtual implies an underlying existence without formal recognition. In other words, a virtual organization, whether it is a total enterprise or a specific core competency, would exist as a provider of integrated performance but not as an identifiable unit of in terms of the formal organization structure of their membership critical activities in an integrated fashion. These work teams could be transparent in terms of the formal organization structure of their membership. In other words, formal organization charts may not be related to actual workflow. In fact, logistics organizations of the future could not be characterized by functional disaggregation throughout the organization in an attempt to focus on workflow rather than structure. 162
THE NEED FOR INTEGRATION Integration is required not just within the organization but integration upstream with suppliers and distributors and customers. This integration is logistical rather than “vertical”; in other words we do not imply ownership or domination of the supply chain but rather that there is a greater emphasis on the linkage of organizations through information. The whole nature of logistics management has been dramatically changed by the information technology revolution. Information systems have now become the driving force pressurizing companies to reconsider their relationships with customers as well as suppliers. It is no longer possible to manage the business as if it were in a vacuum with no interconnections with other organizations. By process integration we mean collaborative working between buyers and suppliers, joint product development, common systems and shared information. For some companies such ideas are yet unthinkable and yet the signs are clearly pointing to a future where it will be the extent and quality of supply chain, integration that will determine market place performance. However in many industries the concept of process integration is increasingly accepted. For e.g. Over the last decade there has been a significant change in the way many car manufacturers in Western Europe have changed from fragmented, transaction focused businesses to highly integrated and relation ship based supply chains.
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11. LOGISTICS COSTING Principles of Logistics costing One of the basic principles of logistics costing 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. Mission Based Costing To operationlize these principles requires an 'output' orientation to costing. In other words we must first define the desire, 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. Mission can be defined in terms of the type of market served by which products and within what constrains of service and cost. A mission by its very nature cuts across traditional company lines. The successful achievement of defined mission goals involves inputs form a large number of fictional areas and activity centers within the firm. Thus as 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. Given that the logic of mission costing is sound, how might it be made to work in practice. The approach requires first by that the activity centers associated with a particular distributor mission be identified e.g. transport, warehousing inventory etc. and secondly that the incremental costs for each activity center incurred as a result of undertaking that mission must be isolated. Incremental costs are used because it is important not into account costs or costs which would still be incurred even if the mission were abandoned. In determining the costs of an activity center e.g. transport attributable to a specific mission the question should be asked. What costs would be 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, vehicle leaves a depot in London to make deliveries in Nottingham, And Leeds retained, what would be the difference in the total cost of transport. The answer would be-not very much. However if the customer in Leeds were dropped, but not those in Nottingham, there would be a greater saving of costs because of the reduction in miles traveled. 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 reduce 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. 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. 164
Profit ROI = ------------------------Capital Employed This ratio can be further expanded : Profit Sales ROI = --------------x -------------------------------Sales Capital Employeed 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. 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 can often be more effective to use the leverage of improved capital turnover to boos - ROI if the productivity of capital is high, e.g. limited inventory, high sales per square foot, premises that are lease rather than owned and so on. TOTAL COST ANALYSIS Total cost analysis is the key to manage the logistics function. That is at a given level at customer service, the total logistics costs must be minimized rather than an attempt to minimise the cost of individual activities. A non-integrative approach to logistics cost analysis may result in attempts to reduce specific costs within the logistics function, which are less than optimal for the system as a whole. This approach will lead to higher total costs. Cost cutting techniques geared to warehouse, transportation or inventory cost will not be effective in reducing the total logistics costs. This is because, reductions in one cost invariables results in increases in one or more of the others. Hence, cost tradeoffs among the various components of the logistics system are essential. For example, profits can be increased if the reduction in inventory cost is more than the increase in the other functional costs; or improve customer service at additional cost yields higher over all revenue. As the cost of logistics increases, there is an increasing need for accurate accounting for the costs. The logistics function is relatively more asset and labour intensive than other areas of the firm. The ratio of logistics cost to the total company costs has been steadily increasing. The full potential of logistics cost trade-off can only be realized if the management can fully determine the costs related to separate functional areas and their interaction. Types of Costs : To manage a Logistics system, the logistics manager must understand and use a variety of cost information. Also it is necessary to understand how the behaviour of one cost differs from that of another. The costs can be broken down in many ways: Fixed, variable and semi-variable, cash and non-cash, direct and indirect and sunk and managerial. A clear understanding of these costs helps managers to make logistics decisions effectively. Examples of various types of costs are as below (a) Salary paid to the logistics executive per month is a fixed cost because it does not very with the number of hours worked per month. (b) The hourly wages paid to the forklift truck driver is a variable cost. If the truck driver works one hour extra per day, he will receive extra wages. (c) Semi-variable cost has both a fixed and a variable cost component, For example, a sales person might be paid fixed monthly salary plus a commission that varies according to the sales achieved per month. (d) Cost like labour cost which involves cash payment of wages to employees is a cash cost. 165
(e) Depreciation cost of a capital asset shown in the balance sheet is a noncash cash. No cash outlay takes place and depreciation expense serves only to reduce the book value of the capital asset over a period of time. (f) Depreciation cost of a capital asset is a direct cost. (g) Indirect costs may be traceable or untraceable to a specific product or a specific department. For example, salary paid to the general manager of maintenance department. Types of Cost Data Needed The quality of the accounting data has a direct influence on management's ability in the following aspects : • To enter new markets, • to take advantage or innovative transportation systems, • to choose between common carriers and private carriers, • to increase deliveries or inventories, • to make changes in the configuration of distribution centres, • to restructure the inventory levels, • to make changes in packaging and • to determine the extent of automation in the order processing system. Based on the information provided by the accounting system, the logistics managers should be able to find answers to the following questions I. How do logistics costs affect contribution by product, territory, customer and sales person? II. What are the costs of providing higher levels of customer service? What kind of trade-off are necessary? What are the incremental benefits and losses? III. What is the optimal level of inventory? How much does it cost to hold inventory? How sensitive is the inventory level to changes in customer service levels or warehousing patterns? IV. What mix of transport modes or carries should be used? V. How many warehouses should be used in the field and where should they be located? VI. How many production set ups should be used? Which plant will be used to produce what product? What are the optimum manufacturing plant capacities? VII.
What product packaging alternatives should be used? VIII. To what extent should the order system be automated? IX. What distribution channels should be used? To answer the above questions, managers must know what costs and revenues will change if the logistics system change. A product's contribution should be determined based on how corporate revenues, expenses and profitability would change if the product line were dropped. TOTAL COST ANALYSIS APPROACH The concept of total cost analysis Many problems at the operational level in logistics management because all the impacts of specific decisions, both direct and indirect, are not taken into account throughout the corporate system. Too often decisions touch in one area can lead to unfortunate results in the other areas, change in policy on minimum order value, for example, may influence customer ordering patterns and lead to additional costs. Similarly changes in production schedules that aim to improve production efficiency 166
may lead to fluctuations in finished stock availability and thus affect customer service. A. The problems associated with identifying with total system impact of distribution policies are immense. By its very nature logistics cuts across traditional company organization functions with cost impacts on most of those functions. B. Conventional accounting systems do not usually assist in the identification of these company wide impacts frequently absorbing logistics related costs in other cost elements. The cost of processing orders for eg. is an amalgam of specific costs incurred in different functional areas of the business which generally prove extremely difficult to bring together. Figure (1.1) outlines the various cost elements involved in the complete order processing cycle, each of these elements having a fixed and variable cost component which will lead to a different total cost per order.
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Order placement and communication.
Order Entry
Credit Check
Documentation
Order Pricing
Delivery
Invoicing and Collection
Fig. (1.1) Stages in the order-to-collection cycle C. Accounting practice for budgeting and standard-setting has touched to result in a compartmentalization of company accounts; thus budgets tend to be set on a functional basis. The trouble in that policy costs do not usually configure themselves within the sense water tight boundaries. It is the nature of logistics that, like a stone thrown into a pond, the effects of specific policies spread beyond their immediate area of impact. (2) A. A further feature of logistics decisions which contributes to the complexity of generating appropriate cost information is that they are usually taken against the benchmark of an existing system. The purpose of total cost analysis in this context is to identify the change in costs brought about by these decisions. Cost must therefore be viewed in incremental terms – the change to the system. Thus the addition of an extra warehouse to the distribution network will bring about cost changes in transport, inventory investment and communications. It is the incremental cost difference between the two options which is the relevant accounting information for decisions making in this case. Fig. (1.2) shows how total logistics costs can be influenced by the additional, or removal, of a depot from the system. 168
Total distribution costs
Y
Trunking costs
Inventory costs
Outlet costs Costs
Local Delivery costs
Order Processing costs
Number of outlets
0
X
Fig (1.2) The total costs of a distribution network To understand the demand of measuring logistics, it is necessary to review traditional accounting methods in terms of analysis requirements and to identify costs relevant to integral logistical systems. PUBLIC ACCOUNTING PRACTICE Logistical functions are on integral part of the two main financial reports of business – the balance sheet and the profit and the loss statements (P& L). However, the primary deficiency in determining logistical costing and analysis in the method by which standardized accounting costs are identified classified and reported. The first problem results from the fact that accounting practice aggregates costs on a standard or natural account basis rather than on an activity basis. The process of classification and assignment helps but does not satisfy the requirements for total – 169
cost analysis. In reality, many expenses associated with logistical performance cut across organizational units. For eg. – efforts to reduce inventory will reduce inventory carrying cost, but they may also lead to more back orders, which would increase total transportation cost. The result is deficient data for integrated performance measurement. In order to design and evaluate logistical operations, it is necessary to identify costs associated with performing specific activities or tasks, such as the warehouse expenses for a specific SKU (stock keeping unit). This means that the individual logistical activities must be identified and that costs be allocated or assigned. An overlapping deficiency of accounting involves the traditional methods of reporting transportation expenditures. It remains a standard practice in retail accounting to deduct freight from gross margin figure. In part, it seems to be based on the belief that managers can do little about inbound freight. However, the problem extends beyond where freight is accounted for and reported. In many purchasing situations, freight is not reported at all as a specific cost. Many products are purchased on a delivered price basis, which includes transportation cost. A final deficiency in traditional accounting practice is the failure to specify and assign inventory cost. Full costs associated with the maintenance of the inventory such as insurance and taxes, are not identified and assigned, thereby resulting in an understatement or obscurity in reporting inventory cost. For eg.- If a brand manager is not held responsible for his brand’s inventory carrying cost, he is not motivated to reduce inventory levels. The financial burden for assets committed to material, WIP and finished goods inventory is not identified, measured, and separated from other forms of capital expense incurred by the enterprise.
LOGISTICS ACTIVITY – BASED COSTING Activity-Based Costing: Activity-based costing seeks to relate all relevant expenses to the value adding activities performed. For example, costs are assigned to a customer or product to reflect all relevant activity cost independent of when and where they occur. The fundamental concept of activity-based costing is that expenses need to be assigned to the activity that consumes a resource rather than to an organizational or budget unit. For example, 2 products produced in the same manufacturing facility, may require different assembling and handling procedures. One product may need an assembly or packaging operations that requires additional equipment or labor. If total equipment and labor costs are allocated to the products on the basis of sales or units produced than both items will be charged for the additional assembly and packaging operations required by only one of them. Activity based costing seeks to relate all relevant expenses to the value adding activities performed. For eg.- costs are assigned to a customer or product to reflect all relevant activity costs independent of when and where they occur. The fundamental concept of activity-based costing is that expenses need to be assigned to the activity that consumes a resource rather than to an organization or budget unit. 170
For eg.- Two products, produced in the same manufacturing facility, may require different assembly and handling procedures. One product may need an assembly or packaging operation that requires additional equipment or labor. If total labor and equipment costs are allocated to the products on the basis of sales units produced, then both items will be charged for the additional assembly and packaging operations required by only one of them. This unjustly reduces the profitability of the simplified product by forcing that product to pay for the operations it does not need. In a manufacturing sense, identifying and assigning cost factors means that a specific product will be fully assigned its fair share of all overhead and operating costs. In the case of logistics, the key event is a customer order and the related activities and relevant costs that reflect the work required to fulfill the order. Logistical activities based costing must provide managers the insights needed to determine if a specific customer, order, product or service is profitable. This requires matching specific revenue with specific costs. Effective costing requires identification of he specific expenses to include in an analysis framework. A second concern is to specify the relevant cost time frame. Finally, costs must be allocated or assigned to specific factors that are relevant to assembly alternative actions. The guiding criteria for effective logistical activity-based costing are relevancy and consistency. Relevancy is important in the sense that the cost assignments help managers to better understand the major factors affecting logistics expenses. Consistency is important in terms of comparing related activities over time. These criteria help in the decision making process where logistical activities are concerned. In case of logistics, the key event is a customer order and related activities and relevant costs that reflect the work required to fulfill the order In other words, logistical activity-based costing must provide managers the insights needed to determine if a specific customer, product, order, or service is profitable. This requires matching specific revenue with specific costs. The guiding criteria for effective logistical activity-based costing are relevancy and consistency. Relevancy is important in the sense that the costs assignment helps managers to better understand the major factors affecting logistics expenses. Consistency is important in terms of comparing related activities over time. In the final analysis, a logistical costing system has to make sense only to the managers who are using it as a guide to decision making. (I) Cost Identification: All costs associated with the performance of logistics function should be in the activity- based classification. The total cost associated with fore casting and order management, transportation, inventory, warehousing, packaging must be isolated. Typical logistics costs can be categorized under two headings – direct and indirect costs, cost of capital and overheads. a) Direct Costs: These costs are those expenses specifically caused by the performance of logistics work. Such costs are difficult to identify. For example, the transportation costs for an individual truckload order can be directly attributed to a specific order. Likewise only minor difficulty is experienced in isolating the direct administration cost of logistical operations. 171
b) Indirect Costs: These are more difficult to isolate. For example, the cost of capital invested in real estate, transportation equipment, and inventory- just a few of the areas within the capital structure of logistics- must be identified to arrive at a comprehensive total cost. The manner by which total costs are attributed to logistics activities are determined by managerial judgments. One approach is to allocate the overhead cost on the basis of the average cost per unit. All expense paid to support capital investment in logistical operations are relevant to activity-based costs. The judgment applied in arriving at cost of capital will greatly influence logistical system design. Thus procedures and standards used to calculate indirect logistical costs are critical. They are also essential for potential outsourcing. c) Cost of Capital : Capital investment Expenses for logistical activities are relevant to logistical activitybased costs. Cost of such capital also needs to be included in your logistical cost. d) Overhead An enterprise incurs considerable expenses on behalf of all organizational units, such as for light and heat in various facilities. Judgement is required to determine how and to what extent various types of overhead should be allocated to specific activities. One method is to directly assign total corporate overhead on a uniform basis to all operational units. At the other extreme, some firms withhold all overhead allocations to avoid distorting the ability to measure direct and indirect logistical activity- based costs. (II) Cost Time Frame A basic concern in logistical activity-based costing is to identify the period of time over which costs are accumulated for measurement. Accounting principles call for accrual methods to relate revenues and expenditure to the actual time period during which services are performed. Expenses associated to raw material procurement through finished product distribution and almost all other logistical operating costs are incurred in anticipation of future transactions, making accrual methods difficult to administer. To overcome the time problem, accountants attempt to break costs into 2 groupscosts assigned to a specific product and costs associated with the passage of time. Using this classification an attempt is made to match the appropriate product and time period costs to specific periods of revenue generation. From a logistical perspective, a great many of the expenses associated with procurement and manufacturing support can be assigned and absorbed into direct product cost. In situations where a considerable period of time elapses between production and sales, such as in highly seasonal businesses, significant costs of maintaining inventory and performing logistical operations may not be associated with revenue generation. (III) Cost Formatting Functional Grouping To format costs by Functional grouping-requires that all expenditures for direct and indirect logistical services performed for a specified operating time be formatted and reported by master and sub-account classification for comparison of one or more operating periods. 172
No standard format of activity costs or functional groupings is available that fits the needs of all enterprises. (i) Logistical functional cost statements must be designed to facilitate control within each unique environment. (ii) It is important to identify as many cost accounting categories as practical and to develop a coding system that will facilitate assignment to three cost accounts. (iii) Effective total-cost groupings can be maintained over time only if appropriate coding to reclassify material accounts into functional groups in incorporated in the basic logistics information system. Allocated cost formatting or grouping i) This consists of assigning overall logistical experiences to a measure of physical performance, for eg.- Total logistical cost can be generated on a per ton, per hundred weight, per product, per order, or per line-item basis, or on some other physical measure that is useful for comparative analysis of operating results. ii) While important for assigning overall expenses to physical performance measures, this grouping typically has limited use outside logistics management. Fixed-Variance Grouping i) This is the most useful for identifying the logistics cost implications of current or alternate operating practices. ii) This method of formatting consists of assigning costs as either fixed or variable to appropriate the magnitude of change in operating expenditure that will result from different volumes of logistical throughput. iii)Costs that do not directly vary with volume are classified as fixed. In the short run, these expenses fixed even if volume were reduced to zero. iv) Costs influenced by volume are classified as variable for eg.- the cost of a delivery truck is fixed: if the truck costs $40,000 to purchase , the firm is charged $40,000 whether the truck is used for 1 or 1,000 deliveries. However, gasoline to operate the truck is variable total gasoline costs depend on how frequently the truck is driven. The use of fixed and variable cost formatting offers a convenient way to handle expenses in logistical system design models. Logistical costing involves the calculation of the total logistical cost. Traditional financial accounting practice is designed for reporting results to external parties like investors and tax authorities. This needs standardization of the practice of financial accounting to ensure tax compliance and enable comparisons between the performances of firs. However, traditional accounting practice aggregates costs on a source of cost basis. Examples are the aggregation of salaries, rent, and depreciation. Source-based costing does not assign costs on a functional basis, and hence, does not permit fixing of the responsibility for these costs. Thus, the conventional methods of accounting do not facilitate logistics costing which is function-based and involving total-cost integration. To overcome the problems faced by managers in utilizing the results of the traditional accounting practice, managerial accounting systems have been devised. This practice has resulted in aggregation of costs on the basis of the managerial or functional areas of a firm. Managerial accounting systems help managers to plan, implement, and control functions within their jurisdiction. These also help in budgeting, resource allocation, and performance measurement related to functional areas. However, logistical costs cut across functional areas involving the total cost consideration. Hence, managerial accounting practices also do not permit integrated logistical permit integrated logistical cost measurement. 173
With increasing competition, firms have been experiencing pressures on pricing. In order to enable managers to determine whether specific products, customer, orders, and services are actually profitable, it is necessary to have a costing system which can correctly allocate costs to a specific product, customer, order, or service. We have seen that traditional financial accounting and managerial accounting practices do not correctly reval the profitability or each specific customer or product due to the arbitrary allocation of indirect and overhead costs. In traditional cost accenting practice, for example, volume-based measures like labour hours or machine hours and utilized to allocated overheads to the cost of products. Consider two products X and Y as follows Product X Product Y Direct Labour : 1 hour per unit 2 hour per unit Direct Labour cost : Rs. 25 per hour Rs. 25 per hour Demand : 200 per week 1900 per week Total overhead cost: Rs. 2,40,000 per week. Total direct labour : 4000 hours Therefore, overhead per labour hour: 240000/4000 = Rs. 60 per labour hour Thus, product X overhead allocation : 1 labour hour : Rs. 60 per unit; and, Product Y overhead allocation : 2 labour hours : Rs. 120 per unit. Activity - based costing involves determining the processes that combine to produce the desired result, breaking down these processes into the relevant activities performed during the processes, and then determining the .costs of those activities. The desired result could be in the case of a specific product, customer, order, or service. This method of costing traces each cost to its origin. The basic premise of activity-based costing is that each cost head like a product or customer requires the performance of activities which consume resources which in turn consume costs. The activity-based Costing method involves: 1. Identifying the activities necessary for each cost head like product, order, service, or customer. 2. Determining the cost for each activity. 3. Determine cost drives 4. Calculate allocation to each cost head. For instance, a logistics manager would be identify the activities and the relevant cost drivers necessary to accomplish the distribution activities for a products as Activity Cost Driver (1) Transportation Number of units (2) Receiving Number of receipts (3) Storage Number of days of storage (4) Order picking Number of order pickings (5) Packing Number of deliveries For the example of products X and Y above, the allocation of overhead can be illustrated as follows Calculation of Total quantity of cost drivers (cd) 1 10500 2100 units Transportation 0 2 Receiving 20000 4 receipts Activity
Cost (Rs.)
Unit cost
Product X
Product Y
50 5000
cds cost cds cost 200 10000 1900 95000 1 5000 3 15000
174
3 Storage 54000 9 days 6000 4 Order21000 3 picks 7000 5 Packing 40000 4 deliveries 10000 24000 Total 0 Therefore, 50000 Overhead for Product X = ----------- -- = 200 Overhead for Product Y =
3 1 1
18000 6 7000 2 10000 3 50000
36000 14000 30000 190000
Rs. 250 per unit
190000 ------------- = Rs. 100 per unit 1900
Hence, we obtain, Total cost of Product X = Direct cost + Overhead cost = Rs. 25 + Rs. 60 = Rs. 85 (traditional cost accounting) Total cost of Product X = Direct cost + Overhead cost = Rs. 25 + Rs. 250 = Rs. 275 (activity based costing) Total cost of Product Y = Direct cost + Overhead cost = Rs. 50 + Rs. 120 = Rs. 170 (traditional cost accounting) Total cost of Product X = Direct cost + Overhead cost = Rs. 50 + Rs. 100 = Rs. 150 (activity based costing) The difference in the total costs obtained by traditional cost accounting and activity based costing is clearly visible in the example above. Activity based costing enables the accurate calculation of the cost of a product or service based on actual activities performed for creating these. This facilities the following for managers: (1) Proper identification of profitable products, services, customers, and orders. (2) Improved decision making by enabling cost comparisons of options. (3) Better detection of cost improvement areas. (4) Preparation of business plans. Activity-based costing is very useful in circumstances when high amount of indirect costs and overheads need to be allocated to a variety of products or services. TOTAL COST PRESENTATION For purposes of implementing and presenting logistical total-cost analysis, it is common practice to focus on INVENTORY and TRANSPORTATION as the two main network design factors. a) Both inventory and transportation expenses can be defined in a format sufficiently broad to include activity and functional cost relationships for related logistical components. 175
For eg.- communication costs that are associated with order processing and with expenditures required for warehouse storage and material handling can be classified under the inventory umbrella. 2) In terms of inventory, total cost includes all expenses related to inventory carrying cost and customer ordering. A Inventory carrying cost includes taxes ,storage, capital, insurance and obsolescence. B The cost of ordering includes the full expense of inventory control, order preparation, communications, update activities and managerial supervision. 3) The total cost of transportation includes for-hire transport expenses and accessorial charges plus costs related to the hazards incurred with the various modes, legal forms of transport, and associated administrative expenses. If private transportation is used, accounts direct, indirect, and overhead costs. 4) A brief summary of the total cost of logistical activities is presented in Fig. 2 (Table). Classification of costs in terms of inventory or transportation highlights the basic trade offs that determine the cost justification for logistical network design. 5) The basic logic for focusing on transportation and inventory as key factors that they logistical operations. A Transportation deals with the geographic (spatial) dimensions of logistical operations by positioning product where the customer wants to purchase it. B Inventory involves the rate at which capital assets are used (temporal) to meet customer requirements by having product available WHEN the customer wants to purchase. 6) A second justification for focusing on transportation and inventory is that these two factors include 80 to 90 percent of overall logistics expenses for the typical firm. 7) The columns on the right side of Fig. 2 (Table) reflect potential activities that may be used to segment costs for managerial review. For eg.- an ordering cost can be assigned to a specific order, or it may be grouped by customer. If the objective is to determine the expenses associated with any specific level of de-aggregated activity, it is essential to assign specific costs to the actual targets or events. For eg.- if the de-aggregated activity is the ordering cost for one specific product, the actual expenses for that product alone must be identified. As noted earlier, the extension of total costs to an activity based format may not meet public accounting precision. The purpose of activity based costing is to give managers a better perspective of the total cost, associated with performance of a specific activity. Total Costs Classified by Inventory and Transportation ACTIVITY-Based Assignments Customer Order Product Value-added Service INVENTORY- related costs 176
Inventory carrying cost (ICC): Tax Storage Capital Insurance Obsolescence Ordering: Communication Processing, including material handling and packaging Update activities, including receiving and date-processing INVENTORY CONTROL Management TRANSPORTATION- related costs Direct: Rates Accessorial charges Indirct, liability not protected by carrier Managerial: Location Analysis Data Requirements: The primary analysis data requirements are definitions of markets, products, network, customer demand, transportation rates, and variable and fixed costs. Market definition: Location analysis requires that demand be classified or assigned to a geographic area. The combination of geographic areas constitutes a logistics service area. Such an area may be a country or a global region. The demand for each customer is assigned to one of the market areas. The selection of the market definition method is an extremely important element of the system design procedure. A number of market definition structures have been developed. The most useful for logistics modeling are: County, Standard metropolitan statistical area (SMSA) and ZIP or postal codes The major issues for selecting a market definition concern the number of areas required to provide accurate results. While more market detail increases accuracy, it also increases analysis efforts. Research indicates that approximately 200 markets offer an effective trade-off between accuracy and analysis effort. Product definition: Although individual product flows can be considered when performing a location analysis, it is usually not necessary to use such detail. Individual items –especially those with similar distribution characteristics, production sites, and channel arrangements – are grouped or simplify the analysis. Network definition The network definition specifies the channel members, institutions and possible locations to be included in the analysis. Specific issues concern the combinations of suppliers, production, locations, distribution centers or channel member alternatives. While using a more comprehensive definition reduces the chance of suboptimising logistics system performance, total channel location analysis increases complexity. Location analysts must evaluate the trade offs between 177
increasing analysis complexity and improved potential for total supply chain optimization. Market demand: Market demand defines the shipment volume in each geographic area defined as a market specifically location analysis is based on the relative product volume shipped to each market area. While the volume may pertain to the number of units or cases shipped to each market, most location analyses are based on weight since transportation cost is strongly influenced by the amount of weight being moved. Market demand utilized in the analysis may also be based on historical shipments or anticipated volume if substantial changes are expected. Transportation rates: Inbound and outbound transportation rates are a major data requirement for location analysis. Rates must be provided for shipments between existing and potential distribution channel members and markets. in addition , rates must be developed for each shipment size and each transportation link between distribution centers and markets. it is common for location analysis to require in excess of a million individual rates. Because of the large number rates are commonly developed using regressions or are retrieved from diskettes provided by most carriers. Variable and fixed costs: The final location analysis data requirements are the variable and fixed costs associated with operating distribution facilities. Variable costs include expenses related to labour, energy. Utilities and materials. in general, variable expenses are a function of throughput. Fixed cost includes expenses related to facilities, equipment and supervisory management. Within a relevant distribution facility operating range, fixed costs remain relatively constant. While variable and fixed cost difference by geography is typically not substantial there are minor locational considerations that should be included to ensure analysis accuracy. the major differences result from locational peculiarities in wage rates, energy cost, land values and taxes. Conclusion: substantial logistics planning emphasis is placed on location analysis. in the past distribution networks were relatively stable, so it was unnecessary for firms to compete system analyses regularly. However the dynamics of alternative distribution channel options, changing logistics cost structures and availability of third party services require that logistics networks be evaluated and refined more frequently today. It is common for firms to perform evaluations annually or monthly. Total cost-analysis: The basic integrative concept in logistical network design is total cost. An example illustrated a total cost justification for using high cost airfreight. The basic thesis was that in situations where the speed and dependability of air delivery would permit other costs (such as warehousing and inventory) to be reduced or eliminated, high cost premium transportation would be justified by achievement of lower total cost. Total cost could be reduced by careful integration of logistical activities. The basic concept of total cost is simple and complements the notion of designing logistics as an integrated performance system. The main problem in operationalizing total cost is that traditional accounting practice for classifying and reporting critical expenses does not typically provide adequate logistics metrics. Public accounting practice:
178
The two main financial reports of business enterprises are the balance sheet and the profit and loss statements (P&L). The purpose of the balance sheet is to summarize assets and liabilities and to indicate the net worth of ownership. The P&L statement reflects the revenue costs associated with the specific operations over a specific period of time. As the name profit and loss implies, its purpose is to determine the financial success of operations. These two are mainly suited for investors, taxation and auditing purposes and not for logistical purposes
The first problem results from the fact that accounting practices aggregates cost on a standard or natural account basis rather on activity basis. The practice of grouping expenses into natural accounts such as salaries, rent, utilities and depreciation fails to identify or assign the operations responsibility .In reality many expenses, associated with logistical performance cut across organizational units. For example efforts to reduce inventory will reduce inventory-carrying costs, but they may lead to back-orders, which would increase the total transportation cost. The practice of classifying the costs on a natural basis also creates a problem in activity-based cost analysis. In order to design and evaluate logistical operations it is necessary to identify costs associated with performing specific activities or tasks, such as the warehousing expenses for a specific SKU. This means that the individual logistics must be allocated or assigned. Transportation expenses- Freight is not accounted for. Many products are purchased on a delivery price basis, which includes transportation cost. Failure to assign inventory costs Finances committed to Raw materials, WIP, Finished goods not carefully separated from other capital expenses.
179
12. MRP & DRP WHAT IS MRP? MRP [Materials Requirement Plan] Popular concept in 1960&1970. Consists of a computer system, a manufacturing information system, building on inventory, production scheduling and administering all inputs to production and a concept and philosophy of management. Definition Of MRP SYSTEM MRP system consists of a set of logically related procedures, decision rules, and records designed to translate a master production schedule into time phased net inventory requirements and the planned coverage of such requirement for each component item needed to implement schedule. An MRP system re plans net requirements and coverage as a result of changes in either the master schedule, demand, and inventory status or product composition. MRP systems meet their objective by computing net requirements for each inventory item, time-phasing them, and determining their proper coverage OBJECTIVES 1. Ensure the availability of materials components and products for planned production and customer delivery. 2. Maintain the lowest possible inventory level. 3. Plan manufacturing activities, delivery schedules and purchasing activities. HOW? PROCESS MRP starts with customer’s demand for the quantity of end product and the time when the products are needed. Then MRP explodes the time and need for components based upon the end product need. MRP System focuses on inbound logistical area MRP System uses following key elements: 1. 2. 3. 4. 5.
Master Production Schedule Bill of Materials Inventory Status Files MRP Program Outputs & Reports
MRP system has developed into its current incarnation in phases. First phase is called MRPI or Materials Requirement Planning and the second phase is called MRPII or Manufacturing Resources Planning MRP I is a computer based production and inventory control system [soft ware] that attempts to minimize inventories while maintaining adequate materials for production process. WHEN DOES IT GET APPLIED? MRP I is applied when 180
1. The process follows an intermittent system. 2. Demand is dependent 3. Purchasing dept., their suppliers and company’s own manufacturing system is flexible enough to handle deliveries on weekly basis ADVANTAGES OF MRP I 1. Improved business results [ROI, profits] 2. Improved manufacturing results 3. Better manufacturing control 4. More accurate and timely information 5. Less inventory 6. Time phased ordering of materials 7. Less materials obsolescence 8. Higher reliability 9. More responsiveness to market demand 10. Reduced production costs DISADVANTAGES OF MRP I 1. Due to small lot purchases high material acquisition costs and high ordering costs 2. Stock out costs are more as safety stock protection is low 3. A limitation of software as adapting to specific situations is difficult. So modification of the software is necessary MRP II MRP I is updated and expanded to include financial and marketing and logistics elements. This newer version is called Manufacturing Resources Planning or MRP II. Includes entire set of activities involved in planning and control of production. It consists of a variety of functions of modules and includes production planning, resource requirements planning, master production scheduling, materials requirement planning [MRP I], shop floor control and purchasing Benefits of MRP II 1. Inventory reductions of one fourth to one third 2. Higher inventory turn over 3. Improved consistency in on-time customer delivery 4. Reduction in purchasing costs due to less urgent purchases 5. Minimization of workforce overtime DISTRIBUTION RESOURCE PLAN [DRP] Distribution requirement planning (DRP) It is a more sophisticated approach that considers multiple distribution stages and the characteristics of each stage. It is a logical extension of MRP, although there is one fundamental difference between the two. • MRP is determined by a production schedule that is defined and controlled by the enterprise. On the other hand, DRP is guided by customer demand, which is not controllable by the enterprise. 181
•
•
So, while MRP generally operates in a dependent demand situation, DRP operates in an independent environment where uncertain customer demand determines inventory requirements. The manufacturing requirements planning component coordinates the scheduling and integration of materials into finished goods. MRP controls inventory until manufacturing or assembly is complete. DRP then takes coordination responsibility once finished goods are received in the plant warehouse.
The fundamental DRP planning is the schedule, which coordinates requirements across the planning horizon. There is a schedule for each SKU and each distribution facility. Schedules for the same SKU are integrated to determine the overall requirements for replenishment facilities such as the plant warehouse. The schedules are developed using weekly time increments known as ‘buckets’. The schedule reports current on-hand balance, safety stock, performance cycle length and EOQ. Distribution Resource Plan is a widely used powerful technique applied to outbound logistics to help determine appropriate level of inventory Distribution requirement planning [DRP I] is defined as “the application of MRP principles to the distribution environment [out bound logistics], integrating the special needs of distribution. It is a dynamic model that looks at the time phased plans of events that effect inventory. Distribution Resource Planning [DRP II] is an extension of DRP I. Distribution resources planning applies the time phased logic of DRP I to replenish inventories in multi echelon warehousing systems. Distribution resources planning extends DRP I to include the planning of key resources in a distribution system –ware house space, man power levels, transport capacity [e.g. trucks, rail cars] and financial flows. As an extension of DRP I, DRP II uses the needs of distribution to drive the master schedule, controlling the bill of materials and ultimately materials requirement planning. In essence, DRP I & DRP II are outgrowths of MRP I & MRP II, applied to logistics activities of a firm. Uses of DRP generated information ♦ Coordinate the replenishment of SKUs coming from the same source [e.g. a company owned or vendor’s plant.] ♦ Select transportation modes and carriers and shipment sizes more cost efficiently. ♦ Schedule shipping and receiving labour ♦ Develop a master production schedule for each SKU Accurate forecasts are essential ingredients for successful DRP II system. MARKETING BENEFITS • Increased service levels - improved OTD, reduced Customer Complaints
• • •
Effective new product introduction plans Ability to anticipate shortages Improved inventory coordination
182
LOGISTICS BENEFITS
• • • • •
Reduced distribution costs Reduced inventory levels Decreased warehouse space requirement as inventory is low Lesser back orders
Improved inventory visibility & coordination between manufacturing and logistics CONSTRAINTS • Needs accurate forecast
•
Sources of errors in the system - Inaccuracy in forecast quantity - Inaccuracy in forecast location - Inaccuracy in forecast time • Variable performance cycles
• •
System nervousness Uncertainty buffers
COMPARE DRP & MRP 1.scope 2.dependence planning inputs
for
DRP Outbound logistics Market
3. Coordination responsibility
Once the finished goods are produced.
4. Nature of plan 5. What is forecast? 6. Planning Tool
Short term and accurate Finished goods Schedule prepared for delivery of supplies in the outbound logistical network. SKUs
7. Inventory management of? 8. Planning availability of stock at?
Market [retailers] warehouses
&
MRP Inbound logistics Production Schedule worked out based on past data in the organization [Forecast based on past data] Up to Finished Goods starting from raw materials production. Dependent demand Production schedule
Raw Materials, components Raw material stores, Conversion process & finished goods store
PURCHASING AND PRODUCTION SCHEDULING In the supply chain management the inbound logistics system is frequently referred to as material’s management and the outbound system is usually called physical distribution. The integration of the inbound and outbound system is extremely important to the efficient and effective management of the logistics supply chain. Materials management involves the planning and control of the flow of materials that are a part of the inbound logistics system. It includes the following activities: 183
Procurement (or purchasing), Warehousing Production planning (or scheduling), Inbound transportation Receiving materials. Quality control, Inventory planning and control all Salvage and Scrap disposal. PROCUREMENT OR PURCHASING Procurement or purchasing which is also known as supply management encompasses any activity involved in moving goods into a firm. It aims at anticipating requirements, sourcing and obtaining supplies, moving supplies into the firm and monitoring the status of supplies as current asset. ROLE OF PURCHASING IN LOGISTICS MANAGEMENT Logistics spans both inbound and outbound relationships and flow of materials. Effective Procurement of goods and services enables an organization to achieve competitive advantage. The procurement process links members in the supply chain and assures the quality of suppliers in that chain. The quality of materials and services which are inputs to the production process affects the quality of finished goods which in turn affects customer satisfaction and revenue for the firm and its profitability. Since cost of inputs is a major cost in many manufacturing firms, Procurement function acts as a determinant of revenues, costs and supply chain relationships. Purchasing is the act of buying goods and services for the firm in the narrow sense, while Procurement consists of all those activities necessary to acquire goods and services consistent with user requirements. Procurement has a strategic importance in the value chain because it includes activities such as qualifying suppliers procuring various types of inputs, and monitoring supplier performance. As such, procurement serves as a vital link between members of the supply chain. Purchasing is important to a firm because of two reasons: (i) cost efficiency and (ii) Operational effectiveness. Purchase managers have a major responsibility of safeguarding the financial interests of their firms by economizing on the cost of purchased goods and services thereby creating a competitive advantage for their firms. Efficient purchasing optimizes inventory holding and avoids production stoppages (due to shortages of materials) thereby maintaining operational effectiveness of the firm. The role of purchasing in the supply chain is illustrated
ROLE OF PURCHASING IN SUPPLY CHAIN MANAGEMENT Logistics Management Information Flow
Tier 1 Supplie r
Tier 2 Supplie r
MRP
MRP
Purchas ing MRP
Materials Managem ent MRP
Producti on
Physical Distributio n
Production Flow 184 MPS
Marketi ng & Sales
Custom Consum ers ers DRP
DRP
DRP
MRP = Materials Requirement Planning MPS = Master Production Schedule DRP = Distribution Requirement Planning EDI = Electronic Data Interchange Purchasing Activities: In earlier days, purchasing was looked upon primarily as a service function, having responsibility to meet the needs of the manufacturing or other internal functions for which it buys. This was a narrow perspective limiting the contribution that purchasing could make to the firm. Nowadays purchasing focuses on getting the right product or service to the right place at the right time - in the right quantity, in the right conditional or quality and from the right supplier at the right price the internal customer decides what is right at each step and purchasing ensures that the internal customer’s expectations are met. However purchasing has the responsibility to keep the Operation of the firm running smoothly by ensuring a reliable source of supply at the lowest total cost. PROCUREMENT (OR PURCHASE) PROCESS The purchasing function has gradually evolved. As organizations increasingly outsource many activities and introduce automation the money spent on purchases increase as compared to expenditures on labors. Hence purchasing activity is receiving more and more attention. Because of the advancement in computer and information technology many routine purchasing activities such as purchase order placement expediting matching documents and calling to check stock have either been eliminated 0r arc now possible on-line with electronic data interchange. The following figure illustrates the procurement process. Procurement Process Need Analysis • Identify Needs • User Requirement
Make or Buy Decision
Make
Buy
Buy Some Components
Purchase Type • Straight Buy • Modified Buy • New Buy
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Selector Vendor • Market Analysis • Potential Vendors • Prescreen Potential Sources • Evaluate Remaining Sources • Choose Vendor
Product Or Service Delivery
Post Purchase Performance Evaluation
The activities involved in the procurement process are briefly discussed in the following section. a. Identify (or reevaluate) need: The procurement activity is usually initiated in response to a new or an existing need of user. In some instances existing needs may have to he reevaluated because of change in them. b. Decides and evaluate user requirement: The requirement to satisfy the identified need must be defined in measurable terms. For example the technical specification must be established so that the procurement professional can communicate the same to potential suppliers. c. Decide whether to make or buy: The firm should first decide whether to make or buy the product or service to satisfy the user's needs. Even to make a product the firm may have to purchase some inputs from outside suppliers (for example. raw materials or components). d. Identify the type of purchase: Three types of purchases are: (a) straight buy or routine purchase, (b) modified rebuy which requires a change to an existing supplier or input, (c) new buy which results from a new user need. e. Conduct a market analysis: Market analysis will help the buyer to determine the number of suppliers available in the rt1arketand to decide the method of buying viz negotiation Competitive bidding and so on. f. Identify all possible suppliers: All possible suppliers that might be able to satisfy the user's needs must be identified. Possible new suppliers maybe included in the list of potential suppliers. g. Prescreen all possible sources: Prescreen reduces the number of possible suppliers to those that can satisfy the user's demands. (Demands for a product or 186
service are those Characteristics that are critical to the user) whereas desires arc those that arc not so critical and are negotiable. h. Evaluate the remaining supplier base: From the pool of suppliers that can meet the user's demands, choose the supplier or suppliers that can best meet the user's negotiable requirements or desires. i. Choose a supplier: The actual choice of the best supplier is based upon criteria to be discussed subsequently such as quality reliability total required price and so on. j. Receive delivery of the product or service: This activity occurs with the first attempt by the supplier or suppliers to satisfy the user's needs upon completion of supply. The performance data regarding the supplier or suppliers is generated to be used for evaluation of the supplier or suppliers. k. Make a post purchase evaluation: The supplier's performance must be evaluated to determine whether it has truly satisfied the user's needs. If the supplier's performance did not satisfy the user's needs, the causes for this variance must be determined and proper corrective actions implemented. OBJECTIVES/GOALS OF PURCHASING:The overall objective/goal of purchasing is the efficient acquisition of products or services. This requires the right materials, in the right quantities, in the right condition, at the right time, from the right source, with the right service, and at the right price (referred to as the seven 'R's of purchasing) Purchasing is expected to accomplish the fol1owing. a. Provide an uninterrupted flow of materials, components, Suppliers and services for the Smooth operation of the firm. b. Minimize inventory investment and inventory costs. c. Maintain adequate quality standards in the purchased items. d. Develop or find competent suppliers. e. Purchase the required items at the lowest price. f. Improve the organizations competency in the market. g. Coordinate with the department and make harmonious relationship. h. Accomplish the purchasing objectives at the lowest possible administrative costs. ROLE OF PURCHASING IN TOTAL CUSTOMER SATISFACTION
Customers
Total Customer Satisfaction
Quality
Cost
Deliver y
Service 187
Quantit y
Strategi c
Organization
Quality
Cost
Service
Deliver y
Quantit y
Strategi c
Suppliers
ROLE OF PURCHASING IN TOTAL CUSTOMER SATISFACTION Traditionally, purchasing has been separated from the firm's final customers or end users. However, customer satisfaction is directly affected by the receipt of high quality, reliable goods and services on a timely basis at a reasonable cost. The following figure illustrates the effect of supplier performance on total customer cost. The quality of goods and services a firm provides its ultimate customers cannot he better than what it receives from 1mits suppliers. Any delay in supply of inputs to the firm from its suppliers or any quality problem in the inputs will affect the operations of the firm unless the firm carries higher inventory. An increased inventory will increase the cost of production and hence that of the product produced by the firm. Hence, it is important that the purchasing professionals understand the needs of their firm's customers so that they can make the "right" decisions to meet the firm's needs. STRATEGIC ROLE OF PURCHASING Purchasing has a strategic role to perform activities related to sourcing in a way that supports the overall objectives of the firm. Purchasing can support the firm to achieve strategic success through its key role as one of the firm's boundary-spanning functions. These functions are as below: 188
a. Access to external markets: Purchasing can establish and maintain contacts with the supply market and can gain vital information about new technologies, potential new materials or services, new sources of supply and changes in market conditions. This competitive intelligence gathered by purchasing can be communicated to the top management of the firm so that the firm's strategy can be reshaped to take advantage of the market opportunities. b. Supplier development relationship management: Purchasing can help support the firm's strategic success by identifying and developing new and existing suppliers. Purchasing can help in getting suppliers involved in the development of new products and services or modifications to existing offerings which can reduce new product development cycle of the firm. This compression of time - getting to market quickly with new ideas - can be vital to the success of those ideas and it also helps the firm to retain its position as a market leader or innovator. c. Relationship with other functions: Almost every department within the firm relies on the purchasing function for some information or support. Purchasing role ranges from a support role to a strategic function. Purchasing will be taking part important decisions of the organization as long as it provides value to other functional areas. Being well informed permits purchasing function to better anticipate and support the needs of other functional areas. Purchasing and logistics need to work closely in coordinating inbound logistics and associated material flows. MANAGING THE PROCUREMENT PROCESS A four step approach can be used and adapted to a firm's particular needs of managing the procurement process. These steps which can be used to maximize effectiveness of the procurement .process can be as follows: a. Determine the type of purchase: Identifying the type of purchase is the most complex activity in the entire procurement process. For example, a straight rebuy situation will mean that all the procurement activities were completed previously when the purchase was either a new buy or modified rebuy. b. Determine the necessary level of investment: Two major types of investment required in the procurement process arc (i) time and (ii) information which arc expended by the individuals involved in purchasing. When the purchase is a new buy more time must be spent on it and both internal and external information may be required. More information is needed for more complex and important purchases. The levels of investment necessary in the procurement process can be determined by determining the type of purchase. The investment needed in terms of time and information must be adequate to meet the user's requirements. c. Perform the procurement process: It includes performing those activities necessary to effectively make a purchase and satisfy the user's requirements. The procurement professional collects data on the time and information actually used in making a specific purchase. d. Evaluate the effectiveness of the procurement processes: This step involves finding answer to the following two questions: (a) were the user's needs satisfied? And (b) Was the investment necessary? If the procurement was not effective, the cause could be traced to inadequate investment or not performing the proper 189
activities or mistakes made in performing some of the activities. The manager must determine why the procurement process is not effective and take appropriate corrective actions to ensure that future purchases will be effective. SUPPLIER RELATIONSHIP A key factor in achieving efficiency and effectiveness in implementing the procurement process is the development of successful supplier (vendor) relationships. Developing strong supplier relationships is crucial to create and sustain a competitive advantage in today's global market place. When vendors are partners, firms tend to rely more upon them to provide input into product design, engineering assistance. Quality control and so on. Vendor Selection Criteria – The following figure illustrates the vendor selection criteria OVERVIEW OF VENDOR SELECTION CRITERIA 1. • • • • •
Quality Technical Applications Design Product Life Ease of repair & maintenance Dependability
3. Capability • Production Capability • Technical Capability • Management • Operating Controls • Labor Relations
2. Reliability • On-Time Delivery • Performance History • Warranty
4. Financial Consideration • Price • Financial Stability
5. Desirable Qualities • Vendor Attitude • Training Aids • Packaging • Vendor Location • Repair Service
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These factors considered in vendor selection are briefly discussed in the following section. 1. Quality: It is the most important factor in vendor selection. Quality often refers to the Specification that a user desires in an item such as technical specifications, chemical or physical properties or design. The actual quality of a vendor's product is compared with the specifications desired by the user, other additional factors related to quality are: (a) life of the product, (b) Ease of repair and maintenance, (c) ease of use and (d) dependability. 2. Reliability: It comprises delivery and performance history. Consistent en-time deliveries are required to prevent production shutdowns resulting from extended supply lead times. The performance life of the product such as a machine or equipment and the vendor's warranty and claim procedure are considered as part of a reliability measure. 3. Capability: This is concerned with the potential vendor's production facilities and capacity, technical capability, management and organizational capabilities and operating controls. These factors indicate the vendor's ability to supply materials of needed quality and quantity in a timely manner. The vendor must demonstrate this capability consistently over an extended time period. 4. Financial consideration: This includes the price charged by the vendor and the vendor's financial position. (i.e., financial stability). Financially unstable vendors pose possible disruption in the long-run continued supply of materials. 5. Desirable qualities: These factors may be desirable but not essential. One such factor that affects vendor selection decision is vendor’s attitude. Also, the impression or image that the vendor project has a similar effect on vendor selection. Training aids, packaging and availability of repair service are the other desirable qualities that affect vendor selection decision. The geographical location where the vendor is located affects the transportation cost. Other factors include (a) Ability to fill rush orders (b) Meet deli very dates (c) Provide shorter delivery lead-times and (d) Utilize greater vendor-buyer co-operation and so on. The relative importance of the vendor selection factors will depend upon the material the buyer is purchasing. For example: When a buyer purchases a computer technical capability and training aids may be more important than price, delivery and warranties. Procurement Price or Cost: Of all the factors that will be considered in the vendor selection decision, price or cost is one significant factor that is widely discussed by purchasing professionals. Sources of Price: Four basic procedures used 10 determine potential vendor's price are: (a) Commodity markets, (b) price lists. (c) Price quotations and (d) negotiations. For the buyer, the total procurement price is more than just the basic price. The following figure illustrates the components of total procurement price.
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TOTAL PROCUREMENT PRICE Basic Input Cost (Price)
+ Direct Transaction Cost
+ Supplier Relationship Cost
+ Transportation Costs
+ Quality Control Costs
+ Operations/Logistics Costs
= Total Procurement Price Basic input cost: In the primary price of the product or materials as paid by the buying firm. This price is sought by buyers by bidding, negotiating or in requests for quotes. Direct transaction costs are the costs of detecting. Transmitting the need for and processing the material flow in the process of acquiring the goods. It includes the process of detecting inventory need, requisition, placing the order, receiving order acknowledgement, and handling shipping documents etc. Supplier relationship costs are the costs of creating and maintaining a relationship with a supplier. These include travel: supplier education, traffic engineering research and product development in both firms. 192
Transportation Costs: Two key cost aspects of the inbound transportation flow are: (i) the actual transportation cost and (ii) the sales/FOB terms. Four transport options are: supplier - selected for - hire carrier or private carrier and buyer selected for - hire carrier or private carrier. The sales terms define the ownership of the firm during transportation as well is invoice payment requirements. Quality control costs include the cost of conformance, non-conformance, appraisal and ultimate use costs. Operations/logistics costs include four key areas: (a) Receiving and make-ready costs. (b) Lot - size costs. (c) Production costs and (d) Logistics costs. These four key areas are briefly discussed in the following paragraphs. Receiving and make-ready costs are the costs of those flow activities that occur between the inbound transportation delivery of a good and it availability for me in production processes, the costs considered arc cost of unpacking, inspection, Counting, Sorting, grading, removing and disposing packaging materials and moving the good to the point of use. Lot-size costs directly affect space requirements, handling flow, unit price and the related cash flows (i.e. cost of inventories). Production costs arc affected by quality of raw material nature of production processes etc. Logistics costs arc cost factors which are affected by product size, weight, volume and shape and their resulting impact upon transportation, handling, storage and damage costs. Other Materials-Management Activities The materials management activities other than procurement arc: (i) Warehousing, (ii) Production planning and control and (iii) Transportation. (iv) Receiving. (v) Quality control. (vi) Salvage and scrap disposal. Warehousing: This function is concerned with the physical storing of raw materials and other parts and components until they are used. Storage of raw-material and storage of finished goods differ in terms of the type of facility each requires, the value of items stored and the perish ability of the product. Raw materials such as coal, sand, Iron ore, or limestone normally are stored in open-air warehouses and the warehousing cost will be lower than that of finished goods and components. Value of raw materials is usually lesser than that of finished goods. Also basic raw materials are less susceptible to damage and loss as compared to finished goods. Production Planning and Control: This function involves coordinating product supply with product demand. The following figure illustrates production planning and control. OVERVIEW OF PRODUCTION PLANNING AND CONTROL Customer Demand for finished goods
Supply of finished goods
Internal demand for finished goods
Supply of finished goods inventory
Internal Supply of demand raw materials for raw inventory materials
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Supply Purchasing of production of raw materials finished goods
Transportation: The transportation function is concerned with the inbound transportation of materials. It originates with the material suppliers and ends in the buyers premises. Transportation provides time, place and possession utility to the buyers. Transportation manager must decide about the mode of transport, the routes, the freight rates, claim handling, carrier service, cost analysis and regulation. Receiving: This process involves the actual physical receipt of the bought-out material from the transport carrier. The receiving stores person compares the materials indicated on the buyer's purchase order and the supplier's packing slip with the material the buyer has actual received. The materials received are examined for any physical damage. Quality Control: This function attempts t0 ensure that the items a firm receives arc those the firm ordered. However the quality control function is directly concerned with defining the product's quality in terms of dimensions, design specification, physical and chemical properties reliability, ease of maintenance, ease of use etc. Salvage and Scrap Disposal: It is the last activity in the materials management function involving disposing of wastage, scrap and obsolete materials. The scrap and salvage materials which can be recycled are sold, thereby earning some income to the firm, whereas certain scrap materials which cannot be sold must be disposed of in a safe and prescribed manner. (Example: hazardous, toxic, corrosive materials). PRODUCTION SCHEDULING Production scheduling determines what will be produced and shipped when. Scheduling is affected by marketing, human resource management, finance, accounting and integrated logistics. Sales, forecasts help to schedule production and co-ordinate material flow into, through and out of a production facility. Integrated logistics deals with production, scheduling in the area of inventory control for MRP I, MRP II, JIT and DRP. Production Scheduling and Marketing Marketing information based on market analysis or marketing research and sales forecasting initiate the scheduling activity in a firm. The master production schedule is prepared based 0n customers' firm orders and on the sales forecast put together. The accuracy of production scheduling depends on the accuracy of sales forecasts and market analysis. Production Scheduling and Integrated Logistics 194
Integrated logistics interfaces with operations, especially with materials management to ensure that the right materials are available for manufacturing. It is necessary to have efficient and effective flow of inbound materials so that products can be manufactured to meet customer requirements. To achieve this, integrated logistics must coordinate with production (or operations) in the following key areas: a. Integrated logistics supports investment in production equipments and computers which can lead to more flexibility in operations and shorter manufacturing lead times. b. Integrated logistics must coordinate with scheduling of operations to minimize the planning cycle time. c. Integrated logistics can also help in better production scheduling. d. Integrated logistics and operations should eliminate the need for long production runs by reducing the production run times and lead times resulting in lower inventory levels and reduced stock-outs. e. Both integrated logistics and operations must establish strategies to decrease supplier lead times for parts and suppliers.
13. PACKAGING INTRODUCTION The material flow concept instructs us that industry that industry can be regarded as a series of pipelines (flows) of materials. Starting with the retrieval of the basic raw materials from the mines, forests, fields and sea, converters and manufacturers produce a variety of materials and products, distributed to a variety of customers; through a variety of channels. The concept also embraces the possibility for reverse flows (disposal, recycling, recalls, etc.). While the material flow concept has been around and accepted for some time, its translation into managerial concepts of material management, physical distribution and logistics has a shorter history. Flows require movement; movement is achieved, in large part, through material handling and material handling requires efficient packaging and unitizing methods for best performance. • • •
The question to be answered while designing packaging includes: How do we package and unitize the product for best handling? How do we handle the packages or unitized product for least damage and best utilization of labour, equipment, and space? How do we package/unitize and handle for best interaction with other flow systems functions (i.e. transportation, warehousing, inventory control etc.) for best overall system performance?
IMPORTANCE Packaging is an important function in logistics ensuring not only protection to materials and goods in the logistics process to ensure maintenance of the right condition until delivery, but also facilitating the other logistics functions of 195
transportation, storage and handling. Packaging also enables communication regarding the contained materials or products. It also helps in improving the appeal of the product to the customers. TYPES OF PACKAGING Packaging can generally be categorized into two types: consumer packaging, which has a marketing emphasis and industrial packaging which has a more of logistics emphasis. •
Consumer Packaging
Consumer – oriented packaging is a packaging which is designed for consumer convenience and appeal, marketing consideration and display. The main emphasis is on marketing. The marketing manager is more concerned with the consumer packaging because it provides information important in selling the product, in motivating the customer to buy the product or in giving the product maximum visibility when it competes with others on retail shelf. •
Industrial Packaging
Industrial packaging focuses on the handling convenience and protection during transportation, material handling, and storage. The main emphasis is on logistics. Logistics or industrial packaging is of primary concern to the logistics manager. This packaging protects the goods that a company will move and store in the warehouse and also permits the company the effective use of transportation vehicle space. It also has to provide information and handling ease. However, we cannot design the interior (consumer packaging) without considering the exterior or the industrial packaging. Industrial packaging is performed at various stages. The first stage is packaging for the product itself. For example, soft drinks are packaged in cans. The next stage involves packaging these products into larger cartons for enabling quantity handling. The carton is referred to as the Master Carton. The next stage of packaging involves unitization. In this case, the master cartons are consolidated into a single, larger unit to facilitate handling, transportation, protection and storage. The next stage of packaging is containerization. Here the unit loads are placed in rigid containers for protection and handling – facilitation. This enables efficiency in transportation. An important aspect of packaging is the ability of reuse and the disposal facilitation and environmental effects of packaging material. For example, the environmental impact of using plastics and wood as packaging materials. FUNCTIONS OF PACKAGING Packaging serves three functions in the context of the product •
Protection
This involves protection from damage, pilferage, contamination, physical effects and environmental conditions. It is generally not economical to provide absolute protection to the product from all possibility of damage and environmental conditions. Hence, packaging design and material utilized is a balancing of economic considerations and adequate protection. The higher the value of the product, the more protection it deserves; and so on, the more expensive the packaging. During the 196
logistical process, a packaged product can be damaged in transportation, handling and storage. The physical effects that cause damage are impact, vibration, piercing and crushing. The environmental conditions that can affect a packaged product are temperature, humidity and contamination. Packaging provides protection against physical effects. Protection from environmental conditions can only be achieved by maintaining the product in the right environment during the logistics process. •
Utility
In this functionality, packaging helps in improving efficiencies of material handling procedures, transportation, storage and order picking. Packaging the products in the form of master cartons, unit loads and containers, promotes handling, transportation, and storage efficiencies by speeding up handling, enabling higher quantities to be transported, more quantity storage in the same space and faster retrieval from storage. Packaging facilitates securing and stacking during transportation, storage and handling. •
Communication
Packaging enables product identification and tracking and displays product care information. This is facilitated by labels on the packages. Product identification improves logistical efficiency. Packaging also provides the facility of displaying handling instructions to ensure proper care of the product during handling, transportation and storage. In case the product is hazardous, requiring special handling, this functionality becomes critical. PACKAGING MATERIALS Many different exterior packaging materials are available to the logistics manager. At one time the use of harder materials such as wood or metal containers was widespread. But these added considerable shipping weight, which increased transport costs since transportation companies’ bill customers for total weight, including packaging. In recent years, companies have tended to use softer packaging materials. Corrugated materials have become more popular, particularly with respect to package exterior. Cushioning materials are used to cushion the product inside the box. Cushioning materials protect the box from shock, vibration and surface damage during handling. Cushioning materials include shrink-wrap, air bubble cushioning, cellulose wadding, corrugated paper and plastics. Plastic materials utilized are expanded polystyrene, polyurethane, foam-in-place and polyethylene. While selecting packaging materials, companies today must consider environmental protection. Packaging waste is also a concern. One way to reduce this waste is to reduce the overall packaging a company uses. Another way is to recycle the packaging materials in such a way that there is no harm to the environment. VALUE ADDITION Value addition can be categorized into two parts: value addition in marketing and value addition in logistics.
197
Value addition in Marketing: Value–added is a relatively new term in direct marketing jargon. Simply put, it means processing or modifying the product. Some ways to add value to a product include: • •
Growing something in a way that is acknowledged as safer, or Adding a component of information, education or entertainment.
The customer is spared the additional work and the producer charges extra for adding value. Adding value holds the promise of additional income, but it is certainly more labor–intensive and requires more management, more investment in equipment, and an awareness of legal and regulatory issues pertaining to processing. Value–added products do not have the same economies of scale as mass–produced goods, and their success hinges heavily on the producer's retail strategy, especially advertising and promotion. There are additional value-added marketing opportunities available to suppliers. Supplier events include the trade show with open floor hours as well as the popular roundtables. Value added products offer more exposure to any company. Value Addition in Logistics: In the age of networking, the traditional ideas about value chain and the activities comprised thereof have undergone a change. The activities such as procurement, manufacturing (operations), marketing etc., were traditionally considered as primary activities and were deemed to be of crucial significance for the business operations. So, corporate preferred to perform these activities themselves. Logistical process adds value across procurement with the inventory flow providing the right material, at the right time and at the right place for manufacturing. Further, manufacturing adds value to the raw materials and components procured to convert these, through work-in-process into the right products required by the customer. The logistical process also adds value to the product during the physical distribution.
The concepts of value system entails the process of conversion of resources i.e. inputs to the outputs i.e. products or offerings resulting out of value addition.
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14. PURCHASING 6R’S of Purchasing 1. Right Material : For making a DIE, Die-steel is required . For making various types of plastic components & items, various types of plastic material are required . For specific components, specific steel alloy is required (Chromium, Manganese contents & Carbon content) . Chemical % of various contents . For Rice Pulav – Basmati Rice is right material . 2. Right Quantity : For smooth production materials should be received in right & required quantity . Where JIT exists, shortage in quantity will directly effect days output – example of Maruti cars production unit . Where days components requirement reaches the factory in the morning any deviation in terms of number of units will directly effect production . 3. Right condition : In Watch industry for various small components various diameter steel rods is used . If during transport and storage , they are not handeled properly, they will get tweist and then during processing they will create difficullty (breakage of tools & stoppage of machines due to non feeding ) . 4. Right Time : Timely supply is essential for smooth production. .Again Maruti Udyog, if material do not reach in the morning ,that day’s production will be lost . Milkman does not supply milk in the morning. News paper does not come on time (for some people). Reach late at railway station. Reach late fir examination! Etc. 5. Right source : As per vendor rating selection of right source to be done. Chemicals directly from factory – otherwise adulterated chemicals may cause problems. We puchase gold items from reputed shops like Tribhuvandas Bhimji Jhavery as we feel guaranteed. 6. Right Service : We buy Godreg or Videocon Tv / Fridge because of their good service. In production unit – service means the other 6-Rs should be followed by a good suppliers. Variation in demand should be well taken by the suppliers. 7. Right Price : Means for specific items : Lowest price or 199
Price considering various other aspects of supplies Eg : a) Quoted price b) Credit offered (Price slightly high but 3 months credit ) c) Good vendor rating d) Technologically superior product than other available eg , HMT / TITAN Watches,Godreg Fridge, etc. e) Competitive price . Purchasing is expected to 1.
Provide un-interrupted service by :. Proper selection of vendor . Ensure proper ordering ( as per capacity of the supplier ) . Transport
2.
Minimize Inventory / Loss : . Staggered Delivery . JIT Supply . As far as possible supply should be nearer to avoid transport delays.
3.
Maintain Quality Standards : . Quality as required by the product . Quality as required by customers . Competitive quality
4.
Competent Supplier : . Vendor rating . Development of suppliers . Make suppliers as partners so that there is a commitment.
5. Standardization of item : . Screws } Reduce sizes to few . Nuts ? Bolts . Knobs – Make 1 or 2 standard size . Components etc. 6. Lowest Ultimate Price : . Negotiations by Purchase Managers 7. Improve Competitive position : By . Better Quality . Better Service . Reduce Prices 8. Harmonious Working : . Integreted Working 9. Lowest Administrative cost : . Lesser manpower . Computerization . Trained Personnel . Follow Economic Order Quantity 200
Pre-requisite to Purchasing Purchase manual with policies The manual should have the following : a) Mission statement : Like mission statement of factory , a mission statement for purchase department / material department is also to be made. It could be something like this : “We are the established industry producing ABC product . We have also an established purchase department with adequate trained man-power . Our aim is to produce good quality materials at the lowest possible prices in the quantity ordered and delivered as per schedule . We want to create a good relationship with the outside agencies, suppliers and internal customer in order to get maximam advantage.”
b) Vision Statement : In order to become a world-class organization & competitive in business the leader (GM or Material chief ) Should make a VISION STATEMENT .A visionary leader will form a vision and make arrangements to achive the set objectives . The vision statement will be something like this . c)
Vision statement : (For the next 3 years ) “ By the end of 2007 our purchase department should be a profit center Our endeavor will be to satisfy the suppliers, internal customers and other agencies So that everybody feels the belongingness to the organization. We will achive our objectives and goals following the ethics of business and to The larger advantage of our stockholders.” d)
Objectives : 1. Procure materials most economically. 2. Scientifully develop supplier chain to get advantage to the organization.
e)
Goals : 1. Save every year 10% 2. Develop at least 1 supplier for various items every year.
f)
Action 1. 2. 3. 4.
Plan : Set KRA for every supervisor and manager. Provide software and facilities to the purchase department. re-organised the department Prepare responsibility and authority charts for the staff etc.
. Watch components from finished part stores are sent to assembly ancillary units , watches are assembled . . After assembly , the wathes come back to factory . Watches are tested and then sent for strapping to strapping units where strapping and boxing is done. . From strapping units again watches come back to factory. . Quality assurance checks are made & watches are sent to distribution centre at Bangalore (at 60 kms away ) 201
# Inward goods transport of components & materials .
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15. PLANNING ORDINATION Strategic Objectives
Capacity Constraints
Logistics Requirements
AND
CO-
Manufacturing Requirements
Procurement Requirements
Transportation & Shipping
Procurement
Inventory Deployment Capacity Constraints
Order Management
Order Processing
Inventory Management
Distribution Operations
OPERATIONS PLANNING AND CO-ORDINATION OF FLOWS 1. Co-ordination is the backbone of overall information system architecture among the participants of the value chain. Coordination results in plans specifying : (i) Strategic objectives, (ii) Capacity constraints, (iii) Logistical requirements, (iv) inventory deployment, (v) Manufacturing requirements, (vi) procurement requirements and (vii) Forecasting. (i) Strategic Objectives detail the nature and location of customers, which are matched to the required products and services to be performed. The financial aspects of the strategic plans detail resources required to support inventory, receivables, facilities, equipment and capacity. (ii) Capacity Constraints coordinate internal and external manufacturing requirements for given strategic objectives, capacity constraints identify limitation, barriers or bottlenecks within manufacturing capabilities and determine appropriate outsource requirements. (iii) Logistics Requirements specify the work that distribution facilities, equipment and labour must perform to implement the capacity plan. Based on inputs from forecasting, customer orders and inventory status, logistics requirements specify value chain performance. (iv) Inventory Deployments are the interfaces between planning/coordination and operations that detail the timing and composition of where inventory will be 203
positioned from an information perspective, inventory deployment specifies the what, where and when of the overall logistics process. From an operational viewpoint, inventory management is performed as a day-to-day event. (v) Manufacturing Plans are driven from logistical requirements and result in inventory deployment. The primary output is a statement of time-phased inventory requirements which drives master production scheduling (MPs) and manufacturing requirements planning (MRP). The output from MRP is a day-to-day production schedule that can be used to specify material and component requirements. (vi) Procurement Requirements schedule material and components for inbound shipment to support manufacturing requirements. Purchasing coordinates decisions concerning supplier qualification, degree of desired speculations, third party arrangements and feasibility of long-term contracting. (vii) Forecasting utilises fast data, current activity levels and planning assumptions to predict future activity levels. The forecasts predict periodic (monthly or weekly) ‘sales levels for each product, forming the basis for logistical requirement and operating plans. 2. Operational Requirements : The second aspect of information requirements is concerned with directing operations to receive, process and ship inventory as required to support customer and purchase orders. Operational requirements deal with: (i) order management, (ii) order processing,(iii) distribution operations, (iv) inventory management, (v) transportation and shipping and (vi) procurement. (i) Order Management refers to the transmission of requirements information between value chain members involved in finished product distribution. The primary activity of order management is accurate entry and qualification of customer orders. (ii) Order Processing allocates inventory and assigns responsibility to satisfy customer requirements. In technology-rich order processing systems, two-way communication linkage can be maintained with customers to generate a negotiated order that satisfies customers within the constraints of planned logistical operations. (iii) Distribution Operations involve information flows required to facilitate and coordinate performance within logistics facilities. The key to distribution operation is to store and handle specific inventory ill little as possible while still meeting customer order requirements. (iv) Inventory Management is concerned with using information to implement the logistics plan as specified. (v) Transportation and Shipping information directs the movement of inventory. It is also necessary to ensure that required -transportation equipment is available when needed. (vi) Procurement is concerned with the information necessary to complete purchase order preparation, modification and release while existing overall supplier compliance. The overall purpose of operational information is to provide the detailed data required for integrated performance of physical distribution, manufacturing support and procurement operations whereas planning/coordination flows provide information concerning planned activities, operational requirements are needed to direct day-today work:]
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LOGISTICS PLANNING PROCESS To match the changing environment in the logistics due to the changes in the markets, competitors, suppliers and technology, there is a need for a systematic planning and design methodology to formally include the relevant consideration and effectively evaluate the alternatives. Methodology The logistics relational and operating environment is constantly changing. Even for the established industries, a firm's markets, demands, costs and service requirements change rapidly in response to the customer and competitive behavior. Just as no ideal logistical system is suitable for all enterprises the method for identifying and evaluating alternative logistics strategies can vary extensively. However there is a general process applicable to most logistics design and analysis situations. The process can be segmented into three phases: problem definition and planning, data collection and analysis, and recommendations and implementation. The following discussion describes each phase and illustrates the types of issues encountered. PHASE I: PROBLEM DEFNITION AND PLANNING Phase 1 of logistics system design and planning provides the foundation for the entire project. A thorough and well-documented problem definition and plan are essential to all that follows. 1. Feasibility Assessment The process of evaluating the need and desirability for change is referred to as feasibility assessment and it includes the activities of situational analysis, supporting logic development, and cost benefit estimation. The objective of doing so is to understand the environment, process, and performance characteristics of the current system and to determine future estimation. a) Situational analysis: The purpose of the situational analysis id to provide senior management with the best possible understanding of the strengths and weaknesses of the existing logistics capabilities for both current and future environment. The situational analysis is the performance of measures and characteristics that describe the current logistics environment through: Internal review: Internal review is necessary to develop a clear understanding of existing logistics by covering the overall logistics process as well as each logistics function with respect to its stated objectives and its capabilities to meet those objectives. It profiles historical performance, data availability, strategies, operation and tactical policies and practices. All major resources such as workforce, equipment, facilities, relationships and information are examined. The comprehensive review attempts to identify the opportunities that might motivate or justify logistics system redesign or refinement. Assessment must consider the process (physical and information flows through the value – added chain), decisions (logic and criteria currently used for value chain management), and key measures for each major logistics activity. These measurements focus on the key performance indicators and the firm’s ability to measure them.
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Market assessment & competitive evaluation: the objective is to document and formalize customer perceptions and desires with regard to the changes in the firm’s logistical capabilities. It’s the review of the trends and service demands required by customers by the use of interviews with the selected customers or through customer5 surveys. The assessment focuses on the external relationships with the suppliers, customers (wholesalers and retailers) and consumers (final consumer). The assessment not only considers trends in requirements and processes but also the enterprise and the competitor’s capabilities. Technology Assessment: it focuses on the application and capabilities of the key logistics technologies, including transportation, storage, material handling, packaging, and information processing. The assessment considers the firm’s capabilities in terms of current technologies and the potential for applying new technologies. The objective of the assessment is to identify advancements that can provide effective trade – offs with other logistics resources such as transportation and inventory. b) Supporting logic development: The second feasibility assessment task is development of a supporting logic to integrate the findings of the internal review, external assessment and technology study. Supporting logic development builds on this comprehensive review in three ways First - supporting logic development forces a critical review of the potential opportunities for logistics improvements and a determination of whether additional investigation is justified, using logistics principles such as tapering principle, principle of inventory aggregation. The resulting benefits or costs should be clearly identified. Second - it critically evaluates current procedures and practices using comprehensive, factual analysis and evaluation that isn’t influenced by opinion and thus help in identifying areas with improvement potential which in turn provides a foundation to determine the need for strategic adjustment. The deliverables of this evaluation process include classification of planning and evaluation issues prioritized into primary and secondary categories across short and long range planning horizons. Third - the process of developing supporting logic should include clear statements of potential redesign alternatives such as Definition of current procedures and systems Identification of the most likely system design alternatives based on leading industry and competitive practices Suggestion of innovative approaches based on new theory and technologies The alternatives along with being practical should also challenge the existing practices. Flow diagrams and /or outline illustrating the basic concepts associated with each alternative are constructed, which frame opportunities for flexible logistics practices, clearly outline value added and information flow requirements and provide a comprehensive overview of the options. A recommended procedure requires the manager responsible for evaluating the logistical strategy to develop a logical strategy to develop a logical statement and justification of potential benefits. Using customer service concept and logistics integration logic and methodology, the manager should commit to paper the most attractive strategy alternatives. 206
c) Cost benefit estimate: The final feasibility assessment is a preplanning estimate of the potential benefits of performing a logistics analysis and implementing the recommendation. Benefits should be categorized in terms of: Service improvements - It includes results that enhance availability, quality or capability. Improved sciences increase loyalty of existing customers and may also attract business. Cost reduction - Cost reduction benefits may be observed in two forms: First, they may occur as a result of a one time reduction in financial or managerial resources required to operate the existing system for e.g. Reduction in capital deployed for inventory and other distribution related assets Second, cost reductions may be found in the form of out - of - pocket or variable expenses. For e.g. new technologies for material handling and information processing often reduce variable cost by allowing more efficient procedures and operations. Cost prevention - Cost prevention reduces involvement in programs and operations experiencing cost increases. Any cost prevention justification is based on an estimate of future conditions and therefore is vulnerable to some error for e.g. many material – handling and information technology upgrades are at least partially justified through financial analysis of the implications of future labor availability and wage levels. In the final analysis, the decision to undertake in – depth planning will depend on how convincing the supporting logic is, how believable estimated benefits are, and whether estimated benefits offer sufficient return on investment to justify organizational and operational change. These potential benefits must be balances against the out 0- of pocket cost required to complete the process. 2. Project Planning: Logistics system complexity requires that any effort to identify and evaluate strategic or tactical alternatives must be planned thoroughly to provide a sound basis for change. Project planning involves five specific items: a) Statement of objectives: The statement of objectives documents the cost and service expectations for the logistics systems revisions. It’s essential that they be stated specifically and in terms of measurable factors. The objective fine market or industry segments, the time frame for revisions, and specific service levels. For e.g., desired delivery of 98 percent of all orders within 48 hours after the order is placed, minimal customer shipments from secondary distribution centers, back – orders held for a maximum of five days, etc. specific definitions of these objectives direct system design efforts to ache9ice explicit performance levels. Total system cost can then be determined. b) Statement of constraints: The second project planning consideration concerns design constraints. On the basis of the situational analysis, it’s expected that senior management will place restrictions on the scope of permissible system modifications depending on the specific circumstances of individual firms. But constraints can affect the overall planning process for e.g. one restriction common to distribution system design concerns the network of manufacturing facilities and their product mix assortment which the management often holds constant for logistical system redesign as there are large financial investments in existing production facilities. The 207
purpose of developing a statement of constraints is to have a well-defined starting point and overall perspective for the planning effort. The statement of constraints defines specific organizational elements, buildings, systems, procedures, and/or practices to be retained from the existing logistical system. c) Measurement standards: Such standards direct the project by identifying the cost structures and performance penalties and by providing a means to ass’s success. Management must stipulate guidelines for each category as a prerequisite to formulation of a plan. It is important that the standards adequately reflect total system performance rather than a limited, sub optimal focus on logistics functions. Once formulated, such standards must be held constant throughout system development. An important measurement requirement is to quantify a list of assumptions that underlie or provide the logic supporting the standards. Measurement standards should include definitions of how cost components such as transportation are calculated and also relevant customer service measures and method of calculation must also be included. d) Analysis procedures: Analysis techniques range from simple manual methods to elaborate computerized decision support tools. For e.g., models incorporating optimization ort simulation algorithms for evaluating and comparing alternative logistics warehouse networks. Once the project objectives and constraints are defined, planning must identify alternative solution techniques and select the best approach. Selection an analysis technique must consider the information necessary to evaluate the project issues and options e) Project work plan: On the basis of feasibility assessment, objectives, constraints and analysis technique, a project work plan must be determined and the resources and time required for completion identified. The alternatives and opportunities specified during the feasibility assessment provide the basis for determining the scope of the study. In turn the scope determines the completion time. One of the most common errors in strategic planning is to undere4stimate the time required to complete a specific assignment. Overruns require financial expenditures and reduce project credibility. There are a number of PC – based software packages available to structure projects, guide resource allocation, and measure progress.
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PHASE II: DATA COLLECTION AND ANALYSIS Once the feasibility assessment and project plan are completed, phase 2 focuses on data collection and analysis. This includes activities to (1) define assumptions and collect data, and (2) analyze alternatives 1) ASSUMPTIONS AND DATA COLLECTION: This activity builds on the feasibility assessment and project plan to develop detailed planning assumptions and identify data collection requirements. Specific tasks are as follows a) Define analysis approach and techniques: The most common techniques are analytical, simulation and optimization The analytical approach uses standard numerical methods, such as those available through spreadsheets, to evaluate each logistics alternative. For e.g., spreadsheet availability have increases the use of analytical tools for distribution applications A simulation approach can be likened to a “wind tunnel” for testing logistics alternatives. Simulation is widely used, particularly when significant uncertainty is involved. The testing environment can be physical (a model material handling system that physically illustrates product flow in a scaled down environment) or numerical (such as a computer model of a material handling environment that illustrates product flow on a computer screen) current software makes simulation one of the most cost effective approaches foe dynamically evaluating logistics alternatives Optimization uses linear or mathematical programming to evaluate alternatives and select the best one. Because of its powerful capabilities, optimization is used extensively for evaluating logistics network alternatives such as the number and location of the distribution centers. b) Define and review assumptions: Assumptions definition and review build on the situation analysis, project objectives, constraints and measurements standards. For planning purposes, the assumption defines the key operating characteristics, variables and economies of current and alternative systems. Assumptions generally fall into three classes: Business assumptions - They define the characteristics of the general environment including relevant market, consumer, and product trends and competitive actions, within which an alternative logistics plan must operate. They are generally outside the ability of the firm to change. Management assumptions define the physical and economic characteristics of the current or alternative logistics environment and are generally within the firm’s ability to change or refine. Typical assumptions include a definition of alternative distribution facilities, transport modes, logistics processes and fixed and variable costs. Analysis assumption defines the constraints and limitations that must be included to fit the problem to the analysis technique. These assumptions frequently concern problem size, degree of analysis detail and solution methodology.
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The elements of assumption categories are as follows BUSINESS ASSUMPTIONS 1. Scope: Definition of business units and product lines to be included 2. Alternatives: Range of options that can be considered 3. Market Trends: Nature and magnitude of change in market preferences and buying patterns 4. Product Trends: Nature and magnitude of change in market preferences and buying patterns particularly with respect to package size and packaging. 5. Competitive actions: Competitive logistics strengths, weaknesses and strategies.
MANAGEMENT ASSUMPTIONS Markets: Demand patterns by market area, product and shipment size Distribution Facilities: Locations, operating policies, economic characteristics and performance history of current and potential distribution facilities. Transportation: Transportation rates for movement between potential and existing distribution facilities and customers Inventory: Inventory levels and operating policies for each distribution facility
ANALYSIS ASSUMPTION 1. Product Groups: Detailed product information aggregated to fit within the scope of analysis 1. Technique. 2. Market Areas: Customer demand grouped to aggregate market areas to fit the scope of analysis techniques c) Identify data resources: The process of data collection begins with a feasibility assessment. A fairly detailed specification of data is required to formulate or fit the analytical technique. For situations when data are extremely difficult to collect or when the necessary level of accuracy is unknown, sensitivity analysis can be used to identify data collection requirements. For e.g. an initial analysis may be completed using transportation costs estimated with distance – based regressions. The types of data required in a logistical design n study can be divided into three classes: business assumptions, management assumptions and analysis assumptions. The majority of data required in a logistical study can be obtained from internal records. Although considerable searching may be needed, most information is generally available. - The first major data category is sales and customer orders. The annual sales forecast and percentage of sales by month, as well as seasonality patterns are necessary for determining logistics volume and activity levels. Historical samples of customer order invoices are also needed to determine shipping patterns by market and shipment size. The combination of aggregate measures of demand and detailed order profiles of projects the requirements that the logistics system must be capable of satisfying. Specific customer data are also required to consider the cost and time associated with moving the products across distance. Customers and markets ate often aggregated by location, type, size, order frequency, growth rate, and special logistical services to reduce analysis complexity. 210
For integrated channel analysis, its necessary to identify and track the costs associated with manufacturing and purchasing. It’s often necessary to consider the number and location of plants, product mix, production schedules and seasonality. Identification of policies and costs associated with inventory transfer, reordering, and warehouse processing, inventory control rules and product allocation procedures. For each of the current and the potential warehouse, the operating costs, capacities, product mix, storage levels and service capabilities should be established. Transportation data requirements Transportation data requirements include the number and type of modes utilized, modal selection criteria, rates and transit times, and shipping rules and policies. For most logistics analysis applications, a select amount of future market data is useful for evaluating future scenarios. Although the management may be able to prepare a consolidated sales forecast it is difficult to prepare a market-by-market projection of sales. There can be two solutions to this problem. 1. Usage of demographic projections that correlate highly with sales can help the company to estimate future demand levels and hence determine future logistics requirements. Secondary data published by various government agencies can also provide a data bank of environmental information 2. Keeping a watch on the competitors strategies and capabilities by documenting competitive logistical system designs and flows can be helpful in providing competitive benchmarks that compare customer service capabilities, distribution networks and operating capabilities. d) Collect Data Once the data sources have been identified the company can start assembly of required data and conversion of that data to an appropriate format for the analysis tool. To avoid errors like overlooking data that does not reflect major components of logistical activity or collection of data from a misrepresentative time period, the data collection process should be properly documented. e) Collect Validation Data The objective of validation is to increase management credibility regarding the analysis process and to ensure that the results of the analysis accurately reflect reality. It is important to ensure that a through investigation is conducted into analytical results based on data that might not accurately reflect the past. 2) ANALYSIS The analyst uses the technique and data from the previous activity to evaluate logistics strategic and tactical alternatives. The process of analysis includes a) Define analysis questions This involves defining specific analysis questions concerning alternatives and the range of acceptable uncertainty. The questions build on research objectives and constraints by identifying specific operating policies and parameters. For e.g.: In the case of inventory analysis questions might focus on alternative service and uncertainty levels. b) Complete and validate baseline analysis The second task completes the baseline analysis of the current logistics environment using the appropriate method or tools. Results are compared with validation data collected previously to determine the degree of fit between historical and analytical findings. The comparison should focus on identifying significant differences, determining sources of possible errors and identifying and correcting them. 211
c) Complete alternative analysis An evaluation of systems alternatives should be accomplished either manually or electronically to determine the relevant performance characteristics of each alternative. d) Complete sensitivity analysis In this phase uncontrollable factors like demand, factor cost or competitive actions are varied to assess the ability of potential alternatives to operate under a variety of conditions. Sensitivity analysis in conjunction with an assessment of potential scenario probabilities is then used in a decision tree to select the best alternative. PHASE III - RECOMMENDATIONS & IMPLEMENTATIONS Phase III operationalize planning and design efforts by making specific management recommendations and developing implementation plans. a) Recommendations Alternative and sensitivity analysis results are reviewed to determine recommendations to management. There are four steps in this part of the phase namely: 1. Identify the Best Alternative Performance characteristics and conditions for each alternative must be compared to identify the two or three best options. The decision tree analysis should identify the best alternative i.e.: The one that meets the desired service objectives at the minimum total cost. 2. Evaluate Costs and Benefits A Cost Benefit analysis compares the alternatives for a base period and then projects comparative operations across a particular planning horizon. Potential benefits such as cost reduction; service improvement and cost prevention are identified and quantified. In other words when evaluating the potential of a particular logistical strategy an analysis comparing present cost and service capabilities with projected conditions must be completed for each alternative. 3. Develop a Risk Appraisal Risk Appraisal considers the probability that the planning environment will match the assumptions. It also considers the potential hazards related to system changeover. Risk related to adoption of a selected alternative can be quantified using sensitivity analysis. For e.g.: Assumptions can be varied and the resulting influence on system performance for each alternative can be determined. The end result of a risk appraisal provides a financial evaluation of the downside risk if the planning assumptions fail to materialize. Risks related to system changeover such as unanticipated delays, a series of contingency plans etc can also be quantified and a series of contingency plans could be tested to determine their possible impact. 4. Develop Presentation The final step in this procedure is a presentation to the management / submission of a report that identifies specific operating and strategic changes, provides qualitative reasons for suggesting these changes and then quantitatively justifies the changes in terms of service, expenses, asset utilization or productivity improvements.
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b) Implementation The actual plan or design implementation is the final process activity. An adequate implementation procedure is the only means to obtain a tangible return from the planning process. This broadly includes four phases. 1. Define Implementation Plan The implementation plan has to be defined in terms of the individual events, their sequence and their dependencies. The planning process may initially develop at a macro level. But it must ultimately be refined to provide individual assignment responsibility and accountability. Plan dependencies identify the interrelationships between events and thus define the completion sequence. 2. Schedule Implementation The implementation plan is scheduled based on the assignments identified in the previous stage. The schedule must allow adequate time for acquiring facilities and equipment, negotiating agreements, developing procedures and training. 3. Define Acceptance Criteria The criteria for evaluating the success of the plan are then developed. The Acceptance Criteria should focus on service improvements, cost reduction, improved asset utilization and enhanced quality. Although the acceptance criteria may focus on the area / function which was the main focus for the Plan, it should also take a broad perspective that focuses on total logistics system performance rather than the performance of an individual function. 4. Implement The final task is actual implementation of the plan or design. Implementation must include adequate controls to ensure that performance occurs on schedule and that acceptance criteria are carefully monitored.
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16. MEASUREMENT
PERFORMANCE
There are three ways of judging logistics service: 1. The subjective views of customers and others 2. Relevant quantifiable measurement such as tones delivered or customers visited: 3. Comparisons with past or other performance. These methods are widely used, but they can never really give a reliable picture. Logistics is so closely integrated with other operations and outside influences that it cannot be viewed in isolation. If deliveries are arriving late at customers, it certainly might be because of poor logistics, but it might also be because demand has suddenly increased and production is not meeting demand or roadworks are causing congestion, or ferry operators are on strike or a whole range of other factors that logistics managers cannot control or even influence. As logistics provide the final link between suppliers and customers, it often gets the blame for faults in other parts of the system. Within each organization, the aim of logistics is to contribute as fully as possible to achieving the mission and corporate strategy. These high-level strategies lead to business and functional strategies, and more specifical1y to a logistics plan. In the shorter. term, logistics should be judged by how well it achieves the aims of this plan. In other words, there is alternative process for measuring performance that: analyses the mission corporate, business and functional strategies from a logistics perspective, uses these analysis to set the overall objectives and goals for logistics, establishes a detailed logistics plan, including standard and performance targets, monitors actual performance over time and compares this with the plants, analysis the differences, identifies the reasons, exp1ains them and looks for ways of improving performance. adjusts operations revises plans and takes any other action necessarily This approach again raises questions about the targets that should be put into a logistics plan and how to know that these have been achieved. There are of course many measures that can be used in logistics – such as retum on assets or labour productivity. Rushton (1994) lists a number of these measures that are used by local grocery retailer raging from cost as a percentage of company sales to overtime hours as a percentage. The total hours: Lenox (1995) reports a survey by KPMG that lists the most widely used measures of customer service starting with: the proportion of items supplied at first demand, the number of orders that pick errors, the availability of back orders the proportion of orders satisfied in full, the amount of damage and continuing down to order - to - ship cycle time order - to - deliver cycle time, courtesy of staff, case of ordering, etc. 214
However as usual, many of these measures have a large element of subjectivity since it is difficult to obtain reliable costs for logistics it is almost impossible to separate the performance of logistics from other operations. External factors play an important part in performance and there is a huge variation in supply chains so that no measures will be appropriate for them all. When we measure - or subjectively assess some.aspects of performance, it is normally only useful for comparison. If we met 97 per cent of demand from stock last month, we only knew if this js good by comparing it to our previous month's performance, or a competitor, industry standard or some other performance. The most widely used sources for such comparisons are: goals and targets given in the logistics plan, absolute standards (such as 'zero defects') accepted industry standards, comparisons with other companies benchmarking - to- give comparisons with the industry's best performers. Improving: Performance have a continual long term reduction in costs, avoid complacency and review operations regularly to make sure that they are still competitive, 3. consider the whole supply chain- as the best overall policy is rarely the sum of individual optima, allow flexibility and necessary movement away from plans make sure that logistics meet needs and not desires, make sure that logistics operations are fully integrated into overall operations, keep emphasizing the importance of logistics. On a wide front, there is no shortage of.suggestions for ways of improving. logistics. All managers face a constant flow of new ideas for improving operations – just – in time, total quality management (TQM), process - centred, organizations, reengineering, empowerment, lean production~ concurrent engineeriing and so on. However, logistics managers also face the stream of ideas that are aimed at the supply chain, strategic alliances, vendor-managed inventories, continuous replenishment, quick response, efficient customer response and so on. PERFORMANCE MEASUREMENT Performance measurement is necessary to evaluate whether logistics activities are efficient and effective. Like the pilot of an aircraft obtains feedback regarding' the performance of the aircraft from the measures displayed on the panel, logistics managers need pert9rmance measures for evaluating the logistical performance pf the firm. The basic objectives for developing and implementing performance measurement systems include monitoring, controlling, and directing logistics operations. Performance measurement helps in ensuring the proper utilization of scarce resources and comparing performance in relation to plans internally, and enables benchmarking with the Competition and customer perception evaluation external to the firm. Performance measures can be classified as follows: (1) output-related measures and process related performance measures. 215
(2) function-based or activity-based and process-based performance measures. (3) internal and external performance measures. The experience obtained by managers from quality measurement of manufactured products has resulted in the' realization that improvements in quality can be achieved by during the process rather than the output. Logistics is basically a process resulting in customer satisfaction. In order to ensure that the output of customer satisfaction is ultimately achieved, it is necessary to monitor and control the process by measuring the logistics variables in the process which ultimately affect customer satisfaction. However, the output Also needs to be measured to ensure that the process being measured is resulting in the desired output. Examples of output-related measures are order cycle time and product Availability : function-based measures are metrics that measures performance of the activities' within functions. The~ are measures like warehouse space utilization, transportation costs, obsolete inventory, and documentation accuracy which are related to functional areas. Functionally oriented measures fail to consider the crossfunctional nature of logistics management, and so, can lead to functional optimization and overall logistics sub optimization. For example, the perfect order process metric measures the percent of customer orders That are flawlessly fulfilled. This metric measures' the effectiveness of the order fulfillment process, crossing the boundaries of functions. Internal performance measures are related to measurement of activities and processes internal to the firm by focusing on historical performance and goal performance comparisons. Thus, actual logistical costs and customer service during this Period can be compared to the previous period's actual performance and the goals set for this period. External performance measures focus on metrics. Concerned with customer perceptions and benchmarking against the Competition. This classification of logistical performance Measures shall be utilized to understand the various performance measures which can be utilized in practice. Internal performance measures These measures are concerned with the activities and processes that ultimately service customers. Due to the focus of these measures on comparison of present performance with Past performance and performance goals, these facilitate performance appraisal and improvement. Internal performance measures can be classified into the following categories~,,: (1) Time: time is an important measure of logistics performance related to effectiveness. Some of the measures in this category are order fulfillment lead time and variability" response time, on-time product shipment/ deliv1ly' and forecasting/planning cycle time. (2) Cost: cost measures are the basic measures used traditionally for measuring performance by most firms. The most commonly utilized logistics cost measures are cost to serve, total .delivered co order process costs, warehouse cost, freight cost, and'~ost trend analysis. (3) Customer service: these metrics measure the ability of firms to satisfy customers. Examples of customer service measures are fill rate, stockouts, on-time 216
delivery, backorder duration, cycle time components ant! Variability, customer feedback, and customer satisfaction survey results. (4) Quality: quality measures involve measurement of the output of a process or a series of activities. Logistics quality performance measures like processing accuracy, Frequency and amount of damage, number of customer returns, forecast and planning accuracy, cost of returned goods, and schedule adherence are frequently utilized. One of the most comprehensive measures of quality in logistics is the perfect order measure. This conceptual performance measure concerns the overall logistics performance of the firm. The perfect order fulfillment means completeness of order, on-time delivery, complete and accurate documentation, and perfect condition on Delivery or installation. (5) Asset: metrics related to assets like facilities, equipment, and inventory measure the extent of their utilization. Measures like inventory turns, inventory accuracy, inventory carrying costs, obsolete inventory, days of supply, cash-to-cash cycle time return on nel: Assets, return on investment are common. (6) Productivity: productivity of a system is the ratio of the output produced to the resource inputs utilized for producing the output. Logistics productivity related measures commonly utilized are 'units picked per employee, orders per sales employee, orders shipped per hour, container utilization and orders processed per Employee. External performance measures: Whereas internal performance measures evaluate the logistics performance of processes and functions within the control of a firm, external measures concern the effects of these Operations on the customer and compare the operations arid effects with those of competitors. The external performance measures in most common use are those related' to customer Perception and competitor benchmarking. (1) Customer Perception: customer perception measurement is achieved by conducting post-order customer feedbacks and general customer surveys sponsored by the firm or the industry. These obtain customer feedbacks regarding response to customer enquiries, availability, lead time, response to order information requests, problem revolution; repeat purchases, and product support. (2) Competitor Benchmarking: competitive benchmarking might simply be defined as the continuous measurement of the company's products, services, processes, and practices against the standards of best competitors and other companies who are recognized as leaders. It is not sufficient to measure performance internal to the firm, but more so performance relative to the competition. The first step in benchmarking is the understanding of the Processes involved in logistics fulfillment. The performance of f these processes are then compared against the competitors' performance in those processes. Further, these processes are compared with the processes and practices, concerning the j 'benchmarking areas, utilized by the best firms in comparable ,related and non related industries. This is known. As best practice benchmarking. The benchmarking areas in logistics t could involve cost, customer service, strategy, technology, order processing, or any other logistics area. The practices Would relate to organizational infrastructure and relationships, facilities and equipment, and information systems. Benchmarking information may be obtained either by sourcing published information, private benchmarking, or information sharing between firms. 217
Logistical Measurement The combination of slower economic growth and increased competition has forced firms in every industry to concentrate on efficient and effective deployment of logistical resources. On result of these efforts has been the emergence of a new corporate position devoted to logistical controllership. The logistics controller is concerned with continuous measurement of a firm’s performance. In order to carry out the measurement process controllership focuses on the assessment of resource deployment and goal attainment. Dimensions of Performance Measurement Substantial effort has been expended to improve the quality of information that logistics managers have at their disposal to measure, compare and guide logistical performance. In most firms old reporting formats need to be redesigned to take advantage of new computer based control systems. In place of traditional status and trend reports, today’s managers require flexible and on demand ad hock report. Objectives The three objectives for developing and implementing performance measurement systems include monitoring, controlling and directing logistics operations. Monitoring measures track historical logistics system performance for reporting to management and customers. Typical monitoring measures include service level and logistic cost components. Controlling measures track ongoing performance and are used to refine a logistics process in order to bring it into compliance when it exceeds control standards. An example of a control application is transportation damage tracking. If a system is in place to periodically report product damage, logistics management can identify the cause and adjust the packaging of loading process as needed. Directing measures are designed to motivate personnel. Typical examples include pay for performance practices used to encourage warehouse of transportation personnel to achieve higher levels of productivity. Specifically consider warehouse material handlers of delivery drivers who are paid for eight hours of work based on standard production rates. If the material handlers can complete the assigned tasks in less than the allotted time, they are allowed personal or unassigned time. On the other hand if they require more than the allotted time, the disincentive is that they are not compensated for the additional time. In some cases employees are actually given a bonus when the task is completed in less than the allotted time. When such directed measures are used it is important that both positive and negative performance be measured. For example the completion of an assigned task such as order selection in less than the standard time must be traded off against increased errors or damage. Typical Logistics Activity Based Measures 218
1. 2. 3. 4. 5. 6. 7. 8.
Order Entry time per order Delivery time per order Order selection time per order Inquiry time per order Order entry time per customer Order selection time per customer\delivery time per customer] Order selection time per product Delivery time per product
Perspective The appropriate management perspective must be evaluated and determined. The continuum of possibilities ranges from all activity based measures to entirely process based measures. Activity based measures focus on individual tasks required to process and ship orders. Examples include customer orders entered, cases received from suppliers, cases shipped to customers. These measures record the level of activity and in some instances the level of productivity. While activity based measures focus on the efficiency and effectiveness of primary work efforts they do not usually measure the performance of the overall process of satisfying customers. For example order takers who are judged on the number of calls per hour may be rated high with respect to activity based measurement may do poorly in the overall satisfaction process because they fail to take the time to listen carefully to customers. For this reason it is important that some performance measures taken an overall process perspective. Process based measures consider the customer satisfaction delivered by the entire supply chain. They examine total performance cycle time or total service quality, both of which measure the collective effectiveness of all activities required to satisfy customers. Today’s firms are paying more attention on process measures while trying not to sub optimize individual activities. The Perfect Order is an increasingly common process measure. Internal Performance Measurement Internal performance measures focus on comparing activities and processes to previous operations and/or goals. For example, customer service might be compared to last period’s actual performance as well as to this period’s goal. Research suggests that logistics performance measures can generally be classified into these categories: 1. Cost. 2. Customer service. 3. Productivity. 4. Asset management. 5. Quality. COST: The most direct reflection of logistics performance is the actual cost incurred to accomplish specific operating objectives. Logistics cost performance is typically measured in terms of rupees, as a percentage of sales, or as a cost per unit of volume. CUSTOMER SERVICE: These measures examine a firm’s relative ability to satisfy customers. 219
PRODUCTIVITY MEASURES: It is unclear whether it is the most important or even necessarily a critical measure of performance for all systems. Productivity is a relationship (usually a ratio or an index) between output (goods/or services) produced and quantities of inputs (resources) utilized by the system to produce that output. Thus it is a very simple concept. If a system has clearly measurable outputs and identifiable, measurable inputs that can be matched to the appropriate outputs, productivity measurement is routine. However, it can be difficult and frustrating if (1) outputs are hard to measure and input utilization is difficult to match up for a given period of time, (2) input and output mix or type constantly changes, or (3) data are difficult to obtain or unavailable. There are 3 types of productivity measures: 1. Static: - if all the output and input in a given system are included in the productivity equation, it would be a total factor static productivity ratio. It is considered static because it is based on only one measurement. 2. Dynamic: - It is completed across time. If outputs and inputs in a system compare static productivity ratios from one period to another, the result is a dynamic productivity index, for example: Outputs 1994/inputs 1994 Outputs 1990/inputs 1994 3. Surrogate: - This represents factors that are not typically included in the concepts of productivity but are highly correlated with it (customer satisfaction, profits, effectiveness, quality, efficiency, etc.). Most managers operationalize productivity in this manner. ASSET MEASUREMENT: Focuses on the utilization of capital investments in facilities and equipment as well as working capital application to inventory to achieve logistics goals. Logistics facilities, equipment, and inventory can represent a substantial segment of a firm’s assets. In the case of wholesalers, the amount exceeds 90 %. It measures focus on how fast liquid assets such as inventory ‘turnover’ as well as how well fixed assets generates return on investments. QUALITY: Quality measures, which are the most process-oriented evaluations, are designed to determine the effectiveness of a series of activities rather than an individual activity. However quality is usually difficult to measure because of its broad scope. A contemporary measurement concept that is increasing in interest is ’the perfect order’. Delivery of the perfect order is the ultimate measure of quality in logistics operations, that is, the perfect order concerns the effectiveness of the overall integrated logistical firm performance rather than individual functions. It measures whether an order processes smoothly through every step – order entry, credit clearance, inventory availability, accurate picking, on-time delivery, correct invoicing and payment without deducting- of the order management process without fault, be it expediting, exception processing, or manual intervention. The perfect order represents ideal performance. From an operational perspective a multi-industry consortium defines the perfect order as one that meets all the following standards 220
1. Complete delivery of all items requested 2. Delivery to customer’s request date with one-day tolerance 3. Complete and accurate documentation supporting the order, including packing slips, bills of lading and invoices and 4. Perfect condition that is faultlessly installed, correct configuration, customerready with no damage. However there are many roadblocks to achieving such a level of success. Today the best logistics organizations report achieving a 55 to 60 perfected perfect order performance, while most organizations report less than 20 per percent. External Performance Measurement While internal measures are important for detailed organizational monitoring, external performance measures are also necessary to monitor, understand and maintain a focused customer perspective and to gain innovative insights from other industries. The topics of customer perception measurement and best practice benchmarking, which address these requirements, are discussed and illustrated below. Customer Perception Measurement To succeed in any activities of business one has to always cater to and satisfy the needs of the customer. To do so, it is essential for one to know how the customer thinks in order to meet his needs in a more satisfying manner. Therefore, an important component of leading edge logistical performance is the regular measurement of customer perceptions. Such measures can be obtained through surveys or by systematic order follow up. These surveys can be company - or industry – sponsored. Such surveys ask questions regarding the firm’s and the competitor’s performance in general or for a specific order in particular. Most of the surveys incorporates measurement of customer perceptions regarding availability, performance-cycle time, information availability, problem resolution and product support. The survey may be developed and administered by the firm itself or by consultants, delivery agents or industry organizations. Conclusion Internal performance measures focus on the activities required to serve customers. Measurement of these activities, as well as comparison with goals and standards, is necessary to improve performance and motivate and reward employees. Cost measurement is the minimum component of any performance measurement system. More sophisticated firms incorporate customer service, asset management and productivity measurement. While such measures generally monitor internal process efficiency, they do not examine external process effectiveness very well, particularly from the customer’s viewpoint. The quality measures applied today by the most sophisticated logistics organizations offer such an external perspective. While the individual internal measures discussed above offer a broad performance evaluation, they do not provide an integrated point of view. For example many customers desire high performance regarding both service and quality. Best Practice Benchmarking: Benchmarking is a critical aspect of comprehensive performance measurement. Many companies are adopting benchmarking as a technique to compare their operations to those of both competitors and leading firms in related and non-related industries. 221
Benchmarking is also used in important strategic areas as a tool to calibrate logistics operations. Most of the firms use the following types of Benchmarking tools: 1. Published Logistics Data: This method uses existing data that are published in various periodicals and university researchers. This method of data is easily obtainable and is cheaper to obtain. But the information got in this means is normally too general and may not be tailor-made for the firm’s exact problems. Since this information is available in public, it does not offer a real competitive advantage. 2. Benchmark against noncompetitive firms: In this method a noncompetitive firm in the related industry is benchmarked. This is done by studying and reviewing the other firms’ measures, practices and processes to develop insights that will improve performance. The firm that is chosen to benchmark might be in the same industry but will be operating in a different market. 3. Alliance of Organisations: In this method, an alliance is formed between two organizations that systematically share benchmark data on a regular basis. These kinds of alliances require more effort to maintain but usually provide substantially better information than the preceding two methods. Strategic Factors The key strategic factor to consider during the make-versus-buy decision is performance capability. The decision to outsource involves evaluating which supplier is the most capable of performing the service at a best practice level. This requires an evaluation of potential outsource services in terms of their contribution to a firms core and noncore activities. Typically a firm will not want to run the risk of diluting core competencies by having external firms perform isolated, highly sensitive activities. Once a firm has isolated those activities that are “core supportive” the balance of required activities or the noncore requirements become outsource candidates. The most difficult step for most firms is to identify which activities are critical core capabilities. The outsourcing decision should not be limited to asset investment. Instead, it must center on capabilities provided or achieved through the asset investment. If the capabilities achieved by performing activities internally do not extend an enterprise’s core competencies, then such activities should be outsourced. The desirability of outsourcing is based in part on the benefits of specialization. If required service can be improved or an enterprise can reduce its overall investment or operating requirements, then outsourcing is an attractive alternative. Make-versus-buy decisions involve trade-off analysis among economic and strategic factors. A large portion of such analysis examines cost to service elements. Outsourcing is easily justified if visible costs decrease and service improves, as long as other economic and strategic requirements are satisfied. Specialization can result in economies of scale enabling simultaneous achievement of reduced cost and improved service. Economic Factors 222
Oliver Williamson examined economic factors in terms of transaction costs. These costs are those expenses associated with performing a specific activity. The fundamental Williamson proposition was that free market allocation would result in a balance of internal sourcing and outsourcing that would minimize the transaction cost. Outsourcing creates a situation where external firms can behave opportunistically at the expense of their customer. Service provider withholding poor performance information to ensure its operational success. Such information withholding could result in a major problem for the service provider’s customers. If only a few companies exist with capability to perform the required logistics service, One that approximates monopoly power replaces the ideal free or competitive market. This situation is further complicated if the requested logistics service require transaction specific assets such as dedicated trucks, buildings or wok forces. In the event of cancellation, such customized assets may not be easily transferred to other customers. Transaction cost analysis suggests that logistics activities be performed internally if the transaction costs are lower than expenses associated with outsourcing. Internal costs are usually lower when (1) only a few potential third-party suppliers are available for outsourcing, (2) transaction- specific assets are required, or (3) various suppliers of such services are in a position to take advantage of the transaction setting. The trade-offs depend on which party is best positioned to achieve i.e. best economies of scale. For example, when considering outsourcing or owning a warehouse, volume is a critical factor. Suppose the product requiring storage follows an erratic demand pattern. On average, 25000 units need to be stored to meet monthly requirements. However, peak storage demand requires 50,000 units, while the lowest point of seasonality requires only 5,000. If a privately owned warehouse is used, it must have the capacity to hold 50,000 units. When demand justifies only 5,000 units storage, the warehouse would be operating at approximately 10 percent of capacity (5000/50000 = 10percent capacity). Under such utilization, fixed, overhead, labour and managerial expenses would be spread over so few units that the cost per unit would be very high. On the other hand, outsourcing to a public warehouse could result in standard per unit cost that is independent of month-to-month storage requirements. When outsourcing is outsourced, customer typically negotiates a rate that requires it to pay only for space used. Therefore, the price is the same per unit whether the firm stores 5,000 or 50,000 units. If the price per square foot is $1.50 and a unit takes up 2 square fees, the total charge per unit is $3.00, regardless of the total no of units stored. The level of rate typically charged would reflect average utilization as contrasted to either a minimum or maximum. Alternative opportunity cost of capital is one such expense involved in outsourcing. A private trucking fleet requires substantial equipment investment. To fully evaluate outsourcing, an enterprise should consider alternative uses of the capital that would be invested in a private fleet of trucks. For example, the same amount of money could be used to increase manufacturing capacity, improve logistics facilities, or expand other aspects of the business. The enterprise must determine which types of investment offer the best long-term advantage. 223
Another consideration is cost associated with obsolescence. Firm’s investment in technologies, which can become obsolete before the enterprise can fully amortize the cost. In such case, technology may not have paid for itself in productivity and efficiency before it must be replaced. Outsourcing logistics activities means that third party service provider is responsible for technology investments, and this reduces the risk of obsolescence. Because of high volume usage, service providers will amortize cost of technology investment before they become obsolete. Furthermore the service provider is forced to update technology, to maintain attractiveness to their customer base. Final important consideration in outsourcing is related to labour. When moving from internal to external performance of logistic, the labour requirements and management responsibilities of the customer will be reduced or shifted to service supplier. This shift affects cost like early retirement, layoffs, reassignment morale, productivity unionization and retaining. And while moving to logistical service inhouse from a third party provider, hiring, training, internal labour shifts and implementation time are the key considerations that may serve to limit flexibility.
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Logistical Performance Cycle
Integrated Logistics can be analyzed by means of performance cycle. 1. Warehouses of a hardware wholesaler may receive merchandise from several hundred manufacturers on a regular basis. 2. A transportation carrier is hired by wide variety of industries, Logistical Performance Cycle Material Source
Procurement Cycle
Components Parts Plant Assembly Parts
Manufacturing Support Cycle
Distribution Warehouse
Customer
Physical Distribution Cycle
Physical Distribution Performance Cycle Integral to marketing & sales performance as it provides timely & economic product availability & delivery to customers
Transaction creating activities
Physical Fulfillment Activities
Advertising & selling
Physical Distribution
Physical distribution performance involves following activities Order Processing
Order Transmission
Customer Order
• Order Selection
Order Transportation
Customer Delivery
• •
Physical Distribution links a firm with a customer. Physical Distribution resolves marketing and manufacturing initiatives into an integrated concept.
Conflicting Interface between marketing & manufacturing: • As marketing is dedicated to the delighting customer, it would like to maintain a board product line with high inventory regardless of each product’s profit potential. By adding any customer’s requirement, no matter how small or large, would be satisfied. • Traditional mind set in manufacturing is controlling cost. Therefore, a narrow line of product is mass-produced. • Inventories are kept to resolve the inherit conflict between these two philosophies. How to reduce physical distribution operational variance? • Improved accuracy of forecast 225
• Better order management and coordinating with the customers • More responsive and flexible cycle It is the customers who initiate the process by ordering. Manufacturing Support Performance Cycle • Provides production logistics • Can be viewed as being positioned between the physical distribution and procurement operation of the firm. • Movement and storage of the product, materials and semi-finished parts and components between enterprise facilities represent the responsibility of manufacturing support logistic. • Similarly, retail and wholesale trading firms select the assortment of the inventories to be moved at the next level of the value chain. • The objective of logistical management support is to facilitate the what, where and when of the production and now how. • Logistical to dock-to-dock movement within the firm and also at any intermediate store-point. • Once the production is completed, finished inventory is allocated and deployed direct to customer or to a distribution warehouse for subsequent customer shipment,. • At this point of moment, physical distribution operation is initiated. A firm having multiple plants specializing in specific production activities: • Require a cast network of performance cycles. • In a company producing and fabricating numerous part prior to final assembly, a large no. of handling and transfers are required to complete the manufacturing process. • Manufacturing support logistic is typically captive to a firm, whereas other areas. Procurement Performance Cycle The activities performed to complete the procurement process are: 1. Sourcing 2. Order placement and expediting 3. Transportation 4. Receiving Sourcing
Order Placement & Expediting SUPPLIER
Sourcing
Sourcing
• • •
The procurement operations are identified as inbound logistics. The objective is to perform inbound logistic at the lowest cost Procurement often requires large shipments necessitating the use of badges, ocean going vessels, trains and multiple Trucks load to transport. • The lowest value of the materials and parts as compared to finished product implies a greater trade- off between higher cost of maintaining inventory in transit and use of low cost modes of transport. • As the cost of maintaining inventory in the supply pipeline is less per day than the cost of maintaining finished inventory, there is no benefit or paying higher rates for faster inbound transport. Due to above procurement, performance cycle are longer. The exceptions to these are in situations where value of the material or component may justify the use of premium high speed and reliable services. The examples are: • A plant manufacturing cake mix requiring a large amount of flour in its production process. Since flour in bulk quantity is relatively inexpensive, the firm would prefer to purchase flour in extremely large quantities that are sniped by rail. It does not make any sense t purchase small quantities losing the prices discounts for ordering bulk and paying to ship flour in smaller, high cost transportation movements. • As automobile customer buying a customized electronic part on requirement basis. Customized packages could be significantly different for every car and package will be relatively expensive. Also, the quantity ordered will be small. Hence, the customer avoids holding inventory and would be willing to pay for premium transportation for fast delivery. 226
A critical issue in procurement is uncertainty in respect of: • Price change, and/or • Supply discontinuity Reducing performance cycle uncertainties • Use of Electronic Date Interchange (EDI) • Monitoring Daily changes in the workload • Human Resource availability • Availability of specialized unloading and other handling equipments • Ensuring consistency in operations
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17. PALLATIZATION CONTAINERIZATION
AND
PALLATISATION / PALLETS FOR UNITISATION The pallets represent an attempt to unify dry cargo loads. At its simplest it is a flat ray upon which several articles can be placed, which can then be handled as one article. Its essential features in the context of freight transport is that it should be rigid and sturdy enough to support its loads and that of products placed on it and should have been constructed so as to allow mechanized handling. Metal strapping or binder twine, nets, plastic films or more elaborate restraining devices are used to secure the articles to the pallets. In some cases the packages provide adequately stability and the no fastening is required. The development of the pallet system has led to the growth of handling equipment like forklift trucks etc. forklifts trucks and pallets make a formidable couple and recognizing this fact the rail cars, road vehicles and ships have modified their cargo containers to accommodate the couples. Although Pallatization is now well established, the design of pallets is still an active area of innovation. This is so because the pallets have to customized according to requirements of the distinct categories of products. The pallets in the form, of • •
Wooden of non -timber pallet Four-way entry pallet or box type pallet.
EFFECTS OF PALLATISATION The most obvious benefit of Pallatization is reduction in time needed to load and unload products from a vehicle, and improved utilization warehouse space. The benefits of pallatisation were recognized in the factories before palates gained acceptance in various modes of transportation. The especially the use forklift trucks and pallets in sea transport has led to saving or” time in various loading activities. This in turn has reduced the turnaround time in port and has led to efficient utilization of the most expensive piece of capital in the system -the ship. This has motivated other modes of transport to explore the possibilities of Pallatization in their fields. The move towards Pallatization has given rise to other benefits: Individual packages can be assembled in plant on to a pallet according to single customer order. This facilitates handling of the pallets for road or rail vehicles as well. It has also been found that pallatisation helps to reduce not only the rate of damage in transits but also cuts the delivery time. Perhaps the most telling benefits of pallatisation is reduction in delivery: rebate unto 30% have been quoted by shippers which when added to other saving incurred due to pallatisation add up to a substantial incentive. The most apparent drawback in pallatisation is lack of uniformity in pallets. More than 1500 types of pallets exist in the industry. These have been standardized to the needs of a wide variety of products. The non-uniformity of pallets poses a strain on intermodal in use of pallets. Attempts are being made aggressively to decrease the limitations of pallatisation.
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CONTAINERIZATION Containerization fits comfortably into a total inter modal transportation system concept. It facilitates quicker transfer of cargo from one transport mode to another, while reducing transit time and taking the advantages of every available mode. It serves almost like an inter-modal liaison tool, incorporating all the existing advantages of the whole system. Various types of container handling equipment, including cranes, straddles and fork trucks, now handle them. This has resulted in increasing mechanization of cargo handling, since machines with heavy lifting capacity of 40 to 80 tonnes have been pressed into service. BENEFITS OF CONTAINERIZATION • Containerization assists in the integration of various modes of transport, which leads to better utilization of the country physical transport assets. • Containerization reduces distributes costs of not only the products itself but cost to the economy as a whole mainly by reduction in the handling time of vehicles. • Containerization leads to a system of a single transport operator taking complete charge of the cargo through out the whole journey. This by itself leads to better care of the cargo. Elimination of interface problems and economies in total costs. • Containerization facilitates low level rail based installations at port, marshalling yards and depots. This leads to reduce capital costs as well as reduced operational costs. • A speedier container service reduces transits time and therefore affects economies in transit inventory costs. • While elaborate infrastructure is no doubt necessary for containerization, on the whole investment per ton of cargo carried is reduced. • Packing of cargo carried in container is lighter. In fact, some shippers have started moving cargo in unpacked showroom, ready display condition. This not only leads to saving in packing costs and processing time and therefore savings in production costs but also savings in freight costs. • Risk of damage to and pilferage of goods is reduced for the cargo carried in container. • Containerization eliminates the need for covered warehouses since container can be stored in the open. This leads to reduction in warehousing costs. • Containerization ties up all the loose ends of the total transportation system whereby it leads to improvement in the regularly and reliability of transport services and promotes the efficiency of the overall transport system because of increasing mechanization. CONSTRAINSTS OF CONTAINERIZATION Containerization is essentially a capital-intensive project. Hence, financially speaking, many shipment owners find it infeasible to switch over to containerization. The expense is further increased because, at the terminal points specialized materials handling equipment namely overhead cranes trailer vans, conveyers system, have to be installed. Further ship -owners have to strengthen the existing quays and create enough stacking space for the containers. It is not possible to containerize each and every type of merchandise because of this, a shipper will have provide capital outlay (Le. adequate finance) to modify his premises so that they become suitable enough to accommodate the restrictive dimensions/ weight imposed by the container In certain types of trade, like in the case of livestock (consisting of goats, sheep etc.) the goods cannot be sent in a containerized manner. The very nature of the 229
product makes it impossible. In some countries, there are government restrictions regarding the heights of the containers. Because of this, in these countries containerized transport using large- sized containers is not practicable. Containerization has yet to make a mark in India. Even though it was introduced in the United States nearly twenty years ago. India with its vast coastline and long distance between major center of commerce and industry, would gain immensely from containerization. Though containerization tends to be change- intensive, because of the reduction in damage and development of sophisticated material handling machinery, which it promotes, this change should be welcomed. More over, with the rapidly increasing costs of labour and the tendency of organized labour to hold to ransom the whole community for petty self- interest, increasing containerization is not only justified but also becomes inevitable.
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Prof. Vinay Pandit
THIRD PARTY LOGISTICS Third party logistic implies the provision of multiple distribution related services in a 'bundle package'. There services are usually managed and /or supplied by a single provide Industrial buyers, formulating functional decision making, evaluate and select third party suppliers for their organization. Multiple year contract and partnership provision are becoming more and more common in these types of business arrangements. Management has understanding adopted' out sourcing' as a visible method of supplying many products and services traditionally produced' in house'. This practice as a primary procedure has resulted from the need to respond to increasingly competitive conditions demanding reduced costs. The design and manufacturing, marketing and distribution processes in the revamped business strategies are also attributed to 'outsourcing'. SERVICES OFFERED BY 3 PL The services offered by 3PL provide vary according to the area they cover. Generally the following types of services are available: 1. Express Most express services are sophisticated versions of common user services involving transport and distribution centers. Companies offering express services accept only relatively small consignment sizes not exceeding 25kg. but offer a high level of services in return, often with next day delivery. Tracking and tracking system also may contribute a high level of customer services. 2. Groupage The main difference between groupage and express is that groupage will accept larger consignment sizes, but will invariably be slower. 3. General haulage This is yet another common user services, but the haulers only perform the transport operations (coal transport to thermal power plant carrying of LPG transport of care, etc.) 4. Shared transport / distribution This services arises when served clients of a 3PL provider have specialized needs in common: For e.g. in packaging handling storage or even common destination. The clients benefits from the 3 PI providers being able to consolidate consignments having specialized needs in both transport needs in both transport and warehousing. 5. Dedicated contract transport /Distribution Services of this involved both transportation and warehousing capacity. Which is divided into’ client sets’ each dedicated to one specific client? This compartmentalization of the contracts capacity among clients means that no individual client’s services needs will be compromised by the conflicting needs of other clients, a situation that may well arises when capacity is shared. Dedicated contract. #PI service is, in effect, a third party replication of private fleet operation and in house logistic services. Logistics Management
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Prof. Vinay Pandit
As a comprehensive 'tailor made' services for clients. Dedicated contract system offer good opportunity for the application of innovation logistic concept and for advanced uses of logistic information technology.
Logistics Management
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