Logistics

Logistics
An Introduction to Supply
Chain Management

Donald Waters
© Donald Waters 2003
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Library of Congress Cataloging-in-Publication Data
Waters, C. D. J. (C. Donald J.), 1949–
Logistics : an introduction to supply chain management / Donald Waters.
p. cm.
Includes bibliographical references and index.
ISBN 0–333–96369–5 (paper)
1. Business logistics. 2. Industrial management. I. Title.

HD38.5 .W384 2002

658.5—dc21
2002073544
Editing and origination by Aardvark Editorial, Mendham, Suffolk
10 9 8 7 6 5 4 3 2 1
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To Dan and Sue
 Contents

List of Figures ix 4 Implementing the Strategy 82

Preface xi Relating Strategy to Lower Decisions 83
Areas for Decisions in Implementation 85
PART I Managing Change 95
Discussion Questions 103
Introduction 1 References 103
1 The Context of Logistics 3
5 Locating Facilities 104
Introduction 4
Importance of Location 105
Definitions 4
Choosing the Geographic Region 109
The Supply Chain 7
Infinite Set Approaches 113
Activities of Logistics 12
Feasible Set Approaches 119
Aims of Logistics 17
Network Models 126
Importance of Logistics 19
Location Planning 130
Discussion Questions 25
Discussion Questions 136
References 26
References 136
Further Reading 26
Further Reading 136
2 Integrating the Supply Chain 27
6 Planning Resources 137
Progress in Logistics 28
Types of Planning 138
Current Trends in Logistics 30
Capacity Planning 139
Integrating Logistics Within an
Adjusting Capacity 144
Organisation 34
Tactical Planning 150
Integration Along the Supply Chain 39
Short-term Schedules 158
Achieving Integration 43
Discussion Questions 165
Discussion Questions 53
References 165
References 54
Further Reading 165

PART II 7 Controlling Material Flow 166

Planning the Supply Chain 57 Material Requirements Planning 167
Extending the Role of MRP 174
3 Logistics Strategy 59 Principles of Just-in-time 178
Strategic Decisions 60 Achieving Just-in-time Operations 183
Logistics Strategy 62 Extending JIT Along the Supply Chain 189
Strategy Options 66 Discussion Questions 194
Designing a Logistics Strategy 73 References 194
Discussion Questions 80 Further Reading 195
References 80
viii CONTENTS

8 Measuring and Improving 11 Warehousing and Material

Performance 196 Handling 282
Measuring Performance 197 Purpose of Warehouses 283
Comparing Performance 207 Activities Within a Warehouse 285
Analysing a Supply Chain 209 Ownership 290
Improving Performance 215 Layout 292
Discussion Questions 222 Materials Handling 297
References 223 Packaging 302
Further Reading 223 Discussion Questions 306
References 306
PART III Further Reading 307
Activities in the Supply Chain 225 12 Transport 308
Introduction 309
9 Procurement 227 Mode of Transport 310
Definitions 228
Intermodal Transport 319
Choosing Suppliers 232
Ownership of Transport 321
Procurement Cycle 236
Routing Vehicles 325
Types of Purchase 242
Discussion Questions 331
Discussion Questions 249
References 331
References 249
Further Reading 331
Further Reading 250
13 Global Logistics 332
10 Inventory Management 251 International Trade 333
Reasons for Holding Stock 252
Problems with International Logistics 338
Economic Order Quantity 259
Organising International Operations 342
Uncertain Demand and Safety Stock 267
Discussion Questions 349
Periodic Review Systems 270
References 349
Effort of Stock Control 274
Further Reading 349
Discussion Questions 280
References 281 Index 350
Further Reading 281
 List of Figures

1.1 Spectrum of products 5 4.5 Capacity of a supply chain set by the

1.2 Operations creating outputs 5 bottleneck 92
1.3 Cycle of supply and demand 6 4.6 Summary of logistics at Ralston
1.4 The role of logistics 6 Energy Systems s.r.o. 93
1.5 Outline of the supply chain for paper 8 4.7 Deming wheel 97
1.6 Activities in a supply chain 9 4.8 Rate of performance improvement 100
1.7 Supply chain around a manufacturer 9
5.1 Break-even analysis for location of
1.8 Using intermediaries to simplify the
Warwick Supplies 108
supply chain 12
5.2 Hierarchy of decisions for locations 109
1.9 Examples of organisational structure 16
5.3 Alternative choices of location 114
1.10 Influence of logistics on ROA 21
5.4 Variation in transport cost with
2.1 Summary of logistics activities 35 location 115
2.2 Three levels of logistics integration 40 5.5 Calculation of centre of gravity 116
2.3 Varying demand 40 5.6 Locations for van Hendrick Industries 117
2.4 Spectrum of relationships 46 5.7 Weakness of the centre of gravity
2.5 Different levels of vertical integration 49 method 117
5.8 Map for Bannerman Industries 120
3.1 Types of strategic decision 61 5.9 Comparison of sites 121
3.2 Role of logistics managers in strategic 5.10 Variation in transport cost with
decisions 63 number of facilities 121
3.3 Different amounts of input from 5.11 Finding the optimal number of
logistics managers 63 facilities 122
3.4 Factors in the design of a logistics 5.12 Map of Ian Bruce’s problem 127
strategy 74 5.13 Spreadsheet of calculations for
Ian Bruce 127
4.1 Levels of decision in logistics 86
5.14 Road network showing travel time
4.2 Structure of a supply chain 87
in minutes between locations 129
4.3 Different shapes of supply chain 88
5.15 Solution to the covering problem 129
4.4 Simplified supply chain for
5.16 Network for Problem 6 135
distributing shoes 89
x LIST OF FIGURES

6.1 An approach to planning logistics 138 9.1 Relative power of a customer and
6.2 The bottleneck of a supply chain a supplier 234
limits the capacity 140 9.2 Outline of steps in a procurement
6.3 Capacity of distribution at J&R cycle 237
Softdrinks 142 9.3 Some arrangements for delivery 246
6.4 Alternative timing of capacity
10.1 Aggregate stock as a percentage
expansion 144
of GDP for the UK 253
6.5 Alternative size of capacity expansion 145
10.2 Types of stock 255
6.6 A typical learning curve 147
10.3 Repeated pattern of stock cycles 259
6.7 Cost of maintenance 148
10.4 Variation of cost with order size 260
6.8 An iterative approach to planning 152
10.5 Using a reorder level to time orders 263
6.9 Graphical approach to planning –
10.6 Order patterns when lead time is
plotting cumulative demand and
longer than stock cycle 263
supply 155
10.7 The cost curve is shallow around
6.10 Revision of plans during cycles 156
the economic order quantity 265
6.11 Spreadsheet to help with planning
10.8 Safety stock raises the average
in Piotr Hucek 158
stock level 267
7.1 Comparison of stock levels 168 10.9 Alternative approaches to ordering 271
7.2 Part of a bill of materials for a table 169 10.10 Order placed at A has to cover
7.3 Summary of MRP procedure 170 demand until B 272
7.4 A closed-loop MRP system 175 10.11 Typical results for an ABC analysis 274
7.5 Enterprise resource planning 177 10.12 Original supply chain for Nalco/
7.6 Stock levels with different types of Exxon 276
control 180
11.1 Using warehouses to reduce
7.7 The simplest form of message for JIT 185
transport costs 287
7.8 A two-card kanban system 186
11.2 Meeting demand with a mixture
8.1 Capacity and utilisation in a supply of private and public warehouses 291
chain 199 11.3 Break-even analysis for public/
8.2 Structure of the UK frozen food private warehouses 292
industry 206 11.4 Basic layout of a warehouse 293
8.3 Steps in benchmarking 208 11.5 Schematic of a common warehouse
8.4 An informal process chart 210 layout 293
8.5 Format for a process chart 211 11.6 Layout of paint in worked example 296
8.6 Part of a process chart for deliveries 11.7 Choice of automation and
at a supermarket 211 warehouse size 300
8.7 Precedence diagram, with activity 11.8 Outline of Handemann Group’s
B following activity A 212 warehouse 301
8.8 Precedence diagram for worked
12.1 Freight moved by transport mode
example 213
in the UK 311
8.9 Example of a multiple activity chart 213
12.2 Transporting coal across Canada 318
8.10 Multiple activity chart for worked
12.3 The travelling salesman problem 326
example 214
12.4 Solution to routing problem 328
8.11 Part of a simulation for Ed’s Drive-
through Bottle Shop 221
 Preface

SUBJECT
This is a textbook about logistics. It describes the way that materials move into an organisation from
suppliers, through the operations within an organisation, and then out to customers. As you can see,
we take a broad view of logistics, looking at every kind of ‘organisation’, moving every kind of ‘mate-
rial’. We talk about manufacturers moving tangible goods – and service providers moving materials
for their intangible services.
Every organisation needs a reliable flow of materials. Logistics is an essential function, and
managers have to make the movement of materials as efficient and effective as possible. This is best
done by an integrated function that is responsible for all aspects of material movement. The results
are important, as they directly affect customer service, costs – and just about every other measure
of performance.
Logistics is not contained within an organisation, but has a unique position in linking external
suppliers and customers. Organisations increasingly recognise that they do not work in isolation, but
form part of a supply chain whose aim is to satisfy customers. To emphasise this broader role, some
people prefer to talk about ‘supply chain management’.
This is a particularly fast-moving field. Developments in operations – such as just-in-time, lean oper-
ations, efficient customer response, enterprise resource planning, e-commerce, globalisation, and
increasing customer service – are rapidly changing the demands on logistics. This book gives an up-to-
date view of logistics, emphasising current trends and developments. It covers important issues, such as:

● increasing strategic importance of logistics

● global operations and increasing international competition
● integration of organisations and activities in the supply chain
● changing requirements from logistics to deal with new types of operations
● better communications allowing closer co-ordination of movements
● new requirements from aspects of e-commerce
● increasing emphasis on quality and customer-based service
● environmental concerns.

APPROACH OF THE BOOK

The book gives an introduction to logistics. It can be used by anyone who is meeting the subject for the
first time. You might be a student taking a course in business studies, or another subject that needs
some knowledge of logistics – or you might read the book to learn more about a central area of manage-
xii P R E FA C E

ment. The book gives a broad description of logistics, covering all the main concepts. It
discusses the topics in enough depth to provide material for a complete course, but it does not
get bogged down in too much detail. By concentrating on key issues, we have kept the text to
a reasonable length.
The book has a number of features. It:

● is an introductory text and assumes no previous knowledge of logistics or experience of

management
● can be used by many types of student, or people studying by themselves
● takes a broad view, covering all types of organisation
● sets logistics within its strategic context
● describes a lot of material, concentrating on topics that you will meet in practice
● develops the contents in a logical order
● is practical, presenting ideas in a straightforward way, avoiding abstract discussions
● illustrates principles by examples drawn from international organisations
● includes a range of features, including chapter aims, examples of logistics in practice, case
studies, projects, worked examples, chapter reviews, problems, discussion questions and
useful readings
● is written clearly, presenting ideas in an informative and easy style.

CONTENTS

The book follows a logical path through the decisions of logistics. An obvious problem is that
the topics are all related, and decisions are made simultaneously rather than consecutively. In
the book we effectively have to make a linear journey through a complex web of material. To
make this easier, we have divided the book into three parts. The first part gives an overall
introduction to logistics. It defines key terms, discusses the role of logistics, its aims, impor-
tance, trends and the general context of supply chain management. It shows how logistics has
developed into a single, integrated function.
The second part looks at the planning for a supply chain. This starts with the design of a
logistics strategy, and then shows how this strategy can be implemented. Important decisions
include the structure of the supply chain and the location, number and size of facilities. These
decisions lead to lower level plans to organise activities and resources. The supply chain keeps
changing, so we look at ways of measuring and improving the performance of logistics.
The third part of the book focuses on some specific functions of logistics, including
procurement, inventory management, warehousing, transport of materials and international
logistics.
Together these chapters cover some of the most important decisions made in any
organisation.

CONTACTS

If you have any comments, queries, requests or suggestions for the book or associated material,
the author and publisher would be very pleased to hear them. You can contact the author at
[email protected].
 PA R T I

Introduction

This book is divided into three parts. Part I contains two chap-
ters and gives an overall introduction to logistics, as well as
setting the scene for the rest of the book. It introduces some
important issues which are developed in later chapters.

Chapter 1 defines the key terms, discusses the role of logistics,

its aims, importance and the general context of supply chain
management. Chapter 2 describes current trends, and shows
how logistics has developed into a single, integrated function.

Parts II and III look at planning in the supply chain, and focus on
different activities of logistics.
 CHAPTER 1

The Context of Logistics

CONTENTS

■ Aims of the chapter ■ Chapter review

■ Introduction ■ Case study – Ace Dairies
■ Definitions ■ Project – Websites
■ The supply chain ■ Discussion questions
■ Activities of logistics ■ References
■ Aims of logistics ■ Further reading
■ Importance of logistics

AIMS OF THE CHAPTER

After reading this chapter you should be able to:

■ D E F I N E ‘logistics’ and associated terms

■ U N D E R S TA N D the role and structure of supply chains
■ L I S T different activities of logistics and understand the
relationships between them
■ D I S C U S S the aims of logistics
■ S H O W how logistics contributes to customer satisfaction
■ R E C O G N I S E the importance of logistics to every organisation
4 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

INTRODUCTION

All organisations move materials. Manufacturers build factories that collect raw materials from
suppliers and deliver finished goods to customers; retail shops have regular deliveries from
wholesalers; a television news service collects reports from around the world and delivers them
to viewers; most of us live in towns and cities and eat food brought in from the country; when
you order a book or DVD from a website, a courier delivers it to your door. Every time you buy,
rent, lease, hire or borrow anything at all, someone has to make sure that all the parts are
brought together and delivered to your door. Logistics is the function that is responsible for
this movement. It is responsible for the transport and storage of materials on their journey
between suppliers and customers.
On a national scale, logistics involves a huge amount of effort. The USA has a gross
domestic product (GDP) of US$10 trillion,1 so its population of 280 million produces and
consumes an average of US$36,000 of goods and services. The world’s seven largest economies
(USA, Japan, Germany, UK, France, Italy and Canada) have a combined GDP of US$20 trillion.
All of this – whether it is oil produced in Canada, consumer electronics in Japan, cars in the
UK or dairy products in France – relies on logistics to collect materials from suppliers and
deliver it to customers. Millions of people are involved in this effort, and it costs billions of
dollars a year to keep everything moving.
Ordinarily we only notice a small part of logistics. We might see lorries driving down a
motorway, visit a shopping mall, drive through a trading estate, or have a parcel delivered to
our homes. These are the visible signs of a huge industry. In this book, we take a more detailed
look at this complex function. We discuss the issues and developments, and see how managers
can get the best results from their logistics.

DEFINITIONS

Supporting operations

Every organisation delivers products to its customers. Traditionally we have described these
products as either goods or services. Then manufacturers like Sony and Guinness make
tangible goods, while AOL and Vodafone provide intangible services. In reality, this view is
rather misleading, and every product is really a complex package that contains both goods and
services. Ford, for example, manufacture cars, but they also give services through warranties,
after-sales service, repairs and finance packages. McDonald’s provide a combination of goods
(burgers, cutlery, packaging, and so on) and services (when they sell food and look after the
restaurant). It is more accurate to describe products as lying on the spectrum shown in Figure
1.1. At one end of this spectrum are products that are predominantly goods, such as cars and
domestic appliances; at the other end are products that are predominantly services, such as
insurance and education. In the middle are products with a more even balance, such as restau-
rant meals and hospitals.
At the heart of an organisation are the operations that create and deliver the products. These
operations take a variety of inputs and convert them into desired outputs, as shown in Figure
1.2. The inputs include raw materials, components, people, equipment, information, money and
other resources. Operations include manufacturing, serving, transporting, selling, training, and
so on. The main outputs are goods and services. The Golden Lion restaurant, for example, takes
inputs of food, chefs, kitchen, waiters, and dining area; its operations include food preparation,
cooking and serving; the main outputs are meals, service, customer satisfaction, and so on.
 THE CONTEXT OF LOGISTICS 5

Largely goods Balance of goods Largely

and services services

Car House Bespoke Fast food Health Sea Education

makers builders tailor restaurant service cruise

Figure 1.1 Spectrum of products

INPUTS OPERATIONS OUTPUTS

■ People ■ Manufacture ■ Goods

■ Buildings ■ Serve ■ Services
■ Raw materials ■ Supply ■ Profit
■ Equipment ■ Transport ■ Waste
■ Information ■ Sell ■ Wages
■ Investment ■ Train ■ etc.
■ etc. ■ etc.

Figure 1.2 Operations creating outputs

The products created by an organisation are passed to its customers, giving the cycle shown
in Figure 1.3. This shows customers generating demands, with operations using resources to
make products that satisfy them. Logistics moves materials around this cycle.
The operations are usually divided into a number of related parts, in the way that a
hospital has an emergency room, surgical ward, purchasing department, heart unit, operating
theatre and so on. So logistics also moves materials through the different parts of an organisa-
tion, collecting from internal suppliers and delivering to internal customers (as shown in
Figure 1.4). This leads to our basic definition.

LOGISTICS is the function responsible for the flow of materials from suppliers into an
organisation, through operations within the organisation, and then out to customers.
6 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Customers
passed to create

Supply of Demand for

products products

arrange passed to

Operations

Other outputs Other inputs

Figure 1.3 Cycle of supply and demand

External Operations within External

supplier the organisation customer

Internal Internal
supplier customer

Inbound Outbound
logistics Materials management logistics

Logistics

Figure 1.4 The role of logistics

Moving materials into the organisation from suppliers is called inbound or inward logistics;
moving materials out to customers is outbound or outward logistics; moving materials
within the organisation is materials management.

Materials

In these definitions we have talked about the movement of materials – but what exactly do we
mean by materials? Sometimes this is obvious when, for example, a power station brings coal
from a mine, a farmer moves potatoes to a wholesaler, or a computer manufacturer delivers PCs
to a warehouse. At other times it is less clear when, for example, a television company delivers
entertainment to its viewers, a telephone company provides a communications service, or a
 THE CONTEXT OF LOGISTICS 7

research company creates new knowledge. Tangible goods clearly have to be moved, and you
can easily see the role of logistics. Even organisations providing the most intangible services
move some goods around – perhaps paperwork or consumables – so they still need logistics.
However, we can take a broader view and say that logistics also moves less tangible things, such
as information and messages. Then a television company uses logistics to move around its
production facilities, and also to transmit programmes to customers. In different circumstances,
logistics is responsible for moving raw materials, components, finished products, people, infor-
mation, paperwork, messages, knowledge, consumables, energy, money and anything else
needed by operations. To simplify things, we describe all of these as materials.

M AT E R I A L S are all the things that an organisation moves to create its products.
These materials can be both tangible (such as raw materials) and intangible (such as
information).

THE SUPPLY CHAIN

Definition

So far, we have focused on the movement of materials through a single organisation. In reality,
organisations do not work in isolation, but each one acts as a customer when it buys materials
from its own suppliers, and then it acts as a supplier when it delivers materials to its own
customers. A wholesaler, for example, acts as a customer when buying goods from manufac-
turers, and then as a supplier when selling goods to retail shops. A component maker buys raw
materials from its suppliers, assembles these into components, and passes the results to other
manufacturers. Most products move through a series of organisations as they travel between
original suppliers and final customers. Milk moves through a farm, tanker collection, dairy,
bottling plant, distributor, and supermarket before we buy it. A toothbrush starts its journey
with a company extracting crude oil, and then it passes through pipelines, refineries, chemical
works, plastics companies, manufacturers, importers, wholesalers and retailers before finishing
in your bathroom. A sheet of paper moves through several organisations before it reaches our
desk (illustrated in Figure 1.5).
People use different names for these chains of activities and organisations. When they
emphasise the operations, they refer to the process; when they emphasise marketing, they call
it a logistics channel; when they look at the value added, they call it a value chain,2 when
they see how customer demands are satisfied, they call it a demand chain. Here we are
emphasising the movement of materials and will use the most general term of supply chain.

A S U P P LY C H A I N consists of the series of activities and organisations that materials

move through on their journey from initial suppliers to final customers.

Every product has its own unique supply chain, and these can be both long and complicated.
The supply chain for Cadbury starts with cocoa beans growing on farms and ends with the
delivery of bars of chocolate to hungry customers. The supply chain for Levi jeans starts with
cotton growing in a field and ends when you buy the jeans in a shop. The supply chain
describes the total journey of materials as they move ‘from dirt to dirt’.3 Along this journey,
8 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Grown
by gard
Seedling en er Planted
Young by
forester
tree
Mature
tree

Felled by
logger
Wood Logs
Raw pulp Chipped
Processed
paper

Processed
Large rolls Finishing
of paper Small rolls
Cutting
of finished
paper
Sheets
of paper

port
Packer Trans

Wholesaler Transport

Transport

Retailer
Final
Purchase customer

Figure 1.5 Outline of the supply chain for paper

materials may move through raw materials suppliers, manufacturers, finishing operations,
logistics centres, warehouses, third party operators, transport companies, wholesalers, retailers,
and a whole range of other operations. Sometimes, the supply chain goes beyond the final
customer to add recycling and re-use of materials.

Structure of the supply chain

The simplest view of a supply chain has a single product moving through a series of organisa-
tions, each of which somehow adds value to the product. Taking one organisation’s point of
view, activities in front of it – moving materials inwards – are called upstream; those after the
organisation – moving materials outwards – are called downstream.
The upstream activities are divided into tiers of suppliers. A supplier that sends materials
directly to the operations is a first tier supplier; one that send materials to a first tier supplier is
a second tier supplier; one that sends materials to a second tier supplier is a third tier supplier,
and so on back to the original sources. Customers are also divided into tiers. One that gets a
product directly from the operations is a first tier customer; one that gets a product from a first
tier customer is a second tier customer; one that get a product from a second tier customer is a
third tier customer, and so on to final customers (see Figure 1.6).
In practice, most organisations get materials from many different suppliers, and sell prod-
ucts to many different customers. Then the supply chain converges as raw materials move in
 THE CONTEXT OF LOGISTICS 9

Upstream activities Downstream activities

Initial Third Second First First tier Second Third Final

supplier tier tier tier customer tier tier customer
supplier supplier supplier customer customer

ORGANISATION

Figure 1.6 Activities in a supply chain

through the tiers of suppliers, and diverges as products move out through tiers of customers. A
manufacturer might see sub-assembly providers as first tier suppliers, component makers as
second tier suppliers, materials suppliers as third tier suppliers, and so on. It might see whole-
salers as first tier customers, retailers as second tier customers, and end users as third tier
customers (as illustrated in Figure 1.7).

Third Second First First Second Third

tier tier tier tier tier tier
supplier supplier supplier customers customers customers

Materials Component Sub-assembly Wholesalers Retailers End users

suppliers makers providers

Manufacturer

Figure 1.7 Supply chain around a manufacturer

10 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

It is fairly easy to imagine the shape of a manufacturer’s supply chain, but most other
organisations use the same general approach. Airlines, for example, move passengers from
pick-up points, through local feeder services to major ‘hub’ airports, on to another hub, and
then back out through local services to their destinations; banks collect all cheques in central
clearing houses before sending them back to branches and customers; blood transfusion serv-
ices have regional centres that act as wholesalers for plasma.
Each product has its own supply chain, and there is a huge number of different configura-
tions. Some are very short and simple – such as a cook buying potatoes directly from a farmer.
Others are surprisingly long and complicated. An everyday product like a shirt has a long
journey from the farm growing cotton through to the final customer. It also has several chains
merging as buttons, polyester, dyes and other materials join the main process. In the same
way, when you buy a computer, many strands of the supply chain merge as Intel provide the
processor, Matshita the DVD drive, Agfa the scanner, Hewlett-Packard the printer, Microsoft
the operating system, and so on.
Supply chains diverge to meet demand from different types of customer. Manufacturers of
car components, for example, sell some products to car assembly plants, some to wholesalers
for garages doing repairs, some to retail shops for individual customers, and some directly to
customers through websites. Then the supply chain divides into separate strands with the
same product following alternative routes.
As you can see, our picture of supply chains is getting more complicated, with various
mergers and divisions along their length. The reality is even more complex, as each organisa-
tion works with many – often thousands – of different products, each of which has its own
supply chain. The French company Carrefour is Europe’s largest retailer, and this comes at the
end of tens of thousands of supply chains; Corus makes steel that is used in countless final
products, DEL makes computers that are used for huge amounts of information transfer.
Some people argue that the term ‘supply chain’ gives too simple a view, and they prefer to
talk about a supply network or supply web. However, we will stick to the usual name, and
recognise that it refers to a complex pattern of movements. You can get some idea of the size
and complexity of these from the Logistics in Practice example of Wal-Mart.

L O G I S T I C S
I N P R A C T I C E
Wal-Mart
In 1962 Sam Walton opened a discount in the USA, and started its international
store in Rogers, Arizona. He attracted cus- expansion. It moved into Mexico, Puerto
tomers with a combination of low prices, a Rico and Canada, and then into South
wide range of goods and friendly service. America, Asia and Europe. Most of its later
Sam called his store Wal-Mart, and was so expansion came through buying local com-
successful that he quickly opened more panies, such as ASDA in the UK.
branches. In 1983 he opened a SAM’S Club Wal-Mart always kept the same empha-
warehouse for members, and in 1988 the sis on low prices, a wide range of products
first ‘Supercenter’ selling groceries. By 1991 and friendly service. The scene is set at the
Wal-Mart had become the leading retailer front door of each store, where a staff
 THE CONTEXT OF LOGISTICS 11

L O G I S T I C S
I N P R A C T I C E
continued

member greets customers and tells them large part of Wal-Mart’s operating expenses
about special offers and promotions. By depend on the efficiency of their logistics.
2000 Wal-Mart was the world’s largest When margins are tight, a small change in
retailer with 4000 stores, serving 100 mil- logistics performance and costs has a con-
lion customers a week, employing 1.2 mil- siderable effect on profit. This is why Wal-
lion staff – or ‘associates’ – an annual Mart use the ‘industry’s most efficient and
turnover of US$175 billion and profit of sophisticated distribution system’. Their
US$6 billion a year. success can be judged by continuing
You can imagine the size of the logistics expansion, with annual sales up 20 per
in Wal-Mart. On mainland USA they have cent in the first quarter of 2000, and like-
85,000 suppliers sending $1.5 billion dol- for-like sales up 5 per cent.
lars’ worth of materials a week to 62 main
Sources: Wal-Mart reports and website at
distribution centres, and on to 1800 Wal-
www.walmartstores.com
mart stores, 800 Supercenters, 460 SAM’s
clubs and 13 Neighbourhood Markets. A

Benefits of supply chains

Supply chains are so complicated that you might wonder if there is some way of avoiding them.
Sometimes this is possible, when we move products directly from initial producers to final
customers – when, for example, farm shops sell vegetables directly to consumers, or authors
publish their works on the Internet. In general, though, there are very good reasons for having
a longer supply chain. Suppose the population of a town decides to buy vegetables from a farm
shop. This would have a minimal supply chain, but the whole population would travel sepa-
rately to the farm. It would make more sense to have a transport company collect the vegetables
and deliver them to a central location in the town – like a supermarket. If the transport
company delivers to one town, it can easily deliver to other nearby towns, perhaps stopping at
a depot to organise local deliveries. As there is a depot, vegetables can be put into storage while
the supply is plentiful, and removed when there are shortages. If the vegetables need cleaning
or preparation, the transport company can divert to a processing plant. Continuing in this way,
you can see why a long supply chain develops, and what benefits it brings.
Supply chains exist to overcome the gaps created when suppliers are some distance away
from customers. They allow for operations that are best done – or can only be done – at loca-
tions that are distant from customers or sources of materials. For example, coffee beans grow in
South America, but the main customers are in Europe and North America. The best locations for
power stations are away from both their main customers in cities and their fuel supplies.
As well as moving materials between geographically separate operations, supply chains
allow for mismatches between supply and demand. The demand for sugar is more or less
constant throughout the year, but the supply varies with the harvesting of sugar cane and
beet. When there is excess supply, stocks are built-up in the supply chain, and these are used
after the harvests finish. Supply chains can also make movements a lot simpler. Imagine four
12 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

(a) Without a wholesaler (b) With a wholesaler

Factories Factories

4 routes
inwards

32 routes Wholesaler

8 routes
outward

Customers Customers

Figure 1.8 Using intermediaries to simplify the supply chain

factories directly supplying products to eight customers (as shown in Figure 1.8). Logistics has
to organise 32 different delivery routes but, if the factories use a central wholesaler, the
number of routes is cut to 12.
The following list suggests some other benefits of well-designed supply chains (where we
use the terms ‘wholesaler’ and ‘retailer’ as a convenient label for intermediaries):

● Producers locate operations in the best locations, regardless of the locations of their
customers.
● By concentrating operations in large facilities, producers can get economies of scale.
● Producers do not keep large stocks of finished goods, as these are held further down the
supply chain nearer to customers.
● Wholesalers place large orders, and producers pass on lower unit costs in price discounts.
● Wholesalers keep stocks from many suppliers, giving retailers a choice of goods.
● Wholesalers are near to retailers and have short lead times.
● Retailers carry less stock as wholesalers provide reliable deliveries.
● Retailers can have small operations, giving a responsive service near to customers.
● Transport is simpler, with fewer, larger deliveries reducing costs.
● Organisations can develop expertise in specific types of operation.

ACTIVITIES OF LOGISTICS

Separate activities

Logistics is responsible for the movement and storage of materials as they move through the
supply chain. But what activities does this include? If you follow some materials moving through
an organisation, you can see that the following activities are normally included in logistics.
 THE CONTEXT OF LOGISTICS 13

● Procurement or purchasing. The flow of materials through an organisation is usually initi-

ated when procurement sends a purchase order to a supplier. This means that procure-
ment finds suitable suppliers, negotiates terms and conditions, organises delivery,
arranges insurance and payment, and does everything needed to get materials into the
organisation. In the past, this has been seen as a largely clerical job centred on order
processing. Now it is recognised as an important link with upstream activities, and is
being given more attention. We describe procurement in more detail in Chapter 8.

● Inward transport or traffic actually moves materials from suppliers to the organisation’s
receiving area. This has to choose the type of transport (road, rail, air, and so on), find the
best transport operator, design a route, make sure that all safety and legal requirements
are met, get deliveries on time and at reasonable cost, and so on. We describe transport in
more detail in Chapter 11.

● Receiving makes sure that materials delivered correspond to the order, acknowledges
receipt, unloads delivery vehicles, inspects materials for damage, and sorts them.

● Warehousing or stores moves materials into storage, and takes care of them until they are
needed. Many materials need special care, such as frozen food, drugs, alcohol in bond,
chemicals that emit fumes, animals, and dangerous goods. As well as making sure that
materials can be available quickly when needed, warehousing also makes sure that they
have the right conditions, treatment and packaging to keep them in good condition. We
describe warehousing in more detail in Chapter 10.

● Stock control sets the policies for inventory. It considers the materials to store, overall
investment, customer service, stock levels, order sizes, order timing and so on. We
describe stock management in more detail in Chapter 9.

● Order picking finds and removes materials from stores. Typically materials for a customer
order are located, identified, checked, removed from racks, consolidated into a single
load, wrapped and moved to a departure area for loading onto delivery vehicles.

● Materials handling moves materials through the operations within an organisation. It

moves materials from one operation to the next, and also moves materials picked from
stores to the point where they are needed. The aim of materials handling is to give effi-
cient movements, with short journeys, using appropriate equipment, with little damage,
and using special packaging and handling where needed. We describe materials handling
in more detail in Chapter 10.

● Outward transport takes materials from the departure area and delivers them to customers
(with concerns that are similar to inward transport).

● Physical distribution management is a general term for the activities that deliver finished
goods to customers, including outward transport. It is often aligned with marketing and
forms an important link with downstream activities.

● Recycling, returns and waste disposal. Even when products have been delivered to customers,
the work of logistics may not be finished. There might, for example, be problems with
delivered materials – perhaps they were faulty, or too many were delivered, or they were
the wrong type – and they have to be collected and brought back. Sometimes there are
14 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

associated materials such as pallets, delivery boxes, cable reels and containers (the standard
20 foot long metal boxes that are used to move goods) which are returned to suppliers for
reuse. Some materials are not reused, but are brought back for recycling, such as metals,
glass, paper, plastics and oils. Finally there are materials that cannot be used again, but are
brought back for safe disposal, such as dangerous chemicals. Activities that return materials
back to an organisation are called reverse logistics or reverse distribution.

● Location. Some of the logistics activities can be done in different locations. Stocks of
finished goods, for example, can be held at the end of production, moved to nearby ware-
houses, put into stores nearer to customers, passed on to be managed by other organisa-
tions, or a range of alternatives. Logistics has to find the best locations for these activities –
or at least play a significant role in the decisions. It also considers related questions about
the size and number of facilities. These are important decisions that affect the overall
design of the supply chain. We discuss location decisions in more detail in Chapter 5.

● Communication. Alongside the physical flow of materials is the associated flow of informa-
tion. This links all parts of the supply chain, passing information about products,
customer demand, materials to be moved, timing, stock levels, availability, problems,
costs, service levels, and so on. Co-ordinating the flow of information can be very diffi-
cult, and logistics managers often describe themselves as processing information rather
than moving goods. Christopher supports this view by saying that, ‘Supply chain compet-
itiveness is based upon the value-added exchange of information’.4 The Council of Logis-
tics Management also highlights the combination of materials and information flow in
their definition:

Logistics is the process of planning, implementing and controlling the efficient, cost-effective
flow and storage of raw materials, in-process inventory, finished goods and related information
from point of origin to point of consumption for the purpose of conforming to customer
requirements.5

Depending on the circumstances, many other activities can be included in logistics. Some-
times an organisation might include sales forecasting, production scheduling, customer service
management, overseas liaison, third party operations, and so on. The important point is not to
draw arbitrary boundaries between functions, but to recognise that they must all work
together to get an efficient flow of materials. In the example of Augulla, logistics may not be
organised particularly well; you might consider the problems that this brings and how you
might start improving things.

L O G I S T I C S
II
N P R A C T I C E
Augulla Limited
In its Bombay factory, Augulla Limited straightforward, but the company’s chair-
makes a range of basic clothes such as plain man, Pradhir Augulla, is disappointed at the
T-shirts and underwear. The process is fairly time it takes a product to reach the final cus-
 THE CONTEXT OF LOGISTICS 15

L O G I S T I C S
I N P R A C T I C E
continued

tomer. He is considering buying other com- about the average times taken by different
panies in the supply chain to see if he can activities, starting with the purchase of fibres
improve overall performance. To help with on the open commodity market and ending
this decision he has collected information with delivery to the final customer.

Start of supply chain with fibre available on the open commodity market:

■ Store fibre in commodity warehouses (140 days)

■ Buy fibre and move to spinners (11 days)
■ At spinners:
store raw fibre (21 days)
spin to form yarn (13 days)
store yarn as finished goods (11 days)
■ Buy yarn and move to knitters (8 days)
■ At knitters:
store yarn (6 days)
knit to form fabric (9 days)
store work in progress as grey stock (12 days)
dye standard colour and finish fabric (7 days)
store fabrics as finished goods (8 days)
■ Buy fabric and move to Augulla Limited (7 days)
■ At Augulla Limited:
store fabric (12 days)
cut to form components (5 days)
store buffer of components (6 days)
sew components to form garments (14 days)
store garments as finished goods (18 days)
■ Deliver to regional distribution centre and store (21 days)
■ Deliver to local wholesaler and store (17 days)
■ Deliver to retail shop and store (19 days)

End of supply chain when customer buys garment from shop.

You can see that it takes an average of 365 days for materials to move through the sup-
ply chain. The main operations of spinning, knitting, dyeing, cutting and sewing only take
48 days, and various aspects of logistics fill the rest.

Sources: Pradhir Augulla and company records

Organising logistics

It is probably easiest to imagine the activities that make up logistics in a manufacturer, with
forklift trucks unloading pallets from lorries and moving them around warehouses. But the
 (a) Conventional functional structure (b) Matrix type of structure

Managing
Director Managing
Director

Finance Human
Logistics Sales Product Product Product Product
Director Resource Others Others
Director Director A B C D
Director

Co-ordination
Transport Warehousing Purchasing Logistics Logistics Logistics Logistics
of all
A B C D
logistics

Figure 1.9 Examples of organisational structure

 THE CONTEXT OF LOGISTICS 17

same principles apply in any other organisation. When a rock band goes on tour they carry
huge amounts of equipment. Procurement buys everything that is needed on the tour, trans-
port packs it and moves it to the next destination, receiving makes sure that everything arrives
safely, warehousing keeps things safe until they are needed, materials handling moves things
between trucks and the stage, location decides where to perform. The same types of decision
are made with even the most intangible service. Insurance companies, for example, decide
what kind of branch network to have, where to locate offices, who to buy telephone and other
services from, how to deliver information to customers, and so on.
You can see logistics in every organisation, and it obviously comes in a huge number of
different forms. The activities can be arranged in many ways within an organisation, and there
is certainly no single ‘best’ arrangement. A small organisation might have one person looking
after everything. A medium sized organisation might have one department with different
sections for purchasing, transport, stock control, distribution, and so on. A large organisation
might have a logistics division employing thousands of people and running huge transport
fleets. Sometimes all the activities are organised in a single department reporting to a logistics
director; sometimes they are part of a larger department such as marketing or production;
sometimes they are spread out in small pockets throughout the organisation; sometimes they
are contracted out to third-party suppliers.
The current trend is towards an organisation where logistics is a single integrated function,
with a logistics director – or equivalent – at its head. This follows a traditional functional struc-
ture, with the logistics director working with directors in production, finance, sales, human
resources, and so on (as shown in Figure 1.9a). There are many variations on this, with a
common one found in companies organised around products or projects. Then some logistics
might exist in each division, with a matrix structure allowing co-ordination of the overall
function (shown in Figure 1.9b).

AIMS OF LOGISTICS
Logistics is responsible for the flow of materials through a supply chain. This function is also
called supply chain management. Some people argue that logistics is somewhat narrower
and concentrates on the movement within a single organisation, while supply chain manage-
ment takes a broader view of movement through related organisations. This is, however,
largely an argument over semantics rather than real differences in practice. Here we will stick
to the convention that the two terms refer to exactly the same function. This view is
supported by the Institute of Logistics and Transport – the main professional body within the
UK – who give the following definitions.6

L O G I S T I C S is the time-related positioning of resources, or the strategic manage-

ment of the total supply-chain

The S U P P LY- C H A I N is a sequence of events intended to satisfy a customer.

Some people also talk about logistics management, business logistics, distribution manage-
ment, materials management, merchandising, or a series of other terms. Sometimes you have
to be careful as these terms can refer to specific parts of the supply chain or slightly different
activities. When someone talks about, say, ‘distribution management’ you should be clear
about whether they mean transport, physical distribution, the whole of logistics, or some
other function.
18 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

With our broad view, logistics managers have two main aims. The first is to move materials
into, through, and out of their own organisation as efficiently as possible. The second aim is to
contribute to an efficient flow through the whole supply chain. Traditionally, managers
concentrate on the first of these, focusing on those parts of the supply chain that they directly
control. Hopefully, if each organisation looks after its own logistics properly, materials will
move efficiently through the whole chain, thus achieving the second aim. To some extent this
is true. It is not, however, inevitable and organisations really need a more positive approach to
co-operation. We will discuss this in the next chapter. Here, though, we look at the more
immediate aims of logistics within an individual organisation.
We have said that managers aim for an efficient movement of materials – but what exactly
do we mean by ‘efficient’? There are several answers to this, including fast deliveries, low costs,
little wastage, quick response, high productivity, low stocks, no damage, few mistakes, high
staff morale, and so on. Although these are all worthy goals, they are really indicators rather
than real aims. To find the real aim of logistics, we must relate it to the wider objectives of the
organisation.
Ultimately, the success of every organisation depends on customer satisfaction. If it does
not satisfy customers, it is unlikely to survive in the long term, let alone make a profit, have
high return on assets, add shareholder value, or achieve any other measure of success. So
organisations must deliver products that satisfy customers. Unfortunately, customers judge
products by a whole series of factors. When you buy a DVD, for example, you judge its
contents, appearance, how easy it is to buy, how long you wait, how expensive it is, whether
the right DVD was delivered, whether it was damaged, how courteously you were treated by
sales staff, and so on. Some of these factors clearly depend on logistics – the availability of the
DVD depends on stocks; the delivery time depends on transport; damage is prevented by good
material handling; the price is affected by logistics costs. So we can phrase the overriding aim
of logistics in terms of customer service. It has to organise the movement of materials in the
best way to achieve high customer satisfaction.
Any organisation can give outstanding customer service if it is prepared to allocate enough
resources. The problem, of course, is that more resources come with higher costs. There is a
limit to the amount that customers will pay for a product and, therefore, on the service that
can be given. Then a realistic aim for logistics balances the service given to customers with the
cost of achieving it.

The overall A I M O F L O G I S T I C S is to achieve high customer satisfaction. It must

provide a high quality service with low – or acceptable – costs.

We can phrase this balance in terms of perceived customer value. Logistics adds value by
making products available in the right place and at the right time. If a product is available at
the place it is needed, logistics is said to have added place utility; if it is delivered at the right
time, logistics has added time utility. Then we can phrase the aim of logistics in terms of
getting the highest customer utility or perceived value. In essence, we are trying to maximise
the difference between perceived value and actual costs.
People often summarise the aims of logistics as getting, ‘the right materials, to the right
place, at the right time, from the right source, with the right quality, at the right price’. This is
broadly correct, but it depends on how we define ‘right’. In different circumstances, logistics is
judged by completely different measures of performance. When you post letters, you sometimes
want them delivered quickly, sometimes as cheaply as possible, sometimes with high security,
sometimes at a specified time, and so on. Managers have to design logistics that are flexible
 THE CONTEXT OF LOGISTICS 19

enough to satisfy a variety of needs. There are two aspects to this. The first is concerned with
planning, when managers take a strategic view and design the best possible supply chain for
their circumstances. We look at these strategic decisions in Chapters 3 and 4. The second
concern is about execution, when materials move through this chain as efficiently as possible.
Harrington summarises this double role by saying that, ‘logistics is both the glue that holds the
materials/product pipeline together and the grease that speeds product flow along it’.7

IMPORTANCE OF LOGISTICS
Essential and expensive

Logistics is essential for every organisation. Christopher8 says that, ‘Logistics has always been a
central and essential feature of all economic activity’. Shapiro and Heskett9 agree, saying that,
‘There are few aspects of human activity that do not ultimately depend on the flow of goods
from point of origin to point of consumption’. Without logistics, no materials move, no oper-
ations can be done, no products are delivered, and no customers are served.
Not only is logistics essential, but it is also expensive. Organisations may reduce their over-
heads as much as possible, but they are often left with surprisingly high logistics costs. Unfor-
tunately, it is difficult to put a figure to these, and there is a good deal of uncertainty in the
area. Normal accounting conventions do not separate expenditure on logistics from other
operating costs, and there is some disagreement about the activities to include. As a result,
very few organisations can put a precise figure on their logistics expenditure, and many have
almost no idea of the costs.
The cost of logistics varies widely between different industries. Building materials, such as
sand and gravel, have very high logistics costs compared with, say, jewellery, pharmaceuticals
and cosmetics. However, one rule of thumb suggests that logistics costs are 15–20 per cent of
turnover. The USA has a GDP of $10 trillion, so it might spend $1–2 trillion dollars a year on
logistics, with half of this spent on transport.10 You have to interpret such figures carefully as
other studies give different views. The UK government, for example, says that 12 per cent of
the GDP comes from wholesale and retail trades and 6 per cent comes from transport and
storage.11 These figures suggest that overall logistics costs are considerably higher – perhaps
supporting an earlier estimate by Childerley that logistics accounted for 32.5 per cent of the
UK GDP.12

L O G I S T I C S
I N P R A C T I C E
Konigshaven Suppliers
Konigshaven Suppliers is a food wholesaler, proving. To get a clearer picture, the com-
delivering to supermarkets in southern Den- pany ran a survey in one main warehouse. It
mark. Its standard accounting systems do used some estimates and simplifications, but
not identify separate logistics costs, and this feels that the following figures give a reason-
makes it difficult to identify areas with partic- able view. These figures show the costs
ularly high costs, or those that need im- incurred for each g100,000 of net sales.
20 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

L O G I S T I C S
I N P R A C T I C E
continued

a. Cost of sales: g58,000 h. Delivery to customers: g5000

The cost of purchasing products Costs of taking goods out of the
sold on to customers, including warehouse and delivering to
administration of the purchasing customers
office
i. Debt financing: g2500
b. Transport inwards: g3000 Costs of financing plant and
Cost of bringing goods from equipment
suppliers and delivering to the
warehouse j. Information processing: g2000
Including all aspects of order
c. Other costs of delivery to processing
warehouse: g4000
A general category covering any k. Returns and recycling: g500
other costs of relations with Cost of recovering pallets and any
suppliers other materials returned to the
warehouse
d. Warehousing and handling: g7000
Costs of receiving materials, These figures are open to some interpret-
checking, sorting, moving to the
ation, but they show that transport accounts
warehouse and storing
for 12 per cent of sales and warehousing
e. Stock financing: g1000 for 8 per cent. Several other costs might
The cost of financing stock, be included in logistics, including some pur-
including debt charges chasing, sales, information processing and
recycling.
f. Sales force: g12,000
Salaries and costs of the sales office
Sources: company reports and publicity
g. Special promotions: g3000
Including presentations, visits and
samples

Despite the differences in these figures, everyone agrees that logistics can be very expen-
sive. Whether it is getting more expensive is open to debate. Some people say that fuel, land,
safety, environmental protection and employee costs are all rising and making logistics more
expensive. They argue that this is a long-term trend that will inevitably continue. An opposing
view says that improvements in logistics are more than compensating for price rises, and the
overall cost is falling. By improving methods and replacing outdated practices, logistics costs
continue to fall as a proportion of product value. The true picture depends on circumstances
within each organisation.

Effects on financial performance

As an expensive function, logistics has an impact on an organisation’s overall financial

performance. We can give many illustrations of this, but will start with the effects on the
return on assets (ROA).
 THE CONTEXT OF LOGISTICS 21

The return on assets is defined as the pre-tax profit earned by an organisation divided by
the value of the assets employed.

profits earned
Return on assets =
assets employed

This gives a measure of how well available resources are used and, in general, the higher the
value, the better the organisation’s performance. Assets are usually described as current (cash,
accounts receivable, stocks, and so on) or fixed (property, plant, equipment, and so on).
Improving the flow of materials reduces the amount of stock. This clearly lowers current assets,
but we can argue that it also reduces fixed assets and increases profit. This argument is
summarised in Figure 1.10.

● Current assets. More efficient logistics reduces the current assets through lower stock
levels. Reducing the investment in stock can also free up cash for other more productive
purposes and reduce the need for borrowing.

● Fixed assets. Fixed assets include property, plant and equipment. Logistics is a heavy user
of these resources, and the warehouses, transport fleets, materials handling equipment
and other facilities needed to move materials through the supply chain form a major part
of fixed assets.

● Sales. By making a more attractive product, or making it more readily available, logistics
can increase sales and give higher market share.

● Profit margin. More efficient logistics gives lower operating costs, and this in turn leads to
higher profit margins.

Current
Stocks
assets

Assets
Property,
Fixed
equipment,
assets
plant, etc.

Return on
Customer assets
Sales
satisfaction

Operating Profit
Profit
costs margin

Product
Price
features

Figure 1.10 Influence of logistics on ROA

22 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

● Price. Logistics can improve the perceived value of products – perhaps making them more
easily available, giving faster delivery or shortening lead times. More attractive products
can get premium prices.

As you can see, the first two points give lower assets, while the last three increase profits. All of
these effects raise ROA, and consequently affect other measures of performance, such as share
price, return on investment, borrowing, and so on.

W O R K E D
E X A M P L E

J. Mitchell currently has sales of £10 million a year, with a stock level of 25% of sales.
Annual holding cost for the stock is 20% of value. Operating costs (excluding the cost of
stocks) are £7.5 million a year and other assets are valued at £20 million. What is the cur-
rent return on assets? How does this change if stock levels are reduced to 20% of sales?

Solution
Taking costs over a year, the current position is:
Cost of stock = amount of stock × holding cost
= 10 million × 0.25 × 0.2 = £0.5 million a year
Total costs = operating cost + cost of stock
= 7.5 million + 0.5 million = £8 million a year
Profit = sales − total costs
= 10 million − 8 million = £2 million a year
Total assets = other assets + stock
= 20 million + (10 million × 0.25) = £22.5 million
Return on assets = profit / total assets
= 2 million / 22.5 million = 0.089 or 8.9%

The new position with stock reduced to 20% of sales has:

Cost of stocks = 10 million × 0.2 × 0.2 = £0.4 million year
Total costs = 7.5 million + 0.4 million = £7.9 million a year
Profit = 10 million − 7.9 million = £2.1 million a year
Total assets = £20 million + (£10 million × 0.20) = £22 million
Return on assets = 2.1 million / 22 million = 0.095 or 9.5%

Reducing stocks gives lower operating costs, higher profit and a significant increase in ROA.

Summarising the importance

Logistics has the awkward combination of being both essential and expensive. It affects
customer satisfaction, the perceived value of products, operating costs, profit and just about
every other measure of performance. Novich says that, ‘Poor logistics are the cause of roughly
 THE CONTEXT OF LOGISTICS 23

50 per cent of all customer complaints’.13 No organisation can expect to prosper if it ignores
logistics and organising logistics properly can give a huge competitive advantage. We can,
then, summarise the importance of logistics by saying that it:

● is essential, as all organisations, even those offering intangible services, rely on the move-
ment of materials
● is expensive, with costs often forming a surprisingly high proportion of turnover
● directly affects profits and other measures of organisational performance
● has strategic importance with decisions affecting performance over the long term
● forms links with suppliers, developing mutually beneficial, long-term trading relation-
ships
● forms links with customers, contributing to customer satisfaction and added value
● has a major affect on lead time, reliability and other measures of customer service
● determines the best size and location of facilities
● gives public exposure with visible locations, advertising on trucks, ‘corporate citizenship’,
and so on
● can be risky, because of safety, health and environmental concerns
● prohibits some operations, such as moving excessive loads or dangerous goods
● can encourage growth of other organisations – such as suppliers and intermediaries
offering specialised services.

❑ Every organisation creates products to satisfy customer demand. The

CHAPTER REVIEW ■ ■ ■ ■ ■ ■ ■ ■ ■

operations that create these products need an effective and efficient flow of
materials. In this sense, ‘materials’ are all the goods and services needed to
create products.
❑ Logistics is the function that is responsible for the flow of materials into,
through and out of an organisation.
❑ Materials move through a series of related activities and organisations
between initial suppliers and final customers. These form a supply chain. Each
product has its own supply chain.
❑ There are many possible structures for supply chains, but the simplest view
has materials converging on an organisation through tiers of suppliers, and
products diverging through tiers of customers.
❑ Although it is a single function, logistics consists of a series of related
activities. These range from procurement at the beginning of operations,
through to physical distribution at the end.
❑ An overall aim for logistics is to achieve high customer satisfaction or
perceived product value. This must be achieved with acceptable costs.
❑ Every organisation depends on the movement of materials, and the way this
is done affects costs, profits, relations with suppliers and customers, customer
service, and virtually every other measure of performance.
24 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

In 1996 a survey by Deloitte & Touche in Canada14 found that 98 per cent of respon-
dents described logistics as either ‘critical’ or ‘very important’ to their company. The same
survey emphasised the rate of change in the area, with over 90 per cent of organisations
either currently improving their supply chain or planning improvements within the next
two years.

C A S E S T U D Y Ace Dairies

Ace Dairies gives a home delivery service for milk, dairy products and a range of
related goods. Roger Smitheram has run the dairy for the past twelve years. His
product is a combination of goods (the items he delivers) and services (the delivery
and associated jobs he does for customers).
At the heart of operations is an information system which contains full details
of all Roger’s 500 customers, including their regular orders, special orders, where to
deliver, how they pay, and so on. Every day the system calculates the likely sales of
all products in two days time. Roger adds some margin of safety, allows for likely
variations and passes his order to Unigate Dairy in Totnes in Devon (about 150 km
away). This Unigate depot acts as a wholesaler for milkmen in Wales and the
southwest of England. The following evening it delivers to a holding depot in
Camborne, and then takes Roger’s goods 10 km to a cold store in Hayle. At 5.30 the
following morning Roger collects the order from his cold store and starts delivering
to customers. This normally takes until 1.30 in the afternoon, but on Fridays he
spends more time collecting money and often finishes after 5.00 pm.
There are several specific problems facing Ace Dairies. There is, for example,
some variation in daily demand, so Roger has to carry spare stock. He cannot carry
too much, as dairy products have a short life and anything not delivered quickly is
thrown away. Roger aims at keeping this waste down to 2 per cent of sales. There
are also problems maintaining a service during holidays, or when Unigate has diffi-
culties with their deliveries.
Perhaps Roger’s main concern is maintaining his sales over the long term.
Demand for doorstep deliveries is declining, as people buy more milk at super-
markets. The number of milkmen in Hayle has declined from ten in 1987 to three
in 2002. Most of Roger’s customers have been with him for many years, but he
generates new custom by canvassing, delivering leaflets, special offers, carrying a
range of other products, and so on.

Source: Roger Smitheram and internal reports

 THE CONTEXT OF LOGISTICS 25

C A S E S T U D Y
Questions
● Describe the supply chain for milk.
● Where does Ace Dairies fit into this? What specific activities form the logistics in Ace
Dairies?
● What are the main problems that Ace Dairies has with logistics?

P R O J E C T

Websites
You can find a huge amount of information about logistics on different websites. Many of these adver-
tise services, but others are aimed at giving information and offering advice. Search the Web and collect
a list of useful sites. The following list gives a useful starting point.

www.iolt.org.uk – Institute of Logistics and Transport in the UK

www.lmi.org – Logistics Management Institute
www.clm.org – Council for Logistics Management in the USA
www.supply-chain.org – Supply Chain Council
www.cips.org – Chartered Institute of Purchasing and Supply
www.infochain.org – Canadian Association of Logistics Management

DISCUSSION QUESTIONS
1. Is it true that every organisation has to move materials to support its operations? What do
service companies like Internet service providers move? Give some examples from dif-
ferent types of organisation to support your views.
2. How important is logistics to the national economy? What proportion of employment
and gross domestic product is due to logistics? How has this proportion changed over
time?
3. The supply chain is a convenient notion, but organisations are only really interested in
making products that they can sell to customers. Provided they have reliable supplies of
materials, and reasonable transport for finished products, logistics is irrelevant. Do you
think this is true?
4. Very few organisations deal with the final customer for a product. Most operations work
upstream and form one step of the supply chain, often passing materials to internal
customers within the same organisation. How does the type of customer affect the organ-
isation of logistics and the measures of customer satisfaction?
5. The cost of logistics varies widely from organisation to organisation. What factors affect
these costs? Are the costs fixed or can they be controlled?
6. How could you find the best balance between service level and costs?
26 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

REFERENCES
1. United Nations (2001) Industrial Statistics Yearbook, UN, New York.
2. Porter M.E. (1985) Competitive Advantage, Free Press, New York.
3. Cooper M.C., Lambert D.M. and Pagh J.D. (1997) Supply chain management, International Journal of
Logistics Management, 8(1), 2.
4. Christopher M. (1996) Emerging Issues in Supply Chain Management, Proceedings of the Logistics
Academic Network Inaugural Workshop, Warwick.
5. Council of Logistics Management, promotional material and website at www.clm.org.
6. Institute of Logistics, (1998 to 2001) Members’ Directory, Institute of Logistics and Transport, Corby.
7. Harrington L. (1996) Untapped savings abound, Industry Week, 245(14), 53–8.
8. Christopher M. (1986) The Strategy of Distribution Management, Heinemann, Oxford.
9. Shapiro R.D. and Heskett J.L. (1985) Logistics Strategy, West Publishing, St Paul, MN.
10. US Statistical Abstract (2001) Survey of Current Business, Department of Commerce, Washington DC.
11. Office of National Statistics, (2001) Annual Abstract of Statistics, HMSO, London.
12. Childerley A. (1980) The importance of logistics in the UK economy, International Journal of Physical
Distribution and Materials Management, 10(8).
13. Novich N.S. (1990) Leading-edge distribution strategies, The Journal of Business Strategy, November/
December, 48–53.
14. Factor R. (1996) Logistics trends, Materials Management and Distribution, June, 17–21.

Further reading
There are many books on logistics, and the following list gives a useful starting point.

Arnold J.R.T. (1996) Introduction to Materials Management (2nd edn) Prentice Hall, Englewood Cliffs, NJ.
Brewer A.M., Button K.J. and Hensher D.A., (2001) Handbook of Logistics and Supply Chain Management,
Pergamon, London.
Christopher M. (1998) Logistics and Supply Chain Management, FT Prentice Hall, London.
Coyle J.J., Bardi E.J. and Langley C.J. (1996) The Management of Business Logistics (6th Edition), West
Publishing, St Paul, MN.
Dix C. and Baird C. (1998) Front Office Operations, Addison Wesley, Reading, Massachusetts.
Gattorna J.L. and Walters D.W. (1996) Managing the Supply Chain, Palgrave – now Palgrave Macmillan.
Handfield R.B. and Nichols E.L. (1998) Introduction to Supply Chain Management, Prentice Hall.
Hill E.R. and Fredendall L. (1999) Basic Supply Chain Management, St. Lucie Press.
Simchi-Levi D., Kaminsky P. and Simchi-Levi E. (1999) Designing and Managing the Supply Chain, Irwin/
McGraw Hill, New York.
Waters D. (1999) Global Logistics and Distribution Planning, Kogan Page, London.
 CHAPTER 2

Integrating the Supply Chain

CONTENTS

■ Aims of the chapter ■ Achieving integration

■ Progress in logistics ■ Chapter review
■ Current trends in logistics ■ Case study – Friedland
■ Integrating logistics within an Timbers asa.
organisation ■ Project – Supply partnerships
■ Integration along the supply ■ Discussion questions
chain ■ References

AIMS OF THE CHAPTER

After reading this chapter you should be able to:

■ O U T L I N E the way that logistics has developed over time

■ S E E how logistics is responding to pressures for change
■ D I S C U S S the benefits of creating a single, integrated logistics
function
■ D E S C R I B E ways of achieving internal integration
■ A P P R E C I AT E the benefits of further integration along the
supply chain
■ D E S C R I B E different approaches to this integration
28 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

PROGRESS IN LOGISTICS

Early views

Despite its obvious importance, logistics has not always received its fair share of attention.
Historically, organisations put all their effort into making products and gave little thought to
the associated movement of materials. Managers recognised that transport and storage were
needed, but they were viewed as technical issues that were not worth much attention – they
were simply the unavoidable costs of doing business. Some early work in the 1920s began to
look more carefully at the transport of finished goods.1–3 In 1962, though, Drucker could still
describe logistics as, ‘the economy’s dark continent’4 and say that this formed ‘the most
sadly neglected, most promising area of … business’. Since then there have been consider-
able changes.
Perhaps the main reason for change was the recognition that logistics was expensive. By
the 1970s5,6 and 80s7–10 surveys were suggesting that the movement and storage of materials
typically accounted for 15–20 per cent of revenue. In the last chapter we said that it is difficult
to get accurate figures for this, and in 1994 Hill could still say that, ‘many distributors are
unaware of the costs of the distribution service they provide’.11 However, logistics had been
identified as a high cost function, and one where organisations can make significant savings.

W O R K E D
E X A M P L E

JL Francisco & Partners run a wholesale fruit business around Rio del Plata. In normal
circumstances the company makes a gross profit of 5% of sales. A consultant’s report has
recently suggested that 22% of their operating costs are due to logistics, and that
improved efficiency might reduce this by 10%. How much extra profit would this gener-
ate? If they do not improve logistics, how much would sales have to rise to get the same
increase in profit?

Solution
Gross profit is 5% of sales, so if we take sales of $100, operating costs amount to $95. At
present, 22% of this, or 95 × 0.22 = $20.90, is due to logistics.
If the company reduces the cost of logistics by 10%, it would save 20.90 × 0.1 = $2.09.
Assuming that there are no changes to the selling price or other costs, this is a direct con-
tribution to profit. A 10% reduction in logistics costs raises profit from $5 to $7.09, or an
increase of 42%.
Without the reduction in logistics costs, the company would have to increase sales by
42% to get the same increase in profit.

Pressures to improve logistics

As well as potential savings, many other factors are encouraging organisations to improve the
management of their supply chains. The following list suggests some of these pressures:
 I N T E G R AT I N G T H E S U P P LY C H A I N 29

● Customers are more knowledgeable, and demand higher quality, lower costs and better
service.

● Competition is getting fiercer, and organisations must look at every opportunity to

remain competitive.

● There is changing power in the supply chain. Very large retail chains, such as Wal-Mart,
Tesco, Toys-R-Us and McDonald’s, demand customised logistics from their suppliers.

● Other changes in retail markets include the growth of 24-hour opening, home deliveries,
out-of-town malls, retail parks, telephone and on-line shopping.

● International trade continues to grow. This is encouraged by free trade areas such as the
European Union and North American Free Trade Area.

● Organisations are introducing new types of operation, such as just-in-time, lean opera-
tions, time compression, flexible manufacturing, mass customisation, virtual operations,
and so on.

● Some organisations are turning from a product focus (where they concentrate on the end
products) to a process focus (where they concentrate on the way products are made). This
encourages improvement to operations, including logistics.

● There have been considerable improvements in communication. These allow electronic

data interchange (EDI), item coding, electronic fund transfer (EFT), e-commerce, shared
knowledge systems, and other new practices.

● Organisations are outsourcing peripheral activities and concentrating on their core opera-
tions. Logistics is a useful area for third-party operators, with specialised companies
offering a range of services.

● Organisations are increasing co-operation through alliances, partnerships, and other

arrangements. This integration is important for logistics, which is usually the main link
between organisations in a supply chain.

● Managers are recognising the strategic importance of the supply chain.

● Attitudes towards transport are changing, because of increased congestion on roads,

concerns about air quality and pollution, broader environmental issues, government poli-
cies for the real cost of road transport, privatisation of rail services, deregulation of trans-
port, and a host of other changes.

This is, of course, only a partial list and there are many other pressures for change,
including uncertain market conditions, political change, deregulation of business, rising costs,
shortage of skilled staff, fluctuating exchange rates, and so on. In the next section, we will see
how logistics is responding to these pressures.
30 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

CURRENT TRENDS IN LOGISTICS

Improving communications

Logistics continually meets new challenges, and is changing faster now than at any time in the
past. Perhaps the most obvious change is the increasing use of technology. Some of this
appears directly in the movement of goods – such as electronic identification of packages,
satellite tracking of lorries and automatic guidance systems – but the greatest impact has come
with communications.
When a company wants to buy something, it typically has to generate a description of the
goods, request for price, purchase order, order confirmation, contract terms, shipping papers,
financial arrangements, delivery details, special conditions, invoices, and so on. In the past, all
of these – and mountains of other paperwork – had to be printed and posted between organi-
sations. This could make even a simple transaction seem complicated and time consuming.
Telephones did not help much, as Sam Goldwyn pointed out, ‘a verbal contract isn’t worth the
paper it’s written on’.
In the past few years technology has revolutionised these communications. Initial
progress came with fax machines that could send electronic copies of documents between
distant locations in seconds rather than days. The drawback with fax machines is that docu-
ments produced by one computer still have to be printed, fed into a fax machine, transmitted
over telephone lines to someone else who reads the text and enters the information to their
own computer.
By the 1990s the obvious next step had arrived with electronic data interchange (EDI).
This allowed remote computers to exchange data without going through any intermediaries.
Early users were supermarkets, who linked their stock control systems directly to suppliers’
order processing systems. The supermarket checkouts recorded sales of each item, and when
stocks got low the system automatically sent a message asking for another delivery. This use of
EPOS – electronic point-of-sales data – gave less paperwork, lower transaction costs, faster
communications, fewer errors, more integrated systems, and closer business relations.
By 1997 about 2000 companies in the UK used EDI for trade with suppliers.12 Over the
next few years electronic trading became more sophisticated and widespread. The mush-
rooming of e-mail was followed by all kinds of e-business, e-commerce – and soon ‘e-
anything’. The efficient transfer of information has been particularly useful for purchasing,
which has developed into e-purchasing or e-procurement. This comes in many forms, all
based on the direct exchange of data between a supplier’s computer and a customer’s. Two
main versions are B2B (business-to-business, where one business buys materials from another
business) and B2C (business-to-customer, where a final customer buys from a business). By
2002 around 83 per cent of UK suppliers used B2B,13 and the worldwide value of B2B trade was
over US$2 trillion.14
Two associated technologies have developed to support EDI. The first is item coding,
which gives every package of material moved an identifying tag. The tag is usually a bar code
or magnetic stripe that can be read automatically as the package moves through its journey.
Then the logistics system knows where every package is at any time, and automatic materials
handling can move, sort, consolidate, pack and deliver materials.
The second technology is electronic fund transfer (EFT). When the delivery of materials is
acknowledged, EFT automatically debits the customer’s bank account and credits the
supplier’s. This completes the loop, with EDI to place orders, item coding to track the move-
ment, and EFT to arrange payment.
 I N T E G R AT I N G T H E S U P P LY C H A I N 31

Improving customer service

It is normally in everyone’s interests to make logistics costs as low as possible. Logistics

managers want low costs so that they remain competitive, and their users want to pay as little
as possible. Many organisations have reduced their logistics costs to levels that affect their
whole operations. Lower transport costs, for example, make it feasible to sell products over a
wider geographic area. The cost of transport for, say, Japanese manufacturers is so low that
they can offer goods at prices that are comparable to those offered by domestic companies.
Similarly, efficient transport can move products quickly over long distances, so there is no
need to build traditional warehouses close to customers.
While striving for lower costs, organisations obviously have to maintain their service levels.
Improved logistics means giving the service that customers want at the lowest possible cost. A
problem, of course, is finding the features that customers really want and the level of service
they are willing to pay for. These vary widely in different circumstances, but a key factor is the
lead time. This is the total time between ordering materials and having them delivered and
available for use. Again, it is normally in everyone’s interest to make this delay as short as
possible. When customers decide to buy something, they want it delivered as soon as possible;
suppliers want to keep customers happy with fast service, and with no products hanging
around and clogging the supply chain. Ideally, the lead time should be as close to zero as
possible, and one approach to this uses synchronised material movement. This makes infor-
mation available to all parts of the supply chain at the same time, so that organisations can co-
ordinate material movements, rather than wait for messages to move up and down the chain.
Another key factor for customer satisfaction is personalised products. Instead of buying a
standard textbook, for example, you describe the contents you want and a publisher supplies a
volume with exactly these specifications. This is mass customisation, which combines the
benefits of mass production with the flexibility of customised products. It uses B2C to give
direct communications between a final customer and a manufacturer, and it needs supply
chains that are flexible, that move materials very quickly, and respond to varying conditions.
Dell Computers was one of the first companies to use mass customisation. They do not
build standard computers, but wait until a customer places an order on their website. Then
they build a computer for the specific order. Logistics makes sure that the necessary mate-
rials are always available for manufacturing, and it delivers the finished machine quickly to
the customer.
Dell work so closely with their suppliers that they have developed ‘virtual integration’,
where they all seem to be part of the same company. This works well with Dell, who have 50
main components, but would it work with a car manufacturer and their three thousand
components? Flexible manufacturing here would put severe pressures on the supply chain, but
the ‘3DayCar Programme’ suggests that 80 per cent of cars in the UK could be built to order
by 2010.15,16

Other significant trends

Apart from increasing technology and emphasis on customer satisfaction, there are several
other important trends in logistics. The following list includes some of the most significant.

● Globalisation: Improved communications and better transport mean that physical

distances are becoming less significant. Organisations can become global in outlook,
buying, storing, manufacturing, moving and distributing materials in a single, worldwide
32 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

market. As a result, international trade and competition are continuing to rise. Organ-
isations used to look for competitors in the same town, but now they are just as likely to
come from another continent.
Efficient logistics makes a global market feasible, and other factors that encourage
international trade include less restricted financial systems, consumer demand for
imported products, removal of import quotas and trade barriers and the growth of free
trade areas. You can see the effects in manufacturing, where producers look for economies
of scale in large facilities located in areas with low production costs. The unit production
cost is low, and efficient logistics keeps the delivered price down. This is the reason why
German companies open large plants in Poland, American companies work in Mexico
and Japanese companies work in China.

● Reduced number of suppliers: In the past, organisations have used a large number of
suppliers. This encouraged competition, ensured that they got the best deal and main-
tained secure deliveries if one supplier ran into difficulties. The current trend, however, is
to reduce the number of suppliers and develop long-term relationships with the best. As
we shall see later, working closely with a small number of organisations can bring consid-
erable benefits.

● Concentration of ownership: Large companies can get economies of scale, and they have
come to dominate many supply chains. There are, for example, many shops and transport
companies – but the biggest ones continue to grow at the expense of small ones. The
result is a continuing concentration of ownership, which you can see in many logistics
sectors ranging from food wholesalers to cruise lines.

● Outsourcing: More organisations realise that they can benefit from using specialised
companies to take over part, or all, of their logistics. Using a third party for materials
movement leaves an organisation free to concentrate on its core activities. McKinnon says
that, ‘Outsourcing has been one of the dominant business trends of the 1980s and
1990s’17 and surveys suggest that around 30 per cent of logistics expenditure is
outsourced in the EU.18

● Postponement: Traditionally, manufacturers move finished goods out of production and

store them in the distribution system until they are needed. When there are many varia-
tions on a basic product, this can give high stocks of similar products. Postponement
moves almost-finished products into the distribution system, and delays final modifica-
tions or customisation until the last possible moment. You can imagine this with
‘package-to-order’, where a company keeps a product in stock, but only puts it in a box
written in the appropriate language when it is about to ship an order.
Manufacturers of electrical equipment, such as Phillips and Hewlett-Packard, used to
build into their products the transformers and plugs needed for different markets. Then
they had to keep separate stocks of products destined for each country. Now they make
the transformer and cables as separate, external units. They only keep stocks of the basic,
standard products, and customise them for different markets by adding the proper trans-
formers and plugs at the last minute. The result, of course, is much lower stocks. In the
same way, Benetton used to dye yarn different colours, knit sweaters and keep stocks of
each colour to meet varying demand. Now they knit sweaters with undyed yarn, keep
much smaller stocks of these, and dye the finished sweaters to meet actual orders.
 I N T E G R AT I N G T H E S U P P LY C H A I N 33

● Cross-docking: Traditional warehouses move materials into storage, keep them until
needed, and then move them out to meet demand. Cross-docking co-ordinates the supply
and delivery, so that goods arrive at the receiving area and are transferred straight away to
a loading area, where they are put onto delivery vehicles. This dramatically reduces stock
levels and associated administration.
There are two basic forms of cross-docking. In the first, packages are moved directly
from arriving vehicles and onto departing ones. This does not really need a warehouse
and a simple transfer point is enough. In the second form there is some additional work
as materials arrive in larger packages which are opened, broken into smaller quantities,
sorted, consolidated into deliveries for different customers and transferred to vehicles.
Cross-docking can develop to the point where nothing actually moves through a ware-
house. Any stock is kept within vehicles, giving stock on wheels. A related arrangement
uses drop-shipping, where wholesalers do not keep stock themselves, but co-ordinate the
movement of materials directly from upstream suppliers to downstream customers. As
warehousing is expensive and time-consuming, these methods can give much more effi-
cient flows, and allow methods such as quick response and efficient customer response
(which we discuss in Chapter 7).

● Direct delivery: More customers are buying through the Web, or finding other ways of
trading earlier in the supply chain, such as mail order or buying directly from manufac-
turers. This has the benefits of reducing lead times, reducing costs to customers, having
manufacturers talking directly to their final customers, allowing customers access to a
wider range of products, and so on. It also means that logistics has to move small deliv-
eries quickly to final customers. This has encouraged the growth of couriers and express
parcel delivery services such as FedEx, UPS and DHL.

● Other stock reduction methods: Keeping stock is expensive, so organisations continually

look for ways of reducing the amount stored in the supply chain. There are many ways of
doing this. One approach uses just-in-time operations to co-ordinate activities and
minimise stock levels. Another approach has vendor managed inventory, where
suppliers manage both their own stocks and those held further down the supply chain.
Improved co-ordination reduces overall costs and can give economies of scale.

● Increasing environmental concerns: There is growing concern about air pollution, water
pollution, energy consumption, urban development and waste disposal. Logistics does
not have a good reputation for environmental protection – demonstrated by the emis-
sions from heavy lorries, use of green field sites for warehouses, calls for new road
building, use of extensive packaging, ships illegally flushing their fuel tanks, oil spillages
from tanker accidents, and so on.
On the positive side, logistics is moving towards ‘greener’ practices. Operators use more
energy efficient vehicles, control exhaust emissions, reuse packaging, switch to environ-
mentally friendly modes of transport, increase recycling through reverse logistics, add
safety features to ships, develop brown-field sites, and so on. They increasingly recognise
that careful management can bring both environmental protection and lower costs. A fair
assessment might be that logistics is making progress on environmental issues, but it has
some way to go.

● More collaboration along the supply chain: Organisations in a supply chain increasingly
recognise that they have the same objectives – which are satisfied final customers. They
34 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

should not, therefore, compete with each other, but should co-operate to get final
customer satisfaction. This is an important point. It means that competitors are not other
organisations within the same supply chain, but are organisations in other supply chains.
Christopher19 summarises this by saying that ‘supply chains compete, not companies’.

In summary

We could continue this list, describing all types of changes in logistics. Our aim, though, is not
to be exhaustive, but to illustrate some of the main trends. These are not independent, but are
all related. Increasing technology, for example, can give less stock, lower costs, shorter lead
times, higher customer satisfaction, and so on. If we take an overview of the trends, we can
suggest three main themes. The first looks for a more efficient flow of materials through the
supply chain. It might, for example, give faster deliveries, reduce stock levels, reduce handling,
or give lower costs. This approach is characterised by lean logistics,20,21 which grew from the
ideas of lean operations, and tries to remove all waste from the supply chain. Its characteristic
approach is to analyse operations, and then systematically remove all the wasted effort, move-
ment, materials, time, and other resources. This seems a simple idea, but it can give dramatic
improvements in performance.
The second theme has logistics becoming more flexible and responsive. It might, for
example, give a customised service or respond quickly to changing demands. This approach is
characterised by agile logistics,22 which focuses on customer satisfaction.
The third theme looks at increasing integration of the supply chain. Organisations cannot
work in isolation, but must co-operate with other organisations in the supply chain to achieve
their wider objectives.
Unfortunately, people often assume that there is some conflict between these three themes.
They assume, for example, that leanness needs standard operations which reduce flexibility, or
that integration needs more complicated systems that increase costs, or that agility needs extra
resources that lower average utilisation. To some extent this is true, but the three themes are
not mutually exclusive and we can design logistics that are lean, agile and integrated.23,24

Three important themes for logistics consider L E A N N E S S , A G I L I T Y and

I N T E G R AT I O N . Ideally, logistics should aim for all three of these.

INTEGRATING LOGISTICS WITHIN AN ORGANISATION

Problems with fragmented logistics

Figure 2.1 summarises our view of logistics within an organisation, where a series of related
activities add value to the final product. These activities have traditionally been managed sepa-
rately, so that an organisation might have a distinct purchasing department, transport depart-
ment, warehouse, distribution fleet, and so on. Unfortunately, dividing up logistics in this way
creates a number of problems.
Purchasing might look for the most reliable suppliers, inventory control for low unit costs,
warehousing for fast stock turnover, materials management for easy handling, transport for
full vehicle loads, and so on. These aims all seem worthy, so it might be sensible for each
activity to judge its own performance in the most appropriate way. Unfortunately, we soon hit
 I N T E G R AT I N G T H E S U P P LY C H A I N 35

Physical distribution
Procurement
Outward transport
Inward transport
Returns
Warehousing
Receiving Stock control Picking
Materials handling Consolidating

Suppliers Operations Customers

Communications
Location

Figure 2.1 Summary of logistics activities

problems when the aims come into conflict. For example, warehousing might save money by
reducing the stock of raw materials – but this leads to more frequent shortages and raises the
costs of expediting for purchasing and emergency deliveries for transport. Similarly,
purchasing can reduce its administrative costs by sending fewer, larger orders to suppliers – but
this increases stock levels and raises the amount of money tied up in the warehouse. Using sea
transport rather than airfreight reduces transport costs – but increases the amount of stock
held in the supply chain. In reality, the different activities of logistics are very closely related,
and policies in one part inevitably affect operations in another.

L O G I S T I C S
I N P R A C T I C E
RP Turner Corp.
RP Turner Corp. makes pipeline valves for for ways of reducing the cost of logistics. It
the oil industry in western Canada. It buys soon found that separate functions worked
materials from Japan, the USA and eastern more or less independently. This was some-
Canada, manufactures valves in Edmonton, times all too obvious when the three main
Alberta and ships the finished products to departments – Marketing, Production and
oil fields in the North. Finance – were in different locations. Pro-
The company grew by emphasising the duction was in Edmonton, as the nearest
high quality of its products, which work reli- major city to the oil fields; Marketing was in
ably in the harsh weather conditions of the Calgary near to oil company headquarters;
Arctic. Transport to remote customers is Finance (including procurement) was in
expensive, and in 2000 the company looked Vancouver near the port and financial
36 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

L O G I S T I C S
I N P R A C T I C E
continued

centre. To appreciate the potential prob- ■ a narrow range of finished goods to give
lems, you have to remember that Canada is long production runs
a big country, so Production was a thousand ■ locations near to suppliers so that they
kilometres away from Finance, 500 kilome- could get raw materials quickly
tres away from Marketing and over two ■ stable production to give efficient opera-
thousand kilometres from delivery points. tions
The company was rewarding different ■ emphasis on the efficient movement of
departments for different types of perform- materials through operations
ance. Not surprisingly, when the depart- ■ realistic sales forecasts that allowed effi-
ments were asked for their priorities, they cient planning.
had different views.
Finance wanted:
Marketing wanted: ■ low stocks everywhere
■ high stocks of finished goods to satisfy ■ few locations to give economies of scale
customer demands quickly and minimise overall costs
■ a wide range of finished goods always ■ large batch sizes to reduce unit costs
held in stock ■ make-to-order operations
■ locations near to customers to allow ■ pessimistic sales forecasts that dis-
delivery with short lead times couraged underused facilities.
■ production to vary output in response to
Despite good communications, the
customer orders
company felt that it was too widely spread
■ emphasis on an efficient distribution
out. It decided to centralise operations at its
system
main plant in Edmonton. This brought the
■ an optimistic sales forecast to ensure
logistics functions geographically closer
production was geared up for actual
together, and major reorganisation over the
demand.
next two years brought a unified view of
Production wanted: the supply chain.
■ high stocks of raw materials and work in
Sources: Ray Turner and internal company reports
progress to safeguard operations

The problems at RP Turner are almost inevitable if logistics is divided into separate func-
tions. Each part will move in a different direction, and there is duplicated effort and wasted
resources. Imagine a wholesaler who has one fleet of vehicles run by materials management to
bring materials in from suppliers, and a separate fleet run by distribution to deliver the same
goods out to customers. This might work, but you can picture the duplicated effort and waste
in managing two separate vehicle fleets. Another organisation might have three stocks – raw
materials, work in progress and finished goods – each run by different departments and using
different standards and systems.
A fragmented supply chain also makes it difficult to co-ordinate the flow of information
through different systems. Suppose a production department knows that it is running short of a
material and needs a new delivery. This information should pass seamlessly to purchasing. If,
however, it has to pass from one system to another there is a greater chance of error, uncertainty,
delay and inefficiency – resulting in late delivery, emergency orders, expediting and shortages.
 I N T E G R AT I N G T H E S U P P LY C H A I N 37

To put it briefly, fragmenting logistics into different parts has the disadvantages of:

● giving different, often conflicting, objectives within an organisation

● duplicating effort and reducing productivity
● giving worse communications and information flows between the parts
● reducing co-ordination between the parts – leading to lower efficiency, higher costs and
worse customer service
● increasing uncertainty and delays along the supply chain
● making planning more difficult
● introducing unnecessary buffers between the parts, such as stocks of work in progress,
additional transport and administrative procedures
● obscuring important information, such as the total cost of logistics
● giving logistics a low status within an organisation.

Bringing activities together

The obvious way of avoiding these problems is to consider logistics not as a series of distinct
activities, but as a single integrated function. Then all the parts work together to get the best
overall result for the organisation. This is why Sheehy, former Chairman of BAT, could say,
‘I believe that a well designed, integrated logistics system is a vital prerequisite for commer-
cial success’.25

■ I N T E G R AT I N G L O G I S T I C S within an organisation has all the related activi-

ties working together as a single function.
■ This is responsible for all storage and movement of materials throughout the
organisation.
■ It tackles problems from the viewpoint of the whole organisation, and looks for
the greatest overall benefit.

In practice, it is difficult to integrate all the logistics within an organisation. The supply
chain consists of many different activities, with different types of operation, using different
systems and geographically dispersed. The usual approach has the integration developing over
time. One department might slowly take over all aspects of ordering and receiving raw mate-
rials. Another department might slowly take over all aspects of delivering finished products to
customers. Some organisations are tempted to stop when they reach this stage, and they work
with two functions:

● materials management, aligned with production and looking after the inwards flow of raw
materials and their movement through operations; and
● physical distribution, aligned with marketing and looking at the outward flow of finished
goods.

However, this still leaves an artificial break in what is essentially a continuous function. The
obvious step is to combine the two into a single function responsible for all material move-
ment into, through and out of the organisation. This completes the internal integration of an
organisation’s logistics.
Despite the obvious benefits of integrated logistics, there can still be practical difficulties.
Perhaps the obvious one is finding someone with the knowledge, enthusiasm, ability and
38 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

authority to carry through necessary changes. This needs a senior manager who has the
necessary power to start the changes – with effects then percolating through all levels of the
organisation. New practices and relationships come from individuals working together,
developing a culture that is based on teamwork and co-operation rather than self-interest
and conflict.
Another factor that encourages internal integration is the analysis of total logistics cost.
We can define this as:

Total logistics cost = transport cost + warehouse cost + stock holding cost + packaging cost
+ information processing cost + other logistics overheads

The traditional view considered each of these separate costs as independent, so reducing, say,
the transport cost automatically lowered the total cost. In the 1960s organisations began to
take a ‘systems’ view of logistics, and analyse the interactions between activities. It became
clear that reducing the cost of one activity increased the cost of another – and the total logis-
tics cost might be reduced by increasing the amount spent on certain activities. Lewis et al.26
gave an early example of this. They found that airfreight was much more expensive than alter-
native road transport, but faster delivery eliminated the need for local stocks and warehouses,
and gave considerable overall savings
One other important factor for integration is the availability of integrated information and
control systems. Managers need a system to collect, store, analyse, distribute and present infor-
mation ranging from the strategic aims of the organisation down to details of each transac-
tion. Most organisations use local networks or intranets for this, but the Internet is
increasingly seen as an efficient route for logistics information. The information can be used
by a control system that assesses current circumstances, makes decisions and implements the
results. An information system might show that stocks are running low, and a control system
uses this information to place an order with suppliers.

L O G I S T I C S
I N P R A C T I C E
International Business Systems
International Business Systems (IBS) is the after ‘the flow of goods and information in
largest international vendor of software for such a way that you give better customer
supply chain management. It is listed on service and achieve shorter lead times, with
the Stockholm Stock Exchange, but works less capital tied up, thereby releasing
internationally with more than 5000 cus- resources for more profitable activities’.
tomers in 40 countries. It was formed in The IBS system has modules based
1969, and now has 2400 employees work- around core activities such as purchasing,
ing in 90 offices. distribution, sales, finance, production, and
IBS offer many software products includ- so on. These modules contain many differ-
ing a range of fully integrated modules that ent components for order processing, fore-
improve performance of the supply chain. casting, sales analysis, Internet trading, bar
In other words, they provide the informa- coding, warehouse management, bar codes,
tion and management controls for looking inventory management, vendor managed
 I N T E G R AT I N G T H E S U P P LY C H A I N 39

L O G I S T I C S
I N P R A C T I C E
continued

inventory, spare part handling, customer supply chain helps organisations to manage
relations management, after sales support, their integrated logistics and ‘puts them in
project management, and so on. control of the supply chain’.
The aim of IBS is to give a sophisticated
Sources: IBS promotional material and website at
system that is comprehensive, but easy to
www.ibsuk.com
run and use. Concise, well-presented and
rapid information about all aspects of the

Stages in integration

We have now described how logistics has moved from being a low priority, fragmented func-
tion, to a strategic, integrated one. This is a major change, which typically goes through the
following stages:

Stage 1 Separate logistics activities are not given much attention or considered important.
Stage 2 Recognising that the separate activities of logistics are important for the success of
the organisation.
Stage 3 Making improvements in the separate functions, making sure that each is as efficient
as possible.
Stage 4 Internal integration – recognising the benefits of internal co-operation and
combining the separate functions into one.
Stage 5 Developing a logistics strategy, to set the long-term direction of logistics.
Stage 6 Benchmarking – comparing logistics’ performance with other organisations, learning
from their experiences, identifying areas that need improvement and finding ways of
achieving this.
Stage 7 Continuous improvement – accepting that further changes are inevitable and always
searching for better ways of organising logistics.

By Stage 4 an organisation has integrated logistics, and the last three stages show how the
function can be improved. Stage 5 emphasises the need for a strategic view, Stage 6 looks at
other organisations for comparisons and lessons, and Stage 7 recognises that logistics must
continually evolve. However, this is not the end of the story. Once an organisation has effi-
cient, integrated and strategic logistics, it can start looking at integration along more of the
supply chain.

INTEGRATION ALONG THE SUPPLY CHAIN

Problems with fragmented supply chains

We have described the benefits of integrating logistics within an organisation. Now we can
extend this argument, and suggest the same benefits for integrating logistics along more of the
40 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

(a) Separate functions within an organisation

Logistics activities

Suppliers Customers
Operations

(b) Integration within the organisation

Logistics with internal integration

Suppliers Customers
Operations

(c) Integration along the supply chain

Logistics with external integration

Suppliers Customers
Operations

Figure 2.2 Three levels of logistics integration

A B C D E F G H
1 Week 1 2 3 4 5 6
2
3 Customer
4 Demand 100 105 100 100 100 100
5
6 Retailer
7 Demand 100 105 100 100 100 100
8 Opening stock 100 100 105 100 100 100
9 Closing stock 100 105 100 100 100 100
10 Buys 100 110 95 100 100 100
11
12 Local wholesaler
13 Demand 100 110 95 100 100 100
14 Opening stock 100 100 110 95 100 100
15 Closing stock 100 110 95 100 100 100
16 Buys 100 120 80 105 100 100
17
18 Regional wholesaler
19 Demand 100 120 80 105 100 100
20 Opening stock 100 100 120 80 105 100
21 Closing stock 100 120 80 105 100 100
22 Buys 100 140 40 130 95 100
23
24 Manufacturer
25 Demand 100 140 40 130 95 100
26 Opening stock 100 100 140 100 130 95
27 Closing stock 100 140 100 130 95 100
28 Makes 100 180 0 160 60 105

Figure 2.3 Varying demand

 I N T E G R AT I N G T H E S U P P LY C H A I N 41

supply chain. If each organisation only looks at its own operations, there are unnecessary
boundaries between them, disrupting the flow of materials and increasing costs. External
integration removes these boundaries to improve the whole chain. Christopher advises this
move, saying that ‘Most opportunities for cost reduction and/or value enhancement lie at the
interface between supply chain partners’.22
This effectively gives three levels of integration. The first has logistics as separate activities
within an organisation; the second has internal integration to bring them together into a
single function; the third has external integration, where organisations look beyond their own
operations and integrate more of the supply chain (as illustrated in Figure 2.2).

■ Organisations within the same supply chain should C O - O P E R AT E to get final

customer satisfaction.
■ They should not compete with each other, but with organisations in other supply
chains.

Forrester27 described one interesting effect of a fragmented supply chain. Imagine a retailer
who notices that demand for a product rises by 5 units in a week. When it is time to place the
next order, the retailer assumes that demand is rising, and orders ten extra units to make sure
it has enough. The local wholesaler sees demand rise by ten units, so it orders an extra 15 units
to meet the growth. The regional wholesaler sees demand rise by 15 units, so it orders another
20 units. As this movement travels through the supply chain, a relatively small change in final
demand is amplified into a major variation for early suppliers.

W O R K E D
E X A M P L E

In a simple supply chain, each organisation holds one week’s demand in stock. In other
words, each buys enough materials from its suppliers to make its closing stock at the end
of the week equal to the demand during the week. Demand for a product has been steady
at 100 units a week. One week, demand from final customers is five units higher than usual.
Assuming that deliveries are very fast, how does this affect movements in the supply chain?

Solution
The spreadsheet in Figure 2.3 shows this for the first week when demand of 100 units
moves through the supply chain. For each tier, you can see:

■ demand – which equals the amount bought by the next tier of customers
■ opening stock at the beginning of the week – which equals its closing stock in the
previous week

■ closing stock at the end of the week – which must equal demand in the week
■ number of units bought – which equals demand plus any change in stock:
buys = demand met + (closing stock – opening stock)
42 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

W O R K E D
E X A M P L E
continued

In week 1 everything is going smoothly, with the usual 100 units flowing down the
supply chain. Then in week 2 customer demand goes up to 105 units. The retailer must
buy 105 units to meet this demand, plus an additional 5 units to raise its closing stock to
105. So it buys 110 units from the local wholesaler. The local wholesaler has to supply this
110 units, plus an additional 10 units to raise its closing stock to 110 units. So it buys 120
units from the regional wholesaler. The regional wholesaler has to supply this 120 units,
plus another 20 units to raise its closing stock to 120 units. So it buys 140 units from the
manufacturer.
In week 3 we get the reverse effect as customer demand returns to 100 units. The
retailer now reduces closing stock to 100 units, so it only has to buy 95 units from the local
wholesaler. The local wholesaler reduces its closing stock by 15, so it only has to buy 80
from the regional wholesaler. The regional wholesaler reduces its closing stock by 40, so it
only buys 40 from the manufacturer. The manufacturer would like to reduce its closing
stock by 100 units, but its demand is only 40 units so it stops production and meets all
demand from stock.
A variation in customer demand of five units in one week, has made manufacturing
vary by 180 units a week, with an effect continuing for several more weeks.

Benefits of integration

Confederated Bottlers used to deliver bottles from their main plant in Elizabethville to a
brewery in Johnston, 115 miles away. The brewery filled the bottles and took them to a distri-
bution centre 20 miles outside Elizabethville. Both companies used their own trucks to deliver
products, returning empty. Eventually, they formed a joint transport company that used the
same trucks for both deliveries. Not surprisingly, the transport costs almost halved. This
example shows one obvious benefit of integration, but there are many others.
Any uncertainty in the supply chain – such as the amplified variation of demand seen in
the last example – encourages organisations to hold higher stocks to give themselves a margin
of safety. These stocks increase costs and make the chain slow to react to changing conditions
(when customers demand new products, all the stocks of old products in the supply chain
have to be sold-on before the new ones appear). If you continue thinking along these lines,
you find the following benefits from external integration:

● genuine co-operation between all parts of the supply chain, with shared information and
resources
● lower costs – due to balanced operations, lower stocks, less expediting, economies of scale,
elimination of activities that waste time or do not add value, and so on
● improved performance – due to more accurate forecasts, better planning, higher produc-
tivity of resources, rational priorities, and so on
● improved material flow, with co-ordination giving faster and more reliable movements
 I N T E G R AT I N G T H E S U P P LY C H A I N 43

● better customer service, with shorter lead times, faster deliveries and more customisation
● more flexibility, with organisations reacting faster to changing conditions
● standardised procedures, becoming routine and well-practiced with less duplication of
effort, information, planning, and so on
● reliable quality and fewer inspections, with integrated quality management programmes.

Many organisations have moved towards external integration28 and a survey by P-E
Consulting in 199729 found that 57 per cent of companies had some form of integration of
their supply chains. More than 90 per cent of companies expected further integration, with a
quarter looking for ‘fully integrated’ systems (although there were clearly different opinions
about what this meant).
The benefits of external integration may be clear, but there are many practical difficulties
of achieving them. Many organisations simply do not trust other members of the supply
chain, and they are reluctant to share information. Even with sufficient trust, there can be
problems with different priorities, competition, data exchange, appropriate systems, skills,
security, the complexity of systems, and so on. This raises the obvious question of how to
achieve integration?

ACHIEVING INTEGRATION

Co-operation and conflict

Normally, a supply chain consists of distinct organisations, each working for their own benefit.
So why should they co-operate? Why should one company work to benefit another? The
answer is that external integration brings benefits that can be shared among all members of
the supply chain, as you can see in the Perman Frère example.

L O G I S T I C S
I N P R A C T I C E
Perman Frère
Perman Frère is a small manufacturer based tics. As an example, some parts were made
in Brussels. It exports most of its products by Perman Frère in Brussels, sent to their
and has a finished goods warehouse near warehouse in Ostende, delivered to van
the port of Ostende. Van Rijn is one of its Rijn’s warehouse in Rotterdam, and then
customers, also based in Brussels. It imports brought back to Brussels. It was fairly easy to
most of its materials and has a raw materi- organise deliveries directly between the
als warehouse near the port of Rotterdam. companies. This gave a much shorter jour-
The two companies have traded for ney across Brussels, reduced transport and
many years and in 2001 they started looking handling costs, removed excess stocks, sim-
for ways of increasing co-operation. It was plified administration, and reduced the lead
soon obvious that they could make a num- time from five days to three hours. They also
ber of small adjustments to improve logis- co-ordinated deliveries to towns in northern
44 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

L O G I S T I C S
I N P R A C T I C E
continued

France, so that one vehicle could deliver time, but could not find any mechanism for
products from both companies. overcoming them.
Both companies benefited from these
Sources: Georges Perman and internal company
changes. When they were introduced peo-
reports
ple in both companies said that they had
been aware of the problems for a long

The first problem with external integration is overcoming the traditional view of organ-
isations as adversaries. When an organisation pays money to its suppliers, people assume that
one can only benefit at the expense of the other. If the organisation gets a good deal, it auto-
matically means that the supplier is losing out: if the supplier makes a good profit, it means that
the organisation pays too much. This adversarial attitude has major drawbacks. Suppliers set
rigid conditions and, as they have no guarantee of repeat business, they see no point in co-oper-
ation and try to make as much profit from each sale as possible. At the same time, organisations
have no loyalty, and they shop around to get the best deal and remind suppliers of the compe-
tition. Each is concerned only with their own objectives and will – when convenient to them-
selves – change specifications and conditions at short notice. The result is uncertainty about the
number and size of orders, constantly changing suppliers and customers, changing products and
conditions, different times between orders, no guarantee of repeat orders and changing costs.
To avoid these problems, organisations have to recognise that it is in their own long-term
interest to replace conflict by agreement. This often needs a major change of culture. The
following table suggests some specific adjustments.

Factor Conflict view Co-operation view

Profit One organisation profits at Both share profits

the expense of the other
Relationship One is dominant Equal partners
Trust Little Considerable
Communication Limited and formal Widespread and open
Information Secretive Open and shared
Control Intensive policing Delegation and empowerment
Quality Blame for faults Solving shared problems
Contract Rigid Flexible
Focus on Own operations Customers

Different types of co-operation

There are several ways that organisations can co-operate. They can, of course, simply do busi-
ness together. If an organisation has a good experience with a supplier, it will continue to use
them and over some period will develop a valuable working relationship. Sometimes the co-
operation is more positive, such as small companies making joint purchases to get the same
quantity discounts as larger companies; EDI links to share information; combining loads to
 I N T E G R AT I N G T H E S U P P LY C H A I N 45

reduce transport costs; agreed package sizes to ease material handling, lists of preferred
suppliers, and so on. The key point with these informal arrangements is that there is no
commitment. This is probably how you shop, as you have favourite shops but are not obliged
to use them. Japanese companies take this approach further forming Keiretsu – which are
groups of organisations that work together without actually forming partnerships.
An informal arrangement has the advantage of being flexible and non-binding. On the
other hand, it has the disadvantage that either party can end the co-operation without
warning, and at any time that suits them. This is why many organisations prefer a more
formal arrangement, with a written contract setting out the obligations of each party. These
are common when organisations see themselves as working together for some time. An elec-
tricity company, for example, might agree to supply power at a fixed price for the next three
years, provided a customer buys some minimum quantity. More formal agreements have the
advantage of showing the details of the commitment, so that each side knows exactly what it
has to do. On the other hand, they have the disadvantage of losing flexibility and imposing
rigid conditions. In 2001, for example, there were power cuts in California when electricity
suppliers found that their long-term contracts with customers specified prices that were too
low to cover the rising costs of generation.

Strategic alliances

When an organisation and a supplier are working well together, they may both feel that they
are getting the best possible results and neither could benefit from trading with other partners.
Then they might look for a long-term relationship that will guarantee that their mutual bene-
fits continue. This is the basis of a strategic alliance or partnership (shown in Figure 2.4).
The supplier knows that it has repeat business for a long time, and can invest in improve-
ments to products and operations; the organisation knows that it has guaranteed – and contin-
ually improving – supplies. These arrangements are now common, and you often hear
statements like ‘Abbey National treats its suppliers as partners’.30 Ellram and Krause prefer the
term supplier partnering and give the following definition.31

S U P P L I E R PA R T N E R I N G is ‘an ongoing relationship between firms, which

involves a commitment over an extended time period, and a mutual sharing of
information and the risks and rewards of the relationship.’

The following list gives the main features of alliances:

● organisations working closely together at all levels

● senior managers and everyone in the organisations supporting the alliance
● shared business culture, goals and objectives
● openness and mutual trust
● long-term commitment
● shared information, expertise, planning and systems
● flexibility and willingness to solve shared problems
● continuous improvements in all aspects of operations
● joint development of products and processes
● guaranteed reliable and high quality goods and services
● agreement on costs and profits to give fair and competitive pricing
● increasing business between partners.
 Adversarial Informal Contractual Formal Minority Joint Vertical
co-operation alliance investment venture integration

Arm’s Medium-term Long-term

Relationship Unspecified
length contract contract

Information
Little More Full
sharing

Trade with
Much Less Little
competitors

Coming
Culture Different Shared
together

Figure 2.4 Spectrum of relationships

 I N T E G R AT I N G T H E S U P P LY C H A I N 47

Partnerships can lead to changes in operations. For example, the stability of a partnership
might encourage suppliers to specialise in one type of product. They give such a commitment
to the alliance that they reduce their product range, make these as efficiently as possible, and
concentrate on giving a small number of customers a very high quality service. They share
information with customers without the threat that this will be used to get some form of
trading advantage. At the same time, customers reduce their number of suppliers, as they no
longer need to look around to get the best deals. Japanese companies were among the first to
develop strategic alliances, and at the time when Toyota had formed partnerships with its 250
suppliers, General Motors was still working separately with 4000 suppliers.
It can be difficult to form a successful partnership. A useful starting point is to analyse
current operations and future plans to see if alliances would be useful. A company cannot
really expect any benefits from an alliance if it only buys a few materials, or is changing its
manufacturing base, or is sensitive about confidentiality, or cannot find reliable suppliers.
Most organisations, however, can see potential benefits, and they should start looking at
possible arrangements. Typically they form a project team to identify potential partners, define
objectives, set timetables, list resource implications, negotiate terms, and so on. When this
project team makes its initial report, potential partners can be approached and negotiations
begin. The following example shows how one company set about this.

L O G I S T I C S
I N P R A C T I C E
Petro-Canada
Petro-Canada (PC) is the largest oil company their own approach. This had targets of
in Canada, with 4500 employees and over reducing costs by 15% in a first phase, and
$6 billion in sales. It owns 750 million barrels eventually by 25%.
of proved reserves, but its main income PC quickly realised that without guaran-
comes from 1700 retail petrol stations. The teed product quality it could make no fur-
Canadian government originally founded PC ther progress, so it consolidated its use of
to compete with major international compa- total quality management. This included
nies, and it still owns 18% of the shares. Deming’s32 ‘14 principles’ which advise
In the 1990s PC started to form strategic organisations not to buy products on the
alliances with its major suppliers. It was basis of cost alone, but to include a range
looking for ways of reducing costs, and of factors such as quality, reliability, timing,
supplier partnerships were a clear option features, trust, and so on.
for a company that spent over $2 billion a Now it had done the preparation, PC
year on materials other than oil. could start talking to prospective partners. It
To find the best way of forming strategic chose these from companies that it currently
alliances, PC benchmarked other compa- did most business with, and those whose
nies who reported a history of successful products were critical. There were already
partnerships, including Motorola and Dow long-standing, informal relationships with
Chemicals. In practice, growing pressure to many of these, and PC extended them to
improve performance meant that PC had create more formal alliances. Important con-
to get results quickly, and they developed siderations were that the suppliers were
48 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

L O G I S T I C S
I N P R A C T I C E
continued

committed to high quality, emphasised cus- with research, training, systems and
tomer satisfaction, and had the potential to practices
become ‘the best of the best’. 2. assess the risk and benefits of partner-
This gave PC its likely partners, and the ships, setting aims and targets
next stage was to form joint development 3. benchmark other partnership arrange-
teams, including representatives from the ments
purchasing and user departments. Because 4. select qualified suppliers
of the time pressure, this team looked for 5. form joint teams to manage the initia-
quick improvements. Their aim was to get tive and move it forward
the initiative moving, get some quick 6. confirm the partnership’s principles,
returns, generate enthusiasm for the ideas, commitments, relationships and obliga-
and then move the partnership forward tions
over the longer term. 7. formalise the terms and conditions
We can summarise PC’s approach to 8. continue training and improving.
developing partnerships in the following
stages: Sources: internal company reports and website at
www.petro-canada.com
1. prepare the organisation for alliances

Of course, forming a partnership is only the first step, and it still needs a lot of effort to
make it a success. Some factors that contribute to a successful partnership include a high level
of achieved service, real cost savings, a growing amount of business, compatibility of cultures,
and so on. Rowley33 gave a more general list of key factors as management commitment, a
contract specifying costs and responsibilities, agreed performance indicators, agreed objectives,
shared culture and joint information systems. Lambert et al.34 summarised these as:

● drivers, which are the compelling reasons for forming partnerships, such as cost reduction,
better customer service, or security

● facilitators, which are the supportive corporate factors that encourage partnerships, such
as compatibility of operations, similar management styles, common aims, and so on

● components, which are the joint activities and operations used to build and sustain the
relationship, such as communication channels, joint planning, shared risk and rewards,
investment, and so on.

Alliances are certainly not the best answer in every circumstance. Some purchases are so
small, or materials are so cheap, that the effort needed for an alliance is not worthwhile; some-
times managers do not want to lose control or share information; sometimes an organisation
may not be able to find a partner willing to make the necessary commitment; organisational
structures or cultures may be too different; it may be impossible to reach the necessary level of
trust; there may be nobody with the necessary skills and enthusiasm, and so on. Several years
after starting its supplier partnership initiative, Petro-Canada still bought 20–40% of materials
through traditional supplier–customer relationships.
 I N T E G R AT I N G T H E S U P P LY C H A I N 49

However, it is clear that alliances are becoming increasingly popular. As Ewer35 says, we
have ‘the powerful combination of improved technology which can enable better partnering,
a growing consensus that partnering enabled by e-B2B is essential, and a growing public profile
for partnering issues in general’.

Vertical integration

If an organisation wants to go beyond partnerships, it has to own more of the supply chain.
One common arrangement has an organisation taking a minority share in another company.
This gives it some say in their operations, but it does not necessarily control them. A manu-
facturer, for example, might take a minority share in a wholesaler, to get some influence in the
way that its products are distributed.
Another option is for two organisations to start a joint venture, where they both put up
funds to start a third company with shared ownership. A manufacturer and supplier might
together form a transport company for moving materials between the two.
The most common arrangement has one organisation simply buying other organisations in
the supply chain. This increases its level of vertical integration.

V E R T I C A L I N T E G R AT I O N describes the amount of a supply chain that is owned

by one organisation.

If an organisation buys materials from outside suppliers and sells products to external
customers, it does not own much of the supply chain and has little vertical integration (as
shown in Figure 2.5). If the organisation owns initial suppliers, does most of the value adding

Suppliers Operations Customers

Type of vertical Parts owned by

integration the organisation

(a) Little

(b) Backward

(c) Forward

(d) High

Figure 2.5 Different levels of vertical integration

50 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

operations, and distributes products through to final customers, it owns a lot of the supply
chain and is highly vertically integrated. If the organisation owns a lot of the supply side it has
backward or upstream integration; if it owns a lot of the distribution network it has down-
stream or forward integration.
In some circumstances vertical integration is the best way of getting different parts of the
supply chain to work together. Ford of America, for example, has at different times owned
everything from steel mills through to distributor networks and repair shops. More often,
widespread vertical integration would be very expensive, leading to huge organisations that
spread their resources too thinly, needing specialised skills and experience that one organisa-
tion does not have, reducing flexibility to respond to changing conditions, and so on. So
vertical integration is not necessarily desirable, and it is usually impossible for even the biggest
organisation to own much of their supply chains. Heinz, for example, cannot buy all the
farmers, processors, steel mills, canners, wholesalers, retailers and other organisations in the
supply chain for their baked beans.

L O G I S T I C S
I N P R A C T I C E
GZ Rexam
In 1996 Rexam Pharmaceutical Packaging ■ Shorter lead-times – from improved co-
and Grafica Zannini formed a joint venture ordination, procedures and administra-
called GZ Rexam. Its primary aim is to sup- tion. With Eli Lilly they reduced lead
ply packaging to the pharmaceutical indus- times from six to two weeks, with just-
try in Europe. This is an important area, as in-time deliveries for specific orders.
over 50% of pharmaceutical companies’
■ Higher quality – with uniform standards,
product recalls are caused by faults in
collaboration in quality initiatives, less
printed material, and each recall costs sev-
reliance on inspections and a commit-
eral million pounds.
ment to long-term improvements.
GZ Rexam looks for the benefits of part-
nerships with its customers. John Steven- Once the objectives of a partnership
son, the Sales and Marketing Director, says, have been agreed, the two key factors for
‘The days of the conventional supply chain success at GZ Rexam are commitment to
where everyone existed as an independent the long-term success of the partnership
entity … are no longer’. He quotes three and good communication between every-
reasons for partnerships: one concerned.

■ Lower costs – due to better co-ordination, Source: Stevenson J. (1999) Partnering –

elimination of duplicated effort, less Improving the Supply Chain, Logistics Focus, 7(2)
9–11
bureaucracy, quantity discounts, and
economies of scale. GZ Rexam estimates
that it can save up to 60% of packaging
costs through partnerships.
 I N T E G R AT I N G T H E S U P P LY C H A I N 51

❑ In the past, logistics did not receive much attention. More organisations now
CHAPTER REVIEW ■ ■ ■ ■ ■ ■ ■ ■

recognise its importance. By organising logistics properly, cost can be reduced,

customer service improved, and other organisational objectives achieved.
❑ There are many pressures on logistics. It is responding to these by
introducing new practices and methods. Perhaps the most obvious changes
are related to new technology for improving communications.
❑ There are three important trends towards lean, agile and integrated logistics.
These are not mutually exclusive, and an organisation can make progress on
all three.
❑ Traditionally, logistics has been organised as a series of distinct activities
within an organisation. This inevitably leads to conflicts and inefficiencies. A
better approach develops a single integrated function that is responsible for
all logistics.
❑ Integration can be difficult and involve major changes. There are, however,
many benefits, and most companies have moved in the direction of internal
integration.
❑ There are also the benefits of extending integration to more organisations in
the supply chain. There are several ways of organising this external
integration, ranging from informal agreements to vertical integration. The
most popular has some form of strategic alliance or partnership.

C A S E S T U D Y Friedland Timbers asa

Johann Klassen is the Managing Director of Friedland Timbers asa. which makes
specialised wood products for the construction industry. He has recently been
worried by late deliveries to some important customers. The industry is very
competitive, and Johann knows that customers will go to other suppliers if he
cannot guarantee deliveries. The marketing manager is particularly upset because
he has worked with these customers for a long time, and promised deliveries that
were not made.
Johann asked the production manager for an explanation. She told him that
‘Our own suppliers were late in delivering certain types of wood. This shortage of a
key raw material disrupted our production plans. We cannot be blamed for this. If
52 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

C A S E S T U D Y continued

anyone in the company is to blame, it is the warehouse manager who does not keep
enough stocks of raw materials to cover for late deliveries.’
Johann then went to the warehouse manager to see what was happening. ‘There
can’t be anything wrong here’, he was told. ‘Stocks have been climbing for the past
year, and last month they were at an all time high. In part, this is a deliberate deci-
sion, as I want to improve service levels to production. In part, though, stocks seem
to have just drifted upwards. Now we have high stocks of most items, but there are
still occasional shortages. These high stocks are causing me problems with space,
and are stretching my budget. I think that the blame lies in purchasing, who do not
order the amounts that we request.’
Johann saw that some stocks were drifting upwards because purchasing were
buying large quantities of some materials. At the same time, they were delaying
some purchases, and this produced the shortages. The purchasing manager
explained to Johann, ‘Let me remind you that eight months ago you instructed me
to reduce materials costs. I am doing this by taking advantage of the discounts
given by suppliers for larger orders. Often I order more than requested under the
assumption that we will need the material at some stage, so I get a discount and the
material is already in stock when we need it. Sometimes keeping things in stock
would take too much space or be too expensive, so then I might delay an order until
I can combine it with others to get bigger discounts.’
Johann thought that he was near the source of his problems, and might ask for
the purchasing policies to be reviewed. Then he talked to the transport manager who
was not so sure. ‘It is much more efficient for me to bring larger quantities into the
company’, he said. ‘If you reduce the average order size, the transport costs will rise.
Our budget is already being squeezed, as we have to pay for expensive express deliv-
eries of materials that production classify as urgent. If you lower the order size,
there will be more shortages, more express deliveries and even higher costs.’
Johann talked to some major suppliers to see if they could somehow improve the
flow of materials into the company. Unhappily, while he was talking to one
company, they raised the question of late payments. This was contrary to Fried-
land’s stated policy of immediate payment of invoices, so he asked the accounting
section for an explanation. He was given the unwelcome news that ‘The company’s
inventory and transport costs are so high that we are short of cash. We are delaying
payments to improve our cash flow. As it is, we had to use a bank overdraft to pay
suppliers for last month.’
 I N T E G R AT I N G T H E S U P P LY C H A I N 53

C A S E S T U D Y continued

Later that day Johann found that the late customer deliveries which had started
his investigation, were actually caused by poor sales forecasts by the marketing
department. They had seriously underestimated demand, and planned production
was too low. All the employees at FT were doing their best, but things seemed to be
going wrong.

C A S E S T U D Y
Questions
● Why do all the logistics costs seem to be rising at the same time?
● What do you think are the basic problems in Friedland?
● What would you recommend Johann do?

P R O J E C T

Supply Partnerships
Find a particular product whose supply chain is easy to study, such as petrol, a telephone service,
cars, a restaurant chain, or a computer game. Discuss the amount of integration in the supply chain.
What alternatives are there for integration? See if different organisations making similar products
have the same approach, and explain any differences. Say why the existing patterns of logistics have
developed, and discuss the benefits of this level of integration.

DISCUSSION QUESTIONS

1. What do you think are the main factors that encourage logistics to change? How is it
responding to these pressures? What changes do you think there will be in the next
decade?
2. When logistics is divided into separate functions, each is likely to have its own objectives.
Is this necessarily a bad thing, or can there be positive benefits?
3. An integrated supply chain is a convenient notion, but it does not reflect real operations.
An organisation is only really concerned with its own customers and suppliers, and does
not have time to consider other organisations further along the chain. Do you think that
this is true?
54 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

4. When Christopher19 says that ‘supply chains compete, not companies’ what exactly does
he mean?
5. Decker and van Goor36 say that integration in the supply chain can be at the level of:
● Physical movement
● Shared information
● Integrated control
● Integrated infrastructure
What do they mean by this?

REFERENCES
1. Shaw A.W. (1916) An Approach to Business Problems, Harvard University Press, Cambridge, MA.
2. Clark F.E. (1922) Principles of Marketing, Macmillan, New York.
3. Borsodi R. (1927) The Distribution Age, D. Appleton, New York.
4. Drucker P. (1962) The economy’s dark continent, Fortune, April, 4, p. 103.
5. Ray D. (1976) Distribution costing, International Journal of Physical Distribution and Materials Management,
6(2), 73–107.
6. Little W.I. (1977) The cellular flow logistics costing system, International Journal of Physical Distribution and
Materials Management, 7(6), 305–29.
7. Firth D., Denham F.R., Griffin K.R. and Heffernan J. et al. (1980) (eds) Distribution Management Handbook,
McGraw-Hill, London.
8. Ray D., Gattorna J. and Allen M. (1980) Handbook of distribution costing and control, International
Journal of Physical Distribution and Materials Management, 10(5), 211–429.
9. McKibbin B.N. (1982) Centre for Physical Distribution Management national survey of distribution costs,
FOCUS on Physical Distribution, 1(1), 16–18.
10. Delaney R.V. (1986) Managerial and financial challenges facing transport leaders, Transportation
Quarterly, 40(1), 35.
11. Hill G.V. (1994) Assessing the cost of customer service, in Cooper J. (ed.) Logistics and Distribution Planning
(2nd edn), Kogan Page, London.
12. Stafford-Jones A. (1997) Electronic commerce: the future with EDI, Logistics Focus, 5(9), 9–10.
13. MRO Software (2001) Supplying the Goods, MRO Software, London.
14. The Gartner Group (2001) Website at www.gartner.com.
15 Holweg M., Judge B. and Williams G. (2001) The 3DayCar challenge: cars to customer orders, Logistics
and Transport Focus, 3(9), 36–44.
16. 3DayCar Programme (2001) Website at www.cf.ac.uk/3DayCar.
17. McKinnon A.C. (1999) The outsourcing of logistical activities, Ch. 14 in Waters D. (ed.) Global Logistics
and Distribution Planning, Kogan Page, London.
18. Marketline International (1997) EU Logistics, Marketline International, London.
19. Christopher M. (1996) Emerging Issues in Supply Chain Management, Proceedings of the Logistics
Academic Network Inaugural Workshop, Warwick.
20. Jones D., Hines P. and Rich N. (1997) Lean logistics, International Journal of Physical Distribution and
Logistics Management, 27(3/4), 153–73.
21. Womack J. and Jones D. (1996) Lean Thinking, Simon & Schuster, New York.
22. Christopher M. (1999) Global logistics: the role of agility, Logistics and Transport Focus, 1(1).
23. Rowley J. (2001) Lean and agile, Logistics and Transport Focus, 3(6), 52–7.
 I N T E G R AT I N G T H E S U P P LY C H A I N 55

24. Evans B. and Powell M. (2000) A pragmatic view of lean and agile, Logistics and Transport Focus, 2(10),
26–32.
25. Sheehy P. (1988) Quality – the springboard to success, Focus on Physical Distribution and Logistics
Management, 7(8), 3–9.
26. Lewis H.T., Culliton J.W. and Steel J.D. (1956) The Role of Air Freight in Physical Distribution, Harvard
Business School, Boston, MA.
27. Forrester J. (1961) Industrial Dynamics, MIT Press, Boston, MA.
28. Guinipero L.C. and Brand R.R. (1996) Purchasing’s role in supply chain management, International Journal
of Logistics Management, 7(1), 29–37.
29. P-E Consulting (1997) Efficient Customer Response – Supply Chain Management for the New Millennium?
P-E Consulting, Surrey.
30. Abbey National (2002) Website at www.abbeynational.plc.uk.
31. Ellram L.M. and Krause D.R. (1994) Supplier partnerships in manufacturing versus non-manufacturing
firms, International Journal of Logistics Management, 5(1), 43–53.
32. Deming W.E. (1986) Out of the Crisis, MIT Press, Cambridge, MA.
33. Rowley J. (2001) Outsourcing across borders in Europe, Logistics and Transport Focus, 3(1), 54–6.
34. Lambert D.M., Emmelhainz M.A. and Gardner J.T. (1996) Developing and implementing supply chain
partnerships, International Journal of Logistics Management, 7(2), 1–17.
35. Ewer G.A. (2001) View point, Logistics and Transport Focus, 3(2), 2.
36. Decker H. and van Goor A. (1998) Applying Activity-based Costing to Supply Chain Management,
Proceedings of the 1998 Logistics Research Network Conference, Cranfield University.
 PA R T I I

Planning the Supply Chain

This book is divided into three parts. The first part gave a
general introduction to the subject of supply chain manage-
ment. This is the second part, which discusses the planning
needed for a supply chain.

There are six chapters in this part. Chapter 3 discusses the

strategic significance of logistics, alternative strategies, and the
choice of most appropriate. Chapter 4 discusses the implemen-
tation of this strategy and approaches to change. Chapter 5
shows how the shape of the supply chain is set by the location
of facilities. Chapters 6 and 7 describe some approaches to
planning resources. Chapter 8 shows how to measure and
improve performance.

This part of the book looks at different types of planning. It

starts with the logistics strategy which sets the scene for all
other decisions in logistics. Then it describes different aspects of
planning, making sure that the supply chain can work effi-
ciently. The last part of the book focuses on different activities of
logistics.
 CHAPTER 3

Logistics Strategy

CONTENTS

■ Aims of the chapter ■ Case study – Hessingen Herb

■ Strategic decisions Farm
■ Logistics strategy ■ Project – Mission and strategy
■ Strategy options ■ Discussion questions
■ Designing a logistics strategy ■ References
■ Chapter review

AIMS OF THE CHAPTER

After reading this chapter you should be able to:

■ S E E how a logistics strategy fits into an organisation’s broader

decisions
■ O U T L I N E the strategic importance of logistics
■ D E F I N E a logistics strategy and D I S C U S S its focus
■ D I S C U S S alternative logistics strategies
■ A P P R O A C H the design of a logistics strategy
60 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

STRATEGIC DECISIONS

Types of decision

Some decisions are very important to an organisation, with consequences felt over many
years. Other decisions are less important, with consequences felt over days or even hours. We
can use their importance to classify decisions as:

● Strategic decisions are most important and set the overall direction of the organisation;
they have effects over the long term, involve many resources and are the most risky
● Tactical decisions are concerned with implementing the strategies over the medium term;
they look at more detail, involve fewer resources and some risk
● Operational decisions are the most detailed and concern activities over the short term; they
involve few resources and little risk

A traditional view has senior managers making the strategic decisions that set their organ-
isation on its course. These strategic decisions give the objectives, constraints and context for
the tactical decisions made by middle managers. These, in turn, give the objectives,
constraints and context for operational decisions made by junior managers. This is still the
usual approach to decisions, but new styles of management and improved technology have
encouraged changes. Now you rarely see such a strict hierarchy, even among conventionally
rigid organisations like the armed forces. Most decisions are discussed, negotiated and
agreed rather than simply passed down. There is also a growing recognition that the best
person to make a decision is the person most closely involved – and this is often a junior
manager who is on the spot rather than a remote, senior manager. You can see this effect
with empowerment (which devolves decisions to the lowest possible level) ‘delayering’ (to
remove unnecessary layers of management) and lean organisations (which remove all
unnecessary activities).
There are several types of strategic decision (as shown in Figure 3.1). People use different
names for these, but the most common are:

● mission – a statement to give the overall aims of the organisation;

● corporate strategy – which shows how a diversified corporation will achieve its mission;
● business strategy – which shows how each business within a diversified corporation will
contribute to the corporate strategy;
● functional strategies – which describe the strategic direction of each function, including
logistics.

Essentially the higher strategies set the goals and general direction of the organisation, and the
functional strategies show how to achieve these. So the business strategy shows what has to be
done, and the logistics strategy shows how the supply chain will help achieve this. If an organ-
isation has a business strategy of being the lowest cost provider of some product, the logistics
strategy shows how it will reduce logistics costs to a minimum; if the organisation is working
to get fast deliveries to customers, the logistics strategy defines policies for achieving this. This
assumes, of course, that logistics really has a strategic role. Perhaps we should review the
evidence to support this.
 L O G I S T I C S S T R AT E G Y 61

Mission

For the whole

organisation

Corporate
strategy

For each
Business Business Business
business unit
strategy 1 strategy 2 strategy 3

Functional Functional Functional For each

strategy 1 strategy 2 strategy 3 function

Figure 3.1 Types of strategic decision

Strategic role of logistics

The last two chapters showed that logistics is essential for every organisation, even those
supplying intangible services. We said that it is concerned with major decisions that have a
clear strategic impact, such as the design of the supply chain, size and location of facilities,
relations with other organisations, partnerships and alliances. We showed that logistics is a
major user of resources, including transport and storage; it has an impact on organisational
performance, including profit and financial measures such as the return on assets; it affects
lead time, perceived product value, reliability and other measures of customer service; it gives
public exposure, raises safety and environmental, issues, encourages some operations and
prohibits others.
You can see more evidence of the strategic role of logistics in mission statements, which
often have some explicit reference to the supply chain. It is, of course, not surprising that
companies offering specialised logistics services refer to the supply chain in their missions. The
mission of Roadway Express, an American transport company, says:

We will contribute to customer success and satisfaction by providing reliable, responsive, and efficient
service. Our principal product will be less-than-load transportation on 2-day and longer lanes within
North America, and on international lanes to and from North America.1

Similarly, Mercia Software is the largest Europe-based provider of software for supply chain
management, and they say that:

Mercia’s mission is to provide customers with optimum value business solutions in demand and
supply chain planning.2
62 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Retailers often form the links to final customers, and their long-term survival depends on
their ability to manage supply chains and move materials efficiently. Boots the Chemist says:

Our vision is to be the world’s leading retailer of products and services that help make our customers
look good and feel good.3

Sainsbury’s objectives include:

To provide unrivalled value to our customers in the quality of the goods we sell, in the competitive-
ness of our prices and in the range of choice we offer.
To achieve efficiency of operation, convenience and customer service in our stores … .4

Neither of these statements mentions logistics directly, but they both emphasise the supply of
products to customers, and their implicit reliance on logistics. The point, of course, is that the
long-term survival of every organisation depends on the flow of materials through its supply
chains. The strategic importance of logistics stems from the basic fact that without logistics
there can be no operations – and no organisation. You can see this message clearly in many
mission statements. GKN, for example, include a commitment:

To treat our suppliers fairly as an integral part of our total capability to serve our customers.5

We could continue discussing the evidence for a strategic role for logistics, but the facts are so
clear that there is little point. This is, however, a relatively new opinion. For many organisa-
tions the recognition that logistics has a strategic impact is one of the most important devel-
opments of recent years. It changes the way that they manage the supply chain, and links it
more closely with other strategic decisions. Logistics has a new, prominent role and gets the
same attention as other core functions. Senior managers make the decisions, based on more
relevant information and a broader view of the organisation’s objectives. The recognition that
logistics has a long-term effect on overall performance has moved it from the periphery to the
centre of decision making.

LOGISTICS STRATEGY

Definition

All the long-term decisions about logistics form a logistics strategy.

The L O G I S T I C S S T R AT E G Y of an organisation consists of all the strategic

decisions, policies, plans and culture relating to the management of its supply chains.

The logistics strategy forms a link between the more abstract, higher strategies and the detailed
operations of the supply chain. While the corporate and business strategies describe general
aims, the logistics strategy concerns the actual movement of materials needed to support these
aims. The business strategy of UPS calls for ‘outstanding service’ to its customers, and this
translates into a logistics strategy of organising a very fast parcel delivery service to almost any
point in the world.
 L O G I S T I C S S T R AT E G Y 63

Discussion
Logistics Other senior
and
managers managers
agreement

Business
strategy

Logistics
strategy

Lower
logistics
decisions

Figure 3.2 Role of logistics managers in strategic decisions

The higher strategies set the context for the logistics strategy. However, logistics managers do
not simply respond to this context, they actively contribute to its formulation. Their views on
what levels of performance are actually achievable by logistics form one of the inputs for the
design of higher strategies (as shown in Figure 3.2). For UPS the recognition that it really can
achieve efficient logistics allows it to have a business strategy of aiming at outstanding service.
There are, of course, many factors other than logistics to consider in designing a business
strategy. But the amount that logistics contributes to the formulation of higher strategies can
have a significant effect on operations. At one end of a spectrum (shown in Figure 3.3) are
organisations where logistics contributes hardly anything to the higher strategies. Logistics
managers simply accept the higher strategies designed by others, and design operations to

Logistics Logistics managers Logistics managers

managers give give some input and give major input
little input and support higher and determine
only implement strategies higher strategies
higher strategies

Figure 3.3 Different amounts of input from logistics managers

64 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

make sure these can be achieved. At the other end of the spectrum are organisations whose
logistics really dictate the higher strategies. The Channel Tunnel, for example, offers a unique
logistics service, and all its higher strategies are based on its logistics operations.

Focus of the logistics strategy

Organisations can only survive by supplying products that customers view as somehow better
than those from competitors. Logistics affects the lead time, availability, cost, customer
support, damage, and so on – and hence the customers’ view of a product. In this sense, logis-
tics actually contributes to the design, quality, perceived value and success of a product. But
which factors are most important for this contribution and should be emphasised in a logistics
strategy? We can start to answer this by taking a traditional view from marketing which says
that organisations compete by concentrating on the ‘four Ps’ – product, place, promotion and
price. Here logistics has a role in the ‘product’ (through its contribution to the overall product
package), ‘place’ (through its delivery of materials) and ‘price’ (through its effect on operating
costs). A logistics strategy could usefully emphasise these features.
A broader view says that customers are concerned with cost, quality, service level, relia-
bility, availability, flexibility, delivery speed, location, sourcing, supplier relations, environ-
mental impact, recycling, and a whole range of other things. These all depend on different
aspects of logistics. In different circumstances, therefore, almost any facet of logistics can be
important for customer satisfaction, and could be emphasised by the logistics strategy. In prac-
tice, a logistics strategy is most likely to emphasise the following:

● Cost: Most organisations want low costs, but some adopt a positive strategy of minimising
their logistics costs. This leads to higher profits for the organisation and lower prices for
customers.

● Customer service: Logistics controls stock levels, delivery times, speed of response, and
other measures of customer service. By concentrating the logistics strategy on customer
service, organisations can get a long-term competitive advantage.

● Timing: Customers generally want products as soon as possible, so a common logistics

strategy guarantees fast deliveries. Timing can also mean rapid supply of new products, or
delivering at the time specified by a customer.

● Quality: Customers demand higher quality in all products. A common logistics strategy
guarantees high quality service, even though it can be difficult to say exactly what we
mean by ‘high quality logistics’ (we return to this question in Chapter 12).

● Product flexibility: This is the ability of an organisation to customise products to individual

specifications. One logistics strategy is based on a specialised or customised service, such
as Pickfords’ removals.

● Volume flexibility: Changing levels of business can cause severe problems for logistics, as
you can see during the morning rush hour in any major city. Volume flexibility allows an
organisation to respond quickly to changing levels of demand.

● Technology: Logistics uses a wide range of technologies for communications, tracking

loads, sorting parcels, identifying products, recording stock movements, and so on. Some
organisations have a strategy of developing and using the latest technologies.
 L O G I S T I C S S T R AT E G Y 65

● Location: Customers generally want products to be delivered as close to them as possible.

This might mean that a book club delivers directly to your door, a shop has a convenient
location in a town centre, or a wholesaler has a regional logistics centre near to major
cities. One logistics strategy is to provide a service in the best possible location, such as
bus stations in town centres.

In principle, organisations should do everything well, giving low cost, good customer
service, fast delivery, flexibility, using high technology, and so on. In practice, this is unreal-
istic. Organisations have to compromise, perhaps balancing the level of service with the cost
of providing it. Effectively they choose a specific focus for their logistics strategy, showing
which factor they consider to be most important. Some organisations, such as Ryanair, focus
on cost, giving a cheap service; others, such as FedEx, focus on delivery speed; others focus on
reliability; or a customised service, and so on. One of the key decisions for logistics managers
is choosing the strategic focus.

L O G I S T I C S
I N P R A C T I C E
The Schenker Group
The Schenker Group was founded in Ger- We will earn our customers’ trust everyday,
many more than 125 years ago, and has and we will never take their business for
been working internationally ever since. granted.
They employ 28,000 people, serving cus- Our customers are our partners in busi-
tomers in 1000 locations. Schenker now ness. Their needs will be our needs.
provide a range of logistics services, includ-
Schenker also describe the ways that they
ing international air and ocean freight,
will achieve customer satisfaction, such as:
logistics management and land transport.
They provide seamless movement of cus- We will service our customers in an innova-
tomer products and information across tive, pro-active manner. We will always be
global supply chains, using the latest tech- aware of how our service impacts their
nology and developing sophisticated sys- business.
tems for e-commerce. However, their This overriding strategy of customer sat-
strategic focus is on customer service. isfaction sets the scene for all other logistics
Schenker opened in the USA in 1947 and activities. When they work with Copeland
now have 46 offices in major cities. All of Corporation in Alabama, their primary goal
these are ISO 9002 certified, which is in line remains customer satisfaction, but to
with their strategy of complete customer achieve this they have to attain the second-
satisfaction. This strategy is clear from their ary goals of shorter stock cycles, faster
statement that, ‘Our customers are our delivery, lower stocks and lower costs.
future. Without them – there is no future.’
Source: promotional material and websites at
To support this view, the company gives a
www.schenker.com and www.schenkerusa.com
number of guarantees, starting with:
Our customers will always be the centre of
our complete attention.
66 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

STRATEGY OPTIONS

Each organisation designs its own logistics strategy, but they often move along similar lines.
The logistics strategies of Ford and Volkswagen, for example, are broadly similar, as are the
strategies of Lufthansa and Air France. This allows us to describe a few generic strategies.
Michael Porter6 suggested that there are two basic strategies:

● cost leadership, makes the same, or comparable, products more cheaply;

● product differentiation, makes products that customers cannot get from other suppliers.

Lyons Bakeries compete by cost leadership, selling standard cakes at low prices; La Patisserie
Française competes by product differentiation, selling cakes that are not available anywhere
else. Similarly, easyJet compete by cost leadership, offering the cheapest fares; Execujet
compete by offering a uniquely luxurious service.
In logistics, these two approaches are usually phrased in terms of lean and agile strategies.
As we saw in Chapter 2, organisations with a focus on lean logistics are aiming at low costs;
those with a focus on agile logistics are aiming at high customer satisfaction.

Lean strategies

No organisation can completely avoid the cost of logistics, so the next best option is to make
it as cheap as possible. Then a reasonable objective is to minimise the total cost of logistics,
while ensuring acceptable levels of customer service. This approach is generalised into
lean logistics.

The aims of a L E A N S T R AT E G Y are to do every operation using less of each

resource – people, space, stock, equipment, time, and so on. It organises the efficient
flow of materials to eliminate waste, give the shortest lead time, minimum stocks and
minimum total cost.

Early work on lean operations was done in the motor industry, led by Toyota.7,8 This work
concentrated on ‘lean production’ but the methods got such good results that they spread into
other areas, eventually developing a ‘lean enterprise’. The approach is summarised in five
main principles:9

● value – designing a product that has value from a customer’s perspective

● value stream – designing the best process to make the product
● value flow – managing the flow of materials through the supply chain
● pull – only making products when there is customer demand
● aim of perfection – looking for continuous improvements to get closer to the aim of perfect
operations.

The first of these principles, ‘value’, sets the target for the organisation, seeing how to add
value for the final customer of the product. The second principle, ‘value stream’, designs a
means of making this product, and effectively sets the requirements of the supply chain. The
last three principles refer directly to the supply chain. The third, ‘value flow’, gets an efficient
flow of materials, eliminating waste, interruptions, waiting and detours. The fourth principle,
 L O G I S T I C S S T R AT E G Y 67

‘pull’, shows how to control the flow of materials by pulling them through (we return to this
theme in Chapter 7). The fifth principle, ‘aim of perfection’, describes a continuing search for
improvement. This is a common theme for management initiatives which often say that areas
of waste should be continually identified and eliminated.
Robert Townsend says that, ‘All organisations are at least 50% waste – waste people, waste
effort, waste space and waste time’.10 During their development work, Toyota identified the
following areas of the supply chain where this waste is most likely to occur:11

● Quality – that is too poor to satisfy customers (either external or internal).

● Wrong production level or capacity – making products, or having capacity, that is not
currently needed.
● Poor process – having unnecessary, too complicated or time-consuming operations.
● Waiting – for operations to start or finish, for materials to arrive, for equipment to be
repaired, and so on.
● Movement – with products making unnecessary, long, or inconvenient movements during
operations.
● Stock – holding too much stock, increasing complexity and raising costs.

A lean strategy looks for ways of eliminating this waste. The typical approach does a
detailed analysis of current operations, and then removes operations that add no value, elimi-
nates delays, simplifies movements, reduces complexity, uses higher technology to increase
efficiency, looks for economies of scale, locates near to customers to save travel, and removes
unnecessary links from the supply chain.
One warning is that low costs do not automatically mean lean operations. Lean operations
maintain customer service while using fewer resources – they do not just minimise costs. A
greengrocer could minimise its inventory costs by having no stock, but it would not generate
much customer satisfaction. Some people also suggest that lean operations might work in the
mass production car industry, but lessons do not necessarily transfer to other supply chains. In
particular, lean operations might not work when there are variable and uncertain conditions.
An alternative is a more flexible strategy based on agility.

Agile strategy

An agile strategy concentrates on the other side of the ‘efficient versus responsive’ – or lean
versus agile – debate. Its supporters say that lean operations put too much emphasis on costs,
and cannot deal with changing conditions, increasing competition, or more sophisticated and
demanding customers. If demand for a product is steady at 100 units a week, lean logistics will
remove all the waste and have enough capacity to deliver these 100 units. Unfortunately, if
demand suddenly rises to 110 units, lean operations cannot cope. As markets are demanding
more variety and customisation, logistics should be more flexible.

The aim of an A G I L E S T R AT E G Y is to give a high customer service by responding

quickly to different or changing circumstances.

There are two aspects of agility. First, there is the speed of reaction; agile organisations keep
a close check on customer demands and react quickly to changes. Second, is the ability to
tailor logistics to demands from individual customers. These are, of course, different aspects of
68 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

customer service, and the implication is that end-customer satisfaction is a prime concern,
even if this comes at somewhat higher price.
Organisations that put a lot of emphasis on customer satisfaction are said to have a
customer focus. The justification for this strategy comes from the obvious importance of
customers. Without customers an organisation has no sales, no income, no profit, no business –
and soon no organisation. As Michael Perry of Unilever says,12 ‘To sustain competitive advan-
tage requires a total commitment to your customer’. Organisations with a customer focus
will typically:

● aim for complete customer satisfaction

● allow customers easy access to the organisation
● find exactly what they want
● design logistics to meet, or exceed, these demands
● be flexible and respond quickly to changing customer demands
● get a reputation for outstanding quality and value
● do after-sales checks to make sure the customers remain satisfied
● look outwards so that they are always in touch with customers, potential customers,
competitors, and so on.

Organisations with satisfied customers have the obvious benefit of bringing them back
with repeat business – remembering the rule of thumb that it costs five times as much to
attract a new customer as it does to retain an existing one. Satisfied customers also attract new
business, as they recommend a good service to four or five other people – compared with
dissatisfied customers who warn a dozen potential customers about a bad experience.

Lean versus agile

At first sight the aims of lean and agile operations seem contradictory. One looks to minimise
costs, and sees customer service as a constraint; the other looks to maximise customer service,
and sees costs as a constraint. This seems to lead to important differences.

Factor Lean logistics Agile logistics

Objective Efficient operations Flexibility to meet demands

Method Remove all waste Customer satisfaction
Constraint Customer service Cost
Rate of change Long-term stability Fast reaction to changing
circumstances
Measures of Productivity, utilisation Lead time, service level
performance
Work Uniform, standardised Variable, more local control
Control Formal planning cycles Less structured by empowered staff

In practice, of course, there is not such a clear divide between the two strategies. If a supplier
improves EDI links with its customers, it can both reduce costs and increase customer service –
becoming both leaner and more agile. Similarly, a manufacturer selling materials through a
 L O G I S T I C S S T R AT E G Y 69

website and a wholesaler introducing cross-docking become both leaner and more agile. Both
strategies accept that customer satisfaction and low costs are dominant themes, but they use
different descriptions of the process to achieve them. Organisations need not choose one
strategy at the expense of the other. Evans and Powell13 discuss the use of both strategies and
conclude that ‘lean and agile are not mutually exclusive, they both have their merits, but also
limitations, especially if an individual aspect is taken, in isolation, to the extreme’.

Strategic alliances

A third strategy develops the ideas of integration that we discussed in Chapter 2. An organisa-
tion can put so much emphasis on close co-operation with other parts of the supply chain that
it has a strategy of forming alliances with suppliers and customers. The purpose of this strategy
is to get efficient supply chains, with all members working together and sharing the benefits of
long-term co-operation.
Usual reasons for a strategy of forming partnerships include better customer service,
increased flexibility, reduced costs, avoidance of investment in facilities, and lack of expertise
within the organisation. In Europe over a quarter of all logistics expenditure uses specialised
contract suppliers, usually in some form of long-term partnership. The most common area for
partnerships is transport, where around three quarters of companies use contract providers.
Other areas for collaboration include warehousing, import/export services, materials storage
and information processing.

L O G I S T I C S
I N P R A C T I C E
Ellis and Everard
Ellis and Everard is a major distributor of Among the benefits Ellis and Everard get
chemicals. It has a turnover of £600 million from partnerships are:
working from 70 locations in the USA and
Europe, and employing 2000 people. ■ faster decision making
The company has been developing ■ higher sales and easier introduction of
long-term partnerships for many years, and new products
is considered a leader in the field. It has ■ stability, making long-term planning
partnerships forward with customers (such easier and more reliable
as Merck, 3M and Sterling organics) and ■ removal of unproductive administration
backward with suppliers (such as ICI, Solvay ■ on-time payments from customers
Interox and Junbunzlauer). Around 95% of ■ easier introduction of new initiatives,
its supplies, and 6% of customer demand such as EDI for stock levels and auto-
are met through partnerships. Chris Whin- matic delivery scheduling.
cup, Director of Sales, says that, ‘Partner-
Sources: company annual reports, Partnership
ships make our lives simpler, and as such
Sourcing Limited’s websites at www.pslcbi.com
more productive and effective’.
70 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Other strategies

We have described three general strategies based on leanness, agility and alliances. There are
several other general strategies, where organisations emphasise other aspects of performance.
Here we will mention a few of the more common.

● Time-based strategies
In the simplest view, time-based strategies aim for a guaranteed faster delivery of products.
Benefits from these strategies include lower costs (by having less stock in the supply chain, less
expediting, and so on), improved cash flow (by not having to wait so long for payment), less
risk (by reducing changes to orders, obsolete stock, and so on) and simpler operations (by
eliminating delays and unnecessary stores). The main assumption, though, is that faster
delivery gives better customer service. This is not necessarily true, and you can find many
examples of faster logistics reducing the quality. A delivery company might speed-up order
processing, but increase the number of mistakes; an airline might rush passengers and make
them feel uncomfortable; a shipping line might reduce delays by stopping in fewer ports.
One important strategy based on time is time compression. This is similar to the lean
strategy, but concentrates on wasted time in the supply chain. Its aim is to eliminate all the
non-value-adding time. Beesley14,15 says that ‘In typical UK manufacturing supply chains at
least 95% of the process time is accounted as non-value adding’.
There is clearly scope for reducing the time materials spend in the supply chain and getting
the associated benefits. Carter et al.16 discuss seven ways of doing this:

1. simplification – making operations simpler

2. integration – improving information and material flows
3. standardisation – using standard procedures and materials
4. concurrent operations – moving away from serial operations and towards parallel working
5. variance control – ensuring high quality and avoiding waste
6. automation – to improve effectiveness and efficiency
7. resource planning – to remove bottlenecks and ensure a smooth flow of materials.

As you can see, most of these are general suggestions for improvement rather than specific
features of time compression. You would, of course, expect this. A strategy that focuses on one
aspect of performance cannot ignore all the others; it still has to achieve performance that is
acceptable when judged by a range of different criteria.

● Environmental protection strategies

A small, but increasing, number of organisations are developing strategies based around envi-
ronmental protection. The Body Shop, for example, designs products with natural ingredients
and based on sustainable development. It uses the same principles in its logistics, with
reusable containers and recycling of materials. There are good reasons for other organisations
to adopt similar policies of environmental protection.
In 1993 a survey of UK companies suggested that most were aware of environmental pres-
sures – mainly from EU and government regulations – but they only changed their practices
when there were significant cost benefits.17 The major environmental concerns were waste and
packaging disposal (25% of respondents), noise and emission (23%), public perception of
HGVs (15%), fuel use (12%) and road congestion (11%). Only 19% of companies reported a
 L O G I S T I C S S T R AT E G Y 71

logistics environmental policy. Despite huge amounts of discussion in the area, there have
been relatively few changes since this survey.
Most organisations assume that ‘going green’ raises costs. There may be some benefits from
customer approval, but in a competitive environment it is difficult to justify the higher over-
heads. The reality, though, is that many programmes for environmental protection actually
reduce costs. Better insulation of warehouses, for example, gives lower heating bills. In the
same way, regular maintenance of road vehicles reduces both fuel consumption and emissions,
as does minimising the distance travelled, avoiding congestion, travelling outside peak hours
and avoiding built-up areas. Packaging is another area with large potential savings. You may be
surprised when a pack of chocolate biscuits has three layers of wrapping – but this is only the
consumer wrapping, and you do not see the three layers of industrial packaging that protects
goods during transport. Careful design and reusable containers can save much of this pack-
aging and considerably reduce costs.

● Increased productivity strategies

These strategies use available resources as fully as possible. Facilities, such as warehouses, have
high fixed costs and using them at full capacity spreads these costs over more units. It follows
that increasing the utilisation of resources reduces the delivered cost of products.
This is really a variation of a lean strategy, but there are important differences. Imagine a
facility that is working at 60% of capacity. Obviously, there is spare capacity that is raising
unit costs. The lean approach would look for ways of removing the 40% spare capacity – and
then continue looking for further reductions over time. A high productivity strategy is more
likely to accept the present capacity, and start looking for alternative uses for the excess. An
office or warehouse might rent out space, while a vehicle fleet might carry materials for other
organisations.

● Value-added strategies
The supply chain consists of a series of activities, each of which adds value to the final
product. Then a reasonable strategy has an organisation adding as much value as possible. This
value is, of course, taken from the customer’s perspective. Organisations can also add value by
adding time and place utility, or doing more work on the product. Imagine a company that
delivers washing machines to customers’ houses. It adds value by delivering to the place and
and at the time preferred by customers, or by doing more work such as installing the
machines, testing them, giving instructions on their use, removing old machines, offering
service contracts, and so on.

● Diversification or specialisation strategies

These strategies look at the range of services offered by logistics. Some organisations have
strategies of diversification, offering the widest range of services and satisfying as many
customers as possible. This is the approach of a department store which sells every product
you can imagine. Other organisations have a strategy of specialising in a very narrow range of
services, but being the best provider in their chosen area. They target a few customers and
provide a service that cannot be found anywhere else – like a bespoke tailor. Some transport
companies, for example, have a strategy of diversification and move every kind of load from
letters through to oversize loads. Others have a strategy of specialisation in, say, small pack-
ages, high security or tanker deliveries.
72 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

● Growth strategies
Many aspects of logistics get economies of scale, and larger operations can give both lower
costs and better service. One common strategy, then, is based on growth. There are several
ways of achieving growth, perhaps taking over competitors, expanding the geographical area
covered, diversifying into more logistics activities, moving different types of materials, or
simply increasing market share.

L O G I S T I C S
I N P R A C T I C E
Tesco plc
Tesco is the largest supermarket chain in the ■ 23 Extras at around 100,000 square feet
UK, with 700 stores taking 16% of the food ■ 274 Superstores at around 40,000
retail market. It also has stores in Asia and square feet
central Europe, giving total sales of £25 bil- ■ 96 Compact superstores at around
lion a year in 1000 stores, with 250,000 20,000 square feet
employees. Their strategy is based on low ■ 38 Metro stores at around 2000 square
cost, but also includes growth, high cus- feet
tomer service and increasing product range. ■ 45 Express stores at around 2000 square
The core purpose of Tesco is, ‘Creating feet
value for customers, to earn their lifetime ■ 216 other stores.
loyalty’. This leads to a business strategy
based around four elements – strong UK The range of products offered by these
core business of food retailing, non-food stores has also changed, with the Extras
sales, retail services such as personal finance and larger superstores offering a full range
and international operations. The logistics of non-food products, and growing sales
strategy supports this business strategy, of services from personal financial service
with a huge logistics network. This has to pharmacies. There are plans to open
evolved over time to meet changing cus- 100 more Express stores on Esso petrol sta-
tomer demands, ‘Following the customer – tion forecourts, and extending opening
as customers’ shopping habits change, we hours so that 300 stores are open 24 hours
change and respond by providing new a day.
products and services’. For the longer term, a significant change
You can see this effect in their stores. In for Tesco’s logistics is the growth of e-
the 1970s most of Tesco’s sales were in fairly commerce. This business grew from 13,500
small supermarkets in town centres. Over customers in 1999, to 370,000 in 2000,
the next 20 years it closed many of these and a million in 2001. With £300 million of
smaller stores and focused on larger ones – annual sales and 70,000 deliveries a week,
up to 100,000 square feet – in out-of-town Tesco has become the largest on-line gro-
developments. More recently, Tesco has cer in the world.
adopted a flexible approach, building a
Sources: company annual reports and website
range of shops to suit various needs. In 2001
www.tesco.co.uk
it had 18 million square feet of sales area in:
 L O G I S T I C S S T R AT E G Y 73

DESIGNING A LOGISTICS STRATEGY

Setting the scene

The important point about a logistics strategy is that it does not happen by chance, but needs
careful decisions. So we can ask, ‘How do organisations make these decisions?’ Why should a
company base its logistics strategy on flexibility rather than cost? Why does one company
choose to specialise, while a similar one chooses to diversify?
The starting point for designing a logistics strategy examines the higher strategies and sees
how logistics can contribute to these. Then we can summarise the results in a logistics
mission. This gives a simple statement of the aims for supply chain management, like the
following example.

Our mission in logistics is to contribute to corporate aims by moving the materials needed by produc-
tion into the company, moving work in progress through the company, and moving finished products
out to customers. We aim to give a flexible, reliable and cost effective service that completely satisfies
our customers, both internal and external.18

Logistics missions are useful for setting the scene, and showing the overall direction and prior-
ities. They are much less common than mission statements for the whole organisation, but
they can suffer from the same weaknesses. Organisations tend to be ambitious and include
aims of being ‘acknowledged leaders’, ‘the best’, ‘world class’, and so on. Smith19 says that
such flowery statements fail in three ways. First, they are over-ambitious, setting targets that
the organisations cannot realistically achieve. Second, they are so vague that no one can tell
whether the mission is actually being achieved or not. Third, they miss the opportunity of
using a powerful tool that can really help manage the logistics.
It is useful to start designing a strategy with a logistics mission, but the next steps are less
clear. There is certainly no single best strategy for any particular circumstance, and there is no
standard procedure for designing a good strategy. Gooderham20 says:

No one ‘right’ way to develop and implement strategy exists. The key to successful planning is to get
the best fit between the chosen tools and techniques, the organisation’s current culture capabilities
and business environment and the desired outcome.

This leads to the usual advice of finding the best balance between the organisation’s internal
strengths and the external constraints – matching what the organisation is good at to what
customers want. So now we have three factors that managers must consider when designing a
logistics strategy – the higher strategies, the business environment and the organisation’s
distinctive competence (shown in Figure 3.4).

1. Higher strategies set the organisation’s goals and the context for all logistics decisions. The
mission sets the overall aims, and the corporate and business strategies show how these
aims will be achieved. The logistics strategy must support these higher strategies. If, for
example, the business strategy calls for high customer service, the logistics strategy must
show how logistics will achieve this.

2. The business environment consists of the factors that affect logistics, but over which it has
no control. These include:

● customers – their expectations, attitudes, demographics

74 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Higher
strategies

Products Customers

Market
Employees
conditions

Organisation’s
Logistics Business
distinctive Resources Technology
strategy environment
competence

Economic
Facilities
climate

Other internal Other external

strengths factors

Figure 3.4 Factors in the design of a logistics strategy

● market conditions – size, location, stability

● technology – current availability, likely developments, rate of innovation
● economic climate – gross domestic product, rate of growth, inflation
● legal restraints – trade restrictions, liability and employment laws
● competitors – number, ease of entry to the market, strengths
● shareholders – their target return on investments, objectives, profit needed
● interest groups – their objectives, strengths, amount of support
● social conditions – customers’ lifestyles, changing demands, significant trends
● political conditions – stability, amount of governmental control, external relations.

3. All competing organisations work in a similar business environment. Each can only
succeed if it has a distinctive competence that sets it apart from competitors. This is defined
by the factors that are under the organisation’s control, and which it uses to distinguish
itself. A distinctive competence stems from an organisation’s assets, which include:

● customers – their demands, loyalty, relationships

● employees – skills, expertise, loyalty
● finances – capital, debt, cash flow
● organisation – structure, relationships, flexibility
● products – quality, reputation, innovations
● facilities – capacity, age, reliability
● technology – currently used, plans, special types
● processes – structures, technology used, flexibility
 L O G I S T I C S S T R AT E G Y 75

● marketing – experience, reputation

● suppliers – service, flexibility, partnerships
● other assets – knowledge, innovation, patents.

In essence, the business environment and distinctive competence show where an organisation
is now, and the higher strategies show where it wants to be in the future. The logistics strategy
shows how to move from one to the other.

Logistics audit

We can get a clear idea of current operations by doing a logistics audit. This describes the
details of all current logistics activities.

The purpose of a L O G I S T I C S A U D I T is to collect relevant information about

existing practices and performance of logistics. It gives a systematic review of current
operations, describing the procedures, costs, resources, utilisation, performance,
products, and all other relevant details.

There are two main parts to a logistics audit, essentially getting information about the business
environment and distinctive competence. First, an external audit looks at the environment in
which logistics work. This reviews the nature of customers, types of demand, accepted service
levels, locations, competitors and their operations, benchmarks and comparisons, services
available, trends in the industry, economic conditions, geographical and political constraints,
and any other relevant external information. Second, an internal audit looks at the way things
are done within the organisation and identifies areas for improvement. It reviews the structure
of the supply chain, warehouse locations and size, stock holdings, methods of materials
handling, achieved service levels, lead times, transport arrangements, order processing,
damage, productivity, and any other relevant internal information.
You can see that this approach is similar in principle to a SWOT analysis, which lists an
organisation’s:

● Strengths – what the organisation does well, features it should build on

● Weaknesses – problems the organisation has, areas it should improve
● Opportunities – openings that can help the organisation
● Threats – hazards that can damage it.

Strengths and weaknesses concern the organisation’s internal operations and show its distinc-
tive competence. Opportunities and threats relate to external features, concentrating on the
business environment. A SWOT analysis by Synergistic Logistical Services listed their strengths
as expertise, innovation and local contacts; weaknesses as small size, local operations and gaps
in experience; opportunities from the increasing use of information technology, growing
interest in logistics, and service-based local economy; threats from larger competitors, high
overheads and a possible take-over.
By this stage we have the aims of logistics set out in a logistics mission. We also have details
of current performance from the audit. We know where we want to go, and where we are at the
moment. The next stage is to identify gaps between these two and show how to bridge the gaps.
76 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Developing the strategy

Usually, the single most important factor for a logistics strategy is the type of demand. A lean
strategy, for example, works best when demand is stable – or at least predictable. It is most
successful when there are few changes to customers, products, or logistics, and when price is an
important factor for competition. This is typical of commodities or staple food items, where the
lowest cost is the main determinant of success. On the other hand, an agile strategy works best
for organisations offering a wider range of products, where demand varies and is less predictable.
It is most successful for organisations that do not really know demand until customers place
orders, with make-to-order operations or mass-customisation, such as the fashion industry.
It would be useful to have some formal procedure that considers factors such as the type of
demand, and then suggests the best logistics strategy. Unfortunately, we have already said that
there is no single ‘best’ strategy, and no method that always gives a good solution. The best
that we can do is use some guidelines. Novich,21 for example, recommends four steps for
designing a strategy – understand and measure customer needs, find the weaknesses of current
logistics, benchmark, and simplify the whole logistic system. A more systematic approach
builds on the analyses we have already mentioned, and has the following eight steps:

1. Do a logistics audit. The external audit gives an analysis of the business environment in
which logistics work. It shows the factors that lead to success in this environment, and
the importance of each one.

2. The internal audit analyses higher strategies from a logistics viewpoint, giving the context
and overall aims for logistics, its strategic focus and perhaps includes a logistics mission.

3. Design the general features of supply chains that can best deliver the desired services. This
includes the design of the network, location of facilities, capacity, technology used, and
so on.

4. Set specific goals to show what each logistics activity must achieve. The internal audit
shows how well the current logistics achieve these goals, and identifies areas that need
improving.

5. Design the best organisational structure, controls and systems to support the logistics
network.

6. Benchmark logistics, looking at the performance of leading organisations, defining meas-

ures to compare actual performance with planned, optimal and competitors’ performances.

7. Implement the strategy, setting the conditions for lower levels of logistics decisions.

8. Monitor actual performance, continually look for improvements, keep the strategies up to
date, and give feedback.

These steps give a guideline for designing and implementing a logistics strategy. The first
two points focus on current circumstances, and are based on a logistics audit. Steps 3 to 5
design the logistics strategy, describing the general features of the supply chain, goals and
supporting structures. Remember that the strategy only deals with broad principles over the
long term, and does not get involved with the tactical and operational detail. Step 6 looks at
operations in the best competitors and sees if there are any lessons to learn. The last two steps
are concerned with implementation, and adjustments to keep the strategy up to date.
We discuss some issues of implementation in the next chapter. Before we go there, however,
we should mention the presentation of the logistics strategy. This might seem a minor concern,
but the way the strategy is presented can be an important factor in its ultimate success.
 L O G I S T I C S S T R AT E G Y 77

A logistics strategy consists of a set of aims, procedures, structures, facilities, beliefs,

systems, and so on. These are typically presented in a logistics plan. This plan might contain
many parts,22 with the following list including the most common.

● a broad summary, giving an overview of the logistics strategy and how this relates to
other parts of the organisation
● the aims of logistics within the organisation, what performance levels are needed and
how these can be measured
● a description of the way that logistics as a whole will achieve these aims, what changes
are involved and how these will be managed
● a description of how the separate functions of logistics (procurement, transport, inven-
tory control, materials handling, and so on) will contribute to the plan, the changes
involved and how operations can be integrated
● projections to show the resources needed by the strategy
● projections of the costs and financial performance
● a description of the way that this strategy affects the rest of the business, particularly in
terms of performance achieved and contribution to customer value and satisfaction.

L O G I S T I C S
I N P R A C T I C E
Bjorg’s Pharmaceuticals
Bjorg’s Pharmaceutical (BP) is a biotech- table summarises the results when cus-
nology company that develops and mar- tomers were asked to rate the importance
kets specialised drugs for Alzheimer’s of factors on a scale of 1 (not important) to
disease. It is one of the smaller companies 5 (very important).
competing against giant internationals,
and its success comes from concentrating Factor Average response
on a niche market.
Same day delivery 3.1
Last year, BP was concerned that a major
Next day delivery 4.9
competitor was introducing a treatment
that was similar to one of its own best- Delivered when promised 2.7
selling products. BP felt that the best way Products delivered from stock 3.4
to compete was to improve its customer Cost of products 1.3
service by opening regional warehouses in
No errors in delivered products 2.8
its major markets of Northern Europe.
These warehouses would guarantee same No errors in paperwork 1.5
day delivery. To make sure that this was a Ease of order entry 1.7
sensible move, the company did a survey of Ease of payment 1.4
60 major customers. This survey confirmed Ease of access to customer relations 2.1
that delivery time was by far the most
Knowledge of customer relations 2.5
important factor to them. The following
78 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

L O G I S T I C S
I N P R A C T I C E
continued

Although same day delivery was fairly Based on this information, BP adopted
important, it seemed that most customers new policies to meet the competition. First,
would be happy with next day delivery. it cancelled the planned regional ware-
From the survey, BP also found that its houses, saving over a million dollars a year.
competitors only guaranteed next day Second, it adopted a policy of next day
delivery for 60% of orders. Another inter- delivery for 95% of orders, giving it the best
esting finding, was the perception that BP logistics performance in the industry. Third,
did not share information with customers, it improved its communications, publishing
and did not publish details of product lead more material on its websites and encour-
times, products that might have shortages, aging customers to contact them.
likely delays, and so on.
Source: internal company reports

❑ Strategic decisions affect an organisation over the long term. There are
CHAPTER REVIEW ■ ■ ■ ■ ■ ■ ■ ■

several types of strategic decision. Higher strategies set the general goals and
direction for the organisation, while functional strategies show how these will
be achieved.
❑ The strategic importance of logistics is clear from its role as an essential
function, its inclusion in mission statements, its involvement in important
decisions, its effect on long-term performance, and so on.
❑ A logistics strategy describes the long-term decisions, plans, policies and
culture for logistics. It is a functional strategy that shows how logistics will
contribute to an organisation’s success.
❑ Many aspects of logistics can have a strategic importance; the focus of the
strategy shows which is considered most important. We can use the focus to
describe some generic logistics strategies. Common ones focus on lean or
agile logistics, developing partnerships, time based strategies, and so on.
❑ A logistics strategy has to be designed, bearing in mind the aims described in
higher strategies, strengths of the organisation and the business environment.
There is no ‘best’ strategy for any particular circumstance.
❑ Although we can give guidelines, there is no standard method of designing a
logistics strategy. Managers have to do appropriate analyses and balance a
number of factors before making their decisions.
 L O G I S T I C S S T R AT E G Y 79

C A S E S T U D Y Hessingen Herb Farm

Conrad and Elizabeth Kole moved into Hessingen Farm in 1983. Over the past few
years their income from milk and traditional crops has dropped because of lower
market prices. They have supplemented this income from other sources, including
the conversion of old barns into holiday homes.
Eight years ago Elizabeth took over a small field and started growing herbs. She
sold a small range of herbs to local people who wanted fresh, organic produce for
cooking. Passing tourists would also buy an unusual souvenir, and the herb business
began to grow. Five years ago Elizabeth started growing more unusual herbs,
expanded her growing area into a second field and opened a visitors’ centre. People
now came to look at the growing and preparation of herbs, and taste samples in
various foods. Three years ago Elizabeth introduced a new range of herb products.
This was a major expansion, converting some of the farm buildings into a ‘herb
kitchen’ and making products for cooking (sauces, dressings and marinades),
perfumes (posies, pot-pourri and sachets of dried herbs) and what she called ‘healthy
stuff’ (herb mixtures traditionally said to have beneficial effects). The farm is now
widely advertised as a tourist attraction. The website is particularly useful, as Eliza-
beth uses it to collect orders. She currently delivers 100 parcels a week to regular
locals (up to about 50 km away) and posts 200 parcels to more distant customers.
Herbs started as a small business to generate additional income for the farm,
but have now become its main activity. Elizabeth is considering another expansion.
She could expand the product range even further and move all the processing to an
industrial estate 15 km away. Supporting this would need sales around ten times
the current postal sales. Elizabeth plans to generate these by introducing a mail-
order catalogue and increasing use of the website.

C A S E S T U D Y
Questions
● How does Elizabeth currently organise her logistics? What do you think are her aims and
priorities?
● What would be the effect of the expansion on logistics? What problems would Elizabeth
face, and what options does she have to overcome them?
80 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

P R O J E C T

Mission and Strategy

Many organisations refer, either explicitly or implicitly, to logistics in their mission. Sometimes you can
find statements about the role of logistics in corporate strategies, objectives, aims, publicity and related
documents. Search through the documents published by different types of organisation, and see how
they mention the strategic role of logistics. You might, for example, look for references made by certain
types of manufacturer, airlines or banks. What differences are there between different industries, and
companies in the same industry?

DISCUSSION QUESTIONS
1. To what extent is logistics a strategic function? Does it really have a long-term effect on
an organisation? Is it possible to be ‘essential’ but not ‘strategic’?
2. When customers judge products, they include factors like availability, lead time and after-
sales service – and these are part of logistics. Is it reasonable to say, therefore, that logistics
plays a role in the design of a product?
3. What are the main options for a logistics strategy?
4. What factors affect the choice of logistics strategy? Take an organisation that you are
familiar with, and say exactly how you would set about designing a logistics strategy.
5. There is only one ‘best’ logistics strategy in any circumstances, and managers should look
for this. Do you think this is true?
6. In 1996 a survey of Canadian logistics companies23,24 listed the main benefits expected
from outsourcing logistics as follows.

Factor % of companies
Reduce total cost 79
Focus on core competency 67
Improve financial performance 66
Improve customer service 53
Improve flexibility 53
Access to new technology or systems 41
Enhance competitiveness 41
Increase capacity 37
Provide alternative logistics channels 29
Increase market share 21
Broader market coverage 20

Are these benefits likely to be different in other countries, or to have changed over the
past few years?

REFERENCES
1. Roadway Express Company Annual Reports and website at www.roadway.com.
2. Mercia promotional material and website at www.mercia.com.
 L O G I S T I C S S T R AT E G Y 81

3. Boots Company Annual Reports and website at www.boots-plc.com.

4. J. Sainsbury Company Annual Reports and website at www.j-sainsbury.co.uk.
5. GKN Company Annual Reports and website at www.gknplc.com.
6. Porter M.E. (1985) Competitive Advantage, Free Press, New York.
7. Ohno T. (1988) Toyota Production System, Productivity Press, New York.
8. Womack J., Jones D. and Roos D. (1990) The Machine that Changed the World, Rawson, New York.
9. Womack J. and Jones D. (1996) Lean Thinking, Simon & Schuster, New York.
10. Townsend R. (1970) Up the Organisation, Coronet Books, London.
11. Monden Y. (1983) Toyota Production System, Industrial Engineering and Management Press, Atlanta, GA.
12. Perry M. (1996) Talk at the Marketing Council, London.
13. Evans B. and Powell M. (2000) Synergistic thinking: a pragmatic view of ‘lean’ and ‘agile’, Logistics and
Transport Focus, 2(10), 26–32.
14. Beesley A. (1995) Time compression – new source of competitiveness in the supply chain, Logistics Focus,
3(5), 24–5.
15. Beesley A. (1999) Time compression in the supply chain, Ch. 11 in Waters D. (ed.) Global Logistics and
Distribution Planning, Kogan Page, London.
16. Carter R., Melnyk P.L. and Handfield S.A. (1994) Identifying Sources of Cycle Time Reduction, Quorum
Books, Texas.
17. Szymankiewicz J. (1993) Going green – the logistics dilemma, Focus on Logistics and Distribution
Management, 12(5), 36–41.
18. Waters D. (2001) Strategic Logistics, Eastern Logistics Forum, New York.
19. Smith R.J. (2000) The logistics mission, Members’ Directory, pp. 22–7, The Institute for Logistics and
Transport, Corby.
20. Gooderham G. (1998) Debunking the myths of strategic planning, CMA magazine, May.
21. Novich N.S. (1990) Leading-edge distribution strategies, The Journal of Business Strategy, November/
December, 48–53.
22. Murray R.E. (1980) Strategic distribution planning, Proceedings of the Eighteenth Annual Conference of
the National Council of Physical Distribution Management.
23. Deloitte & Touche Consulting Group (1996) Canadian Trends in Supply Chain Management and Logistics
Service Outsourcing, Deloitte & Touche, Toronto.
24. Factor R. (1996) Logistics trends, Material Management and Distribution, June, 17–21.
 CHAPTER 4

Implementing the Strategy

CONTENTS

■ Aims of the chapter ■ Case study – Passenger

■ Relating strategy to lower interchange
decisions ■ Project – Structure of a supply
■ Areas for decisions in chain
implementation ■ Discussion questions
■ Managing change ■ References
■ Chapter review

AIMS OF THE CHAPTER

After reading this chapter you should be able to:

■ D E S C R I B E the steps involved in implementing a logistics

strategy
■ A P P R E C I AT E the problems of implementation
■ C O N S I D E R the decisions needed for implementing the
logistics strategy
■ R E C O G N I S E the importance of continual change in the
supply chain
■ D I S C U S S the management of change, particularly the rate of
change
 I M P L E M E N T I N G T H E S T R AT E G Y 83

RELATING STRATEGY TO LOWER DECISIONS

Links with lower decisions

In the last chapter we looked at the design of a logistics strategy. This contains all an organ-
isation’s long-term decisions, policies, plans and culture relating to logistics. Senior managers
design the logistics strategy, and then the remaining managers have to see how the strategy
affects their work. They have to answer questions such as:

● How does the strategy affect the logistics network?

● Should we change our warehouse and transport operations?
● Will our approach to planning and scheduling change?
● Do we have, or can we get, the necessary resources?
● Do we have, or can we train, people with the necessary skills?
● How will the strategy affect present and potential customers?
● What are the impacts on staff, facilities, organisation, technology, and so on?

As you can see, these are not strategic questions, but they are concerned with more detailed
tactical and operational decisions. So the logistics strategy leads to more detailed, lower level
decisions. A strategic decision to sell products through a website leads to medium-term tactical
decisions about warehousing, investment in stock, transport, materials handling, recruiting
and training, customer service, and so on. These tactical decisions, in turn, lead to short-term
operational decisions about resource scheduling, inventory control, expediting, vehicle routes,
and so on.
The distinctions between strategic, tactical and operational decisions are not really this
clear. Inventory, for example, is a strategic issue for decisions about building a warehouse for
finished goods or shipping directly to customers, a tactical issue when deciding how much to
invest in stock, and an operational issue when deciding how much to order this week.
Customer service is a strategic issue when designing the supply chain, a tactical issue when
organising transport for delivery, and an operational issue when scheduling the next delivery.
The important point is to recognise that the strategy leads to a whole series of related decisions
at different levels. What you call these levels and where you draw the boundaries is a matter of
convenience.
When we talk about ‘implementing a logistics strategy’ we mean making the lower deci-
sions, and translating the general aims of the strategy into positive actions. We actually do
what is necessary to achieve the aims of the strategy. So implementation takes us from the
fairly vague aspirations of the strategy to the nuts-and-bolts of how to move materials.

Strategies only become effective when they are I M P L E M E N T E D. This means that
the long-term aims are translated into lower decisions, and the work is carried out to
achieve them.
84 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

L O G I S T I C S
I N P R A C T I C E
Tesco plc
In the last chapter we showed how the over- ■ improving stock replenishment –
riding strategy of Tesco is based on its core moving from batch to continuous re-
purpose of ‘Creating value for customers, to ordering with tills sending hourly reports
earn their lifetime loyalty’. This leads to poli- of goods sold; this has increased avail-
cies of low cost, growth, high customer ability by 1.5%, reduced stocks by 10%
service and increasing product range. and significantly increased productivity
The logistics strategy supports these
■ direct delivery of fast-moving items, such
aims through the design and working of its
as carbonated drinks, in packs that go
supply network. Implementing the logistics
straight on display with no unpacking or
strategy means translating the aims into
shelf-filling
positive actions. These include:
■ improving store design – giving stores
■ a concerted effort to give even better
that are easier for both staff and cus-
customer service
tomers to use, and are cheaper to build
■ improving buying – with, for example,
■ paperless communications giving faster
new non-food sourcing hubs in Hong
and more reliable deliveries
Kong, India, Thailand and Central
Europe that ensure competitive prices ■ a new knowledge-management system
by buying products on a global scale in all businesses around the world,
making it easier to improve communi-
■ improving distribution – including a new
cations and share knowledge.
state-of-the-art freezer centre in Daventry
and a grocery centre in Thurrock Sources: company annual reports and website
www.tesco.co.uk

Difficulties with implementation

It can be difficult to translate a logistics strategy into lower decisions. This is obviously true
when the strategy is poorly designed, and lower managers have to translate vague concepts
like ‘global leadership’ into actual operations. It can also be true when there is a good strategy
that has been properly designed. A strategy based on good customer service, for example,
seems sensible and might be translated into a target of delivering all orders within two
working days. Now managers have to design the detailed logistics procedures to achieve this,
and this is where the difficulties appear. It might simply be impossible to achieve this target, or
it might be achievable, but only at very high cost or with too much strain on the supply chain.
There are two options at this point. First, managers can say that the strategy has been care-
fully designed, and everyone must work harder or find new, innovative ways of achieving the
targets. This might seem too rigid, but managers may believe that goals should be demanding
enough to stretch the organisation. Second, managers can say that the practical difficulties are
too great, and that there was a mistake in setting unrealistic targets. This is more worrying, as
 I M P L E M E N T I N G T H E S T R AT E G Y 85

it means that the logistics strategy was badly designed and all the work has been wasted. It also
suggests that the strategy designers do not have a clear enough view of operations.
An obvious point when designing a logistics strategy, is to make sure that it can be imple-
mented, and that the long-term plans lead to realistic tactical and operational decisions.
Ideally the strategy should set goals that are demanding (forcing the organisation to perform
as well as it can) but achievable (so that it can actually be implemented). Unfortunately, there
is a common problem here, especially with organisations that are rigid hierarchies. Then one
group of senior managers designs the strategies, while a different group of more junior
managers implements them. The two groups have different objectives, goals, information,
experience and skills. Even with good communications, senior managers become remote from
operations – they see the financial ratios, but have little idea how the logistics are really
implemented. On the other hand, people working with the details of day-to-day operations,
have little time for corporate ideals. Lofty aims such as ‘being acknowledged leaders’ have no
relevance for someone who is rushing to make an overdue delivery.
The following list gives some common problems with implementing logistics strategies:

● people who design the strategies are not responsible for their implementation
● strategies are badly designed, perhaps with the wrong aims or focus
● it is impossible, or very difficult, to implement them properly
● they do not take enough account of actual operations, perhaps because there were not
broad enough discussions
● they are over-ambitious, or somehow not realistic
● they ignore key factors, or emphasise the wrong features
● people only pay lip-service to supporting the strategies
● enthusiasm for the strategies declines over time.

One surprisingly common mistake is to design a logistics strategy and then think about imple-
menting it. The obvious way to avoid this is to think about implementation all the way
through the design, and always consider the practical effects of any policies. This needs wide-
spread participation in the design process, particularly from those most closely involved with
implementation. Some other factors that help devise a strategy that can be used are:

● an organisational structure that is flexible and allows innovation

● formal procedures for translating the strategy into reasonable decisions at lower levels
● effective systems to distribute information and support management decisions
● open communications which encourage the free exchange of ideas
● acceptance that strategies are not fixed, but continue to evolve over time
● control systems to monitor progress
● convincing everyone that the strategy is beneficial, so they conscientiously play their part
in implementation
● developing an organisational culture that supports the strategy.

AREAS FOR DECISIONS IN IMPLEMENTATION

Types of decision

When looking at implementation, it is convenient to describe two types of strategic decision.

The first type sets out the principles we work with, and the second type shows how the organ-
isation will achieve these principles. So ‘rapid delivery of customer orders’ is a principle that
86 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Mission

Corporate
strategy

Business
strategy

Logistics mission
Logistics strategy Decisions about principles
Decisions about
implementation

Logistics
tactics

Logistics
operations

Figure 4.1 Levels of decision in logistics

the organisation is adopting, while ‘building warehouses close to customers’ is a practical way
of achieving this: ‘easy customer access’ is a principle, while ‘using websites to collect orders’ is
one means of doing this. All these decisions are strategic, as they clearly have long-term conse-
quences. However, the first type is more concerned with aims and designs, and the second
type is more concerned with practicalities and implementation. In the last chapter we looked
more at the aims and designs; here we will look at the practicalities of implementing these (as
illustrated in Figure 4.1).
A traditional view is summarised by Ballou1 who says that when moving to the implemen-
tation of a strategy, we need to concentrate on four areas; customer service, facility location,
inventory policy and transport. This is a fairly restricted view, and only considers a few of the
functions of logistics. A more inclusive view is given by Helming and Zonnenberg,2 who
suggest decisions in five areas: supply chain configuration, enabling practices, strategic rela-
tionships, organisation and application of information technology. They also emphasise the
importance of implementation by saying, ‘Companies hurl staggering sums of money and
human resources at their supply chain infrastructure, only to fail at implementing their supply
chain strategy’.
An even broader view of implementation says that we should consider decisions in every
function of logistics from procurement through to final delivery. We will look at these deci-
sions in the next few chapters. Here, though, we will consider some general features that set
the overall structure of the supply chain. In particular, we will look at the location of facilities,
ownership and outsourcing, enabling practices and capacity.
 I M P L E M E N T I N G T H E S T R AT E G Y 87

Structure of the supply chain

From an organisation’s point of view, the supply chain for a product consists of tiers of
suppliers feeding materials from original sources into its operations, and then tiers of
customers moving materials out to the final customers (as shown in Figure 4.2).
In practice, there are many variations on this basic model. Some supply chains have few
tiers of customers and suppliers, while others have many; some chains have very simple flows
of materials, while others have complex and convoluted networks. Different types of products
clearly need different structures in their supply chain, and building sand needs a far different
chain to DVD players. Important factors are the product’s value, bulk, perishability, availability,
profitability, and so on. Sand has low value, is bulky and is readily available, so it is best to have
a short supply chain with the suppliers as close as possible to the final customer. DVD players
are small, have high value, and are made in specialised factories, so they have a longer chain.
Different strategies also lead to different types of supply chain, so a company focusing on
fast delivery will build a different chain to one focusing on low costs. Other factors that affect
the structure of the supply chain are the type of customer demand, economic climate, avail-
ability of logistics services, culture, rate of innovation, competition, market and financial
arrangements.
Organisations should consider all such factors, and then design an appropriate structure for
their supply chains. In other words, they decide the types of intermediary (who form the
suppliers and customers in the chain), numbers of these intermediaries, warehousing arrange-
ments, work done in logistics centres, customers served from each centre, modes of transport,
delivery speed, and so on. Perhaps the key questions here concern the supply chain’s length
and breadth (illustrated in Figure 4.3).

Third Second First First Second Third

tier tier tier Organisation tier tier tier
supplier supplier supplier customers customers customers

Operations in
the organisation

Figure 4.2 Structure of a supply chain

88 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

(a) Short and wide supply Quarry

chain for industrial sand

Customer 1 Customer 2 Customer 3

(b) Part of a long and narrow Initial supplier

supply chain for
pharmaceuticals Component maker

Manufacturer

Warehouse

Exporter

International forwarder

Bond warehouse

International distributor

National logistics centre

Figure 4.3 Different shapes of supply chain

● Supply chain length is the number of tiers, or intermediaries, that materials flow through
between source and destination. We might think of a supply chain in terms of suppliers,
wholesalers and retailers. In reality, some supply chains are shorter than this when, for
example, producers sell directly to final customers. On the other hand, supply chains are
often longer with many intermediaries, perhaps including several stages of manufacturing
each of which is connected through intermediaries. Similarly, exporters might use a series
of logistics centres, transport operators, agents, freight forwarders, brokers and agents to
move materials through different parts of their journey.

● Supply chain breadth is the number of parallel routes that materials can flow through. You
can imagine this in terms of the number of routes out to final customers. Cadbury’s has a
broad supply chain, which means that you can buy their chocolate in a huge number of
retailers; Thornton’s has a narrower chain, and most of their chocolate sells through their
own shops; Pigalle et Fils has a very narrow chain and they only sell their chocolate in
two shops in Belgium.

The best choice of length and breadth depends on many factors, with three of the most
important being the amount of control that an organisation wants over its logistics, the
quality of the service and the cost. A manufacturer delivering directly to customers has a short,
 I M P L E M E N T I N G T H E S T R AT E G Y 89

narrow supply chain. This gives a lot of control over logistics, but it may be difficult to achieve
either high customer service or low costs. Broadening the chain gives higher customer service,
but it increases costs and reduces the manufacturer’s control. Making the supply chain long
and narrow can use intermediaries to reduce costs, but the manufacturer loses some control
and the customer service does not improve. Making the supply chain both long and broad
removes most control from the manufacturer, but customers get good service.
We can illustrate some of the options for a supply chain with a basic product, such as shoes.
Figure 4.4 gives a simplified view of some options, assuming that final customer demand is met
by either direct sales (mail order, websites or factory shops) or retailers (specialised shoe shops,
clothes shops, supermarkets, large multiple retailers, small multiple retailers or mixed retailers).
Then we can add other types of retailer, such as shopping clubs, discount stores, retail ware-
houses, and door-to-door sales. We can also add different types of intermediaries, such as manu-
facturers’ wholesalers, retailers’ wholesalers, buying groups, agents, brokers, co-operatives, and
so on. Then there are specialised services such as transport, warehousing, finance, freight
forwarders, and so on. The whole picture soon becomes very complicated.
A series of analyses can help managers with their design of a supply chain. The obvious
ones estimate the total cost of delivery to final customers, and the time needed to satisfy an
order. They might include less tangible factors, such as the efficiency of the supply chains, or
customer satisfaction. Unfortunately, there is never a single ‘best’ solution and ultimately they
have to choose the compromise that comes closest to achieving the aims of the logistics
strategy. One clear trend, though, is towards shorter supply chains. Organisations of every type
are realising that they can reduce costs and increase customer service by moving materials
quickly through a short supply chain. This usually means removing layers of intermediaries,
and concentrating logistics in fewer facilities. Manufacturers increasingly deal directly with
their final customers, removing many of the traditional tiers of intermediaries. Within the

Manufacturer

Imports Logistics centre

Domestic sales Export

Distributor Wholesaler Direct sales

Large Small Supermarket Clothes Specialist Mixed Mail order Website Factory
multiple multiple retailer shoe retailer shop
retailer retailer shops

Public Public Institutions Industry

Figure 4.4 Simplified supply chain for distributing shoes

90 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

European Union the free movement of materials means that companies can replace national
warehouses by a single European logistics centre. Similarly, efficient transport within the
United States allows companies to work from one major centre.

Location of facilities

The structure of the supply chain sets the number of participants, including wholesalers,
warehouses, logistics centres, and so on. The next question concerns the best location for each
of these.
The best location for facilities depends on many factors. A warehouse, for example, might be
near to factories, customers, transport or areas with development grants. The location clearly
has an effect on logistics performance. If an organisation wants fast delivery, it will use local
warehouses that are physically close to final customers; if it wants low costs, it will concentrate
stocks in large, centralised warehouses that are inevitably some distance away from customers;
if it imports and exports a lot of materials it might use warehouses near to ports or rail termi-
nals; if it manufactures goods, it will have a stock of finished products near the factory.
Questions of location should be tackled very carefully, as they have a considerable impact
over the long term. Once a facility is open it is difficult to close it down or move it. An impor-
tant point, though, is that location is not an isolated decision. It leads to a series of related
decisions about the work done in each location, size of each facility, level of technology used,
layout of resources, customers to serve from each location, and so on. We look at location in
more detail in Chapter 5.

Ownership and outsourcing

In Chapter 2 we showed that one organisation does not have to own a supply chain to get the
benefits of integration. Suppliers and customers can get mutual benefits by working together,
typically in a strategic alliance. We have concentrated on supplier–customer partnerships, as
these are easiest to imagine and they have most effect on the supply chain. However, a similar
arrangement can cover a whole range of services, such as electricity supply, banking service,
and office cleaning. A common form of partnership for logistics has a specialised company
looking after all of an organisation’s transport. This arrangement has the advantages of an effi-
cient and experienced specialist to look after the transport, while the organisation can concen-
trate on its core operations. But why stop at transport? An organisation can form partnerships
with other companies to look after warehousing, purchase of materials, materials handling,
and many of the other functions of logistics. When one company uses other companies to run
its logistics, it is called third party or contract logistics.
Later in the book we will look at these arrangements for warehousing (Chapter 8) and
transport (Chapter 11). In essence, though, the use of third party logistics is a special type of
‘make-or-buy’ decision. Sometimes it is better to keep logistics within the organisation, and at
other times it is better to use a specialist. Rowley summarises the benefits by saying that ‘The
results of successful outsourcing are service improvement, cost reduction and quality enhance-
ment’.3 A fuller list of potential benefits includes:

● lower fixed costs, with customers only paying for services they use
● specialist suppliers who have expertise and use the best systems and practices
● suppliers can combine work from several customers to get economies of scale
● guaranteed high, and agreed, levels of customer service
 I M P L E M E N T I N G T H E S T R AT E G Y 91

● flexible capacity, dealing effectively with peaks and troughs in demand

● lower exposure to risk from, say, varying demand
● increased geographical coverage and local knowledge
● a convenient way of entering new markets.

Of course, there are disadvantages to be set against this, such as reduced control, inability
to respond to unusual circumstances, more complicated communications, conflicting objec-
tives, less control over costs, and so on. Nonetheless, the advantages of third party are
becoming clearer, with more organisations moving in this direction. Surveys4 put the value of
the European logistics market at over $150 billion, with contract logistics accounting for $40
billion and rising by 8% a year.

L O G I S T I C S
I N P R A C T I C E
European contract logistics
Contract logistics is a huge business in logistics. These are continuing to grow at
Europe. Datamonitor estimate the total cost about 8% a year, but growth will be faster
of logistics was $150 billion in 1999, with in Italy and Spain which currently have
26% of this involving third party suppliers. large logistics markets, but relatively low
By 2003 the proportion of contracted busi- levels of outsourcing.
ness will be 30% higher – increasing the The two main issues facing contract
market from $38 billion to $57 billion. logistics are consolidation of logistics into
Germany is the biggest European mar- fewer, large companies, and geographical
ket for logistics services (28% of the total) expansion of these companies. The Euro-
followed by France (20%) and the UK pean Union has encouraged trade through-
(17%). Because each of the economies has out an integrated market, and larger
developed differently, and because of the logistics companies are emerging to service
different logistics requirements, the use of the whole market. Few of these companies
third parties varies quite widely. In the UK are expanding by organic growth, but are
almost 40% of logistics is contracted, while looking for mergers, acquisitions and strate-
in Greece it is nearer 12%. If you multiply gic alliances with other logistics companies.
the size of the logistics market by the pro-
Sources: Anon. (1999), European contract logis-
portion that is outsourced, you see that
tics, Logistics and Transport Focus, 1(3), European
Germany, France and the UK each spend logistics 2000 and other reports from www.data-
about $10 billion a year on third party monitor.com

Enabling practices

Enabling practices are the activities associated with the supply chain that allow it to work
efficiently. We might, for example, say that reliable information processing is an enabling
practice that allows logistics to function properly.
92 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

After an organisation has designed the structure of its supply chain, and found the best
locations for facilities, there are many ways of managing the flow of materials through the
chain. It could, for example, use just-in-time methods to reduce stocks, EDI to link with part-
ners, or procurement via websites. These activities are not necessarily part of the supply chain
itself, or they may not be considered core activities. They do, however, ensure a smooth flow
of materials to help the supply chain work as planned. In a bus company, the maintenance of
vehicles does not contribute directly to the movement of people, but it is an enabling practice
that helps the company work properly.
The idea of the enabling practices as supporters of logistics can be important. If you look at
a series of organisations in the same business, it is likely that they will have evolved in similar
ways, and have similar structures for their supply chains. Most whisky distillers or detergent
manufacturers have supply chains with the same general shape. They cannot, therefore,
compete by having a better supply chain structure, but they can use enabling practices to get a
competitive advantage. These allow different methods and procedures to improve performance.

Capacity

The capacity of a supply chain is the largest amount of materials that can flow through it in a
given time. A lorry might have a capacity of 25 tonnes that it can carry on a journey, while an
airline has a capacity of 450 passengers on a flight, a warehouse can unload 210 lorries a week,
or a retail shop can serve 120 customers an hour. Not all parts of a chain have the same capacity,
so the overall capacity is set by the part with the smallest individual capacity. This forms the
bottleneck. If wholesaling forms the bottleneck with a capacity of 200 units of a product an
hour, this sets the capacity of the whole supply chain – even if other parts have a much higher
capacity (as shown in Figure 4.5). The only way of increasing the capacity of the supply chain is
to increase the capacity of the bottleneck; adding more resources elsewhere has no effect, it only
increases the amount of spare facilities and reduces the utilisation. This seems an obvious point,
but you can often see companies spending money on the wrong areas – for example an airline
buying more planes, when its passenger numbers are limited by its landing slots at an airport.

Capacity 400 300 800 450 200 700 850 500 300
(units per hour)

Maximum
flow of
materials
= 200 units
per hour

Bottleneck
limiting capacity

Figure 4.5 Capacity of a supply chain set by the bottleneck

 I M P L E M E N T I N G T H E S T R AT E G Y 93

To get a smooth flow of materials through the supply chain, we have to make sure that
each part has an appropriate capacity. This means that the overall capacity matches total
demand, and the capacity of each part is matched, so that there are no restrictive bottlenecks.
We consider these problems of capacity planning in Chapter 6.

L O G I S T I C S
I N P R A C T I C E
Ralston Energy Systems
Ralston Energy Systems s.r.o. (RES) works in main site in Prague, while others were re-
the Czech Republic as an affiliate of exported to other countries. This warehouse
Eveready Battery Company (EBC). EBC has was 50 km from Prague and was run under
manufacturing plants in America, Europe contract by a specialised international logis-
and Asia, and has distribution branches in tics company. The second warehouse was a
almost every country of the world. Its main ‘sales warehouse’ run by RES on its main
products are its leading brand range of bat- site. This organised the distribution of prod-
teries and torches. ucts made in Prague, which were either des-
Until 1998 RES ran two warehouses tined for the domestic Czech market, or
within the Czech Republic (illustrated in Fig- exported. Local transport from the sales
ure 4.6). The first was a bonded warehouse warehouse was organised by a domestic
used to store imported materials. Some of company that gave a good and flexible
these materials were transferred to the RES service. Two other trucking companies were

Exports

Two trucking
companies

Bonded Sales
Imports Production
warehouse warehouse

Trucking
company

International
Domestic
logistics
market
company

Figure 4.6 Summary of logistics at Ralston Energy Systems s.r.o.

94 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

L O G I S T I C S
I N P R A C T I C E
continued

involved in export and import operations. ■ Flexible warehousing space; RES

The sales warehouse was about three times expanded into the Ukraine, and the new
the size of the bonded warehouse. operator could deal with their increased
This structure had a number of requirements
weaknesses:
■ Variable warehousing costs – based on
■ The sales warehouse was leased from a the volumes actually stored and proc-
company which two years previously essed, without the substantial fixed costs
had become a competitor of RES. The
■ Variable distribution costs – again based
company did not feel that it was appro-
on the amounts actually moved
priate to store finished goods in a
competitor’s facilities ■ Increased service quality – with new
methods and procedures
■ The sales warehouse had become too
small, and RES was having to store ■ Associated services from the operator –
finished goods in the manufacturing such as labelling, display rack assembly,
plant preparation of promotional bundles, and
so on
■ The sales warehouse had poor arrange-
ments for loading and unloading trucks, ■ Saving overhead costs of management
which significantly increased the times in the warehouse
needed ■ Extending opening times from 0700 to
■ All goods imported into the Czech 1900
republic were sent to the bonded ware- ■ Removing the conflict of interest with a
house, and were then moved by weekly competitor-owned warehouse
transport to the manufacturing plant
■ Managing remote stock in Slovenia from
■ Local distributors charged high rates for the same facilities.
each truck load delivered.
The move took place without any dis-
RES looked for a solution that would ruptions to service. One week two-thirds of
improve logistics and solve their problems. the stock was transferred to the new ware-
Their solution was to outsource logistics to house while staff continued working from
a third party. They negotiated an agree- the remaining stock. The following week
ment to run the bonded warehouse with a staff moved across and started working
new operator, who also took over distribu- from the new warehouse, where they were
tion from the sales warehouse. RES effec- followed by the remaining one-third of
tively closed its sales warehouse, and stock. Overall, the move took about two
moved these activities to the new operator. years to plan and implement.
There were various problems and disrup-
tions for about eight months, and then Source: internal reports
everything settled down and gave a much-
improved service. The new service brought
the following benefits:
 I M P L E M E N T I N G T H E S T R AT E G Y 95

MANAGING CHANGE

Change is inevitable

The design of a logistics strategy is based on a range of internal and external factors. Unfortu-
nately, these are constantly changing. Within the organisation there are changes to
employees, goals, products, plans, processes, costs, suppliers, customers, and so on. Externally
the organisation has to deal with changing customers, markets, economic conditions,
competitors, technology, and so on A consequence of these continuous changes, is that the
logistics strategy also has to evolve over time. Managers cannot design a strategy and then just
work on its implementation – they also have to keep adjusting strategy.
As the strategy evolves, the operations of the whole logistics function must adjust and
move forward. New practices affect everyone. Unfortunately, this presents a problem, as most
of us do not really like changes. We might claim to welcome change, as it stops us from stag-
nating and getting bored. The truth, however, is that changes need a lot of effort, forcing us to
abandon old and familiar practices, to learn new skills, new ways of doing things, new proce-
dures, and to form new relationships. Change moves us away from a reasonably predictable
future to one with uncertainty and risk.
Many organisations prefer to stick to their old practices. Unfortunately, this allows more
flexible competitors to gain an advantage, and their performance inevitably declines. Some
signs that an organisation is not changing to meet new circumstances include:

● low sales and falling market share, as old products are overtaken by competitors
● many customer complaints, particularly about quality and delivery dates
● reliance on a few customers, especially with long-term, fixed-price contracts
● old-fashioned attitudes and operations
● poor industrial relations, with low employee morale and high staff turnover
● poor communications within the organisation and with trading partners
● too much inflexible top management with no new appointments
● inward-looking managers who are out of touch with operations or customers.

Change is a normal part of business and if we do not respond we will fall behind competitors.
To be more positive, we should welcome change as it creates opportunities, improves work
conditions, gives better practices and performance, and more interesting, better-paid and more
secure jobs. This new attitude does not happen by chance, but it needs careful management.
One suggestion is that organisations need a champion, or change manager, who leads them
away from their present position. This manager has the vision to see how an organisation can
improve, and the ability to move it in the right direction. Unfortunately, this can be a trau-
matic journey, and organisations typically move through a series of stages:5,6

1. Denial – where employees deny that there is a need for change

2. Defence – defending the current way of doing things and criticising new proposals
3. Discarding – beginning to move away from the old ways and towards the new ones
4. Adoption – using the new ways and accepting that they are beneficial
5. Integration – assuming the new ways are normal and using them naturally.

The key point is that change must be managed. People have to do things differently, and
they must be convinced that changes are both essential and beneficial. Getting this message
across is the difficult part of change management.
96 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

L O G I S T I C S
I N P R A C T I C E
Concerns about the supply chain
In 2001 Warwick Business School’s Opera- desire for more integration and its actual
tions Management Group ran a survey to achievement. Few organisations had made
identify concerns about the supply chain. any real progress at all, and almost none
The most common management worries had achieved widespread integration. The
were: main problem stated by 88% of organisa-
tions was the difficulty of merging systems
Costs 100%
and consolidating EDI.
Integration of the supply chain 86% Similarly, 57% of organisations were
Globalisation 71% concerned about procurement. Many
Procurement 57% people regard e-business as the major
challenge – and opportunity – facing busi-
Integration of the supply chain is clearly
ness. For the respondents to this survey,
a concern of most organisations. We would
between 50 and 70% of their costs were
imagine that they are aware of the benefits
attributed to purchases. Yet less than 40%
of closer integration and are moving in this
felt that e-procurement was a strategic issue,
direction, probably through alliances and
and only 36% had a written strategy for
partnerships. Certainly 70% of respondents
e-procurement.
said that more integration was needed to
reduce costs. Sources: Anon. (2001) Logistics and Transport
However, the survey found that there Focus 3(1), 48–9 and www.lefevre.co.uk
was a considerable gap between the stated

Rate of change

One important feature of change is the rate at which it occurs. Some organisations change
very quickly, such as Intel which works at the frontiers of technology and is continually devel-
oping new products. Others change very slowly, and even make a virtue out of stability, such
as Morgan sports cars whose basic design originated in the 1930s.
Major changes can be very disruptive, so organisations generally prefer a series of small
adjustments. This iterative approach gives continuous improvement which is known by
the Japanese name of kaizen. A stream of relatively minor changes can be absorbed by the
organisation without major interruptions. There is also little risk, as any of the ‘improve-
ments’ that do not work can easily be reversed. Over time, this incremental approach
builds a momentum for improvement, and makes sure that the logistics system is always
getting better.
Suggestions for iterative improvements come from many sources, such as customers,
competitors or suggestion boxes. Sometimes there is a more formal arrangement, such as the
plan–do–check–act cycle, or Deming wheel (shown in Figure 4.7).
 I M P L E M E N T I N G T H E S T R AT E G Y 97

Plan

Act Do

Check

Figure 4.7 Deming wheel

This uses a team of people who positively look for improvements to logistics using
the cycle:

● plan – looking at the existing logistics, collecting information, discussing alternatives, and
suggesting a plan for improvement
● do – where the plan is implemented, and data is collected on subsequent performance
● check – which analyses the performance data to see if the expected improvements actually
appeared
● act – if there are real improvements the new arrangements are made permanent, but if
there are no improvements, lessons are learnt and the new arrangements are not adopted.

The team is continuously looking for improvements, so at this point they return to the begin-
ning of the cycle, and consider more changes.

L O G I S T I C S
I N P R A C T I C E
Hotpoint
Hotpoint is a major supplier of domestic ■ reducing costs
appliances in the UK, owned by GE. In ■ increasing customer service which had
1988 it worked as an independent com- fallen to unsatisfactory levels
pany, but was not responding quickly ■ strengthening the management team
enough to changing conditions. It distrib- ■ renegotiating pay and conditions for
uted its own finished products, but the staff
operations were inefficient and costs were ■ introducing systems to measure and
rising rapidly. The company decided to monitor performance
overhaul its distribution, with the aims of:
98 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

L O G I S T I C S
I N P R A C T I C E
continued

■ reducing the amount of damage to To achieve this service, Hotpoint

products in transit designed a wide and short distribution net-
■ designing a distribution strategy for the work, with satellite depots around the
next five years. country giving daily deliveries to all main
towns and regular visits to rural areas.
As a starting point the company
These depots are largely stockless, being
designed a mission for distribution, which
fed each day with their requirements. They
was: ‘To deliver Hotpoint goods to the cus-
are also used for the distribution of parts
tomer; when expected and agreed; in the
sent from the national distribution centre at
manner expected; in good condition; at an
Peterborough.
acceptable cost to the company.’ This laid
The new arrangements set the scene for
the foundation for a new culture, based on
logistics over the next decade. During this
customer satisfaction and competitive
period the supply chain grew in impor-
performance. It took a huge effort of
tance, and became more responsive. Lead
communication, negotiation, training,
times were reduced, more frequent deliver-
changing long-standing practices, and
ies were made, stocks were lowered by
introducing new systems. The logistics
50%, operating costs were significantly
slowly improved, and progress was moni-
reduced, customer service was increased,
tored by benchmarking other companies,
and staff morale improved. The company
such as TNT, Exel and TDG.
won a Motor Transport Award for ‘Excel-
An important factor for Hotpoint was
lence’. Changes made throughout the
control over the supply chain. It put a lot of
1990s moved the distribution system from
emphasis on its home delivery service,
‘a sleeping dinosaur to a cost effective and
where retailers take orders and Hotpoint
customer-driven entity’.
deliver appliances directly to customers.
This allowed drivers to make sure the appli- Sources: Grange C. (1999) The long and winding
ances were in good condition, installed road, Logistics and Transport Focus 1(4), 36–41,
properly and working. Hotpoint aimed for a Grange C. (1999) The long and winding road,
presentation to the Institute of Logistics and
high quality service, with guaranteed deliv- Transport Annual Conference, and www.
ery in a specified time slot, removal of pack- hotpoint.co.uk
aging, collection of old appliances for
recycling, and so on.

Business Process Re-engineering

Some people say that small continuous improvements to operations are not the best approach.
They suggest that small adjustments only tinker with details and make no real difference. If
you have a poor logistics system, the way of improving it is not to tinker with the details, but
to take a broad stroke and look for dramatic improvements. The best-known approach of this
kind is business process re-engineering (BPR). Hammer and Champy7 define this as follows:
 I M P L E M E N T I N G T H E S T R AT E G Y 99

B U S I N E S S P R O C E S S R E - E N G I N E E R I N G is the fundamental rethinking and

radical redesign of business processes to achieve dramatic improvements in critical,
contemporary measures of performance, such as cost, quality, service and speed.

The idea behind re-engineering is that you do not look for improvements in your current
operations, but you start with a blank sheet of paper and design a new process from scratch.
This is rather like running an old car. You can tinker with it and keep it going a bit longer, but
the re-engineering solution is to buy a new car. If you have a poor logistics system, you should
not waste time tinkering to find small improvements, but should throw away the whole system
and design a new one from scratch. Ford of America gave one classic example of this approach.

L O G I S T I C S
I N P R A C T I C E
Accounts payable at Ford
In 1988 the accounts payable department system. At the centre of this was their pur-
of Ford of America had 500 people work- chasing database, so the new system had:
ing with a standard accounting system. 1. The purchasing department sent a pur-
In this: chase order to a supplier and updated
1. The purchasing department sent a pur- the database
chase order to the supplier and a copy 2. The supplier shipped the goods
to the accounts payable department
3. When the goods arrived at Ford they
2. The supplier shipped the goods ordered were checked against outstanding orders
and sent an invoice to accounts payable on the database
3. When the goods arrived at Ford, they 4. If the details matched, the goods were
were checked and sent to stores. A des- accepted, the database was updated to
cription of the goods arriving was sent show that they had arrived, and the
to accounts payable supplier was paid
4. Accounts payable now had three descrip- 5. If the details did not match, the goods
tions of the goods – from the purchasing were not accepted and were sent back
department, supplier and arrivals. If these to the supplier.
matched they paid the invoice Suppliers soon learnt that the new sys-
5. Sometimes the paperwork did not tem would not allow any mistakes in deliv-
match, and problems had to be sorted eries, and they were quickly eliminated. The
out. This took a lot of effort, often last- streamlined system reduced Ford’s accounts
ing several weeks. payable department to 125 people, giving a
400% increase in productivity.
Ford could have improved this system,
and estimated that they might save 25% of Source: Hammer M. and Champy J. (1993) Re-
staffing costs. Instead they chose a more engineering the corporation, HarperCollins, New
radical solution and re-engineered the whole York
100 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

BPR does not give new methods, but it consolidates several related ideas. Some of its main
principles for the supply chain are:

● a supply chain should be designed across functions and allow work to flow naturally,
concentrating on the whole supply chain rather than the separate parts
● managers should strive for dramatic improvements in performance by radically
rethinking and redesigning the supply chain
● improved information technology is fundamental to re-engineering as it allows radical
new solutions
● all activities that do not add value should be eliminated
● activities should be carried out where they make most sense – information processing, for
example, becomes a part of logistics rather than a separate function
● decisions should be made where the work is done, and by those doing the work
● you do not have to be an expert to help redesign a supply chain, and being an outsider
without preconceived ideas often helps
● always see things from the customer’s point of view.

One important point is that BPR does not replace continuous improvement. It is possible to
have a series of radical improvements, and still introduce smaller continuous improvements
(as shown in Figure 4.8).
BPR is a general approach to change rather than a formal procedure, so we cannot say, ‘this
is how to re-engineer a process’. Perhaps because of this, organisations have mixed experiences
with its use. Some have reported outstanding results – like the early work in the IBM Credit
Corporation which increased output by a factor of 100. But around three-quarters of organ-
isations fail to get the improvements they hoped for.8

(a) Continuous improvement (b) Business process re-engineering

Performance

Performance

Time Time

(c) Combination of continuous improvement

and business process re-engineering
Performance

Time

Figure 4.8 Rate of performance improvement

CHAPTER REVIEW ■ ■ ■ ■ ■ ■ I M P L E M E N T I N G T H E S T R AT E G Y 101

❑ The logistics strategy sets the overall direction for logistics. Implementing the
strategy translates this into a series of lower decisions and actions.
❑ Unless the strategy is designed properly, implementation can be difficult or
impossible. To avoid these problems, managers should consider
implementation during the design of the strategy, they should involve those
involved in implementation, and so on.
❑ Some strategic decisions are concerned with principles, while others are more
concerned with achieving the principles. The first of these are considered
more in the design of a strategy, while the second are considered more in the
implementation.
❑ Important decisions for implementing the logistics strategy include the structure
of the supply chain (length, breadth, number of tiers, type of intermediaries,
and so on), location of facilities, outsourcing, enabling practices and capacity.
❑ The supply chain must continually evolve to keep up with changing
conditions. These changes can be difficult, and need careful management.
❑ An important question concerns the rate of change. Continuous improvement
uses a series of small adjustments to build up a momentum for change-over
time. Business process re-engineering looks for more radical changes.

C A S E S T U D Y Passenger Interchange

In most major cities the amount of congestion on the roads is increasing. Some of
this is due to commercial vehicles, but by far the majority is due to private cars.
There are several ways of controlling the number of vehicles using certain areas.
These include prohibition of cars in pedestrian areas, restricted entry, limits on
parking, traffic calming schemes, and so on. A relatively new approach has road-
user charging, where cars pay a fee to use a particular length of road, with the fee
possibly changing with prevailing traffic conditions.
Generally, the most effective approach to reducing traffic congestion is to
improve public transport. These services must be attractive to people who judge
them by a range of factors, such as the comfort of seating, amount of crowding,
handling of luggage, availability of food, toilets, safety, facilities in waiting areas,
availability of escalators and lifts, and so on. However, the dominant considerations
are cost, time and reliability.
102 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

C A S E S T U D Y continued

Buses are often the most flexible form of public transport, with the time for a
journey consisting of four parts:
■ joining time, which is the time needed to get to a bus stop
■ waiting time, until the bus arrives
■ journey time, to actually do the travelling
■ leaving time, to get from the bus to the final destination.
Transport policies can reduce these times by a combination of frequent services,
well-planned routes, and bus priority schemes. Then convenient journeys and
subsidised travel make buses an attractive alternative.
One problem, however, is that people have to change buses, or transfer between
buses and other types of transport, including cars, planes, trains, ferries and trams.
Then there are additional times for moving between one type of transport and the
next, and waiting for the next part of the service. These can be minimised by an inte-
grated transport system with frequent, connecting services at ‘passenger interchanges’.
Passenger interchanges seem a good idea, but they are not universally popular.
Most people prefer a straight-through journey between two points, even if this is less
frequent than an integrated service with interchanges. The reason is probably
because there are more opportunities for things to go wrong, and experience suggests
that even starting a journey does not guarantee that it will successfully finish.
In practice, most major cities such as London and Paris have successful inter-
changes, and they are spreading into smaller towns, such as Montpellier in France.
For the ten years up to 2001 the population of Montpellier grew by more than 8.4
per cent, and it moved from being the 22nd largest town in France to the eighth
largest. It has good transport links with the port of Sète, an airport, inland water-
ways, main road networks and a fast rail link to Paris. In 2001 public transport
was enhanced with a 15 kilometre tramline connecting major sites in the town
centre with other transport links. At the same time, buses were rerouted to connect
to the tram, cycling was encouraged for short distances, park-and-ride services were
improved, and journeys were generally made easier. As a result, there has been an
increase in use of public transport, a reduction in the number of cars in the town
centre, and improved air quality. When the tram opened in 2000, a third of the
population tried it in the first weekend, and it carried a million people within seven
weeks of opening. In 2005, a second tramline will add 19 kilometres to the routes.

Sources: Hellewell D.S. (2000) Improving passenger interchange, Logistics and Transport Focus,
2(6), 32–6; Gemmell C. (2001) An integrated public transport system, Logistics and Transport
Focus, 3(3), 36–42; DTI (1998) A new deal for transport (White Paper, Cmnd 3950), HMSO
 I M P L E M E N T I N G T H E S T R AT E G Y 103

C A S E S T U D Y
Questions
● Are the problems of moving people significantly different from the problems of moving
goods or services?
● What are the benefits of public transport over private transport? Should public transport
be encouraged and, if so, how?
● What are the benefits of integrated public transport systems?

P R O J E C T

Structure of a Supply Chain

Have a look at the supply chain for a familiar product, such as a brand of lager or a CD. Describe the
structure of this chain, emphasising its length and breadth. Why does it have this particular structure?
Discuss the alternative structures and point out their benefits and disadvantages.

DISCUSSION QUESTIONS

1. What exactly is meant by ‘implementing the logistics strategy’?

2. We suggested a difference between strategic decisions that set the principles for logistics,
and those concerned with the practicalities of implementation. Do you think that this is
a real difference? What kind of decisions fit into each category?
3. It is often more difficult to implement a logistics strategy than to design one. This is why
most logistics plans fail in the practice rather than the theory. Do you think that this is
necessarily true? What can organisations do to improve the implementation?
4. What are the main areas for strategic decisions in logistics?
5. Supply chains are not usually designed from scratch, but evolve over time. What prob-
lems does this create? Can you suggest a better approach?
6. Can you find any examples of good logistics strategies that have given poor results
because of poor implementation? What could have been done better?

REFERENCES
1. Ballou R.H. (1981) Reformulating a logistics strategy, International Journal of Physical Distribution and
Materials Management, 11(8), 71–83.
2. Helming W. and Zonnenberg J.P. (2000) The five fulcrum points of a supply chain strategy, Supply Chain
and Logistics Journal, Winter.
3. Rowley J. (2001) Outsourcing across borders in Europe, Logistics and Transport Focus, 3(1), 54–6.
4. Datamonitor (2000) European Logistics 2000, Datamonitor, London.
5. Cubitt B. (2000) Change: the final frontier? Logistics and Transport Focus, 2(3), 39–42.
6. Carnall C. (1991) Managing Change, Routledge, London.
7. Hammer M. and Champy J. (1993) Reengineering the Corporation, HarperCollins, New York.
8. Hammer M. (1996) Beyond Reengineering, HarperCollins, New York.
 CHAPTER 5

Locating Facilities

CONTENTS

■ Aims of the chapter ■ Chapter review

■ Importance of location ■ Case study – Brenner
■ Choosing the geographic Refrigeration Sales
region ■ Project – Poor locations
■ Infinite set approaches ■ Discussion questions
■ Feasible set approaches ■ References
■ Network models ■ Further reading
■ Location planning

AIMS OF THE CHAPTER

After reading this chapter you should be able to:

■ U N D E R S TA N D the importance of location decisions

■ D I S C U S S factors that affect the choice of location
■ D E S C R I B E a hierarchical approach to locating facilities
■ U S E an infinite set approach, such as the centre of gravity
■ C O M PA R E locations using costing and scoring models
■ U S E models for locating facilities on networks
■ C O M B I N E location decisions into a broader approach to
planning
 L O C AT I N G FA C I L I T I E S 105

IMPORTANCE OF LOCATION

Location decisions

In the last chapter we looked at the design of a supply chain. This sets the number and type of
facilities involved in logistics. Now we are going to see where these facilities should be located.

F A C I L I T I E S L O C AT I O N finds the best geographic locations for the different

elements in a supply chain.

Location decisions are needed whenever an organisation opens new facilities. When Toyota
build a new assembly line, or Carrefour open a new store, or Burger King open a new restau-
rant, or Pfizer extend into new markets, they have to make decisions about the best locations.
These are important decisions that affect the organisation’s performance for many years.
If an organisation makes a mistake and opens facilities in a poor location – perhaps after an
investment of millions of euros – it cannot simply close down and move to a better place.
Working in the wrong location can give very poor performance, but moving can be equally
difficult. The only solution, of course, is to choose the right location in the first place. When
Nissan opened a factory in Sunderland in the north-east of England, they put a lot of effort
into choosing the best site, and now have Europe’s most productive car plant. But if they had
chosen a poor location, they could have low productivity, unreliable suppliers, poor materials,
low-quality products and high costs.
The right location does not guarantee success, but the wrong location will certainly guarantee
failure. This is why you do not find nightclubs in residential areas where most people are retired,
big petrol stations on country lanes where they cannot attract passing customers, factories in city
centres where their costs are too high, or oil refineries far away from ports where inward trans-
port would be too expensive. Nonetheless, you can find examples of organisations working in
the wrong place – and going out of business. Sometimes, people do not recognise that a location
is poor, and some sites around town centres have a string of cafes or clothes shops closing down
shortly after they have opened. Some organisations forget that location decisions are for the long
term and are tempted by short-term benefits, such as development grants, temporary rent reduc-
tions, or tax breaks. Such sweeteners can be attractive, but they rarely form the basis of good
decisions. You can also see cases where organisations make the right decisions, but circumstances
change – such as garages that were in good locations before a new bypass opened.
Location decisions are invariably difficult, and organisations have to consider many
factors. Some of these can be measured – or at least estimated – such as operating costs, wage
rates, taxes, currency exchange rates, number of competitors, distance from current locations,
development grants, population, reliability of supplies. Many other factors are non-
quantifiable, such as the quality of infrastructure, political stability, social attitudes, industrial
relations, legal system, future developments of the economy, and so on. When organisations
look at all the circumstances, they often come to similar conclusions. This is why certain
areas or trading estates become popular, as many organisations identify them as the best
place to locate. This leads to certain trends in location. For example, thousands of plants have
opened in the Maquiladoras on Mexico’s northern border. These aim for the low operating
costs in Mexico, while being close to the major market of the USA. Other rapidly growing
areas are in China, central Europe and the Pacific Rim. Within these broad regions, specific
areas are popular, such as Shanghai, Warsaw and Singapore.
106 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

There are other trends in location, such as a growing number of out-of-town malls, super-
markets and retail estates. The major trend towards shorter supply chains means that layers of
intermediaries are disappearing, and logistics is concentrated in fewer facilities. Free trade and
good transport within the European Union, for example, encourages companies to replace
national warehouses by a single European logistics centre.
Call centres give an interesting example of the concentration of operations in fewer loca-
tions. Good communications – with low business telephone costs – mean that organisations
do not need small call centres within each country or region, but they can open a huge, effi-
cient centre in one convenient location. IBM, for example, employ 800 people in their centre
in Greenock near Glasgow, answering questions from customers in 90 countries. Delhi has 40
major call centres, and is expanding this business to employ a quarter of a million people.
When you call the customer service department of any major company, you do not really
know the continent you are calling, let alone the country.

Alternatives to locating new facilities

Choosing a good location is one of the most common problems that organisations face. There
are several reasons why they need to consider location, including:

● the end of a lease on existing premises

● expansion into new geographic areas
● changes in the location of customers or suppliers
● changes to operations -– such as an electricity company moving from coal generators to gas
● upgrading facilities – perhaps to introduce new technology
● changes to transport – such as a switch from rail transport to road
● changes in the transport network – such as the opening of the Channel Tunnel or road
bridge between Sweden and Denmark
● mergers or acquisitions giving duplicate operations that must be rationalised.

You might think that one way of avoiding the problem of locating new facilities is simply to
alter existing ones. This is, however, still a location decision, as it assumes the current site is
the best available. In practice, when an organisation wants to change its facilities – either
expand, move or contract – it has three alternatives:

● expand or change existing facilities at an existing site

● open additional facilities at another site while keeping all existing facilities
● close down existing operations and move.

As a rule of thumb, around 45% of companies expand on the same site, a similar number
open additional facilities, and 10% close down existing operations and move. The most
radical option of completely relocating often has very high costs and is disruptive. The most
conservative option of expanding existing facilities involves little risk and can give economies
of scale.
Even when new facilities are clearly needed, there are different ways of managing them.
Imagine a manufacturer that is expanding, and wants to work in a new market. This seems like
a standard problem of finding the best location for new facilities, but there are several alterna-
tives that are not so expensive. The following list gives five options in order of increasing
investment:
 L O C AT I N G FA C I L I T I E S 107

1. Licensing or franchising: local organisations make and supply the company’s products in
return for a share of the profit.
2. Exporting: the company makes the product in its existing facilities and sells it to a distrib-
utor working in the new market.
3. Local distribution and sales: the company makes the product in its existing facilities, but
sets up its own distribution and sales force in the new market.
4. Local assembly and finishing: the company makes most of the product in existing facilities,
but opens limited facilities in the new market to finish or assemble the final product.
5. Full local production: the company opens complete facilities in the new market.

If it opens new local facilities, an organisation has the benefits of more control over prod-
ucts and the supply chain, higher profits, avoidance of import tariffs and quotas, and closer
links with local customers. On the other hand it has more investment, risk and complex and
uncertain operations. The best choice depends on many factors, such as the capital available,
organisation’s attitude towards risk, target return on investment, existing operations, time-
scale, local knowledge, transport costs, tariffs, trade restrictions and available workforce.

W O R K E D
E X A M P L E

Warwick Supplies is planning to expand into Europe. It is considering a number of options,

each of which has a fixed annual payment (for rent, electricity, and other overheads) and
a variable cost that depends on throughput (handling, depreciation, staff, and so on). The
following table shows a simplified view of these costs.

Alternative Fixed cost Variable cost

A exporting from existing facilities g800,000 g900

B using a local distributor g2,400,000 g700

C open a facility for local finishing g9,000,000 g520

D open limited production facilities g8,000,000 g360

E open larger production facilities g12,000,000 g440

Alternatively, Warwick can avoid entering the market by licensing a local manufacturer to
make the product in return for a royalty of about 2% of sales. How might it approach this
decision, if it is planning on selling about 10,000 units a year with a contribution to profit
of 10%?

Solution
We have a limited amount of financial information, and can use this for a break-even
analysis. You can see from Figure 5.1 that alternatives C and E are never cheapest. This
leaves a choice between alternatives A, B and D.

■ Alternative A is the cheapest for throughput, X, from 0 until:

800,000 + 900X = 2,400,000 + 700X or X = 8,000
108 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

W O R K E D
E X A M P L E
continued

■ After this alternative B is cheapest until:

2,400,000 + 700X = 8,000,000 + 360X or X = 16,471

■ After this point D remains the cheapest.

With production of 10,000 units a year, alternative B, using a local distributor, is cheapest
with costs of (2,400,000 + 10,000 × 700 =) g9.4 million. Alternative A, exporting directly
with existing facilities is not much more expensive at (800,000 + 10,000 × 900 =) g9.8
million, and is probably easier to organise.
Option B has an average cost of g940, and adding a contribution to profit of 10% gives
a selling price of 940 × 1.1 = g1034, and total profit of g940,000. If Warwick negotiated
a royalty of 2% of sales, they would get a profit of only 1034 × 0.02 × 10,000 = g206,800.
Of course, these figures only give the starting point for a decision. Now Warwick have
to look at the more detailed costs, their aims, longer term plans, amount of control they
want, and a whole series of other factors.

2500000

2000000

1500000
Cost in euros

A
B
C
D
1000000 E

500000

0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Production (in thousands)

Figure 5.1 Break-even analysis for location of Warwick Supplies

 L O C AT I N G FA C I L I T I E S 109

CHOOSING THE GEOGRAPHIC REGION

Overall approach

Facility location involves a hierarchy of decisions. At the top of this are the broad decisions
about which geographic regions to work in. Then come more local views that consider alter-
native countries or areas within this region. Then we look more closely at alternative towns
and cities within this area. Finally we consider different sites within a preferred town (as
shown in Figure 5.2). In the 1990s, for example, Marks & Spencer looked at ways to expand its
retail network in central Europe. It worked with a franchisee, and considered various countries,
including the option of opening branches in Poland. It looked at cities within Poland and
decided to open a branch in Warsaw. After looking at available sites it opened a store next to
the Cultural Palace in the city centre.
The broad decisions about geographical regions and countries come from the business
strategy. An organisation with a strategy of global operations or expansion must continually
look for new locations. In the 1990s it was Marks & Spencer’s business strategy to expand and
get close to new customers that led to its shop in Poland. By 2001, however, the company’s
strategy had changed and it closed many of its European operations to concentrate on the UK
market (as a franchise, the Warsaw branch is not affected).
Obvious choices for location are to get close to customers, or close to suppliers. Toyota
opened plants in the USA to get near to the major car market, and Exxon operate in the

Geographical
Business strategy regions for
locations

Culture, costs,
Countries
customers,
and areas
suppliers, etc.

Local conditions Cities and towns

Available sites Individual sites

Figure 5.2 Hierarchy of decisions for locations

110 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Middle East to get near to sources of oil. Another option is to open facilities in areas that give
lower operating costs. Manufacturers move to areas with low production costs, even when
these are some way from both their customers and suppliers. This puts more pressure on logis-
tics. The supply chains become more complicated, but logistics has to be so efficient that lower
production costs are not swamped by higher logistics costs.
A problem with moving to areas with low cost operations is that they might give higher
total costs than expected. Many people assume that low wage rates automatically mean low
total cost. This is not necessarily true, as low wages can be accompanied by very low produc-
tivity: there is no point in halving wage rates if productivity is cut by three quarters. At the
same time, many operations, particularly in manufacturing, are automated so that wages
form a very small part of overall costs. It makes little sense for a high technology company to
move away from its main markets and work in a low wage economy when wages only form
2% of costs.
Another problem is that transport costs change quickly, and rises can make them more
important than operating costs. Large, efficient steel mills in Japan, Taiwan and South Korea,
for example, have low operating costs – but importing coal and iron ore, and transporting
finished steel is so expensive that their delivered price is high. South Africa breweries make
very good beer, but little of it is exported to Europe because of the high transportation costs.
One example of these effects came in 1980 when Tandy Corporation decided to move
production of its latest computer to South Korea. Then rising shipping costs, long lead times
for the sea voyage to the USA, the changing value of the dollar, and more automation in the
process, encouraged them to reconsider their location. In 1987 they moved back to Fort
Worth, Texas and reduced costs by 7.5%.
Perhaps the overriding consideration is that costs may not be a dominant factor in loca-
tion. A logistics strategy might focus on quality, flexibility, speed of response, reliability,
customer service and so forth, rather than lowest cost. As we shall see in the next section, this
means that organisations prefer to locate in areas that are near markets, have reliable suppliers,
good infrastructure, high productivity, guaranteed quality and skilled workforce.

L O G I S T I C S
I N P R A C T I C E
Millicra Electronic Components
Millicra Electronic Components grew as a all planning assembly plants in the Philip-
supplier of parts to the car industry. Until pines. These would meet the rapidly grow-
1997 their operations were based in Pitts- ing domestic market, which was currently
burgh and Detroit, and their main cus- dominated by Japanese manufacturers
tomers were assembly plants around (Toyota 22%, Mitsubishi 21%, Honda 12%
Detroit. Although they had a largely auto- and Nissan 11%) and they would give a
mated process, their costs were still high by low-cost production base for export to
world standards, and they worked in an other countries in the region.
intensively competitive market. Millicra made a decision to join the car-
In 1998 the main US car manufacturers – makers in the Philippines. They were a rela-
General Motors, Ford and Chrysler – were tively small company, and rather than
 L O C AT I N G FA C I L I T I E S 111

L O G I S T I C S
I N P R A C T I C E
continued

spreading operations over three sites, they easy to recruit staff in Manila, but language
decided to close their plants in America. and cultural problems became more obvi-
There were several advantages to this: ous when they started training. The com-
pany found it difficult to implement their
■ production costs in the Philippines
new procedures, and there were a series of
would be much lower than in America
problems with supervision, training and
■ they could get economies of scale from operations, which gave much lower pro-
a single location ductivity than expected.
■ they could introduce the latest methods There were also problems with trans-
and technology port. Shipping costs rose, increasing the
cost of importing components and deliver-
■ they would be near a growing market, ing finished products to the US. The long
with easy transport back to their existing sea journeys inevitably increased uncer-
customers tainty, tied up stock in the supply chain and
■ the Philippine government gave a six year slowed responses to both customers and
income tax holiday and other tax breaks suppliers.
By 2001 Millicra’s old customers in the
■ there was a pool of cheap labour ready US had formed alliances with a new local
for training.
supplier, and demand in the Philippines
The company allowed six months to was lower than forecast. The world econ-
move equipment and other materials from omy was slowing, particularly in Japan and
America and another six months to iron out the USA, and many local economies moved
production problems. Only one or two of into recession. Millicra could see no end to
their experienced managers moved to the their problems, and ceased trading in
Philippines, and the rest took early retire- August 2001.
ment or moved to other employers. All of
Sources: Marozzi J. (1998) Chrysler and GM
the hourly paid workers in the American follow Ford’s path to Philippines, Financial Times,
plants were laid off. Millicra found it fairly 17 April and internal company records

Considerations in choosing regions

Organisations have to consider many factors when choosing the general regions to work in.
The following list includes some of the most important:

● Location of customers: Service providers must generally be close to their customers – which
is why you find shops, buses, libraries, restaurants, solicitors, banks and so on in town
centres. The same arguments hold for manufactured products which have a high cost of
delivery to final customers – which is why there are many local bakers, brewers, dairies
and double glazing factories. Sometimes being close to customers is particularly impor-
tant, as with just-in-time operations (which we describe in Chapter 7).
112 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

● Location of suppliers and materials: Manufacturers are more likely to locate near to
supplies of raw materials, particularly if these are heavy or bulky. This is why coal-
burning power stations are close to coalmines and pulp mills are near to timber forests.
Some operations have to be close to perishable materials – encouraging fruit and
vegetable processors to move close to farms, and frozen seafood companies near to
fishing ports.

● Culture: It is easier to expand into an area that has a similar language, culture, laws and
costs, than to expand into a completely foreign area. A company currently operating in
Belgium would find it easier to expand in France than in, say, Korea. The decision to build
Disneyland Europe near Paris gives one example where moving a successful American
operation to a European culture met with less initial success than expected.

● Government attitudes: National and local government policies can seriously affect an
area’s attractiveness. Investment in Hong Kong, for example, has fallen since its return
to rule by China. Many governments offer incentives for companies to move into an
area – but others are less welcoming, perhaps trying to control foreign influences on the
economy. Some areas encourage particular types of industry (particularly high tech-
nology or finance companies), but are less keen on, say, nuclear, chemical or polluting
industries.

● Direct costs: These are the costs of operations, including wages, materials, overheads and
utilities. They can vary widely. The most attractive locations offer a combination of low
direct costs and high performance. Often there is a balance, with higher productivity
coming at higher cost. Many organisations prefer to locate in high cost areas to get the
other benefits they bring.

● Indirect costs: There can be many indirect costs of doing business, including local taxes
and charges on the payroll such as social insurance, pension and social costs. There may
also be controls on company ownership (often including a controlling local partner),
currency exchange and repatriation of profits.

● Exchange rates: These can appear as indirect costs, but they are much less predictable.
What seems like a good location one year can become much less attractive after a re-
alignment of currency values.

● Social attitudes: Some countries put more emphasis on social welfare than others, and
there may be higher union membership or emphasis on individual rather than corporate
benefits. Other areas do not necessarily admire ‘high productivity’ methods and there
might be higher absenteeism and staff turnover.

● Organisation: An organisation can keep a close check on new operations by controlling

these from existing headquarters and giving local operations very little autonomy. This is,
however, inflexible, and it does not allow local organisations to adapt to their own condi-
tions or develop skills. An alternative is to devolve decisions. Then a company might
become international (maintaining its headquarters in the home country and running
worldwide activities from there), multinational (opening subsidiary headquarters around
the world so that each area is largely independent) or global (treating the whole world as
a single, integrated market).
 L O C AT I N G FA C I L I T I E S 113

● Operations: If you go into a McDonald’s hamburger restaurant anywhere in the world you
will see virtually identical operations. It is easier to control operations in this way, but it
loses the benefit of local knowledge and practices. Other organisations blend into the local
environment and adapt their operations so they are more familiar to their host countries.

L O G I S T I C S
I N P R A C T I C E
McDonald’s in Moscow
In 1990 the world’s largest McDonald’s the restaurant. Potatoes were plentiful, but
hamburger restaurant with 700 seats they were the wrong type to make McDon-
opened just off Pushkin Square in Moscow. ald’s fries. Seed potatoes were imported
This is operated jointly by McDonald’s of and grown. Russian cheese was not suitable
Canada and local Russian companies. for cheeseburgers, so a dairy plant was
McDonald’s has opened branches through- opened to make processed cheese.
out the world, but this was one of the most When the restaurant opened it was a
difficult, with negotiations starting twenty huge success, with 27,000 people applying
years previously with the Soviet Union. for a single job, 50,000 people served a day
The inside of the restaurant is exactly as and queues half a mile long outside the
you would expect, with the standard restaurant. Now there are 58 outlets in Rus-
menu, colour scheme and decor, staff train- sia and a workforce of 450. But the path is
ing, levels of cleanliness and cooking. still not easy. Russia suffered an economic
Everything follows the standard McDon- collapse in 1998, and this has affected
ald’s pattern, but this was only achieved wages, sales and profits. The initial set up
after considerable effort. As well as the ini- cost was so high that the restaurant does
tial political difficulties, there were major not expect to make a profit in the foresee-
practical problems. Beef in Moscow was able future.
not readily available and the quality was
Sources: company reports and Cockburn P., Big
variable. McDonald’s had to import breed-
Mac, big trouble, Independent, 14/11/2000
ing cattle and start a beef farm to supply

INFINITE SET APPROACHES

After making a decision about the geographical region and country, an organisation has to
look in more detail at the areas, towns, cities and individual sites. There are several ways they
can approach these decisions, and the best depends on specific circumstances. One approach
that is not recommended is personal preference. There are many examples of poor locations
where managers simply chose a site they liked – perhaps in the town they lived or grew up in,
or the area they spent their holidays. Of course, such decisions can be successful, but their
main weakness is unreliability. It is always safer to do some analyses than to rely on intuition
and guesswork.
114 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Two distinct approaches to location decisions are:

1. Infinite set approach – which uses geometric arguments to find the best location, assuming
that there are no restrictions on site availability.
2. Feasible set approach – where there are only a small number of feasible sites, and an organi-
sation has to choose the best.

An infinite set approach finds the best location in principle and then looks for a site
nearby; a feasible set approach compares sites that are currently available and chooses the
best. These approaches are often used together, with an infinite set approach finding the best
location in principle, and then a feasible set approach comparing available sites near to this.
We will start by describing an infinite set approach, and then move on to look at methods for
comparing sites.

Simple models

Hoover1 was the first person to specify the three basic alternatives for location. First, a facility
can be located near to customers; this gives good customer service and low costs for transport
out to customers, but high cost for transport in from suppliers. Second, it can be located near
to suppliers; this moves products quickly into the supply chain, gives low costs for inward
transport, but high costs for outward transport. Third, it can be located at some point between
suppliers and customers, giving a compromise with reasonable service and lower costs (as illus-
trated in Figures 5.3 and 5.4).

Customers
(a) Near to customers Suppliers

Customers
(b) Near to suppliers Suppliers

Customers (c) Compromise position

Suppliers

Figure 5.3 Alternative choices of location

 L O C AT I N G FA C I L I T I E S 115

Cost

Total cost

Outward Inward
transport transport

Locations near to Locations near

customers to suppliers

Figure 5.4 Variation in transport cost with location

A simple way of finding the best compromise location calculates the centre of gravity of
supply and demand.2 The co-ordinates of the centre of gravity are:

∑ Xi W i ∑Y i W i
X0 = Y0 =
∑W i ∑W i

Where:

(Xo, Y0 ) are the co-ordinates of the centre of gravity which gives the facility location
(Xi, Yi ) are co-ordinates of each customer and supplier, i

Wi is expected demand at customer i, or expected supply from supplier i

W O R K E D
E X A M P L E

Van Hendrick Industries is building a central logistics centre that will collect components
from three suppliers, and send finished goods to six regional warehouses. The locations of
these and the amounts supplied or demanded are shown in the following table. Where
should they start looking for a site?

Location X,Y co-ordinates Supply or demand

Supplier 1 91,8 40
Supplier 2 93,35 60
Supplier 3 3,86 80
Warehouse 1 83,26 24
Warehouse 2 89,54 16
116 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

W O R K E D
E X A M P L E
continued

Location X,Y co-ordinates Supply or demand

Warehouse 3 63,87 22
Warehouse 4 11,85 38
Warehouse 5 9,16 52
Warehouse 6 44,48 28

Solution
Figure 5.5 shows a spreadsheet for these calculations.
As you can see, the centre of gravity is X0 = 45.5 and Y0 = 50.3, which you can check
by calculating:

∑ Xi W i 16,380
X0 = = = 45.5
∑W i 360

∑Y i W i 18,108
Y0 = = = 50.3
∑W i 360

A good place to start looking for locations is around (45.5, 50.3). As this is very close
to warehouse 6 it might be better to expand on this site rather than look for an entirely
new location (as shown in Figure 5.6).

A B C D E F
1 Centre of gravity
2
3
4 X Y Weight X*Weight Y*Weight
5 Supplier
6 1 91 8 40 3640 320
7 2 93 35 60 5580 2100
8 3 3 86 80 240 6880
9
10 Warehouse
11 1 83 26 24 1992 624
12 2 89 54 16 1424 864
13 3 63 87 22 1386 1914
14 4 11 85 38 418 3230
15 5 9 16 52 468 832
16 6 44 48 28 1232 1344
17
18 Totals 360 16380 18108
19
20 Centre of X= 45.5
21 Gravity Y= 50.3

Figure 5.5 Calculation of centre of gravity

 L O C AT I N G FA C I L I T I E S 117

100

S3
90
W3
W4
80

70

60
Centre of gravity W2
50
W6

40
S2
30
W1
20
W5
S1
10

0
0 10 20 30 40 50 60 70 80 90 100

Figure 5.6 Locations for van Hendrick Industries

The centre of gravity can give a reasonable location, but we can easily show one of its
weaknesses. Suppose you work in Alberta, Canada and want to deliver 20 tonnes of materials a
day to Edmonton and 40 tonnes a day to Calgary. These two cities are connected by a straight
road 300 km long (see Figure 5.7). If the costs of getting deliveries from suppliers are the same
regardless of location, where would you build a warehouse?
The centre of gravity is ((40 × 300 + 20 × 0)/60 = ) 200 km from Edmonton. A warehouse
here would have to deliver 200 × 20 tonne/kilometres to Edmonton and 100 × 40 tonne/kilo-
metres to Calgary, giving a total of 8000 tonne/kilometres. But if you built the warehouse in
Calgary, you would only have to move 20 × 300 = 6000 tonne/kilometres to Edmonton. This
gives one rule of thumb, which says that a good location is in the centre of highest demand.

Edmonton Calgary

300km

200km 100km

20 tonnes Centre of 40 tonnes

gravity

Figure 5.7 Weakness of the centre of gravity method

118 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Adjusting the model

We can improve the basic centre of gravity model in many ways. We can, for example, use
actual road distances rather than the straight-line distances of our calculation. Often the speed
of delivery is more important than the distance, so we can replace distance by travel time, or
we can use some more direct measure of cost. We can also adjust the basic calculation, perhaps
replacing the straightforward tonne/kilometre measure by a weighted value or some function
of cost. Another approach is to use an iterative calculation which keeps searching for a better
location. One method of this kind takes an initial location, and then iteratively improves it
using the equations.3

xn+1 = ∑ c jw jx j/ d j
∑ c jw j/ d j

yn+1 = ∑ c jw jy j/ d j
∑ c jw j/ d j

where: xn+1 and yn+1 are the next iterated values for the facility co-ordinates
xj and yj are the co-ordinates of customers and suppliers
cj = cost of moving one unit of material a unit distance
wj = weight moved to or from location j
dj = distance from the last iterated position of the facility to location j

Infinite set approaches only need a limited amount of data, typically the locations of
customers and suppliers and some measure of distance or cost. But even this data has to be
approximated, as few organisations know exactly who their customers will be until they start
local operations. Another problem is that the location suggested might not be practical. There
may be no suitable site available anywhere near the solution, or available sites may be too
expensive, or further development may be prohibited, or there may be no roads or workforce,
or the solution might be at the top of a mountain or in the sea. To get around such problems,
we can use the alternative approach of identifying available sites and choosing the best.

L O G I S T I C S
I N P R A C T I C E
Warehouse locations in the USA
For many products we can use the popula- In the UK the centre of gravity of popu-
tion of an area as a surrogate for the lation is near to Birmingham, and this
demand. The population of Stockholm is might be a useful place to start looking for
three times the population of Oslo, so we a facility. In the USA the centre of gravity of
can assume that the demand for a wide population is in Terre Haute, Indiana.
range of products is also three times as We can go further with this approach
large. Then we can look at the population and find the best locations for two or more
distribution, and use the centre of gravity of facilities. With continental USA as an
population to approximate the centre of example we get the following results.
gravity of demand.
 L O C AT I N G FA C I L I T I E S 119

L O G I S T I C S
I N P R A C T I C E
continued

Number Best locations Average distance

of facilities to a customer
1 Terre Haute, IN 859 miles
2 Chillicothe, OH; Fresno, CA 490 miles
3 Allentown, PA; Paducah, KY; Fresno, CA 378 miles
4 Caldwell, NJ; Cincinnati, OH; Stockton, CA;
Dallas, TX 322 miles
5 Summit, NJ; Macon, GA; Dallas, TX; Stockton, CA;
Gary, IN 268 miles

With ten facilities, the average distance and demographic data, and does this kind
to a customer is 174 miles. These figures of analyses to find the best locations for
are based on raw population data, but we serving different types of market.
could refine the approach to look at differ-
Sources: Anon. (1998) Are you putting goods in
ent parts of the population or target mar-
the right location? Purchasing 124(6), 115 and
kets. A lot of software combines geographic report by Chicago Consulting

FEASIBLE SET APPROACHES

Costing models

Feasible set approaches identify available sites, compare them, and find the best. An obvious
analysis calculates the total cost of working from each location and finds the cheapest. In prac-
tice, many of the costs of running a facility are fixed regardless of its location. Then instead of
looking at the total cost, we can concentrate on those costs that vary, particularly the transport
and operating costs.
Total variable cost = Operating cost + Inward transport cost + Outward transport cost
of a facility

Locations near to customers have higher costs of inward transport, and those near to
suppliers have higher costs of outward transport, so the best location is likely to be somewhere
in between. An obvious problem, though, is that we do not know the real costs before we actu-
ally open a facility. How, for example, can we know the cost of outward transport when we do
not know in advance who our customers will be or how much they will demand? Even if we
have good forecasts of demand, the costs will change over time and the analysis becomes
outdated. As a result, these cost calculations are useful for comparisons, but they are not
necessarily the costs that will actually be incurred.
If we can only use the costs for comparisons, we might as well make the calculations as
easy as possible. For example, the operating costs in nearby locations might be virtually the
same, so we can remove these from the equation and concentrate of transport costs. It is diffi-
cult to find the exact cost of delivering to any particular customer, so we can assume that the
transport cost is proportional to the distance moved. In practice, of course, the cost depends
on more than distance, and is also affected by the type of vehicles, frequency of journeys,
120 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

routes taken, ways of combining customer orders, organisation of drivers, order patterns, and
so on. Nonetheless, we are only using these figures for comparison, so can use any reasonable
approximations. Another shortcut uses map references or co-ordinates to find the rectilinear
distance between points.

Rectilinear Distance = Difference in + Difference in

X co-ordinates Y co-ordinates

Then we can use this simple measure to identify the location with the lowest total value of
load × rectilinear distance moved.

W O R K E D
E X A M P L E

Bannerman Industries want to build a depot to serve seven major customers located at co-
ordinates (100, 110), (120,130), (220, 150), (180, 210), (140, 170), (130, 180) and (170,
80). Average weekly demands, in vehicle loads, are 20, 5, 9, 12, 24, 11 and 8 respectively.
Three alternative locations are available at (120, 90), (160, 170) and (180,130). Which is
the best site if operating costs and inward transport costs are the same for each location?

Solution
Figure 5.8 shows a map for this problem.
As operating and transport inward costs are the same for all three locations, we only
need a way of comparing the costs of local deliveries from each. For simplicity we will use
the rectilinear distance to customers. Then the distance from A to customer 1 is:
difference in + difference in = (120–100) + (130–110) = 40
X co-ordinates Y co-ordinates
The calculations for this problem are given in Figure 5.9, which shows that site B is
clearly best.

250

4
200
6
5 B

150
3
2 C

1
100
A
7

50

0
0 50 100 150 200 250

Figure 5.8 Map for Bannerman Industries

 L O C AT I N G FA C I L I T I E S 121

A B C D E F G H
1 Customer Site A Site B Site C
2 Load Distance Distance * Load Distance Distance * Load Distance Distance * Load
3 1 20 40 800 120 2400 100 2000
4 2 5 40 200 80 400 60 300
5 3 9 160 1440 80 720 60 540
6 4 12 180 2160 60 720 80 960
7 5 24 100 2400 20 480 80 1920
8 6 11 100 1100 40 440 100 1100
9 7 8 60 480 100 800 60 480
10
11 Totals 8580 5960 7300

Figure 5.9 Comparison of sites

We can use a version of this costing model to find the best number of facilities. The argu-
ment runs as follows.

● If an organisation concentrates activities in a few key locations – such as main logistics

centres – inward transport consists of large deliveries made to a few facilities and the cost
is low. However, the few facilities are, on average, further away from customers and the
outward transport cost is high.

● If there are a large number of spread-out facilities – such as retail shops – inward transport
consists of small deliveries to more destinations and the cost is high. The facilities are, on
average, nearer to customers, so they have the benefits of higher customer service and
lower outward transport cost.

(a) Few facilities give low

cost for inward transport,
but high cost for outward
transport
➛

(b) More facilities give high ➛

cost for inward transport,
but low cost for outward
transport ➛
➛

Figure 5.10 Variation in transport cost with number of facilities

122 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Cost

Total cost

Inward
transport

Operations

Outward
transport

Optimal number Number of

of facilities facilities

Figure 5.11 Finding the optimal number of facilities

● Operating costs also vary with facility size, with larger facilities generally more efficient
and giving economies of scale. Remember, though, that larger facilities do not necessarily
give economies of scale, and there can be real ‘diseconomies’ caused by higher cost of
supervision, co-ordination, communication and so on.

Figure 5.10 shows how these transport costs vary. If we plot transport and operating costs
against the number of facilities we get the pattern shown in Figure 5.11. This has a clear mini-
mum which corresponds to the optimal number of facilities. In practice, of course, before we
make such a decision we have to consider many other factors, such as management costs, com-
munications, fixed costs, employment effects, customer service, information flows, and so on.

Scoring models

Costing models can give useful comparisons, but they have weaknesses, including the diffi-
culty of finding accurate costs, data that depends on accounting conventions, costs that vary
over time, customer locations not being known in advance, order sizes not known in advance,
factors that cannot be costed, and so on. It is often better to avoid these problems and use
some other method for comparison. The most common alternative is a scoring model.
Scoring models emphasise the factors that are important for locations, but which cannot
easily be costed or quantified. For example, an attractive lifestyle in one location would
certainly benefit employees, reduce employee turnover and assist in recruiting – but we could
not assign a realistic cost or measure to the lifestyle. This is a common problem and Andel4
quotes a commercial estate agent’s view that, ‘More often than not, the decision on site selec-
tion is based upon factors you can’t always put in a matrix or express quantitatively.’
Even if we cannot quantify the important factors, we still need to identify them. Gooley5
says that the important factors in location decisions are the infrastructure, proximity of
suppliers and customers, political and tax considerations, and international trade conditions.
A more complete list of factors includes:
 L O C AT I N G FA C I L I T I E S 123

● In the region and country

● availability, skills and productivity of workforce
● local and national government policies, regulations, grants and attitudes
● political stability
● economic strength and trends
● climate and attractiveness of locations
● quality of life – including health, education, welfare and culture
● location of major suppliers and markets
● infrastructure – particularly transport and communications
● culture and attitudes of people.

● In the city or area

● population and population trends
● availability of sites and development issues
● number, size and location of competitors
● local regulations and restrictions on operations
● community feelings
● local services, including transport and utilities.

● In the site
● amount and type of passing traffic
● ease of access and parking
● access to public transport
● organisations working nearby
● total costs of the site
● potential for expansion or changes.

Although we cannot quantify these factors directly, we can move in this direction by giving
each a score. This is what happens with hotels: you cannot measure the quality of an hotel,
but when you see that one has been awarded five stars you know that it is very good. This is
the basis of scoring models, which have the following five steps:

Step 1 decide the relevant factors in a decision

Step 2 give each factor a maximum possible score that shows its importance
Step 3 consider each location in turn and give an actual score for each factor, up to this
maximum
Step 4 add the total score for each location and find the highest
Step 5 discuss the result and make a final decision.

W O R K E D
E X A M P L E

Williams-Practar considered five alternative locations for a new warehouse for their music
distribution business. After many discussions they compiled a list of important factors,
their maximum scores, and actual scores for each site. What is the relative importance of
each factor? Which site would you recommend?
124 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

W O R K E D
E X A M P L E
continued

Factor Maximum score A B C D E

Climate 10 8 6 9 7 5
Infrastructure 20 12 16 15 8 13
Accessibility 10 6 8 7 9 9
Construction cost 5 3 1 4 2 1
Community attitude 10 6 8 7 4 8
Government views 5 2 2 3 4 3
Closeness to suppliers 15 10 10 13 13 10
Closeness to customers 20 12 10 15 17 10
Availability of workforce 5 1 2 4 5 3

Solution
The most important factors are the available infrastructure and closeness to customers,
with 20 points each. The closeness of suppliers is a bit less important with up to 15 points,
and then come climate, accessibility and community attitude with up to 10 points each.
Construction cost, government views and availability of workforce are least important.
Adding the scores for each location gives:
Location A B C D E
Total Scores 60 63 77 69 62
These scores suggest that location C is the best. The company should now consider all
other relevant information before coming to a final decision.

Rather than changing the maximum score for each factor, some people prefer to give each
factor the same maximum score, but multiply the actual score by a weight to show its impor-
tance. In the example above we might give each factor a score out of ten, and then multiply
the scores for climate by 1.0, the scores for infrastructure by 2.0, the scores for accessibility by
1.0, the scores for construction cost by 0.5 and so on.

Important factors for scoring models

The list of important factors and weight given to each obviously depends on the circum-
stances. Manufacturers look for economies of scale by building large facilities that are often
near to raw materials. Then decisions about the location for a new factory are dominated by:

● availability of a workforce with appropriate skills

● labour relations and community attitudes
● environment and quality of life for employees
● closeness of suppliers and services
 L O C AT I N G FA C I L I T I E S 125

● quality of infrastructure
● government policies toward industry.

On the other hand, services cannot be kept in stock, so they look for smaller locations that
are near to customers. Their decisions about location put more weight on:

● population density
● socio-economic characteristics of the nearby population
● location of competitors and other services
● location of other attractions such as retail shops
● convenience for passing traffic and public transport
● ease of access and convenient parking
● visibility of site.

The objectives in locating factories and services are clearly different, which is why town
centres have shops but no factories, and industrial estates have factories but no shops.

L O G I S T I C S
I N P R A C T I C E
Intel in Costa Rica
Deloitte & Touche Fantus developed a list development. To encourage Intel, Costa
of factors that high-tech industries consider Rica offered eight years free of income tax,
in their location decisions. This includes: followed by four years at half rate, duty-free
import of materials, and unrestricted move-
Essential factors:
ment of money into and out of the country.
■ skilled and educated workforce
In addition, they granted licenses to foreign
■ proximity of research institutions
airlines to increase the number of interna-
■ attractive quality of life
tional flights, built a new power sub-station
■ access to venture capital.
for the site, reduced their cost of electricity
Important factors: by 28%, and reduced the liability for cor-
■ reasonable cost of doing business poration tax.
■ established technology industry Intel decided to locate a $300 million
■ adequate infrastructure semiconductor testing and assembly plant
■ favourable business climate and near to San José, which started work in
regulations. 1998 and, within two years, employed
2000 people.
Desirable factors:
Chuck Mulloy, a spokesman for Intel,
■ established suppliers and partners
said: ‘When we are considering a site we
■ community incentives.
use a multifaceted set of criteria. Incentives
Intel Corporation is the world’s leading are part of this.’
producer of semiconductor devices. In the
Sources: Wall Street Journal Special Report, 25
mid 1990s it was planning a new expan-
September 2000, and website at www.interactive.
sion, and Costa Rica was keen to get the wsj.com
126 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

NETWORK MODELS

Sometimes it is difficult to relate the two approaches we have described to actual road layout
and geographic features. There are, however, many databases of road networks that automati-
cally find the best routes between two points, such as Microsoft AutoRoute Express and
Softkey Journey Planner. Typically, you supply the postcode of starting and finishing locations,
and the package finds the shortest, fastest or cheapest route, or route with some other features.
Then it gives details of the journey, locations and any other relevant information. Such
systems can be put into vehicles, and combined with global positioning and traffic monitoring
systems to find the best route from any current position to an endpoint.
These electronic maps of road networks allow another approach to location, which is based
on actual road layouts. A huge number of models have been built for this kind of analysis, so
we will illustrate typical approaches by two standard models, known as the single median
problem and the covering problem.

Single median problem

Imagine a network of towns connected by roads. There are demands for some product in each
town, and you want to locate a depot to deliver to these towns. In principle the best location
could be anywhere on the network, and might be on a roadside rather than in one of the
towns. However, a standard analysis6 shows that the best location is always in a town. This
makes the problem much easier, as we only have to compare locations in each town and iden-
tify the one that gives the best value for some measure of performance. A common measure is
average travel distance or time, and finding the shortest is called the single median problem.
The easiest way to find the single median starts with a matrix of the shortest distances
between towns. In practice, we can find this from route planning software, or using some
surrogate measure such as the straight-line or rectilinear distance. To find the shortest average
distance, we have to combine these distances with the loads carried. So we multiply the
distances by the demands at each town, to get a matrix of the weight-distances. Then we add
these for each town, and find the lowest overall value.

W O R K E D
E X A M P L E

Ian Bruce delivers goods to eight towns, with locations and demands as shown in
Figure 5.12. He wants to find the location for a logistics centre that minimises the average
delivery time to these towns. Where should he start looking?

Solution
This is a single median problem, so we start with a matrix showing the minimum distances
between each town, as shown in Figure 5.13. This matrix also shows the weight to be
moved in column B. If we take one column, say C, this shows the distance from a centre
located in AL to each other town. If we multiply this distance by the corresponding weight
in column B, we get the weight-distance for each town. Then adding these down the col-
umn gives the total weight-distance for a logistics centre in AL, shown in Row 12.
 L O C AT I N G FA C I L I T I E S 127

W O R K E D
E X A M P L E
continued

Weight-distance of a centre at AL = (10 × 0) + (15 × 15) + (25 × 22) + (20 × 24)

+ (20 × 31) + (10 × 28) + (10 × 32) + (15 × 36) = 3015

Repeating this calculation for each of the other towns allows us to compare the costs
across Row 12. As you can see, town EN has the lowest total cost, and is the single
median. Ian should start looking for a location around this town.

20
10
8
10
DI
9 GO
15 15
AL
BE 7 14

22 8 EN HT
20 5
15
6

CP
6 FR
25
10

Figure 5.12 Map of Ian Bruce’s problem

A B C D E F G H I J
1
2 Weight AL BE CP DI EN FR GO HT
3 AL 10 0 15 22 24 31 28 32 36
4 BE 15 15 0 8 9 16 14 17 21
5 CP 25 22 8 0 17 12 6 25 17
6 DI 20 24 9 17 0 7 13 8 12
7 EN 20 31 16 12 7 0 6 15 5
8 FR 10 28 14 6 13 6 0 21 11
9 GO 10 32 17 25 8 15 21 0 14
10 HT 15 36 21 17 12 5 11 14 0
11
12 Totals 125 3015 1475 1485 1330 1275 1395 2080 1690

Figure 5.13 Spreadsheet of calculations for Ian Bruce

128 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Covering problem

Sometimes the average distance or time to a facility is less important than the maximum time.
Classic examples of this are fire engines and ambulances which try to respond to emergencies
within a maximum time. In the same way, suppliers often guarantee deliveries within one
working day. This is an example of the covering problem.
There are two versions of the covering problem. In the first version, we are looking for the
single location that gives the best service to all towns – in other words we want the location
that gives the lowest value for the maximum time needed to reach any town. If, say, we choose
location A the longest time to reach any customer is 4 hours, but if we choose location B the
longest time to reach any customer is only 3 hours – so location B is clearly better. To solve this
problem we simply compare the longest journey times from each location, and choose the
location with the shortest of these.
The second version of the covering problem specifies a level of service that must be
achieved. This might need an ambulance to arrive within ten minutes, or a parcel to be deliv-
ered within four hours. The problem is then to find the number of facilities needed to achieve
this, and their best locations.
For both of these problems the best location might, in principle, be at any point of the
road network. However, we can again use the standard finding that the best location is always
in one of the towns. This is a common result for network problems, and it makes them much
easier to solve.

W O R K E D
E X A M P L E

Figure 5.14 shows part of a road network, with the travel time (in minutes) shown on each
link. Where would you locate a depot to give best customer service? How many depots
would be needed to give a maximum journey of 15 minutes?

Solution
We could, of course, do the calculations for this covering problem, finding the maximum
time for each town and identifying the best, and then finding the combination of towns
that gives service times of less than 15 minutes. There is no need for this, as a lot of soft-
ware solves network problems and Figure 5.15 shows a printout from a simple package.
As you can see, if a single location is needed the package recommends town C, giving a
maximum journey of 25 minutes. If this is too much, facilities at A and I will reduce the
maximum journey to 15 minutes.
 L O C AT I N G FA C I L I T I E S 129

G 4

15
E
3

6
B 10
J
10
14
5
F
6 3
A C
I
15
10

15
D
10

Figure 5.14 Road network showing travel time in minutes between locations

A B C D E F G H I J K
1 Covering problem
2
3 Distance matrix
4
5 A B C D E F G H I J
6 A 0 10 24 10 29 29 25 20 35 32
7 B 10 0 14 20 19 19 15 30 25 22
8 C 24 14 0 15 11 5 15 25 11 14
9 D 10 20 15 0 26 20 30 10 25 29
10 E 29 19 11 26 0 6 4 23 8 3
11 F 29 19 5 20 6 0 10 21 6 10
12 G 25 15 15 30 4 10 0 27 12 7
13 H 20 30 25 10 23 21 27 0 15 20
14 I 35 25 11 25 8 6 12 15 0 5
15 J 32 22 14 29 3 10 7 20 5 0
16 Maximum 35 30 25 30 29 29 30 30 35 32
17
18 Single location C
19 Maximum time 25
20
21 Two locations A I
22 A 0
23 B 10
24 C 11
25 D 10
26 E 8
27 F 6
28 G 12
29 H 15
30 I 0
31 J 5
32 Maximum time 10 15

Figure 5.15 Solution to the covering problem

130 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

LOCATION PLANNING

We have described several approaches to location, but these are by no means the only ones.
Useful models range from simple rules of thumb (such as, ‘locate near to a similar operation
that is already working successfully’) through to more complex methods (such as mathemat-
ical programming). Whichever methods you choose, they need not work in isolation. We
could, for example, use an infinite set approach to find the best general area, followed by a
finite set approach to compare available sites nearby. A more formal procedure has the
following five steps:

Step 1 Identify the features needed in a new location, determined by the business and logis-
tics strategies, structure of the supply chain, aims, customers, and other relevant
factors. Look for regions and countries that can best supply these.
Step 2 Within the identified region, use an infinite set approach – such as the centre of
gravity or similar model – to find the best area for locations.
Step 3 Search around this area to find a feasible set of available locations.
Step 4 Use a feasible set approach – such as a costing model or scoring model – to compare
these alternatives.
Step 5 Discuss all available information and come to a decision.

Locating facilities is always difficult, and it is important enough for organisations to look at
every available analysis before reaching a conclusion. An important point is that this hierarchy
of location decisions should fit into the logistics strategy. If the logistics strategy calls for short
delivery times, then facilities must be in locations that can achieve this; if the strategy calls for
low costs, facilities will probably be centralised to get economies of scale.
We can describe a useful approach for co-ordinating location decisions with other decisions
about the supply chain. For this, we start by recalling what we want the supply chain to do,
then examine the current supply chain’s performance, identify any problems and design ways
of overcoming these. To be more specific, we can use the following procedure:

1. Examine the overall aims, looking at the logistics strategy and other plans to identify the
aims and goals of logistics in terms of customer service, costs, timing, and so on.
2. Do a logistics audit, describing the details of the current logistics system, including the
location of facilities, network connecting these, measures of performance, and industry
benchmarks.
3. Identify mismatches, where there are differences between the aims (from step 1) and actual
performance (from step 2).
4. Examine alternatives for overcoming the mismatch, looking in general terms to see where and
how the structure of the supply chain can be improved.
5. Location decisions, having set the general features of the supply chain, look in detail at the
facilities needed. Use appropriate models to find the best locations and sizes for these
facilities.
6. Confirm the locations, making sure that the locations identified in step 5 really are best,
and work with the structure identified in step 4.
7. Implement and monitor the solutions, doing whatever is needed to execute the changes and
continuing to check performance.

In this procedure you can see that part 4 designs the general features of the supply chain.
Then part 5 adds some details by finding the best locations – using the five-step procedure
 L O C AT I N G FA C I L I T I E S 131

described above. As with most planning, this is more complicated than it seems, and we
usually need to iteratively revise the plans until we find a satisfactory solution. By part 6 we
have confirmed that the locations are good, and continue to implement the results. We return
to this theme of planning in the next chapter.

❑ Location decisions find the best geographical positions for the facilities in a
CHAPTER REVIEW ■ ■ ■ ■ ■ ■ ■

supply chain. These are important, strategic decisions with long-term effects
on an organisation’s performance.
❑ A location decision is needed whenever an organisation expands, contracts,
or there are major changes to its operations. The choice of best location
depends on many different factors.
❑ There is a hierarchy of location decisions. This starts with a decision about the
region or country to work in, which is influenced by the logistics strategy.
Following decisions identify the best area, town and eventually the specific site.
❑ Infinite set approaches use geometrical arguments to show where the best
location would be in principle. We illustrated this with the centre of gravity
method.
❑ Finite set approaches compare a limited number of feasible locations and find
the best. We illustrated this by costing and scoring models.
❑ Sometimes it is better to consider location in the context of a network of
towns and roads. There are many models for this, which we illustrated by the
median and covering problems.
❑ Finding the best location must fit in with broader business and logistics plans.
We described a general approach to planning which brings these different
ideas together.

C A S E S T U D Y Brenner Refrigeration Sales

John Brenner had worked for the same domestic appliance retailer for over twenty
years when he saw an advertisement from an East European manufacturer which
wanted to start selling its brand of appliances in the UK. John answered the adver-
tisement and spent a year preparing and negotiating with the manufacturer.
The manufacturer was not keen to have all its distribution done by a new and
untried company. In the end John agreed to set up a company called Brenner Refrig-
eration Sales, and the manufacturers agreed to give him exclusive rights to
132 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

C A S E S T U D Y continued

distribute their products throughout Britain for two years. The agreement would be
reviewed after a year and renegotiated after two years.
John invited three other directors to join the company. Their first problem was to
find a location for the head office and main logistics centre. This centre would
receive appliances directly from the manufacturer, and deliver them to retailers
around the country. The directors realised that their future success depended on this
site, but found it difficult to agree on a location.
They considered passing the problem to a firm of management consultants, but
one of the directors discovered that similar companies paid up to £50,000 for an
initial report and £125,000 for a more detailed study. The directors felt that this
was too expensive and they would have to solve the problem themselves. The
following summary gives an idea of their discussions.

■ Stefan Maior worked as a service repairman for many years before being promoted
to service manager. He is now 54 years old and is looking for an opportunity to
make some money for his retirement. Stefan argues that the location should be in
Leeds. The appliances could be shipped to Liverpool or Hull, and then brought to
Leeds by train. Leeds has a good transport system and it is a major population
centre. Two of the directors live in Leeds and they understand local conditions.

■ Pradesh Gupta has a degree in mechanical engineering, and has worked as an

economic consultant in eastern Europe. He knows the manufacturer and is
impressed by their progressive attitudes. Pradesh is critical of Stefan’s approach
as being old fashioned and relying more on where he feels at home than on any
business criterion. He says that the sale of appliances is likely to depend on the
population so they should look at a map of Britain, see where the main centres
of population are, see how many appliances they expect to sell in each of these,
and then do some fairly straightforward analyses to find the best location.

■ Fiona McGregor worked in a retail bank, specialising in consumer loans. She is

now 32 years old and is ambitiously looking for a long-term career that is both
challenging and financially rewarding. She does not like the idea of only opening
a logistics centre, but says that they should become more directly involved in
sales to final customers. They would need a head office – probably in London –
a central receiving area near to a port, and showrooms around Britain. The
fastest way of doing this is to take over an existing retailer, or several retailers, to
give coverage throughout the country.
 L O C AT I N G FA C I L I T I E S 133

C A S E S T U D Y continued

■ John Brenner says that Fiona McGregor’s scheme is too ambitious, while the
other two put the convenience of the company above the customers. He says
there is only one way to sell appliances and that is to give customers a product
they want, in a location they can get to. John’s idea is to open a logistics centre
to serve retailers, combined with a cash-and-carry warehouse for sales direct to
customers. To find the best location for this, they should see where successful
distributors already work, and open their facilities nearby. They would need a
large dominating location that customers can see from a long way off, that they
pass frequently, where they regularly visit to shop, and where other distributors
have traditionally been able to sell.

The time is now getting short for a decision. The directors are concerned that if
they delay any longer the manufacturer will consider them indecisive, and they will
not have time to give a good showing at their first year’s review. To build entirely
new premises could take a year. Alternatively they could find existing premises that
are empty, or they could rent temporary premises until the company finds more suit-
able, permanent premises.

C A S E S T U D Y
Questions
● If you were a director of Brenner Refrigeration Sales, what would you do now?
● What kind of facilities does Brenner need? What factors are important for the location?
● What location – or locations – would you recommend?

P R O J E C T

Poor Locations
Find an example of an organisation that has opened facilities in the wrong location, and see why their
decisions went wrong. You might find a shop that seems to change hands surprisingly quickly, or a
closed factory on an industrial estate. Unfortunately, you can find many recent examples, as well as his-
torical ones (such as the Hillman car plant outside Glasgow, and Victorian railway stations built for towns
that never developed).
134 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

P R O B L E M S

1. Mai Lao Industries manufacture 70 tonnes of goods a week in factory A and 50 tonnes a week in
factory B. The map co-ordinates of these factories are (14,11) and (54,48) respectively. These goods
are delivered to 14 main customers whose average weekly requirements and co-ordinates are shown
below. The company wants to improve its customer service and decides to open a logistics centre.
There are four possible locations, each with the same operating costs, located at (20,8), (61,19),
(29,32) and (50,22). Which of these locations is best?
Customer Demand Co-ordinates Customer Demand Co-ordinates

1 4 (11,16) 8 16 (12,69)
2 11 (30,9) 9 2 (27,38)
3 8 (43,27) 10 4 (51,6)
4 7 (54,52) 11 6 (43,16)
5 17 (29,62) 12 3 (54,16)
6 10 (11,51) 13 12 (12,60)
7 15 (8,10) 14 18 (12, 3)

2. A new electronics factory is planned in an area that is encouraging industrial growth. There are five
alternative sites. A management team is considering these sites and has suggested the important
factors, relative weights and site scores shown below. What is the relative importance of each factor?
Which site appears best?
Factor Maximum Scores for Sites
Score A B C D E

Government grants 10 2 4 8 8 5
Community attitude 12 8 7 5 10 5
Availability of engineers 15 10 8 8 10 5
Experienced workforce 20 20 15 15 10 15
Nearby suppliers 8 4 3 6 3 2
Education centres 5 5 4 1 1 5
Housing 5 2 3 5 3 2

3. Find the centre of gravity of the data in question 1. What would be the transport cost of a distribu-
tion centre located there? Can you find a cheaper solution?

4. An assembly plant is planned to take components from four suppliers and send finished goods to
eight regional warehouses. The locations of these and the amounts supplied or demanded are shown
in the following table. Where would you start looking for a site for the assembly plant?
Location X,Y co-ordinates Supply/Demand

Supplier 1 7,80 140

Supplier 2 85,35 80
Supplier 3 9,81 120
Supplier 4 11,62 70
 L O C AT I N G FA C I L I T I E S 135

P R O B L E M S
continued

Location X,Y co-ordinates Supply/Demand

Warehouse 1 12,42 45
Warehouse 2 60,9 65
Warehouse 3 92,94 25
Warehouse 4 8,79 45
Warehouse 5 10,83 60
Warehouse 6 59,91 35
Warehouse 7 83,49 50
Warehouse 8 85,30 85

5. Pierre Malpasse is opening a logistics centre for his French clothing operations. If the likely demand is
proportional to the population, where should he start looking for locations?

6. Figure 5.16 shows part of a road network and population of nine towns. Where would you start
looking for a location for a new warehouse?

27
57 D F

C 16
17

24 41

32
E
20
14
A

30 22 I
21 B
H

16 7

Figure 5.16 Network for Problem 6

136 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

DISCUSSION QUESTIONS

1. If a company chooses a poor site it can always move to a better one. Such change is an
unavoidable part of business. Do you think this is true?
2. Which areas of the world do you think will have the fastest economic development over
the next twenty years? How will this affect location decisions?
3. What costs should be considered in a location decision? Is cost always an important
factor? What other factors should be considered? What effect do government grants
have?
4. Mathematical models for location take a simplified view and they only include the few
factors that can most easily be quantified. So how useful are they for real decisions?
5. What features would you expect to see in computer software that helps with location
decisions? Do a survey of relevant packages. How do they work, and what analyses do
they do?
6. Different cultures are the main problem of locating facilities in different countries. They
make it impossible to standardise procedures, have consistent operations, compare
performance, or anything else. Do you think this is true?

REFERENCES
1. Hoover E.M. (1948) The Location of Economic Activity, McGraw-Hill, New York.
2. Haley K.B. (1963) Siting of depots, International Journal of Production Research, 2, 41–5.
3. Eilon S., Watson-Gandy C.D.T. and Christofides N. (1971) Distribution Management, Griffin, London.
4. Andel T. (1996) Site location tools, Transport and Distribution, June, 77–81.
5. Gooley T.B. (1998) The geography of logistics, Logistics Management Distribution Report, 37(1), 63–6.
6. Ahituv N. and Berman O. (1988) Operations Management of Distributed Service Networks, Plenum Press,
New York.

Further reading
Drezner Z. (1995) Facility Location: A Survey of Applications and Methods, Springer-Verlag, Secausus, NJ.
Harrington J.W. and Warf B. (1995) Industrial Location: Principles and Practice, Routledge, London.
Hayter R. (1997) The Dynamics of Industrial Location, John Wiley, Chichester.
Salvaneschi L. and Akin C. (eds) (1996) Location, Location, Location: How to Select the Best Site for Your Business,
Oasis Press, Central Point, OR.
Schriederjans M.J. (1999) International Facility Acquisition and Location Analysis, Quorum Books, Wesport, CT.
Waters C.D.J. (1999) Global Logistics and Distribution Planning, Kogan Page, London.
 CHAPTER 6

Planning Resources

CONTENTS

■ Aims of the chapter ■ Chapter review

■ Types of planning ■ Case study – Primal Autoparts
■ Capacity planning ■ Project – Network planning
■ Adjusting capacity ■ Discussion questions
■ Tactical planning ■ References
■ Short-term schedules ■ Further reading

AIMS OF THE CHAPTER

After reading this chapter you should be able to:

■ D I S C U S S the role of planning in logistics

■ M E A S U R E the capacity of a supply chain
■ U S E a standard approach to capacity planning
■ D I S C U S S some practical difficulties with capacity planning
■ S E E how to design medium-term tactical plans
■ E X PA N D the tactical plans into short-term schedules
138 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

TYPES OF PLANNING

The last two chapters looked at the design of a supply chain. They considered the structure,
based on the type and number of facilities, and the best locations for these facilities. Now we
are going to see how to use the chain and how materials actually move through it. The next
two chapters look at questions of planning. We see how activities along the supply chain are
planned, and how resources are controlled.
All activities have to be planned – which means that we design timetables to show when
they will be done. Delivery plans, for example, might show the planned schedules for deliv-
eries over the next month. If an organisation does not plan for the future, it can only work
from hour-to-hour, without any continuity, and in constant danger of meeting unexpected
circumstances that it cannot cope with. Planning lets us face the future with some confidence,
rather than descending into chaos.
Planning the supply chain starts with the logistics strategy, which gives the overall aims.
More details are added, and we get long-term plans which show how these aims will be
achieved. These plans are, in turn, expanded with more details added. The plans move down
through the organisation, where they are continually expanded and described in more detail.
You can see this approach to planning in Capital Trains Corporation. Their business strategy
gives a general description of their products, which provide public transport around Wash-
ington. The logistics strategy shows how they run a network of train services for commuters.
The next level of planning forecasts demand for these services, and then makes sure that there

Mission
Higher strategic
Corporate strategy
decisions
Business strategy

Functional strategy Strategic decisions

for logistics
Logistics strategy

Capacity plans
Tactical decisions
Aggregate plans
for logistics
Master schedule

Operational
Short-term schedules decisions for
logistics

Figure 6.1 An approach to planning logistics

 PLANNING RESOURCES 139

is enough capacity to meet this. In other words, they buy enough trains and hire enough staff
to meet forecast demand. Then they move on to more detailed plans, which give their
timetable of services, saying which routes their trains will serve and when they will arrive.
Capital then expand these timetables into detailed schedules for individual trains and drivers,
inspectors, materials, and any other resources they need.
As you can see, Capital Trains move down from strategic policies, through capacity plans,
medium-term schedules of operations, and on to detailed timetables for all their resources.
This is the usual approach to all planning (shown in Figure 6.1). People use different terms to
describe these levels of planning, but the most common are:

● Capacity plans, which make sure there is enough capacity to meet long-term demand.
● Aggregate plans, which give summaries of the work done in related activities, typically by
month at each location.
● Master schedules, which show a detailed timetable for all activities, typically by week.
● Short-term schedules, which show detailed timetables for jobs and resources, typically by
day.

In this chapter we look at each of these in turn.

CAPACITY PLANNING

Definitions

The capacity of an operation is its maximum throughput in a specified time. All operations
have some limit on their capacity: a factory has a maximum number of units it can make a
week, a university has a maximum intake of students; an aeroplane has a maximum number
of seats, and a lorry has a maximum weight it can carry. Sometime the stated capacity has an
explicit reference to time, such as a maximum number of customers that can be served in a
day. Even when it is not mentioned explicitly, every measure of capacity refers to time. The
number of seats on an aeroplane sets the capacity as a maximum number of passengers on a
particular flight; the number of rooms in a hotel sets the maximum number of guests who can
stay each day.
Sometimes the capacity seems obvious – such as the number of seats on a bus or volume of
a tanker. At other times the capacity is not so clear. How, for example, can you find the
capacity of a supermarket, airport or train network? The usual answer has a surrogate measure,
such as the maximum number of customers per square metre of floor space in a shopping
mall, or the minimum distance between planes. Such measures come from discussion and
agreement rather than any physical limit.
Capacity is an important concept for logistics, as it defines the maximum flow through the
supply chain in a given time.

The C A PA C I T Y of a supply chain sets the maximum amount of product that can be
delivered to final customers in a given time.

Most organisations do not like to work at full capacity, as this puts pressure on resources and
people. Instead they work at a lower level that they can sustain over time. We allow for this
140 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

disparity by defining different kinds of capacity. If you imagine a supply chain that is working
in ideal conditions with no disruptions or problems of any kind, then the maximum
throughput is its designed capacity. In reality, you seldom find such ideal conditions, and a
more realistic measure is the effective capacity. This is the maximum throughput that can be
sustained under normal conditions, and allows for disruptions, variations in performance,
breakdowns, maintenance periods, and so on.

D E S I G N E D C A PA C I T Y is the maximum possible throughput in ideal conditions.

E F F E C T I V E C A PA C I T Y is the maximum realistic throughput in normal conditions.

A C T U A L T H R O U G H P U T is normally lower than effective capacity.

Bottlenecks

Not all parts of a supply chain have the same capacity. There must be some part that limits
overall throughput, and this forms a bottleneck. If you want to move some bulky materials
from Johannesburg to Amsterdam, you might find a bottleneck at the docks in Cape Town.
This part of the supply chain is working at full capacity, but other parts have spare capacity
that is not used. The bottlenecks in a supply chain limit its overall capacity (as shown in
Figure 6.2).

Bottleneck

Flow of materials

Figure 6.2 The bottleneck of a supply chain limits the capacity

W O R K E D
E X A M P L E

The main bottling plant at J&R Softdrinks has a capacity of 80,000 litres a day, and works
a seven-day week. It fills standard bottles of 750 ml, and these are passed to a packing
area which can form up to 20,000 cases a day with 12 bottles each. The packing area
 PLANNING RESOURCES 141

W O R K E D
E X A M P L E
continued

works a five-day week. The cases are taken to warehouses by a transport company whose
8 lorries can each carry 300 cases, and make up to 4 trips a day for 7 days a week. There
are two main warehouses, each of which can handle up to 30,000 cases a week. Local
deliveries are made from the warehouses by a fleet of small vans that can handle every-
thing passed to them by the warehouse. What is the capacity of this part of the distribu-
tion system? How can J&R increase the capacity?

Solution
We have information about five parts of the supply chain, and can use this to find the
capacity of each part in consistent units, say bottles a week.

■ The bottling plant has a capacity of 80,000 litres a day, or:

7 × 80,000/0.75 = 746,666 bottles a week

■ The packing area has a capacity of 20,000 cases a day, or:

5 × 12 × 20,000 = 1,200,000 bottles a week

■ The transport company’s lorries can handle 300 cases on each journey, so their
capacity is:
7 × 4 × 8 × 300 × 12 = 806,400 bottles a week

■ Each warehouse can handle 30,000 cases a week, giving a capacity of:
2 × 30,000 × 12 = 720,000 bottles a week

■ We only know that the capacity of the delivery vans is greater than the capacity of the
warehouses.

The capacity of this part of the supply chain is the smallest of these separate capacities,
and you can see from Figure 6.3 that this is 720,000 bottles a week in the warehouses.
J&R can only increase capacity by expanding the warehouses. Improving other parts of
the supply chain will have no effect at all. Of course, when one bottleneck is removed
another is formed, and this will probably be at the bottling plant.
We have made a number of assumptions here about working days, reliability, and so on
These factors would obviously have to be taken into account before any real decisions
are made.

It is obvious that you can only increase the capacity of a supply chain by adding more
capacity at the bottleneck. Unfortunately, you often see cases where this is not done. Transport
companies, for example, that recruit more managers to give leadership, when they are actually
short of drivers; bus stations increase the size of waiting rooms, when congestion in the
arrivals bay is limiting the number of buses; airlines using bigger aeroplanes when passenger
terminals are already over-crowded. Identifying and overcoming bottlenecks is clearly not as
easy as it seems.
142 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Bottleneck

Bottling Packing Transport Delivery

plant area company Warehouse vans

Capacity in
746,666 1,200,000 806,400 720,000 >720,000
bottles per week

Figure 6.3 Capacity of distribution at J&R Softdrinks

Matching capacity and demand

The aim of capacity planning is to match the available capacity of facilities to the demands put
on them. Any mismatch can be expensive. If capacity is less than demand, bottlenecks restrict
the movement of materials, and customer service declines; if capacity is greater than demand,
the organisation can move all its materials but it has spare capacity and underused resources.
You can see these effects in shops. When you go into some shops there are not enough people
serving and you have to wait. The capacity of the shop is less than demand, and you probably
go to a competitor where the queues are shorter. In other shops there are many people waiting
to serve customers – so there are no queues, but the cost of paying these underused people is
added to your bill.
Thankfully, there is a standard approach to capacity planning that we can illustrate in the
following worked example.

W O R K E D
E X A M P L E

Anne Jenkins has a contract to deliver 100 computer systems a week to schools in South
Wales. The systems have customised software installed, which takes an hour to test before
delivery. The testing is done by trained staff, who achieve an average efficiency of 75%.
They work a single eight-hour shift five days a week, but could move to double shifts or
have overtime at weekends. How many testers should Anne employ?
 PLANNING RESOURCES 143

W O R K E D
E X A M P L E
continued

Solution
Each tester is available for 8 × 5 = 40 hours a week. Average efficiency is 75%, so their use-
ful time is 40 × 0.75 = 30 hours a week. Each computer takes 1 hour to test, so each
employee can test 30 systems a week. This is equivalent to saying:

■ designed capacity = 40 units a tester a week

■ effective capacity = 30 units a tester a week
There are several ways of meeting the demand of 100 units a week:

■ Working a single shift on weekdays would need 100/30 = 3.33 testers. If Anne only
employs full-time testers, she has to round this up to 4. Then the utilisation of each
would be 3.33/4 = 0.83 or 83%.
■ Employing 3 testers full-time, and one part-time tester for 1/3 time would meet all
capacity with 100% utilisation.
■ Using overtime at the weekends would need 3 full time testers who are willing to finish
10 tests at the weekend (working 10 / 0.75 = 13.3 hours).

We could continue like this, suggesting alternative plans, adding allowances for holidays,
problems, varying demand, and so on. Anne now needs to complete her capacity plan-
ning by comparing these alternatives and implementing the best.

From this example, you can see that the main steps in capacity planning find the resources
needed, compare these with the resources available, and then look at alternative plans for
overcoming any differences. To be more specific, we:

1. examine forecast demand and translate this into a capacity needed

2. find the capacity available in present facilities
3. identify mismatches between capacity needed and that available
4. suggest alternative plans for overcoming any mismatch
5. compare these plans and find the best
6. implement the best and monitor performance.

This is a standard approach to all kinds of planning, which is sometimes called resource
requirement planning. Unfortunately, taking the steps in this straightforward sequence does
not usually work. There can be a huge number of potential plans to consider, and it is impos-
sible to look at them all in detail. It is also difficult to compare the alternatives, as there may
be competing objectives and non-quantifiable factors. A more realistic view replaces the single
procedure with an iterative one. This designs a plan and sees how close it gets to achieving its
objectives; if it performs badly, the plan is modified to find improvements. In effect, steps 4
and 5 are repeated until they give a reasonable solution. This iterative procedure recognises
that it is rarely possible to find the single ‘best’ plan, and we are really looking for one that is
generally accepted.
144 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Capacity
Demand

Increase in capacity

Time Capacity

(a) Capacity more or less matches demand Demand

Capacity

Demand Time
(b) Capacity always exceeds demand

Time

(c) Demand always exceeds capacity

Figure 6.4 Alternative timing of capacity expansion

ADJUSTING CAPACITY

Problems with capacity planning

There are several practical problems with capacity planning. You can see one of these in the
last worked example, where demand comes in small quantities and can take almost any value,
while capacity comes in large discrete amounts. Typically, capacity can be increased by
opening another shop, employing another person, using another vehicle, building another
warehouse, and so on.
Suppose that the throughput of a supply chain rises steadily over time. Capacity should be
increased at some point, but the increase will come as a discrete step. There is no way of
exactly matching the discrete capacity to a continuous demand, so we have to use one of three
basic strategies (as shown in Figure 6.4).

(a) more or less match capacity to demand, so that there is sometimes excess capacity and
sometimes a shortage
 PLANNING RESOURCES 145

Capacity Capacity

Demand Demand

Time Time
(a) A few large increases (b) More smaller increases

Figure 6.5 Alternative size of capacity expansion

(b) make capacity at least equal to demand by early expansion, which needs more investment
in facilities and gives lower utilisation
(c) only add capacity when the additional facilities would be fully used, which has lower
investment and high utilisation, but restricts throughput.

Each of these strategies is best in different circumstances. Factors that encourage an early
increase in capacity include high cost of shortages, widely variable demand, varying efficiency,
and low cost of spare capacity. The capacity of a large furniture shop, such as MFI, is largely set
by the number of sales people. The nature of demand and relative costs, mean that the shop is
likely to increase capacity early and make sure that there are always enough staff to serve
customers. The main factor that encourages a delay before increasing capacity is the capital
cost. New motorways are expensive and controversial, so expansions are delayed for as long as
possible, and they are crowded as soon as they open.
A related question about changing capacity concerns the size of any changes. If you want
to hire four new people over the next few months, should you recruit them all in one big
campaign, or is it better to add them in smaller steps. Any change in capacity is likely to cause
some disruption, so it might be better to have a few large increases rather than more smaller
ones (as shown in Figure 6.5).
The benefits of large increases include longer periods without disruptions, less risk of not
meeting unexpected demand, and the expansion might give economies of scale. On the other
hand, there is not such a close match to demand, disruptions may be more serious, capital
costs are higher, utilisation is low, and there are risks if demand changes.

Short-term adjustments to capacity

Capacity planning is largely a strategic function. Organisations can increase the overall
capacity of a supply chain by opening a warehouse, designing a new process, opening new
offices, or moving to a new location. They can reduce excess capacity by closing warehouses,
shutting down a plant, or transferring facilities to other products. These are strategic decisions
with long-term consequences. But an organisation can also adjust capacity by leasing extra
space, working overtime, employing temporary staff, or sub-contracting parts of their work.
146 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

These are clearly tactical and operational decisions. It is fairer to say, then, that capacity plan-
ning includes decisions at all levels; strategic plans give the overall picture, modified by shorter
term adjustments.
There are two ways of making these short-term adjustments to capacity:

● capacity management adjusts capacity to match demand

● demand management adjusts demand to match available capacity.

Imagine a wholesaler that runs a 12,000 square metre warehouse. This sets the normal
capacity. If there is a temporary increase in business because of orders from a nearby construc-
tion site, the wholesaler can use capacity management and rent extra space for the duration of
the construction project. Alternatively, there may be some reason why the wholesaler does not
want to increase capacity, so it can use demand management to increase prices and reduce
demand to match the existing capacity.
An obvious way of making short-term adjustments to capacity is to change the hours
worked, by working overtime to increase capacity or undertime to reduce it. Ways of adjusting
capacity include:

● changing the work pattern to match demand

● employing part-time staff to cover peak demands
● using outside contractors
● renting or leasing extra facilities
● adjusting the speed of working
● rescheduling maintenance periods
● making the customer do some work, such as packing their own bags in supermarkets.

Such adjustments cannot be done too often or too severely, as they can have significant effects
on employees, operations and customers. The alternative is to adjust demand, and the obvious
way of doing this is to change the price. There is, however, only a certain amount of flexibility
here. Prices must be high enough to cover costs, low enough to be competitive, and not
change too many times to confuse customers. Ways to adjust demand include:

● vary the price

● limit the customers served, by demanding specific ‘qualifications’
● change the marketing effort
● offer incentives to change demand patterns, such as off-peak travel rates
● change related products to encourage substitution, such as holiday destinations
● vary the lead time
● use a reservation or appointment system
● use stocks to cushion demand.

Changing capacity over time

So far we have assumed that capacity is constant over time. In practice, the effective capacity of
a supply chain can change quite markedly. Even if there are no changes to the operations, there
are short-term variations due to staff illness, interruptions, breakdowns, weather, enthusiasm of
employees, and so on. Imagine a group of people moving heavy materials about a warehouse. At
the end of an eight-hour shift they will be tired and their effective capacity will be much lower
than at the beginning of the shift, even though there has been no change to their work.
 PLANNING RESOURCES 147

There are, however, other more systematic changes in capacity. One of the most obvious is
the effect of a learning curve. The more often you repeat something, the easier it becomes
and the faster you can do it (as shown in Figure 6.6). A common shape for a learning curve has
the time taken to do an operation falling by a fixed proportion – typically around 10% – every
time the number of repetitions is doubled. If you take 10 minutes to do a job for the first time,
the second time takes only 90% of this, or 9 minutes; the fourth time takes 90% of the time for
the second repetition, and so on. The following table shows the times for repetitions with this
‘90% learning curve’.

Number of repetitions Time for the last (mins)

1 10.0
2 9.0
4 8.1
8 7.29
16 6.56
32 5.90
64 5.31
128 4.78

Another reason for systematic changes in capacity comes from ageing equipment and facil-
ities. As equipment gets older its effective capacity declines as it breaks down more often,
develops more faults, gives lower quality, slows down, and generally wears out. Sometimes the
changes are slow – like the fuel consumption of a car, which rises steadily with age. Sometimes
the change is very fast, like a bolt, which suddenly breaks.
This declining performance is by no means inevitable, and there are many things – ranging
from mobile telephones to tea services – whose performance stays the same for long periods.
Even if performance does decline, there are ways of slowing its effects, such as preventive
maintenance and rational replacement policies.

Time needed
for a task

Number of
repetitions

Figure 6.6 A typical learning curve

148 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Total cost

Cost per unit time Cost of

breakdowns

Maintenance
cost

Time between
Optimal time
maintenance periods

Figure 6.7 Cost of maintenance

With preventive maintenance, equipment is inspected and vulnerable parts are replaced
after a certain period of use. By replacing bits that are worn – or are most likely to wear – the
equipment is restored to give continuing, satisfactory performance. But how often should we
do this maintenance? If it is done too often, the equipment runs efficiently but the mainte-
nance costs are too high; if it is not done often enough, the maintenance costs are low but the
equipment still breaks down. One way of finding the best compromise is to add together the
costs of maintenance and expected failure. If we plot these against the frequency of mainte-
nance, we get a U-shaped curve that has a distinct minimum. This minimum cost shows the
best time between maintenance periods (as shown in Figure 6.7).
Even with regular maintenance there comes a point when repairs become too expensive
and it is cheaper to buy new equipment. These replacement decisions can be expensive when
building, say, a new logistic centre or shopping mall. There are many ways of tackling replace-
ment decisions, but a common one extends the approach of preventive maintenance. In other
words, we add the cost of operating equipment over a number of years and divide this by the
age at replacement to give an average annual cost.

W O R K E D
E X A M P L E

Juanita Princepio has recorded the costs of an automatic guided vehicle (AGV) that moves
materials around an assembly hall. The longer the AGV works without maintenance, the
higher are the expected failure costs (shown below). The maintenance also affects the
resale value, giving a varying capital charge. Preventive maintenance can be done at a cost
of £1000 and this brings the AGV back to new condition. What is the best time between
maintenance periods?
 PLANNING RESOURCES 149

W O R K E D
E X A M P L E
continued

Months since maintenance 0 1 2 3 4 5

Cost of breakdowns in month 0 50 150 200 1600 3000

Capital charge 100 200 400 500 800 1200

Solution
We can find the total monthly cost of running the AGV over some period by adding the
total costs of maintenance, capital and breakdowns, and dividing this by the number of
months in the period. If the machine is maintained every month there is no cost for break-
downs, but maintenance costs of £1000 and capital charge of £100, give a total of £1100
each month. If the machine is maintained every two months the expected cost of break-
downs is £0 in the first month plus £50 in the second month, capital charge is £200 and
maintenance costs £1000, giving a total of £1250 every two months, or £625 a month. If
the machine is maintained every three months the expected cost of breakdowns is £0 in
the first month, plus £50 in the second month, plus £150 in the third month, capital
charge is £400 and maintenance is £1000, giving a total of £1600 for three months or
£533 a month. Repeating this gives the following values, which suggest a minimum cost
of £475 a month when maintenance is done every four months.

Months between 1 2 3 4 5 6
maintenance

Maintenance cost 1000 1000 1000 1000 1000 1000

Cost of breakdowns in month 0 50 150 200 1600 3000
Cumulative cost of breakdowns 0 50 200 400 2000 5000
Capital charge 100 200 400 500 800 1200
Total cost 1100 1250 1600 1900 3800 7200
Average cost per month 1100 625 533 475 760 1200

L O G I S T I C S
I N P R A C T I C E
Capacity of Heathrow Airport
BAA run seven airports in the UK, including an increase of 4.7% over the previous year.
the three London airports at Heathrow, Passenger demand is particularly strong in
Gatwick and Stansted. In the year to April the south-east of England, where the num-
2000, BAA handled 118 million passengers, ber of passengers is forecast to double over
150 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

L O G I S T I C S
I N P R A C T I C E
continued

the next 15 years. To meet this rising express rail link to St Pancras, improved
demand, BAA has a continuing programme access roads, extension to the London
of airport expansion. Underground Piccadilly Line, and £1 million
London Heathrow is the world’s biggest a day spent on upgrading the existing four
international airport, and handled over 62 terminals. Discussions have also started into
million passengers in 2000. This rise of 2% reducing the gap between aeroplanes and
a year is modest compared with other air- allowing more take-offs and landings.
ports around London. Stansted handled 10 Realistically, the congestion at Heathrow
million passengers, a rise of 33%, Gatwick is likely to continue for the foreseeable
grew at 3% to 30 million passengers, Luton future. This has forced growth at other air-
airport is doubling its capacity to 10 million ports. British Airways switched its African
passengers a year, and the smaller London services to Gatwick in 1996, and its South
City Airport is growing by 9% a year to 2 American services in 1997. By 1998,
million passengers. Gatwick was serving 276 destinations –
The reason for Heathrow’s relatively slow more than any other European gateway,
growth is that the runways and, more obvi- including Heathrow. It spent £500 million
ously, the four terminals are already work- to increase its capacity from 27 million to
ing at full capacity. A fifth terminal, due to 30 million passengers, and is currently
increase passenger capacity to 85 million a expanding to a capacity of 40 million.
year, has been delayed by a public enquiry Stansted is expanding from 8 million to 15
lasting four years – the longest-ever hearing million passengers a year. Luton has spent
for a development project in the UK. If £170 million on new facilities to become
everything goes smoothly, the earliest pos- London’s fourth airport.
sible opening date is 2006. There are con-
Sources: Ellson C. (1998) London’s airports set for
tinuing improvements to facilities to give
expansion, The Times, 30 April; Skapinker M.
smaller increases in capacity, including an (1999), BAA plans to expand capacity at
express rail link to Paddington, a second Gatwick, Financial Times, 31 May and websites

TACTICAL PLANNING

Aggregate plans

Tactical plans bridge the gap between longer term strategic plans and operational details. They
show how the capacity will be used, and develop medium-term timetables for activities.
Different names are used for this level of planning, but the most common are aggregate plans
and master schedules.
Aggregate planning takes the forecast demand for logistics and uses this to design plans for
each type of activity for, typically, each of the next few months. Suppose that Proctor Trans-
port forecasts demand of 800 tonnes of materials to be delivered to Scandinavia over the next
year. Capacity plans make sure that there are enough resources to deliver this. Then aggregate
 PLANNING RESOURCES 151

plans design an outline schedule for resources, perhaps planning deliveries of 100 tonnes in
each of the first eight months. Aggregate plans only look at families of activities and are not
concerned with details. They might show the number of cases moved through a logistics
centre, but do not break this down into types of case or contents.

A G G R E G AT E P L A N N I N G makes the tactical decisions that translate forecast

demand and available capacity into schedules for families of activities.

Aggregate plans try to meet forecast demand, while using capacity as efficiently as possible.
They typically aim at low costs, high customer service, stable throughput, full utilisation of
resources, or some other objectives. To achieve this, they can adjust the values of several vari-
ables. They may, for example, change the number of people employed, the hours worked, the
amounts of stock, the amount subcontracted, demand, and so on. Essentially, aggregate plan-
ners are looking for answers to questions, like:

● Should we keep throughput at a constant level, or change it to meet varying demand?

● How should we use stocks to meet changing demand?
● Should we vary the size of the workforce with demand?
● Can we change work patterns to meet changing demand?
● Should we use subcontractors or outside organisations to cover peak demands?
● Can we allow shortages, perhaps with late delivery?
● Can we smooth the demand?

At the end of the aggregate planning, an organisation has schedules for its major types of
activity, typically for each month, at each location. The next stage is to add more detail, and
this is done in the master schedules.
A master schedule ‘disaggregates’ the aggregate plan and shows the planned activities for,
typically, each week over the next few weeks. The aggregate plan of Proctor Transport might
show deliveries of 100 tonnes to Scandinavia next month. Then the master schedule gives
more details, perhaps showing 2 deliveries of 9 tonnes to Denmark in week one, 3 deliveries of
7 tonnes to Sweden in week two, and so on.

The M A S T E R S C H E D U L E gives a timetable for activities, typically for each week.

Its aim is to achieve the activities described in aggregate plans as efficiently as possible.

Overall approach of tactical planning

Master schedules are more detailed than aggregate plans, so they tend to be more complicated
and messy. For both of them, however, we can use the general procedure that we described
earlier as resource requirement planning. Remember that this has six steps:

Step 1 translate forecasts and other information into a demand for resources
Step 2 find the resources currently available
Step 3 identify mismatches between resources needed and available
Step 4 suggest alternative plans for overcoming any mismatches
152 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Step 5 compare these plans and find the best

Step 6 implement the best plan and monitor performance.

We can use this approach (which is illustrated in Figure 6.8) for all types of planning.
Remember that steps 4 and 5 are usually repeated until a reasonable solution is found. This
iterative adjustment can be done many times, but it must stop at some point when the plans
become final. At this point, the planners can move on to the next level of detail.

Take forecasts and

other information for
the planning period

Translate this into

a demand for
resources

Find the resources

available in the
current period

Identify mismatches
between demand
and availability

Design a plan to
overcome these
mismatches

Move on to the next

Evaluate the plan
planning period

No Revise the plan

Is the plan
and look for
acceptable?
improvements

Yes

Finalise details of the

best plan for the
current period

Implement the plan

and monitor
progress

Figure 6.8 An iterative approach to planning

 PLANNING RESOURCES 153

W O R K E D
E X A M P L E

A&B Coaches
A&B Coaches of Blackpool plan their capacity in terms of ‘coach-days’. They classify their
business as either ‘full day’, which are long distance journeys, or ‘half day’ which are
shorter runs. Forecasts show expected annual demands for the next two years to average
400,000 full-day passengers and 750,000 half-day passengers.
A&B have 61 coaches, each with an effective capacity of 40 passengers a day for 300
days a year. Breakdowns and other unexpected problems reduce efficiency to 90%. They
employ 86 drivers who work an average of 220 days a year, but illness and other absences
reduce their efficiency to 85%.
If there is a shortage of coaches the company can buy extra ones for £110,000 or hire
them for £100 a day. If there is a shortage of drivers they can recruit extra ones at a cost
of £20,000 a year, or hire them from an agency for £110 a day.
How can the company approach its tactical planning?

Solution
We can approach this problem using the first five steps of the six-step procedure outlined
above.

Step 1 Translate forecasts and other information into a demand for resources
■ 400,000 full-day passengers are equivalent to 400,000/40 = 10,000 coach days a
year, or 10,000/300 = 33.33 coaches.
■ 750,000 half-day passengers are equivalent to 750,000 / (40 × 300 × 2) = 31.25
coaches.
■ Adding these two gives the total demand as 64.58 coaches. Each coach needs
300/220 drivers, so the company needs a total of 88.06 drivers.

Step 2 Find the resources currently available

■ The company has 61 coaches, but the efficiency of 90% gives an availability of 61 ×
0.9 = 54.9 coaches.
■ There are 86 drivers, but an efficiency of 85% reduces this to 86 × 0.85 = 73.1
drivers.

Step 3 Identify mismatches between resources needed and available

Without details of the timing, we can only take overall figures. There is a total shortage of
64.58 – 54.9 = 9.68 coaches and 88.06 – 73.1 = 14.96 drivers.

Step 4 Suggest alternative plans for overcoming any mismatches

Assuming that A&B do not want to reduce demand, they can either buy or hire coaches,
and employ drivers or hire them from an agency. The only information we have about
these alternatives are some costs.
154 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

W O R K E D
E X A M P L E
continued

■ To buy 10 coaches would cost £1,100,000. To hire coaches to make up the shortage
would cost 9.68 × 300 × 100 = £290,400 a year. There is, of course, the alternative
of buying some coaches and hiring others.
■ To hire 15 drivers would cost £300,000 a year, while using temporary drivers from an
agency would cost 14.96 × 220 × 110 = £362,032 a year. There is also the option of
hiring some drivers and making up shortages from an agency.

Step 5 Compare these plans and find the best

We do not have enough information to make the final decisions, and we have only out-
lined some of the alternatives. This very limited analysis might suggest a reasonable solu-
tion of buying eight coaches and making up any shortages by hiring, and hiring 12 drivers
and making up the shortage from the agency.
When these plans are finalised, A&B can start looking at more detailed plans. The next
stage would develop aggregate plans for types of journeys each month, perhaps showing
the number of continental journeys each month, and so on. Then they could break the
aggregate plans into master schedules of journeys each week, perhaps showing the num-
ber of journeys to the Netherlands in the first week, and so on.

Generating alternative plans

The last worked example illustrates the general approach of planning, but you can see that
there are many practical difficulties. One of the most important concerns the way that alter-
native plans are generated and compared. There are usually so many possible plans that we
cannot even list them all, let alone compare their merits. There are also so many competing
objectives and non-quantifiable factors that it is difficult to find any plan that satisfies
everyone, let alone identify the ‘best’.
There are many ways of generating alternative plans, ranging from simple intuition
through to sophisticated mathematical models. The most appropriate depends on several
factors, the most obvious being the balance between the cost of planning and the expected
benefits. If you are moving huge quantities of oil in tankers and pipelines, costs are high and
it is worth putting a lot of effort into a sophisticated model that guarantees good results. On
the other hand, a small business is unlikely to have the resources for this, and will use a simple
method that will give reasonable results with a lot less effort. The following list shows the
most common methods of generating plans.

1. Negotiations: Planning is so complicated that the best approach is often to negotiate a

solution among the people most closely concerned. This may not give the best technical
answer, but it should have the support of everyone concerned.

2. Adjust previous plans: Demands on logistics may not change much from one period to the
next, so a useful approach is to take previous plans that worked successfully and update
 PLANNING RESOURCES 155

them in the light of current circumstances. This has the benefit of being relatively easy
and giving stable operations. Unfortunately, the results can be of variable quality, they
may take a long time to design, and they rely on the skills of the planner.

3. Other intuitive methods: These include a range of methods that rely on the skills, knowl-
edge and experience of planners. They typically use a series of heuristic rules that have
been successful in the past.

4. Graphical methods: Planners often find it easier to work with some kind of graphs or
diagrams. A popular format uses a graph of cumulative demand over time, and the corre-
sponding line of cumulative supply. The aim is to get the cumulative supply line nearly
straight – giving constant throughput – and as close as possible to the cumulative demand
line (as shown in Figure 6.9). There are many different formats for such diagrams.

5. Spreadsheet calculations: One of the most popular approaches to planning uses spread-
sheets. Data can be presented in a variety of formats that show the effects of plans, and
they can be easily manipulated in a series of ‘what-if’ analyses.

6. Simulation: Simulation imitates real operations over some typical period. Suppose you
want some information about a logistics network; you could simply stand and watch the
network for some time to see what was happening. Unfortunately, this takes a long time
to get results and things may not work normally while you are watching. An alternative is
to simulate the process, based on a computer model of the network. Once this has been
designed, the computer can generate typical jobs and follow their progress through the
model, so that any number of real situations can be simulated.

Cumulative demand

Cumulative supply

1800
1600
1400
1200
Number

1000
800
600
400
200
0
1 2 3 4 5 6 7 8 9

Month

Figure 6.9 Graphical approach to planning – plotting cumulative demand and supply
156 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

7. Expert systems: These specialised programs allow computers to duplicate the methods of
skilled planners. The basic skills, expertise, decisions and rules used by experts are
collected in a knowledge base. A user of the system passes a problem to an inference
engine, which analyses the problem, relates this to the knowledge base and decides which
rules to use for a solution. Expert systems have been developing for many years, and a
growing number of organisations report useful results.

8. Mathematical models: Most of the approaches we have described so far rely, at least to
some extent, on the skills of a planner. More formal mathematical approaches give
optimal solutions without any human intervention. The most common approach uses
mathematical programming. This can be complicated and needs considerable expertise.
In practice, aggregate plans include so many subjective and non-quantifiable factors, that
optimal solutions in the mathematical sense do not necessarily give the best answers for
the organisation.

Planning cycles

As you can see from Figure 6.8, planning is not a job that is done once and is then finished. It
is continuous, and as plans for one period are finalised and implemented, planning moves on
to the next period. The usual way of organising this is to work on plans for several periods at
the same time; plans for the near future are fixed, while those for the more distant future are
still tentative. Planning is then done in cycles. In one cycle an organisation might finalise
plans for the next period and make provisional plans for the following period, and outline
plans for the period after that. This gives the pattern of planning shown in Figure 6.10. It is

Revise plan Revise plan Revise plan

– fixed for period A – fixed for period B – fixed for period C
– tentative for B – tentative for C – tentative for D
– outline for C – outline for D – outline for E

Period A Period B Period C Time

Planning cycle

Planning horizon

Figure 6.10 Revision of plans during cycles

 PLANNING RESOURCES 157

difficult to generalise, but strategic plans might cover the next four years and be updated
annually; aggregate plans might cover the next year and be updated every quarter; master
schedules may cover the next three months and be updated monthly. This pattern of repeated
cycles actually makes planning a lot easier. Most operations are relatively stable, so the plans
for one period can be used as the basis for plans in following periods.

L O G I S T I C S
I N P R A C T I C E
Piotr Hucek Transport
Wiesiek Tomac is the Logistics Manager of Wiesiek has a spreadsheet to help with
Piotr Hucek Transport in Prague, Czech aggregate planning. He looks at the exist-
Republic. Every month he designs, or ing plans, and then makes adjustments to
updates, the aggregate plan to cover the allow for changing circumstances. The
next 6 months. He starts with forecasts of spreadsheet does the associated calcula-
monthly demand for different types of tion, but little else. Figure 6.11 shows how
transport, and collects other relevant infor- he developed an initial idea.
mation to design outline schedules for each As you can see, Wiesiek started by look-
type of transport for each month. At the ing at a smooth supply, set at the average
beginning of 2001 he had the following demand over the six months. This needed
information for one type of transport. six more employees, so there were costs for
transferring people into the function in the
Month Jan Feb Mar Apr May June first month. Other costs came from the
Forecast 80 100 125 130 150 75 unused demand in the first four months
These figures are in nominal ‘truck jour- and shortage in month five. The shortage
neys’, and the company uses euros for cost was particularly high, so Wiesiek kept
internal costs. These main costs are: looking for alternative plans until he had a
reasonable solution. His obvious next move
■ Spare transport that is not used = g1000
was to reduce availability of vehicles in the
a unit held at the month end
first four months, and then increase it later.
■ Shortage of transport = g10,000 a unit
When he finalised an aggregate plan,
at the month end
Wiesiek moved on to design the master
■ Cost of moving an employee to this
schedule. This showed the supply of vehi-
function from other jobs = g1000 per
cles of each type by week. Finally, short-
employee
term schedules were designed to show
■ Cost of moving an employee from this
what each individual vehicle and driver
function to other jobs = g700 per
would be doing each day.
employee
Source: company reports
At the beginning of the period 16 people
were employed, each of whom can make 5
journeys a month.
158 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

A B C D E F G H I
1
2 Line Description 1 2 3 4 5 6 Total
3 1 Forecast demand 80 100 125 130 150 75 660
4 2 Cumulative forecast demand 80 180 305 435 585 660 660
5 3 Supply rate 110 110 110 110 110 110 660
6 4 Cumulative supply 110 220 330 440 550 660 660
7 5 Unused supply 30 40 25 5 0 0 100
8 6 Shortage of supply 0 0 0 0 35 0 35
9 7 Cost of unused supply 30000 40000 25000 5000 0 0 100000
10 (Line 5 × D1000)
11 8 Cost of shortage 0 0 0 0 350000 0 350000
12 (Line 6 × D1000)
13 9 Number of employees 22 22 22 22 22 22
14 10 Cost of moving employees 6000 0 0 0 0 0 6000
15 11 Total cost 36000 40000 25000 5000 350000 0 456000
16 (Line 7 + Line 8 + line 10)

Figure 6.11 Spreadsheet to help with planning in Piotr Hucek

SHORT-TERM SCHEDULES

Definitions

The master schedule gives a timetable for different activities, typically for each week. But this
is not the end to planning, as we still have to design detailed timetables for jobs, equipment,
people, materials, facilities and all other resources that are needed by the master schedule. This
is the purpose of short-term scheduling.

S H O R T- T E R M S C H E D U L E S give detailed timetables for jobs, people, materials,

equipment and all other resources.

Short-term schedules give the sequences of activities, and the times when they should be
done. ‘Sam the Fridge’ runs a repair service and his daily schedule lists the customer to visit
(with the order and time of each job) and the resources needed (the repair people, tools, spare
parts, vans and so on needed for the jobs). The aim of these schedules is to organise the
resources needed for the master schedule, giving low costs, high utilisations, or achieving
some other measure of performance.
Designing these operational schedules is one of the most common problems in any organ-
isation. As it is so common, you might think that short-term scheduling is easy – but in prac-
tice it is notoriously difficult. To start with there are so many possible schedules to consider.
Imagine that you have ten jobs that you must finish today. In how many different ways can
you arrange the ten jobs? You can choose the first job as any one of the ten; then the second
 PLANNING RESOURCES 159

job can be any one of the remaining nine, the third job can be any one of the remaining eight,
and so on. This gives the number of possible schedules as:
10 × 9 × 8 × 7 × 6 × 5 × 4 × 3 × 2 × 1 = 3,628,800
If you have a real problem with hundreds or thousands of jobs, you have a huge number of
possible schedules to consider. Each of these has different features, and performs well by some
criteria, but badly by others. You have to balance each type of performance, and take into
account the complications of real problems, such as the amount and type of equipment,
number and skills of people assigned to jobs, materials needed, patterns of work flow through
equipment, different priority of jobs, objectives of the schedulers, and so on.
The result is that apparently simple scheduling jobs are actually very difficult to solve.
Eilon et al.1 noted that this type of problem ‘has become famous for its ease of statement and
great difficulty of solution’.

Approach to scheduling

You can imagine a typical scheduling problem in terms of a set of jobs waiting to use equip-
ment. You want to organise the jobs to achieve some objective. The master schedule shows
when jobs have to be finished, so the short-term schedules must take these dates into account.
There are two ways of doing this:

● Backward scheduling, where schedulers know when a job has to be finished. Then they can
work back through all the activities to find the date when the job must be started.
● Forward scheduling, where schedulers know when a job can start. Then they can work
forward through all activities to find the date when the job will be finished.

Suppose you are giving a talk in three weeks time and want some photographs to illustrate
this. It will take one week to prepare the photographs. With backward scheduling you know
that the photographs must be ready in three weeks, so you can prepare them in two weeks
time. With forward scheduling, you prepare the photographs as early as possible – starting
now and finishing next week.
These two approaches suggest general principles, but we need some way of finding the best
order for jobs. The available methods are basically variations on the list given above for
tactical plans, and range from negotiation through to mathematical programming. The more
complicated methods are usually too difficult and time-consuming for short-term schedules,
and most organisations use simple methods, often based on scheduling rules. You see an
example of a scheduling rule in banks which schedule customer service at their tellers in the
order ‘first come, first served’.
If you have a number of jobs waiting to use a single piece of equipment, the total
processing time is fixed regardless of the order in which the jobs are scheduled (providing the
set-up time for each job is constant, regardless of the job that was done previously). But the
order of taking jobs does change other measures of performance. You can see this in the
following four scheduling rules.

1. First come, first served: This is the most obvious scheduling rule and simply takes jobs in
the order they arrive. It assumes no priority, no urgency, or any other measure of relative
importance. Its drawback is that urgent jobs may be delayed while less urgent ones are
being processed.
160 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

2. Most urgent job first: This rule assigns an importance, or urgency, to each job and they are
processed in order of decreasing urgency. Emergency departments in hospitals, for
example, treat those who are most seriously in need first. The benefit of this rule is that
more important jobs have higher priority. Unfortunately, jobs that have low priority may
be stuck at the end of a queue for a very long time.

3. Shortest job first: A useful objective is to minimise the average time spent in the system,
where:
time in the system = processing time + waiting time
If a job needs one day of processing but it waits in the queue for four days, its time in the
system is five days. Taking the jobs in order of increasing duration minimises the average
time spent in the system. It allows those jobs that can be done quickly to move on
through the system, while longer jobs are left until later. The disadvantage is that long
jobs can spend a long time waiting.

4. Earliest due date first: This sorts jobs into order of delivery date, and the ones that are due
earliest are processed first. This has the benefit of minimising the maximum lateness of
jobs, but again some jobs may wait a long time.

W O R K E D
E X A M P L E

Zambrucci Transport has to schedule the following six jobs for a heavy lift crane. How can
it design a reasonable schedule?

Jobs A B C D E F

Duration in days 12 8 4 16 2 10
Target completion 12 40 44 48 4 20
(days from now)

Solution
The simplest way of tackling this problem is to use some decision rules. Using ‘first come,
first served’ gives the schedule:

Job Duration Start Finish

A 12 0 12
B 8 6 20
C 4 10 24
D 16 12 40
E 2 20 42
F 10 21 52

The jobs are finished by day 52. Every sequence of jobs is going to give this same com-
pletion time, but they will perform differently when judged by other measures. We can,
 PLANNING RESOURCES 161

W O R K E D
E X A M P L E
continued
for example, minimise the average time in the system by taking jobs in order ‘shortest
first’. This gives the schedule:

Job Duration Start Finish

E 2 0 2
C 4 2 6
B 8 6 14
F 10 14 24
A 12 24 36
D 16 36 52

The average time in the system (which is the same as the average finish time) is 134/6
= 22.3 days, compared with 190/6 = 31.7 days for ‘first come, first served’. By day 36 this
schedule has finished five journeys, while the previous schedule had only finished three.
We do not have enough information to schedule the jobs in order of urgency, but we
can minimise the maximum lateness by taking jobs in order of due date. This gives the fol-
lowing schedule.

Job Duration Start Finish Due date Lateness

E 2 0 2 4 0
A 12 2 14 12 2
F 10 14 24 20 4
B 8 24 32 40 0
C 4 32 36 44 0
D 16 36 52 48 4

This gives a maximum lateness of 4 days for jobs D and F, and an average lateness of 10/6
= 1.7 days.
These are only three scheduling rules, and we could use many others to achieve differ-
ent objectives.

L O G I S T I C S
I N P R A C T I C E
Scheduling at Bombay Taxis
Bombay Taxis have a fleet of 170 cars work- around 100 of these, but at busy times
ing around greater Bombay. They employ there can be up to 200. Their aim is to keep
210 full-time drivers, and a varying number the taxis in use for almost 24 hours a day.
of part-time drivers. Usually there are The taxis are maintained in the com-
162 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

L O G I S T I C S
I N P R A C T I C E
continued

pany’s garage. This has six bays, ten full- tomers who have block bookings. These
time mechanics, four part-time mechanics routes are continually modified as cus-
and eight apprentices. Bombay also employ tomers telephone in with new jobs (which
17 controllers. These take telephone calls are assigned to the nearest car with free
from customers, schedule the work, and time), or the cars pick up passengers who
pass instructions on to taxis. The controllers hail them on the streets.
keep a continuous check on the location As well as scheduling the cars, drivers
and work of each taxi. and routes, the controllers design schedules
You can already see that Bombay have for the maintenance and repair of cars,
to do a range of scheduling. They start by other internal work in the garage, work for
scheduling the hours worked by cars, so external customers of the garage, hours
that there are always enough taxis on the worked by all other staff, purchase of parts
road to meet demand from customers. and materials, cleaning and maintaining
Then they schedule the drivers to make the building, staff training, and all other
sure that there are enough drivers for the operations of the business.
cars. The controllers design routes for each
Source: Chandrasekar J., (2001) Where are the
cab, starting with customers who make
taxis? Western Operations Seminar, Toronto and
advance bookings and a list of regular cus- company reports
CHAPTER REVIEW ■ ■ ■

❑ The logistics strategy gives the general shape of the supply chain. After this,
tactical and operational plans are needed to manage the flow of materials.
Planning is essential, as it gives timetables for all the activities and resources
in the supply chain.
❑ Capacity is an important feature of a supply chain, as it sets the maximum
amount of products that can be delivered to final customers in a given time.
The capacity of the whole chain is set by a bottleneck.
❑ Capacity planning matches the available capacity to demand. Resource
requirement planning gives a standard procedure which iteratively searches
for a reasonable solution.
❑ There are many practical difficulties with organising the capacity, including
discrete capacity size and changing capacity over time.
❑ Capacity plans focus on the longer term, but with shorter term adjustments.
They set the scene for more detailed tactical and operational planning.
C H A P T E R R E V I E W continued PLANNING RESOURCES 163

❑ Tactical aggregate plans describe timetables for families of activities over the
medium term. Master schedules add more details, giving plans for individual
activities. Both of these can use the approach of resource requirement
planning, with plans actually designed by different methods ranging from
negotiation through to mathematical programming.
❑ Short-term schedules give timetables for the resources that support the
tactical plans. The most common approach to short-term scheduling uses
simple rules to get reasonable solutions.

C A S E S T U D Y Primal Autoparts

Primal Autoparts is a supplier of car parts to customers in south-western USA. It

sources these from its own manufacturing plants and from other manufacturers,
primarily in south-east Asia. It plans to extend its operations to include customers
in north-western USA and the western provinces of Canada. George Havering is a
senior partner for Mayer, Jones and Armanti, and has been given the job of
designing realistic alternatives for Primal’s additional logistics requirements. What-
ever alternative he suggests must be integrated with the existing distribution system.
George’s problem is that he does not know much about Primal’s existing opera-
tions. He knows that they work as wholesalers, keeping stocks in warehouses until
delivered to customers. These customers are mainly mechanics working in repair
workshops. They have to repair cars in the shortest time possible, so Primal must
give at least overnight delivery, with parts available at the start of the next working
day. The demand for any part is variable and difficult to forecast. Some demand is
seasonal, such as radiators which are vulnerable during severe winters.
At present Primal’s main warehouse is near San Francisco, with smaller depots
in Los Angeles, Phoenix and Salt Lake City. The largest parts they supply are
bodies, which can easily be carried by road, rail or air. The most reasonable
approach for George would be to study the existing distribution system and look for
ways of expanding. Then Primal can use their existing skills and resources to serve
a wider customer base, and spread their fixed costs.
164 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

C A S E S T U D Y
Questions
● If you were George Havering, how would you start your study? What steps would you
follow, and what would you aim to put in your report to Primal?
● What type of logistics systems might you consider? How would you compare these
alternatives?
● What information would you need for this study, and how would you collect it?

P R O J E C T

Network Planning
Consider an organisation that has a well-established logistics network. You might take a local company
or a national one such as a supermarket, airline, or car manufacturer. Describe the main features of the
network. What is the capacity of the main facilities? How do you think these capacities were chosen?
How does the company plan the flow of materials through its supply chain?

P R O B L E M S

1. A purchasing department sends out about 100 routine orders a day. Each person in the department
can deal with three orders an hour, but has to do associated paperwork that takes an average of 40
minutes an order. Each person also loses about 20% of their time doing other things. The standard
working day is from 0900 to 1600 five days a week, with an hour off for lunch. How many employees
do you think the department should employ?

2. Sean Higgins estimates that his periodic plant maintenance costs g50,000. If he does not close the
plant and do this maintenance, his breakdown costs rise as shown below. How often should he main-
tain the plant?
Time since last maintenance (years) 0 1 2 3 4 5
Annual cost of breakdowns (g000) 0 10 40 80 150 240

3. A warehouse has to meet the demand for a product shown below. Each unit of stock remaining at the
end of a month has a notional holding cost of £20. If there are shortages, 20% of orders are lost at a
cost of £200 a unit, and the rest are met by back orders, at a cost of £50 a unit. A production depart-
ment sends the product to the warehouse. Designed capacity of this department is 400 units a
month, but utilisation seldom exceeds 80%. Every time the production rate is changed it costs
£15,000. How would you set about designing an aggregate plan for the product?
Month 1 2 3 4 5 6 7 8
Aggregate demand 310 280 260 300 360 250 160 100
 PLANNING RESOURCES 165

P R O B L E M S
continued

4. Eight jobs are to be processed on a single machine, with processing times as follows:
Job A B C D E F G H
Processing time 2 5 3 8 4 7 2 3
Due date 13 7 8 30 14 20 2 36
How could you design short-term schedules for the jobs?

DISCUSSION QUESTIONS

1. Capacity is the most important decision in the design of a supply chain, as it affects the
amount of materials that can be moved. Do you find this argument convincing?
2. Tactical plans – such as aggregate plans and master schedules – are useful for manufac-
turing, but they are not so relevant for logistics. Do you think that this is true? What
happens if there is no tactical planning for a supply chain?
3. What decisions are involved in tactical planning for logistics?
4. Mathematical models can find optimal solutions for planning and scheduling problems.
By definition, these solutions are the best. If an organisation uses any other methods, it is
accepting poor results. What do you think of this view?
5. There must be better ways of scheduling jobs than by using simple scheduling rules. What
methods are available, and what are their advantages and weaknesses?

REFERENCES
1. Eilon S., Watson-Gandy C.D.T. and Christofides N. (1971) Distribution Management, Griffin, London.

Further reading
Comel J.G. and Edson N.W. (1995) Gaining Control: Capacity Management and Scheduling, John Wiley, New
York.
Dauzere-Peres S. and Lasserve J.B. (1994) An Integrated Approach to Production Planning and Scheduling,
Springer Verlag, Berlin.
Klammer T.P. and Klammer T. (1996) Capacity Management and Improvement, Irwin, Homewood, IL.
Menasse D. (1993) Capacity Planning: A Practical Approach, Prentice Hall, Englewood Cliffs, NJ.
Morton T.E. and Penticto D.W. (1993) Heuristic Scheduling Systems, John Wiley, New York.
Proud J.F. (1999) Master Scheduling (3rd edn), John Wiley, New York.
Vollman T.E., Berry W.L. and Whybark D.C. (1996) Manufacturing Planning and Control Systems (4th edn),
Richard Irwin, Homewood, IL.
Waters D. (2001) Operations Management, Financial Times/Prentice Hall, London.
 CHAPTER 7

Controlling Material Flow

CONTENTS

■ Aims of the chapter ■ Chapter review

■ Material requirements ■ Case study – JIT at Pentagon
planning Plastics
■ Extending the role of MRP ■ Project – Planning in practice
■ Principles of just-in-time ■ Discussion questions
■ Achieving just-in-time ■ References
operations ■ Further reading
■ Extending JIT along the
supply chain

AIMS OF THE CHAPTER

After reading this chapter you should be able to:

■ D E S C R I B E the distinctive approach of material requirements

planning
■ U S E MRP to timetable orders and deliveries
■ D I S C U S S the benefits and disadvantages of MRP
■ E X T E N D the MRP approach along the supply chain
■ D E S C R I B E the principles of just-in-time operations
■ D E S I G N kanban systems for controlling JIT
■ D I S C U S S the benefits and disadvantages of JIT
■ E X T E N D JIT along the supply chain for efficient consumer
response
 C O N T R O L L I N G M AT E R I A L F L O W 167

MATERIAL REQUIREMENTS PLANNING

Introduction

In the previous chapter we described an approach to planning logistics based on resource

requirement planning. This takes the logistics strategy and continually adds more details to get
capacity plans, aggregate plans, master schedules and short-term schedules. The result is a set
of timetables showing what all the facilities, equipment, people and resources should do at
any time.
This seems a reasonable approach, but it does have drawbacks. It is, for example, fairly rigid
and can be slow to react to changing conditions. If a customer urgently wants a delivery, we
cannot tell them to wait until we fit them in to the next planning cycle. Another concern
arises from the reliance on forecasts. Essentially planners take forecasts of demand for logistics,
and then plan the supply to meet this. The problem, of course, is that forecasts are often
wrong.
A way of getting around these problems is to match the supply of logistics to actual
demand. In other words, we want some way of finding the known, actual demand rather than
using unreliable forecasts. This might seem rather optimistic, but there are several circum-
stances when we know the actual demand in advance. We can illustrate the first of these with
material requirements planning (MRP). This uses the master schedule to give a timetable for
the delivery of materials.1

Dependent and independent demand

The conventional approach to planning assumes that overall demand for a product is made up
of individual demands from many separate customers. These demands are independent of
each other, so the demand from one customer is not related to the demand from another
customer. If you are selling Nike shoes, the overall demand comes from hundreds of separate
customers, all independently asking for a pair of shoes. This gives an independent demand,
where planning is done using the standard methods we described in Chapter 6.
There are, however, many situations where demands are not independent. One demand for
a product is not independent of a second demand for the product; or demand for one product
is not independent of demand for a second product. When a manufacturer uses a number of
components to make a product, the demands for all components are clearly related, since they
all depend on the production plan for the final product. This gives dependent demand. The
characteristic approach of MRP is that it ‘explodes’ a master schedule to plan the deliveries of
related materials.

■ M AT E R I A L R E Q U I R E M E N T S P L A N N I N G uses the master schedule, along

with other relevant information, to plan the supply of materials.
■ It is used for dependent demand.

You can see the differences between the traditional approach and MRP in the way that
restaurant chefs plan the ingredients for a week’s meals. With the traditional approach, the
chefs see what ingredients they used in previous weeks, use these past demands to forecast
future demands, and then make sure there is enough ingredients in the pantry to cover these
168 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Stock level Normal

stock level

(a) Stock level

with
independent
demand
approach

Production Production Delivery Time

starts ends arrives

Stock level

(b) Stock level

with
dependent
demand
approach

Normal
stock level

Delivery Production Production Time

arrives starts ends

Figure 7.1 Comparison of stock levels

forecast demands. With the alternative MRP approach, chefs look at the meals they are going
to cook each day, analyse these to see what ingredients they need, and then order the ingredi-
ents to arrive at the right time.
An important difference between the two approaches is the pattern of material stocks.
With independent demand systems, stocks are not related to production plans so they must be
high enough to cover any likely demand. These stocks decline during operations, but are soon
replaced to give the pattern shown in Figure 7.1(a). With MRP, stocks are generally low but rise
as orders are delivered just before operations starts. The stock is then used during production
and declines to its normal, low level. This pattern is shown in Figure 7.1(b).

The MRP approach

MRP uses a lot of information about schedules, products and materials. This comes from three
main sources:
 C O N T R O L L I N G M AT E R I A L F L O W 169

● master schedule, giving the number of every product to be made in every period
● bill of materials, listing the materials needed for every product
● inventory records, showing the materials available.

A bill of materials is an ordered list of all the parts needed to make a particular product. It
shows the materials, parts and components – and also the order in which they are used.
Suppose a company makes tables from a top and four legs. Then each top is made from a wood
kit and hardware; the wood kit has four oak planks, side panels, and so on. The bill of mate-
rials for this is shown in Figure 7.2. You can see that every item has a ‘level’ number that
shows where it fits into the process, and figures in brackets show the numbers needed to make
each unit. The finished product is level 0; level 1 items are used directly to make the level 0
item, level 2 items are used to make the level 1 items, and so on.
A full bill of materials keeps going down through different levels until it reaches materials
that the organisation always buys in from suppliers. By this time, there might be hundreds or
even thousands of different materials. MRP uses this bill of materials, along with the master
schedule, to get a timetable for the delivery of each of the materials.
Suppose a master schedule shows that the company plans to make 10 tables in February. It
obviously needs 10 tops and 40 legs ready for assembly at the beginning of February. In prac-
tice, these are the gross requirements. The company may not have to order them all, as it may
already have some in stock, or have outstanding orders that are due to arrive shortly. If we
subtract these from the gross requirements we get the net requirements for materials. The
company needs 40 table legs by the beginning of February, but if it already has 8 in stock and
an order of 10 that is due to arrive in January, the net requirement is for 40 – 8 – 10 = 22.
Net requirements = gross requirements – current stock – stock on order

Level 0
Table

Level 1 Legs (4) Top (1)

Wood kit Hardware Wood kit Hardware

Level 2
(1) (1) (1) (1)

Oak planks Pine siding Drawer

Level 3 (4) (4) pack (2)

Figure 7.2 Part of a bill of materials for a table

170 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Master schedule Bill of materials Stock records

Scheduled Any other

Current stock
deliveries factors

Gross Time and

Net requirements Material needed
requirements size of orders

Figure 7.3 Summary of MRP procedure

Now we know the quantities to order, and when these orders should arrive. The next step is to
find the time to place the order. For this we need the lead times – and we place orders this lead
time before the materials are actually needed. If the company buys tabletops and legs from
suppliers who give a lead time of four weeks, it needs to place orders at the beginning of
January. These orders will arrive by the end of January just before assembly is due to start.
Finally, we have to consider any other relevant information, such as minimum order sizes,
discounts, minimum stock levels, variation in lead time, and so on. When the company takes
all of this into account it gets a detailed timetable for orders. This procedure is shown in
Figure 7.3.
We can summarise this MRP procedure by the following steps:

● Step 1: Use the master schedule to find the gross requirements of level 0 items.

● Step 2: Subtract any stock on hand and orders arriving to give the net requirements
for level 0 items. Then schedule production, with starting times to meet these net
requirements.

● Step 3: Take the next level. Use the bill of materials to translate the net requirements from
the last level into gross requirements for this level.

● Step 4: Take each material in turn and:

● subtract the stock on hand and scheduled deliveries to find the materials needed
● use the lead time and any other relevant information to give the size and timing of
these orders.
Then if there are more levels of materials, go back to step 3.

● Step 5: Finalise the timetable, adding any specific adjustments.

 C O N T R O L L I N G M AT E R I A L F L O W 171

W O R K E D
E X A M P L E

Semple-Brown assemble kitchen tables using bought-in parts of four legs and a top. These
have lead times of two and three weeks respectively, and assembly takes a week. The com-
pany receive orders for 20 tables to be delivered in week 5 of a planning period and 40
tables in week 7. It has current stocks of 2 complete tables, 40 legs and 22 tops. When
should it order parts?

Solution
The orders give the following production schedule for finished tables – shown as the gross
requirements for level 0 items. Subtracting the current stock of finished tables gives the
net requirements. Then allowing a week for assembly gives the start times.

Level 0 – kitchen tables

Week 1 2 3 4 5 6 7

Gross requirements 20 40
Opening stock 2 2 2 2 2
Net requirements 18 40
Start assembly 18 40
Scheduled completion 18 40

The ‘scheduled completion’ shows the number of units that become available in a week,
which is the number started the lead time earlier.
We have already described the bill of materials for this example as the first two levels in
Figure 7.2. We can use this, together with the assembly plans, to find gross requirements
for level 1 items – which are legs and tops. In week 4 there is a net requirement of 18
tables, which translates into a gross requirement of 18 × 4 = 72 legs and 18 × 1 = 18 tops.
So we can find the gross requirements for level 1 materials as:

■ legs: 18 × 4 = 72 in week 4, and 40 × 4 = 160 in week 6

■ tops: 18 in week 4, and 40 in week 6.
Subtracting the stock on hand from these gross requirements gives the net require-
ments. To make sure the parts arrive on time, they must be ordered the lead time in
advance – which is 2 weeks for legs and 3 weeks for tops.

Level 1 – legs

Week 1 2 3 4 5 6 7

Gross requirements 72 160

Opening stock 40 40 40 40
Net requirements 32 160
Place order 32 160
Scheduled deliveries 32 160
172 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

W O R K E D
E X A M P L E
continued

Level 1 – tops

Week 1 2 3 4 5 6 7

Gross requirements 18 40
Opening stock 22 22 22 22 4 4
Net requirements 36
Place order 36
Scheduled deliveries 36

There are no more levels of materials, so we can finalise the timetable of events as:

■ week 2: order 32 legs

■ week 3: order 36 tops
■ week 4: order 160 legs and assemble 18 tables
■ week 6: assemble 40 tables.

Benefits of MRP

Traditional, independent demand systems forecast likely demand for materials, and then hold
stocks that are high enough to meet these. To allow for the inevitable errors in their forecasts,
organisations hold more stocks than they really need. These extra stocks give a measure of
safety, but they also increase the inventory costs. MRP avoids these costs by relating the supply
of materials directly to demand. Benefits that come from this direct link include:

● lower stock levels, with savings in capital, space, warehousing, and so on

● higher stock turnover
● better customer service – with no delays caused by shortages of materials
● more reliable and faster delivery times
● less time spent on expediting and emergency orders
● MRP schedules can be used for planning other logistics activities.

MRP can also give early warning of potential problems and shortages. If the MRP schedules
show that some materials will arrive too late, the organisation can speed up deliveries or
change the production plans. In this way MRP improves the wider performance of the organi-
sation – measured in terms of equipment utilisation, productivity, customer service, response
to market conditions, and so on.

Disadvantages of MRP

There are also some problems with MRP, the most obvious being the amount of information
and calculation that it needs. The basic information comes from a detailed master schedule, so
 C O N T R O L L I N G M AT E R I A L F L O W 173

MRP cannot be used when there is no master schedule, the master schedule is not designed far
enough in advance, it is inaccurate and does not show what actually happens, or when plans
are changed frequently.
Other requirements of MRP include a bill of materials, information about current stocks,
orders outstanding, lead times, and other information about suppliers. Many organisations
simply do not record this information. Others find that their information does not have
enough detail, or is in the wrong format, or is not accurate enough. Accuracy is particularly
important, as large numbers of small stock transactions can introduce errors. Ordinarily these
errors are small enough not to matter, as there is enough stock to give cover until the errors are
detected. MRP, however, does not have these reserve stocks, so there is no room for errors.
Another problem with MRP is its inflexibility. The only materials available are those needed
for the specified master schedule, so this cannot easily be adjusted. Some general disadvan-
tages of MRP include:

● reduced flexibility to deal with changes

● needs a lot of detailed and reliable information
● systems can become very complex
● the order sizes suggested by MRP can be inefficient
● MRP may not recognise capacity and other constraints
● can be expensive and time consuming to implement.

L O G I S T I C S
I N P R A C T I C E
British Airways plc
British Airways (BA) is one of the world’s years by improving efficiency, and looked
largest airlines, with flights to 150 destin- for even further savings following a drop in
ations over 1200 routes. You can imagine business in 2001/2. As part of this, BA
the amount of materials that it has to Catering reviewed its services and cost,
move just to serve 50 million meals a year reduced the length of its supply chains and
to passengers. Kitchens at Heathrow and more positively managed links with supply
Gatwick prepare 250 tonnes of chicken chain partners. It also effectively introduced
and 40,000 cases of wine, but third party MRP for several million items from 300 sup-
suppliers around the world provide most pliers. Passenger bookings provide the mas-
of the food. BA is, however, responsible for ter schedule, and these are used to
all the non-food items, such as crockery, co-ordinate the airlines stock levels and
wine, dry foods, cutlery, and so on. A typi- deliveries. By matching supply to known
cal Boeing 747 flight carries around demand – thereby eliminating waste and
45,000 items. reducing stocks – BA saves around £4 mil-
BA is a ‘full service’ airline, which means lion a year. The company’s original invest-
that it emphasises service rather than low- ment was repaid within the first year.
est possible price. Nonetheless, in 1997 it Reduced costs are only one benefit of
announced plans to save £1 billion over five the new system. Less storage space was
174 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

L O G I S T I C S
I N P R A C T I C E
continued

needed at airports, lead times were and even customer, BA has a means of sig-
reduced, there was less wastage, control of nificantly increasing customer service.
materials was improved, shortages were
Sources: Collinge P. and Reynolds P. (1997) Food
reduced, and so on. More reliable informa-
for thought, Logistics Focus, 5(9), 2–8; Jones C.
tion became available, and by recording (1998) Making the missing link, Logistics Focus
every item demanded by every route, flight 6(7), 2–6; and website at www.ba.com

EXTENDING THE ROLE OF MRP

Initial ideas

We have outlined the basic approach of MRP and now can look at ways of improving the
results. For example, the basic procedure might suggest a series of small, frequent orders. It
may be cheaper and more convenient to combine several of these small orders into one larger
one. This is called batching. There are four common methods of batching:

1. Lot-for-lot – where you order exactly the net requirement suggested by MRP for each
period. This has the advantage of minimising the amount of stock, but can give high
ordering, delivery and administration costs.

2. Fixed-order quantity – where you find an order size that is convenient, such as a truck-
load, a container load, or an economic order quantity (which we describe in Chapter 9).
When you want a delivery, you always order this amount, and put any spare in stock.

3. Periodic orders – where you combine the requirements over some fixed period, and place
regular orders for different quantities. You might, for example, place a weekly order for
the amount of materials needed in the following week. Working to a regular timetable is
simple and makes ordering routine.

4. Batching rules – which uses a specific procedure to calculate the best pattern of orders.
Typically they look for the combination of orders that gives the lowest overall cost. In
practice, this can be quite a difficult scheduling problem.2

Another improvement comes when the same material is used for different products. Then
we combine the demands from all products to give the overall gross requirement. Similarly,
when several materials are ordered from the same supplier, it obviously makes sense to add
them all to a single order. Now the batching rules have to extend to cover different products,
and different materials from the same source.
A more significant extension to MRP adds feedback for planning. MRP uses the master
schedule to generate orders for materials, and this schedule usually has some variation. But we
saw in Chapter 2, that this variation can be magnified in the supply chain to give widely
 C O N T R O L L I N G M AT E R I A L F L O W 175

Inventory Other
Bill of materials
records information

Material
requirements Master schedule
planning

Schedule for
material use

Purchase plan Internal supply Adjust plans

Capacity
Purchases requirements
planning

No

Yes Need Yes

Problems? rescheduling?

No

Implement
plans

Figure 7.4 A closed-loop MRP system

varying demands for upstream suppliers. Their operations may not be able to deal with this
varying demand, particularly during the peaks. It is obviously better to anticipate such prob-
lems during the planning stage, so that schedules or capacity can be adjusted before the plans
are finalised. In other words, we introduce feedback from MRP to capacity planning. This
linking of capacity planning to MRP is called capacity requirements planning. Overall
systems with feedback of this kind are called closed-loop MRP, with one system summarised
in Figure 7.4.

Moving to MRP II

You can see how capacity requirements planning extends the MRP approach further into the
organisation. We started by using MRP to schedule the delivery of materials, and can now use it
in capacity planning. But we need not stop here. Materials are only one resource, and organisa-
tions have to schedule others, including people, equipment, facilities, finances, transport, and so
176 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

on. Surely we can use the same MRP approach to consider these other resources. This thinking
has led to a major extension of MRP into Manufacturing Resources Planning, or MRP II.
Imagine an organisation that uses MRP to get a timetable for purchasing materials and
preparing materials internally. If it knows when the internal materials have to be ready, it
knows when to start preparing them. In other words, MRP can give schedules for the produc-
tion of components. But we can use the schedules for components to get timetables for
production equipment, people working on it, raw materials, and other resources. And if we
know when the raw materials are needed, we can schedule inward transport, drivers, quality
checks, and so on. Continuing in this way, we could build an integrated system that would
‘explode’ the master schedule to give timetables for all the jobs, equipment, operators,
machines, and facilities needed to achieve it.
With this approach, MRP would schedule all the operations. However, there is no reason
why we should stop there, and we could look at the associated finance, marketing, sales,
human resource management, and so on. Eventually we would get a completely integrated
system that would use the master schedule as the basis for planning all the resources in an
organisation. This is the aim of MRP II.

■ M R P I I gives an integrated system for synchronising all functions within an

organisation.
■ It connects schedules for all functions and resources back to the master schedule.

Linking all activities to the master schedule can give very efficient logistics. There are no
late deliveries or shortages, no stocks of work in progress accumulate, and products move
smoothly through the whole process. These benefits have encouraged many organisations to
move towards MRP II. Unfortunately, there can be serious practical difficulties. To start with, it
is difficult to get schedules that everyone accepts as being good and workable. A more serious
problem, though, is the difficulty of integrating all functions and systems. Many organisations
have asked if the rewards from such close integration are worth the effort. MRP tends to be
inflexible, so a whole organisation run in this way might become cumbersome, unwieldy, slow
to respond to changing conditions.
Because of these difficulties, many organisations have moved towards MRP II, but have not
implemented complete systems. Often different names are used for these partial systems, and
you might hear about distribution resource planning or logistics resource planning, where
the MRP approach is used to plan logistics. Unfortunately, such terms are used rather incon-
sistently. Some people, for example, use distribution resource planning to describe more
limited systems where the demand does not come from a production plan, but from received
customer orders.

Working with other organisations

MRP II can generate plans for all activities and material movements within an organisation.
But this is still not the end of the story. Following the trend for integrating the supply chain,
we can extend the planning to other organisations. This gives the basis of Enterprise Resource
Planning (ERP).
Suppose a manufacturer’s MRP system finds that it needs a delivery of 100 units of some
material at the beginning of June. It uses this information to schedule its purchases.
 C O N T R O L L I N G M AT E R I A L F L O W 177

Co-ordinated
operations in all
organisations

Master Order and Customer

schedule delivery operations

Material
requirements
planning

Supplier Order and

Purchases
operations delivery

Internal MRP

External ERP

Figure 7.5 Enterprise resource planning

However, EDI (electronic data interchange) can link the MRP system to the supplier’s system,
so the supplier knows in advance when it has to deliver this material, and it can start sched-
uling operations to make sure that it is ready in time. If second tier suppliers are linked to
the MRP system of the first tier supplier, they can also start their preparations. In this way,
the message moves backwards through the supply chain, giving integrated planning (illus-
trated in Figure 7.5).
In principle, the free flow of information needed by ERP is relatively easy to organise with
EDI, EFT, the Internet and other tools of e-business. However, it might be difficult to get such
complete trust between organisations, even when they are prepared to form alliances. You can
also imagine the complexity of systems needed, and the practical problems that arise.
Nonetheless, this approach has considerable potential, and is leading to the next stage of
‘virtual enterprise resource allocation’.3
178 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

L O G I S T I C S
I N P R A C T I C E
SAP AG
ERP software has been available since the cost of $15 million. Of this, 17% is for soft-
1990s and the market has grown very ware, 14% for hardware, 46% for profes-
quickly. Estimates of world sales value vary sional services and 23% for internal staff
widely, but it probably reached $10 billion costs. The time to implement the systems
a year before 2000. vary from under 18 months to over 30
SAP was founded in Walldorf, Germany months. After this, benefits begin to appear
in 1972, and is the world’s largest ‘inter- in about a year and it takes around five
enterprise’ software company. It employs years to break even.
25,000 people, in more than 50 companies Peter Burris of META Group summarises
and has ‘10 million users; 30,000 installa- these results5 with the comment:
tions; 1,000 partners’. You can see how To say that implementing ERM/ERP solu-
quickly its market has grown from the fol- tions requires an enormous commitment is
lowing revenues for ERP in the mid 1990s.4 an understatement. They are expensive,
are time-consuming, and require change
Year 1994 1995 1996 1997
in virtually every department in the
ERP licence revenue 692 1350 1730 2370 enterprise.
($ million)

Sources: Brace G. and Rzevski G. (1998) Elephants

Many other companies supply such inte- rarely pirouette, Logistics Focus, 6(9), 14–18;
Anon (1999) ERM Solutions and Their Value,
grated software, including BAAN, JD Meta Group, Stamford, CT; and websites at
Edwards, SSA, and PeopleSoft. Their very www.SAP.com and www.metagroup.com
large systems have an average installation

PRINCIPLES OF JUST-IN-TIME

Principles and definitions

Just-in-time (JIT) offers another way of planning. It organises all activities so they occur at
exactly the time they are needed. They are not done too early (which would leave materials
hanging around until they were actually needed) and they are not done too late (which would
give poor customer service). You can see this effect when you order a taxi to collect you at
08:00. If the taxi arrives at 07:30 you are not ready and it wastes time sitting and waiting; if it
arrives at 08:30 you are not happy and will not use the service again. When the taxi arrives at
08:00 – just-in-time for your trip – it does not waste time waiting, and you are pleased that the
service arrives exactly when you wanted it.
JIT seems an obvious idea, but it can have a dramatic effect on the way that materials are
organised. You can see this with stocks of raw materials. The traditional approach buys mate-
rials early and keeps them in stock until they are needed. MRP reduces stock by co-ordinating
 C O N T R O L L I N G M AT E R I A L F L O W 179

the arrival of materials with the demand. But JIT aims at delivering materials directly to oper-
ations and virtually eliminating stock.
Companies such as Toyota6,7 spent years developing JIT through the 1970s. Their methods
were so successful that all major organisations now use some elements of JIT. We can start
describing the principles by looking at the effect on stock, and then generalise the approach to
other areas.
The main purpose of stock is to give a buffer between operations. Stocks are built-up
during good times, to be used when there are problems. Then if some equipment breaks
down, or a delivery is delayed, or demand is unexpectedly high, everything continues to work
normally by using the stocks. The traditional view of managers is that stocks are essential to
guarantee smooth operations. They allow for any mismatches between the supply and
demand for materials.
Inventory control systems (which we describe in Chapter 9) define stock levels that are
high enough to cover likely problems. Unfortunately, with widely varying demand or poten-
tial problems, these stock levels can be very high – and expensive. MRP reduces the amount of
stock by using the master schedule to match the supply of materials more closely to demand.
In practice, the batching rules of MRP add some stock, and they keep some more to allow for
uncertainty and problems. However, the principle is clear – the more closely we can match the
supply of materials to demand, the less stock we need to carry. If we can completely eliminate
any mismatch, we need no stocks at all. This is the basis of just-in-time systems (illustrated in
Figure 7.6).

■ J U S T- I N - T I M E systems organise materials to arrive just as they are needed.

■ By co-ordinating supply and demand, they eliminate stocks of raw materials and
work in progress.

You can see an example of just-in-time operations with the fuel in a lawnmower. If a lawn-
mower has a petrol engine, there is a mismatch between the fuel supply that you buy from a
garage, and demand when you actually mow the lawn. You allow for this mismatch by
keeping stocks of fuel in the petrol tank and spare can. This is the traditional approach to
inventory control, where stocks are high enough to cover any likely demand. If a lawnmower
has an electric motor the supply of electricity exactly matches demand and there are no stocks
of fuel. This is a just-in-time system.
So what happens when there really is a mismatch between supply and demand? What does
a supermarket do when it sells loaves of bread one at a time, but gets them delivered by the
truckload? The traditional answer is to hold enough stock to cover the mismatch – the super-
market puts the truckload of bread on its shelves until it is sold or goes stale. JIT says that this
is a mistake. There is an alternative, which is to remove the mismatch. The supermarket might
approach this by using smaller delivery vehicles, or opening a small bakery on the premises.
Now we can summarise JIT’s view of stock:

● Stocks are held to cover short-term mismatches between supply and demand.
● These stocks serve no useful purpose – they only exist because poor co-ordination does
not match the supply of materials to the demand.
● As long as stocks are held, there are no obvious problems and no incentive for managers
to improve the flow of materials.
● Then operations continue to be poorly managed, with problems hidden by stocks.
● The real answer is to improve operations, find the reasons for differences between supply
and demand, and then take whatever action is needed to overcome the differences.
180 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

As you can see, JIT is based on very simple principles. Instead of holding stocks to allow for
problems, you identify the problems and solve them. Unfortunately, this often puts new pres-
sures on logistics. With deliveries of bread to a supermarket, for example, logistics managers
have to design new systems that can deliver small, frequent quantities of fresh bread.

Not linked – giving mismatches

Stock level

Material Customers
supply

Time
High stock levels to cover
differences between supply
and demand

(a) Traditional method of stock control

Some links – with smaller mismatches

Stock level

Material Customers
supply

Time
Lower stock levels as supply
is closer to demand

(b) MRP systems

Strong links – no mismatches

Material Customers
supply
No stocks as supply exactly
matches demand

(c) JIT approach

Figure 7.6 Stock levels with different types of control

 C O N T R O L L I N G M AT E R I A L F L O W 181

Wider effects of JIT

We have introduced JIT as a way of reducing stock levels, but it is much more than this. JIT
involves a change in the way an organisation looks at all its operations. Its supporters describe
it as ‘a way of eliminating waste’, or, ‘a way of enforced problem solving’. In this wider sense,
JIT sees an organisation as having a series of problems that hinder efficient operations. These
problems include long lead times, unreliable deliveries, unbalanced operations, constrained
capacity, equipment breakdowns, defective materials, interruptions, unreliable suppliers, poor
quality, too much paperwork and too many changes. Managers try to get around these prob-
lems by holding large stocks, buying extra capacity, keeping back-up equipment, employing
‘trouble-shooters’, and so on. But these methods only hide the symptoms of problems. A
much more constructive approach is to identify the real problems – and solve them. This
approach leads to a number of changes in viewpoint.

● Stocks: As we have seen, organisations hold stocks to cover short-term differences between
supply and demand. JIT assumes that these stocks actually hide problems. Organisations
should find the reasons for differences between supply and demand, and then take what-
ever action is needed to remove them.

● Quality: Organisations have defined some arbitrary level of acceptable quality, such as, ‘we
will accept one defect in a hundred units’. JIT recognises that all defects have costs, and it
is better to find the cause and make sure that no defects are produced (supporting the
view of total quality management).

● Suppliers: JIT relies totally on its suppliers – so it supports the view of customers and
suppliers working closely together in long-term partnerships pursuing common
objectives.

● Batch size: Operations often use large batch sizes, as they reduce set-up costs and disrup-
tions. But if demand is low, the products made in large batches sit in stock for a long time.
JIT looks for ways of reducing the batch size so that it more closely matches demand.

● Lead times: Long lead times encourage high stocks, as they have to cover uncertainty until
the next delivery. JIT aims for small, frequent deliveries with short lead times.

● Reliability: JIT is based on continuous, uninterrupted production, so all operations must

be reliable. If, say, equipment breaks down, managers must find the reasons and make
sure it does not happen again.

● Employees: Some organisations still have a friction between ‘managers’ and ‘workers’. JIT
argues that this is a meaningless distinction, as the welfare of everyone depends on the
success of the organisation. All employees should be treated fairly and equitably.

By now, you can see that JIT is not just a way of minimising stocks. By co-ordinating all
activities, it increases efficiency and eliminates waste.
182 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

L O G I S T I C S
I N P R A C T I C E
Just-In-Time at Guy La Rochelle International
Guy La Rochelle International is one of customers’ tastes. Now customers are guar-
Europe’s leading manufacturers of cosmet- anteed products that have been made
ics and toiletries. It has a major production within the past few days and have not
plant near Lyon that employs more than spent weeks sitting on a warehouse shelf.
700 people. When La Rochelle reduced its stock of lip-
One of the problems with La Rochelle’s stick by $1 million it saved $250,000 a year.
market is the speed at which customers’ Their Baby Soft bath oil has changed from a
tastes change. To maintain its market share production run of 60,000 units every 30
and meet these changing demands, La days, to 10,000 units every 5 days; the run
Rochelle has to be flexible. It has improved of 200,000 units of lipstick every 65 days has
its response to customers and reduced changed to 60,000 units every 20 days.
costs by introducing just-in-time manufac- The conversion to JIT is well-supported
turing. This has small batch sizes, short pro- and liked by La Rochelle employees. Every
duction runs, low stocks, fast changeover employee now has a variety of skills, and
between products, reliable delivery from works in a team rather than as an individual.
suppliers, efficient shipment of goods to
Source: company reports
customers, and fast response to changing

Key Elements in JIT

One problem with JIT is that it only works well in certain types of organisation. The most
successful users of JIT are large-scale assembly plants, which make virtually identical products
in a continuous process. You can see why this is, from the following arguments:

● Every time there are changes to a process, or it switches from making one product to
making another, there are delays, disruptions and costs. JIT says that these changes waste
resources and should be eliminated. In other words, JIT needs a stable environment where
a process makes large numbers of a standard product, at a fixed rate, for a long time.

● This stable environment can reduce costs by using specialised automation. Then JIT works
best with high volume, mass production.

● The level of production must allow a smooth and continuous flow of products through
the process. Each part of the process should be fully utilised, so the process is likely to be
a well-balanced assembly line.

● Deliveries of materials are made directly to the assembly line at just the time they are
needed. Suppliers must be able to adapt to this kind of operation. It would be impractical
 C O N T R O L L I N G M AT E R I A L F L O W 183

to bring each individual unit from suppliers, so the next best thing is to use very small
batches.

● If small batches are used, reorder costs must be reduced as much as possible or the
frequent deliveries will be too expensive.

● Lead times must be short or the delay in answering a request for materials becomes too
long. This means working closely with suppliers, and encouraging them to build facilities
that are physically close.

● As there are no stocks to give safety cover, any defects in materials would disrupt produc-
tion. Suppliers must, therefore, be totally reliable and provide materials that are free from
defects.

● If something goes wrong, people working on the process must be able to find the cause,
take the action needed to correct the fault, and make sure that it does not happen again.
This needs a skilled and flexible workforce that is committed to the success of the
organisation.

ACHIEVING JUST-IN-TIME OPERATIONS

Push and pull systems

The success of JIT is not solely based on its idea of organising activities at just the time they are
needed, but on its description of how to achieve this. It works by ‘pulling’ materials through
the process.
In a traditional process, each operation has a timetable of work that must be finished in a
given time. Finished items are then ‘pushed’ through to form a stock of work in progress in
front of the next operation. Unfortunately, this ignores what the next operation is actually
doing – it might be working on something completely different, or be waiting for a different
item to arrive. At best, the second operation must finish its current job before it can start
working on the new material just passed to it. The result is delays and increased stock of work
in progress.
JIT uses another approach to ‘pull’ work through the process. When one operation finishes
work on a unit, it passes a message back to the preceding operation to say that it needs another
unit to work on. The preceding operation only passes materials forward when it gets this
request. As you can see, this kind of process does not have earlier operations pushing work
through, but has a later operation pulling it through. You can see the difference in a take-
away sandwich bar. With the traditional push system, someone makes a batch of sandwiches
and delivers them to the counter where they sit until a customer buys them. With a JIT pull
system, a customer asks for a particular type of sandwich, and this is specially made and deliv-
ered – thus eliminating the stocks of work in progress. You can also see that there is inevitably
some lead time between an operation requesting material and having it arrive. In real JIT
systems, messages are passed backwards this lead time before they are actually needed. Mate-
rials are also delivered in small batches rather than continuous amounts, so JIT still has some
stocks of work in progress. These stocks are as small as possible, so it would be fairer to say that
JIT minimises stocks rather than eliminates them.
184 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

L O G I S T I C S
I N P R A C T I C E
Scandinavian Health Products
Scandinavian Health Products (SHP) sell a manager, identified the problem as the trol-
range of 280 products to customers in leys used to move boxes between the ware-
northern Europe. They deliver products by house and finishing. These trolleys carried
post, with orders received by e-mail, tele- over a hundred boxes. People in the ware-
phone, fax and post. Their main products house section loaded up a trolley, and
are vitamin pills, mineral supplements, oil when it was full they used a forklift truck to
capsules, herb extracts and a range of other push it through to the finishing section.
natural products that foster good health. On most days the finishing section
Operations in SHP centre on four sections: would get a surge of work at the end of the
day as the warehouse section cleared their
■ At the beginning of each day the receipt
orders before going home, and pushed
section looks at all new orders, checks
through two or three trolleys just before the
the details and sends orders down to the
four o’clock deadline. Finishing could not
warehouse.
deal with these in time, but worked on
■ The warehouse section looks at each some during overtime at the end of their
order, collects the products requested in working day, and left the remainder until
a box and passes this to the finishing the next morning.
section. Kurt Brandt found a simple solution to
■ The finishing section checks the the problem. He reduced the working day
contents of each box against the order, of people in the finishing section so that
checks the bill, adds some promotional they arrive 15 minutes later than those in
material and seals the box. the warehouse. In return, rather than wait
for the trolleys to be delivered, they go to
■ The transport section consolidates and collect them whenever they run out of
wraps the boxes, and each afternoon at work. The big trolleys were replaced with
4pm they take the day’s orders to a small ones that only carry five boxes and
national parcel delivery service which which can be pushed by hand. People in
guarantees delivery by the following the warehouse make sure that there are
morning. always three or four of the new trolleys
This process should work smoothly, but the filled and waiting for the finishing section
finishing section always complained that to collect.
they had to work late, and orders often Sources: company reports and Brandt K (2002)
missed the post. Kurt Brandt, the logistics Using JIT, Practice Seminar, Logistics Quest, Oslo

Kanbans

JIT needs some way of organising the flow of materials that are pulled through the process.
The simplest system moves materials between two stages in containers. When a second stage
 C O N T R O L L I N G M AT E R I A L F L O W 185

When full the

container returns to
Full container the following stage

Stage 1 Container being Stage 2

making filled with Container of using
materials materials materials materials
being used

Empty container
Moving an empty container
to previous stage gives a
message to refill

Figure 7.7 The simplest form of message for JIT

needs some materials, it simply passes the empty container back to the previous stage as a
signal to fill it (see Figure 7.7).
This method is not reliable enough for most operations, so the usual alternative uses
kanbans. ‘Kanban’ is the Japanese for a card, or some form of visible record.

■ K A N B A N S are cards that control the flow of materials through JIT operations.
■ They arrange the ‘pull’ of materials through a process.

There are several ways of using kanbans. The most common system (shown in Figure 7.8)
uses two distinct types of card, a production kanban and a movement kanban.

● All material is stored and moved in standard containers – with different containers for
each material.

● A container can only be moved when it has a movement kanban attached to it.

● When one stage needs more materials – that is when its stock of materials falls to a
reorder level – a movement kanban is attached to an empty container. This gives permis-
sion to take the container to a small stock of work in progress.

● A full container is found in this stock, which has a production kanban attached.

● The production kanban is removed and put on a post. This gives a signal for the preceding
workstation to make enough to replace the container of materials.
 Full container and Full container and
production kanban movement kanban

Store of work
in progress

Full container Full container

Stage 1 Container Container Stage 2

Production Movement
making of materials of materials using
kanban kanban
materials being filled being used materials

Empty Empty
container container
Movement
kanban
Empty
container

Empty container and Empty container and

production kanban movement kanban

Figure 7.8 A two-card kanban system

 C O N T R O L L I N G M AT E R I A L F L O W 187

● The movement kanban is attached to the full container, giving permission to move it back
to the operation.

Although this system has a stock of work in progress, this stock is small. When a full
container is removed, it is usually the only container in stock – and materials are not replaced
until the previous workstation makes them. JIT almost always uses a product layout – such as
an assembly line – so this stock of work in progress is really a small amount that is kept in the
line, and there is no actual movement.
Each full container in the store has a production kanban attached to it, so the number of
these kanbans effectively fixes the amount of work in progress. If there is only one production
kanban, it means that the stock of work in progress is limited to at most one container of
items. If there are two production kanbans, this doubles the stock of work in progress, and
more kanbans would give even higher stocks. The aim of JIT is to work with minimum stocks
and, therefore, a minimum feasible number of kanbans.
The main features of such kanban systems are:

● A message is passed backwards to the preceding workstation to start production, and it

only makes enough to fill a container.
● Standard containers are used which hold a specific amount. This amount is usually quite
small, and is typically 10% of a day’s needs.
● The size of each container is the smallest reasonable batch that can be made, and there
are usually only one or two full containers at any point.
● A specific number of containers and kanbans is used.
● The stock of work in progress is controlled by the size of containers and the number of
kanbans.
● Materials can only be moved in containers, and containers can only be moved when they
have a kanban attached. This gives a rigid means of controlling the amount of materials
produced and time they are moved.
● While it is simple to administer, this system makes sure that stocks of work in progress
cannot accumulate.

JIT has developed into many different forms. A common one replaces the manual kanbans
with electronic signals. Then a control system monitors movements of materials using bar
codes or other item coding, and it sends a message backwards to signal when it is time to
prepare more materials.

Benefits and disadvantages of JIT

We introduced JIT as a way of lowering stocks, and some organisations have reduced these by
90%.8 This gives a number of related benefits, such as reduction in the space needed (up to
40% less), lower procurement costs (up to 15%), less investment in stocks, and so on. In
general, JIT gives the following benefits:

● lower stocks of raw materials and work in progress

● shorter lead times
● shorter time needed to make a product
● higher productivity
188 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

● higher equipment capacity and utilisation

● simplified planning and scheduling
● less paperwork
● improved quality of materials and products
● less scrap and wastage
● better morale and participation of the workforce
● better relations with suppliers
● emphasis on solving problems in the process.

Unfortunately, some of these benefits can only be bought at a high price. Making high quality
products with few interruptions by breakdowns, for example, can mean buying better quality,
more expensive equipment. Reduced set-up times usually need more sophisticated equipment.
Small batches can increase production costs. Higher skills in the workforce increase training
costs and the subsequent wage bill. Equipment must respond quickly to changing demands, so
there must be more capacity.
One of the main problems with JIT is its inability to deal with unforeseen circumstances.
Accidents or breakdowns, for example, can interrupt supplies and cause problems in the
supply chain. Early in 2001 fuel supplies in the UK were disrupted by industrial action.
Companies working with JIT felt the effects immediately when their materials were not deliv-
ered, while those with higher stocks kept working normally.
Some specific problems listed by JIT users include:

● high risks of introducing completely new systems and operations

● initial investment and cost of implementation
● long time needed to get significant improvements
● reliance on perfect quality of materials from suppliers
● inability of suppliers to adapt to JIT methods
● need for stable production when demand is highly variable or seasonal
● reduced flexibility to meet specific, or changing, customer demands
● difficulty of reducing set-up times and associated costs
● lack of commitment within the organisation
● lack of co-operation and trust between employees
● problems linking JIT to other information systems, such as accounts
● need to change layout of facilities
● increased stress in workforce
● inability of some people to accept devolved responsibilities.

L O G I S T I C S
I N P R A C T I C E
JIT at Harley-Davidson
Harley-Davidson was one of the first com- the local demand. These included Harley-
panies to notice the effects of JIT. In the Davidson in America, BSA in Britain and
1960s many countries had domestic manu- BMW in Germany. But in the 1970s the
facturers of motorcycles who met most of industry changed dramatically, and many
 C O N T R O L L I N G M AT E R I A L F L O W 189

L O G I S T I C S
I N P R A C T I C E
continued

well-established companies went bankrupt. Harley-Davidson recognised that it could

Their problem was the sudden new compe- only compete by using the same methods,
tition from the Japanese companies of and adopted JIT in 1982. They stuck to
Honda, Yamaha, Suzuki and Kawasaki. their ‘materials as needed’ programme –
These four companies could supply their version of JIT – through initial difficul-
motorcycles anywhere in the world with ties and are now thriving in a very compet-
higher quality and lower cost than com- itive market. In a five-year period Harley-
petitors. In 1978 Harley-Davidson in Amer- Davidson reduced machine set-up times by
ica tried – but failed – to prove that the 75%, warranty and scrap costs by 60%,
Japanese companies were dumping motor- and work in progress stocks by $22 million.
cycles on the market at less than the cost of During the same period productivity rose
manufacture. During these hearings it was by 30%.
shown that the Japanese companies’ oper-
Source: company reports, www.HarleyDavidson.com
ating costs were 30% lower than Harley-
Davidson’s. One of the main reasons was
their use of JIT manufacturing.

EXTENDING JIT ALONG THE SUPPLY CHAIN

Efficient consumer response

JIT forces suppliers to change the way they work, with fast deliveries, perfect quality, small
batches, and complete reliability. The easiest way for them to meet these requirements – which
also reinforces the idea of an integrated supply chain – is to adopt JIT methods themselves.
Then second tier suppliers adopt JIT to support first tier suppliers, and so on. This ensures that
the whole supply chain is working together with the same aims and principles. This extension
of JIT along the supply chain is known by a variety of names, including quick response (QR),
continuous replenishment planning (CRP) and more commonly efficient consumer
response (ECR).

E F F I C I E N T C O N S U M E R R E S P O N S E pulls materials through tiers of organ-

isations in the supply chain.

Early work in ECR was done in the fashion industry. This had severe problems with its
stockholdings, largely caused by the traditional planning of production around four seasons.
At the start of, say, the summer season, shops had to be full of new products in the latest
styles. Then shops needed high stocks to give customers a wide choice, and wholesalers
needed high stocks to re-supply the shops at short notice. To make sure that these stocks were
in place, peak manufacturing occurred some time before the start of the season. If demand for
190 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

a product was particularly high, there would be shortages as manufacturers had already moved
on to making their autumn and winter collections. If demand was low, shops could not reduce
their purchases as the clothes were already sitting on their shelves and in wholesalers. At the
end of each season there were major sales as wholesalers and retailers tried to get rid of their
less popular items, and major restocking in preparation for the next season.
The industry realised that it could get huge savings if it smoothed its operations. The way
to do this was not to have huge stocks sitting in the supply chain, but to move items quickly,
and respond to customer demands by more flexible manufacturing. Now they use just-in-time
operations and link information systems so that they can ‘pull’ materials through the supply
chain. When a retailer sells an item, their cash register automatically sends a message to the
wholesaler requesting a replacement. In turn, the wholesaler’s system sends a message to the
manufacturer asking for a delivery. The manufacturer is not bogged down in making excessive
amounts of items that are later sold at discounts, but responds quickly to the demand and
replaces garments that have actually been sold.
With ECR, a message passes backwards through the supply chain, and each organisation
co-operates in moving materials forwards. In 1985 the US retailer J.C. Penney formed one of
the world’s first ECR partnerships with Burlington (a fabric manufacturer) and Lanier Clothing
(a garment maker). As a result, they increased sales by 22% and reduced stocks by 50%.9
Interest in ECR has grown since the mid 1990s. The grocery trade was quick to see the poten-
tial benefits, and when you buy a packet of biscuits in a supermarket the till automatically
sends a message back to the supplier to send a replacement, and the supplier’s system sends a
message to its own supplier, and so on back through the chain.
ECR extends the benefits of JIT to the whole supply chain. So it brings lower stocks, better
customer service, lower costs, more responsive operations, improved space utilisation, less
paperwork, and so on. Organisations introducing ECR in the 1990s reported a string of bene-
fits. Quaker Oats, for example, reported a threefold increase in stock turnover, 65% lower
stocks and 77% reduction in paperwork.10 Integrated Systems Solutions reported 3–4%
increase of service level, 40–50% reduction in stock and 2–3 times increase of stock turnover.11

Features of ECR

It is not necessarily physical transport that slows the flow of materials through a supply chain,
but the associated flow of information. It might take a month for an organisation to prepare
the details for a purchase, collect information, send orders, arrange payments, and so on,
while delivery only takes a day. So ECR only became feasible when a practical method of
control was designed. With JIT this came with kanbans; with ECR it came with EDI.
ECR relies on a string of ‘enablers’, many of which we have already met. For a start, ECR
only really works when organisations and their suppliers are working together in partnerships.
This allows full EDI including purchase orders, invoices, planning information, point-of-sales
data, fund transfer, and so on. Each organisation’s control system sends a message to suppliers
and signals the need for more materials using an ‘electronic kanban’. Some systems go further
and hand over more responsibility to the supplier in vendor managed inventory. Then the
supplier becomes responsible for maintaining stocks at their customers’ operations, checking
the availability, organising deliveries and all other aspects of inventory control that make sure
stocks are available when needed.
There is no point in having a sophisticated signalling system if the physical delivery of
materials is slow. So ECR relies on very fast movement of materials. To some extent, this needs
efficient transport, but we have already noted Beesley’s comment12,13 that: ‘In typical UK
manufacturing supply chains at least 95% of the process time is accounted as non-value
 C O N T R O L L I N G M AT E R I A L F L O W 191

adding.’ Then material movement can be made more efficient by removing non-value adding
steps and, in particular, reducing the time spent in storage. Karabus and Croza9 say that:
‘product should never be warehoused or stored, but should continually be in movement, with
the least possible number of handling steps’. Cross-docking – which co-ordinates materials
movement so that they are transferred from the arrival bay directly to the departure bay
without ever going into storage – can give much faster delivery and reduce costs to less than
half. Luton summarises this by saying that: ‘Efficient consumer response requires cross-
docking’14 and he suggests that an efficient terminal should aim for turning over stock at least
daily, or 250 turns a year. These ideas are consolidated in flow through logistics, which aims
at a smooth, continuous and uninterrupted flow of materials.
In different circumstances there can be many other enablers for ECR. These include inte-
gration of the whole supply chain, transparency (so that all organisations can see what is
happening and how this affects them), understanding the operations of other organisations
(particularly the conditions and constraints they work with), flexible operations that can
deliver materials with short lead times, balanced resources to give a smooth flow of materials,
and so on.

Introducing ECR

ECR is a deceptively simple idea. Like JIT, though, it needs substantial changes to operations
and can only be used in certain circumstances. If the supply chain starts with potatoes, they
are grown in a particular season and farmers cannot suddenly grow a crop at short notice.
Another problem comes with the length of the supply chain, as a single organisation that does
not want to be involved – or cannot adapt – will disrupt the flow. If the supply chain crosses a
slow international border, or includes an area where productivity is low, or hits other prob-
lems, the delays become unacceptable and ECR cannot work.
Introducing JIT can be a huge undertaking, fundamentally changing the way an organisa-
tion works. When JIT is extended to ECR, implementation becomes an even bigger issue. This
is probably why organisations have seemed slow to introduce it. By 1997 almost no organisa-
tions had a fully established ERC system.15 Nonetheless, interest was clearly growing, and
Szymankiewicz said that: ‘If the massive increase in ECR activity predicted … becomes a
reality, it will become the main catalyst for developments in supply-chain thinking. … ECR
could well become the basis for supply-chain management.’16
The following list includes some key stages for an organisation implementing ECR:

● design a logistics strategy based on responsive replenishment

● understand the principles of ECR and how this will affect operations
● define the aims of ECR for the organisation and measures of performance from partner-
ships with organisations that can match the organisation’s aims
● introduce comprehensive EDI with suppliers and customers
● build ‘flow through’ logistics, where materials are moved as efficiently as possible
● benchmark other operations and continue to improve.

This is, of course, only a partial list, and it seems deceptively simple. Forming partnerships, for
example, is not easy, so integrating an entire supply chain is extremely difficult. If it were easy
to get an efficient flow of materials with ‘flow through’ logistics, more organisations would
already be working like this. Despite these cautions ECR can, when working properly, give
dramatic improvements. Estimates suggest a typical return on investment of 250% over the
first three years of use.9
192 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

❑ The traditional approach to planning is based on forecasts of demand. When

CHAPTER REVIEW ■ ■ ■ ■ ■ ■ ■ ■ ■

actual demand is known, we can use approaches based on ‘dependent

demand’.
❑ Material requirements planning is a dependent demand system which
‘explodes’ a master schedule to give timetables for the delivery of materials.
By relating deliveries to actual requirements, MRP can both reduce costs and
improve customer service.
❑ There are several extensions to MRP, such as closed-loop MRP which gives
feedback for capacity planning. MRP II extends the idea of MRP to other
functions, so that all plans within an organisation are related back to the
master schedule.
❑ Enterprise resource planning extends the MRP approach to suppliers. It co-
ordinates the movement of materials along the supply chain.
❑ Just-in-time aims at eliminating waste from an organisation. It does this by
organising operations to occur just as they are needed. This needs a new way
of thinking, which solves problems rather than hides them.
❑ JIT matches the supply of materials to the demand by ‘pulling’ materials
through the process. Kanbans give a simple, practical method of controlling
this flow.
❑ Efficient consumer response extends the ideas of JIT, by pulling materials
through an integrated supply chain. There are several enablers for ECR,
including EDI and ‘flow through’ logistics.

C A S E S T U D Y JIT at Pentagon Plastics

Pentagon Plastics make small injection-moulded parts for a number of manufac-

turers. A few years ago, they faced a new problem with one of their best selling
parts, which was used by an instrument maker and eventually put into Ford cars.
When Ford expanded their quality management programme all their suppliers –
including those who were several tiers up the supply chain – had to change their
habits. In particular, they had to introduce total quality management and just-in-
time operations.
 C O N T R O L L I N G M AT E R I A L F L O W 193

C A S E S T U D Y continued

Jaydeep Julami was the production manager at Pentagon, and he was wondering
how to meet the new demands on his operations. There were 30 main products and
120 minor ones, and the plant worked a single shift for five days a week. Their
current production planning was based on a regular six-week cycle. The first 15
days of this cycle were spent making the main products, and the next 15 days
making minor products. This schedule was designed to reduce the disruption of
changing production from one product to another. Each change usually took less
than an hour, but could take up to four hours if things went wrong.
A dashboard instrument panel was typical of Pentagon’s main products. This
was made in batches of 25,000 and sent to a store of finished goods. When
customers ordered the panel there was a minimum order quantity of 4000. Most
orders were met from stock, but if Pentagon did not have enough stock to meet an
order, they would reschedule production. This might give a week’s delay, as well as
upsetting the schedules of other products.
Transport was arranged with a local company, who picked the parts up from
Pentagon and delivered them directly to customers, usually within two weeks.
Jaydeep was reading an article about Hewlett-Packard’s introduction of JIT. This
said that they introduced JIT in seven stages. They:

1. designed an efficient mass production process

2. implemented total quality management
3. stabilised production quantities
4. introduced kanbans
5. worked with suppliers
6. continually reduced stocks
7. improved product designs.

Jaydeep thought about how he could use Hewlett-Packard’s experience in his

own plant. He knew roughly what was involved, but still was not confident they
could make JIT work.

C A S E S T U D Y
Questions
● Describe in detail the steps that Hewlett-Packard used to introduce JIT.
● From the limited information available, do you think that Pentagon Plastics should
consider JIT? What benefits could they get?
● How might Pentagon set about introducing JIT?
194 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

P R O J E C T

Planning in Practice
One of the main differences between MRP and JIT is their reliance on computer systems. MRP needs spe-
cialised software, often using huge systems. Do a survey to see what programs you can find for MRP and
compare their features. On the other hand, JIT looks for simple systems. Restaurants use a simple form
of kanban when waiters pass messages back to cooks, telling them what to prepare. What other exam-
ples of JIT can you find? How do they send messages back through the supply chain?

DISCUSSION QUESTIONS
1. MRP was developed to plan the supply of parts at manufacturers, so it cannot really be
used in other types of organisation. Do you think this is true?
2. MRP II seems a good idea in theory, but it would be difficult to plan logistics, let alone
finance and marketing, from a master schedule. The systems would also be so unwieldy
that they could never work properly. Even if they did work, operations would be too
inflexible to cope with agile competitors. What do you think of these views?
3. What are the main difficulties of using ERP?
4. If you were in hospital and needing a blood transfusion, would you rather the transfusion
service used a traditional system of holding stocks of blood, or a just-in-time system?
What does your answer tell you about JIT in other organisations?
5. What are the most significant changes that JIT brings to the planning of logistics in an
organisation? What happens if an organisation wants to introduce JIT, but finds that its
suppliers cannot cope with the small batches and frequent deliveries?
6. What are the problems of using ECR? How can these problems be overcome?

REFERENCES
1. Orlicky J. (1974) Materials Requirement Planning, McGraw-Hill, New York.
2. Waters C.D.J. (1992) Inventory Control and Management, John Wiley, Chichester.
3. Brace G. and Rzevski G. (1998) Elephants rarely pirouette, Logistics Focus, 6(9), 14–18.
4. Sharp A.E. (1998) quoted in ‘Better routes for decision makers’, Financial Times, 1/7/98.
5. Burris P. (1999) Study dispels common myths about ERP/ERM, Press release by META Group, 01/01/99.
6. Monden Y. (1994) Toyota Production System (2nd edn), Chapman & Hall, London.
7. Shingo S. (1981) Study of Toyota Production System from an Industrial Engineering Viewpoint, Japanese
Management Association, Tokyo.
8. Hay E.J. (1988) The Just-in-time Breakthrough, John Wiley, New York.
9. Karabus A. and Croza M. (1995) The keys to the kingdom, Materials Management and Distribution, May,
21–2.
10. Boden J. (1995) A movable feast, Materials Management and Distribution, November, 23–6.
 C O N T R O L L I N G M AT E R I A L F L O W 195

11. Margulis R.A. (1995) Grocers enter the era of ECR, Materials Management and Distribution, February,
pp. 32–3.
12. Beesley A. (1995) Time compression – new source of competitiveness in the supply chain, Logistics Focus,
3(5), 24–5.
13. Beesley A. (2000) Time compression in the supply chain, Chapter 11 in Waters D. (ed.) Global Logistics
and Distribution Planning, Kogan Page, London.
14. Luton D. (1995) Efficient consumer response requires cross-docking, Materials Management and
Distribution, April, p. 15.
15 P-E Consulting (1997) Efficient Customer Response, P-E Consulting/Institute of Logistics, Surrey.
16. Szymankiewicz J. (1997) Efficient customer response, Logistics Focus, 5(9) 16–22.

Further reading
Cheng T.C.E. and Podolsky S. (1996) Just in Time Manufacturing (2nd edn) Chapman & Hall, London.
Hutchins D. (1999) Just in Time (2nd edn), Gower, London.
Louis R.S. (1997) Integrating Kanban with MRP II, Productivity Press, Cambridge, MA.
Luscombe M. (1993) MRP II: Integrating the Business, Butterworth Heinemann, London.
Sandras W.A. (1995) Just in Time, Oliver Wight Publications, Williston, VT.
Schniederjans M.J. and Olson J.R. (1999) Advanced Topics in Just in Time Management, Quorum Books, New
York.
Turbide D.A. (1993) MRP+, Industrial Press, New York.
 CHAPTER 8

Measuring and Improving Performance

CONTENTS

■ Aims of the chapter ■ Case study – Ed’s

■ Measuring performance Drive-through Bottle Shop
■ Comparing performance ■ Project – Quality of logistics
■ Analysing a supply chain ■ Problems
■ Improving performance ■ Discussion questions
■ Chapter review ■ References
■ Further reading

AIMS OF THE CHAPTER

After reading this chapter you should be able to:

■ R E C O G N I S E the importance of measuring performance

■ D E S C R I B E different measures of supply chain performance
■ D I S C U S S the best measures and their use
■ U S E benchmarking
■ A N A LY S E a supply chain using different charts
■ D E S C R I B E different approaches to improving logistics
 MEASURING AND IMPROVING PERFORMANCE 197

MEASURING PERFORMANCE

The last few chapters have described the design and planning of a supply chain. At this point,
we have set the structure of the supply chain, and shown how to organise the movement of
materials. However, the supply chain is not fixed, but continues to evolve. So we need some
way of saying how well it works at the moment, and how it can be improved. For this we have
to answer four questions:

1. What are we doing now?

Analysing the current methods, aims and operations of logistics.

2. What do we want to do in the future?

Giving new aims and clear objectives for improvement.

3. What is the best way to get there?

Looking at options and implementing the best.

4. How do we know that we are getting there?

Measuring performance, comparing actual results with expectations.

We have already answered question 2, as the strategy and following plans say what logistics
should do in the future. In this chapter we can look at the other questions, starting with meas-
ures of logistics performance (for question 4). Then we describe some methods of analysing
current operations (for question 1), and suggest some approaches to improvement (for ques-
tion 3).

Measures for logistics

Managers in every organisation have to measure the performance of logistics. If they do not
take measures, they have no idea how well they are doing, whether things are improving or
getting worse, whether they meet targets, or how they compare with competitors. An old
maxim says, ‘what you can’t measure, you can’t manage’. The problem, of course, is finding
what to measure and how to measure it.
There is a huge number of possible measures of logistics. Some of these are indirect meas-
ures and often relate to finance, such as the return on assets, payback period, or contribution
to profits. Financial measures are popular, as they are easy to find, sound convincing, give a
broad view and allow comparisons. However, they also have weaknesses as they concentrate
on past rather than current performance, are slow to respond to changes, rely on accounting
conventions, and do not record important aspects of logistics. Financial performance can
show that something is wrong, but it does not show what is wrong or how to correct it. This is
like a doctor finding that you have a fever – it shows that something is wrong, but does not
show how to get better.
In practice, it is much better to use direct measures of logistics, such as the number of
tonnes delivered, stock turnover or distance travelled. Again, there are many possible meas-
ures. We will start by looking at general ones for capacity, utilisation and productivity.
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L O G I S T I C S
I N P R A C T I C E
Keystone-Gunterbach
Keystone-Gunterbach offers a range of Performance indicator Value Change
transport and warehousing services in year
around Berlin. For several years the major Return on capital 12.4% +2.4%
shareholders felt that the company was Return on assets 6.1% +2.0%
under-performing, and in 2000 they Pre-tax margin 3.3% +0.1%
appointed a new chief executive, with an Return on shareholders’ funds 21.2% +6.5%
explicit goal of improving results. The Equity gearing 28.9% –4.2%
chief executive started a restructuring and Debt gearing 43.7% –6.3%
cost-cutting exercise, and by 2001 could Interest cover 2.5 times –0.2
report some progress. The annual report Current ratio 1.27 times –0.3
showed that the company’s performance
was now generally comparable with the markets of central Europe. They tried to
industry. The table shows an extract of compete on the quality of their service, but
some key indicators. delivery times were getting longer, there
At the annual meeting three sharehold- were increasing problems with reliability,
ers who had worked for the original Gun- lack of investment was making their sys-
terbach transport company asked for some tems outdated, and customer satisfaction
clarification. They felt that the company’s was declining. In the first quarter of 2002
long-term survival depended on its being their business fell by 15% and they
competitive. They could see the financial appointed a new chief executive.
performance, but did not know how well
the company was running its logistics. Source: company annual reports
Actually, the company was having trou-
ble with competition in the developing

Capacity and utilisation

In Chapter 6 we defined the capacity of a supply chain as the maximum amount that can be
moved through it in a specified time. This is a basic measure of supply chain performance.
Each part of a supply chain has a different capacity, and the overall capacity is set by the
bottlenecks.
It might seem strange to describe capacity as a measure of performance, rather than a
fixed value or constraint on the throughput. There are two answers to this. First, we can say
that the capacity depends on the way that resources are used. Two organisations can use
identical resources in different ways, and get different throughputs. Then the capacity gives
a direct measure of performance and management skills. Second, we can point out that
capacity is not fixed, but varies over time. At the start of the day a team of people might be
 MEASURING AND IMPROVING PERFORMANCE 199

able to move 500 cases an hour; at the end of the day the same team are tired and can only
move 400 cases an hour. The operations seem to be exactly the same, but the capacity
has declined.
To allow for these effects, we define difference types of capacity. Designed capacity is the
maximum possible throughput in ideal conditions; effective capacity is what we can actually
achieve over the long term; actual throughput shows what we actually achieved. The
designed capacity of Ellison’s call centre is 1000 telephone calls an hour. They can achieve this
for a short period, but after taking into account different types of calls, staff schedules, holi-
days, faults with equipment and other factors the effective capacity is 850 calls an hour. In one
typical hour Ellison actually handled 710 calls. This shows that they were working below
capacity and have not fully used their resources.
Utilisation shows the proportion of designed capacity that is actually used. Suppose you
have a vehicle fleet that is designed to deliver 100 tonnes of materials a week. This is its
designed capacity. If the fleet only delivers 60 tonnes in one week:

amount of capacity used 60

utilisation = = = 0.6 or 60%
designed capacity 100

The designed capacity of a supply chain is not the same throughout its length, but
different parts have different utilisation. You might, for example, find that a transport fleet is
under-utilised, while the warehouse it is delivering to is working flat out. Figure 8.1 shows an
illustration of some typical calculations.

Part A B C D E F G H

140 units
flowthrough

Designed
200 650 440 180 680 460 220 700
capacity
Effective
180 600 420 160 650 410 200 680
capacity

Throughput 140 140 140 140 140 140 140 140

Utilisation 70% 22% 32% 78% 21% 30% 64% 20%

Figure 8.1 Capacity and utilisation in a supply chain

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L O G I S T I C S
I N P R A C T I C E
Ying-Chua Associates
In July 2000, Ying-Chua Associates had ten
Before After
people organising 1000 specialised insur- reorganisation reorganisation

ance policies for dangerous goods move- Number of 1000/10 = 100 1200/11 = 109
policies processed
ments. In theory they could process 1250 per person
policies a month but breaks, interruptions, Direct costs 115,000/1000 = £115 156,000/1200 = £130
holidays, schedules and other factors lim- per policy

ited this to about 1150. The direct costs of Designed capacity 1250 1600

this operation were £115,000. Effective capacity 1150 1300

Demand for the service was growing, Utilisation 1000/1250 = 80% 1200/1600 = 75%
and in September the company did a small
reorganisation. After this they employed
eleven people, who could deal with a max- Ying-Chua’s reorganisation increased the
imum of 1600 policies a month, but with a number of policies processed per person,
more realistic limit of 1300. They were a lit- but they also increased the direct costs per
tle disappointed to find that in the follow- policy. The capacity has risen, but the utili-
ing month they only processed 1200 sation has declined. Whether performance
policies, with direct costs of £156,000. has improved, or not, depends on the
Some measures of this performance are objectives of the company.
given in the table.
As you can see, even these simple meas- Source: company reports
ures have to be interpreted with some care.

Productivity

Productivity is one of the most widely used measures of performance. Unfortunately, people
often confuse its meaning, assuming that it is the amount of work done by each person. There
are really several kinds of productivity. The broadest picture comes from total productivity,
which relates throughput of a supply chain to the amount of resources used.

total throughput
T O TA L P R O D U C T I V I T Y =
total resources used

Unfortunately, this definition has a number of drawbacks. Throughput and resources must use
consistent units, so they are normally translated into units of currency. This depends on the
accounting conventions used – so we no longer have an objective measure. Another problem is
finding values for all the inputs and outputs. This is particularly difficult for intangible inputs
(such as sunlight, the environment and reliability) and outputs (such as pollution, waste prod-
 MEASURING AND IMPROVING PERFORMANCE 201

ucts and reputation). We could say that we are only interested in the important factors – but
then someone has to decide which these are, and we have again lost our objectivity.
Because of these practical difficulties, hardly any organisations measure total productivity,
preferring to use partial productivity, or single factor productivity. This relates the
throughput of a supply chain to a single type of resource.

total throughput
PA R T I A L P R O D U C T I V I T Y =
units of a single resource used

There are four types of partial productivity relating the throughput to different types of
resource:

● equipment productivity – such as the number of customer visits per van, weight moved per
forklift, or miles flown per aeroplane
● labour productivity – such as the number of deliveries per person, tonnes moved per shift,
or orders shipped per hour worked
● capital productivity – such as the amount stored for each pound of investment, deliveries
per unit of capital, or throughput per dollar invested in equipment
● energy productivity – such as the number of deliveries per litre of fuel, amount stored per
kilowatt–hour of electricity, or the value added for each pound spent on energy.

Productivity can be a very useful measure of performance. But when an organisation

simply reports its ‘productivity’ you have to look very carefully at what they mean. If an auto-
mated warehouse increases its labour productivity, this might be much less important than
changes to its equipment or capital productivities.

W O R K E D
E X A M P L E

The van der Perlitz Corporation runs a number of warehouses in southern Africa. Over the
past two years they collected data about logistics, using standard units for throughput and
converting values into South African rand.
2001 2002

weight of materials moved 1000 1200

selling price R100 R100
raw materials used 5100 kg 5800 kg
cost of raw materials R20,500 R25,500
hours worked 4300 4500
direct labour costs R52,000 R58,000
energy used 10,000 kWh 14,000 kWh
energy cost R1000 R1500
other costs R10,000 R10,000

How can you describe the productivity?

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W O R K E D
E X A M P L E
continued

Solution
From the information given we can use several measures of productivity.

■ The total productivity in 2001 was:

total throughput 100×1000
= = 1.2
total resources used 20,500+52,000 + 1,000 + 10,000

By 2002 this had risen to 120,000/95,000 = 1.26, which is a rise of 5%

■ Units of throughput per kilo of raw material in 2001 was 1000/5100 = 0.196. In 2002
it was 1200/5800 = 0.207 which is a rise of 5%

■ Some other measures are:

2001 2002 %
increase

total productivity 1.20 1.26 5.0

units/kg of raw material 0.196 0.207 5.6
units/R of raw material 0.049 0.047 –4.1
units/hour 0.233 0.267 14.6
units/R of labour 0.019 0.021 10.5
units/kWh 0.100 0.086 –14.0
units/R of energy 1.000 0.800 –20.0

In general, labour productivity has risen, raw materials productivity has stayed about
the same, and energy productivity has fallen.

Other measures

Capacity, productivity and utilisation give general measures of logistics performance, but we
can use many more specific ones. For example, some common measures of transport perform-
ance include:

● Reliability of delivery
● Total travel time and distance
● Delivery cost
● Customer satisfaction
● Frequency of service
● Loss and damage
● Availability of special equipment
 MEASURING AND IMPROVING PERFORMANCE 203

● Helpfulness of drivers
● Time to load and unload
● Total weight moved
● Number of errors in deliveries
● Errors in processing and administration
● Size and capacity of vehicles
● Skills of drivers
● Utilisation of vehicles.

Although we describe these as ‘measures’, some are clearly more difficult to quantify than
others. Nonetheless, they may all be important, so we have to find ways of assigning numer-
ical values. Sometimes we can use surrogate measures, perhaps measuring customer satisfac-
tion by the number of complaints received. More often we use notional scales, so we might ask
customers to rate some factor on a scale of one to five. But remember that when we use these
methods to judge ‘customer satisfaction’, ‘staff morale’, ‘management leadership’, or some
intangible concept, we are trying to give numerical values to essentially non-quantifiable
factors, and should treat the results with caution.
Warehouses have a range of different performance measures, often related to the rate of
stock turnover or utilisation of space. Some measures are based on the value of stock held. This
varies over time – often quite widely – so we use average or typical values. The average value of
stock of a single product is the average number of units held multiplied by the unit value.
When this is summed for all products, we get an average total inventory value.

Average total inventory value = ∑ (average number of units held × unit value)

Managers can track this value over time and look for trends. If the value of stock is rising,
it might be a cause for concern. More useful measures relate the amount of stock to the
demand. Then an organisation can report the number of weeks’ supply held in stock.

average total inventory value

Weeks’ supply =
average weekly throughput

Ideally this should be as low as possible, suggesting that stocks are being kept to a
minimum. Some manufacturers hold 10 weeks’ supply or more, particularly if supply is uncer-
tain or demand is variable; companies using just-in-time operations only hold a few hours’
supply.
A slightly different view measures the stock turnover, or turn. This shows how quickly
materials move through the supply chain.

annual throughput
Stock turnover =
average total inventory value

If the annual throughput of a warehouse is $1 million and the average total inventory value is
$200,000, the turnover is 5. This means that materials are replaced an average of five times a
year, and the average stock level is 1/5 years or 10 weeks’ supply.
Other common measures of warehouse performance include:

● Average stock value

● Changes in stock value
● Utilisation of storage area and volume
204 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

● Proportion of orders met from stock

● Proportion of demand met from stock
● Weeks of stock held
● Stock turnover
● Order cycle time
● Number of orders processed
● Cost of each stock transaction
● Customer services
● Errors in order picking
● Damage and loss
● Special storage facilities.

These lists are obviously not complete, and in different circumstances many other meas-
ures might be important. We could also make similar lists for other functions of logistics. With
procurement, for example, we could measure the performance by the cost per transaction, cost
as a percentage of purchase value, time to submit orders, value of materials bought, discounts
achieved, number of transactions per person, number of errors, proportion of automatic
orders, and so on.
There is clearly no shortage of measures, but we should ask which ones are actually used. A
survey by Harrison and New1 found that most organisations use some formal means of
assessing supply chain performance – but 20% of their respondents did no assessment at all (as
you can see from the following table).

Means of assessing supply chain performance Percentage of companies

No formal means 20
Limited formal means 29
Some formal means 39
Extensive formal means 12

On the positive side it seems that 80% of organisations use some measures of logistics
performance. Ferreira2 said that the ten most common measures are quality, lead time, order
fulfilment (which measures the proportion of orders that are delivered as expected), on-time
delivery, responsiveness to demand, technical support, warranty and service, consolidation of
deliveries, payment terms and ordering systems. Again some of these seem difficult to
measure, but a more interesting point is that none of these measures contains an explicit refer-
ence to cost. Measures like ‘service’ have an implicit reference, but it seems that cost is not
always a major concern. This view is supported by Harrison and New1 who found the most
common measures of logistics performance are customer delivery performance (86%), inven-
tory turn (76%), supplier performance (66%), days of inventory (57%), order fulfilment (54%),
lead time (52%), customer returns (52%), and supplier costs (48%). Less than half of compa-
nies reported using cost as a measure of performance. Other surveys report similar findings,
such as Lennox,3 who suggests that important factors are order fulfilment (68%), delivery
errors (57%), damage (50%) and lead time (40%).

Balancing different measures

One problem is that the different measures give different – and often conflicting – views. If a
truck is driven faster than usual, the miles per hour goes up, but the miles per litre of fuel go
 MEASURING AND IMPROVING PERFORMANCE 205

down; when a shop is renovated its sales per square metre go up, but its sales per pound
invested go down; increasing the amount of automation in a warehouse gives higher labour
productivity but lower capital productivity. To get a reasonable picture of logistics we have to
take a balanced view of measures. But which measures are most important?
We can start answering this with the obvious comment that measuring the performance of
a supply chain is not an end in itself. The measures give basic information for managers to use
in their decisions, and they show how well the supply chain is achieving its goals. If the goal
is to have a fast flow of materials through the chain, managers should measure this speed of
flow and not bother so much about, say, productivity; if the aim is to minimise costs,
managers should measure different aspects of cost, but not worry so much about utilisation.
Unfortunately, managers often ignore this advice and use inappropriate measures that are
easiest to find, support their views, have always been used in the past, or show them in the
best light. Some consequences of this are warehouses full of goods because managers’ status is
judged by the amount of investment they control, rushed service because servers are judged by
the number of clients they speak to and not the quality of their service, double booked seats
because airlines are judged by seat occupancy, speeding trucks because drivers are judged by
the number of deliveries they make in a day.
To give a reasonable view of logistics, a measure must:

● relate to the objectives of the supply chain

● focus on significant factors
● be measurable
● be reasonably objective
● look at current performance, not historical
● allow comparisons over time and with other organisations
● be easy to understand by everyone concerned
● be difficult to manipulate to give false values
● be useful in other analyses.

L O G I S T I C S
I N P R A C T I C E
Delivering frozen food
Figure 8.2 outlines the structure of the UK ■ allowing them to focus on core opera-
frozen food industry. An important feature tions of manufacturing
of this is the dominant role of the retail ■ standard distribution through a single
multiples. The three largest supermarket contractor
chains sell a third of all food, and buy from ■ automated order processing
several hundred manufacturers and ■ integrated stock management system
importers. ■ single stockholding point near to
A problem, which is common for many production
industries, is that manufacturers and ■ low production and distribution costs
retailers use different criteria to judge per- ■ long lead times and production runs.
formance. The main requirements of manu-
The retailers’ requirements from logistics
facturers’ logistics can be summarised as:
include:
206 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

L O G I S T I C S
I N P R A C T I C E
continued

■ no stock-outs in shop displays should move quickly and give a reliable

■ small, frequent, reliable deliveries service. A survey4 of 11,900 trips, delivering
■ deliveries made at any requested time 206,000 pallets of food and covering 1.16
■ short lead times million km found that 25% of journeys
■ linked systems based on efficient were delayed. The main causes of the
customer response delays were problems at the delivery point
■ direct movement of goods arriving onto (31%) and traffic congestion (23%). This
display survey also found that trucks spent 21% of
■ lower stock in stores their time idle.
■ no errors or damage in deliveries
■ influence in the supply chain aiming at Activity of trucks Percentage of time
lower distribution costs Running on the road 35
■ opportunities to backhaul returnables. Idle (empty and stationary) 21
Loading/unloading 16
There is clearly a lot of agreement here, but
Waiting for loading or departure 12
there are some areas where the two groups
Maintenance and repair 6
judge success in different ways. For exam-
Delayed on the road 6
ple, manufacturers want third party con-
Delayed while loaded 4
tractors to take responsibility for logistics,
while supermarkets want a more positive
Sources: Lindfield G. (1998) Logistics Focus, 6(1),
say, with greater influence over costs and
2–8; McKinnon A. (2000) Measuring the effi-
operations. ciency of road freight transport operations, Logis-
One area where manufacturers and tics and Transport Focus, 2(8), 26–7
retailers agree is that delivery vehicles

Exports UK manufacturers Imports Suppliers

Wholesalers Cash and carry Wholesalers

Independent
Retail multiples Catering trade Retailers
retailers

Figure 8.2 Structure of the UK frozen food industry

 MEASURING AND IMPROVING PERFORMANCE 207

COMPARING PERFORMANCE

Standards for comparison

We have already said that measures of performance are not an end in themselves, but they
help managers make decisions about the supply chain. In particular, measures can be used to:

● see how well objectives are being achieved

● compare the current performance of logistics with performance in the past
● make comparisons of logistics with other organisations
● compare the performance of different parts of the supply chain
● make decisions about investments and proposed changes
● measure the effects of changes to the supply chain
● help with other internal functions, such as wage negotiations
● highlight areas that need improving.

As you can see, many of these involve comparisons. This is because absolute measures often
have little real meaning. If you know that a shop has annual sales of $1200 per square metre,
you cannot say whether this is good or bad until you know the sales in comparable shops.
There are basically four ways of judging performance, using comparisons with:

1. Absolute standards – which give the best performance that can ever be achieved. This is an
ideal performance that operations might aspire to – such as the target of zero defects in
total quality management.

2. Target performance – which is a more realistic target that is agreed by managers, who want
to set tough, but attainable, goals. The absolute standard for the number of customer
complaints received each week is zero, but a more realistic target might be four.

3. Historical standards – which look at performance that was actually achieved in the past. As
organisations are always looking for improvement, we can regard this as the worst
performance that might be accepted.

4. Competitors’ standards – which looks at the performance actually being achieved by

competitors. This is the lowest level of performance that an organisation must achieve to
remain competitive. Federal Express deliver packages ‘absolutely, positively overnight’ so
other delivery services must achieve this standard to compete.

There are many ways of making these comparisons. Some are very informal, and when ware-
house managers visit another warehouse they automatically look for ideas they can use. Often
a more formal method is better, and the most common uses benchmarking.

Benchmarking

With benchmarking, an organisation compares its performance with a competitor. There is no

point in comparing performance with some random competitor, so benchmarking compares
an organisation’s performance with the best results achieved in the industry. To be blunt,
organisations use benchmarking to find ideas for logistics that they can copy or adapt.
208 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Identify the process to benchmark

and the measures of performance

Find the competitor with the

best performance and collect
data on its operations

Compare operations, find and

analyse differences in performance

Find reasons for the difference

in performance and look for
ways of overcoming these

Redesign processes in the light

of these analyses and establish
performance goals

Implement plans, monitor progress

and continue benchmarking

Figure 8.3 Steps in benchmarking

There are several steps in benchmarking. These start with an organisation recognising the
need to improve its logistics. Then it has to define the most appropriate measures of perform-
ance, identify the leading competitor in the industry, and examine their logistics to see how
they achieve this superior performance (as shown in Figure 8.3).
The easiest benchmarking to organise is internal, with one division of a company
comparing its operations with another division. However, managers should take a broad view,
and look for possible improvements anywhere they get the chance. You might think that
organisations are reluctant to give details of their operations to competitors. In practice it can
be fairly easy to get this information, and fears that it will be exploited are largely groundless.
Everyone knows how to deliver parcels, serve food, run a shop, provide a taxi service – but
thousands of organisations work very successfully in these industries, despite the fact that
everyone knows all about their operations. Organisations in the same industry will share infor-
mation when they can benefit from the results – as even the best performers can learn things
that make them even better. When Sainsbury’s benchmarked the operations at their depot in
Buntingford, they contacted 45 companies who had agreed to take part in the exercise. More
than half returned useful information, and Sainsbury’s made follow-up visits to ten particu-
larly useful operations.5
 MEASURING AND IMPROVING PERFORMANCE 209

Sometimes, however, it is difficult to find a direct competitor for benchmarking, and then
it is useful to look at organisations that are not in the same industry. BP is not a direct
competitor of Tate & Lyle, but they both run fleets of tankers and may learn from each other’s
transport operations. Sometimes it is possible to learn from completely different types of
organisation. Train operators, for example, might find improvements from bus operators,
airlines, or other companies that are not involved in transport but give high customer service,
such as supermarkets.

L O G I S T I C S
I N P R A C T I C E
Charles Friderikson Car Rentals
When Charles Friderikson Car Rentals that after their first visit a customer can pass
(CFCR) started a business in Copenhagen, a plastic card through a reader and pick up
there were already many competitors in the a car immediately.
market. In general, the major international At the same time, CFCR recognised that
companies tended to compete by service, private customers were more interested in
including Hertz (‘Call the world’s No. 1’), price, so they looked at the operations of
Avis (‘We try harder’), Eurodollar (‘Rent the smaller companies to see how they
from the best’), Europcar (‘All around – a reduce operating costs. For example, they
better service’), Ford (‘A big name in do not use expensive locations like airport
rental’), Thrifty (‘World class service at your arrival lounges, keep their cars for rather
doorstep’). The smaller, local companies longer, and have more flexible pricing.
tended to compete on price, such as Econ- CFCR effectively benchmarked their
omy (‘The lowest prices around’), Capital operations against international companies
(‘Competitive rates, best value’), and Har- when looking at the quality of service, and
ald (‘Lowest rates in town’). local companies when looking for low
CFCR decided that they would compete costs. The important point about their
by giving a good, personal service at a rea- benchmarking is that it identified better
sonable price. They obviously could not performance and it showed how this was
give the scale of service offered by the achieved.
international companies, but they learnt a
Source: Friderikson C. (2000) Benchmarking Car
lot from their operations. For example,
Rentals, Western Operations Group, London
CFCR automated their administration, so

ANALYSING A SUPPLY CHAIN

Process charts

Suppose that we benchmark a competitor’s purchasing system, and find that it is ten per cent
cheaper than ours. Now we have to look at the system and see exactly how it works, and
210 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

where it makes the savings. In other words, we need some way of describing the detailed oper-
ations in the supply chain; we want some means of listing the individual activities and
showing the relationships between them. The easiest way of doing this is with a process chart.
There are several types of process chart, but they all start by breaking down a process into
separate activities. Suppose we look at our process for submitting an order. We could describe
the main activities as:
● receive request to purchase materials
● check departmental budgets and get clearance to
purchase
Receive request ● make a short list of possible suppliers and send a
for purchase
request for quotations
● examine quotations received and pick the best
Check budgets
● discuss, negotiate and finalise terms and
and get conditions
clearance
● issue a purchase order for the materials
● do any necessary follow-up and expediting
Send RFQ to ● arrange payment of the supplier’s invoice.
shortlist of
suppliers
We can draw an informal process chart for this in the
form of a flow chart (shown in Figure 8.4).
Yes Do necessary
This informal chart gives a general view of the
Follow-up
needed? follow-up process, but it does not give many details. A better
approach starts by describing all the activities as:
No

● operation: where something is actually done

Pick best quote ● movement: where products are moved
● storage: where products are put away until they
are needed
Discuss, ● delay: where products wait for something to
negotiate and
finalise
happen
● inspection: to test the quality.
No
Then we can track a series of activities and describe
Satisfactory
result? exactly what happens. For this, we use the following
six steps.
Yes

Issue
Step 1: List all the activities in their proper sequence
purchase order from the start through to the finish.
Step 2: Classify each activity as an operation, move-
Yes
ment, inspection, delay or storage. Find the
Sort out
time taken and distance moved.
Problems
problems Step 3: Summarise the activities by adding the
number of activities, total times, rate of
No
doing each activity, and any other relevant
Arrange
information.
payment Step 4: Critically analyse each activity, asking ques-
tions like, ‘Why is it done this way?’, ‘Can
we eliminate this activity?’, ‘How can we
improve this activity?’, ‘Can we combine
Figure 8.4 An informal process chart activities?’.
 MEASURING AND IMPROVING PERFORMANCE 211

Step 5: Now revise the process to give fewer activities, shorter times, less distance travelled,
and so on.
Step 6: Check the new procedures, prepare the organisation for changes, train staff, and so on
and implement the changes.

The first three steps give a detailed description of current activities, and an example of the
format for a chart is shown in Figure 8.5.6,7 Steps 1 and 2 are usually done by observation,
while Step 3 is a calculation. The last three steps look for improvements.

Process chart

Number Description Operation Move Store Delay Inspect Time Distance Comment
1 Activity 1 X 10
2 Activity 2 X 45 120 Into stores
etc
.

Totals 55 120

Figure 8.5 Format for a process chart

W O R K E D
E X A M P L E

Draw a chart of the process involved when a lorry makes a delivery to a supermarket

Solution
Details of the process, and particularly the time, vary considerably. Figure 8.6 shows the
start of a chart from one supermarket. When this chart is completed in as much detail as
we need, we can start looking for improvements. Why, for example, do we have to move
100 metres to move goods to storage – can we reduce this somehow? Why does it take
30 minutes to put goods onto the shelves – can we do this faster?

Process chart

Number Description Operation Move Store Delay Inspect Time Distance

1 Get details of delivery X 10
2 Unload lorry X 45
3 Check goods X 25
4 Move to storage X 15 100
5 Store X 450
6 Take from store X 15
7 Move to consolidation X 10 75
8 Wait for check X 20
9 Check goods X 15
10 Move to shelves X 12 110
11 Put onto shelves X 30

Totals 647 285

Figure 8.6 Part of a process chart for deliveries at a supermarket

212 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Precedence diagrams

Another format for describing a supply chain uses a precedence diagram. This consists of a
network of circles (representing activities) and arrows (representing the relationships between
them). Suppose a very simple operation has two activities A and B, and A must finish before B
can start. We can represent the activities by two circles and the relationship by an arrow, as
shown in Figure 8.7. Then we can extend this method to more complex supply chains, as illus-
trated in the following example.

A B

Figure 8.7 Precedence diagram, with activity B following activity A

W O R K E D
E X A M P L E

A supply chain has 11 activities with the precedence shown in the following table. Draw a
precedence diagram of the chain.
Activity Must be done after

1 –
2 1
3 1
4 2, 3
5 4
6 4
7 4
8 5
9 6, 7
10 8, 9
11 10

Solution
Activity 1 can be done right at the start. When this is finished both activities 2 and 3 can
start. Activity 4 can be done after both activities 2 and 3, and so on. Continuing with this
logic gives the diagram shown in Figure 8.8. When we have drawn this network, we can
start looking for improvements.
 MEASURING AND IMPROVING PERFORMANCE 213

2 5 8

10 11
1 4 6

9
3 7

Figure 8.8 Precedence diagram for worked example

Multiple activity charts

It is often useful to see what each person or piece of equipment, is doing at any time. We can
do this most easily with a multiple activity chart. This has a time scale down the side of the
diagram, with all the participants listed across the top. The time each participant works on the
process is blocked off (as shown in Figure 8.9).
This chart is for two people working in a small warehouse. When they get an order they go
around and put the goods in a trolley, then they take them to a packing machine. The partici-
pants in the process are two people, two trolleys and the packing machine. The chart shows
what orders (A to E) each participant is working on during 5-minute time slots. As you can see,
each order takes 15 minutes to collect and 5 minutes to pack. We can see exactly what each
participant is doing at any time, and we can look at the pattern of work to identify bottlenecks
and idle periods.

Multiple activity chart

Time Person 1 Trolley 1 Person 2 Trolley 2 Packing machine

5 A A B B
10 A A B B
15 A A B B
20 A A
25 C C B B
30 C C D D
35 C C D D
40 C D D C
45 E E D D
50 E E
55 E E
60 E E

Totals 54 60 30 35 25

Figure 8.9 Example of a multiple activity chart

214 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

W O R K E D
E X A M P L E

One operator is currently assigned to each of three packing machines. The machines
work a cycle with 6 minutes for loading, 6 minutes for operating and 4 minutes for unload-
ing. An operator is needed for the loading and unloading, but the machines can work
without any supervision. The warehouse manager plans to make savings by using two peo-
ple to operate the three machines. Draw a multiple activity chart to see if this is feasible.

Solution
Figure 8.10 shows a multiple activity chart for three machines and two operators,
assuming all people and machines are idle at the start, and we follow the process for the
first hour.

Multiple activity chart

Time Operator 1 Operator 2 Machine A Machine B Machine C

2 Load A Load B Load Load
4 Load A Load B Load Load
6 Load A Load B Load Load
8 Load C Operate Operate Load
10 Load C Operate Operate Load
12 Load C Operate Operate Load
14 Unload A Unload B Unload Unload Operate
16 Unload A Unload B Unload Unload Operate
18 Load A Load B Load Load Operate
20 Load A Load B Load Load
22 Load A Load B Load Load
24 Unload C Operate Operate Unload
26 Unload C Operate Operate Unload
28 Load C Operate Operate Load
30 Unload A Load C Unload Load
32 Unload A Load C Unload Load
34 Load A Unload B Load Unload Operate
36 Load A Unload B Load Unload Operate
38 Load A Load B Load Load Operate
40 Unload C Load B Operate Load Unload
42 Unload C Load B Operate Load Unload
44 Load C Operate Operate Load
46 Load C Unload A Unload Operate Load
48 Load C Unload A Unload Operate Load
50 Unload B Load A Load Unload Operate
52 Unload B Load A Load Unload Operate
54 Load B Load A Load Load Operate
56 Load B Unload C Operate Load Unload
58 Load B Unload C Operate Load Unload
60 Load C Operate Operate Load

Totals 52 52 60 56 50

Figure 8.10 Multiple activity chart for worked example

 MEASURING AND IMPROVING PERFORMANCE 215

W O R K E D
E X A M P L E
continued

The process starts with operators 1 and 2 loading machines A and B respectively. These
machines start working, while operator 1 loads machine C. The operators unload
machines A and B as soon as they are finished, and then they reload the machines.
Machine C has to wait to be unloaded until an operator is free. The chart follows these
activities for the first hour, at which point both operators have been idle for 8 minutes, and
the three machines have been idle for 0, 4 and 10 minutes. Some of this idle time was
needed to get things going at the start of the day, so it does look as if the new arrange-
ment will work. We could confirm this by following the activities for a longer period.

IMPROVING PERFORMANCE

Benefits of better performance

Organisations work with continual change. Products, competitors, costs, markets, locations,
infrastructure, employees, customers, the economy, the business environment, company
objectives, technology, shareholders, and just about everything else changes over time. If
organisations do not respond to these changes, they get left behind by more flexible competi-
tors. The argument is that competitors are always trying to get an advantage by improving
their own supply chains, so every organisation has to keep improving just to stay in the same
place. So the main benefits of better logistics include:

● long-term survival
● lower costs
● increased profits, wages, real income, and so on
● improved competitiveness and growth
● better job security and staff involvement
● better use of available skills
● less waste of resources
● realistic targets for improving performance
● monitoring improving performance
● allowing comparisons between operations
● measuring management competence.

But how do we make sure that our logistics continue to change and improve? The best answer
is to develop an organisational commitment to improvement – accepting that continual
change is inevitable, necessary and beneficial. We develop a culture that welcomes and encour-
ages improvement. Of course, a supportive culture does not necessarily generate new ideas, so
we still need some way of looking at the supply chain and finding ways to improve it.
216 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

It might seem fairly easy to spot ways of improving a supply chain. As you look around,
you continually see things that could be done better – poor road layouts, enquiry desks with
long queues, transport that is not punctual, products that are too expensive, staff who are
poorly trained, long waits for appointments, unhelpful service, and so on. Organisations could
easily improve these. In principle, managers should seize every chance for improvement, but
they seem happy to continue with their old, inefficient methods. Why is this? In practice there
are many explanations. Managers may have tried to improve things in the past, failed, become
disillusioned and not want to repeat similar experiences. More often there is no incentive for
them to change, or they lack authority to push through reforms. They may not have the time
for the necessary investigation, or not see the need, or not like change, or not know how to
improve things, or think that changes would be too expensive and difficult to implement, or
claim that they cannot measure performance. This probably accounts for Robert Townsend’s
observation that8 ‘All organisations are at least 50% waste – waste people, waste effort, waste
space and waste time.’ Beesley9–11 goes further and says that: ‘In typical UK manufacturing
supply chains at least 95% of the process time is accounted as non-value adding.’ This
certainly suggests that there are opportunities to make things better.

Finding improvements

There are numerous suggestions for improving logistics. As we saw when designing a logistics
strategy, many of these adopt general themes, such as total quality management, increasing
technology, lean operations, emphasising human resources, timely operations, controlling
materials flow, alliances, improved communications, and so on.
One clear point from these themes is that the old fashioned idea of ‘getting people to work
harder’ has very little to do with performance. A hard-working person with a spade is far less
productive than a lazy person with a bulldozer. About 85% of performance is set by the system
that is designed by management; only 15% is under the control of individual employees. If
things are going well, it is largely because the managers are doing a good job: if things are
going badly, it is probably the managers who are to blame.
We have already suggested using benchmarking and process charts to highlight areas for
improvement. Another obvious approach is to ask people most closely involved in logistics for
their suggestions. They may already have a string of suggestions, or could quickly find some.
Unfortunately, these people may be reluctant to suggest improvements. They may be so
closely involved with the details of their job that they simply do not notice better options.
And if they do find improvements, there is the unpleasant suggestion that they have been
doing things badly in the past. A more pressing problem is that people who know how to
make improvements do not have the authority to make the changes themselves, and are never
asked for their opinion by those who could change things. In principle ‘empowerment’ and
related ideas should overcome this problem.
Often simple rules of thumb can improve logistics. These make general suggestions, like,
‘reduce the frequency of delivery’, ‘charge a premium for small deliveries’, ‘do value adding
activities for customers’, ‘use the Web’, ‘use third parties for non-core business’, ‘reduce stock
levels’, ‘make sure the warehouse is tidy’, and so on. These can focus on areas that commonly
cause problems in logistics. We have met this approach before, with the experience of Toyota
who found that the following six areas caused most concern.12

● Quality – that is too poor to satisfy customers

● Production level – making products, or having capacity, that is not currently needed
 MEASURING AND IMPROVING PERFORMANCE 217

● Processing – having unnecessary, too complicated or time-consuming operations

● Waiting – for operations to start or finish, for materials, repairs, and so on
● Movement – with products making unnecessary, long, or inconvenient movements during
operations
● Stock – too much stock that needs storing and raises costs.

A different view comes from Devonshire13 who suggests that information processing is the
key, saying that, ‘there is a direct link between the performance of supply chains and the
quality of available information – indeed, in some approaches to making supply chains more
efficient, stock is said to be replaced by information.’
These suggest specific areas to find improvements (like Emmett14), but it might be better to
use a more general approach and talk about principles. For example, Sordy15 suggests that
logistics can be improved by aiming for five principles:

1. Balance, giving a smooth flow of materials through the chain

2. Location, with all operations in the best positions
3. Minimise, using the least amount of handling, distance travelled and cost
4. Simplify, to make everything as simple as possible
5. Communicate, as a good information flow gives good material flow.

Wheatley16 uses a slightly different approach, giving the general advice to reduce the number
of participants in logistics (number of suppliers, and so on), eliminate activities and resources
that do not add value, use EDI, focus on customer needs, use the Internet, benefit from collab-
oration and develop the supply chain into a virtual factory.
Wherever we look for improvements, we need some general procedure for tackling the
problems. In other words, we need to design a structure for our logistic improvement projects.
We have already mentioned one possible structure in Chapter 4 when we described a
plan–do–check–act cycle. This has a team of people whose job is to go around and positively
search for things that could be done better, using the cycle:

● plan – looking at the existing logistics, collecting information, discussing alternatives, and
suggesting a plan for improvement
● do – where the plan is implemented, and data is collected on performance
● check – which analyses the performance data to see if the expected improvements actually
appeared
● act – if there are real improvements the new procedures are made permanent, but if there
are no improvements, lessons are learnt and the new procedures are not adopted.

The team is continuously looking for improvements, and at this point they return to the
beginning of the cycle, and start looking for more improvements. Other people use different
approaches. A reasonable one for most problems has the following steps:

1. Make everyone aware that changes are needed to the supply chain, describing the
reasons, alternatives and likely effects.
2. Examine current practices, identify their aims, see how well they achieve these and iden-
tify problem areas and weaknesses.
3. Use benchmarking and other comparisons to identify potential improvements and
improved methods.
4. Design better procedures using the knowledge, skills and experience of everyone
concerned.
218 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

5. Discuss the proposals widely and get people committed to the new methods.
6. Design a detailed plan for implementing the improvements, anticipating likely problems
rather than waiting for them to happen.
7. Make any necessary changes to the organisation’s structure, systems, facilities, and so on.
8. Give appropriate training to everyone involved.
9. Set challenging, but realistic, goals for everyone, and make it clear how these can be
achieved.
10. Have a specific event to start the new methods.
11. Establish milestones and monitor progress to make sure they are achieved.
12. Give support and encouragement to everyone concerned.
13. Have continuing discussions about progress, problems, adjustments, and so on.
14. Monitor and control progress to make sure that everything continues to go as planned,
remain committed to the new methods while they are giving improvements, and update
them as necessary.
15. Accept that the new methods are only temporary, and continually look for further
improvements.

This seems a rather formal list, but it is based on simple principles – analysing where we want
to go and how we can get there. An important point is that the procedure uses continuous
improvement. When new methods are introduced, we have to recognise that they are only
temporary, and will be replaced again in the future. This generally – but not inevitably –
involves a stream of relatively minor changes that can easily be absorbed by the organisation,
give few disruptions, and cause no major problems. There is little risk, as any small change
that does not work can easily be reversed.
This incremental approach to change builds a momentum for improvement, and makes
sure that logistics is always getting better. Remember, though, that the incremental
approach has critics who say that continually tinkering with the supply chain is counter-
productive. They are more likely to recommend a radical approach such as business process
re-engineering.

L O G I S T I C S
I N P R A C T I C E
Hebblethwaite Ltd
George Hebblethwaite runs a small ware- Fixed costs % Variable costs %
house and transport company distributing Wages 35 Fuel 54
a range of camping equipment in northern Depreciation 27 Maintenance 19
Britain. He was keen to improve company Management 22 Tyres 24
performance and collected data (see table) Insurance 12 Oil 5
on costs for transport and warehousing. Licences 4

(a) Transport fleet operations largely fixed – so his first study looked for
George easily identified the areas where he improvements in the activities for which he
could look for improvements. He got paid got no pay. Specifically, he looked for
for moving vehicles, but his costs were improvements in the loading, unloading
 MEASURING AND IMPROVING PERFORMANCE 219

L O G I S T I C S
I N P R A C T I C E
continued

and idle times (as trucks spend an average of Total time % Of picking time %
58% of their time idle).17 The other area he Receiving 18 Travel 58
focused on was vehicle routes. In general, materials
the variable costs rise with distance, but they Putting on 11 Picking 31
also vary with conditions such as congested, shelves
Picking 39 Checking 8
urban and hilly areas that reduce speeds and
Despatching 23 Other 3
increase fuel consumption.
Other 9
(b) Warehouse operations:
Wages 58%
Picking was clearly most time consuming,
Buildings 23%
and then more than half of the picking time
Equipment 19% was spent moving around. George felt that
this was another place with large potential
The cost of wages in the warehouse was savings.
particularly high, so George analysed peo-
ple’s activities and found the proportion of Sources: company reports; Hebblethwaite G.
(2001) Western Operations Group, Leeds
their time that they spent doing certain
activities.
CHAPTER REVIEW ■ ■ ■ ■ ■

❑ Organisations must continually improve their logistics to remain competitive.

This means that managers in every organisation have to measure the
performance of their supply chains.
❑ Without these measures managers have no idea how well their logistics is
working, how they compare with competitors, how performance has
changed over time or what can be improved.
❑ There is a huge number of possible measures for the supply chain. Many of
these are indirect and based on finance. It is, however, important to have
some direct measures of logistics.
❑ General measures include capacity, utilisation, and productivity. There are
many other specialised measures for transport, warehousing and other parts
of logistics. An organisation has to take a balanced view of these to get an
overall view.
❑ Performance measures are often used for comparisons. This is the basis of
benchmarking, which compares an organisation’s logistics with the best
performance in the industry.
220 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T
continued ■ ■ ■

❑ We can describe the activities in a supply chain using a variety of different

charts. These highlight areas that need improving.
❑ There are several ways that an organisation can approach improvement. It
might focus on specific areas that commonly cause problems, or it might use
a particular procedure. We described a general approach to improvement.

C A S E S T U D Y Ed’s Drive-through Bottle Shop

Ed’s Drive-through Bottle Shop sells alcoholic drinks in Brisbane, Australia. The
prices are low and the ‘drive-through’ shop is busy. Customers accept some delays to
get cheap drinks, but at busy periods the manager saw that he was losing customers.
The basic plan of the shop has a single line of cars driving past a service window
(customers can park and visit the shop as normal, but relatively few do this). The
obvious way of reducing the delays is to have more service windows working in
parallel, but the site is rather long and narrow, so this is difficult.
The manager decided to try a number of improvements, such as dividing the
service into several parts. He found the distributions of times for various operations,
and then used a spreadsheet to simulate a number of options.
Figure 8.11 gives an idea of his approach. For this he put three servers in series.
The first server, A, took the customer’s order, the second, B, looked after the bill and
payment, and the third, C, delivered the goods. The spreadsheet follows ten
customers through the process. It generates times for each activity (randomly gener-
ated to follow actual distributions), and shows how the process performs during a
typical short period.
Behind the shop is an area of bulk storage. Most orders are delivered by eight
wholesalers, who generally make one delivery a week. Sometimes stocks run low,
and the manager arranges a special delivery. Another twenty smaller suppliers
deliver special goods or make special deliveries when there are problems. To make
administration easy, the manager always uses a standard order for each supplier.
Every week he takes the standard orders, adjusts them if there has been any unusual
demand, and prepares for special events such as local football matches. Then he
faxes the orders to suppliers, and the invoices are delivered with the goods.
 MEASURING AND IMPROVING PERFORMANCE 221

A B C D E F G H I J
1 Customer A B C
Join Start Join Start Join Start
2 queue service Leave queue service Leave queue service Leave
3
4 1 8.45 8.47 8.51 8.52 8.55 9.00 9.01 9.02 9.04
5 2 8.45 8.51 8.53 8.53 9.00 9.01 9.02 9.04 9.07
6 3 8.58 8.58 9.01 9.02 9.07 9.09 9.10 9.10 9.13
7 4 9.00 9.01 9.04 9.05 9.09 9.10 9.11 9.13 9.16
8 5 9.05 9.05 9.06 9.06 9.10 9.13 9.13 9.16 9.18
9 6 9.20 9.20 9.21 9.21 9.21 9.23 9.23 9.23 9.25
10 7 9.20 9.21 9.24 9.25 9.25 9.28 9.29 9.29 9.33
11 8 9.22 9.24 9.26 9.27 9.28 9.30 9.30 9.33 9.35
12 9 9.25 9.26 9.29 9.30 9.30 9.34 9.35 9.35 9.38
13 10 9.25 9.29 9.32 9.33 9.35 9.38 9.39 9.39 9.44
14
15 Analysis
16 Number of customers 10
17 Time in queue A 2.10 Service time A 2.50
18 Time in queue B 6.30 Service time B -1.90
19 Time in queue C 1.20 Service time C 2.40
20
21 Time in queues 6.00 Time being served 7.40
22 Time in system 15.20

Figure 8.11 Part of a simulation for Ed’s Drive-through Bottle Shop

C A S E S T U D Y
Questions
● How do you think the manager can measure the performance of the shop?
● Where should he start looking for improvements?
● How can he describe the details of the operations?

P R O J E C T

Quality of Logistics
Take a critical look around you and see if you can see examples of poor logistics. You might find, for
example, that a train is cancelled, a bus arrives at the wrong time, a delivery of goods arrives after the
promised time, a shop runs out of a product that you want, a town centre is poorly laid out, and so on.
What could you do to improve these operations? Why do you think that no one has made these obvi-
ous improvements?
222 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

P R O B L E M S

1. In two consecutive years a warehouse had the following characteristics:

Year 1 Year 2

Weight of materials moved 5000 tonnes 6500 tonnes

Number of orders satisfied 1650 1820
Number of stock-outs 87 53
Average value stocked £254,000 £287,000
Cost of administration £60,000 £76,000
Hours worked 12,000 15,000
Direct costs £115,000 £173,000
Energy used 20,000 kWh 24,000 kWh
Energy cost £2000 £3000

What can you say about the performance of the warehouse

2. The activities of an insurance broker can be described by the following table. Draw a precedence
diagram of the process.
Activity Must be done after

1 –
2 1
3 1
4 1
5 2, 3
6 4
7 2
8 5
9 6
10 7, 8
11 9, 10

3. Quality inspectors in a company take random samples of materials arriving from suppliers. An inspec-
tion involves three separate tests, each of which uses a different type of machine. There are two
machines of each type. Each test takes six minutes for assessment, followed by four minutes for fine
adjustment. There are three inspectors working in the area. Draw a process chart for the inspection
area. How many units can be inspected each hour?

DISCUSSION QUESTIONS

1. ‘What you can’t measure you can’t manage.’ To what extent do you think this is true?
2. Managers can be tempted to use the easiest measures of performance, or those that show
themselves in the best light. What are the consequences of this? Can you give examples
of problems this creates?
 MEASURING AND IMPROVING PERFORMANCE 223

3. What are the most appropriate measures of performance for a supply chain?
4. Performance measures can give conflicting views – changes that improve some measures,
make others worse. How can you decide whether the overall effect is beneficial or not?
5. It is easy to find improvements in any supply chain. So why have the managers not
already made them?
6. Continuous improvement is not really useful as it just tinkers with existing operations
and does not look for significant gains. To what extent do you think this is true?

REFERENCES
1. Harrison A. and New C. (2002) The role of coherent supply chain strategy and performance management
in achieving competitive advantage, Journal of the Operational Research Society, 53(3), 263–71.
2. Ferreira J.A. (1993) Re-engineering the materials and procurement function, APICS – The Performance
Advantage, October, 48–53.
3. Lennox R.B. (1995) Customer service reigns supreme, Materials Management and Distribution, January,
17–19.
4. Cold Storage and Distribution Federation (2000) Key Performance Indicators, CSDF, Bracknell.
5. Chaplen A. and Wignall J. (1997) Sainsbury’s checks out benchmarking, Logistics Focus, 5(9), 13–14.
6. Waters D. (2001) Operations Management, Financial Times/Prentice Hall, Harlow.
7. Brunt D. (1999) Value stream mapping tools, Logistics Focus, 7(2), 24–31.
8. Townsend R. (1970) Up the Organisation, Coronet Books, London.
9. Beesley A. (1995) Time compression – new source of competitiveness in the supply chain, Logistics Focus,
3(5), 24–5.
10. Beesley A. (1995) Time compression tools, Logistics Focus, 3(7), 17–20.
11. Beesley A. (2000) Time compression in the supply chain, Ch. 11 in Waters D. (ed.) Global Logistics and
Distribution Planning, Kogan Page, London.
12. Monden Y. (1983) Toyota Production System, Industrial Engineering and Management Press, Norcross, GA.
13. Devonshire R.M. (1996) Supply chain information, Logistics Focus, 4(5), 29–31.
14. Emmett S. (2000) Improving freight transport and warehouse operations, Logistics and Transport Focus,
2(2), 30–4.
15. Sordy S. (1997) Do you have any principles?, Logistics Focus, 5(8), 19.
16. Wheatley M. (1998) Seven secrets of effective supply chains, Management Today, June, pp. 78–87.
17. McKinnon A. (1999) The effect of traffic congestion on the efficiency of logistical operations, International
Journal of Logistics Research and Applications, 2(2).

Further reading
Armistead C. and Roland P. (1996) Managing Business Processes: BPR and Beyond, John Wiley, Chichester.
Berry L.G. (1995) Great Service, Free Press, New York.
Hammer M. (1996) Beyond Reengineering, HarperCollins, New York.
Leibfried K.H.J. and McNair C.J. (1992) Benchmarking: A Tool for Continuous Improvement, HarperCollins,
New York.
 PA R T I I I

Activities in the Supply Chain

This book is divided into three parts. Part I gave a general intro-
duction to the subject of supply chain management; Part II
discussed the planning needed for a supply chain; and Part III
focuses on some specific functions of logistics.

There are five chapters in Part III, each of which describes a

major activity in the supply chain. Chapter 9 looks at the
procurement of materials. Materials are kept in stock, so
Chapter 10 describes inventory management, while Chapter 11
discusses some questions of warehousing. Chapter 12 describes
the transport of materials and Chapter 13 looks at issues of
international logistics.

This is the last part of the book, which relates to our earlier
discussions on specific activities in the supply chain.
 CHAPTER 9

Procurement

CONTENTS

■ Aims of the chapter ■ Case study – Arnold Haralson

■ Definitions ■ Project – How to buy
■ Choosing suppliers ■ Discussion questions
■ Procurement cycle ■ References
■ Types of purchase ■ Further reading
■ Chapter review

AIMS OF THE CHAPTER

After reading this chapter you should be able to:

■ D E F I N E the role of procurement

■ A P P R E C I AT E the importance of procurement in the
supply chain
■ C H O O S E an appropriate supplier
■ D I S C U S S the steps in a procurement cycle
■ D E S C R I B E e-procurement and its advantages
■ TA L K about different arrangements for purchasing
228 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

DEFINITIONS

Purchasing and procurement

In previous chapters we have described the planning of a supply chain. This starts with
strategic aims, and moves down to organise the flow of materials, makes sure that resources are
available, and continually looks for better methods. But we have not really discussed the mech-
anism for initiating the flow of materials. This is provided by purchasing or procurement.
In a supply chain, each organisation buys materials from upstream suppliers, adds value,
and sells them to downstream customers. As each organisation, in turn, buys and sells, the
materials move through the whole supply chain. The trigger that initiates each move is a
purchase. This is basically a message that an organisation sends to a supplier, saying, ‘we have
agreed on terms, so send us materials and we will pay you’.

P U R C H A S I N G gives a mechanism for initiating and controlling the flow of materials

through a supply chain.

Purchasing is the function responsible for acquiring all the materials needed by an organi-
sation. Many of these transactions are not standard purchases, but include rental, leasing,
contracting, exchange, gifts, borrowing, and so on. This is why some people prefer to talk
about the ‘acquisition of materials’ or the more common term of procurement. ‘Procurement’
and ‘purchasing’ are often taken to mean the same thing. Usually, though, purchasing refers to
the actual buying, while procurement has a broader meaning. It can include different types of
acquisition (purchasing, rental, contracting, and so on) as well as the associated work of
selecting suppliers, negotiating, agreeing terms, expediting, monitoring supplier performance,
materials handling, transport, warehousing and receiving goods from suppliers.

■ P R O C U R E M E N T is responsible for acquiring all the materials needed by an

organisation.
■ It consists of all the related activities needed to get goods, services and any other
materials from suppliers into an organisation.

Procurement does not usually move materials itself, but it organises the transfer. It gives
the message that materials are needed, and arranges the change of ownership and location.
But it is another function, such as transport, that actually delivers them. So procurement is
largely concerned with information processing. It collects data from various sources, analyses
it, and passes information to the supply chain.

Importance of procurement

You can easily see why procurement is important. If we take a broad view, procurement forms
an essential link between organisations in the supply chain, and it gives a mechanism for co-
ordinating the flow of materials between customers and suppliers. At every point in the supply
chain, procurement passes messages backwards to describe what customers want, and it passes
 PROCUREMENT 229

messages forwards to say what suppliers have available. Then it negotiates terms and condi-
tions for delivery.
If we take a more limited view, procurement is clearly an essential function within every
organisation. We know that every organisation needs a supply of materials, and procurement
is responsible for organising this. If procurement is carried out badly, materials do not arrive,
or the wrong materials are delivered, in the wrong quantities, at the wrong time, with poor
quality, at too high price, low customer service, and so on.
You can get a feel for the importance of procurement from the following example. In the
first half of the twentieth century farmers in the US prairies could be fairly isolated. Sears
Roebuck introduced a new way of buying that gave farmers the same access to products as the
rest of the population.

L O G I S T I C S
I N P R A C T I C E
Sears Roebuck
Sears Roebuck is a major retailer in the They have maintained this tradition, and
United States. Founded in 1886 it now has still advertise, ‘Satisfaction guaranteed or
annual revenues of over $40 billion. Much your money back’.
of its early growth was based on delivering According to Ackerman and Brewer1 this
goods to farmers in the remote prairies. In kind of mail order business has some
1913 its catalogue contained 1500 pages, important features for logistics:
with thousands of items ranging from
■ logistics providers have direct contact
boxes of matches to complete houses. Peo-
with customers
ple in any location could post their orders
■ this direct contact allows more precise
or send them to agents, and have goods
ordering
delivered by post or train. Their customers
■ an efficient system for exchanging infor-
were always satisfied, as the company gave
mation is essential
a comprehensive guarantee on their cata-
■ orders are smaller than normal
logue cover:
■ customers are more demanding and
If for any reason whatsoever you were dis- want better service
satisfied with any article purchased from ■ transport is more complicated.
us, we expect you to return it to us at our
expense. We will then exchange it for Sources: promotional material, company reports
and website at www.sears.com
exactly what you want or will return your
money, including any transportation char-
ges you have paid.

Not only is procurement essential, but it is also responsible for a lot of expenditure. For a
typical manufacturer, 60% of its spending goes on materials, with companies like General
Motors spending over $50 billion a year. So procurement is directly responsible for most of a
230 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

company’s spending, and a relatively small improvement can give substantial benefits.
Suppose that a company buys raw materials for a60, spends a40 on operations and then sells
the product for a110. It clearly makes a profit of 110 – (60 + 40) = a10 a unit. Now suppose
that procurement negotiates a 5% discount on materials. Materials now cost 60 × 0.95 = a57,
and with the same selling price the a3 saving goes straight to profit. The profit on each unit
now jumps to a13, so a 5% decrease in materials costs raises profit by 30%.

W O R K E D
E X A M P L E

Last year Wiesiek Limited had total sales of £108 million. Their direct costs were £58 mil-
lion for materials, £27 million for employees and £12 million for overheads. What is the
effect of reducing the cost of materials by 1%? If materials costs are not reduced, how
much would sales have to increase, or overheads fall, to get the same effect?

Solution
■ The actual profit last year was 108 – (58 + 27 + 12) = £11 million.
■ If the cost of materials drops by 1%, it falls to 58 × 0.99 = £57.42 million. Then the
profit rises to 108 – (57.42 + 27 + 12) = £11.58 million. A 1% decrease in materials
costs increases profits by 5.3%. Profit as a percentage of sales rises from 10.2%
to 10.7%.

■ If materials costs do not change, and assuming that other costs remain the same
proportion of sales value, then sales would have to rise by 5.3% to £114 million to get
the same increase in profit.

■ To get the same extra profit the fixed costs would have to fall by £0.58 million
or 4.8%.

In recent years there has been wider recognition of procurement’s position as an essential
function that can control most of an organisation’s expenditure. As a result, the function has
received a lot more attention. It used to be considered little more than a clerical job, buying
materials as they were requested. Now it is recognised as an important management function
in its own right. This trend has been encouraged by changing patterns of procurement. Supply
chains are getting shorter as more customers use the Web or avoid different tiers of suppliers;
alliances are reducing the number of suppliers used by each organisation; amounts purchased
are increasing as companies focus on their core activities and outsourcing more; customers are
more demanding of products and conditions of purchase. These, and other factors, turn a
spotlight on procurement. With this context, it is not surprising that procurement is treated as
a senior management role.
 PROCUREMENT 231

Aims of procurement

The overall aim of procurement is to guarantee that an organisation has a reliable supply of
materials. With this overriding aim, we can develop the following list of more immediate
goals:

● organising a reliable and uninterrupted flow of materials into an organisation

● working closely with user departments, developing relationships and understanding their
needs
● finding good suppliers, working closely with them and developing beneficial relationships
● buying the right materials and making sure that they have acceptable quality, arrive at the
time and place needed, and meet any other requirements
● negotiating good prices and conditions
● keeping stocks low, considering inventory policies, investment, standard and readily
available materials, and so on
● moving materials quickly through the supply chain, expediting deliveries when necessary
● keeping abreast of conditions, including pending price increases, scarcities, new products,
and so on.

Organisation of procurement

The way that procurement is organised clearly depends on the type and size of the organisation.
In a small organisation, a single buyer might be responsible for all purchases, policy and admin-
istration. A medium-sized organisation might have a department with buyers, expeditors, store-
keepers, and clerks. A large organisation might have hundreds of people co-ordinating huge
amounts of purchases.
Usually procurement is organised as a single department to get the benefits of centralised
purchasing. These benefits include:

● consolidation of all orders for the same, and similar, materials to get quantity discounts
● co-ordinating associated activities to reduce costs of transport, stockholding and
administration
● eliminating duplicated effort and haphazard practices
● having a single point of contact for suppliers and giving them consistent information and
service
● developing specialised skills and improving procurement operations
● allowing other people to concentrate on their own work without diverting into
purchasing
● concentrating responsibility for procurement, making management control easier.

These benefits can be considerable, but centralised purchasing has its critics. If you work in an
office in Leeds, it seems nonsensical to contact your purchasing department in Milton Keynes
(450 km away) to buy materials from a supplier in Bradford (20 km away). Nonetheless, this
system should give overall benefits. However, organisations that work over a wide geograph-
ical area are aware of the problems of centralised purchasing, and may use local purchasing.
This can, of course, bring its own benefits. Local offices are likely to have better knowledge of
local conditions and culture, better relations with suppliers, more flexible operations, lower
transport costs, and so on.
232 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

L O G I S T I C S
I N P R A C T I C E
CN Railway
Canadian National Railways (CN) used to who could supply all their main purchases,
have a traditional purchasing and materials and then comparing the companies’ ability
management department. At the beginning to form productive partnerships. Bob Gal-
of the 1990s this employed 1400 people in lant explained that they were ‘looking for a
60 locations. The department had been suc- supplier that could provide us with a total
cessful in lowering prices (by up to 35%) package. We also wanted to work with a
through alliances and volume purchasing. company that had a common view and
Despite this, the company felt that it could management commitment’.
improve procurement performance. Bob The transition to new procurement and
Gallant, head of supply management at CN, changing culture was difficult for a depart-
said that there was a strong push for better ment that served 23,000 employees. They
performance at the railway and that: ‘Pur- changed the department’s name, ran a
chasing is one of the most powerful ways to series of seminars and workshops to explain
enhance economic performance.’ the new philosophy, hired outside people,
CN’s traditional approach was to buy formed alliances and actively searched for
each material from the best supplier, nego- new ideas. The most difficult part was con-
tiating for the lowest price. But they found vincing people that they were aiming for
that they could get lower overall costs by the lowest overall cost, rather than the
purchasing from a few main distributors, cheapest immediate price.
rather than from separate companies. In By 1995 CN had reduced their supply
September 1994, for example, they management department to 280 people in
stopped dealing individually with 500 geo- 25 locations, the total cost of materials pur-
graphically dispersed suppliers in western chased by C$14 million and stocks by C$4
Canada. Instead, they formed an alliance million. The following year they looked for
with Acklands, a major distributor who reductions of C$40 million in costs and
became responsible for co-ordinating these C$34 million in stock, with similar improve-
supplies. CN replaced 6000 annual invoices ments in 1997.
by a single monthly bill and reduced costs
Source: Anon. (1996) Buying power, Materials
by C$1.2 million a year.
Management and Distribution, February, 43–5
They chose Acklands, and other distribu-
tors, by forming a shortlist of companies

CHOOSING SUPPLIERS

Qualified suppliers

Arguably, the most important part of procurement is finding the right supplier. There is no
point in having a well-designed product, if the supplier cannot actually deliver it. Imagine that
 PROCUREMENT 233

you are working on a project and want to buy some important materials – perhaps a prefabri-
cated bridge for a construction project. You will look for two factors. First, a product design
that satisfies your needs. Second, a supplier who can guarantee to deliver the product as
designed. In other words, the supplier must be capable of doing the work, giving high quality,
working to a schedule, with acceptable costs, and so on. An advertised time of four hours for a
train journey might seem a good service, but it has less value if the train operator cannot actu-
ally deliver this.
Procurement starts, then, by finding a qualified supplier. This is one who can actually
deliver the materials needed. In general, organisations look for suppliers who:

● are financially secure with good long-term prospects

● have the ability and capacity to supply the necessary materials
● accurately deliver the requested materials
● send materials of guaranteed high quality
● deliver reliably, on time with short lead times
● quote acceptable prices and financing arrangements
● are flexible to customers’ needs and changes
● are experienced and have expertise in their products
● have earned a good reputation
● use convenient and easy procurement systems
● have been used successfully in the past and can develop long-term relationships.

In different circumstances, many other factors might be important, such as convenient loca-
tion, ability to deal with variable demand, and so on.
Most organisations have a list of approved suppliers who have given good service in the
past, or who are otherwise known to be reliable. If there is no acceptable supplier on file, the
organisation has to search for one. Suppliers for low value items can probably be found in
trade journals, catalogues or through business contacts. More expensive items need a thorough
search, and this can be very time consuming. A useful approach for choosing the best supplier
for a product has the following steps:

● Look for alternative suppliers

● Build a long list of qualified suppliers who can deliver the products
● Compare organisations on this long list and eliminate those who are, for any reason, less
desirable
● Continue eliminating organisations until you have a shortlist (usually four or five) of the
most promising suppliers
● Prepare an enquiry, or request for quotation, and send it to the shortlist
● Receive bids from the shortlist
● Do a preliminary evaluation of bids and eliminate those with major problems
● Do a technical evaluation to see if the products meet all specifications
● Do a commercial evaluation to compare the costs and other conditions
● Arrange a pre-award meeting to discuss bids with the remaining suppliers
● Discuss condition bids, which are specific conditions that have to be agreed
● Choose the supplier that is most likely to win the order
● Arrange a pre-commitment meeting to sort out any last minute details
● Award orders to the preferred supplier.
234 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

This is clearly a time-consuming procedure, but remember that a poor supplier can cause more
problems than poor materials. The whole procedure is only used for major purchases, and if
you are buying pencils the shop next door is probably as good as any other supplier. Normally,
an organisation will spend little time looking at alternative suppliers if:

● it is buying low value materials

● there is only one possible supplier
● there is already a successful arrangement with a supplier
● there is not enough time for extended negotiations
● the organisation has a policy of selecting specific types of supplier.

Sometimes, particularly with government work, procurement has to be visibly fair, and all
potential suppliers must be given an opportunity to submit quotations. Rather than forming a
shortlist of qualified suppliers, an organisation will widely advertise that it is seeking quota-
tions for particular work or materials. The organisation compares all the bids submitted and
chooses the one that best meets the prescribed criteria. This is called open tender. A variation
reduces the administrative effort by putting some qualifications on suppliers, perhaps based on
experience, size or financial status. This gives limited tender.
As you can see, we are talking about customers selecting suppliers – and assume that
suppliers are happy to serve all the customers they can find. This is usually the case, but some-
times suppliers have more power and effectively choose their customers. This might happen
when a supplier has a monopoly, or near monopoly, of some material. It might also happen
when there is a temporary shortage of some commodity, such as oil, and suppliers choose the
customers they will supply, perhaps giving preference to larger customers, those who pay
more, or those who have long-term agreements. In these cases the supplier has more power, as
shown in Figure 9.1.2

100%
Supplier has Mutually
more power dependent –
materials bought from supplier

alliance
Amount of customer’s

Little
Customer has
dependence –
more power
competition

0 50% 100%

Amount of supplier’s materials

sold to customer

Figure 9.1 Relative power of a customer and a supplier

 PROCUREMENT 235

Number of suppliers

We have already discussed the trend towards long-term alliances and partnerships. This
inevitably moves organisations towards single suppliers, either for each material, or for a range
of different materials. Some organisations say that this single sourcing leaves them vulnerable
to the performance of an individual company, and they have severe problems if something
goes wrong. If the single supplier of a vital component hits financial problems, an organisation
may, through no fault of its own, have to stop production. To avoid this, some organisations
have a policy of buying the same materials from a number of competing suppliers. They might
use rules of thumb such as ‘never let a manufacturer account for more than 20% of total
revenue; never let a customer absorb more than 50% of total resources’.3 The choice must
depend on individual circumstances, but we can list some advantages of policy:

● Advantages of single sourcing:

● a stronger relationship between customers and suppliers, often formalised in
alliances or partnerships
● commitment of all parties to the success of the relationship
● economies of scale and price discounts with larger orders
● easier communication, reduced administration and simpler procedures for regular orders
● less variation in materials and their supply
● easier to keep requirements, conditions and so on, confidential.

● Advantages of multi-sourcing:
● competition between suppliers reduces prices
● there is less chance of disrupted supplies, as problems can be avoided by switching
suppliers
● can deal more easily with varying demands
● involving more organisations can give access to wider knowledge and information
● is more likely to encourage innovation and improvement
● does not rely on trusting one external organisation.

Organisations use more suppliers when they want to avoid potential problems. Another
way of doing this uses forward buying. In its simplest form, this happens when an organisa-
tion orders more materials than it currently needs and keeps the excess in stock. Another form
uses contracts to deliver materials at specific points in the future. Both of these bring two
benefits. First, they guarantee supplies for some period in the future and minimise the effect of
possible disruptions. Second, the price of materials is fixed, avoiding the effects of future price
rises or uncertainty. Of course, things can still go wrong. A company that signs a long-term
contract can still go out of business, or a warehouse can burn down, but the chances of a
problem are much smaller. It is probably safest for an organisation to hold spare stock itself,
but this has higher costs; agreeing a contract for future deliveries gives lower costs, but does
not eliminate so much risk (and it is also a poor arrangement when material prices might fall).

Monitoring supplier performance

Most organisations monitor their suppliers to make sure that they continue to give satisfactory
service. This is called supplier rating or vendor rating. Often this is done informally by a
subjective review; sometimes there are complex measures for every aspect of performance. Most
organisations use a compromise that gives a reasonable view of performance, and needs a
reasonable amount of effort. One common approach uses a checklist of important factors and
236 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

checks that the supplier meets an acceptable standard in these. The checklist might ask whether
the supplier is financially sound; whether it delivers on time; if material quality is high enough;
if there is technical support; whether the price is competitive; about relevant trends, and so on.
If the supplier does not meet any criterion the customer has to discuss improvements or look
for new sources. The aim is not really to replace existing suppliers, but to monitor performance,
identify areas that need improving and agree the best way of achieving these improvements.
Only as a last resort should an organisation start looking for new suppliers.
A more useful approach to rating gives the supplier a score for different aspects of perform-
ance. They might, for example, give each supplier a score out of ten for on-time delivery, and
if a supplier’s score drifts down below eight the customer can discuss ways of improving
performance. Although this approach sounds convincing, there can be considerable difficul-
ties. How, for example, can you identify the most important factors of supplier performance,
the relative importance of each, the actual performance, and the lowest acceptable perform-
ance? Each of these is likely to come from a combination of discussion and agreement, rather
than from more precise measurement. The result is a subjective view that may be useful, but
contains little objective measurement.

L O G I S T I C S
I N P R A C T I C E
Philips Semiconductors, Stadskanaal
Philips Semiconductors’ plant in Stad- Criteria Performance required
skanaal, the Netherlands, makes millions of Delivery 99.5% delivered on time, with
diodes a year. These are made on an auto- performance average deliveries twice a
mated assembly line, using just-in-time week

operations. Materials (such as glass, wires Quality less than 3–5 parts per million
defective
and connectors) have to be delivered at
Price expected to fall by 7% a year
exactly the right time, with any delays
Responsiveness supplier feedback within two
interrupting the process. hours for critical problems
Over 65% of the plant’s cost is materials, Audit score compiled score according to
and Philips puts exacting demands on its Philips audit system
suppliers. It only tolerates a few defects per
million parts, and typically demands This system plays a key role in Philips keep-
decreases in price of 7% a year. To monitor ing its leading position in an increasingly
supplier performance, Philips introduced a competitive market.
Supplier Rating System which measures five
Sources: Philips Semiconductors, Stadskanaal,
criteria for 12 main suppliers each month.
Purchasing Annual Report (1998) and Supplier
The criteria measured are as follows. Rating System, manual (1998)

PROCUREMENT CYCLE
Steps in the cycle

Once it has chosen a supplier, an organisation has to follow some procedure for arranging
purchases. Imagine that you want to buy something expensive, like a new computer. You
 PROCUREMENT 237

probably approach this in several stages, listing the facilities you want, searching for systems
that can provide these, identifying suppliers, developing a shortlist of options, comparing
these, and choosing the best. Your aim is to find the combination of products and suppliers
that best satisfies your needs. The procurement function in an organisation does exactly the
same, and follows a specified procedure for each purchase. This procedure is different in every
organisation, and varies with the type of thing being purchased. You would not expect an
organisation such as the US army, which buys millions of items a day, to work in the same
way as the directors of Real Madrid football club when they acquire a new striker. And the
US army would not approach its decision to buy pencils in the same way as its decision to
buy helicopters.
Despite these inevitable differences in detail, we can suggest a general approach to procure-
ment. This has a series of common steps, which start with a user identifying a need for mate-
rials and end when the materials are delivered. Figure 9.2 shows an outline of these steps,
while a more detailed view of a typical procurement cycle has the following steps (with key
documents in bold).

1. A user department:
● identifies a need for purchased materials
● examines materials available and prepares specifications
● checks departmental budgets and gets clearance to purchase
● prepares and sends a purchase request to procurement.

2. Then procurement:
● receive, verify and check the purchase request
● examine the material requested, looking at current stocks, alternative products,
production options, and so on – and after discussions with the user department
confirm the decision to purchase

User department Procurement Suppliers

1. Identify need

Requests purchase 2. receive request

process

request quotations 3. receive request

process

4. receive quotation send quotation

discuss discuss and process

send purchase order 5. receive order

process
ship goods and
6. receive and check invoice
7. receive and check transfer

authorise payment 8. arrange payment receive payment

Figure 9.2 Outline of steps in a procurement cycle

238 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

● make a shortlist of possible suppliers, from regular suppliers, lists of preferred

suppliers, or those known to meet requirements
● send a request for quotations to this shortlist.

3. Then each supplier:

● examines the request for quotations
● checks the customer’s status, credit, and so on
● sees how it could best satisfy the order
● sends a quotation back to the organisation, giving details of products, prices and
conditions.

4. Then procurement:
● examine the quotations and do commercial evaluations
● discuss technical aspects with the user department
● check budget details and clearance to purchase
● choose the best supplier, based on the details supplied
● discuss, negotiate and finalise terms and conditions with the supplier
● issue a purchase order for the materials (with terms and conditions attached).

5. Then the chosen supplier:

● receives, acknowledges and processes the purchase order
● organises all operations needed to supply the materials
● ships materials together with a shipping advice
● sends an invoice.

6. Then procurement:
● acknowledge receipt
● do any necessary follow-up and expediting
● receive, inspect and accept the materials
● notify the user department of materials received.

7. Then the user department:

● receives and checks the materials
● authorises transfer from budgets
● updates inventory records
● uses the materials as needed.

8. Then procurement:
● arrange payment of the supplier’s invoice.

The first three steps sort out the materials and supplier, and then comes the crucial point
with the issue of a purchase order in step 4. At this point the organisation agrees to buy speci-
fied materials from a supplier, and the purchase order triggers the supply (along with necessary
production planning, transport arrangements, finance, and so on). The purchase order is part
of a legal contract between the organisation and its supplier. The remaining steps finalise the
details of delivery.
This procedure seems complicated, and involves many steps and documents. If you are
buying something expensive, this effort is certainly worthwhile – and you may actually follow a
much more complicated procedure to fix product specifications, select the supplier and nego-
tiate terms. But if you are making small purchases, if there are existing relationships with
suppliers, or there is only one qualified supplier, it is clearly not worth going through this whole
 PROCUREMENT 239

expensive, procedure. Then you will look for more routine methods. For these, a rule of thumb
suggests £80 as the cost of processing a basic, simple order, while Allen quotes figures of $115 to
$150.4 Even this is too expensive for very low value items, where the procurement would cost
more than the materials. Then you will look for even simpler, automatic or ad hoc procedures.
Apart from its cost, another problem with the formal procurement procedure is the time
that it takes. It is too slow to make quick purchases. Paul Sigarro buys material to make
designer dresses for l’Haute Vision in Stockholm, and found that a delivery of materials typi-
cally took one day to arrive from the supplier in Nice, but organising this delivery often took
five weeks.5 This supports an earlier survey in the USA6 which found the following average
times for processing orders at manufacturers.

Part of procurement Average days

From customer placing order, to supplier receiving it 1.9

From supplier receiving order, to finishing administration 2.1
From finishing administration, to shipping order 2.2
From supplier shipping order, to customer receiving it 4.1
Total 10.3

Using a traditional, paper-based system took an average of 10.3 days for a customer to get
materials delivered from a manufacturer’s stock. If there were problems such as shortages,
special products that needed some work, special transport or delivery arrangements, difficult
negotiations of conditions, or any similar problems, this time was considerably longer.
In recent years a lot of work has been done to reduce both the cost and time for procure-
ment. Some of these methods are fairly simple. Blanket orders, for example, use a single order
to cover regular deliveries of materials over some specified time in the future. Value analysis
uses a team of people from different functional areas to find substitute materials that are lower
in price but equally as good as the original.
None of these adjustments tackle one of the basic problems with paper-based procurement,
which is its unreliability. Purchasing staff typically spend a third of their time dealing with
problems that occur when the procurement process fails in some way.7,8 Some of these prob-
lems with paper-based procurement include:

● taking a long time to go through the whole procedure

● relying on a lot of forms and paperwork which move around different locations
● needing a lot of people to complete, analyse, process, store and generally deal with all the
paper
● having other people to supervise, manage and control the administrative procedures
● inevitable errors with so many documents and people involved
● not giving attention to related systems, such as stock control.

A major step in improving procurement came with electronic purchasing. Electronic data
interchange (EDI) has been used since the 1980s, and this allows automated procurement. An
organisation links its information system to a supplier’s, and when it is time to place an order
the system automatically sends a message. This works well for small, regular, repeat orders and
most organisations readily adopted the principles. There are several variations on automated
procurement, all of which are considered under the general heading of e-procurement.
240 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

e-procurement

Most organisations already use some form of e-procurement. Surveys7,8 suggest that over 60%
of UK companies used e-procurement by 2002, and 80% of European managers soon expect to
use it extensively. Some of the advantages this brings are:

● allowing instant access to suppliers anywhere in the world

● creating a transparent market where products and terms are readily available
● automating procurement with standard procedures
● greatly reducing the time needed for transactions
● reducing costs, typically by 12–15%7,8
● outsourcing some procurement activities to suppliers or third parties
● integrating seamlessly with suppliers’ information systems.

There are basically two types of e-procurement which are described as B2B (where one busi-
ness buys materials from another business) and B2C (when a final customer buys from a busi-
ness). Most of us are more familiar with B2C transactions, where we buy books, music,
software or travel from websites. Between 1999 and 2002 the number of Internet shoppers in
the UK rose from 2 million to 6 million.9 Nonetheless, many of these sites have hit financial
troubles with the bursting of the ‘dot-com bubble’, and there have been a number of widely
publicised bankruptcies. In 1996 Anderson Consulting predicted that on-line shopping would
soon account for 20% of UK groceries, but by 2002 the figure was still less than 1%.9 Verdict, a
retail research agency, then predicted that on-line sales would rise to 6% of all grocery sales by
2006. It is clearly difficult to get reliable figures in this area, but there is a general feeling that
B2C will continue to grow strongly.
One problem, of course, is that people do not necessarily like e-procurement. If you want to
buy a book, you can use various websites, fill in the forms for your purchase, and get the book
delivered within a day. But if you go to your nearest bookshop, you might use less sophisticated
technology, but pick up the book immediately and without the delivery charge. B2C can hit
difficulties because people actually like going to look at things before they buy. Some evidence
for this comes from the USA, where only 1% of car purchases are made through the Web, but
before buying 75% of people do on-line searches to compare prices and specifications.9
A more important factor is that most e-procurement is actually B2B. The Gartner Group
have produced the following estimates of B2B trade.10,11

Year Value of B2B procurement

($ billion)

1998 43
1999 219
2000 433
2001 919
2002 1900
2003 3600
2004 6000
2005 8500

The attractions of e-procurement are so great that most organisations will continue to move in
this direction. One major software company estimated the following savings from e-procurement
(values are in a per transaction). The system gave a return on investment of 400% a year.
 PROCUREMENT 241

Process step Original cost Cost with

e-procurement

1. Create detailed requirement 17.2 9.3

2. Approval process 5.5 2.7
3. Check requirements 20.2 0
4. Order processing 54.4 6.8
5. Receiving 10.3 2.9
6. Internal delivery 35.0 13.0
7. Payment process 23.6 0.6
Total 166.2 35.3

Many people are enthusiastic about the growth of e-procurement, but they often forget an
important point. If we organise e-procurement very efficiently, it gives much better communi-
cations – but it does not necessarily improve the physical flow of materials. This only happens
when organisations in the supply chain use the communications to find better ways of moving
materials. As Doerflinger et al. say, ‘The real barrier to (B2B) entry is the back-end – fulfilment –
not the website itself’.12 Perhaps the main effects of e-procurement are not the speed of
purchasing but the effects it has on the supply chain. Customers can now buy from a range of
suppliers who might be geographically remote. They also have the option of buying directly
from manufacturers or primary suppliers, and can use the increasing number of specialised
Web retailers. Merrill Lynch13 suggest that the main changes that this will bring are:

● growing use of the Internet for procurement will change patterns of logistics
● e-commerce will change buying patterns, but will probably not generate much new business
● organisations will have to improve customer service by, for example, home delivery services.

L O G I S T I C S
I N P R A C T I C E
Amazon.com
The traditional way of buying books is to a year, compared with three or four times a
visit a bookshop, or perhaps join a book year for a normal bookshop. To develop
club. In 1995 Jeff Bezos went a step further their logistics, Amazon looked at the best
and started an on-line book retailing busi- practices and recruited the Vice President of
ness from his garage. His mission was ‘to logistics (and 15 other staff) from Wal-Mart.
use the Internet to transform book buying At the heart of Amazon’s operations is a
into the fastest, easiest, and most enjoyable sophisticated system to guide customers
shopping experience possible’. His aim of through the steps of making their purchases.
stocking every book in print soon made This system basically records customer
Amazon.com the world’s largest book orders, gets the payment, and arranges
retailer. In its first full year of operation its delivery. However, it does far more than this
sales were $15.7 million, and rose by 34% and can search for material in different ways,
a month. Stock was turning over 150 times list similar books and other people’s pur-
242 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

L O G I S T I C S
I N P R A C T I C E
continued

chases, recommend books, give reviews ment, auctions and so on. They have also
from other readers, authors and publishers, formed partnerships with on-line pharma-
supply information about authors, tell you cies, sporting goods suppliers, grocers, and
about new books that are being released, so on. As a result, they offer 18 million dis-
send newsletters, let you track an order, and tinct products. Their UK branch, for example,
a whole range of other functions. lists 1.2 million British books, 250,000 US
Amazon use their efficient operations to books, 220,000 CDs and 23,000 videos and
give low overheads, so they get substantial DVDs. In July 2000 when Harry Potter and the
economies of scale, and use their size to Goblet of Fire was published, Amazon put in
negotiate discounts from publishers. As a the biggest ever advance order of 410,000
result, they can give discounts of up to 50% copies, 250,000 of which were delivered by
on the publishers’ price of best sellers. This Federal Express on the first day of sales.
combination of customer service, wide Despite its impressive performance,
choice, efficient delivery and low costs has Amazon is not immune from the pressures
attracted 25 million customers in 160 coun- and share price fluctuations of e-business.
tries. Net sales for the first quarter of 2000 In 2000 it was making a net loss of around
were US$578 million, an increase of 84% on $200 million a quarter. The first quarter of
the previous year. They have expanded 2002 saw its first operating profit.
beyond their original operations in Seattle,
Sources: company annual reports and website at
with major operations in the UK, Germany
www.amazon.com; Kotha S. (1998) Competing
and France. They have expanded beyond on the Internet, European Management Journal,
books – first into associated areas of CDs and April
videos, and then into toys, games, garden
furniture, gifts, hardware, kitchen equip-

TYPES OF PURCHASE
Different approaches for different products

When we described a formal procedure for procurement, we said that it can be very compli-
cated and time consuming. It would be expensive and unnecessarily complicated to use this
procedure for every purchase, and nobody wants to spend six months buying a packet of
envelopes. On the other hand, major purchases need much more information and analysis.
This is why organisations vary the details of their procurement procedures, matching the
methods to the types of materials. Generally speaking, the higher the cost of materials and the
more complicated the requirements, the more time and effort procurement needs.
Organisations often set rules for the effort put into procurement, perhaps using ad hoc
procedures for low-value routine supplies, a simple, automatic procedure for purchases up to
 PROCUREMENT 243

£20,000, a more rigorous procedure for purchases up to £150,000, and special, detailed
analyses for bigger purchases. Van de Vliet14 describes a variation on this at 3M, where the
procurement effort depends on the importance of materials:

● non-critical materials have low profits with little risk in supply, and need basic, simple
procedures for purchasing
● bottleneck materials have low profits but have more risk in supply, and need long-term
contracts with alternative sources to avoid potential problems
● strategic materials with higher profits need more formal relationships with suppliers over
the long term, possibly developing into alliances and partnerships.

Once such rules are established, a management control system can monitor purchases and
make sure they are done in the best way. It can see how purchases have been made, if the
outcome is satisfactory, if the effort is reasonable in relation to the costs and importance, and
if the procedure can be improved for the future.
An important point here is the difference between routine, repeat orders and new ones. If a
supplier has given good service over some extended time, an organisation might avoid almost
all the procurement cycle and put minimal effort into administering future orders. Ordering
becomes routine and the organisation effectively sends a message to say, ‘send another order
like the last one’. With non-routine purchases, an organisation has to be more careful and put
more effort into the choice of supplier, and conditions of purchase.
If an order is repeated often enough, an organisation might consider the ‘make-or-buy’
decision. In other words, it has to choose those materials that it can make itself, and those that
are best met by outside suppliers. In its simplest form, this asks whether an organisation can
get materials more cheaply from a supplier than it can make them. Efficient operations and
economies of scale often mean that specialised suppliers can deliver materials at lower prices
than other organisations can produce them. There are, however, many other factors to
consider. Making parts internally can be more reliable, give greater control over supply, tailor
products, have shorter lead times, use spare resources, protect designs, keep value-adding oper-
ations, increase the size of the company, and so on. On the other hand, buying them from
suppliers can get the benefits of specialisation, give access to greater expertise, get economies
of scale, reduce stock levels, transfer some risk, maintain flexibility, and so on.
The Department of Trade and Industry15 suggests that the three main criteria for such deci-
sions are:

● financial factors – relating to the costs

● operational factors –relating to responsiveness, flexibility, reliability, and so on
● strategic factors – relating to the long-term implications of the decision for the organisation.

In practice, the perceived benefits of outsourcing are increasing and more organisations are
happy to concentrate on their core functions and use specialised suppliers for materials.

Terms and conditions

Although we have talked in general terms about ‘placing an order’, there are several different
types of order. Organisations typically talk about ‘placing an order’ for goods, but ‘signing a
contract’ for services and ‘leasing’ equipment. To a large extent, these are different ways of
saying the same things, but there may be legal differences. For example, with hire purchase the
materials remain the property of the supplier until they are fully paid for, while credit financing
244 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

gives ownership to the organisation which becomes responsible for servicing a debt. We have
already mentioned some specific types of order, with the following being most common:

● Purchase orders are used in the standard approach to procurement that we described above.
It is essentially a letter from one organisation to another, giving details of the materials it
wants to purchase and its conditions of purchase. This is usually a response to a quotation
from a qualified supplier, giving the materials it can supply and its conditions of trade.

● Blanket orders give a simple system for cheap, standard items, such as stationery. An organ-
isation places a single order for all the materials that it will need over some period, such
as a year. Then the supplier delivers batches of materials when requested during the year.

● e-Procurement uses EDI or the Internet to simplify purchases by replacing paper-based

procedures with electronic ones. This gives a fast and efficient method for repeat, or
straightforward, orders.

● Contracts give detailed descriptions of an agreement between an organisation and a

supplier; they describe exactly the responsibilities, work and services for each, together
with all relevant terms and conditions. Many organisations use contracts instead of
purchase orders for extended services, so they sign a contract for a supply of electricity. In
the same way, organisations sign a contract for a specific piece of work, such as a
construction company building a length of road.

● Sub-contracts: when a supplier signs a contract with an organisation, it may not do all the
work itself, but prefers to pass on some work to a sub-contractor. Then, there are two
agreements – the contract between the organisation and the supplier, and the sub-
contract between the supplier and sub-contractor. For big projects, there can be several
more layers of sub-contracting.

● Leases and rental agreements again present the terms and conditions of acquiring materials.
They are generally used for buildings or equipment that is returned to the owner after
some period of use. You can rent or lease a car, for example, and when you have finished
with it, you return it to the owner.

The different types of purchase suggest another problem with procurement. There can be
so many different terms and conditions that it is surprisingly difficult to compare them.
Suppose that you are buying some standard commodity, such as electricity. Many competitors
offer the same product so the best is the one that offers the lowest price. Often, however, there
are different conditions of purchase. If you want a telephone service, all suppliers give essen-
tially the same product, but the pricing structure, discounts and offers can make significant
differences. Then it is the conditions of purchase that show the best supplier.
In practice, there can be many factors other than cost to consider. Hill suggests16 that deci-
sions about purchases are made in two stages. In the first, available products are examined and
those with ‘qualifying’ factors get onto a shortlist. Then ‘order winning’ factors identify the
best product from the shortlist. Cost is likely to be one of the qualifying factors, but is only
likely to be an order winning factor with commodities. Quality is particularly important,
which is the reason why total quality management says that the lowest price does not neces-
sarily give the best deal.17
Pricing is a very complicated issue. It is certainly not in an organisation’s long-term interest
to force suppliers to give unrealistically low prices, or they will go out of business and not be
there next time they are needed. Supermarkets in parts of the European Union have followed
 PROCUREMENT 245

consumer pressure to reduce food prices. While this benefits their customers – and presumably
the broad population – it means paying less to farmers who grow the crops. If farmers go out
of business, there is a major impact on rural communities and the countryside, more reliance
on imported food, an effect on the balance of trade, and so on. In general, there are four ways
of setting a price for materials:

1. Price lists – where suppliers quote fixed prices. Book publishers, for example, quote a
selling price that they expect retailers to use. They can give discounts for large or special
purchases, but one organisation essentially fixes the price.

2. Special quotation – where suppliers quote prices to each customer, particularly for non-
standard materials. Customers submit a request for a quotation, and the supplier returns a
price and conditions that it is willing to offer.

3. Negotiation – when there is some flexibility in price and conditions. A supplier might give
a quote, but is willing to negotiate if it can get some benefit such as repeat orders. Simi-
larly, customers can negotiate if they want special conditions, such as fast delivery.

4. Commodity pricing – for commodities such as oil, coffee, gold and wheat, market forces set
the going rate that is used by all suppliers. You can see many such figures in, say, financial
futures markets.

Even when the basic price has been agreed there can be other difficulties with conditions.
Who, for example, pays for transportation to the final location and who accepts the risks for
the journey? Several standard conditions are used (shown in Figure 9.3) and for historical
reasons they seem to be phrased in terms of shipping:

● Ex-works: The purchaser accepts materials ‘at the factory gate’ and takes over all responsi-
bility for transport, documentation, customs clearance, insurance, risk and so on. This type
of contract is best when the supplier has little experience of moving materials through the
relevant area, or the purchaser has a lot of experience. If neither has the necessary experi-
ence, they can sub-contract the actual movement to third party specialists.

● Free alongside (FAS): Here the supplier moves materials to a specified ‘port’ and delivers them
‘alongside a ship’. The customer takes over the loading on a vessel and movement onward.

● Free on board (FOB): This is a variation of FAS, where the supplier also takes care of the
loading onto the vessel, and then the customer is responsible for onward transport. This
might seem like a small adjustment to FAS, but loading might involve heavy lifts, risk of
damage, or use of lighters (which are small vessels used to move materials out to a larger
vessel moored in deeper water).

● Delivered ex-ship: Where the goods are available on the ship (or quayside) but the
customer has to arrange for customs clearance, duty, and so on.

● Cost and freight (C&F): Here the supplier arranges transport to an agreed point, but the
customer accepts any risk and arranges insurance for the journey.

● Cost, insurance and freight (CIF): Where the supplier delivers to an agreed point, and also
arranges insurance for the journey.

● Delivered: Where the supplier is responsible for all aspects of the transport up to delivery
to the customer.
246 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Departure Arrival Intermediate

Transport dock Sea storage
journey dock
Ship Ship Transport Transport

Supplier Customer
operations
$7 7$ ) operations

Point of
transfer from
supplier to
customer

Ex-works Free Free on Delivered Cost and

alongside board Delivered
ex-ship freight or cost,
insurance and
freight

Figure 9.3 Some arrangements for delivery

L O G I S T I C S
I N P R A C T I C E
TT&G
TT&G make a range of prefabricated build- these arrangements, but have found signifi-
ings for use in the Russian and Canadian cant reductions in the times needed for cer-
arctic. Over the past three years they have tain activities. The following table gives a
moved towards single sourcing, developing comparison of their current partnering and
informal partnerships with preferred suppli- previous approach of competitive bidding:
ers. They have not analysed the costs of
Partnering (weeks) Bid process (weeks)

Bid review 2–3 4–6

Drawing preparation 4–5 7–10
Drawing approval 1 2–3
Manufacturing time 10–12 18–24
Test time 1 2–3
Total 17–22 33–46

Source: company reports

 PROCUREMENT 247

❑ Purchasing gives a mechanism for initiating the movement of materials from

CHAPTER REVIEW ■ ■ ■ ■ ■ ■ ■ ■ ■

one organisation to another. Procurement is a broader term which includes a

series of related activities.
❑ Procurement is responsible for acquiring all the materials needed by an
organisation. It consists of all the activities needed to organise an inward flow
of materials from suppliers.
❑ Procurement is an essential function in every organisation. It is often
responsible for the greatest part of expenditure, and a small improvement
can bring significant benefit.
❑ The first step in procurement is finding the right supplier. This decision can
be as important as getting the right products.
❑ Procurement usually works in a cycle with a number of distinct steps. There
are many variations on this basic model.
❑ Traditional approaches to procurement can be expensive and time
consuming. Many organisations have moved towards e-procurement, which
can bring considerable benefits.
❑ Different types of purchase need different conditions, with the amount of
effort generally related to the product value.
❑ Total cost is often important in purchasing decisions, but there can be many
other factors. It is often surprisingly difficult to compare the terms and
conditions.

C A S E S T U D Y Arnold Haralson

For many years Arnold Haralson worked in the port of Bergen. In 1997 he had his
55th birthday and took early retirement. He had a number of projects he wanted to
work on, including writing a history of Norse influence on Russian cultural develop-
ment. He finished the book in two years and published it through Norgeldt, a
specialist local publisher. It sold 300 copies in the first year, and Arnold was soon
working on a second book discussing the links between Norse mythology and
Russian folklore.
Arnold had considerable expertise in his field and planned to continue his series
of books. He recognised that they did not have broad appeal, but there was a steady
demand in this specialised market. Norgeldt seemed happy to consider his new
proposals.
248 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

C A S E S T U D Y continued

Although he enjoyed writing books, Arnold was troubled by the marketing.

Norgeldt only really worked in Norway and Sweden, where they estimated a contin-
uing demand for his type of book at around 200 copies a year. Arnold felt that there
were large Scandinavian populations in the USA, Australia and other countries,
who were not being reached, and there were almost no sales in Russia. Although he
was not expecting a great return from his books he was disappointed by the size of
his royalty cheques. His books retailed for 1000 NKr, but his royalties were calcu-
lated from 6% of the publisher’s selling price, which depended on the discounts
offered but was usually less than 700 NKr.
Arnold was unlikely to get his books published by any of the major, interna-
tional companies, but there were other alternatives. He could, for example,
approach a ‘vanity publisher’ who would charge a fee for publishing the book, but
return more of the income generated. A more attractive option might be to use the
Web. Arnold could simply set up a website to advertise his current books more
widely. But if he set up a website, he might as well bypass the retailer and sell
copies directly to customers. When Arnold started to think along these lines, he
thought that he could also bypass the publisher. Then he could either produce the
book himself and sell it through his website, or avoid the paper version and allow
customers to pay a fee to access an electronic version.

C A S E S T U D Y
Question
● Arnold clearly has to think hard about publishing his books. What options do you think
he has? What would be the benefits and problems with each? What route would you
recommend him to follow?

P R O J E C T

How to Buy
Imagine that you want to buy something relatively expensive, such as a car. What alternative sources are
there? Describe the steps you would follow in making the purchase. Now compare these with the steps
followed by a company making a similar purchase. Is it difficult to get information about the procedure
that an organisation uses for procurement?
 PROCUREMENT 249

DISCUSSION QUESTIONS

1. Some people say that you should always look for quotations, even for repeat orders, as
this encourages competition and keeps prices low. Other people say that you should form
an alliance with one supplier so that you understand each other’s needs. Which of these
views do you think is more persuasive?
2. Everyone is talking about the benefits of purchasing through the Internet. What are
these? How will e-procurement affect wider operations? What other changes will there be
in the future?
3. What features would make an ideal supplier?
4. Forward purchasing has many advantages – as demonstrated by the huge market in finan-
cial futures. What are these benefits? If these are so obvious, why are many organisations
ignoring them and using just-in-time?
5. Do you think an organisation should always negotiate hard with suppliers to get the
cheapest prices and best conditions it can?
6. In October 2000 The Trading and Standards Institute in London made test purchases in
102 retail websites. There were problems with 37% of these, 38% arrived later than prom-
ised and 17% did not arrive at all.9 What does this tell you about e-procurement?

REFERENCES
1. Ackerman K.B. and Brewer A.M. (2001) Warehousing: a key link in the supply chain, Ch. 14 in Brewer
A.M., Button K.J. and Hensher D.A. (eds) Handbook of Logistics and Supply Chain Management, Pergamon,
Oxford.
2. Scott C. and Westbrook R. (1991) New strategic tool for supply chain management, International Journal
of Physical Distribution and Logistics Management, 21(1), 23–33.
3. Perry R. (1998) Quoted in Lawless J. ‘Challenges of going global’, Sunday Times, 26/4/98.
4. Allen S. (2001) Leveraging procurement: the quiet e-business, Logistics and Transport Focus, 3(4), 29–30.
5. Sigarro P. (2001) Speeding up procurement, Western Operations Seminar, Nice.
6. LaLonde B.J. and Zinszer P.H. (1976) Customer Service, National Council of Physical Distribution
Management, Chicago.
7. Cummings N. (2002) UK leading the world in e-procurement, OR Newsletter, March.
8. Website at www.BarclaysB2B.com.
9. Rushe D. (2001) www.basketcase, Sunday Times, 2 September, p. 5.
10. Anon. (2001) The Economic Downturn is Not an Excuse to Retrench B2B Efforts, Gartner, Stamford, CT.
11. The Gartner Group (2001) Website at www.gartner.com.
12. Doerflinger T.M., Gerharty M. and Kerschner E.M. (1999) The information revolution wars, Paine-Webber
Newsletter, New York.
13. Merrill Lynch (1999) E-commerce: Virtually There, Merrill Lynch, New York.
14. Van de Vliet A. (1996) When the gaggling has to stop, Management Today, June, pp. 56–60.
15. Department of Trade and Industry (2001) Logistics and Supply Chain Management, Website at
www.dti.gov.uk.
16. Hill T. (1993) Manufacturing Strategy (2nd edn), Macmillan – now Palgrave Macmillan, Basingstoke.
17. Deming W.E. (1986) Out of the Crisis, MIT Press, Cambridge, MA.
250 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Further reading
Arnold J.R.T (1996) Introduction to Materials Management (2nd edn) Prentice Hall, Englewood Cliffs, NJ.
Baily P., Farmer D., Jessop D. and Jones D. (1998) Purchasing Principles and Management (7th edn), Pitman,
London.
Gattorna J.L and Walters D.W. (1996) Managing the Supply Chain, Macmillan – now Palgrave Macmillan,
Basingstoke.
Leenders M.R. and Fearon H.E. (1996) Purchasing and Supply Management, McGraw-Hill, New York.
Saunders M. (1997) Strategic Purchasing and Supply Chain Management (2nd edn), Financial Times/Prentice
Hall, London.
 CHAPTER 10

Inventory Management

CONTENTS

■ Aims of the chapter ■ Case study – Lennox

■ Reasons for holding stock Wholesale Group
■ Economic order quantity ■ Project – National
■ Uncertain demand and safety Stockholdings
stock ■ Problems
■ Periodic review systems ■ Discussion questions
■ Effort of stock control ■ References
■ Chapter review ■ Further reading

AIMS OF THE CHAPTER

After reading this chapter you should be able to:
■ U N D E R S TA N D why organisations hold stocks
■ A N A LY S E the costs of holding stock
■ C A L C U L AT E economic order quantities
■ C A L C U L AT E associated lead times, costs and cycle lengths
■ D E F I N E ‘service level’ and D O related calculations for safety
stock
■ D E S C R I B E periodic review systems and C A L C U L AT E target
stock levels
■ D O ABC analyses of inventories
252 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

REASONS FOR HOLDING STOCK

Aggregate stockholdings

In the last chapter we saw how procurement organises the flow of materials into an organisa-
tion. But we did not ask when an organisation should buy materials, or how much it should
buy. In this chapter we discuss these questions, and relate them to the broader policies on
inventory management.
Ideally, materials move smoothly and continuously through a supply chain. In practice,
there are always delays – and when materials stop moving they form stocks. All organisations
hold stocks of some kind, whether it is a shop that stocks goods for customers to look at, a
chef with stocks of ingredients in the pantry, or a market research company with stocks of
information in a database.

S T O C K S are supplies of goods and materials that are held by an organisation.

They are formed whenever the organisation’s inputs or outputs are not used at the
time they become available.

An I N V E N T O RY is a list of things held in stock.

In Chapter 7 we discussed material requirements planning and just-in-time. In their

different ways, both of these assume that stocks are a waste of resources that should be elimi-
nated, or at least minimised. From their arguments you might get the impression that every
organisation is getting rid of its stocks and moving to ‘stockless’ operations. There is certainly
a trend in this direction. Surveys by, for example, the Institute of Grocery Distribution1 found
that stock levels fell by as much as 8.5% in a year, while the Institute of Logistics2 found that
in 1999 UK companies, ‘managed to almost halve the stockholding requirements since the
1995 survey’. We can get a broader picture from government figures.3–5 The easiest measure
takes the ratio of aggregate stock to gross domestic product (GDP). This does not give an
absolute measure of performance, but it allows reasonable comparisons over time. Figure 10.1
shows the book value of aggregate stock held in the United Kingdom as a percentage of GDP
from 1949 to 1998.6
At the end of the 1940s and into the early 1950s there was a rapid decline in stocks as the
economy returned to normal after the Second World War. From the early 1950s right through
to the present day there has been a steady decline, which we can attribute to improving inven-
tory management. There are, of course, some unexpected movements, such as the sudden
change in the early 1970s that was caused by the rapid increase of oil prices and the economic
disruption that followed. These can, however, be viewed as a short–term fluctuation on the
underlying downward trend.
The steady fall in stocks clearly suggests improving inventory management, but there may
well be other factors, such as the changing structure of industry, the move towards services,
international competition, economic cycles, inflation, changing GDP, currency value and
increasing mobility. Inventories clearly respond to such external influences. If you look at a
business cycle, for example, it might start with industry being over-optimistic about the
future – they expect sales to rise and increase production to meet this higher demand. Inven-
tories build up as sales lag behind production, and at some point industry loses confidence
and cuts back on production to use the excess stocks. This causes a decline in the economy,
 INVENTORY MANAGEMENT 253

70.0

60.0

50.0
Stock/GDP (%)

40.0

30.0

20.0

10.0

0.0

51
54

57

60

63

66

69

72

75

78

81

84

87

90

93

96
19
19

19

19

19

19

19

19

19

19

19

19

19

19

19

19
Year

Figure 10.1 Aggregate stock as a percentage of GDP for the UK

which only picks up again when stocks are lower and production is not meeting current
demand. Because it is relatively easy to change inventory levels – much easier than, say,
adjusting production levels – they tend to fluctuate more than the business cycle itself.
In the UK manufacturing contributes less than 20% of the GNP, but it holds 40% of the
stocks. There are roughly equal amounts of materials, work in progress and finished goods
(about £20 billion of each). The amount of stock held by manufacturers has fallen much faster
than other sectors of industry, suggesting that they have been at the forefront of stock reduc-
tion – and also that they are in the best position to reduce stocks. Organisations further down
the supply chain have to pay more attention to their final customers and react quickly to
demands – a lead time of one day is very good for a manufacturer, reasonable for a wholesaler,
but not good enough for a retailer.

Buffering supply and demand

Despite the clear trend towards lower stocks, many organisations cannot reduce them. Farmers
grow one crop of hay a year, and then store it to feed animals throughout the year. A distiller
stores whisky in barrels for at least three years before selling it. A video store buys copies of
videos and keeps them in stock until people want to hire them. These organisations do not
want to eliminate stocks, but they want to control them properly.
The main reason for holding such stocks is to give a buffer between variable – and uncer-
tain – supply and demand. Imagine the food being delivered to a supermarket. This is deliv-
ered in large quantities – perhaps a truckload at a time – but it is sold in much smaller
quantities to individual customers. The result is a stock of goods that is replenished with every
delivery, and is reduced over time to meet demand. The stocks give a cushion between supply
and demand. They allow the supermarket to continue working efficiently, even when delivery
vehicles are delayed, or there is unexpectedly high demand from customers.
254 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

■ The main purpose of S T O C K S is to act as a buffer between supply and demand.

■ They allow operations to continue smoothly and avoid disruptions.

To be more specific, stocks:

● act as a buffer between different parts of the supply chain

● allow for demands that are larger than expected, or at unexpected times
● allow for deliveries that are delayed or too small
● take advantage of price discounts on large orders
● allow the purchase of items when the price is low and expected to rise
● allow the purchase of items that are going out of production or are difficult to find
● allow for seasonal operations
● make full loads and reduce transport costs
● give cover for emergencies
● can be profitable when inflation is high.

L O G I S T I C S
I N P R A C T I C E
Stock holdings
Tesco Industrial Specialities and Paints. In the first
Tesco is the largest food retailer in the UK, half of 2000 it reported a trading profit of
where it has 16% of the market. It also £275 million, on a turnover of £3.8 billion.
operates in central Europe and the Far East. Its assets were valued at £7.3 billion, of
Its annual report for 2000 showed: which £920 million were stocks.
Total sales £20,385 million
L.T. Francis
Fixed assets £8527 million
L.T. Francis is a manufacturer of pre-cast
Number of stores 845
concrete fittings for the building trade. Its
Total sales area 24.0 million square feet
2000 annual report showed sales of £14
Stocks £744 million
million and total stocks £2.4 million.
IBM As you can see, these organisations hold
For many years IBM has been a leader in large stocks. In Tesco the stock is around
the computer industry. In 2000 its revenue 4% of sales, in IBM about 7% in total, in ICI
was $87.5 billion, and it held £3.7 billion of it is 11% for the full year, and in L.T. Francis
stocks of work in progress and $1.2 billion it is 17%. Many organisations have very
of stocks of finished goods. high stocks, and it is not unusual for manu-
facturers to hold 25% of annual sales.
ICI
ICI is a major chemical company, with four Sources: company annual reports and websites
www.tesco.com, www.ICI.com and www.ibm.com
major divisions – National Starch, Quest,
 INVENTORY MANAGEMENT 255

Types of stock

Just about everything is held as stock somewhere, whether it is raw materials in a factory,
finished goods in a shop or tins of baked beans in a pantry. We can classify these stocks as:

● Raw materials – the materials, parts and components that have been delivered to an
organisation, but are not yet being used.
● Work in process – materials that have started, but not yet finished their journey through
the production process.
● Finished goods – goods that have finished the process and are waiting to be shipped out
to customers (see Figure 10.2).

This is a fairly arbitrary classification, as one company’s finished goods are another company’s
raw materials. Some organisations, notably retailers and wholesalers, have stocks of finished
goods only, while others, like manufacturers, have all three types in different proportions.
Nationally, around 30% of stocks are raw materials, 40% work in progress and 30% finished
goods.6 Some stock items do not fall easily into these categories, and we can define two addi-
tional types:

● Spare parts for machinery, equipment, and so on

● Consumables such as oil, fuel, paper, and so on.

In Chapter 7 we described material requirements planning as a dependent demand system,

where the demand for an item is found directly from a master schedule. The alternative

Suppliers Operations Customers

Stocks of raw Stocks of work Stocks of

materials in progress finished goods

Consumables Spare parts

Figure 10.2 Types of stock

256 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

approach looks at an independent demand system, where the total demand for an item is
made up of lots of separate demands that are not related to each other. The overall demand for
bread in a supermarket, for example, is made up of lots of demands from separate customers
who act independently. Independent demand systems control stocks by finding the best
balance between various costs. In particular, they look for answers to three basic questions:

1. What items should we stock? No item, however cheap, should be stocked without consid-
ering the costs and benefits. This means that an organisation should stop unnecessary,
new items being added to stock, and it should make regular searches to remove obsolete
or dead stock.

2. When should we place an order? This depends on the inventory control system used, type of
demand (high or low, steady or erratic, known exactly or estimated), value of the item,
lead time between placing an order and receiving it into stock, supplier reliability, and a
number of other factors.

3. How much should we order? Large, infrequent orders give high average stock levels, but low
costs for placing and administering orders: small, frequent orders give low average stocks,
but high costs of placing and administering orders.

The first of these questions is a matter of good housekeeping, simply avoiding stock that is not
needed. The following section looks for answers to the last two questions.

Costs of carrying stock

The total cost of holding stock is typically around 25% of its value a year. A reasonable objec-
tive is to minimise this cost. You might think – especially after the lessons of just-in-time –
that minimising costs is the same as minimising stocks. But this is not necessarily true. If a
shop holds no stock at all, it certainly has no inventory costs, but it also has no sales; it effec-
tively incurs another cost of losing customers.
Lambert7 describes one approach which looks at the costs of capital (for borrowing, oppor-
tunity, and so on), inventory service (insurance, taxes, and so on), storage space (rent, heating,
and so on) and inventory risk (obsolescence, damage, and so on). We will use a slightly
different approach that divides the overall costs of stock into four separate components.

1. Unit cost: the price for an item charged by the supplier, or the cost to the organisation of
acquiring one unit of the item. It may be fairly easy to find this by looking at quotations
or recent invoices from suppliers, but it is more difficult when there are several suppliers
offering slightly different products, or offering different purchase conditions. If a
company makes the item itself, it may be difficult to give a reliable production cost or set
a transfer price.

2. Reorder cost: the cost of placing a repeat order for an item. This might include
allowances for preparing an order, correspondence, receiving, unloading, checking,
testing, use of equipment and follow-up. Sometimes, costs such as quality control, trans-
port, sorting and movement of received goods are included. In practice, the best estimate
for a reorder cost often comes from dividing the total annual cost of the purchasing
department by the number of orders it sends out.
 INVENTORY MANAGEMENT 257

3. Holding cost: the cost of holding one unit of an item in stock for a unit period of time –
for example, the cost to Air France of holding a spare engine in stock for a year. The
obvious cost is tied-up money. This is either borrowed (in which case there are interest
payments) or it is cash that could be put to other uses (in which case there are opportu-
nity costs). Other holding costs are for storage space, loss, handling, special treatment,
such as refrigeration, administration and insurance. Another problem is obsolescence,
which refers to stock that has been kept in storage so long that it has little or no value,
such as spare parts that are no longer needed or food that is past its sell-by date. There is
a trend for products to have shorter life cycles, so the amount of obsolescence might
increase. On the other hand, we are moving materials much more quickly through supply
chains, so in many circumstances the amount of obsolescence is declining.

It is difficult to give typical values for these, but a guideline for annual costs as a percentage
of unit cost, has:
% of unit cost
cost of money 10–15
storage space 2–5
loss and obsolescence 4–6
handling 1–2
administration 1–2
insurance 1–5
Total 19–35

4. Shortage cost: occurs when an item is needed but it cannot be supplied from stock. In the
simplest case a retailer loses direct profit from a sale. But the effects of shortages are
usually more widespread and include lost goodwill, loss of reputation, and loss of poten-
tial future sales. Shortages of raw materials for production can cause disruption, resched-
uling of production, re-timing of maintenance periods, and laying off employees.
Shortage costs might also include payments for positive action to remedy the shortage,
such as expediting orders, sending out emergency orders, paying for special deliveries,
storing partly finished goods or using more expensive suppliers.

It can be difficult to get figures for any inventory costs, but shortage costs are a particular
problem. These can include so many intangible factors, such as lost goodwill, that it is difficult
to agree a reasonable value. Most organisations take the view that shortages are expensive, so
it is generally better to avoid them. In other words, they are willing to pay the relatively lower
costs of carrying costs to avoid the relatively higher costs of shortages. As you can imagine,
this tends to increase the amount of stock held, particularly when there is uncertainty.

W O R K E D
E X A M P L E

Janet Long is a purchasing clerk at Overton Travel Group. She earns £16,000 a year, with
other employment costs of £3000, and has a budget of £6200 for telephone, communi-
cations, stationery and postage. In a typical month Janet places 100 orders. When goods
arrive there is an inspection that costs about £15 an order. The cost of borrowing money
258 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

W O R K E D
E X A M P L E
continued

is 9%, the obsolescence rate is 5% and insurance and other costs average 4%. How can
Overton estimate their reorder and holding costs?

Solution
The total number of orders a year is 12 × 100 = 1200 orders.

■ The reorder cost includes all costs that occur for an order. These are:
■ salary = £16,000/1200 = £13.33 an order
■ employment costs = £3000/1200 = £2.50 an order
■ expenses = £6200/1200 = £5.17 an order
■ inspection = £15 an order

So the reorder cost is 13.33 + 2.50 + 5.17 + 15 = £36 an order.

■ Holding costs include all costs that occur for holding stock. These are:
■ borrowing = 9%
■ obsolescence = 5%
■ insurance and taxes = 4%

So the holding cost is 9 + 5 + 4 = 18% of inventory value a year.

It is even difficult to agree a value for basic figures like the value of stock held. Is it worth the
amount you actually paid for it, the amount you would pay to replace it, the amount you can
sell it for, or some other value? In practice, the most common costing is based on the amount
paid and can use:

● FIFO – first in, first out, which assumes that stock is sold in the order it was bought, so the
remaining stock is valued at the current replacement cost
● LIFO – last in, first out, which assumes that the latest stock is used first, so the remainder
is valued at earlier acquisition costs
● Average cost – which uses a moving average cost over some period.

W O R K E D
E X A M P L E

A company bought the following numbers of an item. In July it had 8 units in stock. What
was the value of this stock?

Month Jan Feb Mar Apr May Jun

Number bought 6 4 5 8 3 2
Unit price 21 19 18 22 24 26
 INVENTORY MANAGEMENT 259

W O R K E D
E X A M P L E
continued
Solution
There is no right answer to this, as it depends on the conventions that we choose to use.

■ FIFO assumes that the remaining units are the last that were bought, and the value of
the last eight units is (2×26) + (3×24) + (3×22) = 190
■ LIFO assumes that the first units bought are still in stock, and the value of these first
eight units is (6×21) + (2×19) = 164
■ Current replacement cost gives a value of (8×26) = 206
■ A three-month moving average gives a smoothed unit price of (22+24+26)/3 = 24, and
a value of (8×24) = 192.

ECONOMIC ORDER QUANTITY

Finding the order size

The economic order quantity (EOQ) was developed early last century8–10 and has remained a
dominant theme for the control of independent demand systems. It remains the best way of
tackling a wide range of inventory problems. It is flexible and easy to use, and gives good
guidelines for a wide range of circumstances.
Imagine a single item, held in stock to meet a constant demand of D per unit time. Assume
that unit cost (U), reorder cost (R) and holding cost (H) are all known exactly, while the
shortage cost is so high that all demands must be met and no shortages are allowed. The item
is bought in batches from a supplier who delivers after a constant lead time. We want to find
the best order quantity, Q, and always place orders of this size. There is no point in carrying
spare stock, so we time orders to arrive just as existing stock runs out. Then we get a series of
stock cycles, with the saw-tooth pattern shown in Figure 10.3.

Stock level

Order quantity

Stock Time
cycle

Figure 10.3 Repeated pattern of stock cycles

260 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

At some point an order of size Q arrives. This is used at a constant rate, D, until no stock is
left. We can find the total cost for the cycle by adding the four components of cost – unit,
reorder, holding and shortage. No shortages are allowed, so we can ignore this cost, and the
cost of buying the item is constant regardless of the ordering policy, so we can also leave the
unit cost out of the calculations. Then we can show that the cost per unit time is:
C = total reorder costs + total holding costs
= RD/Q + HQ/2
If we plot these two parts separately against Q, we get the results shown in Figure 10.4.
From this graph you can see that:

● the total holding cost rises linearly with order size

● the total reorder cost falls as the order quantity increases
● large infrequent orders give high total holding costs and low total reorder costs
● small frequent orders give low total holding costs and high total reorder costs
● adding the two costs gives a total cost curve that is an asymmetric ‘U’ shape with a
distinct minimum
● this minimum cost shows the optimal order size – which is the economic order quantity,
EOQ.

A standard analysis shows that the economic order quantity is found from the following
equation:

2RD
Economic order quantity, Q =
H

where D = demand
R = reorder cost
H = holding cost

Cost Variable cost

per unit time

Total holding cost

Minimum

Total reorder cost

Optimal Order
order size quantity

Figure 10.4 Variation of cost with order size

 INVENTORY MANAGEMENT 261

W O R K E D
E X A M P L E

John Pritchard buys stationery for Penwynn Motors. The demand for printed forms is con-
stant at 20 boxes a month. Each box of forms costs £50, the cost of processing an order
and arranging delivery is £60, and holding cost is £18 a box a year. What are the eco-
nomic order quantity, cycle length and costs?

Solution
Listing the values we know in consistent units:
D= 20 × 12 = 240 units a year
U= £50 a unit
R = £60 an order
H= £18 a unit a year.

■ Substituting these values into the economic order quantity gives:

2RD 2 × 60 × 240
Q = = = 40 units
H 18

■ Then the variable cost is:

C = total reorder costs + total holding costs = RD/Q + HQ/2

= 60 × 240/40 + 18 × 40/2 = 360 + 360 = £720 a year

You can see that the total reorder costs equal the total holding costs. This is always true if
we order the economic order quantity, so we can simplify the calculation to twice the total
holding cost or:

C = HQ = 18 × 40 = £720

■ We also have to consider the fixed cost of buying boxes, which is the number of boxes
bought a year, D, times the cost of each box, U. Adding this to the variable cost above,
gives the total cost of stockholding:

total cost = UD + C = 50 × 240 + 720 = £12,720 a year

■ We buy 40 boxes at a time, and use 20 boxes a month, so the stock cycle length is 2
months. In general, we can find the stock cycle length from T = Q/D:

T = Q/D = 40/240 = 1/6 years or 2 months

The best policy – with total costs of £12,720 a year – is to order 40 boxes of paper every
2 months.
262 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Finding the time to place orders

When an organisation buys materials, there is a lead time between placing the order and
having the materials arrive in stock. This is the time taken to prepare an order, send it to the
supplier, allow the supplier to make or assemble the materials and prepare them for shipment,
ship the goods back to the customer, allow the customer to receive and check the materials
and put them into stock. Depending on circumstances, this lead time can vary between a few
minutes and months or even years.
Suppose the lead time, L, is constant. To make sure that a delivery arrives just as stock is
running out, we have to place an order a time L earlier. The easiest way of finding this point is
to monitor current stock and place an order when there is just enough left to last the lead
time. With constant demand, D, this means that we place an order when the stock level falls
to LD, and this point is called the reorder level.
Reorder level = lead time demand = lead time × demand
ROL = LD
In practice, the inventory control system keeps a continuous record of the stock on hand,
updating this with every transaction and sending a message when it is time to place an order.
Ordinarily, this message is sent to a purchasing department; with e-procurement or some form
of alliance the message is sent directly to the supplier; with ECR systems the message is sent to
the supplier and other organisations down the supply chain.
This calculation works well provided the lead time is less than the length of a stock cycle.
In the next example the lead time is two weeks and the stock cycle is 50/20 = 2.5 weeks.
Suppose the lead time is raised to three weeks. The calculation for reorder level then becomes:
Reorder level = lead time × demand = LD = 3 × 20 = 60 units

W O R K E D
E X A M P L E

Demand for an item is constant at 20 units a week, the reorder cost is £125 an order and
holding cost is £2 an unit a week. If suppliers guarantee delivery within 2 weeks what is
the best ordering policy for the item?

Solution
Listing the variables in consistent units:
D = 20 units a week
R = £125 an order
H = £2 a unit a week
L = 2 weeks
Substituting these gives:

2RD 2 ×125 × 20
Q = = = 50 units
H 2

Reorder level = lead time × demand = LD = 2 × 20 = 40 units

The best policy is to place an order for 50 units whenever stock falls to 40 units.
 INVENTORY MANAGEMENT 263

Stock level

EOQ Economic
order quantity

Reorder level

Lead Time
time
Place Order
order arrives

Figure 10.5 Using a reorder level to time orders

The problem is that the stock level never actually rises to 60 units, but varies between 0 and 50
units. The way around this problem is to recognise that the calculated reorder level refers to
both stock on hand and stock on order. Then the reorder level equals lead time demand minus
any stock that is already on order. In the example above, the order quantity is 50 units, so a
lead time of three weeks would have one order of 50 units outstanding when it is time to place
another order. Then:
Reorder level = lead time demand – stock on order = LD – Q
= 3 × 20 – 50 = 10 units
An order for 50 units should be placed whenever actual stock declines to 10 units. Because the
lead time is longer than the stock cycle, there will always be at least one order outstanding, as
shown in Figure 10.6.

Stock level

Economic order
quantity

Reorder level

Place Order Place Order Place Order

order A order B order C
B arrives C arrives D arrives

Figure 10.6 Order patterns when lead time is longer than stock cycle
264 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

One problem, of course, is that the lead time may not be constant. We know how long the
lead time has been in the past, and we know the current target, but there may be some vari-
ability and the supplier might not always achieve this target. As well as forecasting demand,
we also have to forecast the lead time, so the reorder level is actually based on two forecasts.

Sensitivity analysis

One problem with the economic order quantity is that it can give awkward order quantities. It
might, for example, suggest buying impossible figures, such as 88.39 tyres. We could round
this to 88 tyres, but might prefer to order 90 or even 100. But does this rounding have much
effect on overall costs? In practice, the total cost curve is always shallow around the economic
order quantity. The amount we order can increase to 156% of the economic order quantity or
fall to 64% and only raise variable costs by 10%. Similarly, the order quantity can increase to
186% of the economic order quantity or fall to 54% and only raise variable costs by 20%. This
is one reason why the EOQ analysis is so widely used – although the calculation is based on a
series of assumptions and approximations, the total cost rises slowly around the optimal. EOQ
gives a good guideline for order size in a wide range of circumstances (see Figure 10.7).

W O R K E D
E X A M P L E

Cheng Tau Hang notices that demand for an item his company supplies is constant at 500
units a month. Unit cost is $100 and shortage costs are known to be very high. The pur-
chasing department sends out an average of 3000 orders a year, and their total operating
costs are $180,000. Any stocks have financing charges of 15%, warehouse charges of 7%
and other overheads of 8% a year. The lead time is constant at one week.
Find a good ordering policy for the item. What is the reorder level if the lead time
increases to 3 weeks? What range of order size keeps variable costs within 10% of optimal?
What is the variable cost if orders are placed for 200 units at a time?

Solution
Listing the values we know and making sure the units are consistent:

D = 500 × 12 = 6000 units a year

U = $100 a unit
R = annual cost of purchasing department = 180,000 = $60 an order
number of orders a year 3000
H = (15% + 7% + 8%) of unit cost a year = (0.3) × U = $30 a unit a year
L = 1 week
■ We can find the best ordering policy by substituting these values into the equations:
■ order quantity,

2RD 2 × 60 × 6000
Q = = = 154.9 units
H 30
 INVENTORY MANAGEMENT 265

W O R K E D
E X A M P L E
continued

■ cycle length, T = Q/D = 154.9/6000 = 0.026 years or 1.3 weeks

■ variable cost a year = HQ = 30 × 154.9 = $4647 a year
■ total cost a year = UD + variable cost = 100 × 6000 + 4647 = $604,647 a year.

■ The lead time is less than the stock cycle, so:

Reorder level = LD = 1 × 6000/52 = 115.4 units
The optimal policy is to order 154.9 units whenever stock falls to 115.4 units.

■ If the lead time increases to 3 weeks, there will be 2 orders outstanding when it is time
to place another. Then:
Reorder level = lead time × demand – stock on order
= LD – 2Q = 3 × 6000 / 52 – 2 × 154.9 = 36.4 units.

■ To keep variable costs within 10% of optimal, the quantity ordered can vary between
64% and 156% of the economic order quantity, which is 99.1 units to 241.6 units.
■ If fixed order sizes of 200 units are used the variable costs are:
C = total reorder costs + total holding costs
= RD / Q + HQ / 2 = 60 × 6000 / 200 + 30 × 200 / 2 = $4800 a year
We are not using the economic order quantity, so the variable cost is higher and the total
reorder costs no longer equal the total holding costs.

Cost

20% increase
10% increase
Lowest cost

0.54Q 0.64Q Economic 1.56Q 1.86Q Order

order size
quantity, Q

Figure 10.7 The cost curve is shallow around the economic order quantity
266 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Weaknesses of this approach

The economic order quantity has been used for almost a century, and is still the basis for most
independent demand inventory systems. It has a number of advantages, such as:

● easy to understand and use

● giving good guidelines for order size
● finding other values such as costs and cycle lengths
● easy to implement and automate
● encouraging stability
● easy to extend, allowing for different circumstances.

On the other hand, there are a number of weaknesses, as it:

● takes a simplified view of inventory systems

● assumes demand is known and constant
● assumes all costs are known and fixed
● assumes a constant lead time and no uncertainty in supplies
● gives awkward order sizes at varying times
● assumes each item is independent of others
● does not encourage improvement, in the way that JIT does.

We can overcome some of these problems by, for example, developing more complicated
models. In the next section we will show one step in this direction.

L O G I S T I C S
I N P R A C T I C E
Montague Electrical Engineering
Montague Electrical Engineering (MEE) is a realised that he had been ordering parts
small electric motor manufacturer with without taking any notice of the inventory
annual sales of £8 million. Robert Hellier is costs. The accountant calculated the cost of
the operations manager. He read the inventory as 30% a year and the ordering
monthly inventory report and was surprised costs were about £15 an order. Based on
to find total stocks had jumped from £2.2 these figures Robert adjusted his purchase
million to £2.6 million in the past month. pattern and reduced orders for XCT45 to
Robert noticed there were very high 500. One year later, stocks had fallen to less
stocks of part number XCT45, which is a 3 than £1 million, customer service had
cm diameter bearing. MEE used these improved, emergency orders were almost
steadily, at a rate around 200 a week. The eliminated and MEE was saving over £0.5
bearings cost £5 each and Robert had been million a year.
buying 2500 units at a time. There were
Source: Robert Hellier (2000) Presentation to
many such items in the report, and Robert
Western Operations Group, September
 INVENTORY MANAGEMENT 267

UNCERTAIN DEMAND AND SAFETY STOCK

The basic economic order quantity assumes that demand is constant and known exactly. In
practice demand can vary widely and have a lot of uncertainty. A company selling a new CD, for
example, does not know how many copies will sell in advance, or how sales will vary over time.
When the variation is small, the EOQ model still gives useful results, but they are not so good
when demand varies more widely. There are several ways we can deal with variable and uncer-
tain demand, and we will illustrate one approach where the demand is normally distributed.
You can see easily why our previous calculations do not work with a variable demand. We
used a reorder level found from the mean demand in the lead time. But if demand in the lead
time is above average, stock will run out before the next delivery arrives and there will be
shortages. Unfortunately, when demand is, say, normally distributed, it is above the mean in
50% of cycles. Most organisations would not be happy with shortages in 50% of stock cycles.
An alternative is to hold additional stocks – above the expected needs – to add a margin of
safety. Then organisations increase their holding costs by a small amount, to avoid the higher
shortage costs. These safety stocks are used if the normal working stock runs out. They have
no effect on the reorder quantity – which is still defined by the EOQ – but do affect the time
when an order is placed (shown in Figure 10.8). In particular, the reorder level is raised by the
amount of the safety stock to give:

R E O R D E R L E V E L = lead time demand + safety stock = LD + safety stock

Higher safety stocks obviously give a greater cushion against unexpectedly high demand,
and better customer service. Of course, the costs of holding larger stocks are also higher, so we
have to balance these two effects. The problem is that shortage costs are so difficult to find
that they are little more than guesses. An alternative approach relies on managers’ judgement

Stock level

Economic
order
quantity
Reorder level

Safety stock

Time

Figure 10.8 Safety stock raises the average stock level

268 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

to set an appropriate service level. This is the probability that a demand is met directly from
stock. An organisation typically gives a service level of 95%. This means that it meets 95% of
orders from stock – and accepts that 5% of orders cannot be met from stock. The service level
needs a positive decision by managers, based on their experience, objectives, competition, and
knowledge of customer expectations.
There are several ways of defining service level, but we will take it as the probability of not
running out of stock in a stock cycle. This is the cycle-service level.
Suppose that demand for an item is normally distributed with a mean of D per unit time
and standard deviation of σ. If the lead time is constant at L, the lead-time demand is
normally distributed with mean of LD. The lead-time demand has a variance of σ 2L and stan-
dard deviation of σ √L. We get this result from the fact that variances can be added, and if:

● demand in a single period has mean D and variance σ 2,

then

● demand in two periods has mean 2D and variance 2σ 2,

● demand in three periods has mean 3D and variance 3σ 2,
and

● demand in L periods has mean LD and variance Lσ 2.

The size of the safety stock depends on the service level. To be specific, when lead-time
demand is normally distributed the safety stock is:

S A F E T Y S T O C K = Z × standard deviation of lead-time demand = Zσ√L

As usual, Z is the number of standard deviations away from the mean, and probabilities can be
found from a statistics package or tables. To give some examples:

● Z = 1 gives a stock-out in 15.9% of stock cycles

● Z = 2 gives stock-outs in 2.3% of stock cycles
● Z = 3 gives stock outs in 0.1% of stock cycles.

If demand varies widely, the standard deviation of lead-time demand is high – and very
high safety stocks are needed to give a service level anywhere close to 100%. Usually, organi-
sations choose lower service levels that reflect the importance of each item. Then very impor-
tant items have service levels close to 100%, while less important ones are around 85%.

W O R K E D
E X A M P L E

Associated Kitchen Furnishings runs a retail shop to sell a range of kitchen cabinets. The
demand for cabinets is normally distributed with a mean of 200 units a week and a stan-
dard deviation of 40 units. The reorder cost, including delivery, is £200, holding cost is £6
per unit a year and lead time is fixed at 3 weeks. Describe an ordering policy that gives the
 INVENTORY MANAGEMENT 269

W O R K E D
E X A M P L E
continued

shop a 95% cycle-service level. What is the cost of holding the safety stock in this case?
How much does the cost rise if the service level is set at 97%?

Solution
Listing the values we know:
D = 200 units a week = 10,400 units a year
σ = 40 units
R = £200 an order
H = £6 a unit a year
L = 3 weeks

■ Substituting these values gives:

■ Q = √(2RD/H) = √(2 × 200 × 200 × 52/6) = 833 (to the nearest integer)
■ Reorder level = LD + safety stock = 600 + safety stock

■ For a 95% service level Z = 1.64 standard deviations from the mean. Then:
■ safety stock = Zσ√L = 1.64 × 40 × √3 = 114 (to the nearest integer)

The best policy is to order 833 units whenever stock falls to 600 + 114 = 714 units. On
average orders will arrive when there are 114 units left.
The safety stock is not usually used, so the holding cost is simply:
= safety stock × holding cost = 114 × 6 = £684 a year

■ If the service level is set at 97%, Z becomes 1.88 and:

■ safety stock = Zσ √L = 1.88 × 40 × √3 = 130

The cost of holding this is:

= safety stock × holding cost = 130 × 6 = £780 a year

L O G I S T I C S
I N P R A C T I C E
Wiesiek Teknika
Wiesiek Teknika (WT) market a range of ■ Marketing equipment
diagnostic equipment for clinical laborato- ■ Customising equipment to customer
ries and blood banks. They are the Polish needs
branch of a Dutch parent company, and ■ Installing it in customers’ premises
have been open for 25 years. A summary of ■ Training customers to use the equipment
their activities includes:
270 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

L O G I S T I C S
I N P R A C T I C E
continued

■ Maintaining a 24-hour help and advice standard programs, but decided to get tail-
desk ored software from the company that had
■ Preventive maintenance installed their information system. This set
■ Emergency repairs. stock levels according to company policy,
but related purchases to actual use, forecast
WT currently support 33 types of equip-
demand, and analyses of lead times. Using
ment, guaranteeing a repair within 48
the current supplier had the advantages of:
hours. For this they need stocks of parts and
consumables, and currently hold 22,000 ■ using existing systems to do some of the
items valued at 300,000 Zl (based on inter- necessary analyses
nal transfer prices). These are ordered from ■ integrating the new system easily with
the parent company with a normal lead existing systems
time of 14 days, but rush orders can arrive ■ giving a customised system for the stock
in five days. Up until 2001, the amount of analyses
stock held was determined by the parent ■ building on WT’s experience with
company. WT recorded transactions and current systems
every month placed an order to replace the ■ having a software supplier that has
parts that had been used in the previous proved reliable and helpful
month. This system had a number of disad- ■ having lower development and oper-
vantages, with: ating costs.

■ no attempt to minimise or reduce costs The key parts of the new system are
■ time-consuming procedures to check improved data entry (based on international
transaction records and prepare orders bar codes), analysis of demand (with fore-
■ no check that all items held were actu- casts, monitoring customer service, and so
ally needed on), order generation (automatically gener-
■ no guarantee that stock levels were ating and transmitting orders to the parent
appropriate company) and order tracking (checking
■ occasional shortages needing rush orders progress of each order, timing, costs, and so
■ no records of stock performance on). The benefits of the new system include
■ stock levels rising by 60% in the previous lower stock levels, costs, time spent on
four years. administration and shortages.

In 2001 the parent company encour- Source: company reports

aged its branches to review and improve
their inventory control. WT looked at some

PERIODIC REVIEW SYSTEMS

The EOQ analysis uses a fixed order quantity for purchases, so an order of fixed size is placed
whenever stock falls to a certain level. A heating plant may order 25,000 litres of oil whenever
the amount in the tank falls to 2500 litres. Such systems need continuous monitoring of stock
 INVENTORY MANAGEMENT 271

Stock level

Economic
order
quantity

Reorder
level

Time

(a) Fixed order quantity

Stock level

Target
stock level

Period
Time

(b) Periodic review

Figure 10.9 Alternative approaches to ordering

levels and are best suited to low, irregular demand for relatively expensive items. But there is
an alternative periodic review approach, which orders varying amounts at regular intervals. A
supermarket may refill its shelves every evening to replace whatever it sold during the day. The
operating cost of this system is generally lower and it is better suited to high, regular demand
of low value items. (See Figure 10.9).
If the demand is constant these two systems are the same, but differences appear when
demand varies. We can show this by extending the last analysis, and looking at a periodic
review system where demand is normally distributed. Then we are looking for answers to two
questions. First, how long should the interval between orders be? This can be any convenient
time, and organisations typically place orders at the end of every week, or every morning, or at
the end of a month. If there is no obvious cycle we might aim for a certain number of orders a
year or some average order size. One approach is to calculate an economic order quantity, and
then find the period that gives orders of about this size. This decision is largely a matter for
management judgement.
272 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Second, what is the target stock level? The system works by looking at the stock on hand
when an order is due, and ordering an amount that brings this up to a target stock level.

order quantity = target stock level – stock on hand

At the end of a month a company might have ten units remaining of an item with a target
stock level of 40, so it orders 30 more units.
We can find the target stock level by extending our previous analyses. Suppose the lead
time is constant at L. When an order is placed, the stock on hand plus this order must last
until the next order arrives. As you can see from Figure 10.10:
next order arrives after a time = order interval + lead time = T + L
Again, we will assume that the demand for each period is normally distributed with a mean D
and standard deviation σ , and that both the order period and lead time are fixed at T and L
respectively. Then:

● demand in one period has mean D and variance σ 2

● demand over two periods has mean 2D and variance 2σ 2
● demand over (T + L) periods has mean D(T+L), variance of (T + L)σ 2

The standard deviation in demand over (T + L) is σ√(T + L), so we can define a safety stock
as:
safety stock = Z × standard deviation of demand over (T+L) = Zσ√(T+L)

Stock level

Target
stock level

Place Order Place Order Time

order arrives order arrives

L
T
A B

Figure 10.10 Order placed at A has to cover demand until B

 INVENTORY MANAGEMENT 273

Then:

target stock level = mean demand over (T+L) + safety stock

= D(T+L) + Zσ√(T+L)

Supermarkets traditionally use periodic review, and with EDI you can imagine a store where
the tills pass messages every night to replenish products that were used during the day. But the
system becomes more responsive and reduces stock levels, if it sends messages, say, two or
three times a day. Suppliers consolidate these orders and send deliveries as often as necessary.

W O R K E D
E X A M P L E

Demand for an item has a mean of 200 units a week and standard deviation of 40 units.
Stock is checked every four weeks and lead time is constant at two weeks. Describe a pol-
icy that will give a 95% service level. If the holding cost is £2 a unit a week, what is the
cost of the safety stock with this policy? What is the effect of a 98% service level?

Solution
Listing the values given:

D = 200 units
σ = 40 units
H = £2 a unit a week
T = 4 weeks
L = 2 weeks

■ For a 95% service level, Z is 1.64 (which you can find from a standard package or
tables). Then:
■ safety stock = Zσ√(T+L) = 1.64 × 40 × √6 = 161 (to the nearest integer)
■ target stock level = D(T+L) + safety stock = 200 × 6 + 161 = 1361.

When it is time to place an order, the policy is to find the stock on hand, and place an
order for:
■ order size = target stock level – stock on hand = 1361 – stock on hand.

If, for example, there are 200 units in stock, we place an order for 1361 – 200 = 1161
units.

■ The safety stock is not normally used, so the holding cost:

= safety stock × holding cost = 161 × 2 = £322 a week.

■ If the service level is increased to 98%, Z = 2.05. Then:

■ safety stock = Zσ√(T+L) = 2.05 × 40 × √6 = 201 units
■ target stock level = D(T+L) + safety stock = 200×6 + 201 = 1401 units
■ cost of the safety stock is safety stock × holding cost = 201 × 2 = £402 a week.
274 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

But why stop at two or three messages a day, when the tills can send messages every time they
make a sale? This is the approach of continuous replenishment, which has reduced stocks in
Tesco by 10%, while increasing availability by 1.5% and significantly increasing productivity.11

EFFORT OF STOCK CONTROL

ABC analysis

Even the simplest and most highly automated inventory control system needs some effort to
make it run smoothly. For some items, especially cheap ones, this effort is not worthwhile.
Very few organisations include, for example, routine stationery or nuts and bolts in their stock
control system. At the other end of the scale are very expensive items that need special care
above the routine calculations. Aircraft engines, for example, are very expensive, and airlines
have to control their stocks of spare engines very carefully.
An ABC analysis puts items into categories that show the amount of effort worth spending
on inventory control. This is a standard Pareto analysis or ‘rule of 80/20’, which suggests that
20% of inventory items need 80% of the attention, while the remaining 80% of items need
only 20% of the attention. ABC analyses define:

● A items as expensive and needing special care

● B items as ordinary ones needing standard care
● C items as cheap and needing little care.

Typically an organisation might use an automated system to deal with all B items. The system
might make some suggestions for A items, but decisions are made by managers after reviewing
all the circumstances. C items might be excluded from the automatic system and controlled by
ad hoc methods.
An ABC analysis starts by calculating the total annual use of each item by value. We find
this by multiplying the number of units used in a year by the unit cost. Usually, a few expen-
sive items account for a lot of use, while many cheap ones account for little use. If we list the

Cumulative 100
percentage
of use by
value

50

0
10 50 100
Cumulative
A percentage
B C of items

Figure 10.11 Typical results for an ABC analysis

 INVENTORY MANAGEMENT 275

items in order of decreasing annual use by value, A items are at the top of the list, B items are
in the middle and C items are at the bottom. We might typically find:

Category % of items Cumulative % of use Cumulative % of

% of items by value use by value

A 10 10 70 70
B 30 40 20 90
C 60 100 10 100

Figure 10.11 shows typical results of plotting the cumulative percentage of annual use against
the cumulative percentage of items.
You have to be careful with ABC analyses as they can give misleading advice. The annual
value of a material’s use is often a poor measure of its importance. Essential safety equipment,
for example, has to be present even if it is never used. An assembly line only keeps going if all
materials have the same, high service level, regardless of their cost.

W O R K E D
E X A M P L E

A small store has ten categories of product with the following costs and annual demands:
Product P1 P2 P3 P4 P5 P6 P7 P8 P9 P0

Unit Cost (D) 20 10 20 50 10 50 5 20 100 1

Annual demand (‘00s) 2.5 50 20 66 15 6 10 5 1 50

Do an ABC analysis of these items. If resources for inventory control are limited, which
items should be given least attention?

Solution
The annual use of P1 in terms of value is 20 × 250 = D5000. Repeating this calculation for
the other items gives the following results:
Item P1 P2 P3 P4 P5 P6 P7 P8 P9 P0

% of items 10 10 10 10 10 10 10 10 10 10
Annual use (D’000s) 5 50 40 330 15 30 5 10 10 5

Sorting these into order of decreasing annual use gives the following results:

Product P4 P2 P3 P6 P5 P8 P9 P1 P7 P0

Cumulative % of items 10 20 30 40 50 60 70 80 90 100

Annual use (D’000s) 330 50 40 30 15 10 10 5 5 5
Cumulative annual use 330 380 420 450 465 475 485 490 495 500
Cumulative % annual use 66 76 84 90 93 95 97 98 99 100
Category <–A–><————B————><———————C———————>

The boundaries between categories of items are often unclear, but in this case P4 is clearly
an A item, P2, P3 and P6 are B items and the rest are C items.
The C items account for only 10% of annual use by value. If resources are limited, these
should be given least attention.
276 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Vendor managed inventory

If an organisation is trying to reduce the amount of effort it puts into inventory control, one
option is to leave the whole problem to someone else and use third parties. We have already
seen that outsourcing parts of logistics can bring advantages, and one option is to use a third
party to keep all stock. Another option is to have another organisation look after the stock
control, without them actually holding the stock. Perhaps the most common arrangement of
this kind is vendor managed inventory. You can imagine this is a department store, which
holds stocks of, say, shoes. Ordinarily the store controls its own stocks, and orders more from
a wholesaler when it wants them. With vendor managed inventory, the wholesaler controls
the stocks, and sends more along when they are needed. The benefits of such arrangements are
that the supplier can co-ordinate stocks over a wider area, use optimal inventory policies,
organise transport more efficiently, increase integration in the supply chain, collect more
information about demand patterns, and give a consistent customer service.12 The drawbacks
include more reliance on a supplier who may have different objectives, less clear responsibility
for stock, need for more sophisticated information systems, and less flexibility.

L O G I S T I C S
I N P R A C T I C E
BHP and Nalco/Exxon Energy Chemicals
Every day BHP offshore produces 70,000 management. Local operations gave up
barrels of oil and 300 million cubic feet of their stocks and relied on the supply from
gas. Since 1995 they have had an alliance Nalco/Exxon, removing stages 2, 3, 4 and 6
with Nalco/Exxon Energy Chemicals to sup- from the supply chain in Figure 10.12.
ply specialty chemicals. In 1998 they looked Although the companies already had a
for improvements to the supply chain, a key working alliance, this was a significant step.
section of which is shown in Figure 10.12. The new system was launched after a lot of
This had several problems including: preparation in 1999, and reduced costs by
■ very large safety stocks 28% – or $300,000 a year – with no reduc-
■ poor order policies tion in customer service. There have also
■ no single point of responsibility for stocks been numerous intangible benefits, such as
■ poor management practices the redeployment of scarce resources to
■ barriers and delays to orders. more profitable area.

The companies decided to introduce a Source: Jones A. (2001) Vendor managed inven-
single inventory system, based on vendor tory, Logistics and Transport Focus, 3(5), 31–5

3. 6.
1. 2. Third party 4. 5. Nalco/Exxon
Nalco/Exxon ➜ BHP offshore ➜ shore base ➜ BHP purchasing ➜ Nalco/Exxon ➜ manufacturing
offshore department Customer services
stocks stocks stocks

Figure 10.12 Original supply chain for Nalco/Exxon

CHAPTER REVIEW ■ ■ ■ ■ INVENTORY MANAGEMENT 277

❑ Stocks are the materials that organisations keep in store until they are needed.
Every organisation holds stocks of some kind, to give a buffer between supply
and demand. Their main purpose is to allow for uncertainty and variation.
❑ There are many types of stocks and arrangements for their storage. This is always
expensive and organisations look for methods of control that achieve some
specific purpose. They usually look for a balance between the different costs.
❑ Most independent demand inventory systems are based on an economic
order quantity. This is the order size that minimises the total cost of a simple
inventory system. The reorder level shows the times to place orders.
❑ If demand varies widely we can add a safety stock to achieve a specified
service level. There are many other extensions to the basic models.
❑ An alternative approach uses a periodic review system that places regular
orders to bring stocks up to a target level.
❑ There are several ways of allocating reasonable effort to stock control. One
uses an ABC analysis; another outsources part of the function, perhaps using
vendor managed inventory.

C A S E S T U D Y Lennox Wholesale Group

Brisbane is the main city of Queensland, Australia. To the north are a series of
coastal towns that are growing very quickly. In 1988 George Lennox opened a distri-
bution centre in Cairns to supply pharmaceuticals and related products to retail
pharmacies, hospitals, dispensing doctors and a few other outlets. In the past, deliv-
eries of pharmaceuticals in this remote area had been made directly by manufac-
turers, but the growing population had encouraged wholesalers to open. Now there
is a mature industry giving an efficient delivery service from centralised warehouses.
As more pharmaceutical wholesalers arrived the market has become increasingly
competitive. George Lennox’s company has grown into the Lennox Wholesale Group
(LWG) and is one of the main companies in the area. It is now classified as a
medium-sized private company which is run efficiently and gives a good service to
customers. The three main activities of LWG are:
■ order taking and processing
■ stock holding and control
■ delivery to customers.
278 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

C A S E S T U D Y continued

To ensure his company’s continuing success, George Lennox is always looking for
improved performance. A short while ago he was concerned that the cost of deliveries
to customers was rising. The distribution system had been reviewed occasionally as
the company grew, but it was essentially designed for a much smaller operation.
George hired a management consultant to give advice on improving the transport oper-
ations. The consultant did some work which suggested areas for improvement, and his
final report suggested that the company look at its stock holding policies.
George looked at the stock control system, which was based on standard software
provided by CyborgExceler seven years earlier. This had been updated and expanded
twice, and still seemed to work quite well. Unfortunately, a close examination showed
that stock levels had actually been drifting upwards for some time. The purchasing
department explained that the company was successful because it had a reputation for
reliability and service. A customer could e-mail, fax or telephone an order and delivery
would be guaranteed during the next working day. Unfortunately LWG had occasion-
ally run out of stock and had let down customers (their own lead time from manufac-
turers averaged about a week). To make sure this happened rarely, the purchasing
department had adopted a policy of keeping two weeks’ demand in reserve stock, but
for some reason this seemed to be drifting up to three weeks’ demand.
The same ordering procedure was used for all items. This was based on the
purchasing department’s view that the most important factor was average demand
over the past five weeks. This value was used as a forecast of future demand. Then
a reorder level was set as:
Reorder level = Forecast × (lead time + safety stock) × Factor
where Factor is a variable between 1 and 2 to give a subjective view of the item’s
importance and the supplier’s reliability.
Order quantities are really set by the number of staff in the purchasing depart-
ment. Three people work in the department, each processing up to sixty orders a day.
In 200 working days a year they can process 36,000 orders. As there were 4000
items in stock, each item can have an average of 9 orders a year. To add another
element of safety, each order was made big enough to last about eight weeks.
The system was largely automated, and nobody really checked its performance.
Items were usually in stock when they were needed, so managers did not look at the
details of the operations. Unit costs varied between one dollar and several hundred
dollars, and no one had calculated cost of stock holding or purchasing. As an exper-
iment, George collected some information for a small sample of nine items.
 INVENTORY MANAGEMENT 279

C A S E S T U D Y continued

Item
Week 1 2 3 4 5 6 7 8 9

1 53 284 252 27 145 1235 567 121 987

2 64 301 260 32 208 1098 664 87 777
3 82 251 189 23 177 987 548 223 743
4 41 333 221 22 195 1154 602 304 680
5 73 276 232 27 211 1559 530 76 634
6 18 259 195 30 179 1209 650 377 655
7 40 242 217 31 205 993 612 156 598
8 53 310 225 23 187 1313 608 198 603
9 52 311 186 28 156 1405 596 94 621
10 21 336 265 23 182 1009 637 355 564
11 67 258 245 25 171 985 555 187 559
12 50 277 212 28 169 1237 589 209 519
13 22 263 224 31 210 1119 601 304 485
Reorder level 302 1220 1050 160 1120 6100 2520 900 4400
Order quantity 450 2000 1500 245 1450 7900 4500 1950 6400
Unit cost (A$) 45.25 10.20 8.75 32.60 12.25 6.50 28.50 36.00 4.20

C A S E S T U D Y
Questions
● How well do you think the existing inventory control system works? What are its
weaknesses?
● How could you improve the system?
● George Lennox is keen to make progress in this area. What would you advise him to do
next?

P R O J E C T

National Stock Holdings

On a national scale, the amount of stock seems to be falling. Collect some figures to check this obser-
vation. How do these figures vary for different countries? What are the main factors that affect national
stockholdings? What effect does this have on the economy? What other trends are there in inventory
control?
280 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

P R O B L E M S

1. The demand for an item is constant at 200 units a year. Unit cost is £50, cost of processing an order
is £20 and holding cost is £10 per unit per annum. What are the economic order quantity, corre-
sponding cycle length and costs?
2. Jean Jeanie spa. work 48 weeks a year to meet demand for jeans which is more or less constant at 200
units a week. They pay £20 for each pair of jeans and aim for a return of 20% on capital invested.
Annual storage costs are 5% of the value of goods stored. The purchasing department costs £65,000
a year and sends out an average of 2000 orders. Find the optimal order quantity for jeans, the best
time between orders and the minimum cost of stocking the item.
3. Demand for an item is steady at 40 units a week and the economic order quantity has been calcu-
lated at 150 units. What is the reorder level when the lead time is:
(a) 1 week (b) 3 weeks (c) 5 weeks (d) 7 weeks?
4. Fenicci e Fantocca forecast demand for components to average 18 a day over a 200 day working
year. Any shortages disrupt production and give very high costs. The holding cost for the component
is 120,000 lire a unit a year, and the cost of placing an order is 240,000 lire an order. Find the
economic order quantity, the optimal number of orders a year and the total annual cost of operating
the system if the interest rate is 20% a year.
5. A company advertises a 95% cycle-service level for all stock items. Stock is replenished from a single
supplier who guarantees a lead time of 4 weeks. What reorder level should the company adopt for an
item that has a normally distributed demand with mean 1000 units a week and standard deviation of
100 units? What is the reorder level for a 98% cycle-service level?
6. Wolfgang Heinz stocks an item with a unit cost of $80, reorder cost of $100 and holding cost of $2 a
unit a week. Demand for the item has a mean of 100 a week with standard deviation 10. Lead time
is constant at 3 weeks. Design an inventory policy for the item to give a service level of 95%. How
would you change this to give a 90% service level? What are the costs of these two policies?
7. Describe a periodic review system with an interval of two weeks for the company described in
Problem 10.5.
8. A small store has ten categories of product and the following costs and annual demands:

Product H1 P2 A3 X1 W2 P3 Z1 C2 C3 Z2

Unit Cost (Dm) 60 75 90 3 12 18 30 45 60 66

Annual demand (‘00s) 3 2 2 10 8 7 30 20 6 4

Do an ABC analysis of these items.

DISCUSSION QUESTIONS

1. What costs are incurred by holding stock? Some organisations try to reduce stocks by
making to order, or guaranteeing delivery within a specified period. Do such methods
really reduce inventory costs?
 INVENTORY MANAGEMENT 281

2. What factors in real inventory control are not included in the economic order quantity
model? If the costs of holding stock are so difficult to find, how reliable are the results
from this kind of analysis?
3. What should you consider when setting a service level? How can a hospital set a reason-
able service level for its supplies of blood for transfusions?
4. We have now seen how stocks can be controlled by MRP, JIT and independent demand
systems. When would you use each of these? Are there any other methods?
5. What features would you expect to see in an automated inventory control system? Look
at some commercial packages and compare the features they offer.
6. Stocks are an inevitable. Methods like JIT only transfer stocks from one part of the supply
chain to another. To what extent do you think this is true?

REFERENCES
1. Institute of Grocery Distribution (1998) Retail Distribution 1998, IGD, Herts.
2. Institute of Logistics (1998) European Logistics: Comparative Survey, Institute of Logistics, Corby.
3. Office for National Statistics (2001) Annual Abstract of Statistics, HMSO, London.
4. Office for National Statistics (2001) UK Economic Accounts, HMSO, London.
5. Office for National Statistics (2001) Economic Trends, HMSO, London.
6. Waters C.D.J. (2001) Inventory management, Ch. 12 in Brewer A.M., Button K.J. and Hensher D.A. (eds)
Handbook of Logistics and Supply Chain Management, Pergamon, London.
7. Lambert D.W. (1976) The Development of an Inventory Costing Methodology, National Council for Physical
Distribution Management, Chicago.
8. Harris F. (1915) Operations and Cost, A. Shaw & Co., Chicago.
9. Raymond F.E. (1931) Quantity and Economy in Manufacture, McGraw-Hill, Chicago.
10. Wilson R.H. (1934) A scientific routine for stock control, Harvard Business Review, No. XIII.
11. Tesco plc (2001) Annual Review and Summary Financial Statement. 2001.
12. Herring S. (2000) Inventory management into the 21st century, Logistics and Transport Focus, 2(7), 43–5.

Further reading
Greene J.H. (1997) Production and Inventory Control Handbook (3rd edn), McGraw-Hill, New York.
Lewis C.D. (1997) Demand Forecasting and Inventory Control, Woodhead Publishing, Cambridge.
Silver E.A., Pyke D.F. and Peterson R. (1998) Inventory Management and Production Planning and Scheduling
(3rd edn), John Wiley, New York.
Tersine R.J. (1994) Principles of Inventory and Materials Management, Prentice Hall, Englewood Cliffs, NJ.
Waters C.D.J. (1992) Inventory Control and Management, John Wiley, Chichester.
Waters C.D.J. (1998) A Practical Introduction to Management Science (2nd edn), Addison-Wesley Longman,
Harlow.
 CHAPTER 11

Warehousing and Material Handling

CONTENTS

■ Aims of the chapter ■ Chapter review

■ Purpose of warehouses ■ Case study – Via Cendor
■ Activities within a warehouse ■ Project – Warehouse options
■ Ownership ■ Discussion questions
■ Layout ■ References
■ Materials handling ■ Further reading
■ Packaging

AIMS OF THE CHAPTER

After reading this chapter you should be able to:
■ A P P R E C I AT E the purpose and aims of warehouses
■ D E S C R I B E the main activities in a warehouse
■ C O M PA R E the benefits of private and public warehousing
■ S E E how to design good warehouse layouts
■ C H O O S E the most appropriate type of equipment
■ A P P R E C I AT E the purpose of packaging
 WA R E H O U S I N G A N D M AT E R I A L H A N D L I N G 283

PURPOSE OF WAREHOUSES

Definitions

All organisations hold stocks. The last chapter looked at questions of controlling inventories to
find the best patterns for orders, amount to stock, and so on. In this chapter we are going to
look at the way stock is actually stored.
Stocks occur at any point in the supply chain where the flow of materials is interrupted.
Most organisations arrange for stocks to be kept in warehouses. In practice, these warehouses
might be open fields where raw materials like coal, ores or vegetables are heaped; or sophisti-
cated facilities that give the right conditions for frozen or delicate materials; or databases that
hold stocks of information; or people who have a stock of skills; or almost any other form that
you can think of. To simplify things, we will simply refer to warehouses as any place for
storing materials.
People use a number of different terms for warehouses, with the most common being
distribution centres and logistics centres. Sometimes they describe distribution centres as
storing finished goods on their way to final customers, while logistics centres store a wider mix
of products at different points in the supply chain. Other names are used, such as ‘transit
centre’, to show that the facility not only stores materials, but does a range of other jobs. To
make things easy, we will use the general term ‘warehouse’ to cover all such facilities.

■ A WA R E H O U S E is any location where stocks of material are held on their journey

through supply chains.
■ As well as storage, warehouses can be used for a number of other activities.

Warehouses are an essential part of most supply chains. Olsen1 comments that:

We have seen the demise of warehousing predicted again and again, especially with the evolution of
the philosophies of just-in-time, quick response, efficient consumer response, direct store delivery, and
continuous flow distribution.

As we have already seen, the reality is that every organisation holds stocks to give a buffer
between supply and demand. As long as they need to hold stocks of materials, they need ware-
houses to hold them.
Most warehouses are designed for raw materials collected before operations, and finished
goods during distribution to customers. To a lesser extent, they store work in progress,
consumables and spare parts. In this chapter we are going to look at some of the main deci-
sions relating to these stores.
When we talk about warehouses storing materials, this is really only part of the story.
Many organisations are using warehouses as convenient locations for doing a range of
related jobs. Obviously, they can be used to inspect, sort materials and break bulk (taking
large deliveries and breaking them into smaller quantities). They might also be used for
finishing products, labelling, packaging, making products ‘store ready’ for retailers, doing
other aspects of postponement, servicing vendor managed inventories, and so on. The
overall trend is for warehouses to do more tasks, positively adding value rather than being a
pure cost centre.
284 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Fitting into the logistics strategy

Warehouses are expensive to run and need careful planning. We have already looked at some
of the key decisions for this. The logistics strategy sets the overall structure of the supply
chain, including the role of warehouses; location decisions show where to open warehouses;
capacity plans show the number of warehouses to build and best size for each; inventory
management shows the materials to store and amounts of each to stock. Now we are going to
look at some related decisions. What jobs should we do in the warehouses? Who should own
them? What is the best layout? What equipment should we use to move materials? How do we
measure performance?
As always, there is a hierarchy of decisions, with the strategy leading to a series of tactical
and operational decisions. If, for example, the business strategy is based on high customer
service, the logistics strategy will probably be based on more, smaller warehouses. At least in
principle, warehouses located near to customers can give faster response and better levels of
service. Apart from the obvious factor of total throughput, there are some other important
factors in choosing the best size for a warehouse. These include:

● the number of products using the warehouse

● the type of demand for each product, how much it varies, average order size, and so on
● physical features of the products, particularly size and weight
● special storage conditions, such as climate control, packaging, and so on
● target customer service level
● lead times from suppliers and promised to customers
● economies of scale
● type of material handling equipment
● layout of storage and related facilities.

Most of these are fairly obvious, such as higher customer service level needing bigger ware-
houses to hold higher stocks, and longer lead times needing more safety stock to cover for the
unexpected.
Warehouse operations have to contribute to the logistics strategy. So managers have to
analyse this strategy, design warehouses that will support it, and then run these warehouses as
effectively as possible. We can describe one approach to this with the following steps:2

1. analyse the logistics strategy – setting the context and finding what the warehouse has to
achieve
2. examine current operations – to see the failings and how these can be overcome.
3. design an outline structure – finding the best main location, number of sub-depots, and
so on
4. make detailed plans – finding the size of facilities, stock holdings, material handling
equipment, systems to develop, people to employ, transport needs, and so on
5. get final approval – submitting the plans to senior managers to agree the funding
6. finalise building design – purchasing land, choosing contractors and building
7. finalise equipment design – choosing equipment, suppliers and purchasing
8. finalise systems design – designing the ordering, inventory control, billing, goods loca-
tion, monitoring, and all other systems needed
9. fit out – installing all equipment, systems, staff and testing
10. open and receive stock – to test all systems, finish training and begin operations
11. sort out teething problems – to get things running smoothly
12. monitor and control – ensuring that everything works as planned, measuring perform-
ance, revising incentive schemes, and so on.
 WA R E H O U S I N G A N D M AT E R I A L H A N D L I N G 285

These steps need not be done in strict sequence, but they highlight some of the important
decision areas. To go through this complete process takes some time, perhaps two or three
years for a typical facility.

L O G I S T I C S
I N P R A C T I C E
Daniel West Wholesale Ltd
Daniel West Wholesale (DWW) is a privately Then they contact customers who have not
owned wholesaler of frozen fish and a sent orders, asking if they want anything.
range of fresh foods. It employs 85 people, These orders are consolidated into ‘cus-
receives goods from 52 suppliers, and deliv- tomer requirement lists’, which are sent to
ers to 570 main customers in the north of the warehouse. The goods for each order
England using a fleet of 26 vans. All its are picked from the shelves, assembled, put
operations are based in a single warehouse into a delivery box, checked, and taken to a
in Gateshead. departure bay. At the departure bay the
DWW is successful in a highly competi- materials have final packing and promo-
tive market, and it attributes its success to tional material added.
its outstanding customer service. This is The customer requirement lists are used
judged by the five criteria of close personal to design routes for the vans. The drivers col-
relationships, flexibility to respond to indi- lect the schedule of customers to be visited,
vidual needs, low prices enhanced by dis- pick up the boxes to be delivered, and load
counts, high stocks meeting 98% of orders them into the van in the specified order.
off the shelf, and frequent deliveries, nor- Then they set off on their deliveries, visiting
mally twice a day. an average of 20 customers, travelling 110
DWW’s turnover is £35 million a year, miles a morning, and delivering £3000 of
with a gross margin of about 4.5%. All the goods. This whole procedure is repeated on
costs are classified as acquisition (76%), a slight smaller scale in the afternoon.
storage (7%), distribution (4%) and others After each of the main delivery runs,
(13%). DWW’s purchasing system analyses the pur-
Every morning the order-processing chases, consolidates these into orders, and
room in DWW checks orders that have automatically transmits them to suppliers.
been automatically sent by customer tills,
Source: West D. (2002) Report to Shareholders,
e-mailed, faxed, or telephoned overnight.
Newcastle-upon-Tyne

ACTIVITIES WITHIN A WAREHOUSE

Basic activities

The basic function of a warehouse is to store goods. This means that they receive deliveries
from upstream suppliers, do any necessary checking and sorting, store the materials until they
286 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

are needed and then arrange delivery to downstream customers. We can add some details and
get the following list of activities that are generally included in ‘warehousing’.

● receiving goods from upstream suppliers

● identifying the goods, matching them to orders and finding their intended use
● unloading materials from delivery vehicles
● doing any necessary checks on quantity, quality and condition
● labelling materials (usually with bar codes) so they can be identified
● sorting goods as needed
● moving goods to bulk storage area
● holding them in stock until needed
● when necessary, moving materials from bulk storage to a smaller picking store
● picking materials from this store to meet orders
● moving the materials to a marshalling area
● assembling materials into orders
● packing and packaging as necessary
● loading delivery vehicles and dispatching the order
● controlling all communications and related systems, such as inventory control and
finance.

This is obviously a general picture and some warehouses do not do all of the activities, while
others do many more. You can get some idea of the costs involved from the following example.

L O G I S T I C S
I N P R A C T I C E
Waldenmier TWL
Waldenmier TWL are specialists in transport Storage (rent, depreciation, interest,
between countries in central Europe and local taxes, and so on) 22%

those in the former Soviet Union. To ensure Material handling (fork lift trucks,
pallets, packaging, and so on) 12%
a smooth flow of goods they run a series of
Utilities (electricity, heat, and so on) 8%
logistics centres. Every year they review
Communication and control (Internet,
their operations to see how the costs of telephone systems, and so on) 10%
these centres vary in different countries. In Administration (management, insurance,
2001 they found that warehousing added security, and so on) 12%
an average of 3.8% to selling price. The
breakdown of this cost was: Source: company annual reports

Employment (wages, benefits,

compensation, training and so on) 36%

Other activities in warehouses

Traditionally warehouses were seen as places for the long-term storage of goods. Now organi-
sations try to move materials quickly through the supply chain, so their role has changed.
 WA R E H O U S I N G A N D M AT E R I A L H A N D L I N G 287

They are now viewed more as staging points through which materials move as quickly as
possible. As their role in long-term storage has decreased, they have become convenient loca-
tions to do a range of other jobs. They are, for example, the best place for sorting materials,
packing and consolidating deliveries.
Imagine a customer who needs part loads of different materials from different suppliers.
Part loads are amounts that do not fill the transport used, so a part load might be half a
container or part of a full van. Transport operations are often divided into full load and part
load – so you can hear of TL (truckload) and LTL (less than truckload) operators. As you would
expect, the unit costs are higher for part loads. Our customer needs several part loads deliv-
ering, so it can reduce costs by consolidating these into full loads. Then it gets all the part
loads delivered to a warehouse near the suppliers, consolidates them into full loads, and pays
the lower costs of full-load transport to its operations (as illustrated in Figure 11.1). The extra
cost of consolidation in a warehouse is more than recovered from the reduced cost of trans-
port. This is the way that freight forwarders make their money.
A different form of consolidation occurs when a manufacturer makes, or buys, parts of a
final product in different locations. Then it can arrange for all components to be sent to a
warehouse which combines the parts into the final product, and arranges delivery to
customers. A computer manufacturer, for example, might collect in a central warehouse a
keyboard from Brazil, software from the USA, a monitor from the UK, speakers from Taiwan
and the main box from Japan, and so on. The warehouse assembles the components into final
systems and delivers them to customers.

Suppliers Warehouse Transport Customer

(a) Consolidation

Supplier Transport Warehouse Customers

(b) Break-bulk

Figure 11.1 Using warehouses to reduce transport costs

288 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

This kind of consolidation can go further than simply bringing together materials from
different sources. It might add the final packing and packaging to present a single product, or
even do a limited amount of final manufacturing. This is the basis of postponement, where
the final steps of production are left to the last possible moment. As we saw in Chapter 2, this
has the advantage of reducing stocks and increasing flexibility to meet late changes in
customer demands.
Warehouses also do the opposite of consolidation when they break-bulk. Here a supplier
sends all the demand for a particular area in a single delivery to a local warehouse. The ware-
house breaks this delivery into the separate orders and passes them on to each customer.
Warehouses are increasingly places for sorting and doing work on materials rather than
storing them. In the extreme they do these associated jobs, but the materials are never put into
storage. This is the basis of cross-docking. The arrival of materials at a warehouse is co-ordi-
nated with its departures to customers, so that they are transferred directly from the arrival
area to the loading area, and immediately sent for delivery to downstream customers. In prac-
tice, there might be some delay, but this is usually less than 24 hours. Some depots for cross-
docking do not even have storage, but only organise the transfer of materials from, say, one
truck to another. As well as reducing stock levels, this removes all the non-value adding activ-
ities of putting materials into storage, and later removing them. Dale Ross, Director of Logistics
at Oshawa Foods in Toronto, estimates that: ‘cross-docking full pallets of product can save 60%
of a company’s direct labour costs in a warehouse’.3

L O G I S T I C S
I N P R A C T I C E
25 Canadian Forces Supply Depot
25 Canadian Forces Supply Depot opened weighed and measured. When everything
in Montreal in 1995. This 60,000 square has been checked, and details confirmed,
metre warehouse replaced three earlier the materials are officially ‘received’. Then
facilities in Montreal, Toronto and Monc- WMIS prints a ‘licence plate’ bar code to
ton. Its aim is to, ‘receive, warehouse and identify each unit, and assigns a storage loca-
issue everything needed to support bases, tion. This location is set by the features of the
stations, ships and service battalions across unit, and is chosen to give the best use of
eastern Canada and United Nations peace- storage space. WMIS then delivers the unit to
keeping units around the world’. its storage location, using fixed, hand-held
The warehouse receives new materials and vehicle-mounted scanners around the
from commercial suppliers and returns from warehouse to track and control movements.
Canadian Forces units. When a truck arrives, WMIS is also linked to other Canadian Forces
the documents are checked and the vehicle systems to keep track of ordering, stocks,
is directed to one of 11 receiving docks. invoicing and related information.
There it is unloaded, bar codes on materials WMIS has four different types of storage
are scanned, and data is fed into the ware- location:
house management information system
■ Larger, palletised shipments are moved
(WMIS). Materials are then put onto convey-
by forklift from the conveyor to one of
ors, where each unit is automatically
 WA R E H O U S I N G A N D M AT E R I A L H A N D L I N G 289

L O G I S T I C S
I N P R A C T I C E
continued

six stacker cranes which work in the The warehouse was built using a
high bay area. There are 18 aisles, 20 developer-lease arrangement. With this, the
metres high, providing 140,000 loca- developer paid for all major construction,
tions for storage. retains ownership, and leases the ware-
house to the Canadian Forces for C$6.6
■ Smaller units are taken from the
million a year. Other costs came to C$31.8
conveyor by a monorail system which
million, including $4.4 for minor construc-
delivers them to the mid-rise stacks. Four
tion, C$13 million for warehouse equip-
monorail trains, each with 8 trolleys,
ment, C$4.8 million for the warehouse
move on a 400 metre track and take
management information system, C$3.5
units to delivery chutes. They are picked
million to relocate stock, C$3.4 million for
up by 10 wire-guided stock pickers which
project support, and C$2.7 million contin-
work in the 37 aisles, 10 metres high,
gency allowance. The savings of closing the
providing 600,000 storage locations.
older facilities came to C$33 million a year,
■ Larger units are taken from a special so 25 Canadian Forces Supply Depot paid
arrivals dock to the bulk storage area, for itself in about three years.
which has space 6 metres high for free-
standing goods. Source: Brooker D. (1995) Forward march, Mate-
rials Management and Distribution, August,
■ Hazardous materials are taken from a 19–21
special arrivals dock to a separate area
for special treatment.

Aims of warehousing

In general, the aims of a warehouse are to support the broader logistics function by giving a
combination of high customer service and low costs. More specific aims include:

● providing necessary storage at key points in a supply chain

● giving secure storage of the type needed by materials
● keeping all materials in good condition and with minimal damage
● giving high customer service
● doing all necessary activities efficiently and with low costs
● getting high productivity and utilisation of resources
● controlling all movements of materials effectively and without errors
● sorting materials arriving and quickly transferring them into storage
● picking materials departing, quickly transferring them out of storage and consolidating
deliveries
● being able to store the whole range of materials needed
● being flexible enough to deal efficiently with variations in stock levels
● allowing for special conditions, rotation of stock , and so on
● giving safe working conditions, and compliance with regulations.
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OWNERSHIP

Many organisations own and run their own warehouses. But for small organisations this
would be both difficult and expensive, so they use facilities provided by specialised ware-
housing companies. Even large companies can benefit from this arrangement, so they have a
basic choice between private and public warehouses.
Private warehouses are owned or leased by an organisation as part of its own supply
chains. The organisation runs its own warehouses to support its main operations. This gives
greater control over a central part of logistics, and allows integration of warehousing with
the broader activities of logistics. The warehouse can be tailored to the organisation’s needs,
being in the right location, right size, fitting in with customer service, and so on. Commu-
nications are easier with systems integrated throughout the organisation. It might also give
lower costs (without the profit that would be needed by another organisation), with possible
tax advantages and development grants. Another less tangible benefit comes from the
corporate image, as private warehouses can give an impression of reliability and long-term
dependability.
In Chapter 3 we mentioned that organisations often choose to concentrate on their core
activities and contract out some of their logistics. In the last chapter we mentioned one
aspect of this, where vendor-managed inventories transfer responsibility for inventory
management to an outside organisation. Generally, stocks are still kept within the organ-
isation, but they are managed by a supplier. A more common form of contracting has an
organisation outsourcing parts of its warehousing. Then stocks are actually held by a third
party in a public warehouse.
A public warehouse is run as an independent business, which makes money by charging
users a fee. There are many types of public warehouse, including bonded warehouses, cold
stores, bulk storage, tankers and various speciality stores. The facilities available are gener-
ally so flexible that an organisation can get, within reason, any facilities that it needs. There
are also many arrangements for their use. At one extreme, an organisation might simply
rent an area of empty space in a warehouse that it shares with many other organisations.
The organisation still looks after all aspects of its warehousing and runs the necessary oper-
ations itself. At the other extreme, an organisation might contract out all its warehousing
operations to a specialist third party. Then the organisation does none of its own ware-
housing, but specifies standards that must be met. The provider might meet these standards
by using spare capacity in its existing facilities, or for large operations it might build and run
special, dedicated facilities.
The main benefit of public warehouses is their flexibility. They can be used to cover
short-term changes in demand without buying or disposing of facilities. Some other benefits
include:

● flexibility to deal with changing demand, perhaps due to seasonality

● ability to supply skills and experience that the organisation does not have internally
● access to the latest equipment and practices
● avoiding large capital investment, giving higher return on investment
● easy access to a wider geographical area
● allowing short-term tests of working in new areas
● use of economies of scale to reduce warehousing costs
● consolidating loads with other organisations to reduce transport costs
● guaranteed high quality and efficient service
 WA R E H O U S I N G A N D M AT E R I A L H A N D L I N G 291

● flexibility to deal with changing conditions, removing risks from dated practices and
technology.

These benefits have to be balanced against the loss of control. There is also some question of
cost. Public warehouses might be efficient and large enough to get economies of scale, but
they also have to make a profit and, by definition, generate more income than their costs.
Careful analyses are needed to find the balance of these costs.
The trend in recent years has clearly been to use public warehouses.4,5 This leaves organisa-
tions free to concentrate on their core operations and use the expertise of specialist ware-
housing companies. It might also form the basis of a policy of outsourcing other logistics
services, such as transport.
The move towards contracting out warehousing means that the most common arrange-
ment for warehousing is probably a mixture of private and public. An organisation uses private
warehouses for basic, core needs and then tops this up with public warehousing as needed. As
a rough guideline, a warehouse with enough capacity to meet peak demand will only work at
full capacity for 75–85% of the time. So a sensible option is to have a private warehouse with
enough capacity for this 75–85% of the time, and use public warehouses for the rest of the
time. With such arrangements (illustrated in Figure 11.2) organisations can achieve occupancy
rates of over 90%.6
The choice between private and public warehousing is often seen as another aspect of the
‘make or buy’ decision, and is often presented as a break-even analysis. Private warehouses
have higher fixed costs but lower unit operating costs, while public warehouses have low fixed
costs but potentially higher variable costs, as shown in Figure 11.3. This gives a very simple
view, and many other factors should be included in such decisions. The basic question, of
course, is whether a public warehouse can give the same (or better) service for the same (or
lower) cost. If it can give a better service or lower cost then there are clear arguments for
moving in this direction.

Demand met by
Demand for public warehouses
warehousing

Capacity of private
warehouses

Time

Figure 11.2 Meeting demand with a mixture of private and public warehouses
292 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Public
Total cost warehouses

Private
warehouses

Break-even Throughput
point

Figure 11.3 Break-even analysis for public/private warehouses

LAYOUT
General layout

One of the most important decisions when running a warehouse is its layout. This describes
the physical arrangement of storage racks, loading and unloading areas, equipment, offices,
rooms, and all other facilities. As you can imagine, this has a significant effect on the effi-
ciency of operations. If a frequently used item is stored a long way from the delivery and
departure bays, time is wasted every time a unit is put into, or taken from, stores. Stevenson7
summarises this by saying that:

Layout decisions are important for three basic reasons: (1) they require substantial investments of
both money and effort, (2) they involve long-term commitments … (3) they have significant impact
on the cost and efficiency of short-term operations.

Every time you go into a supermarket you see a sort of warehouse. Materials are delivered
at the back of the supermarket, they are sorted and put onto shelves in the middle, then
customers pick the items they want and take them away from the front. This suggests that the
essential elements in a warehouse (illustrated in Figure 11.4) are:

● an arrival bay, or dock, where goods coming from suppliers are delivered, checked and
sorted
● a storage area, where the goods are kept as stock
● a departure bay, or dock, where customers’ orders are assembled and sent out
● a material handling system, for moving goods around
● an information system, which records the location of all goods, arrivals from suppliers,
departures to customers, and other relevant information.

There are many variations on this basic outline. The most common one – which is also used in
most supermarkets – actually has two storage areas. Goods arrive and are put into a bulk store
(the backroom in a supermarket) which is the main storage area. The packages in the bulk
store are broken into individual units and moved to a smaller picking store that is used to
 WA R E H O U S I N G A N D M AT E R I A L H A N D L I N G 293

Storage area

Arrival Departure
bays bays

Systems and controls

Figure 11.4 Basic layout of a warehouse

assemble orders (the shelves in a supermarket). When an order is received, the items needed
are ‘picked’ from the smaller, picking store and brought together in a consolidation area,
before moving to the departure bays. When stocks in the picking store run low, they are
replenished from the bulk store. This gives the flow of materials from arrival bays, bulk store,
picking store, consolidation area to departure bays, as illustrated in Figure 11.5.
You can see from this that supermarkets are not really typical warehouses, as they have
fundamentally different aims. Warehouses want the picking to be as fast as possible, with
goods moving quickly to the exit; supermarkets want their customers to pick goods slowly, as
the longer they are in the shop the more they spend.

Picking
Bulk store
store

Arrival Consolidation Departure

bays area bays

Systems and controls

Figure 11.5 Schematic of a common warehouse layout

294 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Layout of racking

In most warehouses, materials are stored in some form of shelving or racking. This can take
many forms, leading to three basic questions:

● What type of racking should be used?

● What is the best layout for the racking?
● Where should different items be stored on the racks?

The basic type of storage is an area of floor space, marked out in a grid to identify different
locations. Bulky or heavy items are put into a location, probably by a forklift truck. The next
level of storage uses shelving built in aisles, with materials typically on pallets. A problem with
this arrangement is that the shelves have to be shallow, so that all materials are within reach,
and the aisles tend to be long. Smaller units are stored in bins, which are containers arranged
in pigeonholes, so that materials are easy to find and remove. Flow racks can increase the
density of storage by making the shelves much deeper. These are sloping shelves that are filled
from the back, and as you remove a unit from the front, all the remaining units move forward.
Other options for storage include horizontal carousels (bins on an oval track that rotate to
bring materials to a picker), vertical carousels (shelves that rotate up and down to bring mate-
rials within reach), hanging racks for garments, silos and tanks for fluids, and a huge assort-
ment of other arrangements.
Storage in a warehouse is almost inevitably arranged in aisles. To reduce the ground area
needed, these aisles can be quite high. In practice, the details of the layout are determined by
the existing building, architect’s views, site available, height, or some physical constraint.
Within these constraints, warehouse managers try to design the best layout for racking. This
depends, to a large extent, on the type of goods being stored and the handling equipment
used. If the goods are small and light, such as boxes of pills, they can be moved by hand, and
the warehouse must have low shelving and be small enough to walk round. If the goods are
large and heavy, such as engines, they need heavier handling equipment such as cranes and
forklift trucks. Then the aisles must be big enough for these to manoeuvre. We will return to
this theme in the next section.
One way of approaching the design is to:

● estimate demand for materials over the next five years or so

● translate this into forecast movements of materials into, through and out of the warehouse
● compare available equipment for handling these movements and choose the most
appropriate
● find the space needed for storing and moving each item
● design a general layout for the racking
● see which materials should be close to each other (such as fast moving materials nearer to
transport bays, chilled goods in the same area, high value goods in safe areas, and so on)
and those that should be far apart (such as foods far away from chemicals)
● develop outline plans for the layouts and handling areas and choose the best (using
appropriate analyses such as simulations)
● add details to give final plans.

In any particular circumstances there is not really a single ‘best’ layout, so organisations
usually look for one that satisfies their requirements. Then, because of the wide variety of mate-
rials, locations, operations, objectives, and so on, it is difficult to go far beyond these general
guidelines. Experience does, however, make some suggestions for good layouts. These include:
 WA R E H O U S I N G A N D M AT E R I A L H A N D L I N G 295

● plan the layout to give a smooth flow of materials into, through and out of the warehouse
● simplify movements, eliminating or combining separate movements where possible
● use high level storage where possible, as this reduces the overall area
● have offices outside the main warehouse area, as space above them is wasted
● consider using spare roof space for overhead movement of materials
● give appropriate space for aisles – as narrow as possible to reduce non-working space, but
wide enough for equipment
● consider mezzanine floors for picking and administration
● have movements in straight lines on one floor.

Notice that several of these suggest using all of the available volume. The costs of warehousing
often rise with the area, so there are advantages to having tall buildings, provided that the
extra height is properly used. Rather than looking at turnover per square metre, warehouse
efficiency is often judged on turnover per cubic metre.

Locating materials on shelves

Many costs of running a warehouse are fixed – such as rent, local taxes, utilities, and deprecia-
tion. Some of these fixed costs are set by management policy, such as the total investment in
stock. The main variable cost comes from the details of the layout, and depends on the time
needed to locate items and either add them to stock or remove them. When there are thou-
sands of items in store, small differences in the way they are arranged can give markedly
different service and costs.

W O R K E D
E X A M P L E

A small store has a rack with nine colours of paint in five litre tins. At one end of the rack
is an issue area where the storekeeper works. Weekly demand for the paint is as follows:
Colour Red Blue White Black Brown Green Yellow Grey Pink
Tins 150 210 1290 960 480 180 360 60 90

If all paint is stored in bins that are 5 m wide, design a layout for the rack. Design a layout
if the size of bins varies with the weekly demand.

Solution
A reasonable aim is to minimise the distance walked by the storekeeper, assuming that each
tin of paint needs a separate journey. The paint should be laid out so that colours with
highest demand are nearest the issue area, so the layout has paint in order white, black,
brown, yellow, blue, green, red, pink and grey (as illustrated in Figure 11.6). Assuming that
tins come from the middle of bins, the total distance moved by the storekeeper is:

= 2× (2.5×1290 + 7.5×960 + 12.5×480 + 17.5×360 + 22.5×210

+ 27.5×180 + 32.5×150 + 37.5×90 + 42.5×60)
= 86,400 m

If the size of bin is proportional to the weekly demand, and assuming that paint is taken
from the middle of the bins, the paint can be stored equally well in any order.
296 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Issue area

Storage rack

White Black Brown Yellow Blue Green Red Pink Grey

Figure 11.6 Layout of paint in worked example

Turnaround time

Apart from the layout of the storage areas, the efficiency of a warehouse also depends on how
quickly it deals with delivery vehicles. There are several measures of turnaround time, but the
most common is the time taken between a vehicle arriving (either delivering materials or
collecting them) and departing. Transport operators get paid for having their vehicles and
drivers moving, so they do not want them sitting idly in a warehouse during loading or
unloading. This is why airlines like passengers to disembark quickly, so that new passengers
can be loaded and the plane can move on to its next journey. At the same time, there is
limited docking space, so it must be freed up quickly to get a reasonable throughput.
It is, then, in everybody’s interest to minimise the turnaround time. Three arrangements
can help with this. First, orders can be assembled and waiting to move onto a vehicle – when
the vehicle arrives it is loaded quickly and moved on. Second, special loading and unloading
equipment can be used to speed operations. With, for example, rollers on vehicle floors a stan-
dard vehicle can be loaded and unloaded in five minutes or less. Third, the bays can be laid
out carefully to minimise congestion.

L O G I S T I C S
I N P R A C T I C E
Cornwall, Ontario
Wal-Mart operates 170 stores in Canada, as these need special inspections and finish-
where its logistics is managed by Tibbett & ing which are best centralised.
Britten. In 2000, they opened a new distri- The Cornwall distribution centre covers
bution centre in Cornwall, Ontario. This cen- 100,000 square metres, stocks 10,000 dif-
tre serves the 61 stores in eastern Canada, ferent items, with storage for 55,000 pallets
joining two other centres that serve the rest and 10,000 cases.
of the country. It also specialises in the sup- An order management system analyses
ply of linen and shoes throughout Canada, all demand met by the centre, forecasts
 WA R E H O U S I N G A N D M AT E R I A L H A N D L I N G 297

L O G I S T I C S
I N P R A C T I C E
continued

future sales, and places orders with suppli- Orders are automatically received from the
ers. These deliveries are received in 80 stores’ point-of-sales systems, the cases are
docks, with bar codes added to each pallet picked, put onto a conveyor and sent to the
and case to allow automatic movement. departure docks (automatically guided by
Most goods arrive on pallets and are put bar codes). There are 79 departure docks,
onto conveyors for movement into storage so one dock with its conveyor is used for
and there are 19 docks for articles that can- each store. This makes sorting very easy.
not use conveyors. There is some cross Some goods that cannot go on the convey-
docking, with items going from the receiv- ors are handpicked and moved by forklift.
ing area to the departure docks in 15 min- Independent carriers, or one of the cen-
utes. Sixty high-volume products are kept tre’s small fleet of vehicles, deliver to stores,
near to conveyors, and stay in stock for less usually within 24 hours of ordering.
than a day. The average stay for remaining
Sources: Daudelin A. (2001) Supply chain
items is two weeks.
management the Wal-Mart way, Supply Chain
The centre breaks pallet loads into cases, and Logistics Journal, Spring, and websites at
with a throughput of 115,000 cases a day. www.walmart.com and www.infochain.org

MATERIALS HANDLING

A lot of the work in a warehouse moves materials from one location to another. Everything
has to be taken from delivery vehicles, moved around the warehouse – often several times –
and eventually put onto departing vehicles. The activities involved form part of materials
handling.

M AT E R I A L S H A N D L I N G is concerned with the movement of materials for short

distances generally within a warehouse, or between storage areas and transport.

Every time an item is moved it costs money, takes time, and gives an opportunity for damage
or mistake. Efficient warehouses reduce the amount of movement to a minimum, and make the
necessary movements as efficient as possible. Some objectives of materials handling include:

● moving materials around a warehouse as required

● moving materials quickly, reducing the number and length of movements
● increasing storage density, by reducing the amount of wasted space
● reducing costs, by using efficient operations
● making few mistakes, with efficient material management systems.

These aims rely, to a large extent, on the choice of handling equipment. This can affect the
speed of movement, type of materials that can be moved, costs, layout, number of people
employed, and so on.
298 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

In some warehouses most of the materials handling is done by hand, with little equipment
except, perhaps, for trolleys and baskets. Other warehouses have forklift trucks and cranes for
moving heavy items. These suggest two levels of automation – manual and mechanised.
A third level gives automated warehouses, where all materials handling is managed by a
central computer. These three levels of technology give warehouses with completely different
characteristics.

Manual warehouses

This is probably the easiest arrangement to imagine, and is still one of the most common.
Items are stored on shelves or in bins. People go around and pick items from the shelves, and
put them into some sort of container for movement – like a supermarket trolley. There may be
some aids, like hand trucks for moving pallets, or carousels to bring materials to pickers, but
essentially people control all aspects of movements. You can get an idea of these operations by
looking around a supermarket, which is very similar to a manual warehouse.
Manual warehouses only work if the items are small and light enough to lift. Shelves must
be low enough for them to reach and close together to reduce the distance walked. Materials
are stored on shelves, or in bins, that are no higher than about two metres. The warehouse
must be heated, lit and allow people to work comfortably.

Mechanised warehouses

Mechanised warehouses replace some of the muscle power of manual warehouses by

machines. Typical examples of mechanised equipment are:

● reach trucks, which are usually electrically powered and move pallets and similar loads up
to storage locations. A driver controls the truck, which can raise loads vertically to a
considerable height. These trucks are quite small, slow, and with limited facilities, but
they work well in confined spaces.

● order-picking machines are a variation on reach trucks, where the driver is lifted with the
materials to pick, or deliver, at high locations.

● forklift trucks, come in many different versions and are the standard means of moving
pallets and equivalent loads for short distances. They are very manoeuvrable, flexible, and
can be adapted for many jobs. On the other hand, they need space to work, and are fairly
expensive to use.

● cranes, which describe a family of vehicles used to lift materials.

● towlines, which are continuous cables that can move trailers around a fixed path, rather
like ski lifts.

● conveyors, which are used to move large quantities of goods along fixed paths. You can
see many examples of conveyor belts moving materials that range from iron ore to letters.
An alternative uses roller conveyors.
 WA R E H O U S I N G A N D M AT E R I A L H A N D L I N G 299

● tractors or trains, which are power units that pull loads that have been put onto trailer
units. The tractor delivers trailers to the place needed, rather like small articulated trucks
or tugs and barges.

● carousels, which are basically a series of bins going round a fixed track. At some point on
the journey items are put into a bin, and the bins are emptied when they pass another
chute or collection point.

These warehouses can store heavier goods and may be much bigger. Some equipment needs
wide aisles to manoeuvre, but racking can be higher – typically up to 12 metres with a forklift
truck and higher with cranes or high-reach equipment.
Materials in these larger warehouses will probably not be put straight onto shelves, but are
likely to be in ‘unitised’ loads. These are simply standard sized packages or containers that are
used for all movements. The idea is that standard packages can be moved much more easily
than a set of different sizes and shapes. The most common format, which we have already
mentioned in passing, uses pallets. These are the wooden carriers that evolved into a standard
1.2 m by 1 m format in the 1960s. We will return to this theme in the next section.
A survey8 found that forklifts were by far the most widely used equipment for moving
materials from warehouses, being used by 94% of companies. Other widely used equipment
included various manual trucks (55%), conveyors (40%), various ‘man aboard’ trucks (33%),
horizontal carousels (26%), stacker cranes (23%) and vertical carousels (9%).
The key point about mechanised systems is that they are still under the control of an oper-
ator. Someone actually drives a forklift or controls the movement along a towline. The next
alternative is to pass the control of movements to a computer.

Automated warehouses

Traditional warehouses, even mechanised ones, tend to have high operating costs. These oper-
ating costs can be reduced, as well as improving aspects of service, by using automation.
Unfortunately, this needs a very high investment in equipment, and is only really worthwhile
for very big stores that move large amounts of materials.
Automated warehouses work in the usual way, but they include the following components:

● storage areas that can be accessed by automatic equipment; these often use narrow aisles
up to, say, 40 m tall to get a high density of materials and minimise the distances moved.

● equipment to move materials around the warehouse; these are usually automated guided
vehicles (AGVs) which use guide wires in the floor, but might include conveyors, tractors,
or a range of other moving equipment.

● equipment to automatically pick materials and put them into storage, including high
speed stacker cranes that can reach any point in the narrow aisles very quickly.

● equipment to transfer materials between the different types of equipment; these auto-
matic loaders and unloaders might include industrial robots.

● a warehouse management system to record material locations, and control all movements.
300 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

There can be considerable benefits to automation. Greenwood9 suggests some of these as

reduced errors, improved records of inventory, increased productivity, reduced paperwork,
improved space utilisation, lower stocks, better control of movements, support of EDI, and
better customer service. An obvious point is that no people work in the storage areas, so there
is no need for heat and light.

Choice of equipment

In general, higher volumes of throughput use higher levels of automation. Warehouses for low
volumes of throughput (like a shop) are usually manual, medium volumes of throughput (like
a food warehouse) are mechanised, and high volume of throughput (like an e-mail book seller)
are automated, as shown in Figure 11.7.
Although it is important, volume is only one factor in the choice of equipment. The final
decision needs a lot of analysis, with the key factors likely to include:

● physical characteristics of loads – size, weight, and so on

● number of loads to be moved – from the throughput of the warehouse, plus any internal
movements for sorting, checking, and so on
● distance to be moved – from the size of the warehouse
● speed of movement required – how quickly the warehouse has to respond to demands,
and so on.

Most organisations move to higher technology systems to improve productivity8 but other
aims are improved customer service, reduced costs, safety, better stock control and more flexi-
bility. Many analyses can help with this decision, including break-even points, return on
investment, net present value, and measures of productivity.

Manual
Mechanised
Unit cost

Automated

Throughput
Manual Mechanised Automated

Figure 11.7 Choice of automation and warehouse size

 WA R E H O U S I N G A N D M AT E R I A L H A N D L I N G 301

L O G I S T I C S
I N P R A C T I C E
Handemann Group
Handemann Group run a fairly standard ■ Shelving, 600 square metres with three
warehouse for distributing materials for aisles 35 metres long and 1.5 metres
their gas and electricity supply business in wide. Shelves are 8 metres high, provid-
areas of Austria and Germany. The ware- ing 8000 locations for packages of
house is divided into a number of areas as various sizes and weights up to 200 kg.
shown in Figure 11.8. ■ Bins, 200 square metres, with one aisle
giving 6000 locations for small, fast-
■ Goods in, 1200 square metres contain-
moving items.
ing seven docks, and areas for checking,
■ Despatch area, 800 square metres
bulk breaking, re-packaging, quality
containing ten docks and areas for
assurance and returns.
sorting, assembling deliveries.
■ High bays, 2400 square metres with
eight aisles 45 metres long and 2 metres The materials handling equipment can
wide. Pallet racking is 14 metres high, change according to current needs, but uses
with space for 3580 pallets weighing up a variety of trucks to move people and/or
to a tonne. This is the main storage for materials along aisles and up storage racks.
appliances and bulk materials. Typical configurations have 12 electric trucks
■ Low bays, 1200 square metres with six (based on forklifts but of various designs),
aisles 35 metres long and 1.67 metres 10 hand-operated trucks, 1 sweeper and 4
wide. Pallet racking is 8 metres high, lorries for local deliveries.
providing space for 910 pallets weighing
Source: company reports
up to a tonne.

Goods in High bays Low bays Shelving Bins

Goods in
docks

Despatch docks

Figure 11.8 Outline of Handemann Group’s warehouse

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PACKAGING

Standard packages

We have already mentioned pallets (the standard wooden trays about four feet square that
materials are put on to ease movement) and containers (the 20- or 40-foot metal boxes that are
used to move a huge variety of goods around the world). Collecting together materials into
these standard packages is called unitisation to form unit loads. It is much easier to move
standard loads than it is to move a variety of different sizes and shapes. If a company always
uses standard loads, it can set up all its handling equipment to move these efficiently. This is
why deliveries to a supermarket have all the goods of different sizes put onto standard trolleys
that are simply wheeled on and off trucks. Putting everything into containers means that a
company only has to move the containers, rather than moving each item separately.
Another benefit of standard packages is that they can increase the density of storage.
Imagine a company moving bicycles; the density of a load of finished bicycles is quite low, as
the bicycles have bits that stick out and prevent them being packed closely together. The
company could increase the density of the load and reduce freight charges by using standard
crates for all the pedals, handlebars, saddles and other bits, while frames go into other stan-
dard crates.
You can see the benefits of standard packages whenever loads are being moved. If you get a
removal company to help you move house, they put all your smaller items into standard sized
cardboard boxes. These are often combined into pallet loads that are moved by forklift trucks.
These in turn might be assembled into container loads for moving anywhere in the world by
road, rail or ship. We will talk about containers in the next chapter.
So one of the obvious benefits of packaging is that it makes materials handling easier. This
is why you take your clothes on holiday in a suitcase, rather than carry everything separately.
But there are other reasons for using proper packaging.

Purpose of packaging

Many items need special protective packaging during moves, particularly delicate things like
china and electronics. Sometimes the packaging can protect goods from harsh environments,
such as rain or sun; sometimes it is needed to separate materials that would contaminate each
other, such as sugar and petrol; sometimes it keeps the contents clean, such as foodstuffs and
medicines. In general, packaging serves four basic functions as it:

● identifies the product and gives basic information

● protects items while they are being moved through the supply chain
● makes handling easier
● assists in marketing, promoting the product, advertising and giving information to
customers.

The balance between these depends very much on the product. Bars of chocolate, for example,
might put more emphasis on marketing, while boxes of ice cream might be more concerned
with protection. There are also two types of packaging to consider. First, the interior, or
consumer packaging, is designed for the customer and includes the marketing and promo-
tional materials. This is the one that is brightly coloured and has cellophane and advertise-
ments. Second, the exterior or industrial packaging that is designed to protect and make
 WA R E H O U S I N G A N D M AT E R I A L H A N D L I N G 303

handling easier. This is the plain box or pallet that gives information to organisations in the
supply chain.
This packaging can be made of many different materials, but the consumer packaging
tends towards bright plastic, while the industrial packaging tends towards dull cardboard.
Some perfumes and alcoholic drinks come in very elaborate bottles that cost a lot more to
produce than the contents. With expensive consumer goods this might be acceptable, but it
would certainly not work with basic products such as milk or sugar. So we have to consider the
design and materials of the packaging carefully.
There are five main materials for packaging:

● Glass is easy to clean, reuse and recycle, but is fragile, relatively expensive and difficult to
make
● Plastic is light, strong and easy to clean, but can be expensive and difficult to make or
reuse
● Cardboard is light, cheap and can be recycled, but has little strength and poor durability
● Wood is strong, durable, easy to use and can be reused, but it is heavy, bulky and difficult
to clean
● Metal is strong and durable, but it is heavy and can be expensive.

The choice of these – or other materials – depends largely on the type of products, movement
and protection needed. This can be a difficult decision, balancing many factors. You would, for
example, ordinarily expect liquids to delivered in some form of plastic bottles. But this would
give the wrong image for wine which is generally delivered in glass bottles. Shrink-wrapped
pallet loads give a lot of protection, but they would not be appreciated by JIT operations that
want fast access to small quantities of parts.

Packaging waste

When you buy something, you might be surprised by the amount of packaging. Cakes and
chocolates routinely have three layers of wrapping; sometimes you might find up to five
layers. But remember that you only see the consumer wrapping, and there have probably been
two more layers of industrial wrapping which has already been removed. There are growing
concerns about the amount of packaging, its cost and disposal. The UK produces about eight
million tonnes of packaging waste a year, and half of this comes from industrial packaging.10
Conventionally, industrial packaging is more likely to be reused and recycled than
consumer packaging, because it is more robust, and can be collected from a few locations.
Consumer packaging is more likely to be discarded, but some companies, such as Body Shop,
have policies of reducing this by reusable containers. This is an important issue, as the Euro-
pean Union, and other areas are introducing limits on the amount of packaging waste that
companies can discard. Several countries only allow glass containers if these are collected and
reused, or at least recycled. There are similar regulations for metal containers, particularly
aluminium cans. Perhaps more noticeable are the regulations on other packaging, which are
increasingly forcing organisations to record the amount of packaging they use, and the
amount they recycle. If they fail to achieve some target for recycling, they face heavy fines.
The European Union has moved towards this scheme, with overall recycling targets of 50%.
Such trends have encouraged many organisations to switch away from packaging that is
discarded after delivery to the final customer, and towards reuseable packaging and reverse logis-
tics. Replacing cardboard containers by wood might seem expensive, but it can be used repeat-
edly and actually reduce overall costs – as well as contributing to a cleaner environment.10
304 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

❑ A warehouse is the general term for any place where materials are stored on
CHAPTER REVIEW ■ ■ ■ ■ ■ ■ ■ ■ ■

their journey through a supply chain.

❑ The traditional function of a warehouse is to store materials. This involves a
range of activities from receiving materials for storage, through to preparing
deliveries for customers.
❑ The trend to move materials more quickly through a supply chain is changing
the role of warehouses. Their role as long-term stores is declining, and they
are increasingly seen as a convenient location for other jobs, such as
consolidating part loads and postponement. They are developing value-
adding activities, rather than being pure cost centres.
❑ One important consideration is the ownership of warehouses, with a choice
between private and public operations. The trend is towards public
warehousing, using specialist third-party providers.
❑ The layout of a warehouse has a significant effect on its operations. Each
warehouse is essentially unique, but there are general guidelines for good
layout.
❑ Many types of equipment are used in warehouses. We can classify these as
manual, mechanised or automated. The choice determines the type of
operations and features of the warehouse.
❑ Packaging is an important aspect of materials handling. It serves several
purposes including protection, easing movement and passing on product
information.

C A S E S T U D Y Via Cendor

Hungary had a centrally planned economy for over 50 years, with most economic
activity controlled by the government. By the 1990s commercial and industrial
organisations were inefficient, outdated and falling further behind competitors from
other countries. Political and economic reforms started in the 1990s with the aim of
transferring most organisations back to the private sector. Transport had been
tightly controlled, but was substantially privatised and deregulated.
Janos Cendor was keen to take advantage of new developments, and started a
trucking company. He took over an existing depot with all its facilities, with plans
 WA R E H O U S I N G A N D M AT E R I A L H A N D L I N G 305

C A S E S T U D Y continued

for transforming this into a modern and competitive company. Initially, he had
considerable problems. His facilities were decaying, his vehicles were falling apart,
he was overstaffed, and working practices were outdated. In the past the depot had
focused on trade with countries in the former Soviet bloc, and now had to look for
other trading partners in the West.
By 1997 Janus was making progress, and was profiting from the huge increase in
trade between Hungary and countries within the European Union. He had
modernised his depot, replaced vehicles and was making progress with staff. In
early 2001 he was planning a new warehouse near to the Austrian border to import
consumer goods, and export agricultural produce. However, competition from other
transport companies was increasing, and European operators were introducing new
ideas. So Janus planned his new warehouse to play a leading role in moving his
company forward; it would be a flagship operation that would have a clear advan-
tage over competitors.
The problem facing Janus is that, like everyone else, he does not know exactly
what the future will hold. He read reports5 which suggested that warehouses of the
future would concentrate on:

■ better service to give complete customer satisfaction

■ concentration of operations in fewer logistics centres
■ reducing stocks by improved materials flow
■ paperless electronic transactions
■ flexibility giving customised operations
■ cross-docking
■ third-party warehousing
■ automation of material movements
■ more skilled employees to manage new operations.

C A S E S T U D Y
Questions
● How do you think the changing economic conditions in Hungary changed logistics in the
region?
● If Janus asked for your advice on the facilities needed by his new warehouse, what kind of
operations would you suggest? What are the benefits of the new operations? Would these
give a sustainable competitive advantage?
306 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

P R O J E C T

Warehouse Options
Imagine that you have started a company to make some product, such as a new type of ice cream for
sale in supermarkets. Your logistics system will include warehousing. How would you set about design-
ing the number, size, location and facilities of the warehouses? Have a look around and see how com-
panies actually handle this problem. Are there significant differences between the real companies and
your model?

DISCUSSION QUESTIONS

1. If the flow of materials is properly co-ordinated there is no need for stock and, therefore,
no need for warehouses. When do you think that warehouses will disappear from the
supply chain?
2. Warehouses used to be places where goods were stored, often for long periods, until they
were needed. A more recent view has warehouses as places where loads are reorganised on
their journey through the supply chain. Do you think this is a real difference? If it is,
what effect does this have on warehouse operations?
3. Many organisations are using specialist third party suppliers for warehousing. What are
the benefits of this? What are the different types of arrangement for third party ware-
housing?
4. Why is the layout of warehouses important? Supermarkets are really one type of ware-
house, so the same factors will be important in each. Is this true?
5. Automation is bound to give the most efficient warehouses, so everyone should move in
this direction. Will all warehouses eventually be automated?
6. We are often told that packaging is a major problem for waste disposal. Why is there so
much packaging, and how can the amount be reduced?

REFERENCES
1. Olsen D.R. (1996) Warehousing trends for the next generation, Logistics Focus, 4(2), 6–8.
2. Waters C.D.J. (2001) A Case Study in Warehouse Design, Western Operations Group, London.
3. Robertson R. (1996) On the move, Materials Management and Distribution, May, p. 56.
4. Anon. (1999) The rise of the infomediary, The Economist, 351, 8215.
5. Hurdock B. (2000) Ten 21st century warehouse trends, DSN Retailing Today, 39(15), 14.
6. Doerflinger T.M., Gerharty M. and Kerschner E.M. (1999) The Information Revolution Wars, Paine-Webber
Newsletter, New York.
7. Stevenson W.J. (1993) Production/Operations Management (4th edn), Irwin, Homewood, IL.
8. McGillivray R. and Saipe A. (1996) Logging on, Materials Management and Distribution, January,
pp. 19–23.
 WA R E H O U S I N G A N D M AT E R I A L H A N D L I N G 307

9. Greenwood P.N. (1997) How will a warehouse management system benefit me? Logistics Focus, 5(4),
10–13.
10. Pihl A. (1997) Packaging re-use: how to meet legal obligations and cut costs, Logistics Focus, 5(3), 8–13.

Further reading
Fernie J. and Sparks L. (eds) (1998) Logistics and Retail Management, Kogan Page, London.
Frazelle E. (2001) World Class Warehousing and Materials Management, McGraw-Hill, New York.
Mulcahy D.E. (1993) Warehouse Distribution and Operations Handbook, McGraw-Hill, New York.
Simchi-Levi D., Kaminski P. and Simchi-Levi E. (1999) Designing and Managing the Supply Chain, McGraw-Hill,
New York.
 CHAPTER 12

Transport

CONTENTS

■ Aims of the chapter ■ Case study – Mount Isa Mines

■ Introduction ■ Project – Toorvik Transport
■ Mode of transport Consultants
■ Intermodal transport ■ Discussion questions
■ Ownership of transport ■ References
■ Routing vehicles ■ Further reading
■ Chapter review

AIMS OF THE CHAPTER

After reading this chapter you should be able to:
■ A P P R E C I AT E the importance of transport
■ C O M PA R E different modes of transport
■ D I S C U S S the use of intermodal operations
■ C O M PA R E alternative forms of transport ownership
■ L I S T different organisations who offer services for transport
■ A P P R E C I AT E other operational problems, such as routing of
transport
 TRANSPORT 309

INTRODUCTION

Definition

When you talk about logistics, most people imagine lorries driving down a motorway. As we
know, logistics has a far wider meaning, but transport is certainly one of its main components.
In the last chapter we saw that materials handling is concerned with movements within a
facility. Here we will look at transport, which is concerned with the movement of goods
between facilities.

T R A N S P O R T is responsible for the physical movement of materials between points

in the supply chain.

As we have already seen, e-commerce can have a major effect on an organisation’s logistics.
But remember that it is essentially part of the information system. When you look at a
company’s website you can see descriptions of its products, send an order and arrange
payment – but you still need transport to deliver it. Sometimes, of course, you buy intangibles
such as information, software or music, and the website can deliver it. But most products are
more tangible, and they need transport. At the heart of logistics are transport vehicles moving
goods between suppliers and customers. This is why transport in the UK employs 1.3 million
people out of a workforce of 27 million1 and, along with storage, generates 6% of the GDP.

Transport rate

If an organisation uses third-party transport, the price of moving a unit of material between
locations is the rate or tariff. This is set by the cost of the service provided, value to the
customer, the distance moved, weight, size and value of goods, complexity of journey, and so
on. This rate is an important consideration for logistics, and can affect whole patterns of
movement. If an item costs $20 to make in town A and $25 to make in town B, then the
maximum rate worth paying to move from A to B is $5. If the rate is actually $3, producers in
town A will export to B, customers in town B pay less for the item, price sensitive demand will
rise, logistics companies grow to move the item, competition encourages producers in town B
to look for cost savings, some producers in B may divert to other products that they can trade
back to town A. Trade rises and everyone seems happy. If, however, the rate is actually $6,
none of this happens, and everyone seems to lose out.
You can find many examples of this effect. The Czech Republic can brew beer more cheaply
than countries in western Europe (which may explain why they have the highest beer
consumption in the world). However, transport of heavy, relatively low-value loads across
Europe is expensive, and these additional costs make the trade unattractive.
There is a common view that more expensive fuel, vehicles and drivers are making trans-
port more expensive. The costs for particular journeys vary considerably with conditions, but
it is fairer to say that the relative cost of transport is actually falling. This is largely due to more
efficient operations and vehicles, but also due to changes in fuel prices and taxes. Partly as a
result of this, the overall amount of trade is rising. Manufacturers in the Pacific Rim have effi-
cient operations that give low unit production costs, and cheap transport to Europe means
that they often compete on cost with local producers.
310 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Relatively cheap transport also changes the shape of supply chains, as organisations can
cover a wider area from a facility. A single logistics centre can deliver materials quickly and
relatively cheaply to any destination in Europe. This has encouraged many companies to
replace their national warehouses by regional ones that cover a wide area. In 1995, for
example, Nike was selling $1 billion of goods in Europe, with deliveries through 25 ware-
houses. It replaced these with a single pan-European distribution centre in Belgium, and
worked with four specialised transport companies. These companies gave efficient services
which allowed transport costs to remain constant – with inbound transport costs falling
slightly, and outbound transport costs rising slightly. Then Nike could benefit from the huge
reduction in warehousing and inventory costs.2
The rate is clearly important, but service users seem to have little influence in setting it. A
large organisation negotiating freely with a transport company may have some flexibility. The
transport industry is very competitive, and large customers can get good deals. They also have
the option of running their own fleets if external operators charge too much. Often, however,
the rates are fixed by agreement between transport companies, government policies, or
monopoly suppliers. Shipping conferences, for example, quote agreed rates between destina-
tions, cartels of major transport operators use industry agreed rates, and government owned
rail and road industries fix prices through their monopoly. Transport is one of the most expen-
sive parts of logistics, but users often have little control over it.
In practice, organisations do have more influence, as they can make a series of decisions
about the form of transport. What mode of transport is best? Should we run our own trans-
port or use a third-party carrier? What kind of vehicles should we use? How do we deal with
international transport? What routes should we use? Can we back-haul? Every organisation
faces these questions, but they come to different answers that depend on particular circum-
stances. We can give some general advice, and will start by looking at the question of the
transport mode.

MODE OF TRANSPORT

The mode of transport describes the type of transport used. There are basically five different
options – rail, road, water, air and pipeline. Each mode has different characteristics, and the
best in any particular circumstances depends on the type of goods to be moved, locations,
distance, value and a whole range of other things. Sometimes there is a choice of mode, such
as rail or ferry across the English Channel; road, rail or air between Rome and Geneva. Often,
though, there is little choice. If you want to deliver coffee from Brazil to Amsterdam, you will
use shipping; if you want to move gas from the Gulf of Mexico to Dallas, you use a pipeline; if
you want an express parcel service across the Atlantic, you use air freight.
Overall, most goods travel by road. In the UK, 65% of all freight is moved by road, or about
160 billion tonne kilometres out of 240 billion tonne kilometres.3,4 Figure 12.1 shows the
amount of materials using each mode in the UK over the past ten years or so (the amount of
air freight is too small to appear on this graph). There are some variations between countries,
but this is a familiar pattern.

Rail

Rail transport is most commonly used for heavy and bulky loads over long land journeys.
Trains can maintain a consistent, reasonably high speed, and can link with other modes to
carry containers and bulk freight.
 TRANSPORT 311

180

160

140

120
billion tonne kilometres

road
100
rail
water
80
pipeline

60

40

20

0
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Year

Figure 12.1 Freight moved by transport mode in the UK

Rail services are organised in different ways. They are almost invariably public carriers
(giving a service to all other organisations) rather than private carriers (carrying goods for
one organisation). This public service is often considered so important that it is run by the
state. Even when the rail service is not nationalised, it is allowed a (near) monopoly. The
number of carriers is inevitably small when compared with, say, road transport. The main
reason for this is the large investments needed for tracks, rolling stock and terminals. A
trucking company can start a service between, say, Paris and Zagreb by renting a truck and
using public roads; a rail operator has to build its tracks and terminals and buy the trains
before it can start work.
Costs can be reduced by sharing facilities. Some countries have several train operators
using commonly owned tracks, or tracks owned by another company. Such arrangements are
not common and they present obvious problems for operations.
One advantage of rail is that once the infrastructure is in place, it has very high capacity
and low unit costs. This is another factor that discourages competition, as a track built by one
organisation between two points, will generally have enough capacity to meet all demand,
and it becomes unviable for a competitor to open parallel facilities. There is, for example, only
one rail line under the English Channel, but this has enough capacity to meet demand on this
very heavily used route for the foreseeable future. Historically there has been more competi-
tion in, for example, the USA but this has virtually disappeared.
Another advantage of rail is that the unit transport cost is low, so it can be used to move
large volumes of relatively low-priced materials, such as coal and minerals. For this reason, rail
transport is more common in the earlier, upstream, parts of the supply chain. You are more
likely to see organisations using rail for inbound raw materials than outbound finished goods.
The main disadvantage of rail is its inflexibility. All train services have to be timetabled in
advance, so that they can all fit onto the same tracks. This leaves little flexibility for last
312 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

minute or emergency deliveries. Despite this, train operators can provide a number of different
services, perhaps offering merry-go-round services (where a train continually moves between
two locations, such as a port and a factory), full train services (where customers hire an entire
train), full wagon load attached to scheduled services, container transport, or shared wagons
on scheduled services.
A more obvious concern is that trains can only travel along specified routes between
fixed terminals, and cannot stop at intermediary points. Most customers are some distance
away from these terminals, so they have to transfer goods by road at both ends of the
journey. These transfers add time, and they can leave rail as a fairly slow alternative. It is
more useful for long distances, such as between Perth and Sydney in Australia, but is ineffi-
cient for small journeys, such as between Rotterdam and Arnhem in the Netherlands. In the
UK the average journey length by rail is 180 kilometres, compared with 95 kilometres
by road.3
The problem of limited access is common to several modes of transport, but there are ways
of overcoming its effects. The most obvious is to locate facilities near to rail terminals (or ports,
airports, container ports or appropriate terminals). If demand is big enough, it is worth
building special facilities. A power station, for example, might find that it is cheaper to build a
special rail line to a coal mine, than to use trucks. Another option is to use intermodal trans-
port, which we discuss later in the chapter.

L O G I S T I C S
I N P R A C T I C E
DIRFT Ltd
The Channel Tunnel has given efficient rail Upgrading of the West Coast Main Line
links between the UK and European desti- should make rail movements even more
nations. This has encouraged some com- efficient.
panies to move their freight from heavy The site is popular and has attracted
goods vehicles to the train. Daventry Inter- major customers, such as Eddie Stobart and
national Rail Freight Terminal (DIRFT) Tesco. Demand is strong for the next phase
realised that such moves would create a of four million square feet, which will need
growing demand for a logistics park near no further infrastructure. The Strategic Rail
to Daventry with good connections to rail Authority are encouraging such develop-
and road. ments. One problem, of course, is that not
Construction started on the railport near everyone is keen on the railport. It has
the M1 in Northamptonshire in 1994. The already used 365 acres of green fields, and
first two million square feet of facilities expansion plans may be questioned more
opened in 1997, operated by Tibbett & closely.
Britten. This included facilities to unload
Sources: Jones J. (2001) Success is not enough,
three 750 metre trains simultaneously. Eng-
Logistics and Transport Focus, 3(6), 32–5;
lish, Welsh and Scottish Railway runs 35 Strategic Rail Authority (2001) A Strategic
trains from the Channel Tunnel each week, Agenda, HMSO, London
largely from Germany, France and Italy.
 TRANSPORT 313

Road

Road is the most widely used mode of transport and is used – at least somewhere – in almost
all supply chains. Its main benefit is flexibility, being able to visit almost any location.
Although the maximum speed on roads is limited, this ability to give a door-to-door service
avoids transfers to other modes and can give a shorter overall journey time. You can see this
effect if you want to travel between, say, Paris and Brussels. The plane travels faster, but when
you add on the travel times to and from the airports, check-in and boarding, it is faster to
catch a bus between the city centres. Nonetheless, travel speed can be an important consider-
ation, especially as roads are becoming more congested and vehicles are likely to move even
more slowly.
Road transport has the advantage of being able to use extensive road networks. Unlike rail,
these already exist, so users do not have to build and maintain their own tracks. Also, vehicles
do not have to keep to such rigid timetables, so they can go on journeys at short notice and
with little planning.
In contrast to rail, where each operator is likely to have a (near) monopoly over some
route, road transport is characterised by a large number of carriers working in the same areas.
In the USA, for example, there are 40,000 public carriers and 600,000 private fleets. With so
many operators competition is likely to be more intense and pricing more flexible.
There is a huge number of different types of road vehicle. Many of these are specialised,
and designed for specific purposes, and there are different regulations in different countries.
The following list mentions some of the more important types.

● Delivery vans are the small delivery vehicles which can carry a tonne or two in a sealed
body. Smaller vans are based on car designs, while larger ones – such as Luton Box vans –
are like small removal vans.

● Flat-bed lorries are basic, rigid vehicles with two or three axles, and a flat platform that is
used to stack materials. Materials are tied on, or small sides are added.

● Box-bodied lorries are like the flat beds, except they have bodies added, traditionally with
access from the rear. These give more protection than flat beds. In the 1970s Boalloy
added curtain siding to give easier access to the load.

● Articulated lorries, are more manoeuvrable than rigid lorries, so they can be bigger, up to
the legal weight limit. There are many variations on the theme of trucks that bend in the
middle. A common format has a two- or three-axled tractor and a two- or three-axled
trailer.

● Lorry and trailer, which combine a rigid lorry pulling a two-axle trailer. This gives greater
capacity than an articulated lorry, but maintains some of its manoeuvrability.

Many different formats have been tried. In Sweden, for example, they use articulated lorries
with trailers, giving two, or even three, points of articulation. In Alberta, Canada, they use two
trailers to move loads over the Rockies. In Australia ‘land trains’ have four or five trailers to
move through the outback. Perhaps the overall picture is that, within prevailing regulations,
the type of vehicle is only limited by the designers’ imagination.
Depending on conditions, road transport can normally carry loads up to, say, 20–30
tonnes. The European Union has a gross limit of 42 tonnes and different limits apply in other
areas. In exceptional circumstances, very large loads can be carried, such as the loads of a thou-
314 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

sand tonnes that are moved for oil companies in the Arctic. However, weight and size limits
mean that road transport is more often used for smaller loads. These become relatively expen-
sive, so road transport is generally used for shorter distances. Although it is a very simplistic
view, you are more likely to see road transport used for delivering finished goods than bulky
raw materials. Another problem is that lorries are particularly vulnerable to congestion and
traffic delays.

Water

Both rail and road transport have the obvious limitation of only being used on land. Most
supply chains use shipping to cross the oceans at some point, and over 90% of world trade is
moved by sea. You can see the importance of shipping to a country like the UK, where 95% of
freight arrives or leaves by ship, shipping is the fifth largest service sector exporter, the City of
London insures 25% of the world’s marine risk, the marine and repair business is one of the
largest in Europe, there are 300 ports around the coast, and the surrounding waters are among
the busiest in the world.5
There are basically three types of water transport – rivers and canals (usually called inland
waterways), coastal shipping (moving materials from one port to another along the coast) and
ocean transport (across the major seas). Many countries have well-developed river and canal
transport, such as Canadian and US use of the St Lawrence Seaway, and European use of the
Rhine. We normally associate river transport with smaller loads, perhaps narrow boats and
barges. But river systems can carry ocean-going ships for surprisingly long distances. The
Mississippi, for example, is navigable to Minneapolis, more than 2500 km from the Gulf of
Mexico, and Chicago is a major port in the American prairies.
Realistically, though, most shipping is done by large vessels travelling through the world’s
shipping lanes. Some countries are fortunate enough to have a coastline that can be used for
international transport, and cities such as Rotterdam, Hong Kong and New York have devel-
oped huge ports. The world’s 20 biggest ports handle over half of all world trade.6
Some form of shipping is largely unavoidable for long journeys. There are many different
types of vessel for various cargoes. Ships get considerable economies of scale, so many aim at
moving big loads at low unit costs.

● General cargo ships are the standard design, with large holds that carry any type of cargo.
Most of these are loaded by crane, although some have side doors that allow vehicles to
drive on and off. Many ports around the world do not have facilities to handle the more
specialised ships mentioned below, so these general-purpose vessels are very widely used.

● Bulk carriers carry large quantities of cheap bulk materials in large holds, such as grain
or ores.

● Tankers carry any liquid, but by far the biggest movements are oil. Because of the
economies of scale, these ships are built as big as possible.

● Container ships are specially designed to carry standard containers and their capacity is
commonly rated in TEUs (20-foot equivalent units) or FEUs (40-foot equivalent units). A
typical container ship carries around 5000 of these, with larger ones carrying 10,000.

● Ferries are usually RO-RO (roll-on roll-off) vessels that carry road vehicles over relatively
short distances. There are, however, longer RO-RO routes between, say, Europe and
America.
 TRANSPORT 315

● Barges, which are towed behind ocean-going tugs. These are used for shorter routes where
sea conditions are fairly reliable, such as between the USA and Puerto Rico. They have the
advantage of being cheaper to run than normal ships.

● Combination ships. In addition to the specialised ships, many other designs are used, often
to allow for dominant patterns of trade. Examples of such combination ships are the RO-
RO/container ships that carry vehicles imported into the USA and return with bulk grain
to Japan, and the oil-bulk vessels that carry oil from the Middle East and return carrying
ores. One useful combination is passenger/container, as the passengers are ensured
priority treatment in ports.

The main drawback with water transport is, of course, its inflexibility in being limited to
appropriate ports. Journeys from suppliers and to customers inevitably need a change of
mode, even if they are close to ports. In St Austell, UK, for example, china clay works are very
close to specialised ports in Fowey, but the clay still has to be transported to the quayside. The
other problem with shipping is that it is relatively slow, and needs time to consolidate loads
and transfer them at ports. However, such transfers can be made efficient, and then
coastal shipping can compete with road transport, even for relatively short distances.7–9 The
average water journey in the UK is 400 kilometres, so shipping can compete on, say, a
Forth–Tees–Thames route.
One interesting aspect of shipping is the continued existence of conference services. This
means that all carriers in a given area agree to charge a common price and regulate the
frequency of their service. The justification of this cartel is that it guarantees a more regular
service than would otherwise be available. However, many people question this idea of price
fixing, and non-conference lines now offer deep discounts.

Air

Because of its low unit costs, water transport is the most common mode for international
transport. Sometimes, though, its slow speed is unacceptable. If, for example, you run a factory
in Argentina and a critical machine breaks down, you do not want the spare part to be put on
the next scheduled ship from Japan, which will arrive in four weeks time. In such circum-
stances the alternative is air transport.
Passengers account for most airline business, with eight billion passenger kilometres flown
a year in the UK.3 This continues to grow despite some hiccoughs (in, say, 2001), with low-fare
carriers (Ryanair, Virgin Express, Go, easyJet, buzz, and so on) accounting for around 25% of
the market.10 Airlines also carry a significant amount of freight, for products where speed of
delivery is more important than the cost. In practice, this limits airfreight to fairly small
amounts of expensive materials. Perhaps the most common movements are documents and
parcel delivery, with carriers such as Federal Express and UPS.
There are three main types of operation. The first type is regular service, where major
airlines use the cargo space in passenger aircraft that is not needed for baggage. The second
type is cargo service, where operators run cargo planes on regular schedules. These are public
carriers, moving goods for any customers. The third type is charter operations, where a whole
aircraft is hired for a particular delivery.
In common with shipping, airlines have problems getting materials to and from their jour-
neys. There are all sorts of facilities located around major airports for moving materials from
sources onto the right planes, and then away from planes and out to customers. Unfortu-
nately, these transfers again take time, and can reduce the benefits of air travel.
316 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Another problem for airlines is their costs, over which they have very little control. They
have a combination of high fixed costs (aeroplanes are expensive to buy) and high variable
costs (due to fuel, landing fees, staff, and so on). It is expensive to keep planes flying, and there
is no real way of reducing these costs. Competition can also be fierce, putting a limit on the
amount they can charge, and this frequently sends new airlines into bankruptcy.

Pipeline

The main uses of pipelines are oil and gas together with the utilities of water and sewage. They
can also be used for a few other types of product such as pulverised coal in oil.
Pipelines have the advantage of moving large quantities over long distances. Unfortu-
nately, they have the disadvantages of being slow (typically moving at less than 10 km per
hour), inflexible (only transporting between fixed points), and only carrying large volumes of
certain types of fluid. In addition, there is the huge initial investment of building dedicated
pipelines. Despite this initial investment, pipelines are the cheapest way of moving liquids –
particularly oil and gas – over long distances. Local networks can add flexibility by delivering
to a wide range of locations (such as supplies of water and gas to homes).

Choice of mode

Sometimes the choice of transport mode seems obvious: if you want to move heavy items
between Singapore and Brisbane you will use shipping. For land journeys, many organisations
seem happy to put materials on lorries without much thought for the alternatives. In practice,
the choice of mode depends on a variety of factors. Perhaps the main ones are the nature of
materials to move, the volume and distance. Other factors include:

● value of materials, as expensive items raise inventory costs and encourage faster modes
● importance, as even low-value items that would hold up operations need fast, reliable
transport.
● transit times, as operations that have to respond quickly to changes cannot wait for crit-
ical supplies using slow transport
● reliability, with consistent delivery often being more important than transit time
● cost and flexibility to negotiate rates
● reputation and stability of carrier
● security, loss and damage
● schedules and frequency of delivery
● special facilities available.

Many other factors may be important for a final decision. Organisations that routinely use the
cheapest mode may be performing badly by some of the other measures. Remember that trans-
port costs are often a relatively small part of overall costs, and it can be worth paying more to
get a rapid and reliable delivery. One of the early studies of logistics by Lewis et al.11 showed
that air freight can actually save money. It moves materials through the supply chain so
quickly that organisations need fewer warehouses for distribution to customers – by paying
more for transport they can reduce overall costs.
As a rule of thumb, the cheapest modes of transport are the least flexible. The following
table shows a ranking for the cost, speed, flexibility and load limits of different modes of trans-
port. The modes are ranked in order, with 1 being the best performance and 5 being the worst.
 TRANSPORT 317

Rail Road Water Air Pipeline

Cost 3 4 1 5 2
Speed 3 2 4 1 5
Flexibility 2 1 4 3 5
Volume/weight limits 3 4 1 5 2
Accessibility 2 1 4 3 5

Of course, organisations do not have to use the same mode of transport for an entire
journey. They can break the journey into distinct stages and use the best mode for each stage.
We will look at such intermodal journeys in the next section.

L O G I S T I C S
I N P R A C T I C E
Alberta coalmines
Canada’s largest coalmines are in the west- mine to a terminal on the Great Lakes
ern province of Alberta. Unfortunately most (usually Thunder Bay) and then by ship
of the demand for coal comes from power to a lakeside power station.
stations in the population centres of south-
■ Direct rail shipment: moving coal by rail
ern Ontario over 3000 km away.
directly from the mine to a stockpile at a
The main competitors for coal in power
power station. This avoids the transfer to
stations are oil, gas, nuclear power and
a ship, but replaces a sea journey with a
hydroelectricity. Coal is currently a popular
considerably longer rail journey.
choice as oil and gas are expensive, nuclear
power has questions of long-term safety, ■ High efficiency rail: uses newly designed
and there is limited capacity for hydroelec- rail cars that increase maximum loads
tricity. Alberta coal also has low sulphur and reduce unit costs. With appropriate
content, which reduces the need for expen- investment, high efficiency trains can be
sive flue-gas emission control equipment. used to replace conventional trains in
There are, however, obvious problems with either of the first two options.
transport. ■ West coast ports and Panama Canal: this
About three million tonnes of coal is carries coal by train to a west coast port
shipped each year from Alberta to Ontario, such as Vancouver, transfers it to ship for
with transport costs around $45 a tonne. the journey through the Panama Canal
The coal industry looks for ways of reducing and back through the St Lawrence
this, and the alternatives considered are Seaway to power stations in Ontario.
summarised below (see Figure 12.2).
■ Coal/oil agglomeration – eastbound:
■ Rail and ship: this is the current practice, Alberta is a major oil producer and
with coal transported by rail from the the transport of oil and coal can be
318 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Alberta

Minesites Rail,
pipeline or
energy bus Ontario
Vancouver
Rail or pipeline
and laker

Thunder Bay
St Lawrence
Seaway
Powerstations

Rail or pipeline
and ship via
Panama Canal

Figure 12.2 Transporting coal across Canada

L O G I S T I C S
I N P R A C T I C E
continued

combined. This crushes the coal at the ■ Energy bus, which avoids the movement
mine and mixes it with crude oil to be of coal by generating electricity near to
pumped through a pipeline either the mines and using an inter-provincial
directly to the power stations, or to a port electricity grid to send it for distribution
on the Great Lakes. At the destination the in Ontario.
slurry is separated, with coal being sent
Analysing all the costs showed that a
to the power stations and oil to markets
high efficiency rail service from the mine to
in eastern Canada and the USA.
Thunder Bay, followed by ship to the power
■ Coal/oil agglomeration – westbound: This station gives the lowest cost. This is mar-
is similar to the previous option, except ginally cheaper than the current arrange-
that the slurry is piped to Vancouver for ment, but needs more capital investment.
separation. The coal is put onto ships
Source: Ash L. and Waters C.D.J. (1991) Simu-
bound for the Panama Canal and St
lating the transport of coal across Canada,
Lawrence Seaway, while the oil is sent to Journal of the Operational Research Society, 42(3),
markets in western Canada and the USA. 195–204
 TRANSPORT 319

INTERMODAL TRANSPORT

We have seen some factors that affect the choice of transport mode, but organisations do not
have to use the same mode for an entire journey. Their best option is often to divide the journey
into stages and use the best mode for each stage. This does, of course, depend on factors like the
length of the journey, the relative costs and the penalty of moving between modes. But if you
move materials from, say, Lanchow in central China to Warsaw in Poland, you might start by
putting the goods on a truck, transferring them to rail for the journey across China to Shanghai,
then onto a ship to Rotterdam, then back onto rail to cross Europe, and then truck for local
delivery. Journeys that use several modes of transport are called intermodal.

I N T E R M O D A L T R A N S P O R T refers to journeys that involve two or more different

modes of transport.

The aim of intermodal transport is to combine the benefits of several separate modes, but
avoid the disadvantages of each; perhaps combining the low cost of shipping with the flexi-
bility of road, or getting the speed of air with the cost of road. The main problem is that each
transfer between modes causes delays and adds costs for extra handling. You can experience
this effect when you transfer between a bus and train, or between a car and ferry. Intermodal
transport only works if this transfer can be done efficiently.
At the heart of intermodal transport are the systems for transferring materials between
modes. The aim is to give a virtually seamless journey, and the best way of achieving this is to
use modular or unitised loads. In effect, all materials are put into standard containers, and the
equipment is arranged to move these containers.
The basic container is a metal box 20-feet long. This size has become somewhat restricting,
and it is often replaced by a 40-foot box. Even this can be limiting, and the Hudson’s Bay
Company uses 53-foot containers on the trip from Vancouver to Montreal, reducing costs by
10–15%.12
Putting materials into these boxes eliminates the need to handle items individually, and
the whole container goes from source to destination. Since these containers were introduced
in 1956 on the trip between New York and Houston, they have transformed ideas about trans-
port. In particular, transferring materials between modes has changed from a labour-intensive
operation to a capital-intensive one. Huge container ports and terminals have been built
around the world to move containers efficiently and with minimum delay from one type of
transport to another, or from one carrier to another.
In the late 1960s ships spent about 60% of their time laid up in port for loading and
unloading.13 Largely due to containerisation, this has reduced dramatically, and ships can turn
around in a few hours. A rule of thumb is that it takes one day to turn around a containership
when it used to take three weeks to turn around a conventional ship. Over 70% of freight
movements now use containers.14
Some of the benefits of containerisation include:15

● Simplified transport and flow of goods

● Easier and faster handling
● Genuine door-to-door service
● Faster deliveries
● Reduced loss due to damage, misplacement and pilferage
320 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

● Reduced packing costs

● Lower insurance costs
● Separation of incompatible goods
● Use of less congested routes
● Improved transport encourages trade.

Other types of intermodal transport

A very wide range of materials can be put into containers, but there are inevitably some that
cannot, or are cheaper to transport by other means. Oil, for example, might be put into
container-sized tanks (in the same way as bulk wine), but tankers or pipelines give cheaper
alternatives. Non-standard containers might also be preferred for some journeys. Standard
containers have to be strong enough to stack about eight tall, but if a company simply wants
to transfer a box from rail to road, it can use ‘swap bodies’. These are skeleton truck bodies that
can be transferred to a rail car, but cannot stand the rough treatment of containers.
Another alternative to containers is piggy-back transport, where a lorry – or usually just
the trailer – is driven onto a train for fast movement over a longer distance. You can see an
example of this in the Channel Tunnel, where cars and lorries are driven onto a train for this
part of their journey.
Another extension to this idea uses land bridges. These are used when materials cross land
on what is essentially a sea journey. The most widely used examples are in the USA, where
materials from the Far East cross the Pacific to the west coast of America, and then travel by
rail on land bridges across to ports on the east coast, before continuing their sea journey to
Europe. Two main links are the ‘long bridge’ in the north between Seattle and Baltimore, and
the ‘short bridge’ in the south between Long Beach and New Orleans.

L O G I S T I C S
I N P R A C T I C E
Southampton Container Terminals Ltd
Southampton is one of the UK’s busiest An important factor for unloading contain-
deepwater ports. It covers 176 acres, of ers is the reach of the cranes. The cranes
which 135 acres is container stacking space. have to reach over containers stacked on
On the ship side, the port is 4 km from the deck to lift the next one to unload, and
the main international shipping lane the Southampton cranes have reaches up to
around the south coast of England. The 20 containers wide. They can lift up to 60
main access channel is dredged to 12.6 tonnes, and there is a floating crane for
metres, with other berths dredged to 15 heavy lifts with a capacity of 200 tonnes.
metres. This gives 1350 metres of continu- On the land side straddle carriers move
ous quay, which can handle 4 of the world’s containers between the quay and the stack.
largest container ships at the same time. There are 79 of these, each with a capacity
Along the quays are 13 ship-to-shore of 40 tonnes. The stacking yard sorts con-
gantry cranes for unloading container ships. tainers and keeps them, usually in stacks 3
 TRANSPORT 321

L O G I S T I C S
I N P R A C T I C E
continued

or 4 high, until they are sent inland or deliv- Birmingham and Cardiff are around 200 km
ered to a ship at the quay. Throughput is away. Multi-line sidings allow fast rail con-
fast, as it is in everyone’s interest for the nections, and Freightliner run a main serv-
containers to spend a minimum time in ice of 13 trains a day. These connect to
these stacks. most major destinations in the UK.
The port is 2 km from the motorway
Sources: company reports and website www.sct.
network, and trucks can make this journey
uk.com
within 5 minutes. The major centres of

OWNERSHIP OF TRANSPORT

In Chapter 10 we saw how an important decision for warehousing is the ownership of facilities.
The choice is essentially between privately owned, public or a combination of the two. With
transport we again meet this decision. Is it better for an organisation to run its own transport
fleet, to use public transport, or a combination of the two? With transport the more common
terms are in-house or own account transport compared with third-party transport.

Own account transport

This has an organisation using its own transport fleet to move its materials. The most common
form of private transport has large companies running their own fleets of trucks. This has the
advantage of flexibility, greater control, closer integration of logistics and easier communica-
tions. Transport can also be tailored to the organisation’s needs, with the best type of vehicles,
fleet size, delivery schedule, customer service, and so on.
Own account transport can be expensive and an organisation should only run its own fleet
when it is cheaper than using a specialist third-party carrier. Essentially, this means that own
account transport must be run as efficiently as a specialised transport company. There are,
however, potential cost savings as there is less pressure for transport to make a profit, possible
tax advantages, and development grants. There are also intangible benefits, such as the
marketing benefits of vehicles painted in identifiable livery and an impression of reliability
and long-term dependability.
Only larger organisations can afford the capital investment and costs of running their own
fleet. There are, however, ways of avoiding these costs. Most own account fleets are financed
by some form of hiring or leasing, which gives a means of acquiring vehicles without having
to find all the capital. Hire purchase, for example, spreads the payments over some period,
while long-term hiring allows more flexible use. When you see a truck painted in J. Smith’s
livery, it does not necessarily mean that J. Smith actually owns the vehicle. He or she is more
likely to be leasing it from a company that looks after maintenance, overheads, repairs,
replacements and other running costs, in return for a fixed fee.
322 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Third-party carriers

Specialised transport companies offer a range of services to other organisations. The advantage
of this arrangement is that specialised companies run the transport, leaving the organisation
to concentrate on its core operations. By using their skills and expertise the transport operators
can give better services, or lower costs than own account transport. They might also be large
enough to reduce costs through economies of scale, and they can get a number of operational
benefits. They can, for example, consolidate smaller loads into larger ones and reduce the
number of trips between destinations, or they can co-ordinate journeys to give backhauls,
where delivery vehicles are loaded with other materials for the return journey.
Most third-party transport is provided by common carriers. These are companies like TNT
and Excel Logistics which move materials on a one-off basis whenever asked by another organ-
isation. If you want to send a parcel to Australia, you might use a parcel delivery service such
as UPS, which acts as a common carrier.
Alternatively, an organisation can form a long-term relationship with a contract carrier.
This contract carrier then takes over a part – often most of – the organisation’s transport for
some extended period. Schenker, for example, act as a contract carrier when they are respon-
sible for all the movement of goods for Roche Diagnostics in the USA. Contract transport
companies offer a wide range of services, ranging from an occasional parcel collection to
running a large, dedicated fleet for an individual customer.

Choice of ownership

There are several factors to consider when choosing the best type of ownership.

● Operating cost: In different circumstances either own account or third-party transport

might be cheaper, and there should be significant other benefits before an organisation
moves away from their cheaper option.

● Capital costs: Capital is always scarce, and even if own account transport seems attractive,
an organisation might find it difficult to justify the investment in vehicles. We have
mentioned alternative arrangements for spreading the costs, so these analyses should be
done carefully before reaching any conclusion.

● Customer service: Organisations must use transport that provides acceptable customer
service in the best possible way. Sometimes, it is impossible to get a third-party carrier
that can meets all requirements, and then own account transport is the only option –
and, of course, vice versa.

● Control: An organisation clearly has greater control over transport – and therefore wider
operations – if it runs its own transport. However, this control might be bought at a high
price, and contract companies might offer equivalent services but without the overheads
and inflexibility of a private fleet.

● Flexibility: The structure and operations of a private fleet are fairly rigid, as you cannot
make quick adjustments to allow for changing circumstances. If there is a sudden peak in
demand, you cannot increase the size of the fleet for a few days, and then reduce it again
when the peak passes. In the same way, the fleet is structured to carry a certain mix of
sizes and modes. Common carriers can make these adjustments much faster, as they rely
 TRANSPORT 323

on demand from some companies going through a trough while demand from other
companies is peaking.

● Management skills: Managing transport needs specialised skills, which are not readily avail-
able in even the biggest organisation. This gives a strong argument for third-party carriers.
Large transport companies can support the management teams with specialist skills,
knowledge and experience of different conditions. A supporting argument says that an
organisation with weak transport management suffers as it gives worse performance than
competitors and becomes uncompetitive; one with strong transport management may be
diverting valuable talent from the rest of the business.

● Recruitment and training: As well as being the most widely used, road transport is generally
the most labour intensive. This gives high employment costs. There is also a shortage of
skilled drivers, with many organisations finding it difficult to recruit and train suitable
people. Both of these give an incentive to use third-party transport.

There are many factors to consider in the final decision, but overall – in common with
warehousing – there is a clear trend towards third-party carriers. Many organisations –
including the biggest – are reducing their own fleets, using more contract operators, and
forming alliances. Again in common with warehousing, a common option is to use a mixture
of own account and third-party carriers. Then an organisation can use its own transport for
core activities, with full utilisation giving low costs. Any other transport needs are left to
outside operators who deal with peaks and unusual demands.

Other services

An organisation can pass all its transport problems to a third-party carrier, but there are many
other people who can offer their own specialised services. These can provide the special skills
that are not usually available within a single organisation. Some organisations give fairly
general advice, such as management consultants who work in logistics, and software compa-
nies that tailor packages for transport. Other experts give more specific services, such as freight
forwarders and shipping agents. Many people might help with transport, and you can get the
feel of their services from the following examples.

● Common carriers: As we have seen, these move materials between two points for any
customer, usually in a one-off delivery using common facilities.

● Contract carriers: These offer transport services, but usually for a longer time. They take
over some, or all, aspects of an organisation’s transport for an agreed period. There are
many possible arrangements, but they typically involve dedicated facilities set aside exclu-
sively for one organisation.

● Intermodal carriers: Traditionally carriers have concentrated on one type of transport, such
as shipping lines or road haulers. With the growth of intermodal transport, many compa-
nies offer a wider range of services and operate different types of transport. They typically
look after all aspects of a journey between two specified points.

● Terminal services: Materials have to switch from one mode of transport to another, or
move between different operators. These transfers may be done at ports, airports, termi-
324 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

nals or container bases, which are run by separate organisations. The terminals do more
than just transfer materials, and they might unload delivery vehicles, sort goods, break
bulk for local delivery, concentrate goods for onward movement, load outgoing transport,
keep track of all movements, and provide any other relevant services.

In this context you might hear of demurrage. Terminals earn money from their throughput,
which they want to be as fast as possible. Any goods that are not collected as soon as they
become available take up space and get in the way of other movements. To encourage compa-
nies to collect their materials promptly (perhaps within a day or two), terminal operators
charge demurrage, which is a penalty for late collection and storage.

● Freight forwarders: One problem with third-party carriers is the expense of moving smaller
loads. Unit transport costs fall with increasing quantity, and transport now focuses on
standard loads, such as a full container load. If you only have enough material to fill part
of a container, you have the obvious choice of leaving empty space – but then you are
paying to move a whole container and only using part of it. An alternative is to use a
freight forwarder. These are people who collect relatively small loads, and consolidate
them into bigger loads travelling between the same points. A freight forwarder might, for
example, combine six or seven smaller loads to get a full container, giving lower unit costs
and faster delivery. Freight forwarders also provide all the administration needed to move
materials through their journey, such as documentation, customs clearance, insurance,
and so on.

● Brokers: A broker acts as an intermediary between customers and carriers. Effectively, they
look at the goods to be moved, find the best routes and carriers and negotiate conditions.
There are also specialised brokers who assist with particular parts of the journey, such as
customs brokers who prepare the documents needed for customs clearance, get materials
through customs and move them across international borders.

● Agents: These are usually local people who represent, say, shipping companies. They give
a local presence and act as intermediaries between distant carriers and local customers,
exchanging information, arrangements, and so on.

● Parcel services: These are similar to a Post Office, as they deliver small packages to any loca-
tion. Companies such as Federal Express, United Parcel Service (UPS) offer very fast deliv-
eries to almost any location in the world. Their strength is customer service, as they offer
guaranteed next day delivery over long distances.

L O G I S T I C S
I N P R A C T I C E
Christian Salvesen
In 1846 Christian and Theodore Salvesen a lot of growth, restructuring and change
founded a shipping and fishing company in of focus. In 1997, it demerged its remain-
Norway. Their company has been through ing non-core activities and after restructur-
 TRANSPORT 325

L O G I S T I C S
I N P R A C T I C E
continued

ing in 1999 concentrated on its role as a their European Logistics Centre at Milton
major European logistics business. Their Keynes, with rapid delivery guaranteed by
aim is, ‘to manage clients’ supply chains Christian Salvesen.
seamlessly across Europe under the single At the centre of the operations is Christ-
brand of Christian Salvesen’. They now ian Salvesen’s SHARP (Shipments Handling
work in partnership with manufacturers And Reporting Programme). Every evening
and retailers, controlling stock, and making DaimlerChrysler enter the requirements of
sure that goods are delivered to customers each dealer into this, and the parts are
precisely when they are needed. To support loaded onto large double-decked articu-
this, they have a fleet of 2500 vehicles, lated trucks at Milton Keynes. These leave
5500 trailers and 14,000 staff working at between 1900 and 2200 and travel to 11
160 sites. feeder depots around the country. At the
One of Christian Salvesen’s major con- feeder depots they have an hour to transfer
tracts is to distribute parts for Daimler- parts to local delivery vehicles. There are 35
Chrysler in the UK. The problem is making of these, each of which delivers to up to 11
sure that 300 franchised Mercedes-Benz dealers, starting at midnight and finishing
and Chrysler dealers have adequate sup- by 0800.
plies of parts. The obvious option of having
Sources: company reports and website at www.
big stocks at each dealer is too expensive,
salvesen.com
so DaimlerChrysler meet demand from

ROUTING VEHICLES

Any organisation involved in transport has to consider many types of problem. We have
discussed some of the most important, but there are always operational details to consider. The
number of vehicles needed, type and size, special features required, routes used, assignment of
loads and customers to vehicles, schedules, maintenance schedules, measures of service and
quality, and so on. We cannot look at all these problems, but we can illustrate some principles
by looking at the question of routing vehicles.
A basic routing problem looks for the best path for a delivery vehicle around a set of
customers. There are many variations on this problem, all of which are notoriously difficult to
solve. You can see this in the basic ‘travelling salesman problem’. Imagine a salesman who has
a number of customers to visit before returning home, and he or she wants to find the shortest
journey (illustrated in Figure 12.3). This seems like a simple problem, until you think about
the huge number of possible routes that have to be considered and compared. As we saw in
Chapter 6, the number of possible routes is n × (n–1) × (n–2) × (n–3) … 3 × 2 × 1, where n is
the number of customers to visits. For a problem of any size, it is impossible to imagine the
huge number of possible routes, let alone compare them and find the best.
326 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

Home

Figure 12.3 The travelling salesman problem

The travelling salesman problem is the basic routing problem, and real problems are much
more complicated. They typically contain factors such as a fleet of different types of vehicles,
multi-compartment vehicles, incompatible products, different logistics facilities, time
windows for deliveries, varying speeds caused by traffic conditions, customers with different
importance and conditions for deliveries, competing aims, variable delivery times, special
equipment needed for some deliveries, uncertain costs, separate schedules for vehicles and
drivers, and so on.
Many methods have been suggested for tackling routing problems but, like location, there
are two general approaches. The first uses geographical arguments to look for the best routes,
regardless of the actual roads. The second looks at the road network and finds shortest routes
through it. Because of the increasing sophistication of electronic maps, the second of these is
probably becoming more popular. The following list suggests some specific methods that have
been proposed.

1. Negotiations: Finding acceptable routes is so complicated, with many subjective factors

and people affected, that the best approach is often to negotiate a solution. This may not
give the best technical answer, but it has the support of everyone concerned.

2. Adjust previous plans: Many routing problems are fairly stable, like postmen delivering
letters. Then a useful approach has an experienced router reviewing present circumstances
and updating previous routes to allow for any changes. This has the benefit of being rela-
tively easy and causing little disruption. It also uses a well-understood procedure and
experts can give results that are trusted by the organisation. Unfortunately, the results can
also be of variable and uncertain quality, the routes may take a long time to design and
they rely solely on the skills of a router.
 TRANSPORT 327

3. Other intuitive methods: These include a range of methods that use the skills, knowl-
edge and experience of routers, who typically use a series of heuristic rules that have been
successful in the past.

4. Maps: Schedulers often find it easier to work with some form of diagrams, and the most
popular are simple maps of key features. Then schedulers can draw routes and iteratively
improve them. There are many guidelines to help with this, such as forming routes that
are more or less circular, non-intersecting, no doubling back, and so on. Graphical
approaches have the advantages that they are easy to use and understand, but they are
really only one step better than an intuitive method.

5. Spreadsheet calculations: Using maps can show overall patterns, but they lose some of
the details. An alternative is to concentrate on spreadsheet calculations and look at the
patterns in the numbers. A common format for this lists the customers to be visited down
the left-hand side and the time periods across the top.

6. Simulation: Simulation is one of the most flexible approaches to solving problems. It

gives a dynamic view by imitating real operations over a typical period. Suppose that you
want some information about proposed routes. You could sit in cabs and watch the
process for some time, and see what was happening. This might give a good idea of the
normal operations, but it would take a long time to get results and people may not work
normally while there is someone watching. An alternative is to simulate the process. You
use a computer to generate some typical features of the journey, and follow progress
through the process. Rather than watching and timing a customer being served,
for example, a computer generates typical service times – and any other features that
you want.

7. Expert systems: These specialised programs try to make computers duplicate the thinking
of a skilled scheduler. The basic skills, expertise, decisions and rules used by experts are
collected in a knowledge base. A router then passes a specific problem to an inference
engine, which is the control mechanism. This looks at the problem, relates this to the
knowledge base and decides which rules to use for a solution. Expert systems have been
developing for many years, and some organisations report useful results.

8. Mathematical models: Most of the previous approaches rely, at least to some extent, on
the skills of a router. More formal mathematical approaches give optimal – or near
optimal – solutions without any human intervention. In practice, routing has to include
so many subjective and non-quantifiable factors, that optimal solutions in the mathemat-
ical sense may not give the best answers for the organisation. The most common mathe-
matical approach uses linear programming. These methods are rather complicated, so
they are generally limited to small problems. If, however, you have a problem where small
changes in routes may give significant difference in costs, it is certainly worth looking at
mathematical approaches.

There is a lot of standard software for tackling routing problems, such as Paragon, CAST
and Optrack. Some of this uses standard procedures, but suppliers are often reluctant to
publish details because of confidentiality. It can be a difficult job to compare all the software
available and find the approach that best suits your needs.
328 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

W O R K E D
E X A M P L E

A depot sited at (120,90) has to make deliveries to 12 customers at the following loca-
tions, and then return back to the depot. What is the best route?
Customer X co-ordinate Y co-ordinate

1 100 110
2 120 130
3 220 150
4 180 210
5 140 170
6 130 180
7 170 80
8 160 170
9 180 130
10 80 50
11 100 60
12 140 80

Solution
Real routing problems can have hundreds or thousands of locations to visit, and huge
numbers of complicating factors. This very simple problem has 479,001,600 possible solu-
tions from which we have to evaluate and pick the best. There are methods of doing this,
usually included in routing software. One simple package gave the solution shown in
Figure 12.4. You might check that this is the optimal result.

250

4
200
6
5
8
150 3

2
9
1
100

7
12

50 11
10

0
0 50 100 150 200 250

Figure 12.4 Solution to routing problem

CHAPTER REVIEW ■ ■ ■ ■ ■ TRANSPORT 329

❑ Transport is responsible for the movement of materials between facilities in

the supply chain. It involves many related decisions about the best mode,
ownership, organisation, routes, and so on.
❑ Transport is an essential part of logistics. e-Commerce can deliver intangible
materials, but most products include goods which need transport for delivery
to customers.
❑ There are five basic modes of transport – rail, road, air, water and pipeline.
Each of these has different features and is best in different circumstances.
❑ The best transport between two points is usually intermodal, using the best
mode for each leg of a journey. Transfers between modes can cause problems,
so the aim is to create a seamless journey that combines the advantages of
different modes.
❑ Organisations have a choice between owning their own transport, using third-
party carriers, or some combination of the two. The best alternative depends
on a number of factors, but there is a clear trend towards outsourced transport.
❑ Transport managers have to tackle many other problems. One concerns the
routes to be used by vehicles. This is a surprisingly difficult problem, and
many ways of tackling it have been suggested.

C A S E S T U D Y Mount Isa Mines

Mount Isa Mines is one of the world’s great metal mines. Its main operations are at
Mount Isa, in Queensland, Australia, where it mines adjacent deposits of copper
and silver–lead–zinc ores. Production levels change with world demand and prices,
but in a typical year 7 million tonnes of ore are mined to give 150,000 tonnes of
copper and lead (containing silver) and 200,000 tonnes of zinc.
Mount Isa has serious transport problems. It produces huge quantities of ore in a
remote area of Australia, while the main demand for finished metals is in the
industrialised areas of the world, particularly Europe. The problem is to process the
ores and move them to final markets as cheaply as possible.
You can see the scope of the problem from an outline of the journey for copper. This
starts with underground explosions to break up the ore body. The broken ore is collected
by front-end loaders and put onto ore trains that carry it to underground crushers. The
crushed ore is then hoisted to the surface and stored in crude ore bins, with a capacity
of 60,000 tonnes. A conveyor moves ore from these bins to another crusher, where it is
reduced to about 10 mm, and passed to fine ore bins. The ore then goes to a rod-and-
ball crusher for fine grinding, and is pumped to a floatation process, which produces a
330 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

C A S E S T U D Y continued

concentrate of about 25% copper. This concentrate is passed to smelters that roast it to
remove some of the sulphur, smelt the roast product to remove iron and silica and leave
a copper matte, and then oxidise the matte in a converter to remove more sulphur. The
result at this stage is impure copper. This is sent to a casting furnace to remove most of
the remaining impurities, and cast the copper into 300 kg ingots.
These operations are all carried out at the mine site, so there are two main logis-
tics problems. The first moves huge quantities of materials from the mine to world
markets, and the second moves materials needed by the mine, smelters and other
operations into the remote site.
The copper ingots are taken by train to Townsville, 800 km away on the coast,
for electrolytic refining, which removes any remaining impurities and gives almost
completely pure copper. These facilities have a capacity of over 150,000 tonnes a
year. At this point the copper is cast into its final form, of cake, bars, rods and wire.
These are driven to the nearby port where they are shipped around the world.
Copper is only one of Mount Isa’s products, and it has similar transport problems
with lead and zinc. It also mines coal and gold, has organised its transport opera-
tions into a separate company, generates electricity and supplies water for the city of
Mount Isa, and is involved in a wide range of mining and associated ventures.

C A S E S T U D Y
Questions
● How important do you think transport is for the operations at Mount Isa?
● What alternatives are there for transport? What are the current arrangements and how
might they be improved?
● Do other mining companies have similar transport problems?

P R O J E C T

Toorvik Transport Consultants

You have recently started work for Toorvik Transport Consultants, and are tackling your first study for a
major customer. This customer buys electronic games from Japan, Singapore and Taiwan and imports
them to Scandinavia. Now it is considering replacing some of the increasingly expensive games from
Japan with cheaper models from China. How would you set about finding the different options for trans-
porting these games? How would you start comparing these options?
 TRANSPORT 331

DISCUSSION QUESTIONS

1. ‘Transport is becoming increasingly less important, as e-commerce and other develop-

ments become widespread.’ Do you think that this is true?
2. What types of technology are used in transport? How do you expect this to change in the
future?
3. For most organisations road transport is the only realistic mode of transport. If this is
true, why do so many people disapprove of heavy lorries? Are there any noticeable trends
in the choice of transport mode?
4. One of the major trends in logistics is the move towards contract transport. Why?
5. An organisation with weak transport management suffers as it gives worse performance
than more competent competitors and becomes uncompetitive; one with strong transport
management may be diverting valuable talent from the rest of the business. What does
this argument mean for transport management within an organisation?
6. There has been a huge amount of work done to develop optimal solutions to routing
problems. In reality, most of this work remains theoretical and has not been imple-
mented. Why is this?

REFERENCES
1. Office for National Statistics, (2001) Annual Abstract of Statistics, HMSO, London.
2. Ashford M. and Porter K. (1995) Exploiting the open frontiers of Europe, Logistics Focus, 3(8), 2–6.
3. Department of the Environment, Transport and the Regions (2001) Transport Statistics, HMSO, London.
4. www.transtat.dtlr.gov.uk.
5. Cochran I. (1999) UK shipping, Logistics and Transport Focus, 1(2), 22–5.
6. Karundawala G. (2000) World trade, Eighth Annual CIT Sri Lanka’s conference, Colombo.
7. Anon. (2001) UK marine motorways study, Logistics and Transport Focus, 3(4), 39.
8. Packer J.J. (1997) Roads-to-water revisited, IAME Conference, London.
9. www.logistics.som.hw.ac.uk.
10. Lewis C. (2000) Fortune favours the brash, Logistics and Transport Focus, 2(4), 26–8.
11. Lewis H.T., Culliton J.W. and Steel J.D. (1956) The Role of Air Freight in Physical Distribution, Harvard
Business School, Boston, MA.
12. Anon. (1965) The Bay unveils new container strategy, Materials Management and Distribution, December,
p. 11.
13. Union Internationale Rail Route (2001) Transport Statistics, UIRR, Brussels.
14. Grainger A. (2000) Globalisation – implications for supply chains, Logistics and Transport Focus, 2(2), 46–7.
15. Waters C.D.J. and Soman S.B. (1990) Containerised freight transport in developing countries, Canadian
Journal of Development Studies, 9(2), 297–310.

Further reading
Bamford C. (2001) Transport Economics, Heinemann, London.
Hensher D. (2001) Transport – An Economic and Management Perspective, Oxford University Press, Oxford.
 CHAPTER 13

Global Logistics

CONTENTS

■ Aims of the chapter ■ Chapter review

■ International trade ■ Case study – O’Daid Group
■ Problems with international ■ Project – Parcel transport
logistics ■ Discussion questions
■ Organising international ■ References
operations ■ Further reading

AIMS OF THE CHAPTER

After reading this chapter you should be able to:
■ A P P R E C I AT E the importance of international trade and its
effect on logistics
■ D E S C R I B E the factors that encourage international trade
■ D I S C U S S the main difficulties met with international logistics
■ O U T L I N E some effects of border customs
■ O U T L I N E different ways of entering an international market
■ D E S C R I B E different structures for international organisation
 GLOBAL LOGISTICS 333

INTERNATIONAL TRADE

Logistics and the economy

Despite short-term fluctuations in the economic climate, international trade continues to grow
at a remarkable rate. Leontiades1 notes that:

One of the most important phenomena of the 20th century has been the international expansion of
industry. Today, virtually all major firms have a significant and growing presence in business outside
their country of origin.

This trade is based on the recognition that an organisation can buy things from a supplier in
one country, use logistics to move them, and then sell them at a profit to a customer in
another country. Improved communications, transport, financial arrangements, trading agree-
ments, and so on, mean that organisations search the world to find the best location for their
operations. Then international logistics move the related materials through long and complex
supply chains.

I N T E R N AT I O N A L L O G I S T I C S occur when supply chains cross national frontiers.

In principle, international trade does not necessarily lead to international companies. In

practice, however, the two are inseparable. If an organisation moves into a new country, it can
keep a close check on new operations by controlling these from existing headquarters and
giving local operations very little autonomy. This is, however, inflexible, and it does not allow
local organisations to adapt to their own conditions or develop skills. An alternative is to
devolve decisions. Then a company might become international (maintaining its headquarters
in the home country and running worldwide activities from there), multinational (opening
subsidiary headquarters around the world so that each area is largely independent) or global
(treating the whole world as a single, integrated market). The distinction between these may
not be so clear, and an organisation may choose other formats, perhaps working internation-
ally in one area and multinationally in another.
Perhaps half of the trade between industrialised countries is accounted for by trade
between subsidiaries of the same company.2 In developed countries this is particularly notice-
able, with a third of US exports being products sent by American companies to their overseas
subsidiaries, and another third being products sent by foreign manufacturers back to their
home market.
Some people prefer the term global logistics, to suggest integrated operations in an inter-
national setting. This can bring a whole range of new problems. Some of these are practical,
such as physically moving materials across a frontier and organising transport over longer
distances; some are cultural, such as speaking new languages and meeting different customer
demands; some are economic, such as paying local taxes and tariffs.
It is patently obvious that the world is not a single homogenous area. There are differences
in terrain, physical features, climate, infrastructure, population density, economic strength,
political systems, cultures, and just about everything else. From a logistics point of view, any of
these factors can give problems – it is, for example, more difficult to cross some national
borders than it is to cross a mountain range, and a truck driver crossing Europe must adapt to
repeatedly changing customs and languages.
334 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

One factor that is always important for logistics is the economic strength of a region. In
general terms, stronger economies:

● move more materials, as they can afford to consume more products

● have more efficient logistics, due to better infrastructure, systems and support.

Greater prosperity allows efficient logistics, but there is a cycle and efficient logistics can
actively contribute to prosperity. As well as giving employment to a large part of the popula-
tion, logistics can encourage economic growth. The argument is that lower costs for logistics
reduces the cost of delivered products – and thereby encourages sales, increases trade, opens
new markets, breaks down local monopolies, increases competition and generally encourages
business. This effect was noticed by Adam Smith who wrote in 1776: ‘Roads, canals and navi-
gable rivers … (are) the greatest of all improvements.’3
Porter4 looked at the reasons why nations are prosperous and said that ‘a nation’s ability to
upgrade its existing advantages to the next level of technology and productivity is the key to
its international success’. He listed four important factors for this:

● factor condition – which is a nation’s ability to transform basic factors such as resources,
education and infrastructure into competitive advantage
● demand conditions – such as market size, buyer sophistication and marketing
● related and supporting industries – which include logistics, partners and intermediaries
● company strategy, structure and competition – which give the market structure and features
of domestic competition.

You can see that logistics appear – at least implicitly – several times on this list. To put it
simply, trade increases prosperity, and trade depends on logistics.

Factors that encourage international trade

Governments have given almost universal support for increasing trade. Over the years they
have signed many international agreements on trade, and have formed a range of organisa-
tions like the General Agreement on Tariffs and Trade (GATT), Organisation for Economic Co-
operation and Development (OECD), and World Trade Organisation (WTO). There have also
been significant developments in free-trade areas, such as the European Union, North Amer-
ican Free Trade Agreement, Association of South-East Asian Nations Free Trade Area and
Southern Common Market of South America.
Largely as a result of these policies world trade continues to grow. The growth was about
10% in 2000 and 7% in 2001, compared with an average of 6.5% for the period 1990–99.5
The value of merchandise exports in 2001 was about $6 trillion with commercial services
adding another $1.5 trillion. The following list shows some factors that encourage this inter-
national trade:

● Growing demand in new markets: Many regions of the world are becoming more prosperous
and are consuming more goods. Foreign companies recognise the opportunities in these
growing markets and expand to sell their products in new markets.

● Demand for foreign products: Customers travel, watch television and use the Web to see
products available in different areas. They demand new products that cannot be supplied
by domestic companies.
 GLOBAL LOGISTICS 335

● Convergence of market demands: Centralised manufacturing only works if different markets

accept the same products – or at least products with minor differences in the finishing.
There is clear evidence for a convergence in tastes – which Ohmae calls ‘Californianisa-
tion’6 – which allows Coca-Cola, McDonald’s, Toyota and Sony to sell the same products
in virtually any country.

● Removal of trade barriers: One of the major forces towards global free trade was the General
Agreement on Tariffs and Trade (GATT) which stipulated that all its members should be
treated equally. Countries in several regions have taken this idea further to create free
trade areas. These have encouraged trade by easing trade restrictions and reducing tariffs,
and are one reason why the amounts collected as tariffs fell from 20% of trade in the
1950s, to 7% at the beginning of the 1990s, and 3% by 2000.7,8

● Manufacturers aiming for economies of scale: There have been significant changes in manu-
facturing operations, many of which depend on, or work best with, a stable, large-scale
production. The best size for these facilities is often larger than demand from a single
market. The result is centralised production, with economies of scale giving lower unit
costs that more than cover any increased costs of logistics.

● Specialised support: As we have already seen with warehousing and transport, many organ-
isations are concentrating on their core competencies and are outsourcing other activities.
A major industry has grown of specialised support companies that can help with, say,
exporting, international transport, trade credit, foreign exchange, customs clearance, and
so on.

● Integration of the supply chain: Integration of the supply chain works towards a smooth
movement of goods from initial suppliers through to final customers. This only becomes
possible when national frontiers are transparent, and this means that the same organisa-
tion has to work on both sides of the border.

● Greater demands on suppliers: Customers are putting more demands on suppliers –

including just-in-time operations, total quality, strategic alliances, customisation, and so
on. Local suppliers may not be able to meet these demands, and organisations may have
to look further afield to find the best sources.

● Changing practices in logistics: Developments in logistics can make trade easier. Containeri-
sation, for example, made the movement of goods easier, cheaper and more reliable. This
encouraged many companies to move profitably into new markets. Similarly, ‘postpone-
ment’, allows products to finish manufacture at a later point in the supply chain and be
more flexible to customer demands.

● Improved communications among customers: Satellite television, the Internet and other
developing communication channels have made customers more aware of products from
outside their local regions. This has stimulated demand in new markets, increased brand
recognition and encouraged convergence in tastes and product demands.

● Improved communications in business: Developments in information systems – ranging

from EDI to on-board systems in vehicles – can fundamentally change the way organisa-
tions work. They allow more flexible operations, including efficient logistics in even
remote areas.
336 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

L O G I S T I C S
I N P R A C T I C E
Europeanisation of logistics
A single market was created within the ■ There has been a significant increase in
European Union in 1993. This has had a the number of warehouses serving more
considerable effect on logistics and wider than one country – and a clear trend
operations. The amount of trade within the towards pan-European logistics centres
European Union has continued to grow, ■ Service levels are continuing to rise to
with more companies working internation- meet more demanding international
ally, and seeing the whole of the Union as customers
their market. ■ Opportunities for cost reduction and
Some specific changes are contributing enhanced customer service have raised
to the ‘Europeanisation’ of business. the profile of logistics as a core function
■ EDI has become an essential part of
■ Companies are integrating their opera-
logistics.
tions in different countries, using com-
mon processes and logistics practices Sources: Hefflinger T. (2002) European Logistics,
■ There is rationalisation of supply chains, THCo, Brussels; O’Sullivan D. (1995) Logistics in
with half of companies reducing the Europe, Logistics Focus, 4(6), 9–11

number of facilities they use

■ Rationalisation has lowered the costs of
stock, warehousing and materials

Effect at an organisational level

It is easy to talk about world trade and say that, ‘world exports of office and telecom equip-
ment rose by 10% to nearly $770 billion …’.9 But these aggregate effects come from thousands
of individual organisations deciding to expand their operations into new areas. More and
more companies are doing this and working internationally but what makes them move in
this direction? The single most important factor must be the organisation’s product, and its
suitability for international trade. The product that illustrates this best is the car.
Car manufacturers are among the biggest international operators. They buy materials and
components from suppliers around the world, bring everything to central assembly plants,
and then ship finished cars out to customers, who again might be anywhere around the world.
This system works because of the huge economies of scale for car assembly, and the ability of
logistics to move materials through international supply chains.
You can see the same effect in many manufacturers who aim for economies of scale by
concentrating production in a single facility. A computer manufacturer, for example, might
make keyboards in Brazil, monitors in the UK, speakers in France, motherboards in Singapore,
disc drives in Japan, cases in China, and so on.
The reason why these companies can work internationally is that logistics is efficient
enough to have a relatively small impact on the overall cost of the final product. This is meas-
ured by the value density.
 GLOBAL LOGISTICS 337

The VA L U E D E N S I T Y is the ratio of a product’s value to its weight or size.

Products with low-value density, like soft drinks, are expensive to move and logistics can
form a significant proportion of their final cost. This encourages smaller suppliers who serve
local needs. On the other hand, logistics adds a relatively small amount to the cost of high-
value density products, such as computers. This encourages a few main suppliers to serve wide-
spread, or global, needs.
There are, of course, many other product features that affect the feasibility of international
operations. A well-known brand name can make international operations more attractive, and
Nike, for example, can compensate for generally low-value density products by charging
premium prices. Beer also has a low-value density, but some brands have well-established
names, and significant economies of scale allow these to meet international demand from a
few large breweries. The stage in a product life cycle is also important. Near the beginning of
the life cycle profits are high and short lead times are more important than cost, thus encour-
aging local supplies. Later in the cycle, increased competition makes costs more important,
and these might be reduced by the efficient, centralised stocks and consolidated transport that
come with international operations.
Clearly some products are more suited to international trade than others. Some factors that
encourage local, rather than international, suppliers are products that:

● have relatively low value, or value density

● deteriorate or have short shelf life
● are sensitive to cultural and other differences
● have little differentiation between competitors, or brand loyalty
● need high customer contact or personal service
● have less emphasis on cost
● give limited economies of scale in production
● generate social or political pressures to produce locally
● have uneven development of markets.

L O G I S T I C S
I N P R A C T I C E
Trifast plc
TR Fastenings was formed in 1973, and was Trifast used to make nuts and bolts, but
floated on the London Stock Exchange in they had problems with fierce competition
1994 as Trifast plc. By 1998 it employed at a time when customers were shortening
700 people, mainly in Uckfield, Sussex, their supply chains and reducing the num-
where its main product was fasteners – like ber of suppliers. To become more competi-
nuts and bolts. Although 90% of its cus- tive, Trifast had to expand, and decided to
tomers are companies that originated in move into Asia, Europe and the USA. Their
the US or Japan, 90% of its sales actually strategy for expansion was to move from
occur within the UK. being a manufacturer of nuts and bolts to
338 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

L O G I S T I C S
I N P R A C T I C E
continued

being a service provider. Typically they visit details of the delivery. The most sophisti-
a manufacturer, analyse their products, cated system has Trifast taking full responsi-
design exactly the type of fasteners needed, bility for delivering components directly to
and then supply them. More than 60% of bins on an assembly line.
this trade comes from the electronics indus- As one example of their work, Trifast
try. Trifast cannot make all the fasteners delivers 500 different parts directly to the
themselves, so they source and manage the assembly lines of seven Lear plants in Swe-
supply. This gives the opportunity to diver- den. They store 150 tonnes of materials in a
sify. While they are managing the supply of central warehouse and replace 64 separate
fasteners, they can easily arrange the sup- suppliers.
ply of associated parts, such as springs, Trifast started its international expansion
plastic ties and pulleys. Then they can do by buying manufacturing plants in Singa-
some work on these, assembling parts into pore and Malaysia. It had considered open-
components – or kitting. This adds value for ing distribution centres, but the stocks
Trifast, and brings benefits to manufactur- needed were too high. They then acquired
ers, who have a guaranteed supply of mate- companies in Ireland, Norway and Sweden,
rials, but only deal with one supplier. and established new companies in France
Trifast’s philosophy is now to form sup- and Hungary. They now have six manufac-
ply partnerships with manufacturers and turing plants, 30 distribution divisions, an
their major sub-contractors. Through these annual turnover of £122 million, 1000
partnerships they manage the supply of fas- employees, and carry 100,000 product
teners and just about any other high- lines.
volume, low-cost component. They have
Sources: company annual reports; Lawless J.
six systems for this. The basic system has a
(1998) Challenges of going global, Sunday
manufacturer faxing or e-mailing a list of Times, 26/4/98; website at www.trifast.com
materials it needs, and Trifast manages all

PROBLEMS WITH INTERNATIONAL LOGISTICS

Differences in logistics

International logistics are different from national logistics, and it is not just a case of moving
the same activities to another location. We can list some of the common differences as follows:

● international trade usually has much bigger order sizes, to compensate for the cost and
difficulties of transport
● international markets are more erratic, with large variations in the demand and impor-
tance of any market
● most organisations have less experience with international logistics, so they are working
in areas where they have less expertise
 GLOBAL LOGISTICS 339

● there are more intermediaries, such as freight forwarders and customs agents
● the intermediaries and distances involved make relations with customers more difficult
and remote
● communications become more difficult at a distance and across cultures
● terms of trade vary and may be unfamiliar
● financial arrangements can be less certain
● documentation is more complicated.

International trade is always difficult. If you imagine a simple transaction, where an organ-
isation buys materials in one country, and arranges for them to be delivered to another
country, you can begin to see the complications. It is not just a question of sending someone
to another country to pick up the materials and bring them back. Also included are interna-
tional banks to arrange the finances and exchange currencies, one government’s regulations
on exports and another government’s regulations on imports, customs clearance with duties
and taxes, transport operations in both countries, some mechanism for transferring materials
between transport operators and across borders, translators for documents written in different
languages, lawyers to check the contracts and conditions, and so on. As you can see, there is a
surprising number of people involved in even a small transaction.
As with all logistics, a vital concern is the flow of information. This is obviously more diffi-
cult at a distance, and across borders. Unfortunately, it is also more important to have efficient
information systems for long international supply chains, where there are more opportunities
for things to go wrong. If a delivery is delayed at a border, both the supplier and customer
want to know exactly what is happening, and how to solve any problems. But if the border is
in a remote area, it can be difficult to get any information, let alone an accurate account of the
situation. Intermediaries who help the flow of materials may actually cause problems with
information flows. If several people are working on different aspects of movement, it may be
difficult to co-ordinate their activities or assign responsibilities. Developments in mobile
communications and EDI can certainly improve information flows, and some organisations
are using this to get an advantage over their competitors. Other improvements come with the
removal of trade barriers and harmonisation of business practices.

Problems with trade

Of course, the administrative difficulties are only one type of problem for international trade.
As the European Union moved towards a single market, it identified three types of barrier:

● physical barriers, such as border controls and customer formalities

● technical barriers, such as differing health and safety standards
● fiscal barriers such as different rates of value-added tax and excise duties.

We can add some details to this list to show some of the issues for international logistics. These
might appear at every border, and circumstances can change within a very short distance.

● Political and legal systems: The type of government and laws in different countries give
significantly different conditions. Practices that are accepted in one country may be unac-
ceptable in a neighbour. You can imagine one example from the past when Germany was
divided. Simply stepping from West Germany to East Germany meant a change from a
free market economy with systems aligned to western Europe (including private trans-
port) to a centrally planned economy with systems aligned to the east (including nation-
alised transport).
340 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

● Economic conditions: Political systems directly affect the economy, and there are significant
differences in prosperity, disposable income and spending habits. Sometimes there are
very rapid changes, between, say, the borders of the USA and Mexico or Austria and the
Czech Republic.

● Competition: This varies between very intense, market-driven competition in some coun-
tries, to state run monopolies in others. Logistics in, say, the Netherlands is particularly
well developed and companies compete for business over a wide area.

● Technology available: Many logistics companies use sophisticated technologies for

e-commerce, efficient customer response, satellite location, in-cab navigation, real-time
routing, total communications, and a whole range of other developments. Although such
technology is feasible, it does not mean that everybody uses it. Most of the world does
not have access to, does not need, or cannot afford the latest technological development.
In many areas the movement of loads depends on manual effort and bullock carts, and a
lorry is the most advanced technology available.

● Social systems and culture: It is usually easier to trade with someone who has similar
culture, habits, expectations, and so on. Even language differences give problems, so it
would be easier for a company working in Belgium to open new facilities in France rather
than, say, Sudan. You might assume that these differences are only important if dealing
with widely separate locations, but there are many examples of people who live very close
together, but seem to have little in common.

● Finance: There are many financial factors to consider. Some countries do not allow their
currency to be taken out of the country, the value of some currencies fluctuates wildly or
falls quickly, some banking systems are inefficient, sometimes exchanging money is diffi-
cult, and so on. A different type of problem comes with customs duties and tariffs for
materials entering the country. We mention some of these in the next section.

● Geography: Transport is generally easier in straight lines over flat terrain. Crossing the
American prairies is easy, but very few areas are laid out like this. Physical barriers that
hinder transport include seas, mountain ranges, desserts, jungles, rivers, cities, national
parks, and so on.

It is often the practical details that make the movement of materials across international
frontiers time-consuming and irritating. You often hear of deliveries that are held up for days,
simply because the driver cannot speak the same language as the customs people. Surveys typi-
cally suggest that the main problems found by exporters are as follows:

Main problem Percentage of exporters

Export documentation 23
Transportation costs 20
High import duties 17
Cannot find foreign representatives
with enough knowledge 16
Delay in transfer of funds 13
Currency fluctuations 12
Language barrier 10
Difficult to service products 10
 GLOBAL LOGISTICS 341

L O G I S T I C S
I N P R A C T I C E
Border crossings
Crossing international borders can be very There a Mexican haulier picks up the trailer,
time consuming. Trucks driving across the and organises the journey onwards and to
European Union might cross most borders the customer. This haulier then returns the
without even slowing down, but when they empty trailer near to the border, where a
hit the Polish border they might be delayed cartage agent again moves it through cus-
for days rather than hours. You can see some toms and across into the USA. Then the US
of the reasons for this when considering the haulier can pick it up and return.
border between Mexico and the USA. This system is unusual, but it is not
The North American Free Trade Agree- unusual to be held up at border customs.
ment (NAFTA) was signed in 1994 between The most common cause of delay is queries
the USA, Canada and Mexico. This allowed over paperwork. Customs agents can usu-
Mexico to protect local trucking companies ally sort this out fairly quickly, but EDI gives
by prohibiting USA and Canadian firms the opportunity for pre-clearance. An
from operating within Mexico for ten years. organisation sends a message ahead to a
Until this condition ran out, companies customs point that its vehicle is soon arriv-
moving materials across the USA/Mexico ing at a border. The message gives details
border needed some procedures for actu- of materials carried, owners, destination,
ally crossing the frontier. value, contact points, and any other rele-
For a USA to Mexico crossing a US vant information. If all goes smoothly, cus-
haulier delivers goods in a trailer close to toms clearance is agreed before the vehicle
the border. This company is likely to have arrives, and it can continue its journey with
lower rates than its Mexican counterpart, little interruption.
but it cannot move materials over the bor-
Sources: Helfont G. (2002) Customs Clearance in
der. A cartage agent takes over the paper-
NAFTA, Logistics Forum, Houston; Anon. (1994)
work and organises the trailer’s move Clearing customs, Materials Management and
through customs and across the border. Distribution, November, 24

Customs barriers

Conventionally, customs duty is payable whenever materials enter a country. In practice, there
is more than just customs duty, and it can be quite difficult to add all the taxes and duties to
calculate the amount payable. Materials entering the European Union, for example, might
have to pay customs duty, excise duty, import VAT, countervailing duties, anti-dumping duty,
Common Agricultural Policy levies, and compensatory interest. These tariffs are not neces-
sarily levied at the same rates, but there can be preferential rates. As an example, the duty on
a television tube entering the European Union from Malaysia is 14%, from Thailand is 9.8%,
from South Africa is 7.3% and from Poland is 0%.10
342 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

These are not the only costs of crossing a border, as companies have to pay the cost of
compliance with export/import regulations, such as compulsory documentation and informa-
tion requirements.
If materials cross a series of frontiers, they might have to pay these costs at every one. This
would obviously raise prices and limit trade. As part of a policy to encourage trade, most coun-
tries do not charge duties on materials that are simply moving through, so that duty only
becomes payable in the final destination. This is not always true, and sometimes charges are
made on goods in transit. Normally, materials can also use customs’ warehousing without
paying duty. This allows normal port and warehousing operations, with duty paid when the
materials are removed from the customs’ warehouse and taken to their final market. This idea
is extended in Free Trade Zones, which are duty- and tax-free areas within a country. These
zones give larger areas for port and warehousing operations, and usually work like a container
terminal. Even larger developments of this kind form customs unions. These are areas, like the
European Union, that agree not to charge duties within their borders. Duty is paid when mate-
rials enter the union – which is seen as the final market – but they can then move freely
without paying any more.
Of course, not everybody is in favour of removing barriers at international borders or
encouraging trade. They argue that there should be strict controls over exports and, more
particularly, imports. Thus considerations like excise duty and customs charges serve the main
purposes of:

● preventing goods that are considered undesirable from entering a country

● protecting domestic producers from foreign competition
● generating revenue for the host country
● collecting statistics on trade.

ORGANISING INTERNATIONAL OPERATIONS

Ways of reaching foreign markets

If a company wants to send its products internationally, it does not have to work internation-
ally itself. It can sell its products ex-works or free-on-board, which means that customers make
all the arrangements for logistics. Obviously, though, for such transactions to succeed,
someone has to work internationally – even if it is just the transport operator that physically
moves materials across the border. If you imagine a manufacturer wanting to sell its products
in a foreign country, it has five basic alternatives. The following list shows these in increasing
order of investment and risk.

● licensing or franchising, where a local organisation makes the products to designs supplied
by a foreign company; depending on circumstances, the foreign company might specify a
range of procedures for operations, quality, tests, suppliers, and so on

● exporting finished goods and using local distributors to market them; the main risk here
comes from increasing production to satisfy a demand that depends on the marketing
company

● setting up a local distribution network; products are still exported to meet demand but the
foreign company increases control of the supply chain by replacing the local marketing
company by an owned subsidiary
 GLOBAL LOGISTICS 343

● exporting parts and using local assembly and finishing; this needs facilities in the home
market, but these can start very small, as seen in ‘postponement’

● full local production with new manufacturing facilities either built specially or taken over
from an existing company. This gives access to local knowledge and is often the only way
of getting a presence in a controlled market.

A sixth alternative is to set up some form of joint venture with a local company. More substan-
tial facilities can be opened through a partnership, allowing shared ownership, management
skills, knowledge and risk. The level of commitment here can vary considerably, but local
conditions often limit foreign ownership to no more than 49% of any joint venture.
Each of the six alternatives involves different levels of investment and risk – and clearly put
different demands on the supply chain. The first two options use agents and do not involve
the manufacturer directly in international operations; the last four involve some kind of local
operations.
Opening full production can be very expensive and time consuming. When Nissan, Toyota
and Mazda wanted a presence in the European Union, they spent billions of pounds and years
of preparation opening new car plants in the UK. One faster way of getting a presence in a
foreign market is to buy a company that is already working there. If an organisation is already
working successfully in a market, then a larger company can buy it, inject cash and build on
its assets. This is how Wal-Mart moved into the UK by buying Asda, which was the third
biggest supermarket group.
Usually, organisations cannot afford this kind of investment or risk, and they adopt a more
cautious approach. Typically, they expand their operations in a series of steps. In effect, they
move down the list above, slowly increasing their investment and only moving on when each
previous stage has proved successful.

L O G I S T I C S
I N P R A C T I C E
Renfield Pharmaceuticals
Renfield Pharmaceuticals is a specialised attractive, Renfield move on to the
branch of a major Swiss manufacturer, spe- next step.
cialising in the treatment of hypertension
2. Send a team of field representatives.
and kidney damage. It works in many parts
These work with the local distributors,
of the world, and uses a standard proce-
and also collect orders directly for
dure for organising its expansion – or limit-
Renfield. They can get experience in
ing its risks in less successful markets. This
local conditions and make recommenda-
procedure can be summarised in the fol-
tions for the next step.
lowing steps:
3. Set up a local distribution network.
1. Export to local trading companies and
Occasionally Renfield buy local compa-
independent distributors. This gives lim-
nies that have been distributing their
ited sales, but it is a convenient way of
products. Usually, they start up their own
testing the market. If the market looks
344 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

L O G I S T I C S
I N P R A C T I C E
continued

marketing and logistics organisation, labelling, and passing to the distribu-

which works in parallel with local compa- tion company.
nies. Over time, preferential trading
5. After a reasonably long period of
terms allow the Renfield subsidiary to
successful and profitable operations,
take a dominant position in the market.
with forecasts of continuing growth,
It always uses local employees and
Renfield consider larger production facil-
resources, but there is strong control
ities. These typically make one or two of
from Renfield headquarters.
the company’s main products, together
4. If the subsidiary distribution company with limited production of associated
develops a sizeable and profitable material. The mix of products and size of
market, Renfield considers opening facilities depends on the country’s popu-
production facilities. In the first instance lation, economic conditions, trade and
this is usually a packaging plant. Ingre- monetary restrictions, education levels,
dients are sent in bulk from other raw materials, and so on.
Renfield plants, and the local plant
Source: company reports
arranges final production, packaging,

Alternative types of organisation

Decisions about entering international markets depend on factors ranging from the organisa-
tion’s strategy through to forecasts for economic growth. These are inevitably difficult, and
need a clear appreciation of the costs and operations involved.
The incentive for international operations must come from the business strategy, which
contains an aim of expansion. Then, perhaps the most important factor is that the new,
foreign operations must fit into the general structure of the organisation. The logistics and
other systems must be co-ordinated and work together. This includes a decision about whether
to work nationally, internationally, multinationally or globally. These terms are overused to
mean slightly different things, but essentially:

● National organisations only work within their home market; if they want a presence in
international markets, they export to marketing organisations in foreign countries.

● International companies have facilities in different countries, but their work is really
centred in one home country from which they control the activities of all subsidiaries.

● Multinational companies lose the central control and have loosely linked, largely inde-
pendent companies working in different geographical regions. The separate divisions
have more flexibility to adjust operations and products to local needs. Two dominant
company structures have divisions organised by geography or product. This is somewhat
misleading, as no organisation can use either of these exclusively. An organisation with
 GLOBAL LOGISTICS 345

geographic divisions still needs some broader co-ordination of each product supply chain,
and an organisation with product division still needs some regional structure.

● Global companies see the world as a single market; they usually make standard products
for shipment anywhere in the world, using the locations where they can work most effec-
tively and efficiently. Perhaps the main feature of global organisations is that they try to
co-ordinate all their activities as if they supply a single market. Coca-Cola, for example,
make the same products around the world, with all operations co-ordinated to meet
demand as efficiently as possible.

Some people suggest that these descriptions can be misleading as they suggest that organisa-
tions adopt a single approach to all their operations – they use the single ‘best’ way of
working. In reality, organisations have to be flexible and respond to local conditions, practices
and demands. This needs a looser structure that can include many different types of operation,
but gives a unified culture for the overall organisation. Such structures are sometimes called
‘transnational’.

Achieving global operations

Levitt summarised the features of a global organisation by saying:11

The multinational corporation operates in a number of countries and adjusts its products and prices in
each – at high relative costs. The global corporation operates with resolute certainty – at low relative
costs – as if the entire world (or major regions of it) were a single entity; it sells the same things in the
same way everywhere.

There are clearly advantages in working globally, from both a logistics and operations point
of view. Global organisations limit the range of products, concentrate research and develop-
ment, ensure economies of scale, remove duplicated functions, simplify management struc-
tures, simplify the product design function, use standard processes, generate widespread
expertise in products, give a unified marketing view, and so on. From a logistics point of view
global operations can ensure that facilities are in the best locations, and that the same prod-
ucts move between any combination of facilities and customers. If there is a shortage of prod-
ucts in Sri Lanka the standard products can be shipped from stocks in Brazil rather than wait
for the usual suppliers.
Ideally, then, organisations should aim for global operations, with their efficient operations
and single, seamless market and organisation. Unfortunately, many organisations find it diffi-
cult to implement the strategies needed to achieve these. There are many barriers and prob-
lems including the following:12

● different regions demand different types of product

● products do not lend themselves to global operations
● global products are not viewed favourably and are rejected by customers
● organisations lack the human and technical resources needed to compete globally
● organisations cannot develop the right structures and strategies
● managers in different regions have different objectives for themselves and the organisation
● there are other cultural and economic differences that make co-ordination difficult
● each region, and country within the region, has a different infrastructure and facilities.
346 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

These factors, along with many others, make it impossible for most organisations to have
global operations. Many organisations have started in this direction, but hit problems – often
very simple ones like products that offend local tastes, lack of infrastructure or transport to get
materials to their final destination. Such problems can even occur within relatively homoge-
nous regions, such as western Europe.
Because of the practical difficulties, global operations are often viewed as a conceptual
target rather than a realistic proposition. Nonetheless, there is clearly a trend for more compa-
nies to consider themselves as global.

Global supply chains

Managing the logistics of a global organisation is immensely complicated. It can involve the
movement of huge quantities of materials around the world. Unfortunately, there is no single
‘best’ model for a global supply chain that can be used by every organisation. Each organisa-
tion has to find its own solution. Nonetheless, we can mention some common results, and the
following list shows five common models for global logistics:

● Sell globally but concentrate production and sourcing in one area. Logistics then has a fairly
simple job of moving materials from local suppliers into the organisation, but there are
more problems with distribution from operations to international customers. To some
extent this model gives fairly easy logistics, as the organisation is a pure exporter with
global marketing rather than global operations. This can also be the most vulnerable to
external pressures, as it is seen as concentrating economic benefits in one centre.

● Concentrate production in one centre but buy materials and components from around the world.
Materials are now collected from distant suppliers, and products sold to distant
customers. This gives, perhaps, the most difficult logistics with potential problems for
both inward and outward logistics. It gives more widespread economic benefits, but the
main value-adding activities are still concentrated in one location.

● ‘Postponement’ moves the finishing of production down the supply chain. In a global context,
postponement typically opens limited local facilities to complete production. This gives
some opportunities for local value, but all components and parts are imported from main
production centres. Because of the limited local input, low added value, and competition
for local manufacturers, this kind of ‘screwdriver’ operation can be unpopular with host
countries.

● Operating as a local company, buying a significant proportion of materials from local suppliers.
The inward movement of materials is easier, as it becomes a local matter. Of course, this
means that it may be vulnerable to changing local conditions. The products might be
destined for local markets, or operations could be big enough to export to international
customers. This is the most popular approach with host countries as it develops local
skills and brings considerable economic benefit.

● Some global operations have limited need of logistics. A hamburger chain, for example, might
work globally, but practicalities demand that it does not have an extended supply chain,
but buys almost all materials locally and sells to local customers.
 GLOBAL LOGISTICS 347

The features of the product and the company structure set the overall shape of a supply
chain. A global company, for example, is unlikely to use the first model with centralised oper-
ations, as this is more like an ‘international’ company. There are, of course, many variations
on these basic themes.
CHAPTER REVIEW ■ ■ ■ ■ ■

❑ International trade is continuing to grow very quickly. All of this trade

depends on efficient logistics to move materials around the world.
❑ Many factors encourage international trade. Individual organisations are
increasingly seeing the benefits of working in different countries. A key issue for
such expansion is that the product must be attractive in international markets.
❑ There can be many problems for international logistics. Many of these are
caused by the different conditions on either side of international borders.
Some problems can be overcome by simple administrative arrangements;
others are only solved by major initiatives, such as customs unions.
❑ An organisation does not have to work internationally itself to have a
presence in overseas markets. It might, for example, export or use local
distributors. There are several ways of entering international markets.
❑ Different companies can organise their international operations in different
ways. Each has its own strengths and puts different emphasis on logistics.
There is a general trend towards global operations, which see the world as a
single integrated market.
❑ There are many possible structures for global supply chains.

C A S E S T U D Y O’Daid Group

Sean O’Daid runs part of a family business in Cork, Ireland, producing a range of
natural conditioners for gardens. The main product is peat. This is dug from local
bogs owned by the company, dried, shredded to give a uniform texture, treated to
remove unwanted material and then compressed for packing into 25 kg and 50 kg
bags. These are delivered throughout Ireland, but the highest sales are in the south
around Cork, and east around Dublin.
Over the past 20 years, trade has varied, depending on the state of the economy
and enthusiasm for gardening (which is often affected by television programmes). A
more serious problem is the environmental damage done by peat extraction, and
348 L O G I S T I C S : A N I N T R O D U C T I O N T O S U P P LY C H A I N M A N A G E M E N T

C A S E S T U D Y continued

which is encouraging gardeners to look for environmentally friendly alternatives.

O’Daid Garden Products is a small company, but they extract more than 10,000
tonnes of peat a year. Continuing at this rate of extraction, their accessible reserves
will last about a century. Sean summarises this situation by saying, ‘we have lots of
peat in the ground, but demand is certainly falling, and is likely to go even lower.
We are actively developing new materials as alternatives to peat, but these are more
expensive and will probably be more attractive in the longer term. In the medium
term we want to exploit our existing reserves, and get a smooth transition to the
new products. In particular, we want to increase current peat production, and start
exporting to the UK and the rest of Europe.’
Sandra O’Daid runs another part of the family business. She imports materials
to make a range of high-value Celtic jewellery, which she exports to 42 countries
around the world. Her materials are largely gemstones and precious metals from
South Africa and Australia. Her main exports are to the countries around the Pacific
Rim, particularly Singapore and Australia. Last year sales from her traditional
customers fell slightly, and she started looking for sales in the Middle East and
South America.

C A S E S T U D Y
Questions
● How would you compare the logistics requirements of these two parts of the family busi-
ness? What problems are they each likely to face? How can these be overcome?
● Do you think that expanding internationally is a reasonable strategy for Sean? Can he
learn anything from Sandra’s experience?

P R O J E C T

Parcel Transport
Imagine that you want to send a parcel of books weighing 100 kg from the UK to Peru. Find the alter-
natives available for transport, and identify the best. Describe in detail the journey of your package, and
list the people involved in each stage. What specific problems would you meet? If you were a publisher
wanting to sell 100 kg of books a week in Peru, how would this affect your approach to logistics?
 GLOBAL LOGISTICS 349

DISCUSSION QUESTIONS

1. What are the main differences between logistics within a single country and logistics that
span a number of different countries? What are the specific problems of working interna-
tionally?
2. By their nature, all supply chains must be international. Do you think this is true?
3. Some regions of the world present particularly difficult problems for logistics. What
regions do you think might prove difficult to work in, and why?
4. There is a growing number of free trade areas. Why? Do they really allow free trade
between members? If free trade is such a good idea, why do countries not simply remove
all their duties and tariffs on trade?
5. Why are companies moving towards global operations? What are the implications for
logistics?

REFERENCES
1. Leontiades J.E. (1985) Multinational Business Strategy, D.C. Heath & Co., Lexington, MA.
2. Julius D.A. (1990) Global Companies and Public Policy, Royal Institute of International Affairs, London.
3. Smith A. (1776) The Wealth of Nations, London.
4. Porter M. (1990) Why nations triumph, Fortune, 12/03/90, pp. 54–60.
5. www.wto.org.
6. Ohmae K. (1985) Triad Power – The Coming Shape of Global Competition, Free Press, New York.
7. Grainger A. (2000) Globalisation – implications for supply chains, Logistics and Transport Focus, 2(2), 46–7.
8. Anon. (1998) World trade systems at 50, Financial Times, 18/5/98.
9. World Trade Organization (2001) International Trade Statistics, WTO, Geneva.
10. Grainger A. (2000) Customs and international supply chain issues, Logistics and Transport Focus, 2(9),
40–3.
11. Levitt T. (1983) The globalization of markets, Harvard Business Review, May/June.
12. Jain S. (1989) Standardisation of international marketing strategies, Journal of Marketing, 53, January.

Further reading
Ernst R. et al. (1998) Global Operations Management and Logistics, John Wiley, Chichester.
Wood D.F. (1994) International Logistics, Chapman & Hall, London.
 Index

A Lennox Wholesale Group, 277–9

ABC analysis, 274–6 O’Daid group, 347–8
activities of logistics, 12–14, 34–9 passenger interchange, 101–2
aggregate plans, 150–1 Primal Autoparts, 163–4
agile logistics, 34, 67–9 Via Cendor, 304–5
aims of logistics, 17–19 centralised purchasing, 231
air transport, 315–16 centre of gravity for locations, 114–19
analysing a supply chain, 209–15 change, 95–100
multiple activity charts, 213–15 business process re-engineering, 98–100
precedence diagrams, 212–13 continuous improvement, 96–7, 100
process charts 209–11 managing, 95–6
audit of logistics, 75 of capacity, 146–9
rate of, 96–7
B closed loop MRP, 175
B2B, 30–1 concentration of ownership, 32
B2C, 30–1 consolidation, 287–8
benchmarking, 207–9 continuous improvement, 96–7, 100
bottlenecks, 92–3, 140–2 contract logistics, 90–1
break-bulk, 287–8 see also ownership
business process re-engineering, 98–100 controlling material flow, 166–95
see also material flow
C co-operation, 33, 41–2
capacity, 92–3, 139–40, 198–9 see also integration
adjusting, 144–6 costs
bottlenecks, 92–3, 140–2 of different locations, 119–22
capacity requirements planning, 175 of logistics, 19–22, 28
changes over time, 146–9 of stocks, 256–9
definitions, 140 covering problem, 128–9
planning, 142–50 cross-docking, 33, 288
case studies customers, 4–6
Ace Dairies, 24–5 focus, 68
Arnold Haralson, 247–8 tiers of, 8–10, 87–8
Brenner Refrigeration Sales, 131–3 customs barriers, 341–2
Ed’s Drive-through Bottle Shop, 220–1
Friedland Timbers asa, 51–3 D
Hessingen Herb Farm, 79 Deming wheel, 96–7, 217
JIT at Pentagon Plastics, 192–3 dependent demand, 167
 INDEX 351

distribution centre see warehousing inventory management, 251–81

downstream activities, 8–9 see stock control
inward logistics, 6, 13
E
economic order quantity (EOQ), 259–66 J
sensitivity analysis, 264–6 JIT see just-in-time
efficient customer response (ECR), 189–91 just-in-time 178–91
electronic data interchange (EDI), 30 benefits and disadvantages, 187–8
electronic fund transfer (EFT), 30 effects on organisations, 181–2
electronic point of sales (EPOS), 30 extensions, 189–91
enabling practices, 91–2 kanbans, 184–7
enterprise resource planning (ERP), 176–8 key elements, 182–83
environmental concerns, 33, 70, 303 principles, 178–81
e-procurement, 30, 240–2 pull systems, 183–4
e-purchasing, 30
K
F kaizen, see continuous improvement
facilities location, see location kanbans, 184–7
‘flow through’ logistics, 191
focus of logistics strategy, 64–5 L
layout of warehouses, 292–7
G lead time, 31, 262–4
global logistics, 31–2, 332–49
lean logistics, 34, 66–9
customs barriers, 341–2
learning curve, 147
effects on organisation, 336–7
location, 14, 90, 104–36
factors to encourage, 334–5
alternative approaches, 106–8
international trade, 333–6
centre of gravity, 114–18
organisation of, 342–5
choosing the geographic region, 109–13
problems with, 338–42
costing models, 119–22
supply chains, 345–7
finite set approach, 119–25
value density, 337
hierarchy of decisions, 109–10
importance, 105–6
I infinite set approach, 113–19
implementing strategy, 82–103
network models, 126–30
capacity, 92–4
planning, 130–1
definition, 83
scoring models, 122–5
design of supply chain, 87–91
logistics
difficulties, 84–5
activities, 12–14, 34–5
enabling practices, 91–2
agile, 34
type of decisions, 85–7
aims, 17–19
importance of logistics, 19–23
audit, 75
improving performance, 215–19
comparing performance, 207–9
independent demand, 167, 255–6
controlling material flows, 166–95
integration
costs, 19–22, 28
benefits for logistics, 42–4
definition, 4–5, 14, 17
external, 39–51
enabling practices, 91–2
internal, 34–9
global, 332–49
of logistics activities, 34–9
implementing strategy, 82–103
of the supply chain, 27–55
importance, 19–23
partnerships, 45–9
improving performance, 215–19
intermodal transport, 319–21
integration of activities, 34–9
international logistics see global logistics
inventory management, 251–81
international trade, 333–6
inward, 6
inventory, 252
lean, 34
see stocks
352 INDEX

location of facilities, 14, 90, 104–36 Ralston Energy Systems, 93–4

materials handling, 297–303 Renfield Pharmaceuticals, 343–4
measuring performance, 196–209 RP Turner Corp., 35–6
organising, 15–17 SAG AG, 178
outsourcing, 32, 90–1 Scandinavian Health Products, 184
outward, 6 scheduling at Bombay Taxis, 161–2
planning resources for, 137–65 Sears Roebuck, 229
pressures to improve, 28–9 Southampton Container Terminals Ltd, 320–1
procurement, 13, 227–50 stock holdings, 254
reverse, 13–14 Tesco plc, 72, 84
strategy, 59–81 The Schenker Group, 65
transport, 308–31 Trifast plc, 337–8
trends, 30–4 TT&G, 246
warehousing, 282–307 Wal-Mart, 10–11
logistics centre see warehousing Waldenmier TWL, 286
logistics in practice warehouse locations in the USA, 118–19
25 Canadian Forces Supply Depot, 288–9 Wiesiek Teknika, 269–70
accounts payable at Ford, 99 Ying-Chua Associates, 200
Alberta coalmines, 317–18
Amazon.com, 241–2 M
Augulla Limited, 14–15 manufacturing resources planning (MRP II), 175–6
BHP and Nalco/Exxon Energy Chemicals, 276 mass customisation, 31
Bjorg’s Pharmaceuticals, 77–8 master schedule, 150–1
border crossings, 341 material flow 166–95
British Airways plc, 173–4 inventory management, 251–81
capacity at Heathrow Airport, 149–50 just-in-time, 178–91
Charles Friderikson Car Rentals, 209 material requirements planning, 167–78
Christian Salvesen, 324–5 see also supply chain
CN Railway, 232 materials, 6–7
Cornwall, Ontario, 296–7 materials handling, 13, 297–303
Daniel West Wholesale Ltd, 285 materials management, 6, 37
delivering frozen food, 205–6 material requirements planning (MRP), 167–78
DIRFT Ltd, 312 approach, 168–72
Ellis and Everard, 69 batching, 174
European contract logistics, 91 benefits, 172
Europeanisation of logistics, 336 closed loop MRP, 175
GZ Rexam, 50 definition, 167
Handemann Group, 301 disadvantages, 172–3
Hebblethwaite Ltd, 218–19 extensions, 174–8
Hotpoint, 97–8 measuring performance, 196–209
Intel in Costa Rica, 125 median problem, 126–7
JIT at Harley-Davidson, 188–9 mission, 60–2, 73
just-in-time at Guy la Rochelle International, modes of transport, 310–19
182 air, 315–16
Keystone-Gunterbach, 198 choice of, 316–18
Konigshaven Suppliers, 19–20 intermodal transport, 320–1
McDonald’s in Moscow, 113 pipeline, 316
Millicra Electronic Components, 110–11 rail, 310–12
Montague Electrical Engineering, 266 road, 313–14
Mount Isa Mines, 329–30 water, 314–15
Perman Frère, 43–4 MRP see material requirement planning
Petro-Canada, 47–8 MRP II see manufacturing resources planning
Philips Semiconductors, Stadskanaal, 236 multiple activity charts, 213–15
Piotr Hucek Transport, 157–8
 INDEX 353

N e-procurement, 240–2
network models for location, 126–30 importance, 228–31
organisation, 231
O terms and conditions, 243–6
operations types of purchase, 242–3
cycle, 5–6 productivity, 200–2
definition, 4 pulling materials, 183–4
order picking, 13 purchasing see procurement
organisation
of logistics, 15–17 R
of procurement, 231 rail transport, 310–12
outsourcing, 32, 90–1 receiving, 13
see also ownership recycling, 13
outward logistics, 6, 13 re-engineering see business process re-engineering
ownership reorder level, 262–4, 267–9
concentration of, 32 replacement policies, 147–8
contract logistics, 90–1 resource requirement planning, 143–4, 151–8
of transport, 321–5 resources see planning of resources
of warehouses, 290–2 reverse logistics, 13–14
outsourcing, 32, 90–1 road transport, 313–14
vertical integration, 49–50 routing of vehicles, 325–8

P S
packaging, 302–3 safety stock, 267–9
partnership, 45–9 schedules 158–61
see also integration scheduling rules, 159–61
performance scoring models for location, 122–5
comparing, 207–9 service level, 268–9
improving, 215–19 short-term schedules, 158–61
logistics and organisational, 20–2 single sourcing, 235
measuring, 196–209 stock control, 13, 251–81
of suppliers, 235–6 stocks
periodic review system, 270–4 ABC analysis, 274–6
physical distribution, 13, 37 costs, 256–9
see logistics economic order quantity (EOQ), 259–66
pipelines, 316 lead time, 262–4
plan–do–check–act cycle, 96–7, 217 periodic review systems, 270–4
planning purpose of, 252
capacity, 139–50 reasons for holding, 252
cycles, 156–7 reduction of, 33, 252–3
for location, 130–1 reorder level, 262–4
generating alternative plans, 154–6 safety stock, 267–9
of resources, 137–65 sensitivity of EOQ, 264–6
short-term, 158–61 service level, 268–9
tactical, 150–8 target stock level, 272–4
types of 138–9 types, 255
postponement, 32, 288 stores, 13
precedence diagrams, 212–13 strategic alliance, 69
pressures to improve logistics, 28–9 see also integration
preventive maintenance, 147–8 strategy, 59–79, 83, 138–9
process charts, 209–11 business, 60–2
procurement, 13, 227–50 corporate, 60–2
aims, 231 design of, 73–7
cycle, 236–9 focus of, 64–5
354 INDEX

implementing, 82–103 definition, 309

see also implementing strategy modes, 310–19
logistics, 62–5 ownership, 321–5
options for, 66–72 services, 323–4
time-based, 70 vehicle routing, 325–8
structure of supply chain, 8–12, 87–90 travelling salesman problem, 326–7
suppliers, 4–6 trends in logistics, 30–4
choosing, 232–6
co-operation, 39–50 U
numbers of, 32, 235 unitisation, 302
performance, 235–6 upstream activities, 8–9
qualified, 232–4 utilisation, 198–200
single sourcing, 235 utility, 18
tiers of, 8–10, 87–8
supply chains V
analysing, 209–15 value density, 337
benefits of, 11–12 vendor managed inventory, 33
definition, 7–8, 17 vertical integration, 49–50
global, 345–7
integration, 27–55 W
structure, 8–12, 87–90 warehousing, 13, 282–307
SWOT analysis, 75 activities in, 285–8
synchronised material movement, 31 aims of, 289
automation, 298–300
T decisions, 284–5
tactical planning, 150–8 definitions, 283
target stock level, 272–4 layout, 292–7
tender, 234 materials handling, 297–303
terms and conditions for purchases, 242–6 ownership, 290–2
third party, 90–1, 290–2, 321–5 packaging, 302–3
see ownership waste disposal, 13, 303
tiers of customers and suppliers, 8–10, 87–8 water transport, 314–15
transport, 308–31