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Logistics is concerned with getting the products and services where they are needed when they are desired. It is difficult to accomplish any marketing or manufacturing without logistical support. It involves the integration of information, transportation, inventory, warehousing, material handling, and packaging.

The operating responsibility of logistics is the geographical repositioning of raw materials, work in process, and finished inventories where required at the lowest cost possible

The formal definition of the word ‘logistics’ is: - it is the process of planning, implementing and controlling the efficient, effective flow and storage of goods, services and related information from the point of origin to the point of consumption for the purpose of conforming to customer requirements.

Within the firm the challenge is to coordinate individual job expertise into an integrated competency focused on servicing customers. In most situations the desired scope of such coordination transcends the individual enterprise, reaching out to include customers as well as material and service suppliers. Ina strategic sense, the senior logistics officer leads a boundary spanning initiative to facilitate effective supply chain relationships. The excitement of contemporary logistics is found in making the combined results of internal and external integration one of the core competencies of an enterprise. Throughout the history of mankind wars have been won and lost through logistical strengths and capabilities or the lack of them. Even though the generals of the past have understood the critical role of logistics it only in the recent past that the big organizations have realized its role in the achievement of competitive advantage.

Arth Shaw in 1915 pointed out that: the relations between the activities of demand creation and physical supply… illustrate the existence of the 2 principles of interdependence and balance. Failure to co-ordinate any one of these activities with its group-fellows and also with those in the other group, or undue emphasis or outlay put upon any one of these activities, it is certain to upset the equilibrium of forces which mean efficient distribution. The physical distribution of the goods is a problem distinct from the creation of demand. There are many ways of defining logistics but the underlying concept might be defined as follows: ‘Logistics is the process of strategically managing the procurement, movement and storage of materials, parts and finished inventory through the organization and its marketing channels in such a way that current and future profitability are maximized through the cost-effective fulfillment of orders.’

Competitive Advantage

Effective logistics management can provide a major source of competitive advantage. The bases for successes in the marketplace are numerous, but a simple model has been based around the three C’s – Customer, Company & Competitor. The source of competitive advantage is found firstly in the ability of the organization to differentiate itself, in the eyes of the customer, from its competition and secondly by operating at a lower cost and hence at greater profit.

Seeking a sustainable competitive advantage has become the concern of every manager who realizes the marketplace and it is no longer acceptable to assume that the goods will sell themselves. An elemental, commercial success is derived either form a cost advantage or a value advantage or, ideally both. The greater the profitability of the company the lesser is the production of cost. Also a value advantage gives the product an advantage over the competitive offerings. Successful companies either have a productivity advantage or they have a value advantage or maybe a combination of the two.

There are two main vectors of strategic direction that need to be examined: -


In many industries there will be a competitor who will be a low cost producer and will have greater sales volume in that sector. This is partly due to economies of scale, which enable fixed costs to spread over a greater volume but more particularly to the impact of the experience curve.

It is possible to identify and predict improvements in the rate of output of workers as they become more skilled in the processes and tasks on which they work. Bruce Henderson extended this concept by demonstrating that all costs, not just production costs, would decline at a given rate as volume increased. This cost decline applies only to value added, i.e. costs other than bought in supplies. Traditionally it has been suggested that the main route to cost reduction was by gaining greater sales volume and there can be no doubt about the close linkage between relative market share and relative costs. However it must also be recognized that logistics management can provide a multitude of ways to increase efficiency and productivity and hence contribute significantly to reduced unit costs.


It is a cliché that customers don’t buy products they buy benefits. These benefits may be intangible i.e. they relate not to specific product features but to such things as image and reputation. Unless the product or service that we offer can be distinguished in some way from its competitors there is a strong likelihood that the marketplace will view it as a ‘commodity’ and so the sale will tend to go to the cheapest supplier. Value differentiation can be gained in numerous ways. When a company scrutinizes markets closely it frequently finds that there are distinct value segments. In other words different groups of customers attach different levels of importance to different benefits. The importance of such benefit segmentation lies in the fact that often there are substantial opportunities for creating differentiated appeals for specific segments. Adding value through differentiation is a powerful means of achieving a defensible advantage in the market. Equally powerful as a means of adding value is service. Increasingly it is the case that markets are becoming more service sensitive and this poses a challenge in management of logistics. It is important to seek differentiation through means other than technology. A number of companies have responded to this by focusing upon service as a means of gaining a competitive edge. Service in this context relates to the process of developing relationships with customers through the provision of an augmented offer. This augmentation can take many forms including delivery service, after sales service, financial packages, technical support and so on.
This matrix is a useful way of examining the options available for value and productivity advantage:



In commodity market situations where a company’s products are indistinguishable from their competitors’ offerings the only strategy is to move towards being a cost leader or towards being a service leader. Often the leadership route is not available. This particularly will be the case in a mature market where substantial market share gains are difficult to achieve.

Cost leadership strategies have been based upon the economies of scale, gained through greater volume of sales. This is why market share is considered to be so important in many industries. This cost advantage can be used strategically to assume a position of price leader and make it difficult for high cost competitors to survive. This cost advantage can come through effective logistics management. In many industries logistics cost represents such a large part of total costs that that it is possible to make major cost reductions through fundamentally reengineering logistics processes.

The other way to come out of the commodity quadrant of the matrix is to seek a strategy of differentiation through service excellence. Customers ion all industries are seeking greater responsiveness and reliability from suppliers; they are looking for reduced lead times, just-in-time delivery and value added services that help them do a better job of serving their customers.


A firm can gain competitive advantage only when it performs its strategically important activities (designing, producing, marketing delivering and supporting its product) more cheaply or better than its competitors.
Value chain activity disaggregates a firm into its strategically relevant activities in order to understand behavior of costs and existing and potential sources of differentiation. They are further categorized into two types

(i) Primary - inbound logistics, operation outbound logistics, marketing and sales, and service

(ii) Support – infrastructure, human resource management, technology development and procurement

To gain competitive advantage over its rivals, a firm must deliver value to its customers through performing these activities more efficiently than its competitors or by performing these activities in a unique way that creates greater differentiation.

Logistics management has the potential to assist the firm in the achievement of both a cost/productivity advantage and a value advantage. The under lying philosophy behind the logistics concept is that of planning and coordinating the materials flow from source to user as an integrated system rather than, as was so often the case in the past, managing the goods flow as a series of independent activities. Thus under a logistics management regime the goal is to link the marketplace, the distribution network, the manufacturing process and the procurement activity in such a way that customers are service at higher levels and yet at lower cost.


The mission is to plan and coordinate all those activities necessary to achieve desired levels of delivered service and quality at lowest possible cost. Logistics must therefore be seen as the link between the marketplace and the operating activity of the business. The scope of the logistics spans the organization, from the management of raw materials through to the delivery of the final product.

Materials flow

Requirements information flow


Logistics management from this total system is the means whereby the needs of customers are satisfied through the coordination of the materials and information flows that extend from the marketplace through the firm and its operations and beyond that to supplies.

For example for many years marketing and manufacturing have been seen as largely separate activities within the organization. At best they have coexisted, at worst there has been open warfare. Manufacturing priorities and objectives have typically been focused on operating efficiency, achieved through long production runs, minimized setups, changeovers and product standardization. On the other hand marketing has sought to achieve competitive advantage through variety, high service levels and frequent product changes.

In today’s more turbulent environment there is no longer any possibility of manufacturing and marketing acting independently of each other.

It is now generally accepted that the need to understand and meet customer requirements is a prerequisite for survival. At the same time, in the search for improved cost competitiveness, manufacturing management has been the subject of massive renaissance. The last decade has seen the rapid introduction of flexible manufacturing systems, of new approaches to inventory based on materials requirement planning (MRP) and just in time (JIT) methods, a sustained emphasis on quality.
Equally there has been a growing recognition of the critical role that procurement plays in creating and sustaining competitive advantage as part of an integrated logistics process.

In this scheme of things, logistics is therefore essentially an integrative concept that seeks to develop a system wide view of the firm. It is fundamentally a planning concept that seeks to create a framework through which the needs of the manufacturing strategy and plan, which in turn links into a strategy and plan for procurement


Inventory Flow

Information Flow


Logistics is viewed as the competency that links an enterprise with its customers and suppliers. Information from and about customers flows through the enterprise in the form of sales activity, forecasts and orders. As products and materials are procured, a value added inventory flow is initiated that ultimately results in ownership transfer of finished products to customers. Thus the process is viewed in terms of two inter-related efforts, inventory flow and information flow.

Inventory Flow

The management of logistics is concerned with the movement and storage of materials and finished products. Logistical operations start with the initial shipment of a material or component part from a supplier and are finalized when a manufactured or processed product is delivered to a customer.

From the initial purchase of a material or component, the logistical process adds value
By moving inventory when and where needed. Thus the material gains value at each step.

For a large manufacturer, logistical operations may consist of thousands of movements, which ultimately culminate in the delivery of the product to an industrial user, wholesaler, dealer or customer.

Similarly for a retailer, logistical operations may commence with the procurement of products for resale and may terminate with consumer pickup or delivery.
The significant point is that regardless of the size or type of the enterprise, logistics is useful and requires continuous management attention.

In order to understand logistics it is useful to divide it into three areas.
 Physical distribution
 Manufacturing support
 Procurement

Physical distribution

The area of physical distribution concerns movement of a finished product to the customers. In physical distribution the customer is the final destination of the marketing channel.

Unless the products are delivered where and when needed, a great deal of marketing effort can be wasted.

All physical distribution systems have one feature in common: they link manufacturers, wholesalers and retailers and ensure that the product is available.

Manufacturing support

The area of manufacturing support concentrates on managing W.I.P inventory as it flows between the stages of manufacturing.
A Master Production Schedule is prepared and arrangements are made for timely availability of materials, components, parts etc.
Manufacturing support has one significant difference when compared with physical distribution.
Physical distribution attempts to satisfy the needs of the customers while manufacturing support involves movement requirements that are under he control of the manufacturing enterprise.


Procurement is concerned with purchasing and arranging in-bound movement of materials, parts and /or finished inventory from suppliers to manufacturing or assembly plants, warehouses or retail stores.
Procurement is also known as purchasing and buying and in some cases inbound logistics. Procurement s concerned with availability of the desired material assortments where and when needed.

Within a typical enterprise, the three areas of logistics overlap. The prime concern of an integrated logistical process is to coordinate overall value-added inventory movement. The three areas combine to provide integrated management of materials.

Information flow

Information flow identifies specific locations within a logistical system that have requirements. Information also integrates the three operating areas. The primary objective of developing and specifying requirements is to plan and execute integrated logistical operations. Within individual logistics areas, different movement requirements exist with respect to size of order, availability of inventory, and urgency of movement. The primary objective of information sharing is to reconcile these differences.

Logistical information involves two major types of flows:

1. Coordination flows
2. Operation flows

1. Planning and coordination flows

Coordination is the backbone of the overall information system. Coordination results in plans specifying:

 Strategic objectives
Strategic objectives detail the nature and location of customers, which are matched to the required products and services to be performed.

 Capacity constraints
Capacity constraints coordinate internal and external manufacturing requirements. Capacity constraints identify limitations, barriers, within basic manufacturing capabilities and determine appropriate outsource requirements.

 Logistical requirements
Logistics requirements specify the work that distribution facilities, equipment and labour must perform to implement the capacity plan.

 Inventory deployments
Inventory deployments are the interfaces between planning/coordination and operations that detail the timing and composition of where inventory will be positioned.

 Manufacturing requirements
Manufacturing plans are derived from logistical requirements and typically result in inventory deployment.

 Procurements requirements
Procurements requirements schedule material and components for inbound shipment to support manufacturing requirements. In retailing and wholesaling situations, procurements involve manufacturing requirements.

 Forecasting
Forecasting utilizes historical data, current activity levels, and planning assumptions to predict future activity levels. Logistical forecasting is generally concerned with relatively short –term predictions.

The overall purpose of information planning/coordination flow is to integrate specific activities within a firm and to facilitate overall integrated performance.

2. Operational flows

The second aspect of information requirements is concerned with directing operations to receive, process, and ship inventory as required supporting customer and purchasing orders. Operational requirements deal with
 Order management
 Order processing
 Distribution operations
 Inventory management
 Transportation and shipping
 Procurement

Differences between Supply chain management and Logistics management.

1. Supply chain management is a broader concept whereas Logistics management is a narrower concept.
2. The concept of Supply chain management is relatively new whereas the concept of Logistics management is relatively old.
3. Supply chain management is an extension of Logistics management.
4. Logistics management is primarily concerned with optimizing flows within the organization whilst supply chain management recognizes that internal integration by itself is not sufficient.
5. Logistics is essentially a planning orientation and framework that seeks to create a single plan for the flow of product and information through a business. Supply chain management builds upon this framework and seeks to achieve linkage and co-ordination between processes of the other entities in the pipeline, i.e. suppliers and customers, and the organization itself.
6. The focus of Supply chain management is upon the management of relationships in order to achieve a more profitable outcome for all parties in the chain where as the focus of Logistics management is upon the management of resources within the organization.

Traditional Perspective

Traditionally most organizations have viewed themselves as entities that exist independently from others and indeed need to compete with them in order to survive. However such a philosophy can be self-defeating idf it leads to unwillingness to corporate in order to compete. Behind this seemingly paradoxical concept is the idea of supply chain integration.


“ Supply chain management is the management of upstream and downstream relationships with suppliers and customers to deliver superior customer value at less cost to the supply chain as a whole.”


The supply chain is the network of organizations that are involved through upstream and downstream linkages, in the different processes and activities that produce value in the form of products and services in the hands of ultimate consumer. Thus for example a shirt manufacturer is a part of a supply chain that extends upstream through the weavers of fabrics to the manufacturers of fibres, and downstream through distributors and retailers to the final consumer. Each of these organizations in the chain are dependent upon each other by definition and yet and yet paradoxically by tradition do not co-orporate with each other.

Clearly this trend has many implications for logistics management, not the least being the challenge of integrating and coordinating the flow of materials from a multitude of suppliers, often offshore, and similarly managing the distribution of the finished product by way of multiple intermediaries.


In the past it was often the case that relationships with suppliers and downstream customers (such as distributors or retailers) were adversarial rather than co-operative. It is still the case today that some companies will seek to achieve cost reductions or profit improvements at the expense of their supply chain partners. Companies such as these do not realize that simply transferring costs upstream or downstream does not make them any more competitive. The reason for this is that ultimately all costs their way to the final marketplace to be reflected in the price paid by the end user. The leading- edge companies recognize the fallacy of this convectional approach and instead seek to make the supply chain as a whole more competitive through the value it adds and the costs that it reduces overall. They have not realized that the real competition is not company against but rather supply chain against supply chain.

Figure 1 suggests that there is in effect an evolution of integration from the stage 1 position of complete isolation from the other business functions. An example would be where production or purchasing does their own thing in complete isolation from the other business functions. An example would be where production seeks to optimize its unit costs of manufacture by long production runs without regard for the build-up of the finished goods inventory and heedless of the impact it will have on the need for warehousing space and the impact on working capital.

Stage 2 companies have recognized the need for at least a limited degree of integration between adjacent functions, e.g. distribution and inventory management or purchasing and materials control. The natural next step to stage 3 requires the establishment and implementation of an ‘and-to-end’ planning framework that will be fully described later in this book.

Stage 4 represents true supply chain integration in that the concept of linkage and co-ordination that is achieved in stage 3 is now extended upstream to suppliers and downstream to customers.

Relationship building

It is apparent that supply chain management involves a significant change from the traditional arm-length, even adversarial, relationships that so often typified buyer/supplier relationships in the past. The focus of supply chain management is on co-operation and trust and the recognition that properly managed ‘the whole can be greater than sum of its part’s.

Thus the focus of supply chain management is upon the management of relationships in order to achieve a more profitable outcome for all parties in the chain. This brings with it some significant challenges since there may be occasions when the narrow self-interest of one of the parties has to be subsumed for the benefit of the chain as a whole.

Whilst the phrase ‘supply chain management’ is now widely used, it could be argued that it should really be termed ‘demand chain management’ to reflect the fact that the chain should be driven by the market, not by suppliers. Equally the word ‘chain’ should be replaced by ‘net work’ since there will normally be multiple suppliers and, indeed, suppliers to supplier as well as multiple customers and customers’ customers to be included in the total system.

Figure 2 illustrates this idea of the firm being at the centre of a network of suppliers and customers.

Extending this idea it has been suggested that a supply chain could more accurately be defined as:

“A network of connected and interdependent organizations mutually and co-operatively working together to control, manage and improve the flow of materials and information from suppliers to end users.”

Integrated log cycle
Network design

Customer service
- Dist channels

Supply Network Management Or Demand Network Management

The Phrase ‘Supply Chain Management’ is widely used. It is a management of upstream and downstream of relationships with suppliers and customers to deliver superior customer value at less cost to the supply chain as a whole.

So supply chain management focuses on the management of relationships in order to achieve a more profitable outcome for all parties in the chain. It is argued that it should really be ‘Demand Chain Management’ as a chain should be driven by the market, and not by suppliers. So also the word ‘chain’ should be replaced by ‘network’. Since there will normally be multiple suppliers and, indeed, suppliers to suppliers as well as multiple customers and customers’ customers to be included in the total system.

S = Supplier; SS = Suppliers’ Supplier;
C = Customer; CC = Customers’ Customer


Transport Functionality
Transportation is one of the most visible elements of logistics operations. Transportation provides 2 major functions: product movement & product storage.

Product Movement

Whether the product is in the form of materials, components, assemblies, work-in-process, or finished goods, transportation is necessary to move it to the next stage of the manufacturing process or physically closer to the ultimate consumer. A primary transportation function of product movement is moving up and down the value chain. Since transportation utilizes temporal, financial, and environmental resources, it is important that items be moved only when it truly enhances the product value.

Transportation involves the use of temporal resources because product is inaccessible during the transportation process. Such product, commonly referred to as in-transit inventory, is becoming a significant consideration as a variety of supply chain strategies such as just – in – time and quick response practices reduce manufacturing and distribution center inventories.

Transportation uses financial resources because internal expenditures are necessary for private fleets or external expenditures are required for commercial or public transportation.

Transportation uses environment resources both directly and indirectly.

In direct terms, it is one of the largest consumers of energy (fuel and oil) in the domestic United States economy. In fact, it accounts for close to 67% of all domestic oil use.

Indirectly, transportation creates environmental expense through congestion, air pollution and noise pollution.

The major objective is to move product from an origin location to a prescribed destination while minimizing temporal, financial and environmental resource costs. Loss and damage expenses must also be minimized. At the same time the movement must take place in such a manner that meets customer demands regarding delivery performance and shipment information availability.
Product Storage:

A less common transportation function is temporary storage. Vehicles make rather expensive storage facilities. However, if the in-transit product requires storage but will be moved again shortly (e.g. in a few days), the cost of unloading and reloading the product in a warehouse may exceed the per-daily charge of storage in the transportation vehicle.

In circumstances where warehouse space is limited, utilizing transportation vehicles may be a viable option.

One method involves loading on the vehicle and then having it take an indirect route to its destination. This is desirable when the origin or destination warehouse has limited storage capacity.

A second method to achieve temporary product storage is diversion. This occurs when an original shipment destination is changed while the delivery is in transit.
E.g. suppose a product is initially scheduled to be shipped from Chicago to Los Angeles. However, if during the delivery process, it is determined that San Francisco is in greater need of the product or has available storage capacity; the product could be delivered to the alternative destination of San Francisco.

In short, although product storage in transportation vehicles can be costly, it may be justified from a total cost or performance perspective when loading or unloading costs, capacity constraints, or the ability to extend lead times are considered.


There are two fundamental principles guiding transportation management and operations. They are economy of scale and economy of distance.

Economy of scale refers to the characteristic that transportation cost per unit of weight decreases when the size of the shipment increases.
E.g. truckload shipments cost less per pound than less-than-truckload shipments. It is also generally true that larger capacity transportation vehicles such as rail or water are less expensive per unit of weight than smaller capacity vehicles like motor or air. Transportation economies of scale exist because fixed expenses associated with moving a load can be spread over the load’s weight. The fixed expenses include administrative costs of taking the order; time to position the vehicle for loading or unloading, invoicing and equipment cost. These costs are fixed because they do not vary with shipment volume.
E.g. suppose the cost to administer a shipment is $ 10.00. Then the 1-pound shipment has a per unit of weight cost of $10.00, while the 1,000 pound shipment has a per unit of weight cost of $0.01. Thus, it can be said that an economy of scale exists for the 1000-pound shipment.

Economy of distance refers to the characteristic that transportation cost per unit of distance decreases as distance increases.
e.g. a shipment of 800 miles will cost less than two shipments (of the same combined weight) of 400 miles. Transportation economy of distance is also referred to a se tapering principle since rates or charges taper with distance. The rationale of distance economies is similar to that for economies of scale.
Longer distances allow the fixed expenses to be spread over more miles, resulting in lower overall per mile charge.

These principles are important considerations when evaluating alternative transportation strategies or operating practices. The objective is to maximize the size of the load and the distance that is shipped while still meeting customer service expectations.

Transport Infrastructure

Transportation infrastructure consists of the rights-of-ways, vehicles, and carrier organizations that offer transportation services on a for-hire or internal basis. The nature of the infrastructure also determines a variety of legal and economic characteristics for each mode or multimodal system. A mode identifies the basic transportation method or form.

Modal Characteristics


Since olden times, railroads have handled the largest number of ton-miles. As a result of the early establishment of a comprehensive rail network connecting almost all the cities and towns, railways dominated the intercity freight tonnage till World War II and in some cases of Europe, Asia and Africa they even connected the countries. This early superiority enabled railways to transport large shipments very economically.

Railroads have come a long way, as we can see by just the US figures that 54.0% of intercity transport in 1947 was by Railways, 39.2% in 1958, 36.4 % in 1980 and almost 37% in 1992. The period from 1950-1970 saw a tremendous decline in use of railways.

The capability to efficiently transport large tonnage over long distances is the main reason railroads continue to handle significant intercity tonnage and revenue. Railroad operations incur high fixed costs because of expensive equipment, right-of-way (railroads must maintain their own track), switching yards, and terminals. However, rail experiences relatively low operating costs. The replacement of steam by diesel power reduced the railroads’ variable cost per ton-mile, and electrification offers potential for more reductions. New labor agreements have reduced workforce requirements, further decreasing variable costs

These days’ rail transport only focuses on transporting specific products, which are best, suited to the requirement. Greatest railroad tonnage comes from raw material extractive industries located at considerable distances. Despite problems, Rail fixed-variable costs are still superior for long distances. Railroads basically concentrate on the container traffic and are becoming more responsive of the customer needs, emphasizing bulk industries and heavy manufacturing.

They have expanded their intermodal operations through alliances and motor carrier ownership. Railroads are even concentrating on development of special equipment. There are unit trains which are entire train carrying the same commodity, which are bulk products such as coal or grain. Unit trains are faster, less expensive to operate and quick as it can bypass rail yards and go direct to the product’s destination.

There are also various different types, such as articulated cars for extended Rail chassis, double-stack railcars, have 2 levels of containers, thereby doubling the capacity of each car. It also reduces chances of damage because of their design. These technologies have are being applied by railroads to reduce weight, increase carrying capacity, and facilitate interchange.

After a major decline till 1970, Railroads have emerged as a major mode of transport once again since the early 80’s because of revitalization of rail network. Evidence suggests that Rail network will be used extensively once again in the 1990’s and early 21st century.


Highway transportation has increased rapidly since the end of World War II. This is because Motor carrier industry results from door-to-door operating flexibility and speed of intercity movement. They are even flexible because they can operate on each and every kind of roadways.

In comparison to railroads, motor carriers have relatively small fixed investments in terminal facilities and operate on publicly maintained highways. Although the cost of license fees, user fees, and tolls are considerable, these expenses are directly related to the number of over-the-road units and miles operated.

The variable cost per mile for motor carriers is high because a separate power unit and driver are required for each trailer or combination of tandem trailers. Labor requirements are also high because of driver safety restrictions and the need for substantial dock labor. Motor carriers are best suited to handle small shipments moving short distances.

The characteristics of motor carriers favor manufacturing and distributive trades, short distances, and high-value products. Motor carriers have made significant inroads into rail traffic for medium and light manufacturing. This is also because of delivery flexibility, tat they have captured a major chunk of the market. In short, the prospect for maintaining a stable market share in highway transport remains bright.

This industry even has a few problems, and one of the primary difficulties relate to increasing cost to replace equipment, maintenance, driver wages, and platform and dock wages. Although accelerating, labor rates influence all modes of transport; motor carriers are more labor-intensive, which causes higher wages to be a major concern. One more threat for hire-motor carrier industry is over-the-road transportation by shipper-owned trucks or by specialized carriers under contract to perform transport services for shippers.

Since 1980, the industry segments have become more definitive since deregulation, and include truckload (TL), less than truckload (LTL), and specialty carriers. TL segment includes loads over 15,000 pounds that generally do not require intermediate stops for consolidation. LTL segment of the industry loads less than 15,000 pounds that generally requires stops at intermediate terminals for consolidation. Because of terminal costs and relatively higher marketing expenses, LTL experiences a higher percentage of fixed costs then TL.

These characteristics have caused extensive industry consolidation, since deregulation has resulted in small number of relatively large carriers worldwide.

Specialty carriers include package haulers such as Federal Express and United Parcel Service. These firms focus on specific requirements of the market or product. It is quite apparent that highway transportation will continue to function as the backbone of logistical operations for the foreseeable future.


It is the oldest mode of transportation. First it was the sailing vessels, which was replaced by steamboats in early 1800’s and by diesel power in the 1920’s.

Domestic water transportation – involves the Great Lakes, canals, and navigable rivers. In every country, fewer system miles exist for inland water than any other transportation mode.
The main advantage of water transportation is the capacity to move extremely large shipments. Water transport employs 2 types of vessels. Deep-water vessels, which are generally designed for Ocean and Great Lakes use, & are restricted to deep-water ports for access. In contrast, diesel-towed barges, which generally operate on rivers and canals, have considerably more flexibility.

Water transport ranks between rail and motor carrier in the fixed cost aspect. Although water carriers must develop and operate their own terminals, the right-of-way is developed and maintained by the government and results in moderate fixed costs as compared to railways and highways.

The main disadvantage of water transport is the limited range of operation and speed. Unless the origin and destination are adjacent, supplement haul by rail or truck is required. The capability to carry very high cargo at an extremely low variable cost places this mode of transport in demand when low freight rates are desired and speed of transit is a secondary consideration.

But, water transport on the other hand isn’t all that flexible. Labour restrictions on loading and unloading at docks create operational problems and tend to reduce the potential range of available traffic. Also, a highly competitive situation has developed between railroads and inland water carriers in areas where parallel routes exist.

Great lakes are concentrating towards transportation of bulk products while Deep-water vessels transport a significant high volume of non-bulk items. Containerized cargo facilitates vessel loading and unloading and enhances intermodal capability by increasing the efficiency of cargo transfer between highway, rail and water.

Inland and great lakes will continue to be a viable option in future logistical systems while the slow passage of inland river transport can provide a form of warehousing in transit integrated into overall system design.


Surprisingly, Pipelines are also one of the major form of transportation medium throughout the world. In 1989, in USA over 53% of all crude and petroleum ton-mile movements were through Pipelines.

In addition to Petroleum, other important product transported by pipeline is the natural gas. Pipelines are owned and operated privately in most of the countries and many gas companies act as both gas distributors and contract transportation providers. Pipelines are also utilized for transport of manufacturing chemicals, pulverized dry bulk materials such as cement, flour via hydraulic suspension, and sewage and water within cities and municipalities.

Pipelines are very unique in nature compared to other types of transport, such as; they operate on 24-hour basis, seven days a week, and are limited by commodity changeover and maintenance. Unlike other modes, there is no empty “Container” or “vehicle” that must be returned.

Pipelines have highest fixed cost and lowest variable cost among transport modes. High fixed costs result from right-of-way, construction and requirements for control stations, and pumping capacity. Since pipelines are not labour-intensive, the variable operating cost is extremely low once the pipeline has been constructed. An obvious disadvantage of these pipelines is that they are not flexible and are limited with respect to commodities that can be transported.

Experiments regarding transport of solid products are still going on. Coal slurry pipelines are proving to be economical over long distances but it concerns environmentalists, as it requires massive quantities of water.


Air transport is the newest and the least utilized mode of transport. Its major advantage being its speed, which is accompanied by high costs. A coast-to-coast shipment via air requires only a few hours contrast to days taken by other mean of transportation. The high cost of transport can be traded off for high speed, which allows other elements of logistical design, such as warehousing, inventory to be reduced or eliminated. But still air transport remains more of a potential opportunity than a reality because it is very much under utilized.

The high cost of jet aircraft, coupled with erratic nature of freight demand, has limited the assignment of dedicated planes to all-freight operations. However premium carriers provide planes dedicated for freight operations. This premium service started off with documents and has moved onto large parcels, which is an ideal service for firms with a large number of high-value products and time-sensitive service requirements.

The fixed cost of air transport is low as compared to rails, water and pipeline. In fact, air transport ranks second only to highway with respect to low fixed cost. Airways and airports are maintained by public funds and terminals are by local communities. The fixed costs of airfreight are associated with aircraft purchase and the requirement for specialized handling systems and cargo containers. But the air freight variable cost is extremely high as a result of fuel, maintenance, and labour intensity of both in-flight and ground crews.

Since they require wide-open space, airports are generally not integrated with other means of transport. However more “all freight” airports are being developed so as to reduce conflict with passenger operations.

No particular commodity dominates the traffic carried by airfreight operations. These operations are carried more on emergency basis than routine basis. Firms usually utilize scheduled or non-scheduled air cargo movements when the situation justifies high cost. Products with greatest potential for regular air movements are those having high value or extremely perishable. When the marketing period for an item is extremely limited, air transport comes into the picture, as it may be the only practical method for logistical operations.

Transportation Hidden Costs

The physical distribution component of a major project, including transportation of raw materials, project materials, machinery and equipment and such infrastructure facilities as roads, vehicles etc., usually accounts for 20 to 30% of the total capital cost.
The general scarcity of various goods, unpredictable nature of the economy and economic behavior on the part of the business community and the bureaucracy in India make it all the more necessary for one to plan well ahead. In fact, planning of transportation and infrastructure must be done well ahead of general planning, so that resources spent on other parts of the project do not result in in - fructuous expenditure.
In developed countries, these facilities are already available in abundance or are provided for well in advance. In developing countries, action is generally initiated only after the project has been partially put through or when it becomes totally inescapable to do so.

On the other hand, because of lack of these facilities, such problems are faced even during construction.

Eg. Trucks get stuck in muddy roads, work sites remain unapproachable, and serious vehicular accidents are caused near the project areas.

In developing countries, for the supervision of construction of a building, usually no qualified individual is appointed for the co ordination and planning of transportation infrastructure, which forms a major fraction of the total cost of a project running into crores.

For a major project, the average total cost to the economy of a project costing Rs. 100 crores which is delayed by one year from the date of targeted completion is 39% more than the original budgeted cost on account of the following:

1. The rate of interest on capital may be taken at nearly 12%.
2. The profit on income per year about 12%
3. The cost of depreciation on account of obsolescence or rusting without running of the plant at 5%.
4. The cost of escalation of the project cost at 10%.

The cost of delay in the completion of the project would therefore be roughly about Rs.11 lakhs per day or Rs. 3.25 crores per month. It would be worthwhile to educate senior executives to recognize these facts, for this aspect of the project is usually ignored by project authorities.

Project authorities do not hold themselves responsible for the transportation bottlenecks and resulting delays. These delays are due to non-receipt of equipment, machinery, raw materials etc. and these delays generally run into months. Due to such delays, the project suffers heavy losses, which occur because of congestion in the ports, traffic jams, railway restrictions etc. Therefore, it is financially more practical to obtain critical equipment, machinery and raw materials, critical not from the point of view of availability in the market but critical form the standpoint of transportation bottlenecks- so that the likely delays are avoided.
A proper transportation planning of materials, therefore, may well save a project as well as the economy form the ill effects of wasteful expenditure. At the same time it would help speed up production.

Transportation Cost Elements

Following are the essential elements of transportation to be taken into account:

1. Transport Mode – The most critical decision is the selection of appropriate mode of transport. This fixes two basic elements of distribution function:
a) Transit time or time lapse between production and sale;
b) Level of transportation costs.

There is an inverse relationship between transit time and transport cost – the lower the transit time, the higher the transport cost. However, a decision that takes into account only one cost factor cannot be justified. An evaluation of the effect of transit time on other costs must also be considered. Unsold production represents a high cost, and the longer the transit time, the higher the level of unsold production.

2. Inventory Costs – A first class service to clients often requires immediate delivery and, hence a higher level of inventory at the market centre. Economy, on the other hand, calls for minimum inventory. The level of output held in stock is dictated by-
a) Transit time: If the time lapse between production and sale is longer, the level of inventory becomes higher.
b) Sales pattern: If the pattern of sales is erratic, higher inventory levels are caused.
c) Production pattern: If the production pattern is erratic, higher inventory levels have to be maintained to prevent stock –outs.
Assuming that the sales and production patterns are largely fixed, the important variable, which can influence stock, levels in transit time. As transit time is reduced, the level of static stock can be reduced with accompanying stock reduction.

3. Transit Capital – Capital can be released by changing the proportion of the total output in transit. This can be done by adjusting the transit time. As transit time is reduced, the quantity of goods in transit can be decreased with an associated reduction in transit inventory costs. By realizing the capital cost of transit inventory and goods in transit, capital commitments can be reduced, and more capital can be available for other purposes.

4. Obsolescence - When a slow or erratic mode of transport is employed, a higher level of inventory is necessary to ensure continuous, prompt delivery to the customer. However, when designs change rapidly, obsolescence reduces the market value of the products in store. Rapid advances in technology bring about swifter technical obsolescence. Any goods in the pipeline realize a lower figure when new models are introduced by a company or it’s competitors. Air distribution can overcome this problem, and the effect of such obsolescence can be minimized.

5. Packaging – The nature of packaging of a product is often determined by the mode of it’s transport. E.g. Because of the dry conditions of carriage, short transit times and minimum handling, air cargo generally requires much less packaging than other forms of long distance transport. Goods dispatched by air may require only a dust cover or even no cover at all. In some cases, savings on the packaging of sophisticated products may more than pay for the actual transport charges. Less packaging may lead to other advantages too. These include lower unpacking costs and lower chargeable weight for freight.

6. Insurance – Insurance risks are based on transit time as well as the possibility of damages en route. With faster transit times, skillful handling, substantial reduction in damage and greater security in transit, insurance premiums tend to fall substantially.

7. Breakages – Cost of breakages is an important factor in any cost benefit analysis. Because breakages may be indemnified by insurance companies, the true cost of damage to cargos can easily be overlooked. In the first place, the vulnerability of various products sent by different modes is reflected in the insurance premium. To high premiums must be added the clerical work involved in establishing claims, making replacements and the loss of customer’s goodwill. The replacements themselves will be subject to the same hazards and premiums will require further documentation.
Therefore, only that mode of transport must be selected which substantially reduces real damage in transit. This calls for a selection of the routes which are more direct and which avoid transshipment. Handling equipment must also be more sophisticated. Containers can be used by shippers for door-to-door transportation, thereby avoiding all handling of goods by the carrier.

8. Pilferage – Many expensive administrative problems associated with breakages also apply to pilferage. This problem is reduced for example, when door-to-door containers are used, a fact which is again reflected in lower insurance rates.

9. Deterioration – In many surface cargos, deterioration may be avoided only by complicated and expensive packing to counteract mechanical shock, exposure to weather or unfavorable temperature etc. Some cannot be stored at all, except at great expense, and others deteriorate slowly.
Deterioration can be costly in terms of packing, stock losses and expensive conditioning in store. It can only shut the door on many distant markets. A high speed of transport and the frequency of services can overcome many of these problems.

10. Transport Costs – Transport can be divided into 3 phases:

(i) Delivery to docks, airport or railway station.
(ii) Transport from one terminal to another.
(iii) Delivery from the terminal to the consignee’s place.
In the cost-benefit analysis of the turnaround time of a company’s delivery and collection vehicles, their man hour costs can be significant. Some customers may find this item to be more costly than the cost of the major journey.

Transport Elements:

Whether the movement of material and equipment is by rail, sea, air or road, adequate facilities for their free flow to and from the factory must be ensured. The factors which affect progress at the construction stage, and production and dispatches after commission, have been discussed in the following paragraphs:

1) Terminal Facilities:

Terminal facilities are usually grudgingly provided. One reason for this is that any delay or any in convenience caused to truck operators is not a loss to the project. It is treated as a loss to the carrier. In some cases, this may be true. However, this usual incidence of stoppage or regulation of the production process can be minimized, if not eliminated.

Often extreme stinginess is expressed in planning for these facilities, which include storage space, and loading and unloading arrangements in a suitable area. If the storage space is not adequate or if the traffic is exceptionally heavy, production suffers inevitably. Since transport requirements of each project are different and depend on its location, physical availability of infrastructure, etc, it is not advisable to prescribe one uniform scale of terminal facilities. They must be worked out for an individual project on the basis of its own specific requirements.
Storage, loading and unloading facilities, good quality roads, which are usable throughout the whole year, and suitably, designed yard for railway wagons have to be planned as a part of terminal facilities. It is also essential to pay special attention to the maintenance of loading and unloading equipment, the design, location, length, height and other features of loading and unloading platforms, etc., and the maintenance of circulating area and roads where heavy vehicles ply.

The overall savings in transport rates would more than justify the expenditure incurred on the provision of additional facilities. This ahs not been recognized by the planners of individual projects.

For rail movement, not only sufficient number of loading lines, but also sufficient number of marshalling, examination and holding lines must be planned for. These lines must be suitably connected with one another to ensure smooth shunting operations. The configuration of lines (yard designs) is more important than the number of lines in the yard, for the requirements of prime mover (shunting engines) can also be cut down by a suitable design of yard.

2) Vehicles:

An important feature of movement of finished products of major projects is the type of vehicle used for movement. The vehicle dimensions, capacity. Type and its special characteristics, if any, have to be examined with the reference to the quality and quantity of goods to b moved. In case of sea transport---- the size, speed and the type of ship, in case of road movement---- capacity, moving dimensions and speed of the trucks and in case of rail movement---- the capacity, type and general availability of wagons must be closely examined.

Planned movement on any section must be taken into account utilisation of the existing sectional capacity, the expected general growth in traffic on the section, and the possible future identifiable streams of new traffic. If movement on a saturated section is inevitable, line capacity of the section must be increased.

3) Prime Movers:

The motive power utilized for the internal handling of vehicles and transportation to destinations is another important component of the total movement system. In the case of rail movement, locomotives required for the shunting and marshalling of wagons within the plant must be of such weight, horsepower and performance characteristics as will match the specific tasks of shunting and reception and dispatch of wagons. In case of road movement, suitable design and layout of conveyors and mechanical loaders can reduce the drudgery of manual labour and make pre-despatch and post-receipt handling operations more efficient.

4) Routes And Sectional Capacity:

Another important aspect of transport planning is the routes for streams of traffic, viz., roadways, railways, waterways and airways. The routes or pathways must have adequate capacities. Generally speaking, because of lack of understanding of the transportation subject, executives take it for granted that capacity of routes is unlimited.

A very important but invisible component of movement activity is sectional capacity, which is dependant on permissible sectional speed and other characteristics of a section. In turn, sectional speed depends on the geometrics of the road (track, sea route, road surface, carriage way, gradients and curves, etc.).

Over a section of railways or roadways between two stations A and B, only a limited number of wagons, trucks or vehicles can be pushed through, depending on the availability of terminal facilities to handle these vehicles, the facilities to enable vehicles to move on the section, and availability of sufficient number of vehicles. Unless sufficient capacity is developed on each of the different routes to move the vehicles, the additional number of vehicles provided would not necessarily lead to higher levels of transport availability. On the contrary, movement may become more sluggish.

5) Transit Time:

The relative locations of a plant and the customers or suppliers determine largely the transit time for raw materials, spare parts and finished products. Transit time generally never receives adequate attention in the panning of major projects. There is a general impression that, if need be, transit time can be drastically cut at any time by air-lifting a consignment. Apart from the fact that the neglect of transportation planning leads to an overall higher cost of transportation, in practice, reduction in transit time actually achieved may not justify the heavy cost of air transport. Rough estimates of transit time from unreliable sources are generally utilized for planning movements of goods. Although more detailed information sources may be readily available. It is essential therefore, that executives understand clearly the difference between:

(a) Normal transit time under normal conditions;
(b) Normal transit time under abnormal conditions;
(c) Optimal transit time;
(d) Most optimistic transit time
(e) Most pessimistic transit time; and
(f) Desirable transit time.
Because the importance of transit time is not adequately recognized, it is not realistically provided for. Major projects suffer from the heavy delays even before the commencement of construction because of the non-availability of construction equipment and machinery in time. The existing bottlenecks in the fields of transportation are almost always ignored. Construction schedules, inventories, warehousing facilities, order processing or production schedules, etc., are generally planned without the recognition of the inevitable delays that flow from these bottlenecks.

6) Weigh Bridge:

Another usually neglected aspect of industrial transportation activity is the factory weigh bridge. Weigh bridges ion factories are generally inaccurate, if not actually out of order. It is seldom appreciated that the losses continuously occurring on this single piece of factory equipment and general inefficiency, which results from its ineffective and inefficient management, can be easily avoided by proper advance planning. Executives ignore the usual traffic jams at factory gates slow down receipts and dispatches, which, in turn, indirectly affect output. The relative advantages of various types of weigh bridges must be properly appreciated by executives, and a weigh bridge which will handle the anticipated volume of traffic expeditiously must be selected.

7) Distribution pattern

The pattern of movement of the finished produced by road or rail must be planned properly. For example, when the requirements of the number of rail wagons are to be worked out, it is not sufficient to take the average lead or distance for the whole country for calculating fleet requirements. it is also not sufficient to use the figure of the existing average lead of general goods ,or even that pertaining to a specific commodity.

However, when it comes to actually transport, because of imprecise pre-planning, the manufacturer wants the commodity carrier to transport goods to anywhere and everywhere n the country. This presents a problem. The manufacturer provides information to the common carrier about the quantity o goods to b \e marketed. But detailed information must be supplied to the carrier so that the carrier can plan the movement in entirety.

8) Nature of product

Another aspect, which is often disregarded by project managements as well as common carrier, is the variability arising out of the specialized nature of products to be moved. The generally low level of sophistication in transport planning in the country had made it difficult for the planners to appreciate the fact that transport capacity is influenced by the nature of goods, their packing and other specialized requirements, such as special handling equipment.etc.

Freight Rate Structure

Freight rates of any mode of transport are based on the following principles:

1. Freight should the actual cost of transport operation. The actual cost of operation depends on the following factors:

a) Fixed costs - Freight should cover interest on capital, depreciation, registration and insurance expenses of a vehicle, if applicable, general upkeep of the vehicle, administration overheads, and expenditure on other fixed facilities, etc.

b) Semi-fixed costs - Freight should cover the salary of the driver, cleaner, conductor and miscellaneous maintenance expenses, which vary partially with the running of the vehicle.

c) Vehicle Utilization - A transporter is interested in getting maximum mileage out of his vehicle by moving it at top speed to cover the distance in as short a time as possible.

i. If the consignments loaded or the route covered is not conducive, the transporter would quote a higher freight rates.
ii. Higher freight rates are also quoted when vehicles are detained at terminals either for certain formalities, terminal congestion in busy ports or at factory gates, or while waiting for loading or unloading operations. Terminal detentions are invariably accounted for in the freight rates themselves, but they are normally not noticed at all.
iii. Freight rates are quoted higher if there an expectation of obtaining a return trip with a load or if considerable empty movement of vehicles is involved after unloading.
iv. Vehicle Utilization is affected by the nature of goods. Hazardous goods that are likely to cause damage to the other consignments or the vehicle itself attract higher freight rates.
v. Consignments, which can be loaded less by weight in a vehicle, attract higher unit freight rate since they yield poor utilization of the vehicle.

2. Traffic Bearing Capacity:

An age-old consideration for the freight rates is the doctrine of “what traffic can bear.” Transportation adds place utility to goods, for it makes them marketable at another place. However, after the addition of the cost of transport, the price of goods should be still attractive to the buyer.

3. Public Use:

Freight rates all over the world are governed on human grounds that items of public use should be made available to the common man at the cheapest rate. For example, foodgrains and salt are carried at rock-bottom prices, sometimes even at those, which do not cover the actual cost of operation.

4. Government Policies:

Freight rates are often framed on the basis of government objectives, which aim at serving certain points – such as promotion of certain type of trade, development of certain industries, etc. In such cases, freight rates are either depressed to promote the particular traffic or hiked to discourage particular traffic.

5. Reasonable Profit:

The transporter must provide for a reasonable profit after covering the cost of operations and capital investment. This margin must give not only return of investment but also compensate him for the entrepreneurial time and effort he puts in, but also provide sufficient funds for future development of his enterprise.



Road transport forms an essential part of any transport activity, whether rail, sea or air. It is essential as a supplementary and complementary mode of transport to complete movement by other modes of transport. Eg. From one terminal i.e. the railway station the goods have to be carried to the destination like an area by road.

Road transport offers certain advantages like
i. Door to door service to customers which neither rail nor neither sea nor air transport can offer.
ii. On per unit basis, the cost of making a road is 1/6th that of laying a railway line.
iii. Capital investment in case of railways is much less then railways designed to carry equivalent quantum of traffic.
iv. Road transport provides employment to six million persons (two million direct and four million indirect)

There are negative points also to be viewed like:
i. As much as 6200 crores are collected in dues but only 10% of this revenue is used for development of roads, which a disadvantage as road transport is till not well organized.
ii. Road transport industry is not come of age in India, as there are very few companies, which own the entire fleet of trucks. Single vehicle owners operate most of the road transport.

There is a system of associates, who pool in their vehicles and other resources and share the benefits of vehicle contribution. The associates operate from different cities. An associate in one city, say, Mumbai, watches the interest of his counterpart in Delhi. Together they operate as a team. They minimize expenses on the maintenance of a branch office at the out-station and yet give the identity of a single branch operator.

Problems in Road Transport:

Road transport faces a number of problems. This is evident from the following facts:
1) There is an occasional storage of diesel fuel in the country.
2) Vehicle availability in the country has been problematic. With the recent entry of a number of manufacturers, the situation has improved to some extent.
3) The cost of components and accessories, such as tyres and batteries, has escalated tremendously.
4) The Octroi and police check posts are to many, resulting in heavy detention to road vehicles.
5) The present Motor Vehicle Act regulating the issue of licenses and permits and movement of vehicles is very restrictive. It was decades ago to control and regulate traffic. The current requirements of traffic are for development. There are persistent demands from various transport associations for suitable amendments of the Motor Vehicle act. But they do not seem to receive due attention.
6) Conditions on Indian road are very bad and hazardous. They tend to reduce speed of vehicles, which leads to wastage of natural transport capacity.
7) Roadside maintenance and service facilities have not developed though found necessary.
8) The system of national, zonal and state permits restricts free growth of road transport but the system has to be followed.

Transportation Network Design Options

Classical economists neglected the importance of facility, location and overall network design Economists, when originally discussed supply – demand relationships, facility, location and transportation cost differentials were assumed to be non existent or equal among competitors.

 The number, size, geographical relationship of the facilities are used to perform logistics operation directly affect customer service capabilities and cost.
 Network design – primary responsibility of logistics.
 Typical logistics facilities are manufacturing plants, warehouses, gross dock operations and retail stores.

 Determining
(i) How many of each facility are required
(ii) Their geographic location
(iii) The work to be performed at each is a significant part of network design.

 In specific situations facility operations may be outsourced to service specialists.
 No matter who does the actual work, all facilities must be managed as an integral part of a firm’s logistical network.
 You have a network for internal customers, external customers as well as suppliers. Suppliers should be made to understand what their commitment is and follow it. You have to co-exist with your suppliers and share information with them.
 Network design must take into account geographical location because a great deal of variation exists between different geographical markets. If you set up your base in a place where your demand is high then after a while the demand shifts and come from another location, then again you are in a dilemma.

In a dynamic, competitive environment
• Product assortment
• Customer supplies
• Manufacturing requirements

All of the above are constantly changing. However re-location of all logistics facilities at one time is inconceivable. Relocation or redesign of specific facilities is possible.

Over a period of time, all facilities should be evaluated, to determine if their location is desirable.

Selection of a superior location network can provide the first step.
Your network of facilities forms a structure from which logistical operations are performed. Your network should incorporate transportation and information. Specific work tasks related to network design are processing customer orders, management of inventory, material handling.


To match the changing environment in the logistics due to the changes in the markets, competitors, suppliers and technology, there is a need for a systematic planning and design methodology to formally include the relevant consideration and effectively evaluate the alternatives.


The logistics relational and operating environment is constantly changing. Even for the established industries, a firm's markets, demands, costs and service requirements change rapidly in response to the customer and competitive behavior. Just as no ideal logistical system is suitable for all enterprises the method for identifying and evaluating alternative logistics strategies can vary extensively. However there is a general process applicable to most logistics design and analysis situations. The process can be segmented into three phases: problem definition and planning, data collection and analysis, and recommendations and implementation. The following discussion describes each phase and illustrates the types of issues encountered.


Phase 1 of logistics system design and planning provides the foundation for the entire project. A thorough and well-documented problem definition and plan are essential to all that follows.

1. Feasibility Assessment

The process of evaluating the need and desirability for change is referred to as feasibility assessment and it includes the activities of situational analysis, supporting logic development, and cost benefit estimation. The objective of doing so is to understand the environment, process, and performance characteristics of the current system and to determine future estimation.

a) Situational analysis: The purpose of the situational analysis id to provide senior management with the best possible understanding of the strengths and weaknesses of the existing logistics capabilities for both current and future environment. The situational analysis is the performance of measures and characteristics that describe the current logistics environment through:
 Internal review: Internal review is necessary to develop a clear understanding of existing logistics by covering the overall logistics process as well as each logistics function with respect to its stated objectives and its capabilities to meet those objectives. It profiles historical performance, data availability, strategies, operation and tactical policies and practices. All major resources such as workforce, equipment, facilities, relationships and information are examined. The comprehensive review attempts to identify the opportunities that might motivate or justify logistics system redesign or refinement. Assessment must consider the process (physical and information flows through the value – added chain), decisions (logic and criteria currently used for value chain management), and key measures for each major logistics activity. These measurements focus on the key performance indicators and the firm’s ability to measure them.

 Market assessment & competitive evaluation: the objective is to document and formalize customer perceptions and desires with regard to the changes in the firm’s logistical capabilities. It’s the review of the trends and service demands required by customers by the use of interviews with the selected customers or through customer5 surveys. The assessment focuses on the external relationships with the suppliers, customers (wholesalers and retailers) and consumers (final consumer). The assessment not only considers trends in requirements and processes but also the enterprise and the competitor’s capabilities.

 Technology Assessment: it focuses on the application and capabilities of the key logistics technologies, including transportation, storage, material handling, packaging, and information processing. The assessment considers the firm’s capabilities in terms of current technologies and the potential for applying new technologies. The objective of the assessment is to identify advancements that can provide effective trade – offs with other logistics resources such as transportation and inventory.

b) Supporting logic development: The second feasibility assessment task is development of a supporting logic to integrate the findings of the internal review, external assessment and technology study. Supporting logic development builds on this comprehensive review in three ways

 First - supporting logic development forces a critical review of the potential opportunities for logistics improvements and a determination of whether additional investigation is justified, using logistics principles such as tapering principle, principle of inventory aggregation. The resulting benefits or costs should be clearly identified.

 Second - it critically evaluates current procedures and practices using comprehensive, factual analysis and evaluation that isn’t influenced by opinion and thus help in identifying areas with improvement potential which in turn provides a foundation to determine the need for strategic adjustment. The deliverables of this evaluation process include classification of planning and evaluation issues prioritized into primary and secondary categories across short and long range planning horizons.

 Third - the process of developing supporting logic should include clear statements of potential redesign alternatives such as
 Definition of current procedures and systems
 Identification of the most likely system design alternatives based on leading industry and competitive practices
 Suggestion of innovative approaches based on new theory and technologies
The alternatives along with being practical should also challenge the existing practices. Flow diagrams and /or outline illustrating the basic concepts associated with each alternative are constructed, which frame opportunities for flexible logistics practices, clearly outline value added and information flow requirements and provide a comprehensive overview of the options. A recommended procedure requires the manager responsible for evaluating the logistical strategy to develop a logical strategy to develop a logical statement and justification of potential benefits. Using customer service concept and logistics integration logic and methodology, the manager should commit to paper the most attractive strategy alternatives.

c) Cost benefit estimate: The final feasibility assessment is a preplanning estimate of the potential benefits of performing a logistics analysis and implementing the recommendation. Benefits should be categorized in terms of:

 Service improvements - It includes results that enhance availability, quality or capability. Improved sciences increase loyalty of existing customers and may also attract business.

 Cost reduction - Cost reduction benefits may be observed in two forms:
First, they may occur as a result of a one time reduction in financial or managerial resources required to operate the existing system for e.g. Reduction in capital deployed for inventory and other distribution related assets
Second, cost reductions may be found in the form of out - of - pocket or variable expenses. For e.g. new technologies for material handling and information processing often reduce variable cost by allowing more efficient procedures and operations.

 Cost prevention - Cost prevention reduces involvement in programs and operations experiencing cost increases. Any cost prevention justification is based on an estimate of future conditions and therefore is vulnerable to some error for e.g. many material – handling and information technology upgrades are at least partially justified through financial analysis of the implications of future labor availability and wage levels.

In the final analysis, the decision to undertake in – depth planning will depend on how convincing the supporting logic is, how believable estimated benefits are, and whether estimated benefits offer sufficient return on investment to justify organizational and operational change. These potential benefits must be balances against the out 0- of pocket cost required to complete the process.

2. Project Planning: Logistics system complexity requires that any effort to identify and evaluate strategic or tactical alternatives must be planned thoroughly to provide a sound basis for change. Project planning involves five specific items:

a) Statement of objectives: The statement of objectives documents the cost and service expectations for the logistics systems revisions. It’s essential that they be stated specifically and in terms of measurable factors. The objective fine market or industry segments, the time frame for revisions, and specific service levels. For e.g., desired delivery of 98 percent of all orders within 48 hours after the order is placed, minimal customer shipments from secondary distribution centers, back – orders held for a maximum of five days, etc. specific definitions of these objectives direct system design efforts to ache9ice explicit performance levels. Total system cost can then be determined.

b) Statement of constraints: The second project planning consideration concerns design constraints. On the basis of the situational analysis, it’s expected that senior management will place restrictions on the scope of permissible system modifications depending on the specific circumstances of individual firms. But constraints can affect the overall planning process for e.g. one restriction common to distribution system design concerns the network of manufacturing facilities and their product mix assortment which the management often holds constant for logistical system redesign as there are large financial investments in existing production facilities. The purpose of developing a statement of constraints is to have a well-defined starting point and overall perspective for the planning effort. The statement of constraints defines specific organizational elements, buildings, systems, procedures, and/or practices to be retained from the existing logistical system.

c) Measurement standards: Such standards direct the project by identifying the cost structures and performance penalties and by providing a means to ass’s success. Management must stipulate guidelines for each category as a prerequisite to formulation of a plan. It is important that the standards adequately reflect total system performance rather than a limited, sub optimal focus on logistics functions. Once formulated, such standards must be held constant throughout system development. An important measurement requirement is to quantify a list of assumptions that underlie or provide the logic supporting the standards. Measurement standards should include definitions of how cost components such as transportation are calculated and also relevant customer service measures and method of calculation must also be included.

d) Analysis procedures: Analysis techniques range from simple manual methods to elaborate computerized decision support tools. For e.g., models incorporating optimization ort simulation algorithms for evaluating and comparing alternative logistics warehouse networks. Once the project objectives and constraints are defined, planning must identify alternative solution techniques and select the best approach. Selection an analysis technique must consider the information necessary to evaluate the project issues and options

e) Project work plan: On the basis of feasibility assessment, objectives, constraints and analysis technique, a project work plan must be determined and the resources and time required for completion identified. The alternatives and opportunities specified during the feasibility assessment provide the basis for determining the scope of the study. In turn the scope determines the completion time. One of the most common errors in strategic planning is to undere4stimate the time required to complete a specific assignment. Overruns require financial expenditures and reduce project credibility. There are a number of PC – based software packages available to structure projects, guide resource allocation, and measure progress.


Once the feasibility assessment and project plan are completed, phase 2 focuses on data collection and analysis. This includes activities to (1) define assumptions and collect data, and (2) analyze alternatives


This activity builds on the feasibility assessment and project plan to develop detailed planning assumptions and identify data collection requirements. Specific tasks are as follows

a) Define analysis approach and techniques: The most common techniques are analytical, simulation and optimization

The analytical approach uses standard numerical methods, such as those available through spreadsheets, to evaluate each logistics alternative. For e.g., spreadsheet availability have increases the use of analytical tools for distribution applications

A simulation approach can be likened to a “wind tunnel” for testing logistics alternatives. Simulation is widely used, particularly when significant uncertainty is involved. The testing environment can be physical (a model material handling system that physically illustrates product flow in a scaled down environment) or numerical (such as a computer model of a material handling environment that illustrates product flow on a computer screen) current software makes simulation one of the most cost effective approaches foe dynamically evaluating logistics alternatives

Optimization uses linear or mathematical programming to evaluate alternatives and select the best one. Because of its powerful capabilities, optimization is used extensively for evaluating logistics network alternatives such as the number and location of the distribution centers.

b) Define and review assumptions: Assumptions definition and review build on the situation analysis, project objectives, constraints and measurements standards. For planning purposes, the assumption defines the key operating characteristics, variables and economies of current and alternative systems. Assumptions generally fall into three classes:

Business assumptions - They define the characteristics of the general environment including relevant market, consumer, and product trends and competitive actions, within which an alternative logistics plan must operate. They are generally outside the ability of the firm to change.

Management assumptions define the physical and economic characteristics of the current or alternative logistics environment and are generally within the firm’s ability to change or refine. Typical assumptions include a definition of alternative distribution facilities, transport modes, logistics processes and fixed and variable costs.

Analysis assumption defines the constraints and limitations that must be included to fit the problem to the analysis technique. These assumptions frequently concern problem size, degree of analysis detail and solution methodology.

The elements of assumption categories are as follows

1. Scope: Definition of business units and product lines to be included
2. Alternatives: Range of options that can be considered
3. Market Trends: Nature and magnitude of change in market preferences and buying patterns
4. Product Trends: Nature and magnitude of change in market preferences and buying patterns particularly with respect to package size and packaging.
5. Competitive actions: Competitive logistics strengths, weaknesses and strategies.

Markets: Demand patterns by market area, product and shipment size
Distribution Facilities: Locations, operating policies, economic characteristics and performance history of current and potential distribution facilities.
Transportation: Transportation rates for movement between potential and existing distribution facilities and customers
Inventory: Inventory levels and operating policies for each distribution facility

1. Product Groups: Detailed product information aggregated to fit within the scope of analysis 1. Technique.
2. Market Areas: Customer demand grouped to aggregate market areas to fit the scope of analysis techniques
c) Identify data resources: The process of data collection begins with a feasibility assessment. A fairly detailed specification of data is required to formulate or fit the analytical technique. For situations when data are extremely difficult to collect or when the necessary level of accuracy is unknown, sensitivity analysis can be used to identify data collection requirements. For e.g. an initial analysis may be completed using transportation costs estimated with distance – based regressions. The types of data required in a logistical design n study can be divided into three classes: business assumptions, management assumptions and analysis assumptions. The majority of data required in a logistical study can be obtained from internal records. Although considerable searching may be needed, most information is generally available.
- The first major data category is sales and customer orders. The annual sales forecast and percentage of sales by month, as well as seasonality patterns are necessary for determining logistics volume and activity levels. Historical samples of customer order invoices are also needed to determine shipping patterns by market and shipment size. The combination of aggregate measures of demand and detailed order profiles of projects the requirements that the logistics system must be capable of satisfying. Specific customer data are also required to consider the cost and time associated with moving the products across distance. Customers and markets ate often aggregated by location, type, size, order frequency, growth rate, and special logistical services to reduce analysis complexity.
- For integrated channel analysis, its necessary to identify and track the costs associated with manufacturing and purchasing. It’s often necessary to consider the number and location of plants, product mix, production schedules and seasonality. Identification of policies and costs associated with inventory transfer, reordering, and warehouse processing, inventory control rules and product allocation procedures. For each of the current and the potential warehouse, the operating costs, capacities, product mix, storage levels and service capabilities should be established.
- Transportation data requirements
Transportation data requirements include the number and type of modes utilized, modal selection criteria, rates and transit times, and shipping rules and policies.

For most logistics analysis applications, a select amount of future market data is useful for evaluating future scenarios. Although the management may be able to prepare a consolidated sales forecast it is difficult to prepare a market-by-market projection of sales. There can be two solutions to this problem.

1. Usage of demographic projections that correlate highly with sales can help the company to estimate future demand levels and hence determine future logistics requirements. Secondary data published by various government agencies can also provide a data bank of environmental information

2. Keeping a watch on the competitors strategies and capabilities by documenting competitive logistical system designs and flows can be helpful in providing competitive benchmarks that compare customer service capabilities, distribution networks and operating capabilities.

d) Collect Data
Once the data sources have been identified the company can start assembly of required data and conversion of that data to an appropriate format for the analysis tool. To avoid errors like overlooking data that does not reflect major components of logistical activity or collection of data from a misrepresentative time period, the data collection process should be properly documented.

e) Collect Validation Data
The objective of validation is to increase management credibility regarding the analysis process and to ensure that the results of the analysis accurately reflect reality. It is important to ensure that a through investigation is conducted into analytical results based on data that might not accurately reflect the past.


The analyst uses the technique and data from the previous activity to evaluate logistics strategic and tactical alternatives. The process of analysis includes

a) Define analysis questions
This involves defining specific analysis questions concerning alternatives and the range of acceptable uncertainty. The questions build on research objectives and constraints by identifying specific operating policies and parameters. For e.g.: In the case of inventory analysis questions might focus on alternative service and uncertainty levels.

b) Complete and validate baseline analysis
The second task completes the baseline analysis of the current logistics environment using the appropriate method or tools. Results are compared with validation data collected previously to determine the degree of fit between historical and analytical findings. The comparison should focus on identifying significant differences, determining sources of possible errors and identifying and correcting them.

c) Complete alternative analysis
An evaluation of systems alternatives should be accomplished either manually or electronically to determine the relevant performance characteristics of each alternative.

d) Complete sensitivity analysis
In this phase uncontrollable factors like demand, factor cost or competitive actions are varied to assess the ability of potential alternatives to operate under a variety of conditions. Sensitivity analysis in conjunction with an assessment of potential scenario probabilities is then used in a decision tree to select the best alternative.

Phase III operationalize planning and design efforts by making specific management recommendations and developing implementation plans.

a) Recommendations
Alternative and sensitivity analysis results are reviewed to determine recommendations to management. There are four steps in this part of the phase namely: -

1. Identify the Best Alternative
Performance characteristics and conditions for each alternative must be compared to identify the two or three best options. The decision tree analysis should identify the best alternative i.e.: The one that meets the desired service objectives at the minimum total cost.

2. Evaluate Costs and Benefits
A Cost Benefit analysis compares the alternatives for a base period and then projects comparative operations across a particular planning horizon. Potential benefits such as cost reduction; service improvement and cost prevention are identified and quantified. In other words when evaluating the potential of a particular logistical strategy an analysis comparing present cost and service capabilities with projected conditions must be completed for each alternative.

3. Develop a Risk Appraisal
Risk Appraisal considers the probability that the planning environment will match the assumptions. It also considers the potential hazards related to system changeover. Risk related to adoption of a selected alternative can be quantified using sensitivity analysis. For e.g.: Assumptions can be varied and the resulting influence on system performance for each alternative can be determined. The end result of a risk appraisal provides a financial evaluation of the downside risk if the planning assumptions fail to materialize. Risks related to system changeover such as unanticipated delays, a series of contingency plans etc can also be quantified and a series of contingency plans could be tested to determine their possible impact.

4. Develop Presentation
The final step in this procedure is a presentation to the management / submission of a report that identifies specific operating and strategic changes, provides qualitative reasons for suggesting these changes and then quantitatively justifies the changes in terms of service, expenses, asset utilization or productivity improvements.

b) Implementation
The actual plan or design implementation is the final process activity. An adequate implementation procedure is the only means to obtain a tangible return from the planning process. This broadly includes four phases.

1. Define Implementation Plan
The implementation plan has to be defined in terms of the individual events, their sequence and their dependencies. The planning process may initially develop at a macro level. But it must ultimately be refined to provide individual assignment responsibility and accountability. Plan dependencies identify the interrelationships between events and thus define the completion sequence.

2. Schedule Implementation
The implementation plan is scheduled based on the assignments identified in the previous stage. The schedule must allow adequate time for acquiring facilities and equipment, negotiating agreements, developing procedures and training.

3. Define Acceptance Criteria
The criteria for evaluating the success of the plan are then developed. The Acceptance Criteria should focus on service improvements, cost reduction, improved asset utilization and enhanced quality. Although the acceptance criteria may focus on the area / function which was the main focus for the Plan, it should also take a broad perspective that focuses on total logistics system performance rather than the performance of an individual function.

4. Implement
The final task is actual implementation of the plan or design. Implementation must include adequate controls to ensure that performance occurs on schedule and that acceptance criteria are carefully monitored.


Planning is extremely important when it comes to inventory resources. The lack of planning can be costly to the firm either because of the carrying and financing costs of excess inventory or the lost sales from inadequate inventory. The inventory requirements to support production and marketing should be incorporated into the firm’s planning process in an orderly fashion.

The production side
Every product is made up of a specified list of components. The planner must realize the different mix of components in each finished product. Each item maintained in inventory will have a cost. This cost may be based on volume purchases, lead time for an order, historical agreements or other factors. Each component can be assigned a value. Once the mix is known and each component has been assigned a value, the planner can calculate the materials cost.

The marketing side
The second step in inventory planning involves a forecast of unit requirements during the future period. The marketing department should also provide pricing information so that higher profit items can receive more attention.

Inventory database
An important component of inventory planning involves access to an inventory database. It is a structured framework that contains the information needed to effectively manage all items of inventory, from raw materials to finished goods. This information includes the classification and amount of inventories, demand for the items, cost to the firm for each item, ordering costs, carrying costs and other data.

The task of inventory planning can be highly complex. At the same time it rests on fundamental principles. In doing so we must understand and determine the optimal lot size that has to be ordered. The EOQ (economic order quantity) refers to the optimal order size that will result in the lowest total of order and carrying costs and ordering costs. By calculating the economic order quantity the firm attempts to determine the order size that will minimize the total inventory costs.

An examination of the two curves reveals that the carrying cost curve is linear i.e. more the inventory held in any period, greater will be the cost of holding it. Ordering cost curve on the other hand is different. The ordering costs decrease with an increase in order sizes. The point where the holding cost curve i.e. the carrying cost curve and the ordering cost curve meet, represent the least total cost which is incidentally the economic order quantity or optimum quantity.

The EOQ can be calculated with the help of a mathematical formula. Following assumptions are implied in the calculation:
1. Constant or uniform demand- although the EOQ model assumes constant demand, demand may vary from day to day. If demand is not known in advance- the model must be modified through the inclusion of safe stock.
2. Constant unit price- the EOQ model assumes that the purchase price per unit of material will remain unaltered irrespective of the order offered by the suppliers to include variable costs resulting from quantity discounts, the total costs in the EOQ model can be redefined.
3. Constant carrying costs- unit carrying costs may very substantially as the size of the inventory rises, perhaps decreasing because of economies of scale or storage efficiency or increasing as storage space runs out and new warehouses have to be rented.
4. Constant ordering cost- this assumption is generally valid. However any violation in this respect can be accommodated by modifying the EOQ model in a manner similar to the one used for variable unit price.
5. Instantaneous delivery- if delivery is not instantaneous, which is generally the case; the original EOQ model must be modified through the inclusion of a safe stock.
6. Independent orders- if multiple orders result in cost saving by reducing paper work and the transportation cost, the original EOQ model must be further modified. While this modification is somewhat complicated, special EOQ models have been developed to deal with it.
These assumptions have been pointed out to illustrate the limitations of the basic EOQ model and the ways in which it can be easily modified to compensate for them.
The formula for the EOQ model is:

2 M Co
S Cc

Where M = is the annual demand
Co is the cost of ordering
Cc is the inventory carrying cost
S = is the unit price of an item.

Limitations of the EOQ formula-
1. Erratic changes usages- the formula presumes the usage of materials is both predictable and evenly distributed. When this is not the case, the formula becomes useless.
2. Faulty basic information- order cost varies from commodity to commodity and the carrying cost can vary with the company’s opportunity cost of capital. Thus the assumption that the ordering cost and the carrying cost remains constant is faulty and hence EOQ calculations are not correct.
3. Costly calculations: the calculation required to find out EOQ is extremely time consuming. More elaborate formulae are even more expensive. In many cases, the cost of estimating the cost of possession and acquisition and calculating EOQ exceeds the savings made by buying that quantity.
4. No formula is a substitute for common sense- sometimes the EOQ may suggest that we order a particular commodity every week (six-year supply) based on the assumption that we need it at the same rate for the next six years. However we have to order it in the quantities according to our judgement. Some items can be ordered every week; some can be ordered monthly, depends on how feasible it is for the firm.
5. EOQ ordering must be tempered with judgement- Sometimes guidelines provide a conflict in ordering. Where an order strategy conflicts with an operational goal, order strategy restrictions should be developed to permit honouring the goal.

Quantity discounts: In the EOQ analysis, it has been assumed that material prices and transportation costs were constant factors for the range of order quantities considered. In practice, some situations occur in which the delivered unit cost of a material decreases significantly if a slightly larger quantity than the originally computed EOQ is purchased. Quantity discounts, freight rate schedules and price increases may create such situations. These additional variables can also be included in the formula.

Determining ordering point

In the EOQ model, the leas time for the procurement material is assumed to be zero. Consequently the ordering point for replenishment of stock occurs when the level of inventory drops down to zero. In view of instant replenishment of stock, the level of inventory jumps to the original level from zero level. This is well illustrated in the following diagram:

However, in real life situations, one never encounters a zero lead-time. There is always a time lag from the date of placing an order for materials and the date on which the materials are received. As a result, the ordering level is always at the level higher than zero. If the firm orders the goods when the inventory level reaches the reorder point, the firm will never run out of goods. The decision on how much stock to hold is generally referred to as “Order point problem” that is how low should the inventory be depleted before it is reordered.

The two factors that determine the appropriate order point are the:
a) Procurement or delivery time stock (inventory needed during the lead time) and;
b) The safety stock, which is the minimum level of inventory that is held as a protection against shortages.

In summary, the efficiency of the replenishment system affects how much delivery time is needed.

Determination of level of safety stock involves a basic trade-off between the risk of stock-out, resulting in possible customer dissatisfaction and lost sales, and the increased costs associated with carrying additional inventory. The following diagram represents this better:

Safety stock

When the wage rate and/or lead-time vary, then the reorder level should naturally be at a level high enough to cater to the production needs during then procurement period and also to provide some measure of safety for at least partially neutralizing the degree of uncertainty.
How much should the magnitude of safe stock be?
It depends on the degree of uncertainty surrounding the usage rate and lead-time. It is possible to a certain extent of to quantify the values that usage rate and lead-time can take along with the corresponding ‘chances of occurrences’ known as ‘probabilities’. These probabilities can be ascertained based on the previous experiences and the judgmental ability of executives. Based on the above values and estimated stock out costs and carrying costs of inventory it is possible to work out the total cost associated with different levels of safety stock. Higher the quantity of safety stock, the lower will be the stock-out cost and the higher will be the incidence of carrying costs. Thus the reorder level will call for a trade-off between stock out costs and carrying cost. The reorder level will be such that the total stock out cost and the carrying cost will be at its minimum.

Cost of carrying inventory

Carrying material in inventory is expensive. A number of studies indicated that the annual cost of carrying a production inventory averaged approximately 25% of the value of the inventory. The escalating and volatile cost of money has escalated the annual inventory carrying cost to a figure between 25% - 35% of the value of the inventory. The following five elements make up this cost:
1) Opportunity cost (12% -20%)
2) Insurance cost (2% – 4%)
3) Property taxes (1% - 3%)
4) Storage costs (1%- 3%)
5) Obsolescence and deterioration (4% - 10%)
Total carrying cost (20% - 40%)
Let us briefly look into these costs:

Opportunity cost of invested funds
When a firm uses money to buy production material and keeps it in the inventory, it simply has this much less cash to spend for other purposes. Money invested in external securities or in productive equipment earns a return for the company. Thus it is logical to charge all money invested in inventory an amount equal to that it could earn elsewhere in the company. This is the opportunity cost associated with inventory investment.

Insurance cost
Most firms insure the assets against possible losses from fire and other forms of damage.

Property taxes
This is levied on the assessed value of a firm’s assets, the greater the inventory value, the greater the asset value and consequently the higher the firm’s tax bill.

Storage costs
The warehouse is depreciated every year over the length of its life. This cost can be charged against the inventory occupying the space.

Obsolescence and deterioration
In most inventory operations, a certain percentage of the stock spoils, is damaged, is pilfered, or eventually becomes obsolete. A certain number always takes place even if they are handled with utmost care.

Generally speaking, this group of carrying costs rises and falls nearly proportionately to the rise and fall of the inventory level.

Moreover, the inventory level is directly proportional to the quantity in which the ordered material is delivered. Hence costs of carrying inventory vary nearly directly with the size of the delivery quantity. This relationship is illustrated as follows:

(Carrying Cost per year) = (Average inventory value) x (Inventory carrying cost
as a % of inventory value)

Origin purchase
Buyer incurs the freight cost and product risk when the product is in transit.


While the EOQ formulation is relatively straightforward, there are some other factors that must be considered in actual application. The most important and persistent problems are those related to various adjustments necessary to take advantage of social purpose situations and utilization characteristics.

1. Volume transportation rate: In the EOQ formulation, there was no consideration for the impact of transportation cost on order quantity. The transportation cost from the origin to the inventory depot is incurred by the seller. However if the ownership is transferred at the origin, the impact of the transportation rates on the total cost must be considered when determining the order quantity. As a general rule, greater the quantity, lesser will be the volume transportation rate because many sellers tend to give a discount when the goods are bought in a larger size (both by the truck and rail). Thus all other things being equal, an enterprise will want to buy goods in large quantities to maximize transportation economies. Such quantity may be larger than the actual quantity determined by EOQ. Increasing the size of the order has a two fold impact on the inventory:
• It increases the inventory carrying cost
• It provides better transportation economies.
Finally, two factors regarding inventory cost under costs of origin purchase are:
• The transit inventory is a part of the enterprise’s average inventory and therefore subjected to an appropriate charge.
• The transportation cost should be added to the price of the goods purchased to assess the value of the goods tied up in inventory. Thus the inventory carrying cost should be assessed on the combined cost of the item and transportation.

2. Quantity Discounts
Purchase quantity discounts represent an EOQ extension. If the discount at any associated quantity is sufficient to offset the added cost of maintenance less the reduced cost of ordering, then the quantity discount offers a viable alternative. It should be noted that quantity discounts and volume transportation rates each effect later purchase quantities. However, this does not mean that the lowest total cost purchase will always be a large quantity.

EOQ Adjustments
A variety of special situations can occur that will require adjustments to basic EOQ model. Some of them are:
• Production lot size (most economical quantity from manufacturing perspective)
• Multiple item purchase.
This describes situations when more than one product is bought concurrently, so that quantity and transportation discounts must consider the impact of the product combinations.
• Limited capital (limited capital – budget limitations for total inventory investment)
• Private trucking (influences order quantity since it represent a fixed cost once the decision is made to replenish the product.)
If the enterprise decides to use its own truck, it should fill the truck regardless of the value calculated by the EOQ. Transporting a half empty truck does not make any sense.

Inventory Related Definitions
This includes definitions related to an inventory management policy.
1) INVENTORY POLICY: It consists of guidelines concerning what to purchase or manufacture, when to take action and in what quantity. It also deals with the inventory positioning and placements in plants and distribution centers. E.g some plants may maintain stock at a plant and hence postpone the inventory positioning. The second inventory policy element concerns inventory management strategy. One approach is to manage inventory at each distribution center independently. The other extreme deals with inventory interdependence across distribution sites by managing inventory centrally. Centralized inventory management requires more coordination and communication.

(2) Service level: It defines the performance objectives that the inventory function mustr be capable of achieving. It can be defined in terms of the following:

(a) Order cycle time: the time taken to complete from the time of placing the order to the payment for the goods received. It can also be defined as the elapsed time between the release of a purchase order by a customer and the receipt of the corresponding shipment.
(b) Case fill rate: it can be defined as the percentage of cases or units ordered that can be shipped as 4requested. For e.g. 95% case fill rate indicates that on an average, 95 cases out of 100 could be filled from available stock. The remaining 5 will be back ordered or deleted.
(c) Line fill rate: % of order lines that could be filled completely. Each time on an order is a request for an individual product, so an order may have multiple lines. E.g. if a customer order is received requesting 80 units of product A and 20 units of product B, the order is of 100 cases and 2 lines. If there are 75 units of product A available and all 20 of product B, the case fill would be 95% (75+20)/(80+20) and the line fill rate would be 50%.
(d) Order fill: it is a % of customer orders that could be filled completely. In the above example, the order could not be filled completely filled, so the resulting order fill would be zero.

The inventory function is a major element of the logistics process that must be integrated in order to meet the service objectives. To improve service level, once can increase the inventory. Other approaches would be faster transportation modes, better information mgmt, or alternative sources of supply.

Average inventory: this consists of the materials, components, WIP and finished products typically stocked in logistical facilities. Average inventories include cycle, safety stock and in transit inventory components.

Cycle inventory: it is also known as base stock. It can be defined as the % of the inventory that results from the replenishment process. Cycle inventory can also be said to result when in order to reduce unit purchase costs (or increase production efficiency), the number of units purchased (or produced) inventory from to which the lot size is applied. It may be more economical to order the product in a large size than to order it in small batches. At the beginning of a performance cycle, the stock level is at the maximum level. However daily customer demands stock to be withdrawn from the inventory until it reaches zero. Prior t this, a replenishment order must be given. The amount ordered for replenishment is called the order quantity. The average inventory held as a result of the order process is referred to as base stock, which is also called as the lot size stock. Usually the base stock equals to one half of the order quantity.

Safety stock inventory: It has been explained on pg 6

Transit inventory: this represents the stock that is either moving or awaiting movement in transportation vehicles. This portion of the total inventory is also known as pipeline inventory. It can also be defined as the materials moving forward but not yet received. It is necessary to achieve order replenishment. Transit inventory represents real assets and must be paid for even though it is not accessible or usable. There has typically been a high degree of uncertainty associated with transit inventory because shippers were unable to determine where a transport was located or when it was likely to arrive. While satellite communications have somewhat reduced this uncertainty.

Shippers bill have limited accessibility to such information. Increased focus on smaller order quantities, more frequent order cycles and just in time strategies have resulted in transit inventory becoming a larger percentage of the total inventory assets. As a result, greater attention is paid to reducing the amount of transit inventory and its associated uncertainty.

Formulating inventory policy
Inventory turnover is a widely used performance measure that reflects the liquidity of a firm’s inventory and the speed with which inventory is converted into sales.
This indicates the number of times the inventory is sold or turned over during a stated period.
Inventory turnover ratio = Cost of goods sold
Average inventory value

e.g, if the firm’s annual cost of goods sold = Rs.5,00,000 and its average inventory value = Rs.50,000, the inventory turns over 10 times. If the cost of goods sold rises to Rs.10, 00,000 and the value of the inventory remains as it is, the turnover ratio jumps to 20.
Inventory turnover is related to actual sales. Hence high inventory levels are not penalized if the sales are very high and low inventory levels are not rewarded, if the sales are low. If the inventory turnover is high, it means that the inventory is kept in stock for a less period of time and hence it is more liquid. The cash flow needed to finance the inventory also decreases as the number of inventory turnover increases. A high level of sluggish inventory amounts to unnecessary tie-up of funds, reduced profits and increased costs. If these inventories are written off, it will adversely affect the Working capital and liquidity position of the firm. However, if the inventory level is maintained at a very low level (inventory turnover high), then it may result into frequent stock outs, which means the firm replenishes its inventory in small lot sizes. This may be costly to the firm.

Elements of logistics Management
Inventory planning methods use a common information base to co-ordinate inventory requirements across multiple locations or stages in the value added chain. Planning activities may occur at the plant warehouse level to coordinate inventory allocation and delivery to multiple distribution centers. Planning may also occur to coordinate inventory requirements across multiple channel partners such as manufacturers and retailers.
Two inventory planning methods are:
a) Fair share Allocation
b) Distribution requirement planning.

Fair share Allocation
It is a simplified inventory management planning method that provides each distribution facility with an equitable or ‘Fair share’ of available inventory from a common source such as a plant warehouse.

Example of a fair share allocation

The above figure illustrates the network structure, current inventory levels and daily requirements of three distribution centers served by a common plant warehouse. Using fair share allocation rules, the inventory planner determines the amount of inventory that can be allocated to each district center from the available inventory at the plant warehouse. For this example assume that it is desirable to retain 100 units at the plant warehouse, hence 500 units are available for allocation.

DS =

DS = common days supply for distribution center inventory.
Aj = inventory units to be allocated from plant warehouse.
Ij = inventory in units for distribution center ‘j’
Dj = daily demand for distribution center j.
n = number of distribution centers.

In this example, DS = 500 + (50+100+75)
10 + 50 +15

= 500 + 225
= 9.67 days
Hence the fair share allocation indicates that each distribution center should be brought up to 9.67 days of stock. The amount to be allocated to each distribution center is determined by:
Aj = (DS – Ij ) x Dj

Aj = amount allocated to distribution center ‘j’.
Ds = days’ supply that each distribution center is brought up to Ij and Dj are as above.
The amount allocated to distribution center 1 in this case:
A1 = (9.67 – 50/10) x 10 = (4.67) x 10 = 46.7 ~ 47 units.

However fair share allocation does not consider site-specific factors such as differences in performance cycle time, EOQ, safety stock requirements.

SKU (Stock keeping unit – it is a specific item purchased by the customer including colour and size uniqueness.)

Distribution requirement planning (DRP)
It is a more sophisticated approach that considers multiple distribution stages and the characteristics of each stage. It is a logical extension of MRP, although there is one fundamental difference between the two.
• MRP is determined by a production schedule that is defined and controlled by the enterprise. On the other hand, DRP is guided by customer demand, which is not controllable by the enterprise.
• So, while MRP generally operates in a dependent demand situation, DRP operates in an independent environment where uncertain customer demand determines inventory requirements. The manufacturing requirements planning component coordinates the scheduling and integration of materials into finished goods.
• MRP controls inventory until manufacturing or assembly is complete. DRP then takes coordination responsibility once finished goods are received in the plant warehouse.

The fundamental DRP planning is the schedule, which coordinates requirements across the planning horizon. There is a schedule for each SKU and each distribution facility. Schedules for the same SKU are integrated to determine the overall requirements for replenishment facilities such as the plant warehouse. The schedules are developed using weekly time increments known as ‘buckets’. The schedule reports current on-hand balance, safety stock, performance cycle length and EOQ.

Distinction between DRP and MRP


Guiding factor Guided by production schedules
Guided by customer demand
Control of the firm Under control of the firm
Not under control of the firm
Demand situation Operates in dependant demand situation Operates in independent demand situation
Area of operation and coordination Coordinates scheduling and integration of materials into finished goods Coordinates demand between outlets and supply sources
Stage of functioning Controls inventory until manufacturing and assembly is complete. Controls and coordinates inventory after manufacturing and assembly of finished goods

The figure below shows the areas of functioning of MRP and DRP. MRP plans the procurement of raw materials as per their requirements, right from the first stage till the final assembly.

After the goods have been manufactured, DRP plans the distribution of finished goods from the plant warehouse to the wholesalers and retailers till it reaches the customer.

The integrated model seeks to combine these two areas. Taking into consideration the requirements of both MRP and DRP, it provides integrated planning.

DRP Benefits And Constraints
An inventory management system such as DRP offers a number of benefits for management. The major organizational beneficiaries include marketing and logistics.

The major marketing benefits are:
• Improved service levels that increase on time deliveries and decrease customer complaints.
• Improved and more effective promotional and new product introduction plans.
• Improved ability to anticipate shortages so that marketing efforts are not expended on products with low stock.
• Improved inventory coordination with other enterprise functions, since DRP facilitates a common set of planning numbers.
• Enhanced ability to offer customers a coordinated inventory management service.

The major logistics benefits are:
• Reduced distribution center freight costs resulting from coordinated shipments.
• Reduced inventory levels, since DRP can accurately determine what product is needed and when.
• Decreased warehouse space requirements because of inventory reductions.
• Reduced customer freight costs as a result of fewer back orders.
• Improved inventory viability and coordination between logistics and manufacturing.
• Enhanced budgeting capitability, since DRP can effectively simulate inventory and transportation requirements under multiple planning scenarios.

The constraints of DRP are:
• Inventory planning systems require accurate and coordinated forecasts for each distribution center. The forecast is necessary to direct the flow of goods through the distribution channel. To the extent that this level of forecast accuracy is possible, inventory-planning systems operate well. However, this requires forecasts for each distribution center and SKU as well as adequate lead-time to allow product movement. However there are 3 potential sources for error exist. The forecast itself may be wrong, it may have predicted demand at the wrong location, or it may have been predicted demand at the wrong time.
• Inventory planning requires consistent and reliable performance cycles for movement between the distribution centers. While variable performance cycles can be accommodated through safety lead times, performance cycle uncertainty reduces planning system effectiveness.
• Integrated planning is subject to system nervousness and frequent rescheduling, because of production breakdowns and delivery delays. The system nervousness leads to fluctuations in capacity utilization, rescheduling cost, and confusion in deliveries. This is intensified by the volatile operating environment characteristic of distribution. Uncertainties such as supply transportation performance cycles and vendor delivery reliability can cause an extremely nervous DRP system.
• DRP is not the universal solution for inventory management.

Question 16

Logistical Organization And Development: 3 Stages Of Evolution
Prior to the 1950s,functions now accepted as logistics were generally viewed as facilitating or support work. Organizational responsibility for logistics was dispersed throughout the firm. This fragmentation often meant that aspects of logistical work were performed without cross-functional coordination, often resulting in duplication and waste information was frequently distorted or delayed and lines of authority and responsibility were typically blurred. Managers recognizing the need for total cost control began to reorganize and combine logistics functions into a single managerial group. Structuring logistics as an integrated organization first appeared in the 1950s.
The motivation behind functional aggregation was the belief that grouping logistics functions into a single organization would increase the likelihood of integration. The paradigm (model) was that functional proximity would facilitate improved understanding of how decisions and procedures in one area affect performance in other areas. The belief was that eventually all functions would begin to work as a single group focused on total system performance. This integration paradigm, based on organizational proximity, prevailed throughout a thirty-five year period. However, by the mid 1980s, it was becoming increasingly clear that the paradigm of functional aggregation might not, in final analysis, offer the best approach to achieve integrated logistics. For many firms, the ink had barely dried on what appeared to be the perfect logistics organization, when new and far more pervasive rethinking of what constituted the ideal structure emerged.
Almost overnight, the emphasis shifted from function to process. Firms began to examine the role logistical competency could play in the overall process of creating customer value. This ushered in new thinking regarding how to best achieve logistical performance. To a significant degree, the focus on process reduced the pressure to aggregate functions into all encompassing organization units. The critical question became not how to organize individual functions but rather how to best manage the overall logistical process. The challenges and opportunities of functional disaggregation and information driven integration began to emerge.
The mission of logistics is to position inventory when and where it is required to facilitate profitable sales. This supportive work must be performed around the clock and typically throughout the world, which means that logistics needs to be an integral part of all processes. The ideal structure for logistics would be an organization that performs essential work as part of the processes it supports while achieving the synergism of cross functional integration.
Information technology introduced the potential of electronic integration as contrasted to physically combining logistics functions. Using information technology to coordinate or orchestrate integrated performance allows the responsibility for work itself to be distributed throughout the overall organization. Integration requires that logistics combine with other areas such as marketing and manufacturing. For example, rather than focusing on how to relate transportation and inventory, the real challenge is to integrate inventory, transportation, new product development, flexible manufacturing and customer service. in order to achieve overall organizational integration, a firm must combine a wide variety of capabilities into new organizational units. This means that the traditional single function department must be assimilated in a process. Such assimilation often requires the traditional organizational structure be dissaggregated and then recombined in new and unique ways in one sense, such a functional disaggregation may appear to come full circle back to the early days of fragmented single-function departments. However, the critical differences in the emerging organization model are widespread availability of unbridled information. The new organization format is characterized by an extremely different culture concerning how information is managed and shared.
Understanding the organizational development process permits logistics managers to evaluate the firm’s current state of organization and plan changes that can be accommodated.

Stages of functional organization

Figure illustrates a traditional organizational structure with dispersed logistical functions.. the initial belief was that integrated performance would be facilitated by grouping logistical functions normally spread throughout the traditional organization into a single command and control structure.. It was felt that these functions would be better managed, trade-offs better analyzed, and least-Total cost solutions better identified if all logistics work was integrated into one organization. In order for operational integration to occur, managers had to believe that performance could be improved.
Without this belief, they would continue To emphasize structure as opposed to management practice.
While the idea of functional integration is logical and appeals to common sense, it is not always supported by other unit managers. It is natural that any attempt to reposition management authority and responsibility will meet resistance. Many logistics executives can provide examples of how attempts to reorganize were met with rivalry and mistrust--- not to mention accusations of empire building. Traditionally, in organizational structures, financial budgets follow operational responsibility. Likewise, power, visibility, and compensation result from managing large head counts and substantial budgets. Logistical reorganization, therefore, was typically seen as a way for logistical managers to gain power, visibility and compensation at the expense of other mangers. This also was ample reason for other managers to protect their power by resisting logistics functional integration. As a result, unified logistical organizations faces considerable resistance. But in an increasing number of firms, benefits were sufficient to empower reorganization. The resulting evolution typically involved three stages of functional aggregation.


The initial attempt at grouping logistical activities emerged during the late 1950s and early 1960s. Organizations with even a minimal degree of formal unification emerged only after senior management became committed to the belief that improved performance would result. The typical evolutionary pattern was for two or more logistics functions to be operationally grouped without significant change in the overall organization hierarchy. Such initial aggregation Occurred at both the staff and line levels of organization.. Seldom were organization Units engaged in purchasing and physical distribution integrated during this initial development stage.
Figure illustrates a typical stage 1 organization. Although completely separate, physical distribution and material management units serve to aggregate related functions. As the potential of integrated logistics developed recognition within an enterprise, one or two clusters of unified operations emerged. In the marketing area, the cluster typically centered around customer service. In the manufacturing area, concentration was usually on inbound materials or parts procurement.. However, with few exceptions, most traditional departments were not changed and the organization hierarchy was not altered significantly. For the most part, stage 1 organizational change involved grouping functions within the traditional domains of marketing and manufacturing. The notable deficiency of stage 1 organization was a failure to focus direct responsibility for inventory.
For example, initial physical distribution organizations typically controlled warehousing, transportation and order processing. Few stage 1 organizations had direct responsibility to manage trade-offs between transportation and finished inventory deployment.


As the overall enterprise gained operational experience with unified logistics and cost benefits, a second stage of organization began to evolve. Figure illustrates stage 2, which began to emerge in the late 1960s and early 1970s. The significant feature of stage 2 was that logistics was singled out and elevated To a position of higher organizational authority and responsibility. The motivation was simple: Positioning logistics at a higher organization level increased the likelihood of strategic impact. Independent status allowed logistics to be managed as a core competency. A likely candidate for elevated status was physical distribution in firms where customer service performance was critical to overall success. The grocery manufacturing business was an example where materials management often increased in operational authority and responsibility because inbound materials and production were a major portion of product costs. Thus the focal group that was elevated to higher organizational prominence in the stage 2 organizations typically depended on the nature of the enterprise’s primary business. The example in the figure illustrates a situation wherein physical distribution was restructured and elevated.
In order to establish a stage 2 organization, it was necessary to reassign functions and position th newly created organization at a higher level within the overall enterprise structure. In the stage 2 organization, the concept of a fully integrated logistics unit was not achieved. Rather, integration was focused on either physical distribution or materials management. This failure to synthesize logistical management into an integrated system was due in part to a preoccupation with the performance of specific functions, such as order processing or purchasing, which were perceived as essential to traditional operations. A second limiting factor to total integration was the lack of cross – functional logistical information systems.. As a general rule, organizational integration reflected the information systems capability of the firm.
A significant point about the stage 2 organization is that integrated physical distribution and/or materials management began to gain acceptance among financial, manufacturing, and marketing counterparts. The other corporate officers viewed these integrated organization as something more than purely reactive efforts aimed at cost reduction or containment. In the stage 2 organizations, it was common for the integrated unit to become a primary contributor to business strategy. The stage 2 organization is readily observable in industry today and may well remain the most adopted approach to logistical facilitation.


Stage 3 organizations emerged in the 1980s the logistical renaissance began. This organizational structure sought to unify all logistical functions and operations under a single senior manager. Stage 3 organizations, having the comprehensive nature, were and continue to be rare. However, the trend at the stage 3 level of organization structuring is clearly to group as many logistical planning and operational functions as practical under single authority and responsibility. The goal is the strategic management of all materials and finished product movement and storage to the maximum benefit of the enterprise.
The rapid development of logistical information systems provided an impetus for stage 3 organizations. Information Technology became available to plan and operate systems that fully integrated logistical operations. Several aspects of the stage 3 organizations justify further discussion.
First, each area of logistics – purchasing, manufacturing support and physical distribution is structured as a separate line organization. The lines of authority and responsibility directly enabled each bundle of supportive services to be performed within the overall integrated logistical effort. Since areas of operational responsibility are well defined, it is possible to establish manufacturing support as an operational unit similar to purchasing and physical distribution. Each of these units is operationally self-sufficient. Therefore, each can maintain the flexibility to accommodate critical services required by its respective operational area. In addition, since overall logistical activities can be planned and coordinated on an integrated basis, operational synergies between areas can be exploited.
Second, five capabilities grouped under logistical support are positioned as operational services. This common service orientation is the mechanism to integrate overall logistical operations. It is important to stress that logistical support is not a staff organization. Rather, the group manages the day-to-day logistics work, which is structured with matrix accountability for direct liaisons between physical distribution, manufacturing support, and purchasing operations.
Third, logistical resource planning embraces the full potential of management information to plan and coordinate operations. Order processing triggers the logistical system into operation and generates the integrated database required for control. Logistical resource planning facilitates integration. The plans are based on product/market forecasting, order processing, inventory status, and capacity strategy to determine overall requirements for any planning period. On the basis of identified requirements, the planning unit operationalizes manufacturing by coordinating production scheduling, capacity planning, and materials requirement planning.
Finally, overall planning and controllership exist at the highest level of the stage 3 organization. These two efforts serve to facilitate integration. The planning group is concerned with long-range strategic positioning and is responsible for logistical system quality improvement and reengineering. The logistical controller is concerned with measurement of cost and customer service performance and with provision of information for managerial decision-making. The development of procedures for logistical controllership is one of the most critical areas of integrated logistical administration. The need for careful measurement is a direct result of the increased emphasis placed on customer service performance. The measurement task is extremely important because of te large operating and capital dollar expenditures involved in logistics.
The stage 3 logistical organization approach offers a single logic to guide the efficient application of financial and human resources from material sourcing to customer delivery. As such a stage 3 organization, stage 3 logistical positions a firm to manage trade-offs between purchasing, manufacturing support, and physical distribution.

Interdependent of functional aggregation or disaggregation it is clear that organizations are struggling to position their operating capabilities to better support oriented process management. Mckinsey Consultants, frank Ostroff and Doug Smith proposed architecture to illustrate how functional hierarchical vertical organization to transition to become a process oriented horizontal model.
The concept of 21st century organization is envisioned as the result of three factors: development of a highly involved work environment with self directed work teams (SDWT) as a vehicle to empower employees to generate maximum performance; second, improved productivity that results from managing processes rather than functions (this notion has always rested at the core of integrated logistics) and third, the rapid sharing of adequate information that allows all facets of organization to be integrated.
The essence for the argument for radical restructuring is that the traditional evolutionary concept of organization change is not sufficient to stimulate major breakthroughs in service or productivity. Rather, traditional change shifts the balance of centralization and decentralization or realigns operating structure between customers’ territories or products without any serious redesign of the basic work process. Because such restructuring typically assumes that functional organizations will continue to perform the basic work, little or no difference in actual practice results. In essence, companies are refocusing old business practices rather than designing new, more efficient processes.
The challenges of managing logistics as a process are three fold. First all effort must be focused on value added to the customer. an activity exists and is justified only to the extent that it contributes to customer value. Therefore, a logistical commitment must be motivated by a belief that customers desire a specific activity to be performed. Logistical managers must develop the capacity to rethink externally. Second, organizing logistics as part of process requires that all skills necessary to complete the work be available regardless or functional organization. Organizational grouping on the basis of selected functions can artificially separate natural workflows and create bottlenecks. When horizontal structures are put in place, critical skills need to be put into position to ensure that required work is accomplished. Finally, work performed in a process context should stimulate synergism. With systems integration, the design of work as a process means that overall organizational trade-offs are structured to achieve maximum output for minimum input investment.
The radical changes proposed by the shift from functional to process orientation have mixed messages for managers involved in logistics. On the positive side, general adoption of a process orientation builds on the basic principles of systems integration. At the core of integrated logistics is a commitment to functional excellence in the context of contribution to process performance. A general shift in managing logistics as a process means that it will be positioned as a central contributor to all initiatives that focus on new product development, customer order generation, fulfillment and delivery. The overall trend of process integration expands the operational potential and impact of logistics.


It is highly unlikely that the attention being given to process will end management ‘s quest for the ideal logistical organization. While several different scenarios concerning the organization of the future are technologically feasible, one of the most intriguing is speculation
That formal hierarchical command and control organization structure will be replaced with an informal electronic network often referred to as a virtual organization. The word virtual implies an underlying existence without formal recognition. In other words, a virtual organization, whether it is a total enterprise or a specific core competency, would exist as a provider of integrated performance but not as an identifiable unit of in terms of the formal organization structure of their membership critical activities in an integrated fashion. These work teams could be transparent in terms of the formal organization structure of their membership. In other words, formal organization charts may not be related to actual workflow. In fact, logistics organizations of the future could not be characterized by functional disaggregation throughout the organization in an attempt to focus on workflow rather than structure.


Integration is required not just within the organization but integration upstream with suppliers and distributors and customers. This integration is logistical rather than “vertical”; in other words we do not imply ownership or domination of the supply chain but rather that there is a greater emphasis on the linkage of organizations through information.
The whole nature of logistics management has been dramatically changed by the information technology revolution. Information systems have now become the driving force pressurizing companies to reconsider their relationships with customers as well as suppliers. It is no longer possible to manage the business as if it were in a vacuum with no interconnections with other organizations.
By process integration we mean collaborative working between buyers and suppliers, joint product development, common systems and shared information. For some companies such ideas are yet unthinkable and yet the signs are clearly pointing to a future where it will be the extent and quality of supply chain, integration that will determine market place performance.
However in many industries the concept of process integration is increasingly accepted. For e.g. Over the last decade there has been a significant change in the way many car manufacturers in Western Europe have changed from fragmented, transaction focused businesses to highly integrated and relation ship based supply chains.
Question 17

Plant and distribution center location is a common problem faced by logistics managers. Increased production economics of scale and reduced transportation cost have focused attention on distribution centres.
In recent years, location analysis has been further extended to include logistics channel design as a result of global sourcing and marketing decisions. Global operations increase logistics channel decision complexity, design alternatives and related logistics cost.

Location decision focus on selecting the number and location of distribution centres. Typical management questions:-
 How many distribution centers should the firm use and where should they be located?
 What customers or market areas should be serviced from each distribution center?
 Which product lines should be produced or stopped at each plant or distribution center?
 What logistics channels should be used to source material and serve international markets?
 What combination of public and private distribution facilities should be used?

Location analysis problems are very complex and data intense. Complexities are created because of the number of locations multiplied by the alternative location sites multiplied by the stocking strategies for each location. Data intensity is created because the analysis requires detailed demand and transportation information. The techniques used are:
 Analytic techniques
 Optimization or linear programming techniques
 Simulation techniques

Analytic techniques: they generally describe methods that identify the center of gravity of logistics geography. A center of gravity method is appropriate for locating a single distribution plant or center. A number of methods both mathematical and non mathematical can be applied to a problem of a single location. The cost and complexity of the technique is to be matched to the difficulty of the problem.
In the following example technique employed is evolved from analytic geometry.
The model is based on Cartesian co-ordinates, where the horizontal axis is labeled as the x-axis, and the vertical axis is labeled as the y-axis. The figure below illustrates such a coordinate system.

Any given point in the quadrant can be identified with reference to x and y coordinates. Taken together, these co-ordinates define unique points. The figure below illustrates the x and y co-ordinates of Detroit, Michigan, Columbus, Ohio. The co-ordinates for Detroit are 3.5 and 3. the co-ordinates of Columbus are 3.8 and 2. the x and y co-ordinate system can be used to calculate the distance between any two points on the plane using the Pythagoras theorem.

By use of this basic system of orientation, it is possible to replicate the geographic market area in which the distribution centre is to be located.
This method to solve the location problem determines the ideal co-ordinate position of the distribution warehouse on the basis of distance, weight or a combination of both. The computation is a weighted average of the distance, weight or combined factors, with the warehouse location as the dependent variable. The algebric solution may use either the weighted average x and y co-ordinate or the median location. The median location uses the coordinate location with half the demand on each side. The formulae of this calculation depend on the independent variables expressed in the location measure. The problem is in a manner such that identical service standards exist for all potential distribution warehouse locations. The objectives are to minimize transportation cost.

Transportation cost are a function of time, weight and distance. Historically, in mathematical techniques it is not possible to consider all the factors together. The 4 solution methods that consider combination of factors are:-
ton – center solution
mile – center solution
ton – mile center solution
time – ton – mile center solution

Ton – center solution: the location point represents the center of gravity or movement in market area. The assumption is that the center of movement represents the least cost location. In Ton – center solution only weight is given consideration. All demand locations are plotted on the co-ordinate plane and identified by subscripts. To express tonnage requirements to each demand center, annual tonnage is reduced to standard units. Once each demand location is defined and the total units load to each demand center are known, the best warehouse location can be determined.
The location solution is found by adding the products of location and delivery frequency to each demand center from the x- co-ordinate and dividing the total number of units. The process is requested from the y co-ordinate. The result is a location in terms of x and y for the distribution warehouse. The final location solution indicates the point that provides the balance of weight between destinations over a specific period.

X,Y= unknown co-ordinate values of the warehouse.
Xn,Yn= delivery locations, designated by the appropriate script.
Fn= annual tonnage to each destination, expressed as standard trailors.

Mile – center solution: this determines the geographical point that minimizes the combined distance to all demand centers. The assumption underlying the solution is that delivery costs are solely a function of distance. Therefore, if distance is minimized a least cost location is determined. The basic deficiency of this omission of weight and time considerations.
The mile center solution cannot be determined by solving for the weighted average co-ordinate location along each dimension. It requires a iterative process to detmine an increasingly improved warehouse location. This optimum location is determined by utilizing the general formula for the length of a straight line between two points.
The procedure:
The solution uses initial X and Y co-ordinates to initiate an iterative process that refines the previous mile – center warehouse X,Y location co-ordinates. The location problem is solved when the incremental charges in the co-ordinates are within the acceptable range of the initial or previous values.
Example: initial values of X and Y are 30 and 40 respectively. The location solution is obtained by using these values to determine the new warehouse co-ordinates.

New values X=36 and Y=43. The new values indicate a shift, therefore the procedure is not complete

For next iteration the most recent values are used X=36 and Y=43. If the iteration results in values X=36 and Y=43 then the difference is minimal or zero, the problem is optimized.
Tolerance range= +/- 1 mile on X and Y co-ordinates.
Therefore 4 square mile area.

Xk,Yk= co-ordinate values of the warehouse for iteration k.
Xi,Yi= demand point, designated by the appropriate subscript.
di= distance between each demand point (Xi,Yi) and warehouse location for iteration k.

Ton –Mile – Center Solution: it combines the variables of weight and distance in selecting warehouse locations. This solution considers the frequency of delivery to each destination in when selecting a warehouse location. This solution also requires an iterative process since the distance between demand point and warehouse is included.

Where Yk,Xk= co-ordinate values of the warehouse for iteration k.
Xi,Yi= demand pint designated by the appropriate subscript.
Fi= annual tonnage to each demand point, expressed as standard.
di= distance between each demand point (Xi,Yi) and warehouse location for iteration k.

Time – Ton – Mile – Center Solution: it includes all factors influenced by cost. Costs are a function of time weight and distance. The warehouse site derived as a product of this solution is a least cost location. The procedure for selecting the solution is iterative because time and distance factors are differentiated from a given ware house location.

Xk,Yk= unknown co-ordinate value of a warehouse
Fi= annual tonnage to each location expressed as a standard trailers, identified by the appropriate subscript.
Mi= delivery location differentiated in terms of miles per minute from the initial warehouse location to each new location until the iterative process is complete.

Mi considers both distance and time to all demand points from the warehouse location for each iteration.

Mi=dn =distance
tn time


Plant location decisions
Manager’s goal when locating facilities and allocating capacity should be to maximize the overall profitability of the resulting supply chain network. The following information must be available before the design decision can be made
Location of supply sources and markets
Location of potential facilities sites
Demand forecast by market
Facility, labor, and material cost by site
Transportation cost between each pair of sites
Inventory cost by site as well as function of quantity

The fundamental trade off managers space when making facilities decision is between the cost of the number, location and type of facility(efficiency) and the level of responsiveness that these facilities provide the company’s customers (Internal as well as External)

A firm’s competitive strategy has a significant impact on network design decisions within the supply chain. Firms focusing on cost leadership will tend to find the lowest cost location for their manufacturing facilities even if that means locating very far from the market they serve.
Firms focusing on responsiveness will tend to locate facilities closer to the market and may select high-cost location if this choice allows the firm to react quickly to changing market needs.
Global supply chain networks can best support their strategic objectives with facilities in different countries playing different roles. For example, Nike has production facilities located in many countries in Asia. He facilities in China and Indonesia focus on cost and produce the mass-market, lower-priced shoes for Nike. In contrast, facilities in Korea and Taiwan focus on responsiveness and produce the higher-priced new designs. The differentiation allows Nike to satisfy a wide variety of demands in the most profitable manner.
The following is the classification of possible roles for various facilities in a global supply chain network.

Offshore facility-low cost facility for export production: - an offshore facility serves the role of being a low-cost supply source for markets located outside the country where the facility is located. The location selected for an offshore facility should have low labor and other costs to facilitate low-cost production.
Source facility- low cost facility for global production: - A source facility also has low cost as its primary objective, but its strategic role is broader than that of an off shore facility. A source is often a primary source of product for the entire global network. Source facilities tend to be located in places where production costs are relatively low, infrastructure is well developed, and skilled workforce is available.
Server-facility – regional production facility: - A server facility’s objective is to supply the market where it is located. A server facility is built because of tax incentives, local content requirement, tariff barriers, or high logistics costs to supply the region from elsewhere.
Contributor facility- regional production facility with development skills.: - A contributor facility serves the market where it is located but also assumes responsibility for product customization, process improvements, product modification or product development.
Outpost facility- regional production facility built to gain local skill: - An outpost facility is located primarily to obtain access to knowledge or skills that may exist within a certain region.. Given its location, it also plays a role of server facility. The primary objective remains one of being a source of knowledge and skills for the entire network.
Lead facility – facility that leads in development and process technologies: a lead facility creates new products, processes, and technologies for the entire network. Lead facilities are located in areas with good access to a skilled workforce and technological resources.

Focused attention on Distribution Center due to increased production, economy of scale and reduced transportation cost.

Technology wise:
Characteristics of available production technologies have a significant impact on network design decisions. If production technology displays significant economies of scale, few high capacity locations are most effective. This is the case in the manufacture of computer chips, in which factories require a very large investment. As a result, most companies build few chip production facilities, and each one they build has a very large capacity.
In contrast, if facilities have lower fixed costs, many local facilities are preferred because this helps lower transportation costs. For example, bottling plants for coca cola do not have a very high fixed cost. To reduce transportation cost, coca cola sets up many bottling plants all over the world, each serving its local market.
Flexibility of production technology affects the degree of consolidation that can be achieved in the network. If the production technology is very inflexible and product requirements vary from one country to another, a firm has to set up local facilities to serve the market in each country. Conversely, if the technology is flexible, it becomes easier to consolidate manufacturing in a few large facilities.

Transportation wise:

The fundamental trade-off for transportation is between the cost of transporting a given product (efficiency) and the speed with which that product is transported (responsiveness)

Transportation has a large impact on both responsiveness and efficiency. Faster transportation, whether in form of different modes of transportation or different amounts being transported, allows a supply chain to be more responsive but reduces its efficiency. The type of transportation a company uses also affects the inventory and facility locations in the supply chain. For example: Dell flies components from Asia because doing so allows the company to lower the level of inventory it holds. Clearly, such a practice increases responsiveness but decreases transportation efficiency because it is more costly than transporting parts by ship.
The role of transportation in a company’s competitive strategy figures prominently when the company is considering the target customer’s needs. If a firm’s competitive strategy targets customers that demand a very high level of responsiveness and that customer is willing to pay for this responsiveness then a firm can use transportation as one driver for making the supply chain more responsive. The opposite is true as well. If a company’s competitive strategy targets customers whose main decision criterion is price, then the company can use transportation to lower the cost of the product at the expense of responsiveness.
As a company may use both inventory and transportation to increase responsiveness or efficiency, the optimal decision for the company often means finding the right balance between the two.
The companies can gain economies of scale when a product is manufactured or stored in only one location; this centralization increases efficiency however the cost reduction comes only at the expense of responsiveness, as many of a company’s customer maybe located far from the production facility. The opposite is also true. Locating facilities close to customers increases the number of facilities needed and consequently reduces the efficiency. However, if the customer demands and is willing to pay for the responsiveness that having numerous facilities adds, then this facilities decision helps meet the company’s competitive strategy goals.
There are also many instances, in which the pricing schedule yield economies of scale, with prices decreasing as lot size is increased. This form of pricing is very common in business to business transactions. A discount is lot size based if the pricing schedule offers discounts based on quantity orders in a single lot. A discount is volume based if the discount is based on the total quantity purchased over a giver period, regardless of the number of lots purchased over a given over that period. Two commonly used discount based schemes are
All units quantity discounts
Marginal unit quantity unit discount or multi block tariffs.

Companies must also decide what a facility’s capacity to perform its intended function or functions will be. A large amount of excess capacity allows the facility to be very flexible and to respond to wide swings in the demands placed on it. Excess capacity, however costs money and therefore can decrease efficiency. A facility with little excess capacity will likely be more efficient per unit of product it produces then one with a lot of unused capacity. The high utilization capacity will, however , have difficulty responding to demand fluctuations. Therefore, a company must take a balanced trade off to determine the right amount of capacity to have at each of its facilities.

Typical decisions of location decisions

Deciding where a company will locate its facilities constitutes a large part of the design of the supply chain. A basic trade off here is whether to centralize to gain economies of scale or decentralize to become more responsive by being closer to the customer. Companies must also consider a host of issues related to various characteristics of the local areas in which the facility may be situated. These include: -
 Macro economic factors
 Strategic factors
 Quality of workers
 Cost of workers
 Cost of facilities
 Availability of Infrastructure
 Proximity to customers and the rest of the network
 Tax effects

Distribution centers- how many and where??????????
When deciding upon locational decision a manager basically decides upon suppliers, plants, ware houses and markets. There may also be other facilities such as super stockists, consolidation centers or transit points.


Besides locating the facilities a manager must also decide how market may be allocated to ware houses and how ware houses will be allocated to plants. The allocation decision can be altered on a regular basis as different costs change and markets evolve. When designing the network, both location and allocation decisions are made jointly.
In some cases, companies want to design supply chain networks, in which a market is supplied from only one factory. This is commonly known as the capacitated plant location model with single sources. Companies may impose this constraint because it lower the complexity of coordinating the network and requires less flexibility from each Facility.
A much more general form of the plant location model needs t be considered if the entire supply chain network from the supplier to the customer must be designed. Consider a supply chain in which suppliers send materials to factories that supply ware houses that supply markets. Location and capacity allocation decision has to be made for both factories and ware houses. Multiple ware houses may be used to satisfy demand at a market, the multiple factories may be used to replenish warehouses.

Supply chain design decision should be evaluated for a variety of future scenarios that reflect the underlying uncertainty. Accounting for uncertainty relieve the managers to built extra capacity in to supply chain network and make the available capacity more flexible in terms of the markets that can be served. If capacity is flexible, demand can be reallocated within the supply chain network to react best to changing demand, prices, costs, and / or exchange rates. If capacity is inflexible, production cannot be changed in response to change in condition. The presence of flexibility thus increases potential profits.

Customer / market- to be served from each distribution center.

Firms must consider the response time customers desire when designing their supply chain methods. Firms that target customers who can tolerate a large response and require few locations and can focus on increasing the capacity of each location. In contrast, firms that customers who value short response time need to locate close to them. these firms must have many facilities, with each location having low capacity. First, a decrease in the response time customers desire increases the number of facilities required in the network.
For example customers are unlikely to come to a convenient store if they have to travel a long distance to get there. It is thus best for a convenient store chain to have many stores distributed in an area so that most people have convenience stores close to them. In contrast, customers shop for larger amount at super market and are willing to travel longer distances to get to one. Thus, super market chains tend to have stores that are much larger tan convenient stores and not as densely distributed.
If a firm is delivering product to customers, use of rapid means of transportation allows it to build fewer facilities and still provide a short response time. However, this option increases transportation cost. Moreover, there are many situations in which the presence of a facility close to a customer is important. For example a coffee shop is likely to attract customers who live or work nearby. No faster mode of transport can serve as a substitute and be used to attract customers that are far away.

Use of logistics channel- for material sources:
The procurement cycle occurs at the manufacturer/supplier interface and includes all processes necessary to ensure that materials are available for manufacturing to occur according to schedule. During the procurement cycle, the manufacturer orders the components from suppliers that replenish the component inventories. The relationship is quite similar to that between a distributor and manufacturer, with one significant difference: whereas retailer or distributor orders are triggered by uncertain customer demand, component orders can be determined precisely once the manufacturer has decided what the production schedule will be. Component orders are dependent on the production schedule. Of course, if a supplier’s lead times are long, the supplier has to produce to forecast because the manufacturer’s production schedule may not be fixed that far in advance.
In practice, there are several tiers of suppliers, each producing a component for the next tier. A similar cycle would then flow back from one stage to the next. The processes are shown as below


A firm can vary supply of product by controlling a combination of the following two factors:
Production capacity

The objective is to maximize profits. Some of the specific approach to managing capacity and inventory are listed below:
Time flexibility of workforce so as to comfortably utilize the idle or unused space

Use of seasonal workforce so as to meet the sudden shoot in demand and not loose on the revenue thus generated.

Use of subcontracting so as to acquire an economical way since it works out to be cheaper.

Use of dual facilities- dedicated and flexible so as to produce at a relatively steady rate with fluctuations being absorbed by the flexible facility.

Designing product flexibility into the production processes, modification in layout, so as to meet the sudden demand as well as effectively extract the best possible from all the resources in an accommodating and flexible manner.

Managing inventory:’
Using common components across multiple products, which would facilitate a relatively constant overall demand.

Build inventory of high demand or predictable demand products, which helps in synchronization of supply and demand making the utmost and optimum use of seasonal and off seasonal advantage.

Use of Public and Private distribution facilities:
His aspect involves a two-fold consideration
From the transportation point of view
From the warehousing point of view

As can be clearly understood, transportation involves either owning the means of transport or appointing an agency for transport commonly known as outsourcing of transportation service. This has to be analyzed considering the long-term benefits, the cost-benefits, the responsive benefit, and efficiency, comparing the estimated results in both the cases – owned as well as outsourced. Again if the lead time is high, the location facility if at a greater proximity to the suppliers, and if the cost structure is suitable to the company the company shall go ahead to establish its own infrastructure to increase the transportation efficiency. This is mostly the case with companies that practice just in time method and is affiliated to a reduced inventory system. Similarly, the reason not many companies owning is its involves huge capital investment, increased complications, increased labour and the like.
Companies now a days also design their own shapes in the trucks and other means of transport so as to accommodate maximum in the limited possible space.
A warehouse, may be, privately owned and operated by company making its own goods. Commonly known as private warehouse. A warehouse may be owned and operated by another organization, including a government agency, and only used by a company on certain terms and conditions. Commonly known as public ware house.
Irrespective of whether a warehouse is privately or publicly owned, the following factors have to be taken into account to work out the cost of storage:
Interest on the cost of buying the site
Interest on the cost of furniture
Cost of repairs and maintenance
Depreciation on building and equipment
If productivity (or efficient use) of the warehouse can be increased by 20% there is an equivalent reduction in costs per unit handled and processed.
There are fixed costs in the shape of the cost of space per square meter or per cubic meter, which have to be borne, whether or not the warehousing is operating.

Maximum efficiency is obtained by processing a larger number of units through the warehouse space. The larger the number of processed units, the lower the cost per unit.
There is nothing as a better or the best option but both have their sets of advantages and disadvantages and a company should critically evaluate all the expenses related and accordingly decide the better and the most suitable option for itself.
However it is always advised to use a perfect blend of both, private as well as public warehouses. Also, private warehouses need not be owned, they can be rented or leased with or without equipment.

Product lines – produced at plants, stocked at distribution centers:

Product lines- production and Distribution Centres

The tour material in this fig delineates the areas of material handling function and its tour of duties. Typically, material is handled at the following stages.

1. Raw material is transported from the vendor to the warehouse of the production unit. It is received by trucks, by rail wagon or even by ship. At the warehouse, the handling of material takes place, and a system is required to be evolved. Thereafter, the material is stored.
2. At the time the material is required for production process, it is again handled. It is retrieved and transferred or fed in to the production process.
3. During the production process too, the material is handled in many ways. After the material has been finally processed and turned in to a finished product, the finished product is handled and loaded for despatch by a given mode of transport to a warehouse or to a dealer.
4. Sometimes, the finished product is packed and directly loaded on to the transport to vehicle.
5. Sometimes, the material produced at the end of a production process is not the final finished product but only an intermediate finished product. This intermediate product is required to be handled and stored to be retrieved again, whenever required for finishing.
6. Sometimes, the semi-finished product is required to be sent out of the production unit to another manufacturer. This would require the physical transport of this intermediate product to the other production unit. In this case, the product may again be transported back to the production unit for final processing or storage before despatch
7. Sometimes, the semi-finished product may be finished in another processing plant and loaded and despatched from there.

8. Assuming that the product has been stored in its final finished form, it has to be handled before despatch from the production centre.
9. The goods may be despatched straight to he customer, in which case the handling of the product is done by the customer himself as a one-time job. If despatches to the customer are regular feature and if specialised handling of goods at the time of delivery is required, suitable arrangements will have to be made to ensure that handling is good.
10. Sometimes the goods are sent to a retailer or a dealer. In this case, the quantity of goods despatched may be larger. If the despatches are regular and in large quantities specialised handling may be required. Accordingly, the necessary arrangements will have to be made.
11. The goods may be despatched to a field warehouse of the company, or to a public warehouse, or to the warehouse of a stockist or distributor. In this case, they are required to be stored suitably for sometime before they are despatched to a customer, retailer, or dealer, as the case may be. The alternative requires the handling of the finished product during its retrieval and despatch to a proper destination. At the destination the product is handled again.


The concept of total cost analysis

Many problems at the operational level in logistics management because all the impacts of specific decisions, both direct and indirect, are not taken into account throughout the corporate system. Too often decisions touch in one area can lead to unfortunate results in the other areas, change in policy on minimum order value, for example, may influence customer ordering patterns and lead to additional costs. Similarly changes in production schedules that aim to improve production efficiency may lead to fluctuations in finished stock availability and thus affect customer service.

A. The problems associated with identifying with total system impact of distribution policies are immense. By its very nature logistics cuts across traditional company organization functions with cost impacts on most of those functions.

B. Conventional accounting systems do not usually assist in the identification of these company wide impacts frequently absorbing logistics related costs in other cost elements.
The cost of processing orders for eg. is an amalgam of specific costs incurred in different functional areas of the business which generally prove extremely difficult to bring together.
Figure (1.1) outlines the various cost elements involved in the complete order processing cycle, each of these elements having a fixed and variable cost component which will lead to a different total cost per order.

Fig. (1.1)

Stages in the order-to-collection cycle

C. Accounting practice for budgeting and standard-setting has touched to result in a compartmentalization of company accounts; thus budgets tend to be set on a functional basis.
The trouble in that policy costs do not usually configure themselves within the sense water tight boundaries. It is the nature of logistics that, like a stone thrown into a pond, the effects of specific policies spread beyond their immediate area of impact.

(2) A. A further feature of logistics decisions which contributes to the complexity of generating appropriate cost information is that they are usually taken against the benchmark of an existing system.

The purpose of total cost analysis in this context is to identify the change in costs brought about by these decisions. Cost must therefore be viewed in incremental terms – the change to the system. Thus the addition of an extra warehouse to the distribution network will bring about cost changes in transport, inventory investment and communications.
It is the incremental cost difference between the two options which is the relevant accounting information for decisions making in this case.
Fig. (1.2) shows how total logistics costs can be influenced by the additional, or removal, of a depot from the system.

Fig (1.2)

The total costs of a distribution network

To understand the demand of measuring logistics, it is necessary to review traditional accounting methods in terms of analysis requirements and to identify costs relevant to integral logistical systems.


Logistical functions are on integral part of the two main financial reports of business – the balance sheet and the profit and the loss statements (P& L). However, the primary deficiency in determining logistical costing and analysis in the method by which standardized accounting costs are identified classified and reported.

The first problem results from the fact that accounting practice aggregates costs on a standard or natural account basis rather than on an activity basis. The process of classification and assignment helps but does not satisfy the requirements for total – cost analysis. In reality, many expenses associated with logistical performance cut across organizational units. For eg. – efforts to reduce inventory will reduce inventory carrying cost, but they may also lead to more back orders, which would increase total transportation cost. The result is deficient data for integrated performance measurement.

In order to design and evaluate logistical operations, it is necessary to identify costs associated with performing specific activities or tasks, such as the warehouse expenses for a specific SKU (stock keeping unit). This means that the individual logistical activities must be identified and that costs be allocated or assigned.

An overlapping deficiency of accounting involves the traditional methods of reporting transportation expenditures. It remains a standard practice in retail accounting to deduct freight from gross margin figure. In part, it seems to be based on the belief that managers can do little about inbound freight. However, the problem extends beyond where freight is accounted for and reported. In many purchasing situations, freight is not reported at all as a specific cost. Many products are purchased on a delivered price basis, which includes transportation cost.

A final deficiency in traditional accounting practice is the failure to specify and assign inventory cost.
Full costs associated with the maintenance of the inventory such as insurance and taxes, are not identified and assigned, thereby resulting in an understatement or obscurity in reporting inventory cost. For eg.- If a brand manager is not held responsible for his brand’s inventory carrying cost, he is not motivated to reduce inventory levels.
The financial burden for assets committed to material, WIP and finished goods inventory is not identified, measured, and separated from other forms of capital expense incurred by the enterprise.


Activity based costing seeks to relate all relevant expenses to the value adding activities performed. For eg.- costs are assigned to a customer or product to reflect all relevant activity costs independent of when and where they occur.

The fundamental concept of activity-based costing is that expenses need to be assigned to the activity that consumes a resource rather than to an organization or budget unit.
For eg.- Two products, produced in the same manufacturing facility, may require different assembly and handling procedures. One product may need an assembly or packaging operation that requires additional equipment or labor. If total labor and equipment costs are allocated to the products on the basis of sales units produced, then both items will be charged for the additional assembly and packaging operations required by only one of them. This unjustly reduces the profitability of the simplified product by forcing that product to pay for the operations it does not need. In a manufacturing sense, identifying and assigning cost factors means that a specific product will be fully assigned its fair share of all overhead and operating costs.

In the case of logistics, the key event is a customer order and the related activities and relevant costs that reflect the work required to fulfill the order. Logistical activities based costing must provide managers the insights needed to determine if a specific customer, order, product or service is profitable. This requires matching specific revenue with specific costs.

Effective costing requires identification of he specific expenses to include in an analysis framework.
A second concern is to specify the relevant cost time frame.
Finally, costs must be allocated or assigned to specific factors that are relevant to assembly alternative actions.
The guiding criteria for effective logistical activity-based costing are relevancy and consistency. Relevancy is important in the sense that the cost assignments help managers to better understand the major factors affecting logistics expenses. Consistency is important in terms of comparing related activities over time. These criteria help in the decision making process where logistical activities are concerned.

(5) Cost Identification
To have a representative presentation, all costs associated with the performance of a logistics function should be included in the activity-based cost classification.
The total costs associated with forecasting and order management, transportation, inventory, warehousing and packaging must be isolated. Typical logistics costs can be categorized as:
Direct Costs
Indirect Costs
a) Direct or Operational Costs
Those expenses specifically caused by the performance of logistics work. Such costs are not difficult to identify.
The direct costs of transportation, warehousing, material handling , and some aspects of order processing and inventory can be extracted from traditional cost accounts. For eg.- the transportation costs for an individual truckload order can be directly attributed to a specific order. Likewise, only minor difficulty is experienced in isolating the direct administration cost of logistical operations.

b) Indirect Expenses
These expenses are more difficult to isolate. Costs associated with indirect factors are experienced on a more or less fixed basis as a result of allocation of resources to logistical operations. For eg., the cost of capital invested in real estate, transportation equipment, and inventory – just a few areas within the capital structures of logistics – must be identified to arrive at a comprehension total cost.
The manner by which indirect costs are attributed to logistics activities is determined by managerial judgments. For eg.- how should the indirect costs, such as equipment, associated with a warehouse be allocated to the customer order shipped from that warehouse? One approach is to allocate the overhead costs on the basis of the average cost per unit.

b) i) All capital allocated to the logistical system represents a scarce commodity. Therefore all expenses paid to support capital investment in logistic operations are relevant to logistical activity-based costs .The judgments applied in arriving at cost of capital will greatly influence logistical system design. Thus, procedures and standards used to calculate indirect logistical costs are critical. They are also essential for potential outsourcing.

c) Overheads
A final costing allocation is overhead. An enterprise incurs considerable expenses on behalf of all organizational units, such as for lighting and heat in various facilities.
Judgement is required to determine how and to what extent various types of overhead should be allocated to specific activities.

One method is to directly assign total corporate overhead on a uniform basis to all operational units.

At the other extreme, some firms withhold all overhead allocations to avoid distorting the ability to measure direct and indirect logistical activity-based costs.

From the viewpoint of effective logistical activity-based costing, it is sound practice not to allocate any overhead cost that cannot be directly assigned to a logistical activity.

A general rule to follow is that a specific cost should not be assigned to logistical factors unless it is under the managerial control of the logistical organization. Because of subjective cost allocation, enterprise in the same industry will report vastly different logistical expenses. It is important to realize that such cost differentials may have no direct relationship to the actual efficiency of logistical operations.

Cost Time Frame
A basic concern in logistical activity based costing is to identify the period of time over which costs are accumulated for measurement.

(1) Generally accepted accounting principles call for accrual methods to relate revenues and expenditures to the actual time period during problems can be associated with establishing logistical activity-based costs.
Expenses associated with raw material procurement through finished product distribution and almost all other logistical product distribution and almost all other logistical operating costs are incurred in anticipation of future transactions, making accrual methods difficult to administer.

(2) To overcome the time problem, accountants attempt to break costs into two groups:
a) Costs assigned to a specific product and,
b) Costs associated with the passage of time.
This classification is an attempt made to match appropriate product and time period costs to specific periods of revenue generation.

(3) From a logistical perspective, a great many of the expenses associated with procurement and manufacturing support can be assigned and absorbed into direct product cost. Thus, because they can be assigned to a specific product, inventories are valued on the basis of fully allocated cost.
Such practices can significantly influence logistical system design, depending on the characteristics of the business.

(4) In situations where a considerable period of time elapses between production and sales, such as in highly seasonal businesses, significant costs of maintaining inventory and performing logistical operations may not be associated with revenue generation.
Unless this potential mismatch is clearly understood and accommodated in the assignment process, logistics can be significantly mismeasured.

(7) Cost Formatting
(1) The typical way to format activity-based costs is to assign expenses to the event being managed, for eg.- if the object of analysis is a customer order, then all costs that result from the associated performance cycle contribute to the total activity cost. Typical units of analysis in logistical activity-based costing are customer orders, channels, products and value added services.

In addition to activity-based costing, management may wish to format financial reports regarding operational measurement and control. Logistical expenses can be presented in a number of ways for managerial use.
Three common ways are:-
Functional Grouping,
Allocated Grouping and
Fixed–Variance Grouping.

Functional Grouping
To format costs by
Functional grouping-requires that all expenditures for direct and indirect logistical services performed for a specified operating time be formatted and reported by master and sub-account classification for comparison of one or more operating periods.
No standard format of activity costs or functional groupings is available that fits the needs of all enterprises.
(i) Logistical functional cost statements must be designed to facilitate control within each unique environment.
(ii) It is important to identify as many cost accounting categories as practical and to develop a coding system that will facilitate assignment to three cost accounts.
(iii) Effective total-cost groupings can be maintained over time only if appropriate coding to reclassify material accounts into functional groups in incorporated in the basic logistics information system.

Allocated cost formatting or grouping

i) This consists of assigning overall logistical experiences to a measure of physical performance, for eg.- Total logistical cost can be generated on a per ton, per hundred weight, per product, per order, or per line-item basis, or on some other physical measure that is useful for comparative analysis of operating results.
ii) While important for assigning overall expenses to physical performance measures, this grouping typically has limited use outside logistics management.

Fixed-Variance Grouping

i) This is the most useful for identifying the logistics cost implications of current or alternate operating practices.
ii) This method of formatting consists of assigning costs as either fixed or variable to appropriate the magnitude of change in operating expenditure that will result from different volumes of logistical throughput.
iii)Costs that do not directly vary with volume are classified as fixed. In the short run, these expenses fixed even if volume were reduced to zero.
iv) Costs influenced by volume are classified as variable for eg.- the cost of a delivery truck is fixed: if the truck costs $40,000 to purchase , the firm is charged $40,000 whether the truck is used for 1 or 1,000 deliveries.
However, gasoline to operate the truck is variable total gasoline costs depend on how frequently the truck is driven.
The use of fixed and variable cost formatting offers a convenient way to handle expenses in logistical system design models.


For purposes of implementing and presenting logistical total-cost analysis, it is common practice to focus on INVENTORY and TRANSPORTATION as the two main network design factors.
a) Both inventory and transportation expenses can be defined in a format sufficiently broad to include activity and functional cost relationships for related logistical components.
For eg.- communication costs that are associated with order processing and with expenditures required for warehouse storage and material handling can be classified under the inventory umbrella.

2) In terms of inventory, total cost includes all expenses related to inventory carrying cost and customer ordering.
A Inventory carrying cost includes taxes ,storage, capital, insurance and obsolescence.
B The cost of ordering includes the full expense of inventory control, order preparation, communications, update activities and managerial supervision.

3) The total cost of transportation includes for-hire transport expenses and accessorial charges plus costs related to the hazards incurred with the various modes, legal forms of transport, and associated administrative expenses. If private transportation is used, accounts direct, indirect, and overhead costs.

4) A brief summary of the total cost of logistical activities is presented in Fig. 2 (Table). Classification of costs in terms of inventory or transportation highlights the basic trade offs that determine the cost justification for logistical network design.

5) The basic logic for focusing on transportation and inventory as key factors that they logistical operations.
A Transportation deals with the geographic (spatial) dimensions of logistical operations by positioning product where the customer wants to purchase it.
B Inventory involves the rate at which capital assets are used (temporal) to meet customer requirements by having product available WHEN the customer wants to purchase.

6) A second justification for focusing on transportation and inventory is that these two factors include 80 to 90 percent of overall logistics expenses for the typical firm.

7) The columns on the right side of Fig. 2 (Table) reflect potential activities that may be used to segment costs for managerial review.
For eg.- an ordering cost can be assigned to a specific order, or it may be grouped by customer.
If the objective is to determine the expenses associated with any specific level of de-aggregated activity, it is essential to assign specific costs to the actual targets or events.
For eg.- if the de-aggregated activity is the ordering cost for one specific product, the actual expenses for that product alone must be identified.

As noted earlier, the extension of total costs to an activity based format may not meet public accounting precision. The purpose of activity based costing is to give managers a better perspective of the total cost, associated with performance of a specific activity.

Total Costs Classified by Inventory and Transportation

ACTIVITY-Based Assignments

Customer Order Product Value-added Service

INVENTORY- related costs

Inventory carrying cost (ICC):
Processing, including material
handling and packaging
Update activities, including
receiving and date-processing


TRANSPORTATION- related costs

Accessorial charges
Indirct, liability not protected by carrier

Location Analysis Data Requirements: The primary analysis data requirements are definitions of markets, products, network, customer demand, transportation rates, and variable and fixed costs.

Market definition:
Location analysis requires that demand be classified or assigned to a geographic area. The combination of geographic areas constitutes a logistics service area. Such an area may be a country or a global region. The demand for each customer is assigned to one of the market areas. The selection of the market definition method is an extremely important element of the system design procedure.
A number of market definition structures have been developed. The most useful for logistics modeling are: County, Standard metropolitan statistical area (SMSA) and ZIP or postal codes
The major issues for selecting a market definition concern the number of areas required to provide accurate results. While more market detail increases accuracy, it also increases analysis efforts. Research indicates that approximately 200 markets offer an effective trade-off between accuracy and analysis effort.

Product definition: Although individual product flows can be considered when performing a location analysis, it is usually not necessary to use such detail. Individual items –especially those with similar distribution characteristics, production sites, and channel arrangements – are grouped or simplify the analysis.

Network definition The network definition specifies the channel members, institutions and possible locations to be included in the analysis. Specific issues concern the combinations of suppliers, production, locations, distribution centers or channel member alternatives. While using a more comprehensive definition reduces the chance of suboptimising logistics system performance, total channel location analysis increases complexity. Location analysts must evaluate the trade offs between increasing analysis complexity and improved potential for total supply chain optimization.

Market demand: Market demand defines the shipment volume in each geographic area defined as a market specifically location analysis is based on the relative product volume shipped to each market area. While the volume may pertain to the number of units or cases shipped to each market, most location analyses are based on weight since transportation cost is strongly influenced by the amount of weight being moved. Market demand utilized in the analysis may also be based on historical shipments or anticipated volume if substantial changes are expected.

Transportation rates: Inbound and outbound transportation rates are a major data requirement for location analysis. Rates must be provided for shipments between existing and potential distribution channel members and markets. in addition , rates must be developed for each shipment size and each transportation link between distribution centers and markets. it is common for location analysis to require in excess of a million individual rates. Because of the large number rates are commonly developed using regressions or are retrieved from diskettes provided by most carriers.

Variable and fixed costs: The final location analysis data requirements are the variable and fixed costs associated with operating distribution facilities. Variable costs include expenses related to labour, energy. Utilities and materials. in general, variable expenses are a function of throughput. Fixed cost includes expenses related to facilities, equipment and supervisory management. Within a relevant distribution facility operating range, fixed costs remain relatively constant. While variable and fixed cost difference by geography is typically not substantial there are minor locational considerations that should be included to ensure analysis accuracy. the major differences result from locational peculiarities in wage rates, energy cost, land values and taxes.
Conclusion: substantial logistics planning emphasis is placed on location analysis. in the past distribution networks were relatively stable, so it was unnecessary for firms to compete system analyses regularly. However the dynamics of alternative distribution channel options, changing logistics cost structures and availability of third party services require that logistics networks be evaluated and refined more frequently today. It is common for firms to perform evaluations annually or monthly.
Total cost-analysis:

The basic integrative concept in logistical network design is total cost. An example illustrated a total cost justification for using high cost airfreight. The basic thesis was that in situations where the speed and dependability of air delivery would permit other costs (such as warehousing and inventory) to be reduced or eliminated, high cost premium transportation would be justified by achievement of lower total cost. Total cost could be reduced by careful integration of logistical activities.

The basic concept of total cost is simple and complements the notion of designing logistics as an integrated performance system. The main problem in operationalizing total cost is that traditional accounting practice for classifying and reporting critical expenses does not typically provide adequate logistics metrics.

Public accounting practice:

The two main financial reports of business enterprises are the balance sheet and the profit and loss statements (P&L). The purpose of the balance sheet is to summarize assets and liabilities and to indicate the net worth of ownership. The P&L statement reflects the revenue costs associated with the specific operations over a specific period of time. As the name profit and loss implies, its purpose is to determine the financial success of operations.
These two are mainly suited for investors, taxation and auditing purposes and not for logistical purposes

 The first problem results from the fact that accounting practices aggregates cost on a standard or natural account basis rather on activity basis. The practice of grouping expenses into natural accounts such as salaries, rent, utilities and depreciation fails to identify or assign the operations responsibility .In reality many expenses, associated with logistical performance cut across organizational units. For example efforts to reduce inventory will reduce inventory-carrying costs, but they may lead to back-orders, which would increase the total transportation cost.
 The practice of classifying the costs on a natural basis also creates a problem in activity-based cost analysis. In order to design and evaluate logistical operations it is necessary to identify costs associated with performing specific activities or tasks, such as the warehousing expenses for a specific SKU. This means that the individual logistics must be allocated or assigned.
 Transportation expenses- Freight is not accounted for. Many products are purchased on a delivery price basis, which includes transportation cost.
 Failure to assign inventory costs
 Finances committed to Raw materials, WIP, Finished goods not carefully separated from other capital expenses.

Activity-Based Costing:

Activity-based costing seeks to relate all relevant expenses to the value adding activities performed. For example, costs are assigned to a customer or product to reflect all relevant activity cost independent of when and where they occur. The fundamental concept of activity-based costing is that expenses need to be assigned to the activity that consumes a resource rather than to an organizational or budget unit. For example, 2 products produced in the same manufacturing facility, may require different assembling and handling procedures. One product may need an assembly or packaging operations that requires additional equipment or labor. If total equipment and labor costs are allocated to the products on the basis of sales or units produced than both items will be charged for the additional assembly and packaging operations required by only one of them.

In case of logistics, the key event is a customer order and related activities and relevant costs that reflect the work required to fulfill the order In other words, logistical activity-based costing must provide managers the insights needed to determine if a specific customer, product, order, or service is profitable. This requires matching specific revenue with specific costs. The guiding criteria for effective logistical activity-based costing are relevancy and consistency. Relevancy is important in the sense that the costs assignment helps managers to better understand the major factors affecting logistics expenses. Consistency is important in terms of comparing related activities over time. In the final analysis, a logistical costing system has to make sense only to the managers who are using it as a guide to decision making.

(I) Cost Identification:

All costs associated with the performance of logistics function should be in the activity- based classification. The total cost associated with fore casting and order management, transportation, inventory, warehousing, packaging must be isolated. Typical logistics costs can be categorized under two headings – direct and indirect costs, cost of capital and overheads.

a) Direct Costs:
These costs are those expenses specifically caused by the performance of logistics work. Such costs are difficult to identify. For example, the transportation costs for an individual truckload order can be directly attributed to a specific order. Likewise only minor difficulty is experienced in isolating the direct administration cost of logistical operations.

b) Indirect Costs:
These are more difficult to isolate. For example, the cost of capital invested in real estate, transportation equipment, and inventory- just a few of the areas within the capital structure of logistics- must be identified to arrive at a comprehensive total cost. The manner by which total costs are attributed to logistics activities are determined by managerial judgments. One approach is to allocate the overhead cost on the basis of the average cost per unit.
All expense paid to support capital investment in logistical operations are relevant to activity-based costs. The judgment applied in arriving at cost of capital will greatly influence logistical system design. Thus procedures and standards used to calculate indirect logistical costs are critical. They are also essential for potential outsourcing.

c) Cost of Capital :
Capital investment Expenses for logistical activities are relevant to logistical activity- based costs. Cost of such capital also needs to be included in your logistical cost.

d) Overhead
An enterprise incurs considerable expenses on behalf of all organizational units, such as for light and heat in various facilities. Judgement is required to determine how and to what extent various types of overhead should be allocated to specific activities. One method is to directly assign total corporate overhead on a uniform basis to all operational units. At the other extreme, some firms withhold all overhead allocations to avoid distorting the ability to measure direct and indirect logistical activity- based costs.

(II) Cost Time Frame

A basic concern in logistical activity-based costing is to identify the period of time over which costs are accumulated for measurement. Accounting principles call for accrual methods to relate revenues and expenditure to the actual time period during which services are performed. Expenses associated to raw material procurement through finished product distribution and almost all other logistical operating costs are incurred in anticipation of future transactions, making accrual methods difficult to administer.

To overcome the time problem, accountants attempt to break costs into 2 groups- costs assigned to a specific product and costs associated with the passage of time. Using this classification an attempt is made to match the appropriate product and time period costs to specific periods of revenue generation. From a logistical perspective, a great many of the expenses associated with procurement and manufacturing support can be assigned and absorbed into direct product cost.
In situations where a considerable period of time elapses between production and sales, such as in highly seasonal businesses, significant costs of maintaining inventory and performing logistical operations may not be associated with revenue generation.

(III) Cost Formatting

The typical way to format activity-based costs is to assign expenses to the event being managed. For example, the object of analysis is a customer order, than all costs that result from the associated performance cycle contribute to the total activity cost. Typical units of analysis in logical activity- based costing are customer orders, channels, products and value added services. The cost analysis will vary depending on which analysis unit is selected for observation Logistical expenses can be presented in a number of ways for managerial use. Three common ways are
• Functional grouping,
• Allocated grouping, and
• Fixed variance grouping.

A) Functional Grouping:
To format costs by functional grouping requires that all expenditures for direct and indirect logistical services performed for a specified operating time be formatted and reported by master and sub account classifications. Thus ,a total cost statement can be constructed for comparison of one or more operating periods .It is important to identify as many cost accounting categories as practical and to develop a coding system that will facilitate assignments to these cost accounts.

B) Allocated Costs Grouping:
This consists of assigning overall logistical expenditures to a measure of physical performance. For example, total logistical cost can be generated on a per ton, per product, per order, or on some other physical measure that is useful for comparative analysis of operating results.

C) Fixed Variance Grouping:
This is the most useful for identifying the logistics cost implications of current or alternative operating practices. This method of formatting consists of assigning costs as either fixed or variable to approximate the magnitude of change in operating expenditure that will result from different volumes of logistical throughput. Costs that do not directly vary with volume are classified as fixed. In the short run, these expenses would remain if volume were reduced to zero. Costs influenced by volume are classified as variable. For example, the cost of a delivery truck is fixed, however gasoline to operate the truck is variable.

Total Cost Presentation:

It is the common practice to focus on inventory and transportation as the two main network design factors, which are sufficiently broad to include activity and functional cost relationships.

In terms of inventory, total cost includes all expenses related to inventory carrying cost and customer ordering. Inventory carrying cost includes all taxes, storage; capital, insurance and obsolescence .The cost of ordering includes the full expense of inventory control, order preparation, communications, update activities and managerial supervision.

The total cost of transportation includes for – hire transport expenses and accessories charges plus costs related to the hazards incurred with the various modes, legal forms of transport, and associated administrative expenses.

The basic logic for focusing on transportation and inventory, as key factors are that they represent the spatial and temporal dimensions of logistical operations. Transportation deals with the geographical (spatial) dimensions of logistical operations by positioning the product where the customer wants to purchase. Inventory involves the rate at which capital assets are used (temporal) to meet customer requirements by having product available when the customer wants to purchase.

Logistical Measurement

The combination of slower economic growth and increased competition has forced firms in every industry to concentrate on efficient and effective deployment of logistical resources. On result of these efforts has been the emergence of a new corporate position devoted to logistical controllership. The logistics controller is concerned with continuous measurement of a firm’s performance. In order to carry out the measurement process controllership focuses on the assessment of resource deployment and goal attainment.

Dimensions of Performance Measurement

Substantial effort has been expended to improve the quality of information that logistics managers have at their disposal to measure, compare and guide logistical performance. In most firms old reporting formats need to be redesigned to take advantage of new computer based control systems. In place of traditional status and trend reports, today’s managers require flexible and on demand ad hock report.


The three objectives for developing and implementing performance measurement systems include monitoring, controlling and directing logistics operations.

Monitoring measures track historical logistics system performance for reporting to management and customers. Typical monitoring measures include service level and logistic cost components.

Controlling measures track ongoing performance and are used to refine a logistics process in order to bring it into compliance when it exceeds control standards. An example of a control application is transportation damage tracking. If a system is in place to periodically report product damage, logistics management can identify the cause and adjust the packaging of loading process as needed.

Directing measures are designed to motivate personnel. Typical examples include pay for performance practices used to encourage warehouse of transportation personnel to achieve higher levels of productivity. Specifically consider warehouse material handlers of delivery drivers who are paid for eight hours of work based on standard production rates. If the material handlers can complete the assigned tasks in less than the allotted time, they are allowed personal or unassigned time. On the other hand if they require more than the allotted time, the disincentive is that they are not compensated for the additional time. In some cases employees are actually given a bonus when the task is completed in less than the allotted time. When such directed measures are used it is important that both positive and negative performance be measured.
For example the completion of an assigned task such as order selection in less than the standard time must be traded off against increased errors or damage.

Typical Logistics Activity Based Measures

1. Order Entry time per order
2. Delivery time per order
3. Order selection time per order
4. Inquiry time per order
5. Order entry time per customer
6. Order selection time per customer\delivery time per customer]
7. Order selection time per product
8. Delivery time per product


The appropriate management perspective must be evaluated and determined. The continuum of possibilities ranges from all activity based measures to entirely process based measures.

Activity based measures focus on individual tasks required to process and ship orders. Examples include customer orders entered, cases received from suppliers, cases shipped to customers. These measures record the level of activity and in some instances the level of productivity.
While activity based measures focus on the efficiency and effectiveness of primary work efforts they do not usually measure the performance of the overall process of satisfying customers. For example order takers who are judged on the number of calls per hour may be rated high with respect to activity based measurement may do poorly in the overall satisfaction process because they fail to take the time to listen carefully to customers. For this reason it is important that some performance measures taken an overall process perspective.

Process based measures consider the customer satisfaction delivered by the entire supply chain. They examine total performance cycle time or total service quality, both of which measure the collective effectiveness of all activities required to satisfy customers. Today’s firms are paying more attention on process measures while trying not to sub optimize individual activities. The Perfect Order is an increasingly common process measure.

Internal Performance Measurement

Internal performance measures focus on comparing activities and processes to previous operations and/or goals. For example, customer service might be compared to last period’s actual performance as well as to this period’s goal. Research suggests that logistics performance measures can generally be classified into these categories:
1. Cost.
2. Customer service.
3. Productivity.
4. Asset management.
5. Quality.

COST: The most direct reflection of logistics performance is the actual cost incurred to accomplish specific operating objectives. Logistics cost performance is typically measured in terms of rupees, as a percentage of sales, or as a cost per unit of volume.

CUSTOMER SERVICE: These measures examine a firm’s relative ability to satisfy customers.

PRODUCTIVITY MEASURES: It is unclear whether it is the most important or even necessarily a critical measure of performance for all systems.

Productivity is a relationship (usually a ratio or an index) between output (goods/or services) produced and quantities of inputs (resources) utilized by the system to produce that output. Thus it is a very simple concept. If a system has clearly measurable outputs and identifiable, measurable inputs that can be matched to the appropriate outputs, productivity measurement is routine. However, it can be difficult and frustrating if (1) outputs are hard to measure and input utilization is difficult to match up for a given period of time, (2) input and output mix or type constantly changes, or (3) data are difficult to obtain or unavailable.

There are 3 types of productivity measures: -

1. Static: - if all the output and input in a given system are included in the productivity equation, it would be a total factor static productivity ratio. It is considered static because it is based on only one measurement.
2. Dynamic: - It is completed across time. If outputs and inputs in a system compare static productivity ratios from one period to another, the result is a dynamic productivity index, for example:

Outputs 1994/inputs 1994
Outputs 1990/inputs 1994

3. Surrogate: - This represents factors that are not typically included in the concepts of productivity but are highly correlated with it (customer satisfaction, profits, effectiveness, quality, efficiency, etc.). Most managers operationalize productivity in this manner.

ASSET MEASUREMENT: Focuses on the utilization of capital investments in facilities and equipment as well as working capital application to inventory to achieve logistics goals. Logistics facilities, equipment, and inventory can represent a substantial segment of a firm’s assets. In the case of wholesalers, the amount exceeds 90 %. It measures focus on how fast liquid assets such as inventory ‘turnover’ as well as how well fixed assets generates return on investments.

QUALITY: Quality measures, which are the most process-oriented evaluations, are designed to determine the effectiveness of a series of activities rather than an individual activity. However quality is usually difficult to measure because of its broad scope.

A contemporary measurement concept that is increasing in interest is ’the perfect order’. Delivery of the perfect order is the ultimate measure of quality in logistics operations, that is, the perfect order concerns the effectiveness of the overall integrated logistical firm performance rather than individual functions. It measures whether an order processes smoothly through every step – order entry, credit clearance, inventory availability, accurate picking, on-time delivery, correct invoicing and payment without deducting- of the order management process without fault, be it expediting, exception processing, or manual intervention.

The perfect order represents ideal performance. From an operational perspective a multi-industry consortium defines the perfect order as one that meets all the following standards
1. Complete delivery of all items requested
2. Delivery to customer’s request date with one-day tolerance
3. Complete and accurate documentation supporting the order, including packing slips, bills of lading and invoices and
4. Perfect condition that is faultlessly installed, correct configuration, customer-ready with no damage.

However there are many roadblocks to achieving such a level of success. Today the best logistics organizations report achieving a 55 to 60 perfected perfect order performance, while most organizations report less than 20 per percent.

External Performance Measurement

While internal measures are important for detailed organizational monitoring, external performance measures are also necessary to monitor, understand and maintain a focused customer perspective and to gain innovative insights from other industries. The topics of customer perception measurement and best practice benchmarking, which address these requirements, are discussed and illustrated below.

Customer Perception Measurement

To succeed in any activities of business one has to always cater to and satisfy the needs of the customer. To do so, it is essential for one to know how the customer thinks in order to meet his needs in a more satisfying manner. Therefore, an important component of leading edge logistical performance is the regular measurement of customer perceptions. Such measures can be obtained through surveys or by systematic order follow up. These surveys can be company - or industry – sponsored.

Such surveys ask questions regarding the firm’s and the competitor’s performance in general or for a specific order in particular. Most of the surveys incorporates measurement of customer perceptions regarding availability, performance-cycle time, information availability, problem resolution and product support. The survey may be developed and administered by the firm itself or by consultants, delivery agents or industry organizations.


Internal performance measures focus on the activities required to serve customers. Measurement of these activities, as well as comparison with goals and standards, is necessary to improve performance and motivate and reward employees. Cost measurement is the minimum component of any performance measurement system. More sophisticated firms incorporate customer service, asset management and productivity measurement. While such measures generally monitor internal process efficiency, they do not examine external process effectiveness very well, particularly from the customer’s viewpoint. The quality measures applied today by the most sophisticated logistics organizations offer such an external perspective. While the individual internal measures discussed above offer a broad performance evaluation, they do not provide an integrated point of view. For example many customers desire high performance regarding both service and quality.

Best Practice Benchmarking:

Benchmarking is a critical aspect of comprehensive performance measurement. Many companies are adopting benchmarking as a technique to compare their operations to those of both competitors and leading firms in related and non-related industries. Benchmarking is also used in important strategic areas as a tool to calibrate logistics operations.

Most of the firms use the following types of Benchmarking tools:

1. Published Logistics Data: This method uses existing data that are published in various periodicals and university researchers. This method of data is easily obtainable and is cheaper to obtain. But the information got in this means is normally too general and may not be tailor-made for the firm’s exact problems. Since this information is available in public, it does not offer a real competitive advantage.

2. Benchmark against noncompetitive firms: In this method a noncompetitive firm in the related industry is benchmarked. This is done by studying and reviewing the other firms’ measures, practices and processes to develop insights that will improve performance. The firm that is chosen to benchmark might be in the same industry but will be operating in a different market.

3. Alliance of Organisations: In this method, an alliance is formed between two organizations that systematically share benchmark data on a regular basis. These kinds of alliances require more effort to maintain but usually provide substantially better information than the preceding two methods.

Strategic Factors

The key strategic factor to consider during the make-versus-buy decision is performance capability. The decision to outsource involves evaluating which supplier is the most capable of performing the service at a best practice level. This requires an evaluation of potential outsource services in terms of their contribution to a firms core and noncore activities. Typically a firm will not want to run the risk of diluting core competencies by having external firms perform isolated, highly sensitive activities. Once a firm has isolated those activities that are “core supportive” the balance of required activities or the noncore requirements become outsource candidates.

The most difficult step for most firms is to identify which activities are critical core capabilities. The outsourcing decision should not be limited to asset investment. Instead, it must center on capabilities provided or achieved through the asset investment. If the capabilities achieved by performing activities internally do not extend an enterprise’s core competencies, then such activities should be outsourced.

The desirability of outsourcing is based in part on the benefits of specialization. If required service can be improved or an enterprise can reduce its overall investment or operating requirements, then outsourcing is an attractive alternative.

Make-versus-buy decisions involve trade-off analysis among economic and strategic factors. A large portion of such analysis examines cost to service elements. Outsourcing is easily justified if visible costs decrease and service improves, as long as other economic and strategic requirements are satisfied. Specialization can result in economies of scale enabling simultaneous achievement of reduced cost and improved service.

Economic Factors

Oliver Williamson examined economic factors in terms of transaction costs. These costs are those expenses associated with performing a specific activity. The fundamental Williamson proposition was that free market allocation would result in a balance of internal sourcing and outsourcing that would minimize the transaction cost. Outsourcing creates a situation where external firms can behave opportunistically at the expense of their customer. Service provider withholding poor performance information to ensure its operational success. Such information withholding could result in a major problem for the service provider’s customers.

If only a few companies exist with capability to perform the required logistics service,
One that approximates monopoly power replaces the ideal free or competitive market. This situation is further complicated if the requested logistics service require transaction specific assets such as dedicated trucks, buildings or wok forces. In the event of cancellation, such customized assets may not be easily transferred to other customers.

Transaction cost analysis suggests that logistics activities be performed internally if the transaction costs are lower than expenses associated with outsourcing. Internal costs are usually lower when (1) only a few potential third-party suppliers are available for outsourcing, (2) transaction- specific assets are required, or (3) various suppliers of such services are in a position to take advantage of the transaction setting.

The trade-offs depend on which party is best positioned to achieve i.e. best economies of scale. For example, when considering outsourcing or owning a warehouse, volume is a critical factor. Suppose the product requiring storage follows an erratic demand pattern. On average, 25000 units need to be stored to meet monthly requirements. However, peak storage demand requires 50,000 units, while the lowest point of seasonality requires only 5,000. If a privately owned warehouse is used, it must have the capacity to hold 50,000 units. When demand justifies only 5,000 units storage, the warehouse would be operating at approximately 10 percent of capacity (5000/50000 = 10percent capacity). Under such utilization, fixed, overhead, labour and managerial expenses would be spread over so few units that the cost per unit would be very high.

On the other hand, outsourcing to a public warehouse could result in standard per unit cost that is independent of month-to-month storage requirements.

When outsourcing is outsourced, customer typically negotiates a rate that requires it to pay only for space used. Therefore, the price is the same per unit whether the firm stores 5,000 or 50,000 units. If the price per square foot is $1.50 and a unit takes up 2 square fees, the total charge per unit is $3.00, regardless of the total no of units stored. The level of rate typically charged would reflect average utilization as contrasted to either a minimum or maximum.

Alternative opportunity cost of capital is one such expense involved in outsourcing. A private trucking fleet requires substantial equipment investment. To fully evaluate outsourcing, an enterprise should consider alternative uses of the capital that would be invested in a private fleet of trucks. For example, the same amount of money could be used to increase manufacturing capacity, improve logistics facilities, or expand other aspects of the business. The enterprise must determine which types of investment offer the best long-term advantage.

Another consideration is cost associated with obsolescence. Firm’s investment in technologies, which can become obsolete before the enterprise can fully amortize the cost. In such case, technology may not have paid for itself in productivity and efficiency before it must be replaced. Outsourcing logistics activities means that third party service provider is responsible for technology investments, and this reduces the risk of obsolescence. Because of high volume usage, service providers will amortize cost of technology investment before they become obsolete. Furthermore the service provider is forced to update technology, to maintain attractiveness to their customer base.

Final important consideration in outsourcing is related to labour. When moving from internal to external performance of logistic, the labour requirements and management responsibilities of the customer will be reduced or shifted to service supplier. This shift affects cost like early retirement, layoffs, reassignment morale, productivity unionization and retaining. And while moving to logistical service in-house from a third party provider, hiring, training, internal labour shifts and implementation time are the key considerations that may serve to limit flexibility.

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Re: notes for sem v - August 3rd, 2007

cant u just put it in a word file ?????? plzz
btw nice matter

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Re: notes for sem v - August 9th, 2007

thanks yaa they are really good notes where did u get it from? pls reply wich ext bk hvae u used?
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Re: notes for sem v - April 20th, 2009

plz summit in word file since many graph has not come
plz do it fast its urgent for me summit mine report on crude oil
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Re: notes for sem v - April 24th, 2009

career development is missing. can any one sent me th details on career development notes
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Re: notes for sem v - May 21st, 2009

never ever rely on tips in the markets
because many investors have lost their capital
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Alistair Rego
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Re: notes for sem v - May 21st, 2009

Originally Posted by arauf View Post
career development is missing. can any one sent me th details on career development notes
Try going through this link on career dev notes Career Development & Planning

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Re: notes for sem v - June 8th, 2009

I plan to become etail consultant after I graduate. How is the market in this field?
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