DECISION MAKING
1
Transport fundamentals
• Basic transportation modes
rail, truck, air, water and pipeline
• Intermodal services (piggyback, fishyback
and birdyback, containerization)
• Transportation cost characteristics and rates
• Agencies
• Documentation
2
Transport Decisions
•
•
•
•
Service selection
Freight consolidation
Vehicle routing
Vehicle routing and scheduling
3
Service Selection: Total cost concepts
Inventory cost
Cost of
transportation
Rail
Truck
Air
Inventory and transportation costs trade-off
4
Mode/Service Selection (Cont’d)
Example Finished goods are to be shipped from a
plant inventory to a warehouse inventory some
distance away. The expected volume to be
shipped in a year is 1,200,000 lb. The product is
worth $25 per lb. at the plant and carrying costs are
30% per year.
Other data are:
Transport
choice
Rail
Truck
Air
Rate,
$/lb.
0.11
0.20
0.88
Transit
time,
days
25
13
1
Shipment
size, lb.
100,000
40,000
16,000
5
– Transportation cost
RD
– In transit inventory holding cost
I C  D 
T
365
– Inventory holding cost at the plant
I  C  Average Inventory at Plant
– Inventory holding cost at the warehouse
I  C ' Average Inventory at Warehouse
6
Transport Selection Analysis
Cost
type
Computation
Rail
Truck
.20(1,200,000)
= $240,000
Air
TransRD
portation
.11(1,200,000)
= $132,000
.88(1,200,000)
= $1,056,000
In-transit ICDT
inventory 365
[.30(25)
[.30(25) 
[.30(25) 
1,200,000(25)]/365 1,200,000(13)]/365 1,200,000(1)]/365
= $616,438
= $320,548
= $24,658
ICQ
Plant
inventory 2
[.30(25) 
100,000]/2
= $375,000
[.30(25) 
40,000]/2
= $150,000
[.30(25) 
16,000]/2
= $60,000
IC'Q
Whse
inventory
2
[.30(25.11) 
100,000]/2
= $376,650
[.30(25.20)
40,000]/2
= $151,200
[.30(25.88)
16,000]/2
= $62,112
$1,500,088
$ 861,748
$1,706,770
Include transport rate
Totals
Improved service
7
Complications
Many complications arise when the shipper
and receiver are separate legal entities.
• Competition
• Price
• Information
8
Freight Consolidation
 Combine small shipments into larger ones
 A problem of balancing cost savings against
customer service reductions
 An important area for cost reduction in many
firms
 Types of consolidation
• Inventory
• Vehicle
• Warehouse
• Temporal
9
Freight Consolidation Analysis
Suppose we have the following orders for the
next three days.
From:
Ft Worth
Day 1
To: Topeka
5,000 lb.
Kansas City 7,000
Wichita
42,000
Day 2
25,000 lb.
12,000
38,000
Day 3
18,000 lb.
21,000
61,000
Consider shipping these orders each day or
consolidating them into one shipment. Suppose that
we know the transport rates.
10
Freight Consolidation Analysis (Cont’d)
Separate shipments
Day 1
Rate x volume = cost
Day 2
Rate x volume = cost
Topeka
Kansas City
Wichita
3.42 x 50 = $171.00
3.60 x 70 = 252.00
0.68 x 420 = 285.60
1.14 x 250 = $285.00
1.44 x 120 = 172.80
a
0.68 x 400 = 272.00
Total
a
$708.60
Total
$729.80
Ship 380 cwt., as if full truckload of 400 cwt.
Topeka
Kansas City
Wichita
Day 3
Rate x volume = cost
Totals
1.36 x 180 = $244.80
1.20 x 210 = 252.00
0.68 x 610 = 414.80
$700.80
676.80
972.40
Total
$911.60
$2,350.00
11
Freight Consolidation Analysis (Cont’d)
Consolidated shipment
Computing transport cost for one combined, three-day
shipment
Day 3
Rate x volume = cost
Topeka
Kansas City
Wichita
a
0.82 x 480 = $393.60
0.86 x 400 = 344.00
0.68 x 1410 = 958.80
Total
a
$1,696.40
480 = 50 + 250 + 180
Cheaper, but what about
the service effects of holding
early orders for a longer time
to accumulate larger shipment
sizes?
12
Vehicle Routing
• Separate and single origin and destination points:
determine the best path between the origin and
destination points over a network of routes
– shortest route method
– Linear programming
• Multiple origin and destination points
– Linear programming
• Coincident Origin and Destination Points
13
Seervada Park
Seervada Park has recently been set aside for a limited amount of
sightseeing and backpack hiking. There is a narrow, winding road
system for trams and for jeeps driven by park rangers. This road
system is shown in the next slide, where O is the entrance into the
park; other letters designate the locations of ranger stations. The
numbers give the distances of these roads in miles.
The park contains a scenic wonder at station T. A small number of
trams are used to transport sightseers from O to T. The park
management currently faces the problem of determining which
route from O to T has the smallest total distance for the operation
of the trams.
14
A
2
7
2
5
O
4
C
D
4
B
3
1
5
T
1
E
7
4
 Nodes: intersections, airports
 Arcs: roads, air lanes
• directed or undirected arc
 Flow: vehicles, aircraft
The Shortest-Path Problem: The essence of the procedure is that
it fans out from the origin, successively identifying the shortest
path to each of the nodes of the network in the ascending order
of their (shortest) distances from the origin, thereby solving the
problem when the destination node is reached.
15
16
Vehicle Routing:
Multiple origin and destination points
4
Supplier A
Supply 400
Requirements 600
5
5
Supplier B
9
Supply 500
7
Plant 2
5
Supply 700
Supplier C
Plant 1
5
8
Requirements 500
6
Plant 3
Requirements 300
17
LP Formulation
Define xij  quantity to be shipped from sup plier i to plant j
3
min
X
3
 c x
i 1 j 1
ij ij
st. x11  x21  x31  600
x11  x12  x13  400
x12  x22  x32  500
x21  x22  x23  700
x13  x23  x33  300
x31  x32  x33  500
xij  0 for all i, j.
18
Vehicle Routing:
Coincident origin and destination points
• Computer model (Travel salesman problem)
• Pattern recognition
– The paths of the route do not cross
– Teardrop shape
D
D
19
Vehicle Routing and Scheduling
• Each stop may have volume to be picked up as well as
delivered;
• Multiple vehicles may be used having different capacity
limitations to both weight and cube;
• A maximum total driving time is allowed on a route before
a rest period of at least 8 hours;
• Stops may permit pickups and/or deliveries only at certain
times of the day (time windows);
• Pickups may be permitted on a route only after deliveries
are made;
• Drivers may be allowed to take short rests or lunch breaks
at certain times of the day.
20
Some Principles
• Load trucks with stop volumes that are in the
closest proximity to each other.
21
• Stops on different days should be arranged to
produce tight clusters
22
• Build routes beginning with the farthest stop from the
depot;
• The sequence of stops on a truck route should form a
teardrop pattern;
• The most efficient routes are built using the largest
vehicles available;
• Pickups should be mixed into delivery routes rather than
assigned to the end of routes;
• A stop that is greatly removed from a route cluster is a
candidate for an alternative means of delivery;
• Narrow stop time window restrictions should be avoided.
23
Example: Case Casket
• Caskets are delivered from the warehouse to
funeral homes from Monday to Friday
• Two racked trucks (capacity 18 casket each)
• Design:
– Starting with the farthest customer and then adding
customers by progressively moving toward the
warehouse (five groups, balance the workload)
– For each cluster, group enough stops in close proximity
to each other until the capacity of a truck is filled.
– try to avoid crossing, teardrop shape
24
25
26
27
Methods for Routing and Scheduling
• The sweep method (two stages)
– Sweep
– Sequence
28
• The saving method
– Objective: minimize the total distance traveled by all vehicles and
to minimize indirectly the number of vehicles needed
– Logic: Begin with a dummy vehicle serving each stop and
returning to the depot. Next, two stops are combined together on
the same route and calculate the possible saving.
29
Case: National Logistics Management
• Draw a picture of the process that NLM’s Expedited
Management System facilitates, from the shipper to the
receiver. What role does NLM play in the shipping
process?
• Why would a customer use a third-party logistics (3PL)
service, such as NLM? What are the advantages and
disadvantages in using a 3PL? As customers move towards
using 3PLs, which players in the industry benefit and
which players lose?
• What are some growth strategies for NLM?
• How has the Internet revolutionized the 3PL industry?
30
Inventory Policy
Decisions
CR (2004) Prentice Hall, Inc.
31
ORGANIZING
Customer
service goals
• The product
• Logistics service
• Ord. proc. & info. sys.
Transport Strategy
• Transport fundamentals
• Transport decisions
PLANNING
Inventory Strategy
• Forecasting
• Inventory decisions
• Purchasing and supply
scheduling decisions
• Storage fundamentals
• Storage decisions
CONTROLLING
Inventory Decisions in
Strategy
Location Strategy
• Location decisions
• The network planning process
CR (2004) Prentice Hall, Inc.
32
Inventory in the Economy
• Inventory in the Economy has decreased.
– As a percentage of the GDP, from 1985 to
2000, inventory levels have decreased from
5.4% to about 3.8%
– Examine Table 6-1.
33
Table Macro Inventory Cost in Relation to
U.S. Gross Domestic Product
34
Inventory Costs: Why are they so
important?
• First, inventory costs are a significant
portion of total logistics costs for many
firms.
• Second, inventory levels affect customer
service levels.
35
Table
Total Logistics Costs --- 1999
36
Management of Inventory Flows in
the Supply Chain: Introduction
• Inventory as an asset has taken on increased
significance as companies struggle to reduce
investment in fixed assets that accommodate
inventory (plants, warehouses, etc.).
• Changes in inventory affect return on assets (ROA),
an important internal and external metric.
• “Ideally, zero inventory will maximize cash flow.”
37
What are Inventories?
•Finished product held for sale
•Goods in warehouses
•Work in process
•Goods in transit
•Any owned or financially controlled
raw material, work in process, and/or
finished good or service held in
anticipation of a sale but not yet sold
CR (2004) Prentice Hall, Inc.
38
Where are Inventories?
Inbound
transportation
Production
Outbound
transportation
Finished goods
warehousing
Customers
Receiving
Material
sources
Production
materials
Finished goods
Shipping
Inventories
in-process
Inventory
locations
CR (2004) Prentice Hall, Inc.
39 9-4
Reasons Against Inventories
•They consume capital resources that might be put to
better use elsewhere in the firm
•They too often mask quality problems that would more
immediately be solved without their presence
•They divert management’s attention away from careful
planning and control of the supply and distribution
channels by promoting an insular attitude about
channel management
CR (2004) Prentice Hall, Inc.
40
Reasons for Inventories
•
•
•
•
•
•
•
Purchase economy
Transport economy
Production savings
Safety stocks
Seasonal stocks
Speculative purchase
Improve customer service
41
Types of Inventories
•Pipeline
-Inventories in transit
•Speculative
-Goods purchased in anticipation of price increases
•Regular/Cyclical/Seasonal
-Inventories held to meet normal operating needs
•Safety
-Extra stocks held in anticipation of demand and
lead time uncertainties
•Obsolete/Dead Stock
-Inventories that are of little or no value due to being
out of date, spoiled, damaged, etc.
42
Inventory Management
Philosophies
•Pull
-Draws inventory into the stocking location
-Each stocking location is considered independent
-Maximizes local control of inventories
•Push
-Allocates production to stocking locations based on
overall demand
-Encourages economies of scale in production
•Just-in-time
-Attempts to synchronize stock flows so as to just
meet demand as it occurs
-Minimizes the need for inventory
CR (2004) Prentice Hall, Inc.
43
Pull vs. Push Inventory Philosophies
PUSH - Allocate supply to each
warehouse based on the forecast
for each warehouse
PULL - Replenish inventory with
order sizes based on specific needs
of each warehouse
Demand
forecast
Warehouse #1
Q1
A1
A2
Q2
Plant
Warehouse #2
A3
Demand
forecast
Q3
A = Allocation quantity to each warehouse
Q = Requested replenishment quantity
by each warehouse
CR (2004) Prentice Hall, Inc.
Warehouse #3
Demand
forecast
44 9-11
Inventory Costs:
Inventory Carrying Cost
• Capital Cost
– Opportunity cost associated with investing in
inventory, or any asset.
– What is the implicit value of having capital tied
up in inventory, instead of some other
worthwhile project?
– Minimum ROI expected from any asset.
– Debate on inventory valuation at fully allocated
or variable costs only.
45
Inventory Costs:
Inventory Carrying Cost
• Storage Space Cost
– Handling costs, rents, utilities.
– Logistics develops a cost formula for storage
space costs based on cost behaviors.
• Public space mostly variable.
• Private space a mix of fixed and variable.
46
Inventory Costs:
Inventory Carrying Cost
• Inventory Service Cost
– Insurance and taxes on stored goods.
– Varies according to the value of the goods.
• Inventory Risk Cost
– Largely beyond the control of the firm.
– Due to obsolescence, damage, theft, employee
pilferage.
47
Relevant Costs (Cont’d)
•Procurement costs
-Cost of preparing the order
-Cost of order transmission
-Cost of production setup if appropriate
-Cost of materials handling or processing at the
receiving dock
CR (2004) Prentice Hall, Inc.
48
Relevant Costs (Cont’d)
•Out-of-stock costs
-Lost sales cost
›Profit immediately foregone
›Future profits foregone through loss of goodwill
-Backorder cost
›Costs of extra order handling
›Additional transportation and handling costs
›Possibly additional setup costs
CR (2004) Prentice Hall, Inc.
49
Stockouts
• Four possible outcomes from a stockout
– Customers wait
– Back orders
– Lost sales
– Lost customers
50
Expected Costs of Stockouts
Event
Probability
Costs
Expected
Costs
Back Order
70%
$ 6.00
$ 4.20
Lost Sale
20%
$20.00
$ 4.00
Lost
Customer
10%
$200.00
$ 20.00
Estimated
cost per
stockout
100%
---
$ 28.20
51
Inventory Management Objectives
Good inventory management is a careful balancing act
between stock availability and the cost of holding
inventory.
Customer Service,
i.e., Stock Availability
Inventory Holding costs
•Service objectives
-Setting stocking levels so that there is only a
specified probability of running out of stock
•Cost objectives
-Balancing conflicting costs to find the most
economical replenishment quantities and timing
CR (2004) Prentice Hall, Inc.
52
Inventory’s Conflicting Cost Patterns
Minimum cost
reorder quantity
Cost
Total cost
Procurement cost
Stockout cost
CR (2004) Prentice Hall, Inc.
Replenishment quantity
53 9-16
Reorder Point Method Under Certainty
for a Single Item
Quantity on-hand
plus on-order
Q
Reorder
point, R
0
CR (2004) Prentice Hall, Inc.
Lead
time
Order
Order
Placed Received
Lead
Time
time
Order
Order
Placed
Received
54 9-22
Quantity on hand
Reorder Point Control for a Single Item
Q
Place
order
Q
DDLT
ROP
Receive
order
0
P
Stockout
LT
LT
Time
CR (2004) Prentice Hall, Inc.
55 9-25
Periodic Control for a Single Item
Quantity on hand
M
Q2
~
Q1
q
Stock
level
reviewed
Order
received
0
LT
T
M = maximum level
M - q = replenishment quantity
LT = lead time
Time
LT
T
T = review interval
q = quantity on hand
56
Qi = order quantity
9-39
Min-Max Inventory Control
Add increment ROPq to order size
Quantity on hand
M
Q1
~
Q2
Q*
ROP
q
LT
CR (2004) Prentice Hall, Inc.
LT
Time
57 9-54
Classifying Inventory:
ABC Analysis
• Ranking system
– Developed in 1951 by H. Ford Dicky of
General Electric3.
– Suggested that GE classify items according to
relative sales volume, cash flows, lead time, or
stockout cost.
– Most important inventory put in Group A.
– Lesser impact goods put in Groups B and C
respectively.
58
Classifying Inventory:
ABC Analysis
• Pareto’s Rule (80-20 Rule)
– Based on a nineteenth century mathematician’s
observation that many situations were
dominated by a very few elements.
– Conversely, most elements had very little
influence in most situations.
– Separates the “trivial many” from the “vital
few”.
59
Classifying Inventory:
ABC Analysis
• 80-20 Rule
– 80% of sales will come from 20% of the
inventory SKUs.
– 20% of sales will come from 80% of the
inventory SKUs.
• The 80-20 Rule has been found to explain
many phenomena that interest managers.
– For example, 80% of sales come from 20% of
customers; and vice versa.
60
100
90
Total sales (%)
80
70
60
50
40
30
A items
B items
C items
20
10
0
0
CR (2004) Prentice Hall, Inc.
20
40
60
Total items (%)
80
100
Aggregate Inventory Control
Product items can be grouped according to 80-20
curve, each with different stocking policies
61
9-72
Risk Pooling (Cont’d)
Safety stock in 1 warehouse
SSc 1.96(19.07) 0.5  26.43 units
Total inventory
AIL = Regular stock + Safety stock
Two
warehouses
AIL = 59.75 + 27.66 = 87.41 units
In a one-warehouse channel
AIL = 42.56 + 26.43 = 68.99 units
Conclusion There is a reduction in the average
inventory level of an item as the number of stocking
points in the supply channel is decreased. In this
example, both regular stock and safety stock decline.
CR (2004) Prentice Hall, Inc.
62 9-77
Evaluating the Effectiveness of a Company’s
Approach to Inventory Management
• Are customers satisfied with the current
level of customer service?
• How frequently does backordering or
expediting occur?
• How is the inventory turns relative to
industry average?
• Is inventory cost as percentage of sales
higher or lower than industry average?
63
Purchasing and Supply
Scheduling Decisions
64
Purchasing in logistics
Transportation
Inventory
Customer
Service
Location
65
Materials Management vs. Physical
Distribution
Sources of
supply
Plants/
operations
Materials management
(Physical supply or inbound
Logistics)
Customers
Physical distribution
(outbound logistics)
66
Objectives of Purchasing
Efficient acquisition of products and services
requires
–
–
–
–
–
–
–
The right materials
In the right quantity
In the right condition
At the right time
From the right source
With the right service
At the right price
67
Types of Purchases
•
•
•
•
•
•
•
•
Component parts
Raw materials
Process materials
Accessory equipment
Major equipment
Operating supplies
Finished product
Services
68
The Purchasing Process
Recognize a need
Identify a supplier
Qualify and place an order
Monitor and manage the delivery
process
Evaluate the purchase and the
supplier
69
Activities of purchasing
• Selects and qualifies
• Sets terms of sale
suppliers
Evaluates the value
• Rates supplier performance •received
• Negotiates contracts
inbound quality if
• Compares price, quality, and •notMeasures
a responsibility of quality
service
• Times purchases and delivery control
• Predicts price, service, and
• Quantity of purchases
demand
• Who delivers, who controls the sometimes
changes
freight movement
Selection of product form and
• what is the routing of inbound •transportation
method
movement
Which activities are of direct concern to logisticians?
70
Importance of Purchasing
Leverage principlecosts
A company with $100 million in sales wishes to double profits. How to
do it?
Current
Sales
+17%
Price
+5%
$100
$117
$105
Purchased
goods and
services
60
70
Labor and
salaries
10
Overhead
Profit
Sales
Labor and
Salaries
-50%
Overhead
-20%
Purchases
-8%
$100
$100
$100
60
60
60
55
12
10
5
10
10
25
25
25
25
20
25
$5
$10
$10
$10
$10
$10
Conclusion Reducing purchase prices requires the least change
71
Importance of Purchasing
Leverage principlereturn on assets
Sales
$10 million
Less
Total cost a
$9.5 million
(9.25 million) b
Profit
$500,000
($750,000)
Divided
by
Sales
$10 million
Profit
margin
5%
(7.5%)
Multiplied
by
Sales
$10 million
Divided
by
c
Inventory
$2 million
($1.9 million)
aPurchases
Total
assets
$5 million
($4.9 million)
are 50% of total sales.
in parentheses assume a 5% reduction in purchase prices.
cInventory is 40% of total assets.
bFigures
Investment
turnover
2 times
(2.04)
Return
on
assets
10%
(15.3%)
A 5% reduction
in purchase
price can lead to
a 53% increase
in return on
72
assets
Supplier Criteria: Evaluation
Price Variable
Delivery Variable
Quality Variable
Service Variable
73
Supplier evaluation variables
breakdown
• Price
– Price of the materials
– Financing terms
• Delivery
– Reliability of delivery
– Total transit time
• Quality
– Overall reputation
– Product reliability
– Technical
specifications
• Service
– Ease of operation or
use
– Ease of maintenance
– Reliability of service
– Sales service
– Flexibility
– Training
– Technical service
– Ordering convenience
74
Supplier Selection (Cont’d)
Single vendors
•Allows for economies of scale
•Consistent with the just-in-time philosophy
•Builds loyalty and trust
•May be only source for unique product or service
Multiple vendors
•Encourages price competition
•Diffuses risk
•May disturb supplier relations, reduce loyalty, reduce
responsiveness, and cause variations in product quality and
service, higher admin cost
75
Ericsson vs. Nokia
• Both sourced parts from a Philips semiconductor plant in Albuquerque,
New Mexica. Ericsson single sourced many of its parts, including the
Philips chips, to simplify its supply chain.
• In March 2000, a small fire was triggered by a bolt of lightning at the
Philips plant, but the fire was put out by staff within minutes. The damage
seemed to be minor at the time and the company expected to resume
production within a week.
• Philips later realized that smoke and soot had contaminated a much larger
area of the plant than had first been thought. Production could be halted for
months.
• Nokia continues to be the leader in handsets. In 2001, Ericsson decided to
quit making handsets on its own. Instead, it left the business to a joint
venture with Sony.
76
Supplier Selection (Cont’d)
Finding suppliers
• Personal contacts
• Trade publications
• Web sites, catalogs, and directories
• Advertisements and solicitations
Qualifying suppliers
• Previous experiences and formal rating schemes
• Word of mouth
• Samples of product
• Reputation
• Site visits and demonstrations
77
Supplier Rating
Example of weighted checklist method for supplier evaluation
Weight
50%
25%
25%
Factor
Quality
Service
Price
Formula
100% - % rejects
100% - 7% for each failure
Lowest price offered
Price actually paid
Scoring actual performance
Factor
Weight Performance
Quality
50
5% rejects
Service
25
3 failures
Price
25
$100
Overall
Evaluation
50x(1-.05)
= 47.50
25x[1-(.07x3)] = 19.75
25x($90/$100) = 22.50
89.75
Compare to best score of 100 and to scores for other suppliers.
78
Sourcing
Vendor 1
Vendor 2
Vendor 3
Vendor 4
……
Plant 1
Plant 2
Plant 3
…
79
Complications
•
•
•
•
•
•
•
Multiple shipping points
Multiple destination points
Vendors quote different prices
Transportation
Supply constraints
Requirement constraints
Supply contracts
80
Allocation to Suppliers
Allocation methods
•Company policy considering risk, fairness, ethics, etc.
•Definitive methods
Example of a definitive method
The Acme Company has received quotes for a component
(X-16) that is part of a larger assembly (industrial motors).
The prices are as follows:
Supplier
Philadelphia Tool
Houston Tool & Die
Chicago-Argo
LA Tool Works
Shipping
location
Philadelphia
Houston
St Louis
Los Angeles
FOB price
$100 ea
101
99
96
81
Allocation (Cont’d)
The company has 3 plants to be supplied at Cleveland,
Atlanta, Kansas City. The transportation rates, plant
requirements (cwt.), and available supply limits (cwt.) are:
Shipping
point
Cleveland Atlanta
Philadelphia
2
3
Houston
6
4
St Louis
3
3
Los Angeles
8
9
Requirements 4,000
2,000
Kansas
City
5
3
1
7
7,000
Availability
5,000
15,000
4,000
15,000
Each part weighs 100 lb. (1 cwt.) and rates are in $/cwt.
82
Allocation (Cont’d)
Current purchase: Buy from supplier with lowest price.
Thus, all purchases from LA Tool for a total cost of:
Purchase costs
Transport to CLE
Transport to ATL
Transport to KC
13,000 x 96 = $1,248,000
4,000 x 8 =
32,000
2,000 x 9 =
18,000
7,000 x 7 =
49,000
Total
$1,347,000
Is buying based on lowest price a good strategy?
83
Allocation (Cont’d)
Allocate using linear programming
Shipping
point
Philadelphia
Houston
Saint
Louis
Los
Angeles
Requirements
CLE
ATL
KC
102
103
105
4,000 1,000
107
105
104
102
104
4,000
102
Purchase price
plus transport
Dummy
0
5,000
0
15,000
0
100
4,000
105
103
0
1,000 3,000 11,000
2,000
7,000
Availability
26,000
15,000
4,000
15,000
84
Allocation (Cont’d)
Revised plan
PHI to CLE
PHI to ATL
STL to KC
LAX to ATL
LAX to KC
102 x 4000 =
103 x 1000 =
100 x 4000 =
105 x 1000 =
103 x 3000 =
Total
$408,000
103,000
400,000
105,000
309,000
$1,325,000
This allocation saves $22,000 per purchase
Now, asking “what if” questions can provide insight into
good allocation plans.
85
Allocation (Cont’d)
Problem
What if CLE and KC markets are increased by 20% and
ATL market is increased by 50%.
Solution
CLE ATL KC
PHI 4800 200
HOU
STL
2800 1200
LAX
7200
Total cost = $1,657,400
86
Allocation (Cont’d)
Problem
What if Philadelphia price is increased by 10%?
Solution
CLE
ATL
KC
PHI
HOU
STL
2000 2000
LAX 4000
5000
Total cost = $1,335,000
87
Allocation (Cont’d)
Problem
What if STL is no longer a supplier?
Solution
CLE ATL
PHI 4000 1000
HOU
STL
LAX
KC
1000 7000
Total cost = $1,337,000
88
Allocation (Cont’d)
Problem
What if STL’s capacity is doubled?
Solution
CLE ATL KC
PHI 4000 1000
HOU
STL
1000 7000
LAX
Total cost = $1,313,000
Observations Houston is a
weak supplier. Perhaps some
price concessions can be
negotiated? Philadelphia is
price sensitive and cannot
withstand much of a price
increase. St Louis is a valuable
supplier and more capacity
should be sought.
89
Timing of purchases
• Speculative buying
• Forwarding buying
• Hand-to-mouth buying, or buying to current
requirements
90
Timing of Purchases (Cont’d)
Speculative buying
Buying more than the foreseeable requirements at
current prices in the hope of reselling later at higher
prices. Some of the purchased quantities may be used
in production and some simply resold. Generally a
financial activity, not a materials management one.
Forward buying
Buying in quantities exceeding current requirements,
but not beyond foreseeable needs.
- Takes advantage of favorable prices in an unstable
market, or takes advantage of volume transportation
rates
- Reduces risk of inadequate delivery
91
Timing of Purchases (Cont’d)
Hand-to-mouth buying
Buying to satisfy immediate needs such as those
generated through MRP.
- Advantageous when prices are dropping
- May improve cash flow by temporarily reducing
expenses of carrying inventory
92
Timing of Purchases (Cont’d)
Forward buying example--volume buying
A firm is able to forecast
the following price curve
over the next two years
with usage averaging
20,000 units per month
Note: The reason
to look at
forecasting methods
Objective To buy in larger volume when prices are
rising and to buy only to immediate needs when
prices are falling.
93
Timing of Purchases (Cont’d)
Strategy Try purchasing every four months while
prices are rising and hand-to-mouth purchasing when
they are falling.
Price upswing purchase cost
Date
Jan
May
Sep
No of
units
80,000
80,000
_______
80,000
240,000
Cost
per unit
$2.00
2.35
2.75
Total
cost
$160,000
188,000
________
220,000
$568,000
Average cost per unit = 568,000/240,000 = $2.37 per unit
94
Timing of Purchases (Cont’d)
Price downswing purchase cost
Date
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
No of
units
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
240,000
Cost
per unit
$2.86
2.83
2.80
2.75
2.65
2.55
2.45
2.35
2.25
2.15
2.05
2.00
Total
cost
$ 57,200
56,600
56,000
55,000
53,000
51,000
49,000
47,000
45,000
43,000
41,000
40,000
$593,800
Note: This is the
same average price
as hand-to-mouth
buying on price
upswing.
Average cost per unit = 593,000/240,000 = $2.47 per unit
95
Timing of Purchases (Cont’d)
Savings
Savings for one year out of two are:
Price reduction  2.47  2.37 x100  4%
2.47
or $593,800 – 568,000 = $25,000
But trades with increased inventory
Buying in 80,000 lot quantities instead of 20,000 will
add to inventory.
80,000  20,000  30,000 units
2
This is the incremental
inventory needed
for forward buying
compared with H-to-M
96
Timing of Purchases (Cont’d)
Suppose inventory carrying costs are 25% per year
on an approximate value of $2.37 per unit.
Incremental inventory costs would be:
CC = 0.25(2.37)(30,000) = $17,775
Net savings = 25,000 – 17,775 = $7,225 in favor of
forward buying. Now, try other lengths of forward
buying, such as once a year, to see if further
improvement can be made.
97
Facility Location
Inventory
Transport
Customer
Service
Location
98
Importance of Location
• Gives structure to the network
• Significantly affects inventory and
transportation costs
• Impacts on the level of customer service to
be achieved
99
Facility location decisions
• Decisions
– Number of facilities
– Location of facilities
– Size of facilities
• Facilities
– Plants, ports, vendors, warehouses, DC, retail
outlets, service centers
100
Central questions
– How many warehouses (or other facilities) should there
be in the logistics network? How large should they be,
and where should they be located?
– Which customers should be assigned to a warehouse?
Which warehouse should be assigned to each plant,
vendor or port?
– Which products should be stocked in each warehouse?
Which products should be shipped directly from plants,
vendors, or ports to customers?
101
102
Guadalajara
…
Ground zero of this structure shift is Guadalajara, a graceful city
of 3.3 million known more for its fiery tequila and mellifluous
mariachis. Since the NAFTA took effect in 1994, contract
manufacturers, their suppliers, and some of their customers have
made decisions to locate there. As a result, Mexico’s No. 2 city is
on its way to supplanting China and other Asian counties as the
principle manufacturing center for products sold in the US. …
Customer proximity
Tax breaks
Availability of low-cost state land for new investors
A friendly governmental attitude
103
Dell
After evaluating more than twenty cities in other geographical
areas of the US, Dell Computer chose Nashville, Tennessee, as the
site for an expansion of its personal computer manufacturing
operations. This location represented the first move for this
company beyond its operations in the state of Texas. Following
consideration of other locations, Dell’s selection of Tennessee was
based on a number of factors, including: proximity to customers,
access to capable logistics network, general business climate,
telecom capabilities, and the availability of skilled workers.
104
Renley Watch
“ Ten years ago there were maybe 200 or 300 watchmakers in
Hong Kong. Now there are only three or four and we are
probably the biggest of them,” Mr. Lau (founder and managing
director of Renley Watch Manufacturing) said … “We mostly
ship by air and the better air links is one of the reasons we stay
in Hong Kong,”
Hong Kong’s airport handled more than two million
tonnes of cargo last year, more than all three of China’s busiest
airports combined. While many Chinese airports have a modern
infrastructure, those using air freight on the mainland say they
are hamstrung by red tape and complex customs clearing
procedures.
SAR stalwarts cling to home-base edge, SCMP, Aug. 26, 2002
105
SHENZHEN, China — Persistent labor shortages at hundreds of Chinese
factories have led experts to conclude that the economy is undergoing a
profound change that will ripple through the global market for manufactured
goods.
……
Li & Fung, one of the world's biggest trading companies, said recently that
labor shortages and rising manufacturing costs in China were already forcing it
to step up its diversification efforts and look for supplies from factories in
other parts of Asia.
"I look at China a lot differently than I did three years ago," said Bruce
Rockowitz, president of Li & Fung in Hong Kong, citing the rising costs of
doing business in China. "China is no longer the lowest-cost producer. There's
an evolution going on. People are now going to Vietnam, and India and
Bangladesh."
New York Times, April 3, 2006
106
Nokia has built a $150m mobile phone plant in an industrial zone
near Chennai. Others are following in its footsteps, including LG
and Motorola. Suppliers are setting up shop in the zone. The zone
will be a hub for component suppliers and service providers to cut
down the time and cost of importing phone parts from China or
elsewhere.
India has the highest volume of net mobile additions (80m) from
Q4 of 2006 to Q4 of 2007. Local production allows more nimble
response to the Indian market, which tends to favor brightly
colored handsets that are dust proof and have built-in flash-lights,
handy during the country’s ubiquitous power cuts.
By far the biggest obstacle is infrastructure. Chennai’s roads are
becoming increasingly congested. The airport is also small and
congested. An uncovered loading area caused critical supplies to
get wet during rainstorm…
Summarized from Nokia’s hub fosters creativity, FT, April 4, 2007
107
The need for logistics network redesign
• Changing customer service requirements
• Shifting locations of customer and/or supply
markets
• Change in corporate ownership
• Cost pressures
• Competitive capabilities
• Corporate organizational change
108
Major locational determinants
Regional determinants
• Labor climate
• Availability of transportation
• Proximity to markets and
customers
• Quality of life
• Taxes and industrial development
incentives
• Supplier networks
• Land costs and utilities
• Company preference
Site-specific determinants
• Transportation access
–
–
–
–
•
•
•
•
Truck
Air
Rail
Water
Inside/outside metropolitan area
Availability of workforce
Land costs and taxes
utilities
109
110
Main factors
• Different facilities
– Plant and warehouse (economic factors)
• Cost of labor, land and transportation
– Retail location (revenue generation)
• Population base and income, no. of competitors
or complementary stores …
– Service facility (accessibility)
• Population, traffic flow, availability of mass
transit…
111
• Product life cycle
–
–
–
–
Early stage
Growth
Maturity
Decline
• Industry type
– Labor intensive
– High-tech
– Industries with high logistics costs
112
A Historical Perspective on Location
113
Bid-rent curves
114
Classification of industries
115
Tapered Transportation Rates
116
Factor-rating systems
A refinery is considering a set of possible sites
Range
Fuels in region
0 to 330
Power availability and reliability 0 to 200
Labor climate
0 to 100
Living conditions
0 to 100
Transportation
0 to 50
Water supply
0 to 10
Climate
0 to 50
Supplies
0 to 60
117
Single Facility Location
Center-of-Gravity Approach
118
Objective
Minimize TC=ViRidi
Vi = volume at point i
Ri = transportation rate to point i
di = distance to point i from the facility to be
located
= K ( X i  X )2  (Yi  Y )2
119
Differentiate TC with respect to X and Y:
V R X / d
X 
V R / d
i
i
i
V R Y / d
Y 
V R / d
i
i
i
i
i
i i
i
i
i
i
i
i
i
i
Approximation
X 
V R X
V R
i
i
i
i
i
i
i
Y 
V R Y
V R
i
i
i
i
i
i
i
120
Algorithm for exact solution
1.
Approximate the initial location as:
X 
V R X
V R
i
i
i
2.
3.
Y 
i
V R Y
V R
i
i
i
i
i
i
i
i
Using X, Y from step 1 to calculate di
Calculate X, Y again by
X 
V R X / d
V R / d
i
i
i
i
i
i
4.
5.
i
i
i
i
V R Y / d

V R / d
i
i
Y
i
i
i
i
i
i
i
i
Recalculate di again
Repeat step 3 and 4 until X and Y do not change or change very
little.
121
Example
122
123
Appraisal
•
•
•
•
Demand volumes are concentrated at one point
Do not include fixed cost
Linear transportation cost
Straight-line routes between facility and other
network points
• Static
124
Multifacility Location
• How many warehouses should there be in the
logistics network? How large should they be,
and where should they be located?
• Which customers should be assigned to a
warehouse? Which warehouse should be
assigned to each plant, vendor, or part?
• Which products should be stocked in each
warehouse? Which products should be shipped
directly from plants, vendors, or ports to
customers?
125
Multiple Center-of-Gravity Approach
• Form clusters
– Group points that are the closest to each other
• Find the exact center-of-gravity location for
each cluster
• Revise clusters
• Find the new center-of-gravity locations
• Continue until there is no further change
126
MILP
Find the number, size and locations of warehouses in a
logistics network that will minimize the fixed and
variable costs of moving all products through the
selected network subject to:
– The available supply of the plants cannot be exceeded for
each product
– The demand for all products must be met
– The throughput of each warehouse cannot exceed its capacity
– A minimum throughput of a warehouse must be achieved
before it can be opened
– All products for the same customer must be served from the
same warehouse
127
128
Decision Variables
• Integer variables
–
• Continuous variables
–
129
Constraints
• Demand
• Plant capacity
• Warehouse capacity
• Service requirements
130
Other examples
• Digital Equipment Corp. saved over $100 million by using
Global Supply Chain Model (GSCM), a large mixedinteger linear program.
• GSCM recommends a production, distribution and
distribution network subject to meeting demand,
restrictions on local content, offset trade, and joint capacity
for multiple products, echelons and time periods.
131
Franz Edelman Award
• INFORMS (Institute for Operations Research and
Management science)
• Best applications of OR/MS methodology
• The six finalists published in the Jan-Feb issue of
Interfaces every year
• Some finalists in the past
– DEC, IBM, HP, HIT (Hong Kong International Terminals, 2004)
– American Airline, National Car Rental
– AT&T, British Telecom
132
Retail/Service Location
•
•
•
•
•
Local demographics
Traffic flow and accessibility
Retail structure
Site characteristics
Legal and cost factors
133
A Hypothetical Weighted Factor Checklist for a
Retail Location Example
(1)
Factor
Weight
a
(1 to 10) Location Factors
8
Proximity to competing stores
5
Space rent/lease
considerations
8
Parking space
7
Proximity to complementary
stores
6
Modernity of store space
9
Customer accessibility
3
Local taxes
3
Community service
8
Proximity to major
transportation arteries
Total index
a
b
Weights approaching 10 indicate great importance.
Scores approaching 10 refer to a favored location status.
(2)
(3)=(1)(2)
Factor Score
b
(1 to 10)
5
Weighted
Score
40
3
10
15
80
8
9
8
2
4
56
54
72
6
12
7
56
391
134
Some smart examples
Customers are hungry
because airlines no longer
serve food on short flights
Locate “real” restaurants in
airports.
Customers want more
convenient locations to save
time
Combine previously separate
service operations into one
location (convenience stores
with gas stations)
Customers are reluctant to
shop frequently in large
mega stores because they are
time consuming
Add other services to
increase convenience such as
fast food and banking.
(McDonald in Wal-Mart,
Starbuck in Chapters)
135
136
Summary
• What are facility location decisions
• The formulation of single and multiple
location problems
• Different solution methods
137