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Module 3 LOGISTICS IN THE FIRM

Learning Objective Understand the relationship between logistics and the other functional areas, including manufacturing, marketing, and finance Discuss the contribution of logistics activities in the firm Determine the logistics cost and understand the cost trade-offs in a logistics system

INTRODUCTION According to www.philstar.com in Manufacturing Firms in Southeast Asia Benefits from Logistics Integration, updated on November 29, 2010, The Southeast Asian manufacturing companies can benefit from the seamless flow of their goods and services across the region when the logistics industry becomes fully integrated. Logistics connectivity within the Association of Southeast Asian Nations (ASEAN) will help spur the manufacturing industry in the region and make the ASEAN a very competitive region. According to a study done by the APEC Policy Support Unit, a one percent increase in logistics performance and competitiveness could lead to an immediate three percent improvement in exports. Experts said each member country of the ASEAN could be good at doing different things such as providing skilled labor or strong infrastructure. As such, economies of scale can be achieved by having different countries participate in different parts of the value chain. After China, the ASEAN looks like a strong next source of manufacturing competitiveness, with Vietnam and Indonesia as strong contenders.1

The role of logistics in the firm is an important strategic decision that companies must make to ensure that the needed raw parts, materials and services can be distributed efficiently from the point of supplier to their manufacturing plants and warehouses, and the finished products to their end customers. As companies have become more global, it is important to ensure proper interfaces of logistics function with operations/ manufacturing and other supporting departments. Thus, the firms must have the capability to provide efficient and effective logistics services so as to add value to their business. The logistics organizations in the firms display robustness towards changes in the outer context of the firm. This means, the logistics organizations can encounter considerable changes in the environment without altering their position in the firm. Logistics issues have become important components in the strategic planning and budgeting processes of many firms.

Manufacturing firms in Southeast Asia benefit from logistics integration, November 29, 2010, www.philstar.com

IMPORTANCE OF AN EFFECTIVE LOGISTICS ORGANIZATION The problems and challenges that organizations face do not lie primarily with strategic decision making, but in system, structure, mission, people, corporate culture and reward structure.2 Thus, many firms have decided to reengineering their logistics organizations and systems rather than making minor changes. A good case study that can be a good reference for us can be seen in IBMs PC division, as below: IBM: Reorganizing to Regain Competitive Advantage IBM presents an example of a company that did not employ its strategic resources properly. Once the leader in all type of computing, its sluggish personal computer (PC) division lost an estimated $1 billion in 1994. What happened? Much of the problem can be blamed on IBMs internal operating structure. Previously, IBM had its major functions spread out physically across the United States in nine different locations. This created extremely long introduction cycles for new products over two years at least. This is unacceptable in an industry with nine month product life cycles! Since 1994, IBMs PC division has made radical moves to restructure for strategic reasons. New product development processes have been revamped from the old, geographically spread-out functions to teams. These teams include personal from procurement, logistics, research, design, and manufacturing, now collocated in Raleigh, North Carolina. This team approach lead to the creation of the Butterfly subnotebook from lab to finished product in 18 months a record for IBM, but still a need of improvement. Previously, IBMs new product introductions were hurt because the product development group was sending designs to manufacturing past deadlines, and twothirds complete! Under the new structure, logistics, procurement, and manufacturing work closely on product development. This ensures that once a part is selected (design engineering), the source, availability, and price are known (purchasing), as well as how long it will take to arrive (logistics), and how easy it will be to use the component (manufacturing). The competition beat IBM by paying attention to the details of purchasing and logistics; building millions of PCs requires the coordination of hundreds of suppliers to deliver thousands of components. Yet IBMs old structure prevented it from doing this effectively. Some other signs that IBMs new organizational structure is working include:

Douglas M. Lambert, James R. Stock, and Lisa M. Ellram, Fundamentals of Logistics Management, Boston,

MA: Irwin/McGraw-Hill, 1998 Chapter 12

Finished goods inventory is down 65 percent, yet factory delivery promises are met 80 percent of the time instead of 45 percent of the time, as in 1994. Procurement and distribution cost are down 50 percent. The PC division closed 13 European warehouses due to improved management of supplies. Inventory supply is 60 days instead of the 80 days it was in 1994. In July 1995, IBMs stock price hit $100 a share for the first time in three years.

Restructuring has helped IBM tremendously. However, IBM realizes it still has a long way to go to regain its competitive advantage. Source: Douglas M. Lambert, James R. Stock, and Lisa M. Ellram, Fundamentals of Logistics Management, Boston, MA: Irwin/McGraw-Hill, 1998 Chapter 12, pp. 435 Dell, Wal-Mart and IKEA are all examples of companies with a high degree of logistics content in their strategies. In traditional firms, the functions of logistics were not specialized and were scattered throughout the firm. There will be no single personal, division, or department responsible for managing the logistics processes. This type of situation is depicted in Figure 3-1.

CEO

VP Marketing Responsibilities Sales service Channels of distribution Product returns and warranties

VP Production Manufacturing Purchasing/ procurement Traffic Warehousing

VP Financial Information system Budgeting Inventory Data processing Low inventories

Objectives

Large inventories Small & frequent production runs Decentralized warehousing Large product assortment Rapid order processing Generous returned goods policies Fast transportation Expedited shipments Large & infrequent production run Plant warehousing Fewer products

Centralized warehosuing

Inexpensive order processing More rigid returned goods policies Low cost transportation Few or no exceptions

Figure 3-1: Traditional approach to logistics management Source: Douglas M. Lambert, James R. Stock, and Lisa M. Ellram, Fundamentals of Logistics Management, Boston, MA: Irwin/McGraw-Hill, 1998 Chapter 12, pp. 437 Until the late 1970s, the firm paradigm was bigger is better. Firms grew by expanding their boundaries vertically. LOGISTICS INTERFACES MARKETING WITH MANUFACTURING, OPERATIONS AND

The big challenge for logistics function in a firm is to manage the whole logistics system in such a way that order fulfillment can meets or exceeds customer expectations. A new face of logistics started from early 1980s, has force the firms to align themselves to new strategy structure to ensure the logistics functions can add value through interfaces with many sub-departments.

Therefore, the changes in the micro dimension of logistics in the firm, has created the trend of integrations of many operations department for the well-being of the firm. The logistics interfaces with production will determine the length of the production run. While, the logistics interfaces with marketing will determine the selling of the products. LOGISTICS INTERFACES WITH MANUFACTURING The logistics capabilities in interfacing with manufacturing can be conceptualized as a three dimension construct: process capability, flexibility capability, and information integration capability. With the quick development of information technology and globalization, manufacturing firms have been in a new era of competition between supply chains. Logistics and supply chain management have become important sources of sustainable competitive advantage. And, logistics has been the most crucial element for supply chain success. For sustainable competitive advantage, the supply chain should not only better deploy logistics assets and coordinate the dispersed manufacturing and marketing activities, but also make related logistics capabilities created by these resources the focus of efficient supply chain operation. The efficiency and effectiveness of the logistics operations has a considerable influence not only on the business performance of manufacturers but also on the customers perception of the quality of the products and service provided by the plant. If inbound materials flow from the suppliers are inconsistent, then the firms internal operations will not be able to sustain their production strategies without a high level of safety stock. Similarly, if the flows of finished goods to the customer are unreliable, the firms customer base will be dissatisfied. Accordingly, logistics is strategically important in many industries as it is central to achieving competitive advantage.3 LOGISTICS ACTIVITY WHICH INTERFACES WITH MANUFACTURING The common logistics services that can be provided to the firm are: a) b) c) d) e) f) g) Transportation Warehousing Distribution Inventory management Staging Kitting Packaging

Bower sox, D.J., Closs, D.J., & Cooper, M.B. (2010). Supply Chain Logistics Management (3 edition ed). Boston, Mass.: McGraw-Hill.

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a) Transportation The logistics in the firms have to ensure the availability of parts and raw materials, from suppliers to the facility as per permitted time line. This will become more crucial if the firms run its operations 24 hours seven (24x7) basis and expected the arrival of parts and raw materials in few trips or interval in order to meet the JustIn-Time (JIT) requirement. Thus, in order to avoid any production hiccups, the right parts and raw materials supply to the right facility at the right time is the utmost crucial factor that required monitoring closely. Any inconsistency or failure in feeding of parts and raw materials to the manufacturing line will cause the line down and eventually it will be a loss of sales for the firms as it fails to produce finished goods that planned for sale. Similar requirement is anticipated in delivering finished goods to the warehouse or customers location. As the business in outside world is very competitive, ensuring product availability in the market at the right time, right quantity, and at right place will give the competitive advantage to the firm. If the delivery of the finished goods always face the uncertainty and discontinues in the supplying flow, this will resulted to no products situation in the market, loss of sales and eventually cause loss of revenue for the firms. b) Warehousing Warehousing or storage is another important logistics activity which provided to manufacturing. It is a space that stored all the components, raw materials and finished goods of a firm. An adequate size of storage space with proper layout and proper segregation between raw materials and finished goods, can confirm correct picking, packing and delivery process which is vital for production continuity or filling customers with finished goods. A right number of safety stock kept in warehouse always can ensure the availability of products even if there is a revision in daily production planning or changes in customer demands. But, one has to be cautious, this have to be done with proper study to ensure it does not cause an increase in the logistics cost heavily. c) Distribution Within a facility, there are separations between production floor, warehouse, loading and unloading bays for containers and other offices. Therefore a certain number of movements of materials are involved within the facility. Distribution is involving management of goods on the physical path between production, consumption and storage. Distribution is important especially when if the firms have stored their products in distribution centers and meant for distribution to many drop points (customers locations). A good routing planning will ensure the effective distribution plan to meet the customers demand.

d) Inventory management Inventory management can be assumed as a life line for one firm. Inventory per se, does not reflect a huge responsibility to execute. But, the managing part of the inventory is the daunting task to carry on and to many managers in logistics; this can be the toughest one! Keeping right quantity and right product is very important for continue producing the products a per production plan. If inventory of the required parts is not available in the storage or warehouse, it will bring to down time of production due to materials not available. Thus, this will cause failure in fulfilling the demand as per plan. Beside this, managing and distribute the inventory information to relevant parties in firm, also a critical factor in interfacing with manufacturing. The information of the inventory shared or given to manufacturing and production planner has to be match with the physical inventory. With the accuracy in the inventory information and physical inventory, it will streamline the process flow of material movement to production floor and help in achieving order fulfillment. It also will able to provide a lean logistics services to manufacturing by eliminating the unwanted waste. On the other hand, if found to be false information was given to production planner and manufacturing, deviation in actual production will occur thus it will require changes or revision in production planning. It will cause a lot of time, capacity, productivity and reliability loss in the interfacing between logistics and manufacturing. e) Staging Staging is a component that very much inter-related with Just-In-Time (JIT) and kanban in order to have a lean material movement to support the production. A dictionary will define that staging areas are an area where materials or equipment in transit are assembled or processed. In some firms due to space constraint, the same staging area with some layout will be used for both inbound and outbound activities. Meanwhile, in big facilities, where the space is not an issue, two separate staging areas will be used for inbound and outbound activities. f) Kitting Kitting is a process in which individually separate but related items are grouped, packed, and supplied together as one unit. For example, in ordering a PC online, a customer may select memory, drives, peripherals, and software from several alternatives. The supplier then creates a customized kit that is assembled and shipped as one unit.4 In manufacturing, kitting involves the gathering of all the parts needed for a particular assembly from the stockroom and issuing the kit to

Definition of kitting, http://www.businessdictionary.com/definition/kitting.html

the manufacturing line at the right time and in the right quantity.5 When this has been executed properly, the benefits of kitting include:6 Maximize value add time of operators Easier operator training resulting in reduced training cost Maximized machine utilization no line stoppage due to part shortages or searching for parts Reduced Work-In-Progress (WIP) Reduced lead times Reduced part damage due to excess handling Contrary, mistakes can happen in kitting process due to inaccuracy and lack of granularity and combined with stockroom personal mistakes. This negligence, may lead to kitting problems that include: Insufficient quantity of components Excessive quantity of components Wrong components Incomplete kits Insufficient quantity of component packages (for example insufficient quantity of reels for split parts)

These kitting problems if not controlled, will lead to increase in machine down time, lead times, and man power. Case example: "Kitting" Can Dramatically Slash Your Costs A Real World Example Miles operates a web store specializing in nutraceuticals. He ships about 1,000 orders a week and offers a total of 25 different diet and health items. But 80 percent of his orders involve a popular three-for-the-price-of-two offer for his lead product. Prior to kitting, Miles had his fulfillment house pick and pack all orders as they arrived. The cost was $1.85 per order plus $.40 per item and, in the case of his buy-two-get-one-free orders, his fulfillment cost was therefore $3.05 [$1.85 + (3 x $.40)] per order.

Ranko Vujosevic, Jose A. Ramirez, Larry Hausman-Cohen, and Srinivasan Venkataraman, Lean Kitting: A Case Study, The University of Texas at Austin, Department of Mechanical Engineering,, Austin, Texas, http://www..optelco.com/pdf/Lean-Kitting.pdf 6 Ibid

Costs Were Cut Three Ways At the suggestion of his fulfillment house, Miles switched to preassembly of the buy-two-get-one-free kits and immediately earned three big cost savings. 1. Reduction of fulfillment fee. The fulfillment fee dropped from $3.05 per order to $2.25 [$1.85 + (1 x $.40)] because all 3-for-2 orders were then processed as prepacked kits thus saving $.80 per order in picking fees. The cost savings offset was the kit assembly labor of $.30 per kit, which was based on a $35 per hour labor fee divided by the 120 kits per hour assembly rate. In spite of the assembly cost, Miles net pick-and-pack savings was $400.00 per week ($.80 - $.30 = $.50 x 800 orders a week) or $20,800 per year. 2. Postal savings. The ship weight of the 3-for-2 orders was 14 ounces, which resulted in a Priority Mail delivery cost of $4.95 when shipped in a Priority Mail flat rate box. By kitting the orders using a custom made box, however, the ship weight could be reduced to 13 ounces, which made the entire 800 orders per week eligible for First Class package postage of $3.26 per package. The resulting $1.69 per order postage savings worked out to a $70,306 annual cost reduction. 3. Expedite weighing and labeling. It was further realized that by accumulating the 3-for-2 orders to twice a week shipping, the fulfillment house could preprint the first class mail ship labels in 400-order batches, thus eliminating the individual weighing and label printing steps. As such, the base fee per order was cut from $1.85 to $1.30, saving an additional $.55 per order or $22,800 per year. It is true that not all kitting projects yield savings in all three areas, but in this real life example, the web store merchant was able to use kitting to cut his costs by roughly $114,000 per year.

Figure 3-2: Case example: "Kitting" Can Dramatically Slash Your Costs Source: John Lindberg, Order Fulfillment: "Kitting" Can Dramatically Slash Your Costs, March 04, 2010, http://www.practicalecommerce.com/articles/1700-OrderFulfillment-Kitting-Can-Dramatically-Slash-Your-Costs

g) Packaging Packaging is a process that enclosing the goods for protection for distribution, storage, sale, and, use while handling in warehouse and transporting in a vehicles. By providing packaging services to the manufacturing, it can make sure the good condition of the products. Certain packages will be printed with certain symbols which classify product certification, trademarks, proof of purchase, communicate aspects of use and safety, and environment and recycling. In Figure 3-3, are some examples of symbols that commonly can be found on packaging: 10

Symbols on packaging

Fragile

Do not use hand hook

This way up

Keep away from sunlight

Keep away from water

Flammable Explosives Do not clamped Clamped as liquid as indicated indicated Figure 3-3: Symbol of packaging Source: http://en.wikipedia.org/wiki/Packaging_and_labeling#Symbols_used_on_packages _and_labels LOGISTICS INTERFACES WITH MARKETING The main content of marketing management philosophy is emphasizing on the needs and wants of target markets and delivering the desired satisfactions more effectively and efficiently than competitors.7 This translate the marketing concept is very much a customer-driven perspective. In this marketing concept, there are three critical elements involve, which are: Customer satisfaction Integrated efforts/ system approach Adequate corporate profit Logistics play an important role in each of the elements in several ways. The relationship shown in Figure 3-4 clearly illustrate the role of logistics
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Center of gravity

Philip Kother and Gary Armstrong, Principles of Marketing, 5 ed. (Englewood Cliffs, NJ: Prentice Hall, 1993), pp. 22

th

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Customer satisfaction Suppliers Intermediate customers Final customers

Integrated effort Product Price Promotion Place (distribution)

Company profit Maximize long-term profitability Lowest total costs given at acceptable level of customer service

Figure 3-4: Marketing/ logistics management concept Source: Douglas M. Lambert, James R. Stock, and Lisa M. Ellram, Fundamentals of Logistics Management, Boston, MA: Irwin/McGraw-Hill, 1998 Chapter 1 Logistics play a crucial role particularly in assisting of getting the product to the right place. This is a part of supply chain process which logistics support the marketing initiatives. In order to ensure the success of the marketing effort, the firm have to integrate the ideas of having the right product, at the right price, publicized with promotion and it have to be available in the right place. Figure 3-5 summarizes the tradeoffs required between and among the major elements of the marketing mix and logistics.8

Douglas M. Lambert, James R. Stock, and Lisa M. Ellram, Fundamentals of Logistics Management, Boston,

MA: Irwin/McGraw-Hill, 1998 Chapter 1

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Produc t Marketing

Pric e

Promotio n

Place/ customer service levels

Inventory carrying costs Logistics

Transportati on costs

Lot quantity costs

Warehousing costs

Order processing and information costs

Figure 3-4: Cost trade-offs required in marketing and logistics Source: Douglas M. Lambert, James R. Stock, and Lisa M. Ellram, Fundamentals of Logistics Management, Boston, MA: Irwin/McGraw-Hill, 1998 Chapter 1 Achieving customer satisfaction requires an integrated effort both internally and with suppliers and ultimate customers. The main objective of an organization is to maximize long term profitability.

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Product Generally, since the size, shape, weight, and other physical characteristics of the products impact on its storage, transportation, and handling, the logistics personal should be included in any decision making regarding this product traits. Price Price is the amount of money that a customer pays for the products or services offering. Some of the items that should be factored into price include discounts for buying in quantities or for belonging to a certain class of customers, discount for prompt payment, rebates, whether inventory is offered on consignment, and who pays delivery costs. Promotion The most important factor is that the logistics division must aware of any changes in demand pattern so that it can plan for any consequences. Pull strategies tend to be more erratic, whereas push strategies tend to be more predictable. Place Generally, since wholesaler are combining purchases for multiple retailers, the shipment sizes tend to be larger and the number of transactions that have to be processed are fewer, with the result that logistics cost are smaller. Meanwhile, a smaller scale of sale at retailer is the norm. These generally cost more for transportation and order processing. FACTORS AFFECTING THE COST IMPORTANCE OF LOGISTICS Logistics cost is very much driven by the activity involve to support the whole logistics process. The major categories which contributing to logistics cost are: a) b) c) d) e) f) Customer service Transportation Warehousing Order processing and information Cost quantity Inventory carrying

a) Customer service level Capital that spent to enhance the customer service include the cost associated with order fulfillment, parts, and service support (such as after sale service). Not forgotten, they also include the cost of return and rejections goods handling, which impact greatly on customers perception. The cost which incurred due to lost sales, beside the loss of current sale, it also includes the potential future sales from the

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customers. It is no wonder that it is extremely difficult to measure the true cost of customer service! b) Transportation cost The delivery of materials drives transportation costs. Cost can be grouped by product line, customer, and type of channel such as inbound versus outbound. The cost can be differing considerably with volume of cargo, weight of cargo, distance, and point of origin and destination. c) Warehousing cost This cost is purely created by storage and warehousing activities. It also includes all of the costs that vary due to a change in the number or location of warehouse. d) Order processing/ Information systems costs This cost includes all activities of order processing, communications, distributions, and forecasting demand. Order processing cost covers cost such as order entry, processing the order, notifying the carriers and customers of shipping information and product availability. e) Lot quantity cost Lot quantity costs are purchasing or production related cost that vary with changes in order size or frequency and include:9 1. Set up costs a. Time required to set up a line or locate a supplier and place an order b. Scrap due to setting up the production line c. Operating inefficiency as the line begins to run, or as a new supplier is brought on board 2. Capacity lost due to downtime during changeover of line or changeover to a new supplier 3. Material handling, scheduling, and expediting 4. Price differentials due to buying in different quantities 5. Order cost associated with order placement and handling f) Inventory carrying cost This inventory carrying costs include inventory control, packaging, and salvage and scrap disposal. Four major type of inventory cost are:

Douglas M. Lambert, James R. Stock, and Lisa M. Ellram, Fundamentals of Logistics Management, Boston,

MA: Irwin/McGraw-Hill, 1998 Chapter 1

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1. Capital cost or opportunity cost, which is the return that the company could make on the money that it has tied up in inventory. 2. Inventory service cost, which includes insurance and taxes on inventory. 3. Storage space cost, which include those warehousing space-related cost which change with the level of inventory. 4. Inventory risk cost, including obsolescence, pilferage, relocation within the inventory system, and damage.

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Module concept mapping

LOGISTICS IN THE FIRM


Introduction Importance of an effective logistics Bigger is better paradigm Requires reengineering in system, structure, mission, people, corporate culture and reward structure Logistics interfaces with manufacturing, operations & marketing Interfaces with production - determine the length of the production run. Interfaces with marketing - determine the selling of the products.

Raw parts, materials and services must be distributed efficiently Companies have become more global Important to ensure proper interfaces of logistics function with operations/ manufacturing and other supporting departments

LOGISTICS IN THE FIRM


Logistics interfaces with manufacturing Logistics services in manufacturing: -Transportation -Warehousing -Distribution -Inventory management -Staging -Kitting -Packaging Logistics interfaces with marketing Logistics play a crucial role particularly in assisting of getting the product to the right place Logistics play an important role in: -Customer satisfaction -Integrated effort/system approach -Adequate corporate profit Factors affecting the logistics cost Major categories which contributing to logistics cost: -Customer service -Transportation -Warehousing -Order processing & information -Cost quantity -Inventory carrying

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Questions and Problems 1. Discuss the logistics functions contribution to the firm in your own working place. 2. What do you think? Is it better for a firm to run own logistics or outsource it to 3PL. 3. How do you measure the cost of customer service? 4. For many organizations, logistics play a very important behind the screen role. How does it help in marketing? 5. Dilemma for a firm is logistics is a support function. How important it is to financially invest in logistics to support the firms growth?

Reading materials 1. Douglas M. Lambert, James R. Stock, Lisa M. Ellram, Fundamentals of Logistics Management, Boston, MA: Irwin/McGraw-Hill, 1998, Chapter 1, 11, 12 2. Manufacturing Firms in Southeast Asia Benefits from Logistics Integration, updated on November 29, 2010, www.philstar.com 3. Bower sox, D.J., Closs, D.J., & Cooper, M.B. (2010). Supply Chain Logistics Management (3rd edition ed). Boston, Mass.: McGraw-Hill 4. Ranko Vujosevic, Jose A. Ramirez, Larry Hausman-Cohen, and Srinivasan Venkataraman, Lean Kitting: A Case Study, The University of Texas at Austin, Department of Mechanical Engineering,, Austin, Texas, http://www..optelco.com/pdf/Lean-Kitting.pdf 5. John Lindberg, Order Fulfillment: "Kitting" Can Dramatically Slash Your Costs, March 04, 2010, http://www.practicalecommerce.com/articles/1700-OrderFulfillment-Kitting-Can-Dramatically-Slash-Your-Costs 6. Philip Kother and Gary Armstrong, Principles of Marketing, 5th ed. (Englewood Cliffs, NJ: Prentice Hall, 1993), pp. 22

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