10.1007 978 1 4419 8939 0

Distribution
Planning and Control

Distribution
Planning and Control
Managing In The Era Of Supply

Chain Management
Second Edition
David Frederick Ross

Library of Congress Cataloging-in-Publication Data
A C L P . Catalogue record for this book is available

from the Library of Congress.
Distribution: Planning and Control

Managing in the Era of Supply Chain Management
Second Edition
by David Frederick Ross

ISBN 978-1-4613-4728-6 ISBN 978-1-4419-8939-0 (eBook)
DOI 10.1007/978-1-4419-8939-0
Copyright 2004 by Springer Science+Business Media New York

Originally published by Kluwer Academic Publishers in 2004
Softcover reprint of the hardcover 2nd edition 2004
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TABLE OF CONTENTS
PREFACE I xi
UNIT 1. DEFINING THE SUPPLY CHAIN MANAGEMENT

ENVIRONMENT I 1
1. The Rise Of Supply Chain Management I 3

Advent of Supply Chain Management / 4
Evolution of Supply Chain Management / 10
Defining e-SCM / 23
SCM and Logistics / 36
Summary / 51
Questions for Review / 55
References / 56
2. Components Of Distribution Management I 59

Defining the Term "Distributor" / 60
Characteristics of the Wholesale Distributor / 65
Role of the Distribution Function / 75
Understanding the Wholesale Distribution Industry / 79
Summary / 92
References / 95
UNIT 2. TOP MANAGEMENT PLANNING I 97
3. Business And Strategic Planning I 101

Defining Business Goals and Strategies / 102
Developing the Business Plan / 114
Summary / 129
References / 132
4. Forecasting In The Supply Chain Environment I 133

Forecasting - An Overview / 134
vi CONTENTS
Forecasting Types / 140

Managing the Forecast / 160
Summary / 169
Problems / 171
References / 173
5. Demand, Operations, And Channel Planning I 175

Demand, Operations, and Channel Planning - Overview / 176
Elements of Marketing Planning / 181
Elements of Sales Planning / 195
Elements of Production Planning / 202
Elements of Logistics Planning / 210
Elements of Supply Channel Planning / 223
Integrating Demand, Operations, and Channel Plans / 236
Summary / 238
References / 242
UNIT 3. DISTRIBUTION OPERATIONS PLANNING / 243
6. Managing Supply Chain Inventories I 245

Elements of Supply Chain Inventory Management / 246
Principles of Supply Chain Inventory Management / 255
The Inventory Management Process / 262
Inventory Costs / 266
Inventory Control / 281
Summary / 292
Questions for review / 294
Problems / 294
References / 296
7 . Replenishment Inventory Planning I 297

Inventory Planning Techniques / 298
Inventory Replenishment Techniques - An Overview / 305
Defining the Order Point / 310
Order Quantity Techniques / 328
Just-In-Time / 335
Inventory Replenishment Planning Process / 341
Inventory Operations in the Supply Chain Environment / 343
Summary / 353
Problems / 355
CONTENTS vii
References / 357
8. Distribution Requirements Planning I 359

Problems with Statistical Techniques / 360
Historical View / 366
DRP Processing / 374
DRP in a Supply Chain Environment / 383
DRP Planning Process / 389
Detailed Logistics Capacity Planning / 393
DRP and Supply Chain Management Systems / 401
Summary / 412
Problems / 414
References / 416
UNIT 4 . DISTRIBUTION OPERATIONS EXECUTION I 417
9. Customer Relationship Management I 419

Defining Customer Relationship Management / 421
Demand Management / 429
Order Management and Fulfillment / 437
Customer Care Management / 447
The Internet-Enabled CRM Environment / 465
Summary / 470
References / 472
10. Supplier Relationship Management I 475

Defining Purchasing / 477
Defining Supplier Relationship Management / 486
Anatomy of Purchasing Strategy / 492
Purchase Order Management Process / 501
Performance Measurement / 515
Impact of e-Business on SRM / 522
Summary / 529
Problems / 531
References / 533
viii CONTENTS
11. Warehousing / 535

Defining Warehousing / 537
Developing Warehouse Strategies / 550
The Warehouse Management Process / 557
Trends in Modern Warehousing / 571
Designing the Warehouse Network / 577
Warehouse Layout and Equipment / 585
Summary / 604
References / 607
12. Transportation / 609

The Scope of Transportation / 610
Modes of Transportation / 620
Types of Transportation / 630
Transportation Management Process / 636
Issues Confronting Transportation / 652
Logistics Service Providers / 658
Summary / 670
Appendix / 673
References / 677
UNIT 5. INTERNATIONAL DISTRIBUTION AND DISTRIBUTION

INFORMATION TECHNOLOGY / 679
13. International Distribution / 679

Forces Driving Globalization / 683
Developing Global Strategies / 693
Channel Strategies / 699
Managing Global Distribution Networks / 705
International Transportation and Warehousing / 718
International Purchasing / 726
Today's Global Trade Environment / 737
Summary / 742
References / 745
14. Information Technology and Supply Chain Management

/ 747
Foundations of Enterprise Information Technologies / 748
Configuring the EIS Solution / 756
Information Technology Solutions / 772
CONTENTS ix
Implementation Issues / 782

Summary / 791
References / 794
BIBLIOGRAPHY / 795
INDEX / 803
PREFACE
When work began on the first volume of this text in 1992, the science of dis-
tribution management was still very much a backwater of general manage-
ment and academic thought. While most of the body of knowledge associated
with calculating EOQs, fair-shares inventory deployment, productivity
curves, and other operations management techniques had long been solidly
established, new thinking about distribution management had taken a definite
back-seat to the then dominant interest in Lean thinking, quality management,
and business process reengineering and their impact on manufacturing and
service organizations. For the most part, discussion relating to the distri-
bution function centered on a fairly recent concept called Logistics Manage-
ment. But, despite talk of how logistics could be used to integrate internal
and external business functions and even be considered a source of com-
petitive advantage on its own, most of the focus remained on how companies
could utilize operations management techniques to optimize the traditional
day-to-day shipping and receiving functions in order to achieve cost contain-
ment and customer fulfillment objectives. In the end, distribution manage-
ment was, for the most part, still considered a dreary science, concerned with
expediting and the tedious calculus of transportation rates and cost trade-offs.
Today, the science of distribution has become perhaps one of the most im-
portant and exciting disciplines in the management of business . In the space
of a decade or so the management of supply and distribution channels has
catapulted to world-wide prominence as the central fulcrum in the search for
competitive advantage . Since the early 1990s, a host of critical trends,
events, and ideas have intervened that have dramatically altered the theory
and practice of logistics management and opened fresh areas for research and
practical application. Much of the dialogue is the result of the maturation of a
number of radically new marketplace dynamics such as the growth in power
of the "voice of the customer," demands for the mass customization of prod-
ucts and services, a veritable explosion in globalization and outsourcing, a
heavy focus on reengineering, cost control, and cash conservation, the end of
the vertically integrated enterprise, and several order-of-magnitude break-
throughs in information and communications technologies. But of all the dy-
namics impacting today 's business environment, perhaps the two most im-
xii PREFACE
portant are the rise of the concept of Supply Chain Management (SCM) and
the birth of the Internet.
In 1992 SCM and the Internet were not even on the radar screen of logis-
tics practitioners and theorists. Simply put, the Internet did not exist and was
totally in the realm of odd pockets of "computer geeks" and very academic
scientists. As for SCM, while a few visionaries began talking about it as
early as 1990, it was really not until the middle of the decade that the concept
began to gain traction as a new management science evolving out of the
logistics concept.
Today, SCM and the Internet have come to dominate all thinking and it has
become hard to talk about one without reference to the other. The literature
on the topic has grown astronomically. Literally hundreds of articles and
books have generated countless pages of perspectives on SCM/Internet theory
and practice over the last few years . The discipline has its own journal - Sup-
ply Chain Management Review (founded 1996) - and trade magazines with
evocative titles, such as e-Supply Chain Management, Supply Chain Technol-
ogy News, and others, continue to emerge. College courses and business
seminars discussing just about every aspect of channel management abound.
Most consulting firms have whole practice areas devoted to SCM. The con-
cept has actually engendered a whole genus of computer software.
The rise to dominance of the convergence of SCM and the Internet has not
happened by chance. It has evolved as a response to the very real require-
ments that companies must now act through their supply chains if they expect
to be capable of providing the market-winning value demanded by the cus-
tomer; they must be agile and scalable to bring new products to market faster,
flexible in the design of production and distribution processes, and capable of
quick supply channel redesign; and they must be capable of engineering daz-
zlingly fast flow order-to-delivery cycles utilizing Internet technologies that
eliminate channel costs and redundancies while increasing customer con-
venience. While the rise and fall of the Internet economy gave witness to the
relative immaturity of the dot-com e-business revolution, the dramatics were
an unfortunate side-show to the slow, but real changes being engineered by
savvy executives who were coming to understand that the emerging ver-
nacular of idioms like connectivity, interoperability, networking, e-business,
and collaboration were more than j ust the newest management buzzwords but
were, in reality, the kernels of new paradigms of how business in the twenty-
first century would be conducted.
The changes to the concept and practice of distribution management
brought about by the SCM/Internet manifold (termed e-SCM in the pages to
follow) is the main driver for the redrafting of this text. While the word "sup-
ply chain management" appeared in the original 1996 edition, it was given
scant attention. In its place, the concept of Integrat ed Enterprise Manage-
PREFACE xiii
ment had been coined to compensate for the lack of a more robust definition.
This construct has been eliminated in the revision in favor of e-SCM. In fact,
the importance and recognition of the impact of e-SCM had become so
critical in the intervening years since publication that the relevance of the
first edition to today's student of distribution and logistics was in serious
doubt. In addition, the footprint of the e-SCM body of knowledge had
expanded so quickly, that every chapter in the original text had grown in
many places seriously out of date and in need of drastic revision. Because of
the importance of SCM, the author even considered changing the title to
Supply Chain Managem ent: Planning and Control. After much thought the
original and all-inclusive title was retained with the phrase "Managing in the
Era of Supply Chain Management" added as the subtitle.
The second edition of Distribution: Planning and Control follows the ori-
ginal structure of the first edition. Based on the assumption that, like all or-
ganizations, the distribution function is driven by purposes or goals and is
composed of people working together to achieve common objectives, the
most effective organizations are best managed through an interactive method
of planning and control. At its highest level, enterprise planning seeks to
develop comprehensive strategies that define clearly company goals while en-
abling operations functions to quick response to changing marketplace needs.
Control , on the other hand, is a continuous management activity that strives
to have in place the operational skills and performance measurements neces-
sary, first of all, to direct the flow of energy and materials into executing
business functions in support of strategic plans, and, second, to collect and
communicate information to ensure processes are focused on achieving the
best marketplace opportunities. Without purposeful planning and control, to-
day's enterprise cannot hope to survive, much less achieve competitive superi-
ority.
Unit 1 of the text attempts to set the background and define the terms nec-
essary to understand today's distribution environment. The objective is two-
fold. To begin with, the Unit seeks to explore the origins, opportunities, and
challenges confronting SCM and logistics management at the dawn of the
twenty-first century. Particular importance is paid to the evolution of the
body of management knowledge surrounding SCM and logistics, concluding
with a concise definition and detailed dissection of contributing features and
concepts. The second objective is to describe in detail the nature and func-
tions of the distribution industry and its place next to manufacturing and re-
tail in the supply chain. The unit provides a full review of the various types
of distributor, ranging from wholesalers, brokers and agents, and manufac-
turers' and retailers' branches and offices, to exporting and importing distribu-
tors. Special attention is paid to the rise of new forms of distribution brought
about by the Internet.
xiv PREFACE
Once the goals and nature of SCM and distribution management have been
defined, Unit 2 begins the discussion of the enterprise planning and control
process. The Unit opens with a review of business and strategic planning.
Business plans are formulated by top management to achieve enterprise
goals. The objective of the entire process is to architect the strategies de-
tailing the firm's growth, asset, revenue, and capital management goals in
light of the political, economic, demographical, technological, and com-
petitive challenges of the marketplace. Finally, business objectives define the
culture of the enterprise, its competitive posture, and its perception of itself in
the marketplace.
The second area considered in Unit 2 is demand, operations, and channel
planning. These plans are the culmination of the enterprise planning process
that began with the formulation of the business plan. The goal of this process
is the creation of a set of highly integrated business functional plans that en-
sure that the five critical plans constituting the core of the executive planning
process - the marketing plan, the sales plan, the production plan, the logistics
plan, and the supply chain plan - are in balance. Individually, each of these
plans attempts to define the strategies and operations decisions that must
occur if the overall business mission is to be achieved. In detail, these plans
center on strategic operations issues, such as determining the overall rates of
product family sales and production, aggregate inventories, supply chain val-
ue delivery, and logistics capacities. Once each of these aggregate plans has
been developed, they can be then integrated together to provide corporate de-
cision makers with a medium- to long-range "rough-cut" window into how
well individual enterprises and whole supply chains are responding to meet
the overall business plans.
Unit 3 centers on the translation of strategic plans into the detailed oper-
ations plans that will guide the organization in the calculation of inventory re-
quirements, detailed logistics capacity plans, and distribution channel re-
source deployment. One of the most important challenges facing the logistics
organization is the effective control of inventory. Channel planners must
seek effective techniques to minimize inventory carrying costs while at the
same time continuously improving customer service levels. Inventory plan-
ners can utilize two broad methods of planning and controlling inventories:
statistical inventory replenishment and Distribution Requirements Planning
(DRP), or a combination of both. Statistical replenishment attempts to utilize
historical usages and item planning data to calculate reorder points and opti-
mal order quantities. DRP is a computerized technique encompassing two
distinct processes. The first consists of the time phased calculation of the in-
ventory requirements of each warehouse in the distribution network. This
calculation is based on the difference between gross requirements and on-
hand inventory, scheduled receipts and in-transit shipments. Gross require-
PREFACE xv
ments are attained by compiling the total demand placed on each distribution
center. The second process passes the net requirements of each warehouse to
the supplying source . Statistical planning methods are classically associated
with push systems of channel replenishment, whereas DRP is associated with
pull systems.
The effective control of inventory requires detailed logistics resource plan-
ning. This area of planning attempts to measure key resource capacities re-
quired for the realization of the inventory acquisition plans necessary to ex-
ecute the marketing and sales strategies. Detailed logistics planning is
focused on the management of four possible capacity resource constraints.
The first capacity constraint is concerned with determining whether the or-
ganization has the financial ability to maintain the necessary inventory levels
detailed in the inventory acquisition plan. The second capacity constraint in-
volves reviewing the availability, cost, dispatching, and selection of trans-
portation to support the inventory acquisition and delivery plans. The third
capacity is concerned with individual warehouse stocking capacities, storage
space, and equipment requirements. Finally, logistics planning provides a
tool to gauge the need for staffing to receive, stock, and ship products as well
as for requirements caused by seasonality or other factors. Logistics planning
enables planners to keep demand and capacity in alignment by providing a
window into the events occurring out in the distribution channel. Corrective
action, such as adding overtime, temporary storage, or subcontracting, can
then be taken effectively . When logistics capacities are insufficient, in-
ventory planners must work with sales and marketing to align anticipated
marketplace demands with the resources of the enterprise.
Unit 4 of the text is concerned with the execution of the strategic and op-
erations planning processes . The Unit begins with a discussion of the focal
point of the enterprise : customer relationship management. Superior custom-
er service in the twenty-first century requires order processing and customer
service functions that provide for the speedy and accurate transference of
goods, value-added services, and order information. Among the topics discus-
sed are the generation of effective demand management strategies, utilization
of the Internet to facilitate customer ordering and service management, the
development of the customer-centric organization , fulfillment management,
establishing responsive customer service, and identifying performance gaps.
Following customer management, the Unit focuses on three areas tra-
ditionally considered at the heart of logistics management: purchasing, ware-
housing, and transportation. The performance of purchasing and value-added
processing functions resides at the very core of supply channel management.
Procurement is responsible for ensuring the availably of product throughout
the channel network and, because of its impact on revenues, costs, and opera-
tional efficiencies , has become a key enabler of supply chain strategy. Pro-
xvi PREFACE
curement is also the establishment of collaborative relationships with sup-

pliers, termed supplier relations management (SRM). Similar to CRM, SRM
seeks to utilize integrative technologies, like the Inter-net and trading
exchanges, to leverage the supply chain landscape to architect agile supplier
relationships capable of collaborative product design, infor-mation transfer,
mutual responsibility for quality, and close computerized linkages for
replenishment planning.
Whereas the central focus of inventory acquisition function is to have in-
ventory ready at the time and place required by the customer, the role of
warehousing is to ensure the smooth flow of goods through the distribution
pipeline. In today 's "Lean" and highly interoperable supply chains, the con-
cept of the warehouse as a static repository for product storage has been re-
placed by a more dynamic view that considers the warehouse as a high-vel-
ocity customer service center. Instead of an inflexible, lumbering giant ac-
counting for the bulk of a typical distributor's costs and manpower require-
ments, today 's distribution center utilizes computerization, automation, Lean
concepts of quality and elimination of wastes to provide the channel network
with a source of competitive differentiation and marketplace leadership.
Whereas procurement and warehousing focus on product and place utili-
ties, transportation attempts to solve the issue of time utility by providing in-
expensive, efficient, and easily accessed methods of moving product through
the channel pipeline. By providing for the swift and uninterrupted flow of
products, transportation provides companies with the ability to compete with
other businesses in distant markets on an equal footing. Transportation also
permits wider and deeper penetration of new markets far from the point of
production. In addition, by maximizing vehicle and materials handling capa-
cities and cargo requirements, effective transportation permits enterprises to
leverage economies of scale by lowering the per-unit cost of transporting
product. Efficient transportation enables firms to reduce the selling price by
holding costs down, thereby providing for more competitive product po-
sitioning. Finally, transportation provides other business functions with es-
sential information concerning products, marketing place and time utilities,
and transit costs and capabilities necessary for effective supply chain plan-
ning and operational execution.
Unit 5 concludes the text with an analysis of two of the most important de-
velopments in today's distribution industry. The first, the emergence of inter-
national distribution, relates to the explosion in global trade, the integration
of the world's economic activities, and the growth of world trading blocks.
Among the topics discussed are international material and product sourcing,
the nature and functions of international distribution, and managing inter-
national distribution channels. The final chapter in the text provides an over-
view of the impact of the computer revolution on the distribution industry and
PREFACE xvii
how enterprise distribution management can search and implement informa-

tion technologies effectively from automation to enterprise information sys-
tems .
FEATURES
This text was written primarily for use by practitioners, instructors, students,
and consultants involved in Supply Chain Management, logistics and distri-
bution channel management courses, seminars, and internal company devel-
opment programs, as well as professionals seeking to improve their know-
ledge concerning logistics topics. Although the text is broad enough to
encompass all the management activities found in today's logistics and distri-
bution channel organizations, it is detailed enough to provide the reader with
a thorough understanding of essential planning and control processes, as well
as problem-solving techniques that can be applied in everyday operations.
Although the text deals largely with concepts, a concerted effort has been
made to ground them by including examples from various industries. Each
chapter provides the following features to facilitate the learning process.
The contents of each chapter are provided on the first page of each new
chapter. This assists readers in quickly gaining insight as to the key
points of discussion in each chapter.
Case studies and topical information are provided in the form of inserts
into each chapter. These inserts help to broaden the discussion through
real-world examples.
Each chapter is concluded with a detailed summary. The goal is to pro-
vide a forum for concept summary and transition to the next chapter.
Summary questions and problems are provided at the end of each cha-
pter. The goal is to challenge readers as to their knowledge of topics
presented in each chapter and to offer a tool for learning reinforcement.
ANCILLARIES
An instructor's manual is available for the text containing chapter outlines,

transparency masters/PowerPoint slides covering the text, and additional
multiple choice, essay, and case studies per chapter. These materials can be
attained from the author in CD format through the author's Web-site or email
[email protected].
xviii PREFACE
ACKNOWLEDGEMENTS
The author is greatly indebted to the many individuals and companies that
have provided the insight and understanding of logistics and manufacturing
functions fundamental to the writing of this text. Of particular importance
are the comments of the many students gleaned from countless hours spent in
the classroom in a variety of settings. I am particularly grateful to the Ameri-
can Production and Control Society (APlCS) for their support and sponsor-
ship of the book. It has been a gratifying experience to have the text selected
for use in the CPIM certification program. The author would also like to
especially thank Mr. L. Eugene Magad who was responsible for shepherding
the first edition through to completion. I would also like to thank the staff at
Kluwer Academic Publishers for their keen support in drafting the second
edition and finishing it through to completion. Finally, I would like to ex-
press my loving thanks to my wife Colleen and my son Jonathan who had to
bear yet again another period of lost afternoons and long evenings but who
receive little of the rewards.
PREFACE xix
ABOUT THE AUTHOR
A distinguished educator and consultant, David Frederick Ross, Ph.D.,

CFPIM, has spent over 25 years in the fields of production and distribution
management. During his 13 years as an operations management professional,
he held several line and staff positions in a number of manufacturing and dis-
tribution companies. For the past 16 years Dr. Ross has been involved in
ERP, project management, and e-business education and consulting for sev-
eral software companies . Currently, he is Education Business Group Man-
ager for Intentia-Americas and is located in the corporate offices in Schaum-
burg, IL (e-mail: david.ross@intentia .com). He has also taught production
and operations management courses at Eastern Illinois University and Oakton
Community College. He is a long-time instructor in the APICS practitioner
education program. Finally, he also offers supply chain management educa-
tion, training, and consulting to companies through his own consulting
company. Dr. Ross 's degree is from the University of Chicago.
Besides numerous articles, Dr. Ross has published three books in the field
of distribution and supply chain management. His first book, Distribution:
Planning and Control (Kluwer Academic) , first appeared in 1996 and has
been used as a standard logistics management text by several universities and
is a cornerstone book for the APICS CPIM certification program. The book
has been updated and released in a new edition (Kluwer Academic, 2003).
His second book, Competing Through Supply Chain Management (Kluwer
Academic, 1998), was one of the very first complete texts on the science of
supply chain management. The book has also been placed on the reading lists
at several universities for courses in logistics and operations management.
His third book, Introdu ction to e-Supp ly Chain Management (St. Lucie,
2003), explores the concepts, techniques, and vocabulary of the convergence
of supply chain management and the Internet to help companies optimize
their customer management planning, scheduling, engineering, manu-
facturing, and inventory management functions.
UNIT 1
DEFINING THE SUPPLYCHAIN
MANAGEMENT ENVIRONMENT
CHAPTERS:
1. The Rise of Supply Chain Management

2. Components of Distribution Management
The objective of Unit I is to squarely position the student of logistics and dis-
tribution channel management in the business environment found at the dawn
of the twenty-first century. As discussed in the Preface, the pace of change
brought about by the power of the customer, information technology, and
globalization have forced all companies toady to critically reexamine the
operating values and cultures of their organizations , the way their businesses
and processes are structured, and the strategies and tactics by which they
compete in the marketplace. The ability of supply chain strategists to con-
tinuously align their enterprises to meet these changes constitutes the fore-
most challenge before their organizations. Companies that can leverage the
dramatic breakthroughs in information technologies and global trade will be
those who gain market share and thrive in the new millennium.
Unit 1 begins by defining Supply Chain Management (SCM), modern lo-
gistics, and the organization of the distribution function. In Chapter 1, the na-
ture and functions of SCM and logistics are examined . The chapter begins by
exploring six critical dynamics that are reshaping the face of business on a
global basis. Responding to each of these dynamics has required companies
to look outward to their supply chain systems to gain quick access to critical
competencies and resources in order to remain competitive . Building these
networks is the objective of the new science of Supply Chain Management
(SCM). This chapter seeks a definitive definition of SCM which traces the
concept from its origins up to today 's Internet-enabled "virtual" supply chain
2 DEFINING THE SCM ENVIRONMENT
organization. The chapter concludes with a full definition of logistics man-

agement and its relationship to SCM.
Whereas Chapter I attempts to describe the organizational, operational,
and philosophical foundations guiding the management of today's supply
chain, Chapter 2 focuses on defining the meaning of "distributor" and the
scope of the distribution industry. After detailing the operational charac-
teristics and marketplace role of the distributor, the chapter offers a detailed
analysis of the various types of distributor, ranging from manufacturers who
distribute their own products, to wholesalers, brokers, retailers, and global
importers and exporters. Among the topics covered are understanding the
need for distribution, the channel functions performed by the distributor, and
the inbound and outbound materials and information flows found within the
typical distribution organization. The chapter concludes with a brief over-
view of the challenges facing the distribution industry in the business climate
of the first decade of the twenty-first century.
1
THE RISE OF SUPPLY
CHAIN MANAGEMENT
ADVENT OF SUPPLY CHAIN e-SCM Definition

MANAGEMENT Components of e-SCM
Today's Business Environment
SCM AND LOGISTICS
EVOLUTION OF SUPPLY CHAIN Defining Logistics
MANAGEMENT Functional Definition
Stages of Supply Chain Develop- The Magnitude of Logistics
ment Logistics Operations
Stage I: Decentralized Functions The Organization of Logistics
Stage 2: Total Cost Management Team-Based Organizational
Stage 3: Integrated Functions Structure
Stage 4: Supply Chain Management
Stage 5: e-Supply Chain Manage- SUMMARY
ment
QUESTIONS FOR REVIEW
DEFINING e-SCM
In the Preface it was stated that the accelerating pace of change is the single
most important factor shaping all aspects of contemporary business from eco-
nomics to technology, from the way products are produced to the way they
are bought. Whereas it is true that technology has revealed exciting new
methods of designing and producing products and communicating them to the
customer, it is through the activity of distribution that products reach the mar-
ketplace and the exchange process is determined. Throughout history, busi-
nesses have been faced with the problem that demand for goods often extend-
ed far beyond the locations where they were made and that products were not
always available at the time when customers wanted them. Where the capa-
bilities of distribution have been limited, people must live close to the source
of production and will have access to a limited range of goods and services.
On the other hand, societies that possess highly complex and inexpensive dis-
tribution systems are marked by production efficiencies, a wide spectrum of
available products, the rapid exchange of goods, and accelerating standards of
living. Efficient and constantly developing supply chain systems enable en-
terprises to leverage and focus productive functions while extending the reach
of their products to meet national and international demand. In today's mar-
ketplace, supply chain management provides the bridge linking products to
distant markets separated by global time and distance.
Chapter I is focused on exploring the opportunities and challenges con-
fronting supply chain and logistics management at the dawn of the twenty-
first century. The chapter begins by defining six critical marketplace forces
that are dramatically transforming today's global business environment. Re-
sponding effectively to these challenges has required corporate strategists to
search for solutions outside of their internal organizations to gain quick ac-
cess to core competencies and resources in the race for competitive survival.
Next, the evolution of supply chain management (SCM) is explored. The
argument is that SCM is the product of five distinct management stages, be-
ginning first with logistics operations decentralization and progressing to to-
day's Internet-driven supply chains. Once the foundations of SCM have been
established, the discussion proceeds to a concise definition of SCM in the In-
ternet Age. Full attention is given to exploring the distinct components of the
SCM model and their merger with today's expanding Web-based capabilities.
The chapter concludes with a full definition of logistics management and its
relationship to SCM.
ADVENT OF SUPPLY CHAIN MANAGEMENT
Over the past decade, companies have become increasingly aware that to re-
main competitive in an era of accelerating change and intensified competition
they can no longer depend solely on their own inventive and productive
strengths but must look to the core competencies of supply chain partners to
enhance and accelerate customer-winning products and services. In the past,
companies sought to architect complex vertical organizations that provided
them with access to unique competencies, physical resources, and market-
place value. Today, the myth of the self-sufficient corporation has been
largely exploded. In reality, companies have always been interconnected and
have survived more because of the relationships they have established with
their supply chain partners than any particular internal strength. Once con-
sidered a strategic prohibition, creating chains of supporting channel net-
THE RISE OF SUPPLY CHAIN MANAGEMENT 5
work partners has become one of a successful company's most powerful com-
petitive objectives.
lODAY'S BUSINESS ENVIRONMENT
What has caused this concern with the development of channel alliances?
What forces have obsoleted long-practiced methods of en-suring corporate
governance, structuring businesses , and developing strategies? What will be
the long-term impact on the fabric of business ecosystems of an increasing
dependence on channel partnerships , increased outsourcing, and the estab-
lishment of virtual organizations? What computerized and business
management tools should be utilized that will enhance supply channel inte-
gration and provide for new sources of market-winning product and service
value? How will executives and workforces adapt long-standing models of
business management and workplace structures that permit them to remain
competitive and on the cutting-edge while retaining organizational continuity
and purpose?
Answering these and other questions requires that strategic planners under-
stand the following six dynamics that are reshaping the nature of both corpor-
ate governance and work life in the twenty-first century [1].
The Power of the Customer. Without a doubt, the expanding power of the
customer to influence the dynamics of the marketplace has altered forever
previous customer service paradigms. In the past, it was the producer and
distributor who determined product and service offerings, pricing, methods of
transaction , fulfillment, and information transfer. In contrast, today's cus-
tomers are exerting an ever-expanding influence over the terms of fulfillment
management, demanding to be treated as unique individuals, and expecting
their supply partners to provide configurable, solutions-oriented bundles of
products, services, and information that meet a specific want or need. In ad-
dition, with their expectations set by "world class" companies across global
marketplaces, customers are demanding that their supply channels provide the
highest quality for the lowest price, computerized ordering tools that em-
power them to design product and service content, speedy fulfillment, robust
information content , ease of search, ordering, and self-service follow-up, and
increased digitization of all processes.
These new marketplace values have dramatically altered the balance of
power between customer and producer/distributor. Past business models as-
sumed that each company was an island and that collaboration with other or-
ganizations, even direct customers and suppliers, was self-defeating. At the
dawn of the twenty-first century, it is apparent that market-leading enterprises
will increasingly depend on the creation of closely integrated supply chains to

remain competitive . Such collaborative channel networks would possess the
flexibility to merge supporting productive resources and core competencies to
enable the joint development of new products, the acceleration of the time-to-
market life cycle, the implementation of unifying information technologies
like the Internet, and the structuring of radically new forms of partner-based
vertical integration. As the pressures of the marketplace intensify, companies
will have to become more capable of responding to requirements for in-
creased customer product and service customization, mo~e willing to engage
in supplier, customer, even competitor value-creating relationships, and more
agile and scalable in the design of internal and supply chain partner produc-
tion and distribution processes and information flows. Today's most success-
ful and revolutionary companies, such as Wal-Mart, Amazon.com, Intel,
W.W. Granger, and others, know that continued market dominance will go to
those who know how to harness the core competences and resources of chan-
nel partners to provide unsurpassed customer value.
Globalization. The growth of business and industry throughout the globe at

the start of the twenty-first century has already made a profound and dynamic
impact on the course of the industrial market system. The end of the Cold
War, the growth of new markets in eastern Europe and Asia, Internet techno-
logy, the speed of transportation, and the integration of the world's economic
activities have propelled companies large and small at a dizzying pace into
the global marketplace . This explosion in internationalism is the result of
four trends. The first can be found in the maturing of the economies of the
world's industrialized nations. This reality has forced companies to look to
foreign markets as a source of competitive advantage, as well as of basic ma-
terials, cost-effective components, and low-cost labor. This tightening of
markets has generated the second global trend: increased competition. The
emergence of China and Japan and the formation of trading blocks in North
America, Europe, and Asia have altered the balance of trade established at the
conclusion of the Second World War. Third, the connectivity power of the
Internet, the growth in incomes worldwide, the development of distribution
channel infrastructures, the formation of global strategic alliances and joint
ventures, and the speed of communications have also increased global de-
mand for products and services. Finally, the goal of competitive global distri-
bution requires the integration of entire supply channels into single marketing
systems focused on attaining the best cost and customer service possible .
Some economists have argued that business has become so "international-
ized" that it is meaningless to speak of companies as if they belonged to a sin-
gle country. The enabling power of the Internet has made it possible for busi-
nesses large and small to market and sell their products and services directly
to any customer, at any time on the earth. Supplier search, comparison shop-
ping, and ordering can be executed on a real-time basis without clumsy paper
catalogues or direct contact with sales people. This expansion in global trade
can be easily demonstrated by such facts as the following [2]:
Almost 25 percent of the output of U.S. companies is produced
globally.
Almost 25 percent of U.S. imports occur between U.S. parent com-
panies and global affiliates.
61 percent of manufacturers have moved production to lower cost geo-
graphical regions.
Of these companies, most have spread supply chain and other opera-
tions worldwide, in some cases leaving them with more assets in
foreign lands than in their own countries.
Global sales account for almost 50 percent of the sales for the 100 larg-
est U.S. companies.
In addition, globalization is also being impacted by governmental issues.
The influence of domestic and foreign governments can be seen in two
critical areas. The first relates to free trade and the formation of continental
trading blocks. Economic embargoes, tariff barriers, and monetary policies
are seen as critical elements of strategy and tactics in the new era of inter-
national global trade. A second area that governments are impacting global
trade is internally through transportation, commerce restrictions, and other
types of regulation.
Finally, environmental issues can be expected to playa much larger role
both internally and externally. During the last decade, American presidents
and their administrations have focused on a strong commitment to the en-
vironment in regard to clean air and water, the safe transport of toxic and haz-
ardous materials, the repair of basic transportation infrastructures such as
roads and waterways, and urban congestion and gridlock. Environmental is-
sues can be expected to playa greater role in the trading negotiations between
nations . One of the newest environmental issues is the concept of reverse lo-
gistics. This involves the reclamation of packaging materials and other
wastes, and backhaul to a central collection point for recycling. Reverse lo-
gistics, however, is not just the collection of used, damaged or outdated prod-
ucts and packaging from end users, nor simply reducing wastes. The objec-
tive of reverse logistics is the effective coordination of both the forward and
reverse processes necessary to fully utilize products and materials throughout
their life cycles.
Supply Chain Structure. The requirement that today's businesses be agile as

well as efficient in order to be responsive to customer demands for shorter cy-
~F' -- -
1."1
Conservation Music
it ,~. ,~.~ _
Over the past several decades, energy consumption by 15% in 200 I

Yamaha Music Manufacturing, Inc. and another 7% in 2002.
have found their environmental ef-
forts are creating beautiful music In total, it has recycled 3.8 million
when it comes to their financial pounds of wood products, 360,000
statement. Yamaha Corp., which in- pounds of metals, and 485,000
cludes Yamaha Music Manufact- pounds of cardboard. The cost
uring (YMM), has made it a mission savings for YMM has reached
to be a good environmental citizen $109,000, or I% of its total annual
since 1974 when the company costs.
established the Environmental
Management Division. Some of the reverse logistics irun-
atives were easy to come by. For
Since earning IS014001 certifi- example, instead of dumping tons of
cation (the international environ- sawdust from piano manufacturing
mental standard) in December 2000, into landfill, YMM found channel
Yamaha has been realizing the partners willing to take the waste
benefits accompanying a successful and use it to make other kinds of
recycling and reusing program. material such as particleboard.
YMM has reduced hazardous waste
and air emissions by 26%, non- Sour ce: Purdum. Traci, "Conser-
hazardous waste by 21 %, and scrap vation Music," Industry Week. May,
by 44%. Additionally, it reduced 2003, pp. 57-58.
cle times regarding services, product mixes, and volume and variety changes
has spawned the engineering of virtual organizations and interoperable
processes performed by channel partners . As vertical integration declines as
a strategy, businesses are increasingly migrating to outsourcing, contract
manufacturing, service fulfillment, and third party logistics to counter ever
shortening product life cycles, increasing costs, and tight profit margins. By
divesting themselves of labor and capital intensive assets not central to their
businesses, companies feel that they can much better focus on core strengths
while retaining or even increasing market presence. Today's most successful
companies, such as Wal-Mart, Intel, and others, depend on collaborative
strategies with their channel partners to generate networked organizational
structures capable of merging unique capabilities for the development of new
products, productive processes, and service delivery.
There are a number of key advantages to outsourcing. To begin with, com-
panies can reduce costly assets, like personnel, warehousing, transportation,
non-core manufacturing, and other functions, thereby enhancing return on
current assets and capital expenditure. Second, by eliminating non-core func-

tions, employee productivity will increase. Third, outsourcing provides com-
panies with the flexibility to access new markets and build new products
without shouldering completely the associated costs. Fourth, by leveraging
third party companies to handle non-core functions, customer service can ac-
tually be improved without changing the business. Finally, as requirements
for computerized toolsets focused on increasing collaboration and data trans-
fer grows, companies can outsource functions to realize EDI or Internet capa-
bilities without the need to acquire or develop them in-house.
Logistics as a Competitive Weapon . In the past, logistics was seen pri-

marily as an operational activity, consisting of a series of independent ware-
house, transportation, and inventory management functions focused on
delivery and cost performance. For the past two decades this narrow percep-
tion of the role of logistics has been gradually replaced by a growing under-
standing that logistics can provide today's dynamic, global organization with
the capabilities to span geographical barriers, deliver product in as quick and
cost effectively a manner as possible, and weld together channels of trading
partners. Corporate strategists have actually defined logistics as a key com-
petitive weapon whose mission is to plan and coordinate all activities neces-
sary not only to achieve delivered service and quality at the lowest cost but
also to enable today's enterprise to realize new avenues of competitive advan-
tage. In fact, the effective positioning of the logistics function has the poten-
tial to create new value for customers , drive down operational costs, enable
the marketing and sales effort, and facilitate operations flexibility. Logistics
and supply chain management are concomitant strategies: the former provides
the operational structure for the realization of the strategic objectives set by
the latter.
Cost and Process Improvement. Over the past decade, companies have be-
gun to extend the theories of cost reduction and business process improve-
ment encapsulated in such management philosophies and techniques as En-
terprise Resource Planning (ERP), Total Quality Management (TQM), and
Business Process Reengineering (BRP) outside their organizations into the
supply chain in search of additional sources of cost reduction and business
process improvement. The objective is to relentlessly eradicate all forms of
waste where supply channel entities touch, such as logistics, channel inven-
tory management, procurement, customer management, product development,
and financial functions . The goal is to architect performance metrics and or-
ganizational models that optimize channel productive capabilities and acti-
vate highly agile, lean supply networks capable of providing superlative cus-
tomer value.
Information Technology. Finally, the development of radically new infor-

mation and communication technologies driven by the Internet have enabled
companies to deploy revolutionary methods of building levels of competitive
advantage virtually impossible just a decade ago. Before the Internet, busi-
. nesses used their channel partners to realize tactical advantages, such as
shortening cycle times by integrating logistics functions or using EDI to pass
documents between channel members. With the advent ofe-commerce, en-
tirely new business models could now be architected that leveraged supply
chains to create dazzlingly new regions of strategic advantage and market-
place value. In place of logistics channels, the Internet has permitted compa-
nies to develop "value networks" consisting of the following three elements :
High performance networks of supply chain partnerships and informa-
tion flows capable of capturing customer requirements for customized
product and service solutions and transmitting them in "real-time, " dig-
itally to the trading partners best able to respond .
Highly agile and scalable supply chains capable of being rapidly as-
sembled to provide targeted resources to respond to new product de-
velopment and roll-out, flexible manufacturing, distribution, and infor-
mation processes, and fast flow fulfillment before the competition.
Utilization of Internet tools providing interactive pathways that enable
the allocation of customer fulfillment tasks to specialist channel part-
ners while presenting to the customer the appearance of dealing with a
single, seamless enterprise dedicated to total customer service.
The ability of today's enterprise to respond effectively to these challenges
will determine competitive survival in the twenty-first century. As the needs
and expectations of customers and the information technologies available
continuously change in the decade of the 2000s, the demand for low-cost,
efficient distribution services will significantly expand. The explosion in glo-
bal trade, product proliferation and customization, pressures to reduce inven-
tories, and a growing spectrum of value-added services will dramatically in-
crease the need for supply channel functions to develop complex, yet afford-
able solutions to meet tomorrow's customer services expectations . In this
light, the strategic advantages afforded by flexible distribution functions nec-
essary to meet the requirements of the virtual supply chain will increasingly
be recognized as the competitive edge of marketplace leadership.
EVOLUTION OF SUPPLY CHAIN MANAGEMENT [3]
While the concept of supply chain management (SCM) is little more

than a decade old, it has its roots in the ages old struggle of producers
and distributors to overcome the barriers of space and time to deliver

products and services as close as possible to the desires and needs of
the customer. In fact, the origins of SCM can be traced back to the
evolution of the logistics function. Logistics has always been about
managing the synchronization of product and service availability with
the time and place requirements speci-fied by the customer. Over the
past half century, logistics has progressed from a purely operational
function to become a fundamental strategic component of today's leading
manufacturing and distribution companies. As logistics has evolved
through time, the basic features of SCM can also be recognized: first in
their embryonic state as an extension of integrated logistics management,
and then, as a full-fledged business philosophy encompassing and
directing the pro-ductive efforts of whole supply chain systems. A
comprehensive understanding of SCM, therefore, requires a thorough
understanding of the evolution of logistics management.
From the beginning of history, producers have been faced with the funda-
mental problem of the dispersion of goods and services to the marketplace.
Traditionally, it had been the role of logistics functions to satisfy this funda-
mental need by providing for the efficient and speedy movement of goods and
services from the point of manufacture to the point of need. Economies pos-
sessed of complex and inexpensive logistics systems are marked by elaborate
and enriching market systems, a wide spectrum of available products, the
rapid exchange of goods, and accelerating standards of living. What is more,
enterprises that have been able to effectively utilize supply channel partners
to deliver products and services have been able to more profitably operate
and focus their productive functions while extending their reach to capture
marketplaces and generate demand beyond the compass of their physical lo-
cations. When considered from this perspective, the supply chain concept
can be described as not only an operational facilitator for satisfying market-
place demand, but also as a strategic operator that provides more competitive
advantage and more robust customer value the more the supply channel is
used. In this sense the supply chain can be described as a network of inter-
dependent partners who not only supply the necessary products and services
to the channel system but who also stimulate demand and facilitate the syn-
chronization of the competencies and resources of the entire supply network
to produce capabilities enabling a level of operational excellence and market-
place leadership unattainable by each business operating on its own.
STAGES OF SUPPLY CHAIN DEVELOPMENT
While as far back as the beginning of the twentieth century economists con-
sidered the activities associated with the effective management of the supply
channel to be crucial to the smooth functioning of marketplace exchange, this
concept, first termed logistics, was slow to develop. Most business execu-
tives considered their channel management functions to be of only tactical
importance and, because of the narrow scope and lack of integration among
channel trading partners, virtually impossible to manage as an integrated
function. In fact, it was not until the late 1960s when cost pressures and the
availability of computerized information tools enabled forward-looking com-
panies to begin to dramatically revamp the nature and function of the supply
chain that the strategic opportunities afforded by logistics began to emerge.
As portrayed in Figure 1.1, the SCM concept can be said to have evolved
through five distinct stages. The first can be described as the era of logistics
decentralization. In the second stage, logistics began the evolution from
functional decentralization to organizational centralization driven by new at-
titudes associated with cost optimization and customer service. Stage three
witnessed the dramatic expansion of logistics from a narrow concern with
internal cost management to embrace new concepts calling for the linkage of
internal operations with analogous functions performed by channel trading
partners. As the concept of channel collaboration grew, the old logistics con-
cept gave way in stage four to full-blown SCM. Today, with the application
of Internet technology to the SCM concept, SCM can be described as entering
into stage five, e-SCM.
STAGE 1: DECENTRALIZED FUNCTIONS
Historically, the first stage of SCM occurred in the period extending from the
late 19th century to the mid-1960s. During this era logistics was not perceived
as a source of significant competitive advantage. Viewed essentially as an in-
termediary function concerned with warehousing and transportation, it was
felt that logistics could not make much of a contribution to profitability and,
therefore, was not worthy of much capital investment, accorded little manage-
ment status, and assigned less qualified staff. For the most part, companies
fragmented logistics activities, often dividing them among different depart-
ments. It was not uncommon to find transportation functions reporting to
sales and inventory to finance (since inventory appeared on the ledger sheet
as a current asset). Not only were activities that were natural extensions of
the same process, such as procurement management, inbound transportation,
and inventory management, separated from one another, but narrow depart-
to 19608 19708 - 19805 19808 - 19905 19905 - 1999 2000 +
Stage 1 Stage 2 Stage 3 Stage 4 Stage 5
'\ / / '\ /
Warehousing Total Integrated Supply e-Supply ~
and Cost Logistics Chain Chain ~

==
Transportation Management Management Management Management ~
TJ)
~
A'1allagellu!tlt FOCIIS Matlagemetlt FOCIIS Matlagemelll FOCIIS Matlagemetlt FOCIIS Matlagemetlt Focus o
Operations '---l Optimizing Supply Chain Internet, e-Business ~
'--
,....... Tactics/Strategies ~ TJ)
Performance ...---. > Operations Cost & Strategies. Channel = e-Mnrkcting, SCM
Logistics Planning ~
Efficiencies Customer Service Coevolution, Goals Synchronization ""=
~
r-
Orgatlizatiotl Desig/l Orgallizatiotl Desigtl Orgallizatiotl Desigll Orgallizatioll De.~igtl Orgallizatioll Desigtl
-<
(';)
Decentralized Pnrtnering Networked Channel ::=
Centralized Integration of
Functions VirtualOrganizntion .coms, Exchanges >
Functions Logistics Functions
Market Coevolution Agility/Sca lability Z
-
'- ./ '- \. ./ ~
-
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>
C')
FIGURE 1.1 Five stages of supply chain managem ent.
~
~
Z
~
...
~
mental performance measurements actually pitted logistics functions against

each other. What is more, the whole field of logistics was woefully ill-de-
fined as a management science. The result was a rather disjointed, relatively
uncoordinated, and costly management of logistics activities.
In an era when process and delivery cycle times were long, global compet-
ition practically non-existent, and the marketplace driven by mass production
and mass distribution, logistics decentralization was a minor problem for
most companies . By the early 1960's, however, changes in the economic cli-
mate were forcing corporate strategists to re-think the role of their logistics
functions. To begin with, expanding product lines, demand for shorter cycle
times, and growing competition had begun to expose the dramatic wastes and
inefficiencies of logistics decentralization. Second, executives were finding
themselves handcuffed by the lack of a unified logistics planning and execu-
tion strategy. Logistics responsibilities were scattered throughout the organi-
zation and no single manager was responsible for the development of a co-
herent logistics plan supportive of the business mission. Finally, logistics de-
centralization had made it impossible to pursue a comprehensive program to
reduce costs and improve productivity. Logistics was often caught in a per-
fonnance measurement paradox . For example, transportation might seek to
reduce delivery costs by requiring a higher payload-to-cost ratio. Such an in-
itiative, however, would require warehousing to stock more inventory while
increasing cycle times.
Despite the gross inefficiencies of the decentralized logistics system, by even
the late-1960s academics and practitioners had not yet begun to tackle the task
of broadening the science of modem logistics. Much work needed to be done.
Logistics suffered from a lack of standardized definitions and vocabulary.
Questions regarding organizational structure needed to be answered. There was
a distinct lack of professionalism, training, and skills among logistics man-
agers, most of who had emerged out of operations roles in purchasing or ware-
housing. The true aggregate costs of logistics in the U.S. had never been ac-
curately assessed, and there was little known about likely future trends. Should
logistics be part of the marketing function? Should it be associated with manu-
facturing or perhaps with finance? Should it be a department on its own? How
would the implementation of new information technologies impact logistics?
What was the relationship between the budding research on logistics occurring
in academic circles and practical application in the field [4]?
STAGE 2: TOTAL COST MANAGEMENT
The second stage in the evolution of SCM can be said to have emerged out of
two critical management initiatives. The first can be described as the de-
cision of companies to centralize logistics functions into a single depart-

mental organization. By merging what previously had been a series of frag-
mented functions into a single management system, it was reasoned that it
would be possible to decrease individual costs associated with transportation,
inventory, and physical distribution while simultaneously increasing the pro-
ductivity of the logistics system as a whole. By the 1970's, companies had
begun the process of moving logistics functions formally under a single man-
ager who was not only accountable for all functions, but also was now ex-
pected to possess the ability to make decisions in terms of the whole logistics
system and not just local departmental optimization. Achieving such a syn-
ergy would involve reengineering the entire organization to leverage produc-
tivity opportunities , charting the impact of logistics cost decisions on sales
volume and profits, and determining the required and probable return on in-
vestment.
In Stages 1 and 2, logistics was perceived as internally and externally
neutral in providing the enterprise with competitive advantage. The role of
logistics in such environments was defensive in nature and was concerned
purely with the effective management of inventories and delivery and cost-
containment. Management objectives revolved around detailed measure-
ments of and control over performance in order to ensure that logistics as a
cost center functioned optimally. When making logistics decisions, the goal
of planners was to enable strategies that would keep logistics flexible and re-
active. The objective of logistics functions was to have the product and val-
ue-added services available so that customer-facing functions could respond
to any type of customer demand. In business environments where companies
could dominate a particular market niche or where the competition was weak,
such as characterized the 1960s and 1970s, companies could ignore
considering logistics as critical to competitive advantage.
By the end of the period, however, logistics managers had become aware
that to assist in sustaining competitive advantage they needed not only to op-
timize the flow of goods occurring within the boundaries of the company but
also the flow through the entire supply chain right up to the customer's re-
ceiving dock. This also meant thinking about the flow of materials backward
to the source of supply. Such thinking cut across traditional company depart-
mental boundaries and supply chain systems. Logistics was on the merge of
its next evolutionary step.
STAGE 3: INTEGRATED FUNCTIONS
During the 1980s, corporate strategists became increasingly aware that focus-
ing solely on total cost management, although critical in aligning logistics
costs with customer service levels, represented a passive approach to channel

management. In place of a preoccupation with minimizing logistics costs in
isolation from other corporate performance targets, managers began to under-
stand that integrating logistics with other business departments could result
not just in minimizing enterprise costs but also actively enhancing customer
value. Operational factors, such as speed of delivery, value-added services,
and product availability realized when enterprise functions worked closely to-
gether, could in themselves provide a powerful facilitator significantly assist-
ing the entire organization in sustaining competitive advantage. Past organi-
zational strategies neither sought to activate the potential of their logistics
functions nor to leverage the close links existing between logistics and other
enterprise business areas. As firms began to search for new avenues of gain-
ing competitive advantage, it became apparent that an integrated logistics sys-
tem could be used as a powerful marketing tool, capable of generating ad-
ditional value beyond product and price leadership.
In addition to the changes in executives' perception of the strategic role of
logistics, powerful organizational and management processes were further
fueling the growth of the integrated logistics model. If the 1980's could be
compressed into two quintessential catchwords, they would be competition
and quality management. Competition came in the form of global companies,
often deploying radically new management philosophies and organizational
structures that were realizing unheard of levels of productivity, quality, and
profitability. The second driver of change came from the deployment of new
management concepts, driven by JIT and total quality management (TQM)
philosophies, that were providing competitors with tools to compress time out
of development cycles, engineer more flexible and "lean" processes, tap into
the creative powers of the workforce, and generate entirely new forms of
competitive advantage.
Businesses responded to these challenges by focusing, first of all, on re-
vamping their organizations by pursuing both cost/operational and ser-
vice/value advantages through continuous process improvement and closer
integration with channel partners. Second, companies began to understand
that logistics and other channel management functions could be leveraged as
a dynamic force capable of winning customers beyond the execution of logis-
tics functions. Instead of being considered an isolated department, logistics
capabilities and strategies could be integrated with the strategic plans of other
enterprise departments. In this sense logistics could serve as an active
catalyst derived from and in support of the firm's overall competitive strategy.
Rather than simply a function to handle day-to-day fulfillment activities lo-
gistics could be perceived as having an long-term, strategic impact.
Stage 3 distributors recognized the strategic value of their logistics func-
tions and sought to draft plant charters and mission statements to guide logis-
tics development and ensure alignment with other enterprise functions. The
concept of integrated logistics also afforded the logistics function an equal
position alongside marketing, sales, and operations in the formulation of stra-
tegic plans, determining the allocation of enterprise resources, and defining
the scope of customer service objectives. By closely aligning logistics capa-
bilities and marketing, sales, and operations objectives, the enterprise could
present customers with a unified approach, guaranteeing product, price, and
delivery competitiveness.
STAGE 4: SUPPLY CHAIN MANAGEMENT
By the 1990's, companies began to understand that the integrated logistics

concept was insufficient to tackle the new realities of the marketplace. The
acceleration of globalization, the explosion in new information technology
enablers, business process reengineering, increased outsourcing, and the
growing power of the customer were forcing companies to look beyond the
boundaries of their own core competencies to the capabilities and resources
of their supply channel partners to remain competitive. The necessity of re-
sponding to these new challenges compelled companies to implement what
can only be called a dramatic paradigm shift from Stage 3 logistics to supply
chain management (SCM).
In the past companies had sought to integrate operational channel func-
tions, such as transportation and warehousing, with supply network partners
in an effort to increase pipeline velocities and cut costs. By the 1990's it had
become apparent that this early attempt at channel integration needed to be
dramatically expanded and elevated to a strategic level. In place of the infor-
mal, short-term, tactical use of supply chain partners, corporate planners were
now advocating strategies that sought the development of close collaborative
relationships between channel constituents with the objective of optimizing
and synchronizing the productive competencies of each trading partner. Lo-
gistics channels were to be replaced by "value networks."
SCM can be broken down into four main components.
Strategy. While Stage 3 logistics functions sought to interface active-
ties with channel partners, the focus was still primarily inward-looking.
Logistics planners were mainly concerned with the execution of daily
distribution processes, internal performance measurements, and paro-
chial business strategies. In contrast , the SCM paradigm requires logis-
tics managers to be transformed from internal keepers of cost and chan-
nel operations to strategists responsible for the development of "value
chains." Building collaborative relationships, optimizing and synchro-
nizing the total resources of the chain to achieve high-value customer
service, and activating the potential for productivity to be found in the

deployment of the collective competencies of trading partners dom-
inates the thinking and planning of companies operating according to
SCM principles.
Sourcing and Procurement. Stage 3 logistics sought to integrate inter-
nal demand, production, and purchasing functions in order to facilitate
sourcing and planning, cut inbound logistics and warehousing costs,
and ensure timely product delivery. SCM, in contrast, not only seeks to
reduce sourcing, procurement, and delivery cycle times and costs, it
also strives to develop close relationships with suppliers. Instead of fo-
cusing on competitive pricing and adversarial negotiations, SCM has
opened exciting new vistas for the interactive, real-time sharing of
product designs and costing, synchronization of channel product roll-
out, application of procurement savings and efficiencies down the
length of the supply chain, and the engineering of truly collaborative
partnerships where core competencies can be merged to generate a
common competitive vision.
Production . Traditional companies focus on making standardized, "one
-size-fits-all" products pushed sequentially from one network node to
another. Such organizations resist sharing product design and process
technologies with their channel partners; They are slow to respond to
changing customer needs, slow to change configurations to accom-
modate new products and alternating product mixes, and are concerned
only with internal performance metrics. Manufacturing functions driv-
en by SCM, on the other hand, treat collaborative design planning and
scheduling with their supply chains as a fundamental issue. When pos-
sible, they seek to closely integrate their ERP systems with those of
their trading partners to eliminate time and cost. SCM production faci-
lities are "customer-centric" and capable of responding to shrinking
product life cycles and increasingly configurable products. Finally,
SCM-driven firms also understand that speedy product design and
release to market occurs when they leverage the competencies and
resources of channel partners to generate "virtual" manufacturing en-
vironments capable of being as agile and scaleable as necessary to take
advantage of every marketplace opportunity.
Delivery. Customer management in Stage 3 companies is squarely fo-
cused on making internal sales functions more efficient. Heavy priority
is placed on available-to-promise functionality, finished goods manage-
ment, and determining the proper timing of product differentiation in
the channel. Specific information on market segments and customers is
rarely communicated to channel partners, databases are considered pro-
prietary, and pricing data is never shared. In contrast, SCM-driven cus-

tomer functions are concerned with reducing logistics costs and chan-
nel redundancies and increasing customer service by converging chan-
nel partner warehouse space, transportation equipment, and delivery
capabilities . SCM regards computerized avenues to engage with the
customer, no matter where in the supply chain, as critical. SCM cus-
tomer management looks toward automation tools to facilitate field
sales, capability to promise tools, customer relationship management
(CRM) software, mass customization, and availability of general supply
chain repositories ofjoint trading partner market and customer data.
SCM-driven organizations possess the capability to move beyond a narrow
focus on internal logistics optimization to a strategy that identifies and lever-
ages the best core competencies and collaborative relationships among their
supply chain partners to architect "value networks" capable of realizing con-
tinuous breakthroughs in product design, manufacturing, delivery, customer
service, cost management, and value-added services before the competition.
This strategic, channel-building attribute of SCM revolutionizes everyone in
the supply chain and provides all network trading partners with the capability
to view themselves and their channel partners as extended, "virtual organiza-
tions" possessed of radically new methods of responding in unique ways to
provide total customer value.
STAGE 5: e-SUPPLY CHAIN MANAGEMENT
While SCM provided companies with the ability to escape from the four-wall
boundaries of their own businesses and view the supply chains in which they
participated in as a fertile new source for competitive advantage, by the tum
of the twenty-first century it had become apparent that vertically integrated
SCM was too brittle a concept to respond effectively to three major channel
dynamics: accelerated global outsourcing, ever more ruthless competition,
and demand and supply mismatches in the channel network. Several critical
problems had arisen to the surface [5].
Information visibility, velocity, and timeliness . It simply was taking too
long to register and communicate important changes occurring in cus-
tomer demand and supply to the channel network. Information, in fact,
cascaded serially through the supply channel, with the result that trad-
ing partners located far from the channel event did not receive the in-
formation until it finally was passed to them by their immediate trading
partners. In the meantime, companies continued to plan and build to
what had become an increasingly obsolete plan. The problem was the
lack of information systems that permitted all levels of the channel to
be in touch with actual customer demand, and the absence of decision-

support and analytical tools providing for rapid analysis and concurrent
response among all affected trading partners.
Information variability and accuracy. The traditional practice of creat-
ing long-range forecasts, generating large production lots, and pushing
inventory downstream was often compromised by abrupt, unplanned
changes in channel demand and supply patterns. Without timely and
accurate information, the planning practices of even closely interlocked
trading partners often became atomized. As the plan slowly spun out of
control, planners begin increasingly to rely on second-guessing, intu-
ition, and rule-of-thumb solutions, all of which simply further degraded
the credibility of channel plans.
Analytics and control. Regardless of the commitment to channel inte-
gration, traditional SCM depends on historical data to calculate trends,
determine critical metrics, and guide decision-making for individual
companies, and by extension, the entire supply chain. In such an en-
vironment, control and exception management tends to be centralized,
proprietary, and prone to stand-alone point solutions.
Expense. The lack of timely information about real demand and supply
forced supply network nodes to shelter themselves from possible chan-
nel variances by stocking safety inventories . The impact of this prob-
lem becomes apparent when it is considered that excess inventory costs
tend to compound as the number of channel partners expands.
Flexibility and scalability. The SCM model is limited by what is term-
ed the "chained-pairs trading model" [Figure 1.2]. The foundation of
this model resides on the fact that channel members normally focus
their efforts on one channel partner at a time. These one-to-one rela-
tionships consist of linear handoffs of goods and information from a
company to its immediate channel partner. The problem with the mod-
el is its lack of responsiveness to the value chain needs of clusters or
multiple tiers of channel business relationships . Information in the
chained-pairs model is limited by system interoperability and its arc-
hitecture inhibits the synchronization of data from multiple sources.
Company-centricity. Despite the desire to participate in supply chain
collaboration, Stage 4 SCM companies view their strategic and opera-
tional plans primarily from the inside-out. The result is that market-
place and channel decisions are made primarily to benefit the company,
often at the expense of the supply chain. This problem of supply chain
suboptimization results in suppliers and customers being left out of the
process . When compounded with the lack of a formal and closed-loop
feedback process to capture and communicate execution exceptions, the
(Pair I) (Pair 2)
Requirements Flow Requirements Flow
Materials Flow Materials Flow
(Pair 3) (Pair 4)
Requirements Flow Requirements Flow
Materials Flow Materials Flow
FIGURE 1.2 Cha ined-pairs trading model.
promise of the SCM concept begins to breakdown into disparate, often

irreconcilable components.
Solving the problems residing at the core of SCM revolves around devel-
oping supply chain networks capable of possessing the highest visibility, the
greatest information velocity, and the best analytical tools to manage channel
variability . Obviously, the common thread permeating each of the above de-
ficiencies in traditional SCM is the inability of whole supply chains to re-
ceive simultaneously and in real-time information regarding the interplay of
actual demand and supply as it occurs through time in the channel network.
Previous attempts at inter-channel data communication, such as EDI, were
plagued by expensive equipment, transmission standards, and delays caused
by the batch transfer of data up and down the supply chain.
By the opening ofthe twenty-first century, the application of the Internet to
the SCM concept provided the necessary mechanism for SCM to escape from
previous technology and operations limitations and move to the next level in
the history of channel management: e-SCM. In place of rigid supply chains,
the Internet enabled the establishment of more "adaptive" supply chains that
were capable of truly leveraging the integrative and collaborative network to
manage channel demand/supply variability and provide the necessary infor-
mation visibility and velocity for each network node to execute decisions
concurrently with a resulting minimal loss of operational and financial effi-
ciency [6]. The application of the Internet to each of the above problem dy-
namics of classical SCM have been summarized in Table 1.1.
TABLE 1.1. Elements of e-SCM
Channel Issue SCM e-SCM

Information visibility, Slow, sequential, poor Dynamic, parallel,
velocity, and timeliness visibility across the supply concurrent , responsive to
chain change, Web-based central
nervous system
Information variability, Batch driven, inaccurate Real-time, synchronized,
and accuracy through time, inconsistent, networked, reliable and
rule-of-thumb response predictable data
Analytics and control Historical , proprietary, Real-time, data sharing ,
centralized, local concurrent/distributed
performance metrics decision making
Expense Buffer inventories and Continuou s cost reduction
capacities and process improvement
Flexibility and "Cha ined-pairs" model, Multiple tiers model, open
Scalability proprietary standards , systems, functional
stand-alone point solutions interoperability
Company-centricity Strategies benefit Strategies benefit supply
company, channel sub- chain, channel optimi-
optimization , irreconcil- zation, supporting plans
able plans
Implementing e-SCM requires a radical evolutionary step in channel pro-

cess and management design. To make the transition to e-SCM companies
must pass through three stages. Enterprises begin first with the integration of
supply chain functions within the enterprise. As described above in Stage 3
logistics, the goal is to improve internal operational visibility and produc-
tivity. An example would be integrating sales and logistics through the im-
plementation of a warehouse and transportation system. By linking the new
system to the ERP backbone, increased visibility to delivery, cost, and other
execution activities could be provided to the entire customer and supplier or-
der process. The next step would be to integrate and synchronize inbound
and outbound order management activities with channel partners. In this step
companies are willing to share important information with immediate trading
partners, but the information is normally restricted to tactical functions and
are focused on short-term cost savings and operational efficiencies. Finally,
the highest level would be achieved by utilizing Internet connectivity to

synchronize the channel functions of the entire supply network into a single,
scaleable "virtual" enterprise capable of optimizing core competencies and
resources from anywhere at any time in the supply chain to enhance business
processes and strategic development and optimize each component of the
value network.
At the beginning of the twenty-first century most companies and their sup-
ply chains have not moved much beyond Stage 3 or even Stage 2 logistics.
While increasing attention is being paid to collaborating with customers,
many business strategists still see their supply chains as a minefield where
predatory habits and short-term cost savings dominate. While companies
would like to leverage common strategies, product and demand information,
and deploy event-management and alert notification applications that would
illuminate actual channel requirements and enable high velocity "value net"
logistics, too many are simply at the beginning stages of the SCM evolu-
tionary process.
As this section concludes , it is clear that channel management is no longer
the loose combination of business functions characteristic of the early stages
of logistics. New Internet-enabling technologies and management models
have not only obscured company internal functional boundaries, they have
also blurred the boundaries that separate supply chain partners, transforming
once isolated channel functions into unified, "virtual" supply chain systems.
Today 's top companies are using Internet connectivity to reassemble and en-
ergize supply chain management processes that span trading partners to acti-
vate core competencies and accelerate cross-enterprise processes. They are
also using Web technologies to enable new methods of providing customer
value by opening new sales channels as they migrate from pure "bricks-and-
mortar" to "clicks-and-mortar" business architectures. The next section will
continue this discussion by offering a detailed definition of e-SCM that will
serve as the cornerstone for the rest of the book.
DEFINING e-SCM [7]
SCM can be approached from several perspectives. Like most management

philosophies, definitions of SCM must take into account a wide spectrum of
applications incorporating both strategic and tactical objectives. As illus-
trated in Figure 1.3, SCM can be divided into four regions. The first, internal
optimization , is the simplest, and consists of the integration of the internal
channel functions of the enterprise. The goal of this region is logistics opti-
mization. If technology is applied at all, it consists of local intranets that link
only logistics functions. The second region, external integration. focuses on
integrating day-to-day internal operations activities with the analogous in-

bound and outbound functions performed by channel trading partners. The
goal is to streamline process flows, reduce network costs, and optimize pro-
ductivity and delivery resources centered on conventional channel relation-
ships. If technology is applied, EDI or intranet capabilities are used to link
operations and transaction information transfer.
Adaptive Inter-
c
Channel
..f
0
;:
Strategic Value
..
.5
Gcnerntion
lnter-Channel
c Productand
'i Service Value
.c
U Generation
~
a.
a. Inter-Channel
...en
:J
logistics
0 Functions
III
a.
0
"
u
en Internal
Channel
Functions
Extranei Web-enabled
Channel Web Enabled
Operations Strategic
Collaboration Collaboration
Level of Supply Chain Integration
FIGURE 1.3 Phases of SCM
In the third region, supply chain strategic collaboration, the impact of

SCM is dramatically enhanced as it moves from integrating inter-channel op-
erations functions to the generation of strategically integrated supply chains.
The mission of SCM is the establishment of collaborative partnerships char-
acterized by the architecting of cross-channel correlative processes that create
unique sources of value by unifying the resources, capabilities, and com-
petencies of the entire network ecosystem to enhance the competitive power
of the supply channel as a whole and not just an individual company. The
technologies necessary to achieve this objective require channel partners to
use extranet enablers that provide the capability to work in a real-time, inter-
operable information environment.
Finally, in the fourth region, e-supply chain value interoperability, the en-
abling power of the Internet is merged with strategic SCM. The application
of the Internet is such a radical enhancement to the SCM concept that it de-
serves to be relabeled e-SCM. This new view of SCM is so radical because it

enables companies to use the Internet to develop new methods of integrating
with their customers, suppliers, and support partners. As is illustrated in Fig-
ure lA, e-SCM extends channel management systems beyond traditional
boundaries to integrate in real-time the customer/product information and
productive competencies to be found in customers' customers and suppliers'
suppliers channel systems. What had been missing in Stage 4 SCM was an
effective mechanism to enable the intense networking of commonly shared
strategic visions and mutually supportive competencies among channel part-
ners. The architecture of technologies such as ERP and EDI imposed severe
barriers to the range of information communication and erected unscaleable
barriers limiting participation. The merger of the Internet and SCM, on the
other hand, offers whole supply chains the opportunity to create value for
their customers through the design of agile, flexible systems built around dy-
namic, high performance networks of Web-enabled customer and supplier
partnerships and critical information flows.
Fulfillment
FIGURE 1.4. e-Supply chain management
a-SCM DEFINITION
Since e-SCM is perhaps the central theme to be found in this text, a concise
definition is necessary to guide the student through the various topics to
come. The definition is as follows: [8]
e-SCM is a supply chain operational and strategic management philosophy that

utilizes Internet-enabling technologies to effect the continuous regeneration of
networks of supply channel partners empowered to execute superlative, unique
customer-winning value at the lowest cost through the collaborative, real-time
synchronization of product/service transfer, demand priorities, vital marketplace
information, and logistics delivery capabilities.
The critical components of this definition are revealing. To begin with, e-

SCM is a supply chain operational and strategic management philosophy dri-
ven by the enabling power of the Internet. This defines the scope of e-SCM.
The concept, continuous regeneration of networks of supply channel part-
ners, implies that companies succeed in the twenty-first century by generating
constantly evolving chains of channel partners capable of respond to the dy-
namic nature of today 's ceaseless demand for new forms of customer/supplier
collaboration and sca1eab1e product and information delivery flows. This ele-
ment defines how supply channels will organize to compete. Unique custom-
er-winning value refers to the ability of companies to assemble agile, scalable
production/distribution systems capable of continuously reinvent unique
product and service configurations and value-creating relationships. This ele-
ment defines the mission of the channel. And finally, collaborative, real-time
synchronization refers to the application of technology process enablers that
network internal enterprise systems, decision support tools, and data ware-
houses to merge, optimize, and effectively direct supply channel competen-
cies. This element describes the mechanics of how Internet-enabled supply
chains will compete.
COMPONENTS OF e -SCM
The evolution of adaptive, Internet-enabled supply chains has required a

transvaluation of the former principles of supply channel management. Past
definitions of SCM were more or less preoccupied with attempts to extend
the concepts of channel integration to the performance of operations activities
associated with optimizing manufacturing and logistics processes and ac-
celerating the flow of inventory and information through the network system.
With the emergence of Internet technologies, channel management was freed
from the constraints of the past. The e-SCM model provides for the inter-
locking of information connectivity between channel systems. Today's Web
applications provide whole supply chains with the capability to instanta-
neously share data bases, forecasts, inventory and capacity plans, product in-
formation, financial data, and just about anything else companies may need
for effective decision making. And the integration can be global, 24/7/365,
with 100 percent accuracy. Enabling the full power of e-SCM requires an un-
derstanding of the following principles [Figure 1.5].
FIGURE 1.5 Components ofe-SCM.
e-Information. If it can be said that the prime driver of SCM is information,

then the faster information can be gathered, analyzed, and defused through
the channel network, the more competitive will be the channel 's trading part-
ners. The application of Internet technology tools has created a new form of
in formation-e-inJormation-that has the power to dramatically enhance the
capabilities for SCM information collaboration. The spread of technology
tools for the networking of disparate channel systems and the nascent de-
velopment of global standards for Internet operations have enabled forward-
looking companies to be able to effectively accumulate, track, monitor, and
harness e-information from anywhere in the supply chain in real-time and use
it for effective decision-making .
Internet technology provides supply chains with an almost unlimited op-
portunity to apply e-information to not only link the complex processes of
channel-wide demand management, logistics, manufacturing, and storage, it
also provides the necessary insight and understanding so that trading partners
can harmonize the main interacting components of supply chain design and
execution. On the marketing side, e-information enables companies to inte-
grate customers directly into their fulfillment systems thereby assisting in ex-
ecuting a perfect order every time, including the performance of all value-ad-
ded services and billing. On the shop floor, e-information improves planners '
backward visibility into supplier resources to smooth capacity spikes and im-
prove throughput. In the supply channel, e-information provides the bridge
.''""t, ..
F.ec:l,Ex,.Cisco and e-Information
rt.n.t. ..
Today's best companies are able to to continuously reengineer processes
capitalize on the Internet to provide to achieve a truly global networked
exciting new ways of servicing the organization. Each critical node in
customer. Federal Express, for ex- Cisco's supply chain , from Web-
ample , uses e-information to enabled order entry (fifty percent of
manage in real-time the daily rout- orders received) and customer
ing and tracking of 2.5 million service (inquiry, pricing. configu-
packages. Fed Ex utilizes such ap- ration. validation. product catalog)
plications as remote bar-code to software distribution download, is
scanning that updates a centralized executed through Internet-based
database. transmission bandwidth processes. In addition, Web-enabled
enabling concurrent rather than collaborative planning. foreca sting,
serial processing of transaction and replenishment (CPFR) appli-
events driven by nearly 400 ,000 cations permit Cisco to com-
daily service calls. the evolution of municate demand changes with
new e-businesses as in the case of suppliers and distributors. Finally ,
FedEx 's alliance with Proflowers Cisco 's e-procurement programs
.com (a .com company operating a provide online access to purchasing!
portal for ordering fresh flowers), marketplaces exchanges. Cisco's e-
and a total company dedication to strategy has enabled the company to
continuously accelerating the speed reduce costs by $560 million per
of e-information and logistics flows. year during the late 1990's. while
spearheading an annual growth rate
Cisco Systems applies e-information of 400 percent for the past five
as the critical driver in their efforts years.
between company-level optimization planning and the global demand pull of

the entire business network. e-Information enables the generation of what
one writer has described as "a portfolio of triggerable decisions with options
to proceed or abandon by milestone [9]." As detailed below, these know-
ledge-driving components can be broken down into five areas [10].
Customer e-information. Understanding and responding effectively to
the needs of the customer pose as the first challenge to e-SCM. Mar-
ketplace intelligence is centered on gathering information relating to
three channel areas providing insight into the customer. The first is the
use of e-information to gather demand management intelligence regard-
ing the validity of forecasts, the impact of out-of-bounds events, and ac-
tual product/service mix usage occurring at any point in the channel.
Such intelligence can be accumulated by leveraging Internet-linked
point-of-sale, collaborative forecast sharing, or event-management

SCM software. The second area seeks to unearth data regarding the
impact of pricing and promotions decisions governing channel ful-
fillment. e-Information tools in this area need to provide intelligence as
to the velocity of sales and the timely reporting of revenues, costs, and
profits. Finally, in the last area, Internet intelligence needs to detail the
status of channel inventories, optimize the trade-off between capacity
utilization and customer service, and enable replenishment visibility
and rapid redeployment of channel inventories.
Logistics e-information. The role of channel logistics functions is to
utilize demand intelligence to determine the optimal application of
transportation and warehouse resources that maximizes customer ful-
fillment value. Accomplishing this objective requires channel members
to gain insight into the capacities of internal and external logistics func-
tions in order to determine the optimal allocation of resources along a
specific channel flow that best meets a specific demand flow. Such a
process depends on real-time intelligence capable of providing logistics
planners with the ability to configure unique value networks where the
best channel partner is assigned the responsibility for customer fulfill-
ment as the order moves through the distribution pipeline. To be suc-
cessful, planners will require e-information applications that enable
cross-channel system interoperability to provide insight into the status
and velocity of production capacities, storage capabilities, inventory
availability and replenishment processes, and transportation resources
at each node in the supply network.
Channel network resource alignment e-information. Critical to the
cost-efficient management of the supply chain is timely intelligence as
to the positioning and planned allocation of products and services as
they exist in the channel network at any given point in time. Ensuring
the optimal location of demand-satisfying resources requires an inti-
mate knowledge of the total cost to serve a single customer using a
specific channel configuration as well as re-aligning those resources to
match changes in demand behavior. Channel partners would need to
leverage e-information tools that enable the utilization of models such
as activity-based costing, the balanced scorecard, or the supply chain
operations reference model (SCOR) to identify in a graphical manner
pools of costs residing at the points were the processes of trading part-
ners intersect. The models deployed must be capable of determining
such critical channel fulfillment values as reliability, responsiveness,
flexibility, cost, and efficiency of asset utilization while communicating
the metrics in real-time to other channel constituents.
Produ ct and process e-information . Because of the sheer size, scope,

and complexity of manufacturing methods and databases, manufac-
turing has always been considered a prime area for computerization.
MRP, MRP II, MES, ERP, and a host of other acronyms bear witness to
the many information technologies applied over several decades to
manufacturing. While all of these tools focused on optimizing the in-
ternal functions associated with production, increasingly companies to-
day have become aware of the need for greater connectivity with cus-
tomers and suppliers and have turned to the Internet for assistance.
Three major areas come to mind . The first is the use of Web-based
toolsets to execute design product content synchronization. Today's
design teams are linked together by real-time, concurrent peer-to-peer
(P2P) technologies that provide for the construction of interoperable
knowledge repositories linking CAE/CAM systems, direct customer
configuration feeds, design collaboration software (DCS), and product
lifecycle management (PLM). The second area is associated with the
slow but steady growth in business-to-business (B2B) supplier manage -
ment which uses the Web to build trading communities that facilitate
product and supplier search, order status/tracking, product catalogs, and
buyer/supplier back-end integration. The final area of e-information
used by manufacturers is the application of cross-channel advanced
planning and scheduling (APS) systems that not only enable them to
more effectively run production processes, but which also permit plan -
ners to be more proactive to impending changes in channel demand and
supply by permitting them to more effectively synchronize and
optimize channel resources and capacities.
e-Procurement information . Working with suppliers today requires
two types of information: intelligence about collaborative relationships
and intelligence about supplier capabilities. Both are focused on a
single objective: to reduce supply chain risk. While many companies in
the past attempted to utilize EDI or merge ERP output, the results were
inward-facing and did little to enhance the integration and collaborative
relationships necessary to enhance the speed of transfer and depth of
information needed by sales and manufacturing management. With the
application of the Internet this gap in supplier intelligence is rapidly
disappearing, e-Supplier management is permitting today's cutting
edge companies for the first time to assemble a complete picture of
their supply relationships and apply Web technologies to enhance
traditional buyer functions , such as supplier product sourcing, e-RFQs,
auctions, trading exchanges , logistics interfaces, and automated shop-
ping applications, and Web-enabled services such as strategic sourcing,
fulfillment, collaborative design, and finance and billing .
Customer Relationship Management. As was discussed earlier in this chap-

ter, the central focus of today's e-supply chain is unparalleled customer ser-
vice. e-SCM utilizes the enabling power of the Internet not only to find ra-
dically new ways of servicing the customer, but also of generating new forms
of collaborative relationships that permit companies to design channel fulfill-
ment systems that meet the individual needs of each customer. The goal is to
align the core capabilities of unique configurations of channel partners to pro-
vide unique customer solutions any-where, at any time in the channel net-
work. Bovet and Martha [11] have termed such an organization a "value net"
and characterize the customer-supplier relationships that emerge as
"symbiotic," in that customer choices trigger a cross-channel reaction in
supply network sourcing, manufacturing, delivery, and information transfer to
meet the requirement, "interactive," in that the customer owner can assign
aspects of customer demand to the partner best able to perform the
requirement, and "value-enhancing," in that both the customer and the entire
supply channel ecosystem receive total value either through the streamlining
of costs or flawless execution of customer product and service needs.
e-SCM enables companies to enhance the concept of customer relationship
management (CRM). By implementing such Internet-enabled applications as
Web sites for marketing and catalog information, entering orders, reviewing
pricing, configuring orders, and participating in on-line auctions, self-service
capabilitie s ranging from training, to order review and payment, and analyt-
ical tools providing business intelligence regarding marketing and sales infor-
mation, the Internet provides the depth of information to provide the 360-
degree view of the customer required by CRM. e-SCM provides supply net-
works with the ability to respond to three critical customer requirements [12]:
1. Superior service. The goal of the supply chain is to provide the cus-
tomer with an unbeatable buying experience that not only meets but
dramatically exceeds price, product availability, delivery and service
expectations . Creating such a level of service requires two critical at-
tributes possessed only by "world class" value chains: speed of re-
sponse and a tireless attention to reliability . Speed means providing
the critical values customers want at the highest velocity of response
possible. Superior supply chains utilize the Internet to achieve such
goals by passing demand information not serially, but simultaneously
and automatically to supporting network partners through advanced
shipping notices, bar coded shipments, on-line transportation tracking,
and real-time fulfillment information. Reliability means executing the
perfect order each and every time. This attribute is attained when each
order is shipped complete and on time, received at the customer's site
when desired, and is ready for use. In addition, reliability requires sup-
ply chains to be flexible enough to respond to last minute changes

while never compromising high service levels.
2. Convenient solutions. In today's marketplace customers are searching
for supply chains capable of providing them not just products and ser-
vices but rather solutions to their business needs. In addition, custom-
ers should be able to define, configure, order, and review the progress
of demand fulfillment in as convenient a manner as possible. Effective
supply chains are able to leverage technologies that provide for the rap-
id deployment and synchronization of high performance networks cap-
able of responding to each customer touch-point. Visibility to customer
requirements in tum provides each channel partner with the opportunity
to integrate core competencies that ensure each customer can realize
their choice of product and/or service solution.
3. Customization. With the rise of the concept of mass customization,
customers are no longer willing to purchase standardized goods and
services, but instead require the ability to configure solutions to meet
their own particular needs. Meeting this challenge can be accomp-
lished in several ways. To begin with, supply chains may define strate-
gies that postpone and place actual product differentiation at the points
in the channel that actually touch the end-customer. Another strategy is
to utilize Internet-driven order entry systems that permit customers to
configure their own solutions from an extensive but controlled menu of
choices. The order is then communicated directed to the ERP planning
system for order manufacture. Often, the product is sent to other
channel partners who complete the work of final assembly and delivery
to the customer. Companies such as Dell, Sun Microsystems, ffiM, and
Gateway, for example, treat their reseller channels as extensions of
their own manufacturing processes, expecting them to complete the
final configuration based on the actual customer order. Channel
synchronization is crucial: customization requires direct linkage of
demand and supply at all points in the channel with the goal of
minimizing cost and accelerating total channel throughput.
Supply Chain Synchronization. Utilizing e-information to respond to the re-

quirements of the customer constitutes only two of the four components of e-
SCM. The ability to simply transmit and share demand and supply informa-
tion has always been present with tools like ED!. The real challenge is not
only to send information in real-time but also to present it concurrently so
that all points in the supply chain can receive it at the same time. The value
of such synchronization is obvious: intelligence concerning actual demand
and supply dynamics can be broadcast in real-time to all channel constituents
so that effective planning and operations decisions can be made. The benefits
are equally as obvious : minimization of work-in-process and finished good

inventories up and down the channel, dampening of the channel "bullwhip
effect" as products are pulled through the distribution pipeline, overall
reduced costs, and the perfect matching of customer requirements with
available products.
While supply chain synchronization provides channel trading partners with
radically new opportunities for competitive advantage, the concept is very
much at the beginning stage of development. In today 's environment supply
chain synchronization is limited by current interchannel information technol-
ogies and the level of their adoption. Networked computer systems are ex-
pensive to implement and have as yet to reach a critical mass. In addition, the
economic conditions of the early 2000s have caused companies to heighten
their focus on managing internal inventory, service, and costs. When they
have sought to utilize their trading partners it has been more to pressure them
into collaborative behaviors where one side wins and the other side complies
just to retain the business.
To be of value, supply chain synchronization requires all members of a
channel ecosystem to engage in partnerships that collectively optimize re-
sources and reduce costs. Such a channel system will require the creation of
highly integrated channel structures, cross-channel planning and control, and
information architectures capable of promoting continuous channel synchro-
nization through collaborative design. A synchronized supply chain will con-
sist of the following key components:
Unified business strategy. The development of a single, focused strate-
gy to gain channel-wide marketplace success is a critical starting-point.
In reality, most channel partners have always enjoyed a fair degree of
cooperation that enabled them to structure mutually supportive resour-
ces in pursuit of common customer-winning objectives. No company,
especially today, can say that it possesses all the strengths necessary to
remain competitive. As such, the creation of business strategies right-
fully extends beyond a company's boundaries and should be folded
within an inter-channel effort. Such an effort should result in the form-
ulation of joint strategies that foster the use of optimal methods of cost-
effectively designing, building, and delivering unique, customer-win-
ning value to the marketplace by leveraging the capabilities of the en-
tire supply chain.
Common measurements for channel excellence. Effective supply chain
synchronization requires all channel members to collectively achieve
superlative levels of operations excellence. Such an effort, however,
means more than establishing electronic transaction transfer or sharing
forecasts for joint planning and decision-making : it requires synchro-
nizing the performance of each channel member and blending them into
a total supply chain balanced scorecard. A quick view of these mea-

surement goals is provided in Table 1.2. A measurement methodology
that is growing in popularity that will assist with model development is
the Supply Chain Council's Supply Chain Operations Reference
(SCOR). The model includes a cross functional framework, standard
terminology, common metrics, and best practices that can be applied to
entire supply chains.
TABLE 1.2. Synchronized Performance Elements
Channel Function Function Measurement

Channel Management ERP data integration Reductions in inbound and
ED! and Web-driven outbound total costs
processing Levels of channel resource
Collaborative customer/ alignment with demand
supplier efforts Cycle time metrics
Utilization of outsourcing Velocity of product!
service transfer
Product and Service Product/service develop- Speed of new product

Processing ment design and roll-out
CPFR initiatives Cross-channel capacity
Manufacturing optimization
Procurement Changes produced by
Channel physical event notification and
distribution exception management
Levels of channel
inventories
Channel Customer CRM Channel sales and profits

Management Service/Call centers Channel customer service
Marketing levels
Order management costs
Fulfillment objectives
Channel Support Logistics Channel asset utilization

Assets Warehousing ROA
Administration Outsourcing costs
Selection ofenabling technologies. The foundations for effective chan-

nel synchronization rest on the ability of trading partners to synchro-
nize their internal business systems. Companies have always deployed
the latest technologies to link themselves with channel members. First
it was the telephone, the fax, and ED! that provided an information out-
let. Today, companies are equipping themselves with powerful Internet
applications that span intranets and extranets to enable participating
partners access to the applications and content objectives of each sup-

ply network node. The goal is the development of interoperable pro-
cess components that enable whole supply chains to encapsulate the
databases and processes of both member ERP backbones and front- and
back-end application such as CRM, HTMLlXML document integra-
tion, data warehouses, and various forms of trading exchange .
Supply Chain Collaboration. The last, and perhaps, most critical component
of e-SCM is to be found in the willingness of channel members to engage in
and constantly enhance collaborative relationships with other chan-nel
trading partners. What many companies have come to realize is that short-
term benefits brought about by logistics optimization and technology
automation are incapable of producing the radical competitive breakthroughs
that can be attained when channel partners strive to build long-term, collabo-
rative relationships. While the term "collaboration" has become today's new-
est buzzword and is subject to the same level of hype that accompanied JIT
and TQM when they first appeared, when linked to the other three compon-
ents of e-SCM it provides a powerful competitive force. As a supply web, e-
SCM is composed of two things - collaboration and synchronization. Collab-
oration is really an ability to share . Synchronization is possessing the chan-
nel intelligence to be able to know how the right product and the right service
can be accessed in the supply chain to satisfy the customer. Such statements
reinforce the view that e-SCS is not just enabling trading partners to employ
e-information and synchronization tools : it is demanding that companies up
and down the supply chain embrace the accompanying cultural and organi-
zational changes as well.
The application of collaboration to configure e-supply chains can have a
wide meaning . As stated in another work,
While the term describes an activity pursued jointly by two or more entities to
achieve a common objective, it can mean anything from transmitting raw data
by the most basic means, to the periodic sharing of information through Web-
based tools to the structuring of real-time technology architectures that enable
partners to leverage highly interdependent infrastructures in the pursuit of
complex, tightly integrated functions ensuring planning, execution, and
information synchronization [13].
One group of experts [14] divided the concept of collaboration into two
spheres of ascending collaboration intensity. In the first can be found techni-
cal collaboration. Collaboration here ranges from no electronic connectivity
to EDI and extranet, to server-to-server links, and finally to Internet applica-
tions providing real-time information and transaction synchronization. In the
other sphere can be found business collaboration. On the low end, collabo-
ration practices are at a bare minimum. As the level of collaboration intensi-
fies so does the requirements for business-to-business integration and syn-
chronization as it migrates from facilitating joint operations, to efforts fo-
cused on the coordination of network partner competencies, to joint visioning
where partners cooperate and compete as if they were a single channel entity.
According to Prahalad and Ramaswamy [15], each level of collaboration gen-
erates value through four critical drivers:
The collaborative capacity of intra-company management teams grows
in proportion to the level of collaboration intensity.
As collaborative intensity grows there is an exponential growth in the
need for more complex technical and business infrastructures to create
and extract value.
While unifying intra-channel business processes are critical in effecting
collaborative value, they are just the beginning of the possible col-
laborative opportunities.
Strategic planners must constantly search for and implement new tech-
nologies and management methods if supply network collaboration is to
continue to provide useable knowledge and new competitive insights.
While no one can disagree on the efficacy of collaboration, there are many
barriers inhibiting implementation . Perhaps one of the biggest impediments
is overcoming existing corporate cultures. Long-tradition and internal per-
formance silos often pose an almost insurmountable barrier to espousing an
environment encouraging openness, communication, and mutual-dependence.
Another barrier is trust. Companies fear that proprietary information will be
broadcast to partners who will in tum pass it on to competitors or use it for
unfair advantage. Collaborative relationships normally take years of good
will, investment in resources, and proof of mutual benefit. In addition, col-
laboration has often been confused with process reengineering. In reality,
while collaboration will increase efficiencies, such a short-term understanding
misses the real advantages found in the leveraging of channel competencies,
utilization of cross-channel best practices, and innovation. Finally, today's
technology presents real barriers . The incompatibility of channel computer
systems pose a serious deterrent to shared communications .
SCM AND LOGISTICS
As discussed earlier in the chapter, the science of logistics has evolved from a
purely operation function to a competitive weapon capable of providing
goods and services to the farthest regions of the supply chain. Originally, the
role of logistics was to provide cost effective warehousing and transportation
functions capable of meeting the day-to-day requirements of customer order

fulfillment and channel inventory resupply. By the mid-1990s , logistics had
risen to such a position of competitive importance that the concept required
reformulation, the strategic side morphing into supply chain management and
the tactical side focused on logistics operations execution. This section is
concerned with a discussion of logistics as a operations function.
DEFINING LOGISTICS
When referencing current literature, a number of adequate definitions of lo-

gistics can be found . Perhaps the most popular describes logistics as consis-
ting of the Seven R's: that is having the right product, in the right quantity
and the right condition, at the right place, at the right time, for the right cus-
tomer, at the right price. This common sense definition covers most of the
value-added functions performed by logistics operations. Logistics provides
pla ce utility by moving goods from the producer through each node in the
supply network to the demand origin . Logistics provides time utility by en-
suring that the goods are at the proper place to meet the occasion of customer
requirement. Logistics provides possession utility by facilitating the ex-
change of goods . Finally, logistics provides f orm utility through the use of
value-added processing and light manufacturing. Time and place utilities,
product movement and storage, and price and customer service are all
specified .
The most often quoted formal definition of logistics is the one composed
by the Council of Logistics Management. Logistics is defined as
the process of planning, implementing and controlling the efficient, cost-effec-

tive flow and storage of raw materials, in-process inventory, finished goods,
and related information from point of origin to point of consumption for the
purpose of conforming to customer requirements.
Equally as concise is the definition found in the APICS Dictionary (9th

edition) . Logistics is defined as
The art and science of obtaining, producing and distributing material and prod-
uct in the proper place and in properquantities.
These and other definitions imply that logistics creates competitive value by
optimizing operations cost and productivity, the efficient utilization of assets ,
facilitating internal business fulfillment functions , integrating external chan-
nel suppliers, and achieving conformance to performance standards . All defi-
nitions characterize logistics as serving three central functions . To begin
with, logistics is concerned with the storage of inventory. Activities occur-

ing in this function are inventory control, replenishment and procurement,
and the number, design, type, and location of storage areas and warehouses.
The second function focuses on the movement of inventory from the supplier
through the manufacturing and distribution channel, ending with delivery to
the end user. Pivotal to this function is the effective selection and use of
modes of transportation. The final, and most important, function found in the
above definitions is the capability of logistics to satisfy customer require-
ments.
FUNCTIONAL DEFINITION
Another way of defining logistics is to separate it into two separate, yet close-
ly integrated operations regions as illustrated in Figure 1.6. A definition of
these two regions is as follows:
Inbound Outbound
Logistics Functions Logistics Funct ions
Material Flow
FIGURE 1.6 Logistics management functions.
Materials Management . This component has been classically identi-

fied with the incomingjlow of materials, components, and products into
the enterprise. Materials management can be defined as the group of
operation functions supporting the cycle of materials flow from the pur-
chase, receipt, and control of production inventories, to the manu-
facture and delivery of finished goods to the channel system.
Physical Distribution Management . This function is normally associ-

ated with the outbound flow of finished goods and supporting services
through the distribution channel necessary to satisfy customer require-
ments. Often logistics is associated with the execution side of market-
ing and sales management, as it is concerned with the warehousing and
movement of finished goods and service parts through the distribution
channel to meet customer delivery demand. Detail activities encom-
pass warehousing, transportation, finished goods handling and control,
value-added processing, customer order administration, shipping, ser-
vice, and return goods processing.
It can be argued that breaking down logistics into the above two categories
is somewhat artificial, and to a large extent, the argument is justified. Al-
though materials management and physical distribution management have de-
fined functions, it is clear that there are many shared activities . In fact, many
of the same skills, knowledge, and management control processes necessary
to manage incoming and outgoing inventories, traffic, materials handling, and
warehousing are identical and are to be found in each area. Most distribution
organizations normally have a single department called "materials manage-
ment" or "logistics" that manages the matrix of distribution activities. Rather
than describing an organizational structure, the objective of establishing the
logistics concept is to communicate regions of discrete business functions in
order to facilitate understanding.
THE MAGNITUDE OF LOGISTICS
The sheer size of financial size of the logistics function bears witness to its
central place in the business economy. According to Delaney [16], the cost
of logistics for the year 2002 in the u.s. amounted to $910 billion. This ex-
penditure was equivalent to 8.7 percent of U.S. gross domestic product in the
same year. A breakdown of the detail can be seen in Figure 1.7.
LOGISTICS OPERATIONS
The daily activities of logistics are concerned with the management of the
following five operational elements : (I) network design, (2) operations plan-
ning and execution, (3) logistics partnership management, (4) application of
information technologies, and (5) logistics performance measurement. Each
of these critical areas will be reviewed in succession.
Network design. The network of manufacturing plants, distribution ware-

houses, and retail stores provides the physical pipeline by which products
$ Billions
Carrying Costs - $1.444 TrillionAll Business Inventory
Interest. .. 23
Taxes, Obsolescence, Depreciation, Insurance .. 197
Warehousing ; .. --.1L
Subtotal 298
Transportation Costs
Motor Carriers:
Truck- Intercity . 300
Truck- Local. .. -lQL
Subtotal 462
Other Carriers:
Railroads . 37
Water (International 21, Domestic 6) . 27
Oil Pipelines .. 9
Air (International 7, Domestic 20) . 27
Forwarders : . 9
Subtotal 109
Shipping RelatedCosts . 6
Logistics Administration . 35
Total Transportation Costs 910
FIGURE 1.7 Total logistics costs - 2002
find their way to the customer and information relating to marketing and
channel transaction events makes its way back to channel origins. The num-
ber, size, and geographical location of distribution facilities can be said to
have a direct impact on a company's ability to provide the levels of service
and cost demanded by the customer. Determining how many each of the dif-
ferent types of facility are needed, where they should be geographically locat-
ed, and the nature of the fulfillment functions performed is the starting point
in determining logistics strategy. Operationally, the logistics channel strategy
is concerned with finding answers to several critical questions . What is the
level of inventory to be stored at each location? How is inventory replenish-
ment planning to be performed? How are customer orders going to be alloca-
ted for fulfillment? How are transportation costs to be measured? Are logis-
tics partners to be involved, and at what point in the logistics network? In ad-
dition, marketing campaigns, new product introduction as well as product
phase-out, actions of competitors, changes in technology, capabilities of
channel partners, and others all will impact the viability of network strategies
over time. Logistics planners must continually review network strategies to
ensure they are providing optimal levels of customer service and compete-
tiveness .
Operations Planning and Execution. Logistics is charged with the daily ex-
ecution of a number of critical business functions. The overall goal of these
activities is the optimization of internal resources and their application to ef-
fectively respond to material management and customer fulfillment needs.
These functions can be separated into the following five operations areas:
Order managem ent. Perhaps the most important function performed by
logistics, this activity is concerned with the navigation of the customer
order through the inventory allocation , picking, pick relief, and back-
order cycles. The fundamental performance target is always ensuring
product shipment based on quoted lead times and order quantities and
quality specifications.
Production and procurement. While normally the reserve of other de-
partments, the production and acquisition of inventories is fundamental
to effective logistics. As the number of product families and distribu-
tion sites grow, many of today's firms have found that optimization of
product across multi-channels requires close coordination with logistics
or actual control by logistics planners.
Freight cost and service management. The main functions in this area
consist of managing inbound/outbound freight, carrier management,
total cost control, operations outsourcing decisions, and execution of
administrative services. Effective fulfillment planning in this area re-
quires the architecting of fulfillment functions that can optimize in-
bound materials and outbound product movement, warehousing, and
administrative services that utilize the most cost effective yet efficient
transportation partners and carriers.
Warehouse management. The effective management of inventory in the
supply chain requires efficient and well-managed warehousing techni-
ques. Among the activities found in this area of traditional logistics
management can be found inventory storage, material handling, equip-
ment utilization, receiving, putaway, and returns.
Transportation routing and scheduling. The movement of product is a
primary function of logistics. Areas to be considered are optimization
of shipping capacity utilization, decreasing less-than-truckload ship-
ments, and applying postponement strategies that assign actual end-
product differentiation to the optimal channel node. Another important
function is selection of third-part transportation providers. An often
overlooked area is shipment documentation and compliance. Key
points are concerned with ensuring accurate documentation regarding
country quotas, tariffs, import/export regulations, product classifica-
tion, and letters of credit.
Fleet management. When companies maintain their own fleets, it is the

responsibility of logistics to ensure the effective utilization of physical
transportation assets. Critical areas revolve around equipment utilize-
tion and maintenance, and total cost. The goal is to determine the opti-
mum use of transportation assets, whether internal or through a third
party supplier, without compromising service levels.
Load planning. Utilizing transportation assets to achieve maximum
fulfillment optimization requires detailed load planning. Critical func-
tions in this area are concerned with packaging and labeling, load
building and consolidation, and possible third party transfer point or
cross-docking functions.
Special functions. Often logistics must develop strategies and policies
to deal with several miscellaneous functions. Among these can be
found managing service parts inventories and working with return
goods. A grow area is handling reverse logistics . This process invol-
ves the reclamation of packaging materials and other wastes, and back-
haul to a central collection point for recycling. The object of the pro-
cess is the effective coordination of both the forward and reverse pro-
cesses necessary to fully utilize products and materials throughout their
life cycles.
While the effective management of each one of these areas is essential to or-
ganizational success, their benefits dramatically increase when the entire lo-
gistics channel network is integrated together in the pursuit of supply chain
optimization and development of robust, flexible sourcing, warehousing,
transportation, and delivery capabilities that unify total logistics capabilities.
Logistics partnership management. Providing agile and flexible fulfillment

to meet customer demands often requires logistics planners to utilize a third
party logistics (3PL) service provider. Over the past decade 3PL support
partners have become more valuable as they utilize new technologies and ex-
pand services that permit them to integrate into the supply chain systems of
their customers. Instead of being engaged merely to perform delivery func-
tions on a spot basis, logistics planners have come to depend on the close col-
laboration of their 3PLs to execute strategic objectives. Besides the core ser-
vices of motor cartage, transportation and warehouse leasing, warehouse op-
erations, small package delivery, customs and export management, brokerage,
and value-added processing, the utilization of Internet applications have en-
abled 3PLs to offer a variety of advanced services. Among these can be
found track and trace, rate negotiation/carrier selection, freight payables, re-
verse logistics, order fulfillment utilizing Web and EDI interfaces to custom-
ers and suppliers, compliance consulting, and advanced information and ma-
terial handling technologies. Some companies have even turned over the en-
tirety of their logistics functions to fourth-party (4PL) or lead logistics pro-
viders (LLP) that deliver a comprehensive logistics solution to their custom-
ers through a single point of contact.
Application of information technologies. Increasingly, logistics manage-

ment is turning to new forms of information technologies that utilize the In-
ternet to assist them in channel management. One of the most critical is ex-
panding shipment visibility. While it is critical that customers possess real-
time "track and trace" data regarding their shipments, it constitutes the very
first layer of service management. Of increasing importance is visibility to
information about product s and fulfillment capabilities found not just
between immediate buyer and supplier, but also among all network trading
partners. This requirement has become even more critical as the complexity
of the supply chain has deepened, caused by the increase in contract manu-
facturing, raw material providers extending several levels upstream, global
sourcing efforts requiring overcoming geographic boarders and language
barriers, and the establishment of often separate Internet sales functions.
Lack of shipment visibility simply increases fulfillment time delays, pro-
liferates inventory safety stocks, and amplifies the "bull-whip effect,"
especially in complex supply channels. Supply chain visibility is about being
able to access accurate infor-mation about inventory and shipments any-
where, anytime in the supply net-work so logistics planners can respond
quickly and intelligently.
Another critical area where information technologies tools are being ap-
plied is fulfillment event management. The goal of these applications is to
provide logistics planners with a window into the impact of events occurring
at different points in the supply chain. These tools provide several channel
fulfillment event information drivers such as
Monitoring: Providing real-time information about supply network
events such as the current status of channel inventory levels, open
orders, production, and fulfillment.
Notifying: Providing real-time exception management through alert
messaging that will assist supply channel planners to make effective de-
cisions as conditions change in the supply pipeline .
Simulating: Providing tools that permit easy and fast supply channel
modeling and "what-if' scenarios that recommend appropriate remedial
action in response to an event or trend analysis.
Controlling: Provides channel planners with capabilities to quickly and
easily change a previous decision or condition, such as expediting an
order or selecting less costly delivery opportunities .
Measuring: Provides essential metrics and performance objectives or

KPIs to assist supply chain strategists to assess the performance of ex-
isting channel relationships and to set realistic expectations for future
performance [19].
Event management applications provide logistics planners with functions
such as order and shipment tracking, workflow, alert messaging/notification,
escalation processes, and performance/compliance management that alert
them when an event violating predetermined fulfillment or channel stocking
parameters has occurred requiring planner intervention. Altogether, the bene-
fits of applying the latest computerized techniques that seek to automate lo-
gistics functions and increase the accuracy of logistics decisions can produce
enormous benefits not only for individual companies, but for entire supply
chains.
Performance measurement. Effective logistics performance requires the

successful execution of those values deemed essential by the customer. Es-
sentially, logistics performance is composed of three key metrics. The first,
logistics productivity, provides meaningful productivity standards, optimi-
zation of logistics costs, integration of quality management processes, and
broadening of logistics service levels. The second metric, logistics service
performance, tracks the ability of logistics functions to meet customer service
goals, such as product availability, order cycle time, logistics system flexi-
bility, depth of service information, utilization of technologies, and breadth of
postsales service support. The final performance component, logistics per-
formance measurement systems, details the content of the actual metrics and
how performance is to be tracked. Often this means working closely with
trading partners to ensure the proper data is being gathered from channel
SCM systems, ERP systems, and data warehouses [19].
Overall, logistics can be said to possess the following seven critical opera-
ting performance objectives [20]:
Service. Today's supply chain is about creating value as determined by
the customer. A value chain is about constructing agile, flexible opera-
tions that permit customers to configure the mix of product/service so-
lutions they need. Effective channel operations imply that the custom-
er-satisfying elements of manufacturing, product/service availability,
fulfillment, and service can be constructed to meet the unique require-
ments of every customer.
Fast flow response. This performance value refers to the ability of the
supply chain to fulfill the delivery requirements of each customer in a
timely manner. Rapid response requires the architecting of highly agile
and flexible channels where all forms of processing time are collapsed
or eliminated. Besides accelerating the order-to-delivery cycle, this at-

tribute also means migrating the supply chain away from stagnant pools
of buffer inventory driven by forecasts to an environment capable of
rapidly responding to each customer order on a shipment-by-shipment
basis.
Reduction of operating variance. In a Lean manufacturing and distrib-
ution environment variance in any sphere, from production, to quality,
to inventory balances, is not permitted. Operating variances can occur
both internally and externally out in the supply chain. Since logistics
productivity is directly increased when variances are minimized, one of
the most important duties of logistics management is the establishment
of processes for the continuous elimination of all forms of variance.
Minimum inventories. The levels of inventory necessary to support
company sales and revenue objectives are part of the entire supply
chain's commitment to customer service. The operating goal of logis-
tics is to continuously reduce inventory to the lowest level as part of the
process of achieving lowest overall logistics costs. Achieving this op-
erating goal means pursuing inventory minimization and tum velocity
for the entire supply chain and not merely one trading partner.
Transportation reduction. The movement of products across the chan-
nel network constitutes one of the most important supply chain costs.
Reduction in transportation costs can be achieved by closer inter-chan-
nel inventory planning and replenishment, utilization of larger ship-
ments over longer distances to achieve movement economies of scale,
and the effective use of third party service providers.
Quality management. Total quality management (TQM) is not just an
operating philosophy to be applied to manufacturing, but rather to the
whole supply chain. In fact, it can be argued that the requirement for
absolute quality is even more essential for logistics than anywhere else
in the company. Logistics transactions often deal with transporting in-
ventories and services over large geographical areas. Once set in mo-
tion, the cost of solving a quality problem, ranging from incorrect in-
ventories to invalid orders and late shipments, require lengthy and cost-
ly processes to be reversed.
Product life-cycle support. As stated above, environmental laws and
popular opinion has mandated an increase in reverse logistics func-
tions . Some of the critical challenges posed by recalls and returns are
that they often involve a complex paper and product trail from world-
wide sources, they can mean re-manufacturing, repairing, or destroying
the return, and they can influence just about every link within the
supply chain. Responding to this operational need requires logistics
planners to develop detailed return, recycle, and repair programs that

enable the efficient management of product life-cycles that can actually
provide companies with a wealth of information on product perfor-
mance, ease of use, defects , and consumer expectation.
THE ORGANIZATION OF LOGISTICS
The logistics function provides the physical aspect of channel management.

The activities of the marketing function are to manage the channel and facili-
tate customer transactions by coordinating product, price, and promotional
objectives . In contrast, logistics, regardless of the type of distributor, serves
three central functions: the storage and management of inventories, the move-
ment of inventory from the supplier through the distribution channel, ending
with delivery to the end user, and the realization of the place and time utilities
defined in the firm's marketplace strategy.
Logistics functions are generally structured around a combination of the
following three organizational models [21]:
Strategic versus Operational. This organizational model refers to the
position of logistics relative to other enterprise functions. In the past
logistics was treated as purely an operational function and considered
of minimal strategic importance. In contrast, in today's business cli-
mate successful companies have learned that logistics must occupy an
equal place alongside marketing, manufacturing, and finance. The
strategic importance of logistics has, furthermore, required a close
coupling of traditional logistics activities (warehousing, transportation,
customer service, and inventory) with corporate management.
Centralized versus Decentralized. Logistics functions can be admini-
stered from a centralized location, or authority can be decentralized
throughout the distribution channel. In a centralized logistics system,
activities are normally performed only at a corporate facility, managed
by a single department or individual. Firms using this organizational
model attempt to exploit economies of scale in transportation and stor-
age, order processing, and information systems by managing them from
a central location . Companies, on the other .hand, with decentralized
logistics systems are normally characterized as offering a diverse set of
products to a heterogeneous marketplace. The most important argu-
ment for using a decentralized structure is positioning products and ser-
vices close to the customer location.
Line versus Staff. Finally, logistics functions can be oriented around
line, staff, or a combination of line and staff. In a line organization, the
activities of logistics (warehousing, customer service, transportation,
etc.) are centralized into a department, similar to sales, accounting, and

production, and placed under the responsibility of a single manager.
Logistics in this environment is centered on the performance of daily
operational responsibilities. In contrast, in a staff organization logistics
functions are divided up among marketing and sales, production, and fi-
nance. Various staff activities serve to coordinate and administer the
line functions. Logistics in this model acts mostly in an advisory role
to the responsible departments. Most companies combine elements of
these two organizational models in order to optimize, coordinate, and
integrate enterprise logistics strategies and operations.
As is illustrated in Figure 1.8, organizational structures can take various
Model I
Corporate
Disncrscd Rcsnonsibilities
Managem en t
... ... ... ...

Inform ation Acco unting! Manufactu rin g! Marketin g!
Services Finance Operations ales
____ _ J _______ ___ ____ J _ _ _ _ ___ ____ ___ J __ ___ _ _ _______ J _____ _ _
., ., -. I
- ystcms Planning - Financial Perform- :- Engineering - Sale Forecasting :

nnce :- Purchasing - Customer crvicc ]
:- Production Planning - Channel tanage-:
,:- Production Manage- merit
~
:
I rn cnt - Outbound Trans- :
:- \ arehousing portalion :
:- Inbound Trans- - Finished Goods :
I I
: ponauon Invcnloric ,
1- ornponcnt lnven- I
l.o gistics FUllctiolls , . :
_________ ___ __ l
, tones
l --- ------ ----- ,1
Model II
Co r po ra te
Centralized Resoonsibilities
Management
... ...
Accounting!
-
- -- - - - - -
... .
Manufacturing!
...
Marketing/
Information
Logistic
ervices Finance Operations ale s
- Major
Logistic '
Activities
FIGURE 1.8 Types of logistics organizations.
forms based on the three organizational models detailed above. For the most
part, traditional methods of viewing the logistics structure have focused either
on a structure of dispersed responsibilities (Model I) or of consolidated re-
sponsibilities (Model II). Some may argue, however, that each possesses in-
herent weaknesses. In dispersed organizations, for example, logistics active-
ties tend to be performed in isolation from related activities, resulting in less
than optimal overall performance . Consolidated organizations, on the other
hand, tend to focus narrowly on departmental budgets, performance measure-
ments, and defense of departmental "turf." One approach has been to com-
bine the two models into what is called a matrix organization (Figure 1.9).
This structure is based on the simple premise that logistics activities are en-
countered in various business departments and are spread throughout the en-
terprise in basically a horizontal manner. As local responsibility presents the
optimal method of executing logistics functions, they should remain under
their functional departments. However, the management of costs and overall
direction is the responsibility of the logistics manager. In this sense, logistics
line managers are subject to both the functional departmental manager and
the logistics manager.
Markclin~1 Trans- Finance/

:\tanuraclurin~ En~inecrin~
Sales portation Accounting
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I
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I
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I
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I I I I I I I I
S
t I I I I I I I
I Procurement I I I I
I I I Process I I Customer Packing! : : Performance
I Product I I
Service Packaging I I
Systems
c I I I Engineering : : I I
I Planning I I I I I I
S I I I I I I I
FIGURE 1.9 Matrix Organization
The advantages of a matrix organization can be found in its flexibility in

adapting to most companies, its ability to provide enterprise-wide functional
integration and coordination on a strategic level, rather than just solving tac-
tical problems, and its placement of logistics as a responsibility center, en-
abling management by objective techniques. Despite the apparent benefits,
matrix management models suffer from a critical fault stemming from the fact
that lines of authority tend to become confused by making some functions re-
sponsible to two different managers. Issues can arise over conflicting man-
agement directives and differing performance targets.
TEAM-BASED ORGANIZATIONAL STRUCTURES
Since the early 1990s, companies have been exploring team-based manage-
ment techniques as an alternative to the traditional organizational models de-
tailed above. In the past, hierarchical structures of management were neces-
sary to ensure that essential information was collected and summarized, work
optimally designed and allocated, and execution activities supervised,
monitored, controlled, and checked as work was performed and moved from
one operator or function to the next. In today's fast-paced marketplace, the
shift to total customer service, and the availability of interoperable computer
networking have rendered this model obsolete. It has become increasingly
clear that the focus of the organization must shift from a concern with man-
aging internal operational performance measurements to an integrated supply
chain perspective. Today's customer wants extremely rapid delivery, in-
stantaneous answers to price and product availability, and immediate re-
sponse to changing requests all without incurring penalties in cost or quality.
Customer-based organizational strategies, therefore, must be based on opti-
mizing both internal capabilities as well as channel partner competencies to
react flexibly and quickly to the needs of the customer rather than on
actualizing company-bound performance metrics. Over the past decade, cor-
porations large and small have been "de1ayering" themselves in an effort to
remove needless structure that simply clogs the velocity of product and
information throughput and renders the organization unresponsive to the
marketplace. Two features have facilitated this process: the growing power
of computerized networking infrastructures and the rise of team-based
management.
As was discussed in Chapter 1, the revolution in information technology
has provided companies with exciting new opportunities for working with the
supply channel. Organizationall y, the most important facet of this revolution
is the ability of a variety of computer systems to be linked together by Inter-
net technologies to form an information network. Today, Web applications
move information freely across departmental functions, empowering users to
make decisions and perform activities that not only impact their own business
areas but also those of their channel trading partners simultaneously. Take,
for instance, advanced planning software that pulls inventory planning infor-
mation from the database server and, through the use of simulation tools that
include graphs and pie charts, enables planners to formulate several different
production capacity and order release sequencing plans. Once the optimal
choice has been decided on, the information is loaded back to the database
server for the use of planners in other departments . The more sophisticated
can also take these planning "events" and pass them through the Web to
channel suppliers for input into their planning systems.
The ability of Web-based technologies to network people enables the cre-
ation of focused virtual teams. As is illustrated in Figure 1.10, instead of an
organization structured around mutually exclusive tasks Gobs) and depart-
mental assignments (charters), team-based management views the organiza-
tion as a skills repository where individuals can be formed into teams hori-
zontally within a function or vertically across departments. Natural work
teams (composed of people who naturally work together) and cross-func-
tional teams (composed of members from several business functions in the
enterprise) have distinct advantages over traditional methods when it comes
to accelerating daily activities as well as problemsolving.
FIGURE 1.10 Team Networking
Teams have a much wider range of expertise, knowledge, and facts at

their disposal than do narrowly defined departmental task forces.
Teams have a broader perspective and therefore can consider a broader
range of approaches and alternative solutions.
Teams promote company-wide ownership of critical issues, thereby en-
abling a quick solution and facilitating implementation.
Teams are synergistic. The knowledge of individual team members
mutually stimulate collective thinking and the generation of solutions
unattainable by individuals or departments acting on their own.
Teams develop individual member capabilities by providing oppor-
tunities to lead, facilitate, manage tasks, and implement solutions
beyond their normal departmental functions.
When utilizing Internet-based SCM as an organizational model, companies
must depart radically from traditional structures and the way work is organi-
zed. Hierarchical management styles lack the flexibility and adaptability to

meet the constantly changing requirements of today's customer. In contrast,
organizations characterized by flat hierarchies and virtual teams management
styles have the ability to focus their resources into targeted teams to respond
quickly and decisively to business issues as they occur. To be successful,
these virtual organizations will require the following:
1. Multifunctional management specialists. In the past, managers needed
to be experts in their own departments . In today's environment of vir-
tual teams, managers need to have a wide functional understanding of
manufacturing, finance, scheduling, marketing, and customer service,
as well as warehousing and transportation . This is particularly true of
logistics management who must be able to assemble cross-functional
and cross-channel focused teams capable of linking logistics strategies
with the strategies of other business functions, and to work effectively
with supply chain partners to resolve conflicts and to actualize oppor-
tunities .
2. Technology-literate personnel. As information technology provides
new interoperability tools that automate functions and provide for the
closer peer-to-peer networking of professionals within the enterprise
and outside in the supply channel, companies will increasingly be de-
pendent on personnel who can leverage the power of technology to
achieve targeted business results . In addition, it is the responsibility of
the firm's personnel to continually search for new ways to utilize exist-
ing systems, as well as to search for newer technologies that will ac-
celerate the velocity of information transfer and network system consti-
tuents closer together.
3. Culture of continuous change and improvement. Traditional organiza-
tions were organized around optimizing functional roles in response to
static conditions. The business climate of the 2000s, however, requires
that enterprises be flexible and adaptable to meet changing marketplace
needs. The mindset necessary to actualize this challenge is an accep-
tance that change is the only management constant. The customer-driv-
en organization of tomorrow must be prepared to constantly improve
and redesign the organization in the never-ending search for superior
customer service and marketplace leadership.
SUMMARY
Over the past decade, it has become increasingly clear that to remain compet-
itive in the emerging global markets of the new century companies can no
longer depend on their own core strengths to drive marketplace leadership but
must look to the competencies of their supply chain partners for new avenues
of cost reduction and innovation. Six key dynamics are driving this dramatic
shift in both corporate governance and worklife at the dawn of the twenty-
first century. The first is the growing power of the customer. Instead of a
passive player, today's customer is seeking to expand their control over the
entire channel fulfillment process, demanding the power to configure the
product/service mix to match unique solutions, and flawless, fast flow de-
livery all at the lowest price. The second dynamic is the explosion in globali-
zation. This dynamic is characterized by the growth of strategic alliances and
partnerships on a global scale. The close interlinkage of companies along a
supply chain has produced the third dynamic, the establishment of inter-enter-
prise "virtual" organizations capable of leveraging the skills and resources of
a matrix of companies and the ability to utilize Internet technologies to ex-
ploit the peer-to-peer networking of channel partners anywhere, at any time
on the earth.
These factors have engineered a revolution in the fourth dynamic: logistics
management. Instead of a purely operational function concerned with the
day-to-day management of fulfillment activities, logistics has become a criti-
cal strategic enabler permitting companies to successfully manage complex
supply channel networks. As the focus of management has moved from the
company to the supply chain sphere, so have the requirements for effective
cost control and process improvement. The goal is to architect performance
models that optimize channel productive capabilities and activate highly
agile, lean, and scalable networks capable of being quickly reconfigured to
provide pathways of value to the customer. Finally, the last dynamic, infor-
mation technology, provides the interoperable infrastructure permitting chan-
nel partners to synchronizing information about demand and supply require-
ments and events across each network node in "real time."
Success in managing collectively these dynamics requires a new view of
the supply chain. As is the case with most ideas, supply chain management
(SCM) has its roots in the ages old struggle of producers and distributors to
overcome the barriers of space and time to deliver products and services as
close as possible to the desires and needs of the customer. Tracing this ev-
olution of the modem Internet-enabled supply chain can be said to have pro-
gressed through five stages. In the first, the role of distribution was simply to
execute the day-to-day activities of material management and fulfillment. In
this stage logistics functions were decentralized and absorbed into various
company departments such as sales and finance. In stage 2, companies began
to centralize what became to known as logistics into distinct departments in
order to better control the "total cost" of distribution by assigning it a man-
agement team and set of performance targets.
By the 1980s executives began to understand that a focus solely on logis-

tics total cost management presented a passive approach to the marketplace.
Organizational strategists began to consider a new model that sought to inte-
grate logistics with other business departments in the pursuit of both op-
erational optimization and as a way of enhancing customer value. Stage 3 lo-
gistics enabled companies to closely align logistics capabilities and mar-
keting, sales, and operations objectives to provide customers with a unified
approach to demand fulfillment. In Stage 4, the concept of integrated lo-
gistics was significantly enhanced by the growth of the concept of supply
chain management (SCM). The impact of new marketplace dynamics re-
quired businesses to look beyond the four walls of their companies to their
trading partners for new sources of competitiveness. Planners began to re-
gard the development of close collaborative relations with their channel part-
ners as critical in mobilizing the agile, scalable, lean organizations necessary
to match the speed of global business.
The application of the Internet to SCM provides the foundation for stage 5:
e-SCM. This most recent stage can be defined as a
supply chain operational and strategic management philosophy that utilizes

Internet-enabling technologies to effect the continuous regeneration of networks
of supply channel partners empowered to execute superlative, unique customer-
winning value at the lowest cost through the collaborative, real-time
synchronization of product/service transfer, demand priorities, vital marketplace
information, and logistics delivery capabilities.
e-SCM consists of four critical components. Enabling the full potential of e-

SCM requires strategists to first of all understand the connectivity power of
Internet-driven information . e-SCM enables the "real-time" synchronization
of information from all quadrants of the supply chain and provides for the in-
stantaneous visibility of events necessary for collaborative decision-making
across channel regions. Second, the goal of this interconnectedness of supply
chain information is to ensure new ways of providing customer-winning
value. "Value chains" continuously seek the generation of channels of
unique configurations of trading partners capable of providing solutions to
the unique, individualized needs and priorities of customers anywhere, at any
time.
While the use of e-information to respond to today's customer is critical,
the real challenge is to present it concurrently so that all points in the supply
chain can receive it at the same time. The value of such synchronization is
obvious: intelligence concerning actual demand and supply dynamics can be
broadcast simultaneously to all channel constituents so that effective planning
and operations decisions can be made. The final component of e-SCM is a
corollary of the preceding three: nothing will work without constant attention
among all channel partners to enrich channel collaborative relationships .
Collaboration is really about sharing. Synchronization is possessing the
channel intelligence to be able to know how the right product and service can
be accessed by the customer at any point in the channel network. Such a
management philosophy will require more than just acquiring the right con-
nectivity tools : it is demanding that all channel network partners embrace the
accompanying cultural and organizational changes as well.
The rise of SCM has expanded the role of logistics. SCM requires logis-
tics functions to shoulder the task of creating competitive value by optimizing
operations costs, efficiently utilizing channel assets, and facilitating supply
and fulfillment functions. The daily activities of logistics is concerned with
the management of five critical operations elements. The first is performing
the task of actual network design which involves determining how many of
each of the different facilities are needed, where they should be located, and
the nature of the tasks to be performed. The second activity is optimizing the
performance of the operational functions involved in order management, pro-
duction and procurement, freight costing and service management, warehouse
management, transportation , and load planning. The third activity is to de-
velop effective logistics outsourcing opportunities with service providers wil-
ling to engage in collaborative relationships. The fourth activity is to search
for and implement computerized technologies that assist in automating non-
value-added functions while providing tools to expand critical enablers such
as shipment visibility, fulfillment event management, and providing customer
with the ability to perform self-service ordering and shipment tracking.
Finally, the last activity is determining the cross-channel logistics metrics that
will allow effective review of company and channel productivity and service
performance through the establishment of performance systems permitting
the collection of data from business systems and data warehouses across the
channel network.
1. What is the relationship between SCM and logistics?

2. How can logistics functions influence economic systems?
3. Supply chains can be described as extended enterprises . What does this mean?
4. What has been the impact of the "power of the customer" on the utilization of
supply chains?
5. It has been stated that the changes brought about by global competition and the
power of the customer have radically changed the business climate. Describe
how these and other issues have required companies to rethink their logistics
functions.
6. Of the challenges facing today's distribution function, which will be the most
significant in the next several years. Why?
7. Whereas cost trade-offs are important in guiding enterprise decisions, they can
also have a negative affect on enterprise competitiveness. Discuss.
8. Why is the application ofIT tools to SCM so important?
9. What is impact on worklife and organizational behavior of the SCM concept?
REFERENCES
1. These comments have been summarized in part from Ross , David F.,
Introduction to e-Supply Chain Management: Engaging Technology to Build
Market-Winning Business Partnerships. Boca Raton, FL: St. Lucie Press, 2003 ,
pp . 2-4; Ross, David F., Competing Through Supply Chain Management:
Creating Market-Winning Strategies Through Supply Chain Partnerships.
Boston, MA: Kluwer Academic Publishers, 1998, pp. ix-xi; and, Coyle, John J.,
Bardi, Edward J., and Langley, C. John, The Management ofBusiness Logistics,
7th ed. New York: West Publishing Co., 2003, pp. 5-11.
2. Coyle, et al., p. 9 and Deloitte & Touche, "The Challenge of Complexity in
Global Manufacturing - Trends in Supply Chain Management," 2003 .
3. For more detail on the historical evolution of the SCM concept see Ross,
Competing Through Supply Chain Management, pp . 72-107 .
4. For an interesting historical approach to logistics in the late 1960's see the
articles in Bowersox, Donald J., LaLonde, Bernard J., and Smykay, Edward W.,
eds. , Readings in Physical Distribution Management : The Logistics of
Marketing . London: Macmillan, 1969.
5. For a more in-depth analysis of the problems besetting conventional SCM
channels see Small, Jeffrey C., "Convergence of Technology: The Supply Chain
Meets the Web," Supply Chain Management Review, 5, 1,2001, pp. 52-59 and
Harrington, Lisa H., "Adversity Breeds Creativity," Inbound Logistics, 22, 12,
2002 , pp. 43-46.
6. See the comments in Radjou, Navi, "Exit Supply Chains; Enter Adapative
Supply Networks," Supply Chain e-Business, (July/August) , 2002, pp . 42-43.
7. For a more detailed treatment of this topic see Ross, Competing Through Supply
Chain Management, pp . 13-33.
8. This definition has been adapted from Ibid, p.18.
9. Reary , Rob and Springer, Alicia, "Return on Relationship: a Different Lens on
Business," in Achieving Supply Chain Excellence Through Technology, 3,
Anderson, David L., ed., Montgomery Research, San Francisco, 2001, 41.
10. See the analysis in Haydock, Michael, "Supply Chain Intelligence," in Achieving
Supply Chain Excellence Through Technology, 5, Mulani, Narendra, ed., San
Francisco, CA: Montgomery Research, Inc., 2003, pp. 15-21 and Aberdeen
Group, "Strategic e-Sourcing: A Framework for Negotiating Competitive
Advantage," April, 2001.
11. Bovet, David and Martha, Joseph, Value Nets: Breaking the Supply Chain to
Unlock Hidden Profits. New York: John Wiley, 2000, p. 4.
12. These three principles have been defined in Ibid, pp. 37-53 .
13. Ross, Introduction to e-Supply Chain Management, p. 53.
14. Treacy, Michael and Dobrin, David, "Make Progress in Small Steps," Optimize
Magazine, November, 2001 , pp. 53-60.
15. Prahalad, C.K. and Ramaswamy, Venkatram, "The Collaboration Continuum ,"
Optimize Magazine, November, 2001 , pp . 31-39 .
16. Delaney, Robert V., "14th Annual 'State of Logistics Report,' The Case for
Reconfiguration," ProLogis/Cass Information Systems, June 2, 2003 , Figure #7.
17. See Ross , Introduction to e-Supply Chain Manag ement, p. 285 .

18. Ibid , pp . 280-281.
19. For a greater treatment of these basic measurements consult Bowersox, Donald
1. and Closs , David 1., Logistical Management: The Integrated Supply Chain
Process. New York: The McGraw-Hill Companies, Inc., 1996, pp. 41-43 .
rd
20. Lambert, Douglas M. and Stock, James R., Strategic Logistics Management, 3
ed., Homewood, IL: Irwin, 1993, pp. 632-633 . See also La Lande, Bernard L.
and Masters, James M., "Organizational Trends and Career Paths in
Distribution," in The Distribution Management Handbook, Tompkins, James A.
and Harmelink, Dale A., eds., New York: McGraw-Hill, 1994, pp. 7.5-7 .11.
2
COMPONENTS OF
DISTRIBUTION MANAGEMENT
DEFINING THE TERM UNDERSTANDING THE

"DISTRIBUTOR" WHOLESALE DISTRIBUTION
Supply Channel Components INDUSTRY
Channel Organizational Structures The Need for Wholesale
The Magnitude of Wholesale Distribution
Distribution Transaction Functions of the
Wholesale Distributor
CHARACTERISTICS OF THE Elements of Physical Distribution
WHOLESALE DISTRIBUTOR Flow Management
Types of Whole sale Distributors Wholesale Distribution Industry
Rise of New Forms of e-Businesses Challenges
ROLE OF THE DISTRIBUTION SUMMARY

FUNCTION
Although the components of modern materials and physical distribution man-

agement are comparatively easy to define, pinpointing exactly which compa-
nies are distributors and which are not is a much more difficult task. The def-
inition of what constitutes a distributor encompasses such a wide range of
businesses and marketing permutations that the ultimate results cannot help
but to be so all encompassing that they can be somewhat ambiguous. Often
the student of logistics finds that determining whether or not a company is a
distributor is best pursued by identifying the extent to which they perform
functions that clearly belong to other types of businesses, such as manufac-
turing or retailing. Ultimately, it can be maintained that all enterprises that
sell products to retailers and other merchants and/or to industrial, institution-
al, and commercial users but who do not sell in significant amounts to the ul-
timate customer can be termed distributors. In this sense, instead of being

confined to a narrow band of businesses, most companies that deal with the
disbursement of raw materials and finished products belong in one sense or
another to the distribution industry.
Chapter 2 focuses on defining the nature and functions of the distribution
industry. The chapter opens with a detailed discussion of the essential char-
acteristics of the distribution industry. Following this introduction, the
chapter turns to a full review of the various types of distributor, ranging from
wholesalers, brokers and agents, and manufacturers' and retailers' branches
and offices, to exporting and importing distributors. Special attention is paid
to the rise of new forms of distribution brought about by the Internet. Next,
the role of distribution is described. Among the topics covered are under-
standing the need for distribution, the channel functions performed by the
distributor, and the inbound and outbound material flows found within the
typical distribution organization. The chapter concludes with a brief over-
view of the challenges facing the multi-faceted distribution industry at the
dawn ofthe twenty-first century.
DEFINING THE TERM "DISTRIBUTOR"
References in the previous chapter to distributors or the distribution industry

assumed a general knowledge on the part of the reader as to the content of
these terms. Although there are some excellent definitions of logistics and
distribution, there are no good concise definitions of what constitutes a dis-
tributor. Webster's Dictionary, for example, defines a distributor as "one that
markets a commodity, such as a wholesaler." The APICS Dictionary de-
scribes a distributor as "A business that does not manufacture its own prod-
ucts but purchases and resells these products. Such a business usually main-
tains a finished goods inventory [1]."
Despite the relative simplicity of such generalized statements, arriving at a
functional definition of just what constitutes a distributor is a difficult one.
The term, for example, can apply to enterprises ranging from various forms of
stock jobbers, importers, cooperative buying associations, and drop shippers
to manufacture distributors, brokers, and commission merchants. In addition,
the growing power of Internet storefronts and e-marketplaces, giant retailers
like Wal-Mart, and alternative forms of distribution, such as warehouse clubs,
catalog sales, marketing channel specialists, and mail order, have blurred
functional distinctions and rendered traditional definitions tenuous. What is
worse, the term distributor often gets confused with definitions relating to
marketing channels . Bowersox and Cooper [2], for example, define market-
ing channels as "a system of relationships existing among businesses that par-
COMPONENTS OF DISTRIBUTION MANAGEMENT 61
ticipate in the process of buying and selling products and services." It could
be easily argued that such a statement provides a functional definition of the
essential activities performed by distributors. The truth of the matter is that
no matter what definition can be used, some easily hit the mark in some
instances, and completely miss the target in others.
SUPPLY CHANNEL COMPONENTS
Some of the vagueness surrounding the term distributor is the result of the
way the various players constituting the supply chain network have been
defined. As Figure 2.1 illustrates, the primary channel constituents have
traditionally been organized into three essential groups that reflect the basic
movement of goods through the channel. The first component, manufactur-
ers, are focused primarily on the development and production of products .
Although it is true that some products, such as wood, coal, and grains, often
by-pass manufacturing and move directly into the supply channel , manufac-
turing's role as a product originator places it at the opening stage of the distri-
bution process. Some manufacturers, such as Ford Motor Company, Sony,
and Gateway Computers, assume the responsibility of assembling and man-
aging a distribution channel, whereas others depend on trading partners to
perform that role.
Primary Channel Constituents
Materials
Wholcsale
Managcmcnt
Distributor
1 - - - - - - - - + 1 Retai ler Customer

Manufacturer
Filli.\!ted CO(1(l\' Flow

1 _
FIGURE 2.1 Supplychannel constituents.
If manufacturers can be said to originate the distribution process, then re-

tailers can be considered to be at the terminal points in the channel. Whether
performed by a manufacturer, a wholesaler, or a retailer, the function of
retailing is to sell good s and services directly to the customer for their per-
sonal, non-bus iness use. In contrast to manufacturers and wholesalers, re-
tailers have a completely different set of business decisions and objectives.

Among these concerns are identifying the target market so that retailing
operations can be optimally leveraged, meeting customer expectations with
the appropriate mix of product assortments, services, and store convenience
and ambience, and determining pricing and promotions that will provide com-
petitive differentiation. It would be a gross error to regard retailers purely as
passive channel members. Although many retailers are dependent on up-
stream channel suppliers, others, like Sears, Home Depot, Best Buy, and Wal-
Mart, take a very active role in the development and management of the
supply channel.
Somewhere in between manufacturers and retailers stands the wholesale
distributor. Because wholesale distributors are less visible than their two
channel partners and can assume a number of different forms, wholesaling is
more difficult to define. The traditional function of wholesale distributors in
the supply channel has been to serve as middlemen, providing retailers with
products originating from the manufacturer. Wholesale distributors exist be-
cause of their ability to act as a consolidator, assembling and selling mer-
chandise assortments in varying quantities from a number of manufacturers.
In addition, wholesale distributors also design and operate channel arrange-
ments between customers and those manufacturers who do not have distri-
bution functions. At the beginning of the twenty-first century, Internet appli-
cations and management philosophies, such as Just-in-Time (JIT)/Lean Man-
ufacturing and Quick Response, have enabled manufacturers and retailers to
expand their role to encompass many of the functions traditionally performed
by wholesale distributors. Although it can be expected that supply channel
members will continue the search for ways of eliminating pipeline costs and
improving customer service, wholesaling, as testified by the strength of such
companies as Burgen Brunswig, SYSCO, McKesson, and ACE Hardware, is
still an extremely important part of the supply chain.
CHANNEL ORGANIZATIONAL STRUCTURES
Commensurate with their channel roles, manufacturers, wholesalers, and re-

tailers will be organized differently. Manufacturers with distribution func-
tions can be organized according to one of three possible methods. The first
and most popular strategy is processed based. The object of this model is to
manage the entirety of enterprise functions as a single value-added chain.
The emphasis is on achieving optimal efficiencies and productivities by man-
aging marketing and sales, product development and manufacturing, logistics,
and finance as an integrated system. The second possible organizational
strategy pursued by manufacturers is market based . This strategy is con-
cerned with managing a limited set of logistics functions across a multidivi-

sional enterprise or across multiple-enterprise units. The object of the model
is to execute joint product shipments to customers originating across the en-
terprise or to facilitate sales and logistical coordination by a single-order
invoice. The final manufacturing strategy is channel based. In this strategy a
manufacturer seeks to manage the distribution process by forming functional
alliances with wholesalers and retailers. Enterprises that employ this strategy
typically have large amounts of finished goods in the supply channel [3].
The organizational structure of wholesale distributors reflects their position
as being the link connecting manufacturers with retailers. Because whole-
salers do not produce products, the focal point of operations is centered on
two critical functions: sales and the execution of logistics activities. In many
cases, wholesalers are much more conscious of marketing and sales issues
than manufacturers . Like retailers, the life blood of wholesaling is extremely
merchandise and promotion oriented, centered on strong order processing
functions and exceptional customer service. In addition to warehousing and
delivery, wholesalers today must also be organized to provide value-added
services such as ease of product search, EDI, Internet transactions, and value-
added processing.
Because they represent the end point in the supply channel, retailers are or-
ganized around meeting the needs and expectations of the end customer.
Similar to, but to a much greater degree than wholesalers, retailers are organ-
ized around promotions, selling, customer service, and inventory and ware-
housing functions. Typically, retailers stock a very broad assortment of prod-
ucts. A large grocery chain, for example, stocks over 11,000 products; mass
merchandisers and department stores stock even more. The supply channels
of retailers characteristically are geographically focused, with central sup-
plying warehouses generally located one or two day's delivery distance from a
cluster of stores. To facilitate this process, retailers are constantly restruc-
turing and integrating their organizations. For example, the traditional depen-
dence on central warehouses and transportation functions has been giving
way in the 2000s to leveraging manufacturing and wholesale channel part-
ners, or even to using a third-party service provider. Finally, today's retailers
have accelerated the process of buying direct from the manufacturer. Techni-
ques such as the use of EDI, the Internet, and centralized retail buying offices
that facilitate the process of cost-effective shipment consolidation and "milk-
run" delivery practices result in lower logistics costs while maintaining a high
level of customer service.
In addition to the three structures above, a number of enterprises exhibit
hybrid combinations. Of the three possible combinations, that of wholesaler
and retailer is the most common. An example of a typical hybrid organiza-
tion is a large food-service company identified by Bowersox [4).
This company operates a number of regional distribution centers, each serving

approximately 5,000restaurants or other food-service establishments. Products
are sold at wholesale prices to these traditional customers. Over the past ten
years, this firm has begun to open retail stores which sell wholesale products at
discount retail prices directly to consumers. Typically, the firm operates a
single retail location in a given city. The image maintained at retail is one of a
large, institutional package size store with few conveniences. The appeal is
price, unusual products or large sizes, coupled with the feel of shopping at
wholesale.
Another example is Wal-Mart's Sam's Wholesale Club which presents cus-

tomers with a wholesale type of retail environment. Regardless of the mix of
enterprise type, hybrid operations pose special organizational challenges.
Among the most important is the logistical capability of the company to sup-
port supply channel positions occurring on multiple levels.
Because of the great variety of distributors, there can be no optimal organi-
zational structure that fits all channel components. The actual structure of an
organization is dependent on a number of factors, such the goals of the busi-
ness strategy, availability of capital, extent of international involvement,
nature of the product, capacities of transportation, capabilities of information
technologies, and predilections of the enterprise's management. Often com-
panies occupying similar positions in the supply chain can have radically dif-
ferent organizations. Bowersox, for example, found two large mass mer-
chandisers with different views of the supply channel. One company was
heavily committed to maintaining an extensive distribution channel, whereas
the other sought to eliminate their channel structure, preferring to pursue
direct shipments from the manufacturer/wholesaler to retail outlets [5].
THE MAGNITUDE OF WHOLESALE DISTRIBUTION
Although the wholesaling industry has been losing ground over the past
decade to alternate forms of distribution, it still represents a formidable
portion of the U.S. total economy. Merchant wholesale distribution sales in
1992 approached $1.9 trillion dollars. This figure can be contrasted against
the 1997 sales figures by Special Industry Code (SIC). According to the U.S .
Department of Commerce, Bureau of the Census, in 1997 total durable
wholesale distribution sales in that year amounted to $2.1 trillion, whereas
nondurable wholesaling amounted to $1.9 trillion. Altogether, wholesale dis-
tribution sales totaled $4.1 trillion. In addition to these figures, the wholesale
distribution industry consisted of approximately 455,000 enterprises. These
companies, furthermore, employed 5.8 million people.
CHARACTERISTICS OF THE WHOLESALE DISTRIBUTOR
Although the above descriptions provide a useful way of categorizing the dif-
ferent types of industry constituting the supply channel, it only indirectly
sheds light on which businesses can be considered as "distributors." The
problem can be resolved by abstracting the essential characteristics of what
constitutes the functions of a distributor. Essentially, three fundamental char-
acteristics are apparent: the acquisition of products, the movement of prod-
ucts, and the nature of product transactions.
Product acquisition. Current definitions describe distributors as ac-
quiring products in a finished or semi-finished state from either a man-
ufacturer or through another distributor higher up in the supply chan-
nel. These products are then processed to a finished state and/or sold
as-is to other levels in the supply chain for resale or to be consumed in
the production process. These functions can be performed by indepen-
dent channel intermediaries or by the distribution facilities of manufac-
turing companies .
Product movement. The central activity of a distributor is the manage-
ment of product delivery. Delivery encompasses those activities neces-
sary to satisfy the marketing utilities of time, place, and possession by
ensuring that the right product is available to the customer at the right
time and place. Often this means that a distributor must maintain a
structure of central, branch, and field warehouses that are geographi-
cally located to achieve optimum customer service based on marketing
analysis. When an internal distribution channel exists, network plan-
ners must also ensure the timely movement of product to stocking
nodes within the network, as well as externally to the customer. In this
sense, any manufacturer or retailer that must expend significant effort
on product movement up or down the supply channel is performing the
functions of a distributor. .
Product transaction . For the most part, distributors can be character-
ized as selling products in bulk quantities solely for the purpose of re-
sale or business use. Downstream businesses will then sell these prod-
ucts to other distributors , retailers who will sell them directly to the end
customer, or manufacturers who will consume the materials/compo-
nents in the production process. This characteristic can best be seen
when contrasted with retailing . Classically, retailers sell products indi-
vidually to the final customer through a wide variety of outlets, such as
department stores (Bloomingdale's), specialty stores (boutiques), super-
markets, superstores, or combination stores (Wal-Mart), discount
stores, warehouse stores, and catalog showrooms. Often the division
between retailing and distributing becomes unclear when it comes to

direct marketing forms of product transaction. Companies who sell
through a catalog, perform telemarketing activities, or engage in televi-
sion marketing and Internet shopping can be selling either to the end
customer or for resale. Finally, large franchising and merchandizing
conglomerates, such as McDonald's, Nordstrom's, and Gateway, con-
tain complex distribution functions responsible for the transaction and
movement of product to independent affiliates or corporate chain
stores.
The three functional characteristics describing a distributor come very
close to the formal definition of wholesaling as formulated by the U.S.
Bureau of the Census.
Wholesaling is concerned withthe activities of those persons or establishments

which sell to retailers and other merchants, and/or to industrial, institutional,
and commercial users, but who do not sell in significant amounts to ultimate
consumers.
Accepting the ultimate logic of this definition would mean that every sale
made by every organization to anyone but the end consumer would be a
"wholesale sale." Such an interpretation would apply to merchant whole-
salers, all manufacturers (except those who sell to the public from factory
outlets), internal supply chain replenishment management, mail-order distrib-
utors, Internet sales, and mega-retailers that possess distribution channels.
This definition becomes clearer when the idea of a distributor is separated
from being attached to a type of business and is thought of as a series offunc-
tions. Although it is true that many manufacturers and retailers have created
vertical organizations to eliminate wholesale distributors from their supply
channels, they have become, in the process, distributors as well as product
producers and retailers. Regardless of the identity of the players within a
given supply channel, the three characteristics of a distributor outlined above
must be assumed by one or multiple channel members.
This definition of what constitutes a distributor is perhaps the most funda-
mental principle in this text. By adopting this definition, the scope of this
book can be expanded to cover nearly every form of materials management
and physical distribution activity performed by channel constituents, except
for the processes of manufacturing and retailing. Instead of concentrating
just on marketing channels or logistics functions, the text seeks to explore the
great diversity of distribution in various business environments. As stated in
Chapter l, this viewpoint has particular relevance in today's business climate.
As the opportunities and challenges of global distribution accelerate and com-
panies scramble to find ways of gaining and sustaining competitive advan-
tage, the traditional divisions among producer, wholesale distributor and re-
tailer will become even more tenuous. In addition, the rise of supply chain
management requires that all channel network trading partners be increasing-
ly focused on superior customer service through the application of technology
and management techniques that seek to integrate product, delivery, and en-
terprise resources. In this, an understanding of the principles and functions of
distribution stand as essential for survival in today's extremely competitive
global economy.
TYPES OF WHOLESALE DISTRIBUTORS
In this section the various types of wholesale distributor will be detailed.

Distributors can be divided into five general types: merchant wholesalers,
brokers and agents, manufacturers' and retailers' branches and offices, export-
ing and importing distributors, and miscellaneous wholesalers. Each of these
areas are described below [6].
Merchant Wholesalers. Merchant wholesalers are independent enterprises

that buy finished products from producers and other wholesalers and sell to
companies for resale or manufacturing consumption. Although this type of
business has been declining over the past decade in response to challenges
from powerful retailers, such as Wal-Mart, and alternative channel marketers,
such as warehouse clubs and Internet sales, merchant wholesalers account for
at least 50 percent in sales volume and number of businesses of all types of
wholesale distributor. Merchant wholesalers can be further divided into full-
service wholesalers and limited-service wholesalers .
Full-Service Wholesalers. This subtype of distributor provides a wide
range of products and services to the customer. Besides stocking in-
ventory and maintaining a sales force, other value-added functions such
as sales order management, credit, transportation, EDI, and Web com-
munications are also performed. In this grouping can be found the fol-
lowing types of companies.
- Wholesale Merchants. This type of distributor generally provides
products and a full range of value-added services to the retail in-
dustry. Wholesale merchants can be categorized further by the ro-
bustness of the product lines they offer to the marketplace. General
merchandise wholesalers will normally stock a targeted range of
products within several merchandise lines in an effort to service
both multi-line and single-line retailers . In contrast general-line
wholesalers will carry an extensive assortment of products in one or
multiple product lines. Auto parts, drug store, and clothing whole-
salers are possible examples. Finally, specialty wholesalers focus

on carrying in great depth the products of a single line. Examples
include produce, meat and fish, and fashion apparel wholesalers.
- Industrial Distributors. This type of distributor is composed of
wholesale merchants who sell products exclusively to manufactur-
ers. Similar to retail distributors, they may carry a multitude of
products lines (often called a mill supply house), a general line, or a
specialty line. Many industrial distributors also may focus their in-
ventories around MRO items (maintenance, repair, and operating
supplies), OEM items (original equipment supplies), or industrial
equipment (such as machinery).
Limited-Service Wholesalers. Distributors in this type are character-
ized by the fact that they offer a limited range of services to their sup-
pliers and customers. There are several kinds of distributor in this sub-
group.
Cash-and-Carry Wholesalers. This type of distributor normally
stocks a limited line of fast-moving products that are sold to small
retailers. Cash-and-carry distributors require the customer to pick
up and pay for the goods at the point of transaction. An example
would be a small grocer who each morning picks up and pays for
vegetables from a produce distributor.
Truck Wholesalers. Often termed a truck jobber, this type of dis-
tributor performs primarily a selling and delivery function only.
They normally carry a limited line of products (such as milk, bread,
and soft drinks) that they sell for cash to supermarkets, small gro-
ceries, restaurants, business and institutional cafeterias, and hotels.
Drop Shippers. This type of distributor operates in industries as-
sociated with commodities handled in bulk, such as building mate-
rials, coal, lumber, and heavy equipment. Drop shippers normally
do not inventory or transport the product. When they receive a cus-
tomer order, they will locate a suitable supplier who, in tum,
delivers the product to the customer. Drop shippers assume title and
risk for the inventory from the moment the order is placed with the
supplier until the time it is delivered to the customer.
Rack Jobbers. This type of distributor normally provides highly ad-
vertised, brand-name nonfood products and accompanying services
to grocery, convenience, and drug stores. Examples of products sup-
plied by rack jobbers are toys, paperback books, greeting cards,
hardware items, and health and beauty aids. Rack jobbers are re-
sponsible for delivery of the product to the retailer, product setup
and display, pricing, item rotation, effectivity dating, and inventory
maintenance. Inventories are stocked in consignment: that is the

rack jobber retains title to the inventory, billing the retailer only for
the goods sold since the last visit.
Producers ' Cooperatives. This type of distribution organization is
formed by a group of agricultural producers who assemble food
products from co-op members for sale in local markets. An im-
portant goal of these organizations is the promotion of brand names,
such as Sun Maid raisins or Sunkist oranges, and increased product
quality. The profits from sales are distributed to the members at
year's end.
Mail-Order Wholesalers. This type of distributor depends on the
sale of products from a catalog. Customers span the range from in-
dustrial to retail and institutional. Products are selected from the
catalog, and then delivered by mail, truck, or other means of trans-
portation. Their main customers are located in rural or geographi-
cally isolated regions.
Brokers and Agents. This category of distributor differs from merchant

wholesalers in two important regards: they do not take ownership of inven-
tory and they offer their customers an extremely limited number of services.
For the most, part their function is to act as middlemen, who for a commis-
sion, facilitate the buying and selling of products between suppliers and cus-
tomers. Similar to merchant wholesalers, they generally specialize by prod-
uct line or customer types.
Brokers. The primary role of brokers is to serve as middlemen, bring-
ing seller and buyer together and assisting in price, product, and de-
livery negotiations . Brokers do not take possession of inventories, as-
sume risk, or provide financing. They are usually paid for their
services by the party that contracted them.
Agents. There are several types of buyer and seller agents who re-
present or are contracted to represent either the producer or act in the
role of a buyer.
Manufacturer's Agents. Also termed manufacturers' representa-
tives, these independent agents usually represent two or more manu-
facturers that produce complimentary product lines. Normally, they
enter into a formal written agreement with each manufacturer re-
lating to pricing policies, territories, order handling procedures, de-
livery service and warranties, and commission rates. Most manufac-
turers' agents are small firms composed of highly skilled sales
people who have an extensive knowledge of the products they repre-
sent and the best marketplaces in which to sell them. They are often
contracted by small manufacturing firms that cannot afford an exten-

sive sales force, or large manufacturers who wish to explore new
marketplaces but which as yet do not generate sufficient revenue to
support a full-time sales staff. Manufacturers' agents are used to sell
such products as furniture, apparel, and electrical goods.
Selling Agents. In contrast to manufacturers' agents, selling agents
are contracted by a manufacturer to sell the firm's entire production
output. In most cases, the manufacturer does not wish or is incapa-
ble of employing a sales staff. Functioning as the de facto market-
ing and sales function of the company, they have a significant influ-
ence over prices, buying terms, and conditions of sale. This type of
agent is found in such industries as textiles, industrial machinery
and equipment, coal and coke, chemicals, and metals.
Purchasing Agents. This type of agent is normally a product expert
who, besides obtaining for the customer the best goods and prices
available, can provide consultative services. Purchasing agents gen-
erally have a long-term relationship with their customers, often pur-
chasing, receiving, inspecting, warehousing, and shipping the goods
to customers based on agreement with company buyers.
Commission Merchants . Often termed commission houses, this type
of agent takes possession of goods from the producer and then sells
them in the marketplace for the best price. After deducting a fee
covering the commission and miscellaneous expenses, the balance is
then passed back to the producer. They are most often used in agri-
cultural marketing by farmers who do not wish to sell their own pro-
duce or who do not belong to a producers' cooperative.
Manufacturers' and Retailers' Branches and Offices. The third major cate-
gory of distributor consists of manufacturers and retailers who perform the
functions of sales and distribution themselves without the assistance of an in-
dependent wholesaler. Organizations in this category operate either as
wholly owned and operated divisions of a manufacturing or retailing compa-
ny or as independent businesses belonging to a large, multicompany corpora-
tion. Manufacturer channel formats can be described as follows:
Factory Direct. In this format, product is shipped and serviced directly
from the manufacturer's warehouse. Company catalogues, the sales
force, or agents are responsible for the sale.
Sales Branches and Offices. In this format can be found manufacturers
who distribute their own products through simple or complex matrices
of sales offices and channel warehouses. Sales offices do not carry in-
ventory but are responsible for regional marketing, pricing, promotion,
customer order processing, and customer service. In contrast, channel

warehouses do stock inventory targeted at satisfying local marketplace
delivery and services requirements.
Manufacturer-Owned Full-Service Wholesale Distributor. This fonnat
describes an acquired wholesale distribution company serving the
parent's markets. Typically, these enterprises form the connecting link
between a company's manufacturing and distribution operations. When
demand warrants, these companies will also distribute the products of
other manufacturers . Examples can be found in the clothing and ap-
parel industries.
Manufacturer's Outlets. These stores are actually retail outlets located
in high-density markets. Although they are primarily used to liquidate
seconds and excess inventory, such as designer clothing and athletic
wear, they, nevertheless , provide easy access to branded consumer
products.
License. In this fonnat, a manufacturer contracts with an independent
distributor or retailer, granting product and marketing function exclu-
sivity for a specific period of time. This distribution method is often
used for products in the development stage of their life cycles.
Retailer channel formats can be described as follows:
Franchise . In this format, product, brand recognition, and marketing
expertise are sold to small entrepreneurs who in tum execute the func-
tions of product sales and delivery.
Buying Clubs. Although largely consumer oriented, this format pro-
vides manufacturers with the opportunity to penetrate certain niche
markets or experiment with product variations. Normally, product se-
lection is limited and products are usually sold in bulk quantities.
Mail Order/Catalog. In this format, product is sold through catalog lit-
erature. Normally, a central or regional distribution centers are re-
sponsible for warehousing and shipping direct to the customer.
Food Retailer. This type of retailer sells a wide range of foodstuffs,
health and beauty aids, and general merchandise bought from manu-
facturers and wholesalers . Warehouses are used as consolidation
points to facilitate receiving and inventory deployment.
Department Stores and Mass Merchandisers. These types of national
retailers stock a broad mix of soft goods (clothing, food, and linens)
and hard goods (appliance and hardware). Distribution centers act as
receivers and consolidators, often with a direct link with the manufac-
turer.
Exporting and Importing Distributors. The fourth major category of distrib-

utor consists of companies that specialize in international distribution. The
strategy of some multinational organizations is to develop and maintain their
own international supply channels, complete with foreign sales offices and
warehouses. Others may choose to engage in global trade by using an inter-
national distributor. The various types of international distributor are de-
scribed below.
International Trading Company. This type of international interme-
diary performs many functions. Among them are the purchasing and
selling of goods, arrangement of logistics services between the exporter
and the importer, financing currency conversion and rate fluctuations,
assisting with consulting advice, and other marketing and logistics
issues.
Export Merchants . Export merchants act as a form of international
wholesaler. Similar to merchant wholesalers in the domestic market-
place, they purchase goods from domestic manufacturers and whole-
salers and then pack and ship them to distribution points in foreign
markets. Although some export merchants may have facilities located
in foreign countries close to the target market, they mostly deal with
foreign distributors in the country of destination.
Resident Buyers . Large international firms will often locate their own
buyers directly in an exporting country. Their responsibility is to
locate, purchase, and ship goods back to their home country or to com-
pany distribution facilities across the globe.
Export Commission House. This type of international intermediary
performs the same functions as a resident buyer, except that the buyer
is not a company employee but rather a contracted agent empowered to
negotiate, buy, and ship products located in foreign markets. In return,
the agent is paid a commission by the foreign buyer.
Allied Manufacturer. In this type of arrangement, firms will export and
import products by using a foreign business partner. Normally, both
companies will negotiate to "piggyback" their products through the
international channel. There are a number of advantages. By carrying
each others products, both firms can improve market share by pre-
senting foreign markets with extended product lines, or achieving high
logistics utilization. The end result is that both companies can enjoy
the benefits of a mature foreign distribution system without the invest-
ment.
Export Management Company. This type of distributor acts as a prod-
uct line or foreign market specialist, who represents that export for one
or a group of noncompeting manufacturers and/or distributors. Al-
though most act as selling agents for the companies they represent,
some of the larger firms will stock inventories for resale.
Miscellaneous Distributors. In addition to the categories detailed above,

there also exist specialized distributors found in certain sectors of the
economy, such as agricultural assemblers, petroleum bulk plants and
terminals, and auction companies.
Durable and Nondurable Goods Distributors. Distributors can also be cate-

gorized by the type of goods that they sell. There are two classifications of
goods: durable and nondurable. Durable goods can be defined as products
that are designed to last for an extended period of time without rapid deterio-
ration or obsolescence. Examples of products in this group are motor vehi-
cles and automotive parts and supplies, construction materials, professional
and commercial equipment and supplies, metals and minerals, electrical
goods, hardware, plumbing and heating equipment and supplies, machinery,
equipment, and supplies, and miscellaneous goods such as sports equipment,
toys and hobbies, jewelry, and scrap and waste materials. In 1997 total sales
for this category totaled $2.2 trillion.
Nondurable goods can be defined as products that are consumed or must
be consumed quickly or that deteriorate rapidly. Products in this group
consist of paper and paper products, apparel and footwear, groceries and pro-
cessed foods, raw farm products and materials, chemicals and allied products,
distilled beverages, and miscellaneous goods such as printed matter, flowers
and nursery stock, tobacco, and paints, varnishes, and supplies. Total sales
for nondurable goods totaled $1.9 trillion in 1990.
RISE OF NEW FORMS OF e-BUSINESSES [7]
While the forms of wholesale distribution described above are a permanent

feature of today's economic landscape, the rise of new and very different
types of Internet-driven e-businesses have required their inclusion as a critical
type of distributor. Historically, distributors have existed because of their
ability to serve as intermediaries, providing retailers with products originating
from the manufacturer or direct sales to the end-customer. Their ability to act
as aggregators, assembling and selling merchandise assortments in varying
quantities originating from a number of manufacturers fills a critical position
in the economy. With the advent of e-business, this traditional role has come
under attack. In the high-flying days on the dot-com, it was even suggested
that the wholesale distributor would eventually disappear as they were "dis-
intermediated" from the supply chain.
The argument was compelling. By combining the advertising and ordering

capabilities of the Web, even the smallest of companies could now by-pass
costly channel intermediaries and be able to present its products and process
orders from anywhere in the world, at any time. In addition to the growth of
direct sales, the Internet also provided the opportunity for the birth of a new
type of "electronic marketplace" where buyers and sellers were brought to-
gether through auction sites, private exchanges, buyer/seller matching, and
other functions. The Internet seemingly had provided all companies with the
power to continuously reconfigure their supply networks, eliminating costly
channel partners, streamlining the flow of information and products, and en-
abling the creation of radically different types of customer value.
Although this process of supply channel "disintermediation" has been iden-
tified as signifying the coming end of the traditional broker, distributor, and
freight-forwarder, such prognostications have proven to be premature. While
some are doomed, forward-thinking channel intermediaries have been build-
ing new competencies by using the Internet to "re-intermediate" themselves
at critical points in their supply channels. According to AMR Research, the
traditional linear, sequential supply channel will give way to the evolution of
real-time, electronically connected networks composed of the traditional
players described above, joined by a number of nontraditional intermediaries.
In the past, companies used vertically integrated business models to cut costs
from the channel system, speed transaction through-put, and connect directly
with the customer. In the "Internet Age" savvy entrepreneurs will utilize the
Web to transfer non-value-added functions to channel partners while continu-
ing to cut costs and tightening their connection to the marketplace.
In contrast to traditional supply chains where inventory flows down
through the channel network node by node, the new Internet-enabled "cyber-
mediaries" may never even own or physically inventory the product. Their
role in the supply network is to leverage the Internet to perform matching of
products and buyers or coordinate marketing and transaction . processes
among network trading partners. Take for instance the partnership between
Amazon.com and Circuit City. The partnership is designed to provide shop-
pers with the option of buying electronics from the Amazon Web site and
then picking them up at one of 600 Circuit City stores or having them sent
directly to consumers' homes. Amazon, who will never touch the product,
will be able to increase its consumer electronics inventories by several
thousand items and will receive a percentage of the sales originating from the
Web site.
According to AMR Research [8] at least four new e-SCM business cyber-
mediary models are emerging today:
Virtual Manufacturers. This channel component actually does not
physically manufacture any products. Its role is to control product de-
velopment, marketing, and sales as well as coordinate customer service

for its products . An example is Sun Microelectronics which outsources
the manufacturer of its electronic boards while retaining control of all
product designs .
Virtual Distributors. This channel component neither owns any ware-
houses nor does it physically distribute any products . Its role is to per-
form marketing and sales functions while coordinating order manage-
ment by using contract manufacturers, third-party logistics, and fulfill-
ment service providers.
Virtual Retailers. This channel component does not own any "brick-
and-mortar" stores, but rather utilizes the Internet to present to custom-
ers products displayed in on-line catalogs and other Web mediums. e-
Tailers like Barnes and Noble.com and Grainger control the order man-
agement process while relying on their own distribution capabilities, or
those of partners, to execute order fulfillment.
Virtual Service Providers . This channel component provides channel
services without possessing any physical assets. Examples would in-
clude lead logistics providers (LLPs) that perform contract logistics
functions or logistics exchanges (LX) which use Internet exchanges to
purchase and monitor logistics functions.
As time moves forward, it can be expected that new e-business models will
appear. The goal of all such virtual business models is to leverage the Inter-
net to locate and use channel partners to perform non-core functions while
linking supply networks closer together by providing for the sharing of real-
time information and decoupling the flow of goods and information from
traditional supply chain flows.
ROLE OF THE DISTRIBUTION FUNCTION
Whether carried out by the sales and distribution division of a manufacturing

company, a mega-retailer, or by an independent merchant wholesaler, there
are a number of critical functions performed by the channel distributor.
These functions are described below.
Selling and Promoting. This function is extremely important to manu-

facturers. Whereas retailers develop complex place and promotion strategies
to reach the marketplace , manufacturers have only a limited number of loca-
tions and have great difficulty in executing sales, promotions, and fulfillment
as customers are located geographically further from the home factory. To
counter this deficiency , manufacturers can pursue two strategies. In the first,
the manufacturer establishes its own marketing and direct sales staff re-
sponsible for channel development and logistics and locates finished goods
warehouses close to wholesale and retail customers. The advantages of this
strategy are direct control over products, pricing, and marketplace identity.
Disadvantages include the people, physical plant, and inventory carrying
costs associated with the maintenance of these organizations.
The second strategy involves the use of a wholesale distributor to carry out
the responsibilities of product deployment. Wholesalers have direct-selling
organizations, are often marketing experts in their industry, and have a detail-
ed knowledge of local customers and their expectations. What is more, be-
cause of the scale of operations and specialized skill in channel management,
most wholesalers can significantly improve place, time, and possession utili-
ties by housing inventories close to the target market. The advantages of
using a wholesaler are enabling the manufacturer to reach many small, distant
customers at a relatively low cost, keeping manufacturing expenditures
focused on product development and core production processes, and im-
proving finished goods carrying costs. Disadvantages include loss of price
and promotion control, disruption in the direct flow of information concern-
ing marketplace needs, and possible gaps in expectations regarding products
and services.
Buying and Building Product Assortments. This function is extremely im-

portant to retailers . Unless they are a highly specialized business selling
products made by only one or a few manufacturers, most retailers prefer to
deal with suppliers that can provide as wide an assortment of products that
closely fit their merchandizing strategy as is possible. The reason is simple:
the more products that can be sourced from a single supplier, the less the cost
involved in purchasing, transportation, and merchandizing. Wholesalers are
particularly structured to serve this requirement. By purchasing related prod-
uct families from multiple manufacturers they have the ability to assemble the
right combination of products and quantities to meet the requirements of the
retailer and deliver it in a cost-effective manner.
Bulk Breaking. Along with building product assortments, this function is one
of the fundamental reasons for the existence of distributors. The term refers
to the fact that whereas manufacturers normally produce large quantities of a
limited number of products, retailers normally require a small quantity of a
large number of diverse products. Take, for instance, a candy manufacturer
who must produce large lot quantities of product due to cooking and ingredi-
ent requirements . The retailer, however, needs only a portion of this lot,
thereby forcing the manufacturer to perform bulk breaking and repackaging
activities designed to fit marketplace requirements. Often manufacturers will
sell bulk lots to wholesalers who will perform bulk break functions. In ad-
dition, by combining confectionery-type products from several manufactur-

ers, the wholesaler can also offer a wider assortment to the retailer in the de-
sired quantities than can a single manufacturer. In today's competitive en-
vironment, Lean Manufacturing techniques are continuously seeking ways to
reduce lot sizes and produce exactly to customer requirements. These techni-
ques have solved some of the problems associated with bulk breaking, espe-
cially with goods produced by assembly line and continuous flow production
methods. Manufacturers who use such techniques have been able to elimi-
nate channel middlemen by being able to sell just the right quantity of prod-
ucts as demanded by the retailer.
Value-Added Processing. Distributors today are increasingly involved in

transforming finished goods derived from the manufacturer into their final
form through the processes of sorting, labeling, blending, kitting, packaging,
and light final assembly performed at one or various nodes in the supply
channel. The economic justification for value-added processing rests on the
Principle of Postponement. Postponement seeks to minimize the risk of car-
rying finished forms of inventory by delaying product differentiation to the
latest possible moment before customer purchase. Stocking and transport-
ation cost savings are attained by keeping product at the highest level pos-
sible in the pipeline and by moving products through the supply channel in
large, generic quantities that can be customized into their final form as close
as possible to the actual sale. A large apple juice manufacturer, for example,
bottles product in nine different unmarked container sizes. This unlabeled
product is then shipped to distribution warehouses across the Midwest. As
orders from food retailers and wholesalers are received, the appropriate brand
and store labels are fixed on the containers . This practice enables the compa-
ny to carry a great deal less product in the pipeline, shrink warehousing and
handling, and significantly reduce end-product obsolescence .
Transportation. The movement of goods from the manufacturing source to

the retailer is one of the most critical functions performed by the distributor.
The ability to move goods from one node in the supply channel to another is
fundamental in assisting companies achieve time and place utilities . Simply,
no matter how sophisticated the marketing and warehousing system, if a
product is not available at the time and place wanted by the customer, the
result will be a lost sale, faltering customer confidence, and possible in-
creased costs resulting from order expediting. Transportation attempts to
solve this problem by ensuring that goods are positioned properly in the chan-
nel by moving them as quickly, cost-effectively, and consistently as possible
from the point of origin to the point of consumption. The marketing strate-
gies of some manufacturers and retailers require that they maintain their own
transport fleets, whereas others can effectively use common and contract car-
riers. Wholesalers also perform a critical role in product movement. Because
of their close proximity to the customer, possession of transport fleets, and
expertise, many wholesalers can move product to the customer much quicker
than distantly located manufacturers.
Warehousing. The function of warehousing is to ensure that the supply

channel possesses sufficient stock to satisfy anticipated customer require-
ments and to act as a buffer, guarding against uncertainties in supply and de-
mand. Warehousing also exists simply because demand for products are
often geographically located far from the place where they are produced.
Most manufacturers and retailers perform some fonn of finished goods ware-
housing in order to assure the even flow of goods in the supply channel. In
addition to maintaining their own facilities and channels of distribution, they
can also use a wholesaler. Because of their specialized logistics skills and
knowledge of local markets, wholesalers can provide products to a wide
range of marketplaces that manufacturers, functioning independently, can not
possibly penetrate. By serving as middleman, wholesalers provide retailers
with access to a spectrum of products and ease of resupply while simulta-
neously minimizing inventories.
Sequencing. As finished goods move closer to the customer, distributors

also perform product sequencing. Sequencing consists of sorting goods into
unique configurations necessary to fit the requirements of specific customers.
The goal of sequencing is to reduce customer receiving, sorting, and put-away
activities by combining a mix of products into single lots or arranging com-
ponents in the sequence in which they are to be used by the manufacturer
during the production process. For example, Continental Freezers of Illinois
sequences mixed lots of frozen foods that allow direct delivery to Jewel
Foods grocery stores. By creating small lots of frozen food products, hand-
ling and storage in the channel on the part of distributors and Jewel can be
eliminated, thereby reducing total costs and leveraging the efficiency of direct
manufacturer to retailer distribution. Another important form of sequencing
is utilized by Lean Manufacturing. The goal is to have components delivered
to the production process in the order in which they are to be used. Manufac-
turing sequencing is typically provided by channel distributors who will
combine components acquired from one or multiple suppliers into kits
sequenced to match the assembly schedule. Because of the cost and highly
customized nature of delivery sequencing, recent trends have been to contract
with distributors who specialize in such services.
Merchandizing. In many cases, product coming out of the manufacturer is

not ready to be delivered directly to the retailer without additional handling
and modification. Some of this value-added service involves bulk breaking
manufactured product into smaller lots that can be easily digested through the
supply chain. In other instances, product is placed into special packaging or
assembled in a display unit determined by marketing and sales campaigns.
One of the most visible forms of merchandizing performed by a distributor is
the assembly and maintenance of specialized point-of-sale display units found
at the check-out counter of every grocery store. Distributors will work close
with retailers to ensure the best mix of product and service displays in re-
sponse to special promotions . Another example is the promotional pack that
is assembled by the distributor to meet the needs of a special sale to be given
by the retailer or wholesaler. The pack normally consists of a product family
or related products. The promotional pack has the advantage of offering the
customer a volume discount while enabling the retailer or wholesaler to trans-
act volume quantities and avoid restricted labeling.
Marketing Information. A severe problem encountered by the manufacturer

without a strong supply channel is the quality and timeliness of information
arising from the customer base relative to product quality and performance.
Manufacturers who sell direct to a geographically dispersed end-user mar-
ketplace often must rely on the scant information arising from customer com-
plaints and voluntary product assurance cards. In contrast, manufacturers
with a robust supply channel can receive information regarding product, mar-
ketplace issues, and competitors' activities in a relatively short time.
UNDERSTANDING THE WHOLESALE DISTRIBUTION

INDUSTRY
Wholesale distributors serve as one of the three primary facilitators of the

supply channel management process. Fundamentally, wholesale distributors
differ from manufacturers in that they are not engaged in the process of pro-
duction, and differ from retailers who are concerned with selling small quan-
tities of goods to the end user from fixed store locations, catalogs, and show-
rooms. Unfortunately, because distribution is in the middle of these two
fairly recognizable industries, many people have rigidly misidentified the
function of distributing with the industry. Although it is true that all whole-
salers are distributors, it is also true, as has been pointed out, that many man-
ufacturers and retailers perform complex distribution functions. In fact, some
manufacturers and retailers engage in more elaborate distribution activities
and support a more extensive network of warehouses and transportation con-
solidation points than do large wholesalers . Finally, the maze of enterprises

constituting the distributive trades adds to the confusion.
THE NEED FOR WHOLESALE DISTRIBUTION
Distribution channels are formed to solve three critical distribution problems:

functional performance, reducedcomplexity, and specialization [6]. The pro-
blem of increasing the efficiency of time, place, and delivery utilities is the
central focus of channel functional performance. When product availability
and delivery is immediate, the functions of exchange and delivery can be per-
formed directly by the producer . As the number of producers and the size
and geographical dispersion of the customer base grows, however, so does
the need for internal and external intermediaries who can facilitate the flow
of products, services, and information through the marketing and distribution
process. In fact, by streamlining information, marketing, and product flows
in a distribution channel, an intermediary can substantially reduce the number
of transactions between producers and customers. For example, say that three
producers trade directly with five customers. To calculate the number of
trading links, the number of producers would be multiplied by the number of
customers . As illustrated in Figure 2.2, this would mean that there would be
a maximum of fifteen exchange transactions.
[ill = P = Producer
@l = C = Customer
# transactions = P x C
=3 x 5
= 15
# transactions = P + C
=3 + 5
=8
FIGURE 2.2 Role of channel intermediaries.
By positioning a channel intermediary in between producers and custom-

ers, the number of transactions in the channel would be dramatically cut. In
the illustration, the positioning of an intermediary would reduce the number
of possible transactions from fifteen to eight. The role of an intermediary
grows in importance in facilitating channel efficiencies as the number of pro-
ducers and customers expands. If there are just 20 producers and 2000 cus-
tomers, the number of transactions without an intermediary would be calcu-
lated at 40,000. With the presence of a single intermediary, the number of
transactions drops to 2020 or over a 95 percent reduction in total channel
transactions. Channel efficiencies can be further achieved by the addition of
a second tier of intermediaries. Depending on the product and the marketing
approach, intermediaries are a key part of the business strategy of many pro-
ducers. It would be impossible to think of Coca-Cola selling it products
directly to the consumer from the bottling plant! Whether a company opera-
ted and serviced its own distribution centers or a wholesale distributor per-
forms the channel management tasks , intermediaries reduce the number of
transactions and consolidate flows of information and products through the
supply network channel.
The creation of distribution arrangements can also decrease overall channel
complexity in other areas. Channel intermediaries also assist in the routin-
ization of business functions and product sorting. Routinization refers to the '
policies and procedures that provide channel members and new entrants with
common goals, channel arrangements, and expectations, and structures chan-
nel exchange mechanisms to facilitate transactional efficiencies. Sorting is
defined as a group of activities associated with transforming products and
product quantities acquired from producers into the assortments and lot sizes
demanded by the marketplace. The "sorting" process can be broken down
into four primary functions:
1. Sorting. The function of physically separating a heterogeneous group
of items into homogeneous subgroups. Examples of sorting are grading
and then grouping individual items into an inventory lot by quality or
eliminating defects from a lot.
2. Accumulating. The function of combining homogeneous stocks of
products into larger groups of supply. An example is a television dis-
tributor who combines the products of different manufacturers into a
television product line .
3. Allocation. The function of breaking down large lots of products into
smaller salable units . Often wholesalers will purchase products in bulk
and then break the quantities down into case lots or even down into in-
dividual units. A hardware distributor may, for example, purchase fas-
teners in kegs and then repackage them into a variety of quantities.
4. Assorting. The function of mixing similar or functionally related items
into assortments to meet customer demand. For example, an auto-
motive distributor may package the components necessary for brake
repair into a kit.
Few producers wish to perform the sorting and consolidation functions under-
taken by channel intermediaries. In addit ion, most producers would be ex-
tremely reluctant to carry and market similar products produced by com-

petitors alongside their own.
The final reason why distribution channels are formed is to solve the prob-
lem of specialization. As the supply chain grows more complex, costs and in-
efficiencies tend to grow in the channel. To overcome this deficiency, many
marketing channels contain partners that will specialize in one or more of the
elements of distribution, such as exchange or warehousing. The net effect of
specialization is to increase the velocity of goods and value-added services
through the distribution pipeline by reducing costs associated with selling,
transportation, carrying inventory, warehousing, order processing, and credit.
Sometimes a dominant channel member, such as the manufacturer, may seek
to eliminate a specialist partner by absorbing the function into its own
operations. Vertical integration can be beneficial if it seeks to facilitate the
flow of product, decrease cycle times, decrease costs, and eliminate redun-
dancies.
One school of thought, on the other hand, feels that not only will compa-
nies move away from vertical organization and focus most of their attention
on core competencies, but channels will be structured around "virtual" net-
work organizations . According to this model, the distribution channel, sup-
ported by the integrative power of the Internet, will be composed of tempo-
rary alliances of independent specialists, ranging from suppliers to possible
competitors that rapidly coalesce to form an operational unit to satisfy a mar-
ket need, and then disbands when the need is satisfied. The concept under-
lying this theory is that the optimization of the core competencies of each
partner in the network would provide the best value to both customer and
participating channel members. Regardless of the form of the arrangement,
the goal is the same: the integration of each of the parties' operations to
obtain mutual benefit.
TRANSACTION FUNCTIONS OF THE WHOLESALE DISTRIBUTOR
Perhaps the best way to define a wholesale distributor is to detail the supply
channel transaction functions that they perform. To begin with, it is quite
true that many manufacturers do market and distribute goods through the sup-
ply channel directly to the retailer or end customer. Similarly, some buyers in
large retail and industrial firms will bypass the wholesaler altogether and pur-
chase directly from product sources. These dominant buyers, so called be-
cause of their purchasing power, will purchase from the manufacturer in an
effort to achieve quality, lot size, delivery, and price benefits. Wholesalers
exist, however, because of certain efficiencies and economies that many man-
ufacturers and retailers either do not or chose not to possess. For the most
part, many of these enterprises do not have the financial resources to develop
the necessary marketing, sales, and logistics functions to effectively run a dis-
tribution channel. The cost of housing inventory, establishing distribution
centers, some of which may be thousands of miles away from the manu-
facturing facility, transportation costs, and heavy capital investment for
people and equipment are beyond their reach. Performing such functions
would severely dilute their enterprise and product strategies and force them to
radically shift their business focus, organization, and the available range of
technologies and skills.
Wholesale distributors are used most effectively when performing one or
more of the following transaction functions [10]:
Logistics Services. Because of their logistics expertise and channel
connections, wholesale distributors have the capacity to store goods in
anticipation of customer demand close to the target market. This prox-
imity enables them to respond to the needs of the retail customer much
more quickly than can centralized manufacturing facilities.
Selling and Promoting. Wholesale distributors can reach a much larger
customer base than most manufacturers . By providing national and
localized marketing and sales forces, wholesalers can target specific
market segments. Often the wholesaler can leverage their contacts and
reputation to sell product that cannot be reached by the distant manu-
facturer. In addition, because of their knowledge of local and national
markets, wholesalers can gain greater market share than the manufac-
turer by targeted promotion campaigns using special pricing, product
offerings, and value-added services such as short delivery cycles,
financing, and transportation economies .
Ownership. Merchant wholesalers take possession of and inventory
goods. In this sense, they absorb manufacturer and retailer carrying
cost. Customers also can reduce their carrying costs by being able to
purchase goods in much smaller lots than they could when buying
directly from the manufacturer. It would be hard to conceive of the
Mars Candy Company selling a single display's worth of M & M's to a
local retailer.
Value-Added Processing. As detailed above, one of the fundamental
functions of a wholesaler is transforming goods as they move through
the supply channel through the processes of sorting, bulk breaking,
labeling, blending, kitting, packaging, and light assembly. Value-added
processing enables the wholesaler to attain economies of scale by pur-
chasing in large, undifferentiated lots which can then be processed into
smaller units and product assortments required by the retailer.
Risk. By assuming possession and ownership of goods, wholesalers

incur a much greater risk than manufacturers or retailers of financial
loss caused by inventory shifts in the marketplace, carrying costs, ob-
solescence, and spoilage. In addition, many wholesalers will also as-
sume responsibility for product failures, warranties, and price fluctu-
ations. In some cases, they will even guarantee product satisfaction, ac-
cepting returns for full credit.
Negotiations. The transfer of ownership of goods from one indepen-
dent business unit in the channel to another usually involves attaining
agreement on price and other sales terms. Negotiation should always
be supportive of the overall competitiveness of the distribution system.
Ordering Flow. The actual placement of customer and inventory re-
plenishment orders, as well as information concerning marketing
trends, provides critical information for the supply network. This infor-
mation cascades backward from the end consumer through retailers,
distributors, and manufacturers, ending up eventually with the com-
ponents and raw materials supplier.
Payment Flow. The flow of cash payment proceeds backward through
the distribution channel. Often banks and other financial institutions
are involved in payment for goods and services.
Financing. Wholesalers must finance the distribution process by pur-
chasing inventories, providing for transportation, managing accounts
receivables, and extending credit to their retail customers. When a dis-
tributor assumes physical possession of inventory, the distributor is, in
effect, financing the manufacturer by exchanging capital for inventory.
Often wholesalers will receive assistance in the form of advice and
capital from financial institutions, such as commercial banks, brokerage
houses, and finance companies.
Information Services. The explosion in information technology and
communications has required some manufacturers and retailers to con-
tract with specialist wholesalers who possess the necessary equipment
and technical skills. These services exist on several levels. Some
wholesalers provide equipment, such as telephones, computers, leased
lines, and facsimile machines essential to the maintenance of sales and
logistics continuity. In recent years, more complex communications
technology and accompanying channel specialists have appeared. Per-
haps the most critical has been the growth of Electronic Data Inter-
change (EDI) and Internet Web-services. Many wholesalers offer this
service to their channel partners who do not wish or who do not have
the technical expertise and equipment.
Management Services and Consulting. In some instances, wholesalers

can assist their channel partners to enhance their operations or provide
targeted services . Wholesalers can assist retailers by training their
point-of-sales staffs, helping with stores and stockroom layout, building
and arranging displays, and setting up inventory and accounting sys-
tems. Manufacturers can be assisted through staff training, plant lay-
out, equipment usage, and technical services.
Marketing Information . Wholesalers engage in a wide spectrum of
sales and marketing activities, such as promotions, customer service,
catalog data tracking, and advertising. The information arising from
these activities is critical in ensuring that upstream manufacturing
plants are making the right products and that the correct inventory in
the proper quantities is moving through the supply channel. More so-
phisticated wholesalers maintain on-line sales, inventory, and pur-
chasing systems that can directly transmit critical marketing infor-
mation to concerned channel partners.
Channel transaction functions, such as physical possession, ownership, and
promotion, are usually characterized as forward flows, describing the move-
ment of goods and services from the supplier to the end customer. Inventory,
for example, moves "down" through the distribution network until it reaches
the consumer. On the other hand, functions such as ordering and payment are
backward flows from customer to supply source. Finally, marketing informa-
tion, negotiating, finance, and risk taking move in both directions up and
down the channel. In addition, negotiation and ordering can be grouped
under the term exchange flows because they facilitate the buying and selling
of goods. Inventory title can alternately be described as a logistics flow be-
cause the activities of transportation and storage occur with the transfer of the
ownership of goods. Finally, financing, risk, and payment flows collectively
can be called facilitating flows because their performance is necessary to
complete financial exchange and logistic transfer [11].
The supply channel should be designed to facilitate and make as efficient
as possible each one of these transactional flows. Regardless of the physical
structure of the distribution network, each of these functions must be per-
formed someplace by one or multiple business units in the distribution net-
work. Channel members can be eliminated or substituted; the above func-
tions, however, cannot be eliminated and must be assumed by remaining busi-
ness units either upstream or downstream in the distribution pipeline. A man-
ufacturer, for example, may elect to sell direct to the end customer, bypassing
the distribution middleman . Such a channel strategy would require the manu-
facturer to perform a number of forward and backward transactional flows
previously provided by channel partners. When a trading partner is elimi-
nated and its function is transferred to one or more channel members due to
inefficiencies, redundancies, or cost, it is termed channel absorption. Con-
versely, when functions are transferred to one or more channel members, it is
termed channel functional spin-off. In the final analysis, the real value of the
structure of a particular distribution system is that it provides a form of syner-
gy, permitting individual channel partners to reach objectives they would
otherwise be unable to achieve acting individually.
Channel functions can be performed multiples times depending on the
number of levels in the distribution system. Marketing channels can be com-
posed of one or multiple levels. Figure 2.3 illustrates several different mar-
keting channels. A zero-level channel consists of a manufacturer who sells
directly to the end customer from the factory. A manufacturer who sells
direct through their own distribution channels also fits within this category.
A one-level channel consists of one intermediary business unit between the
manufacturer and the customer. A two-level channel contains two intermedi-
aries, and so on. As the number of levels in the supply channel grow, it be-
comes more difficult to maintain functional efficiencies and productivity due
to lack of timeliness and accuracy of information and the cost incurred to
move and store inventory in the pipeline.
Customer
FIGURE 2.3 Types of channel structures .
ELEMENTS OF PHYSICAL DISTRIBUTION FLOW MANAGEMENT
Most enterprises organize the physical flow of goods through the firm into
two separate but related phases. The first management cycle is concerned
with the flow of products and information into the enterprise and is com-
monly termed Materials Management. The second management cycle is con-
cerned with the flow of products and information out of the enterprise and is
commonly termed Physical Distribution. As outlined in Chapter 1, when
these two management cycles are combined in a continuous flow, they con-
stitute the logistics function. The separation of the two cycles does not imply
that they are independent of one other. Functionally, they are interdependent.
As customer demand pulls finished goods through the system, physical dis-
tribution responds by ensuring that product is at the right node in the distri-
bution structure, and when it is not, triggers a requirement to materials man-
agement to either build or purchase more products. The interrelatedness of
the two cycles is further accentuated by the similarity of the supply chain
functions they perform. Each is concerned with the basic activities of trans-
portation , warehousing, and management. In addition, the system processing
activities associated with customer order management are similar to the func-
tions performed in purchasing. A high-level illustration of the relation of
these entities can be found in Figure 2.4. A detailed examination of each of
these areas is described below.
INPUT ~ Material Flow ~ OUTPUT
I
I
Materia ls I Physica l
Management I Dist rib ution
I
I
.. Information Flow ....4f---- -
FIGURE 2.4 Supply channel materials flow .
Incoming Materials and Infonnation. This segment of the materials flow

cycle encompasses the activities associated with the planning and control of
all inbound materials (finished goods, materials, and component parts) into
the enterprise. It also extends in many organizations to the management of
production inventories for those firms that are manufacturers. The major sub
functions involved in incoming materials management are briefly described
as follows :
Material Planning and Control. The ability to plan for inventory both
in the short- and long-term is absolutely essential to every enterprise.
The goals of this function are to effectively translate marketing and
sales forecasts into detailed production and finished goods require-
ments, to project resource requirements associated with capital, man-
power, materials, and physical plant, and to perform strategic simula-
tion to validate overall enterprise goals. System tools used by material
planners include Material Requirements Planning (MRP) for manufac-

turing inventory planning and statistical inventory replenishment mod-
els and Distribution Requirements Planning (DRP) for distribution in-
ventory planning. Just-In-Time techniques are applicable to both areas.
Purchasing. Activities associated with the procurement of raw ma-
terials, components, finished goods, and MRO inventories is the re-
sponsibility of purchasing. The primary functions of purchasing in-
clude value analysis, supplier selection, price and delivery negotiation,
the generation of purchase orders and the expedition of on-time receipt
when necessary, acting as a liaison between the company and the sup-
plier relating to issues of quality, cost, and delivery, and the develop-
ment of supplier partnerships.
Receiving. The receiving process involves the actual physical receipt
of purchased material into the firm. Critical activities occurring in this
function are physical shipment verification, receiving inspection of
goods, claims, and documentation completion.
Warehousing and Storage. These functions are concerned with the
physical management of materials, components, finished goods, and
MRO items. Critical activities center on efficiently storing received
and inspected materials, issuing and accepting material returns, main-
taining the physical accuracy of the inventory, and performing periodic
and annual physical inventories.
Materials Handling. This function consists of two activities. The first
revolves around analyzing, designing, and improving the processes in-
volved in the efficient physical movement of inventory. The second
activity is concerned withthe actual physical movement of products to
and from storage areas to the points where they will be used.
Outgoing Products and Information. Often termed distribution, this func-

tion can be defined as the management of the storage and movement of fin-
ished goods originating from the supply source, and concluding with delivery
to the customer. Often physical distribution activities must also perform
transportation functions that link together storage nodes into a distribution
network. Objectives of physical distribution can be defined as providing
superior customer service, optimizing total distribution costs, minimizing fin-
ished goods inventories in the supply channel, minimizing the order process-
sing cycle, and providing cost effective transportation. The major sub-func-
tions of physical distribution consist of the following:
Order Processing. This sub-function is responsible for the timely, ac-
curate, and efficient processing of customer orders into the finn . Order
processing can be described as consisting of three interrelated pro-
cesses: order entry, inventory allocation and picking, and order confir-
mation and shipping. A critical part of this function is the management
of customer service.
Warehousing. The purpose of warehousing is to satisfy the discrepan-
cies that arise between inventory availability and the time and place re-
quirements of the marketplace. The goal of warehousing is to have in-
ventory available for customer sale at the least possible cost. Although
some companies inventory and ship from one warehouse, many organi-
zations have simple to complex channels consisting of various levels of
warehouses . Storage warehouses are used to house unsold or pro-
motion goods for medium to long periods of time. Distribution ware-
houses, on the other hand, receive products from upstream outside and
inside suppliers for the purpose of immediate or short-term sales.
Finished Goods Management. The control of finished goods inven-
tories covers a wide spectrum of activities ranging from managing
stocking levels and order picking, to interbranch warehouse transfer
and customer order shipment. Perhaps the most critical task involves
determining the proper amount of stock to carry in the supply channel
to satisfy customer requirements without stockout while minimizing the
inventory carrying cost. Optimizing inventories is the responsibility of
the firm's inventory planners who can utilize computerized statistical or
time-phased methods for item review and ordering.
Materials Handling and Packaging. This function consists of such
activities as containerization, vehicle loading, hazardous product hand-
ling, and packaging .
Shipping. Although the former is concerned with the management of
incoming orders and the latter with outgoing orders, receiving and
shipping have many similarities . Both work with docks and carriers;
both utilize the same material handling equipment and often the same
personnel; and sometimes both are organized into a single department.
The main functions of shipping consist of customer order packing,
vehicle loading, order confirmation, and shipment documentation.
Transportation. For many distributors, transportation is one of the
most costly parts of the business, sometimes accounting for over 50
percent or more of the cost of goods. Distributors have the option of
using five methods of transport: motor carrier, railroads, pipelines,
water, and aircraft. The goals of transportation are to provide for the
continuous flow of product through the supply channel, optimize
vehicle capacities and loading equipment during shipment, provide spe-
edy and timely delivery, and minimize shipment damage and theft.
WHOLESALE DISTRIBUTION INDUSTRY CHALLENGES
The maturing of the U.S. economy, the growing power of alternative forms of
distribution, and the expansion of manufacturers and retailers into distribu-
tion have created formidable challenges for today's wholesale distributors.
Like other sectors of the U.S. economy, wholesalers can expect continued
mergers and consolidations, growing demand on the part of channel partners
for more complex value-added services at lower prices, shrinking margins,
and declining profitability. The most critical issues facing wholesale dis-
tributors at mid-point in the first decade of the twenty-first century can be
summarized as follows:
The growing movement for channel disintermediation in order to
squeeze every unnecessary cost out of the supply chain can only be ex-
pected to intensify. To survive and flourish in this environment whole-
sale distributors will have to continuously pursue new forms of organi-
zation and new types of business if they are to remain competitive.
These changes will take the form of consolidation, organizational re-
engineering, increased use of information technology, and closer ties
with supply channel partners .
Both manufacturers and retailers will continue to narrow the number of
channel partners with whom they do business. Requirements for opti-
mized operational functions, such as quality, delivery and price, as well
as increased collaboration among channel partners, spanning everything
from product development to information connectivity, will push chan-
nel strategists to continually shrink the number of suppliers they deal
with.
Although wholesalers as an industry have improved productivity and
the variety of available services, greater leaps of productivity through a
more aggressive application of technology tools have become impera-
tive.
Although the implementation of Lean/JIT and Quick Response has
been gaining ground with wholesalers, they still lag behind consider-
ably in these areas as compared to manufacturers and retailers.
Many wholesalers have not taken the growing power of alternate chan-
nel formats seriously, such as warehouse clubs, co-ops, mass mer-
chants, and telemarketing. Often, these new forms of competition are
viewed by wholesalers as businesses targeted at narrow market niches.
To counter this form of competition, wholesalers' sales mix is expected
to change to emphasize more direct mail/catalog, Internet sales, retail
sales, as well as increased valued-added processing.
There is significant excess capacity in the industry. This means that

underperformers face a bleak future as compared to their more stream-
lined and focused competitors . Mergers and acquisitions in the in-
dustry can be expected to continue focused not on diversification but
rather on how to better penetrate existing markets, eliminate weak com-
petitors, and gain market share.
Gross margins can no longer be improved by increasing prices for prod-
ucts and value-added services. Prices and margins have been and will
continue to be squeezed by the maturing of the economy and com-
petitive pressures.
Many wholesale distributors have been unwilling to risk or unable to
attract the capital investment necessary to retool their information sys-
tems, human resources , physical plants, and marketing strategies to
tackle these and other issues.
The ability of wholesalers to respond to these challenges is clearly related
to their ability to identify and willingness to aggressively seize on the internal
and external factors affecting growth in the industry. The development of
new value-added services and implementation of technology connectivity en-
ablers followed by quality and productivity improvements and increased
product diversification are the factors that will provide the most growth.
How these factors will improve competitive positioning is to be seen in the
range of possible strategies to be pursued by wholesalers. Perhaps the most
critical is using competitive factors, like the Internet, to retain and better
penetrate their current customer base. Secondary strategies focus on expand-
ing geographically and decreasing reliance on product/commodity line di-
versification. This shift from being product oriented to customer oriented is
an acknowledgment that the costs involved in gaining new and losing existing
customers to competitors is prohibitive . Another key strategy targeted at in-
creased customer base penetration is the addition of new value-added services
or improving those basic services the firm already offers. As detailed in
Table 2.1, the sum total of these service criteria are to reduce or eliminate
costs and channel redundancies and poor quality while enabling distributors
to capitalize on marketplace opportunities by possessing recognizably superi-
or products and services.
SUMMARY
As the pace of global competition and demands for flawlessly executed cus-
tomer service accelerate at the opening of the twenty-first century, the re-
quirements for effective and efficient distribution functions can be expected
to grow accordingly. Far from being associated with a narrow segment of in-
TABLE 2.1 Wholesale Distribution Strategies
Strategy Objective Impact on Supply Chain Examples

Lower cost for value Reduced product/service Utilization of Internetsales;
received cost growth ofwarehousel whole-
sale clubs; powerbuying;
manufacturer direct and other
channel formats targetedat
cost reduction
Improved efficiency Reducedchannel Focus on collaborative re-
investment lations; LeanlJIT and Quick
Response
Improvedquality Reducedcost of errors Implementation of Total
Qualitymanagement pro-
grams
Channel simplifi- Reduced redundant Growth in contracted services
cation channel functions
Improved infor- Increasedchannel Implementation of Internet-
mation connectivity and enabled systemconnectivity;
collaboration integration of internal busi-
ness functions; co-opadverti-
sing and marketing programs
Improved value- Increasedease of Customerempowerment to
added services customer management design productsand services;
engaging in value-creating
relationships; agile and
scalable functions; fast flow
delivery; focus on e-com-
merce enablers
dustry, the dynamic nature of today's supply channel requires expanding the
definition of what constitutes a distributor by describing it broadly as any or-
ganization that sells finished goods to retailers or industrial, institutional, and
commercial users but that do not sell in significant amounts to the end con-
sumer. Such an interpretation would apply to wholesalers, all manufacturers
(except those who sell factory direct), internal supply chain replenishment
management, mail-order distributors, Internet e-marketplaces, and mega-re-
tailers that possess distribution channels
The essence of what constitutes a distributor is perhaps best detailed by
abstracting the essential characteristics of distribution. Essentially, three fun-
damental characteristics are apparent: how products are acquired; how prod-
ucts are moved through the supply channel to the customer; and, finally, how
products are transacted. The content of these characteristics make it fairly
easy to divide distributors from the other two components in the supply chain
- manufacturers and retailers. From this analysis, five types of distributor

emerge: merchant wholesalers, brokers and agents, manufacturers' and re-
tailers' branches and offices, exporting and importing distributors, and mis-
cellaneous wholesalers. In addition, a whole new class of Internet-enabled
"cybermediary" has begun to emerge over the last half decade capable of
utilizing the Web to generate new forms of business and radically different
approaches to managing the supply chain.
Whether carried out by the sales and distribution division of a manufactur-
ing company, a mega-retailer, or by an independent merchant wholesaler,
there are a number of critical functions performed by the channel distributor.
To begin with, distributors solve three critical supply channel problems:func-
tional p erformance, reduced complexity, and specialization. The goal of dis-
tribution is to increase the efficiency of time, place, and delivery utilities by
acting as intermediaries focused on facilitating and rationalizing the flow of
products, services, and information through the marketing and distribution
process. In addition, distribution functions facilitate the performance of for-
wardflows (physical possession, ownership, and promotion), backwardflows
(marketing information, negotiating, and risk taking), exchange flows (buying
and selling), logistics flows (transportation and storage), andfacilitatingflows
(financing and payment).
The tremendous changes brought about by the maturing of today's in-
dustrial economies, the growth of alternative forms of distribution, and the
expansion of manufacturers and retailers into areas once the preserve of the
independent wholesaler have created a new set of formidable challenges to
the wholesale distribution industry. Several critical issues come to mind. In-
creased "disintermediation" of the supply channel, continued industry con-
solidation, growth of collaborative supply chain strategies, and narrowing of
the base of channel partners have forced many distributors to search for ways
to leverage technology and new management styles to cut channel cycle times
and costs, respond to warehouse clubs, mass merchants, and Internet sales
formats, and enable improvements to both fixed and human resources to
remain competitive
1. What are the components of the supply channel and how do they differ from one
another?
2. Why is defining the term "distributor" and the distribution industry so difficult?
3. Why would manufacturers and retailers use a wholesaler?
4. Why has the wholesale industry declined during the past 15 years?
5. How can wholesale distributors "re-intermediate" themselves into today's supply
chain?
6. Material movement can be essentially divided into two fundamental flow
processes. Discuss.
7. Physical distribution has a special relationship to sales and marketing. Why is
this relationship so special?
REFERENCES
1. The APICS Dictionary, 9th ed. Falls Church, VA: American Production and
Inventory Control Society, 1998, p. 27.
2. Bowersox, Donald J. and Cooper, M. Bixby, Strategic Marketing Channel
Management . New York: McGraw-Hill, 1993, p. 4.
3. Bowersox, Donald 1., Daugherty, Patricia J., Droge, Cornelia L., Rogers, Dale
S., and Wardlow, Daniel L., Leading Edge Logistics: Competitive Positioning
for the 1990s. Oak Brook, IL: Council of Logistics Management, 1989, pp. 34-
35.
4. Ibid, p. 41.
5. Ibid, pp. 83-84.
6. These classifications have been attained from The Standard Industry And
Classification Manual . Springfield, VA: National Technical Information
Service, 1987, pp. 287-314; Kotler, Philip, Marketing Management, 6th ed.
Englewood Cliffs, NJ: Prentice Hall, 1988, pp. 571-573; and Bowersox and
Cooper, Strategic Marketing Channel Management , pp. 40-44.
7. This section has been abstracted from Ross, David F., Introduction to e-Supply
Chain Management: Engaging Technology to Build Market-Winning Business
Partnerships. (Boca Raton, FL: St. Lucie Press, 2003), pp. 62-65.
8. Lapide, Larry, "The Innovators Will Control the e-Supply Chain," in Achieving
Supply Chain Excellence Through Technology, 3, Anderson, David L., ed.,
Montgomery Research, San Francisco, 2001, 186.
9. Bowersox and Cooper, Strategic Marketing Channel Management , pp. 14-22
and Stem, Louis W. and El-Ansary, Adel, Marketing Channels, 3rd ed.,
Englewood Cliffs, NJ: Prentice-Hall, 1988, pp. 3-10.
10. For further discussion on these points see Kotler, p. 570 and Bowersox and
Cooper, Strategic Marketing Channel Management, pp. 74-79.
II . These elements are further discussed Bowersox and Cooper, Strategic
Marketing Channel Management , pp. 15-16.
UNIT 2
TOP MANAGEMENT
PLANNING
CHAPTERS:
3. Business and Strategic Planning

4. Forecasting in the Supply Chain Environment
5. Demand, Operations, and Channel Planning
Unit 1 focused on defining the terms and organizational structures, as well as

the challenges and opportunities, constituting SCM and modern logistics. Of
primary importance was examining the ways today's global business, market-
ing, and customer requirements have reshaped traditional perceptions of the
function of supply channel management. In the 2000s, distributors can no
longer treat distribution as performing a purely operational function: channel
management must be viewed as a strategic function that provides individual
enterprises and associated trading partners with distinct competitive
advantage. As was discussed , fundamental to the activation of new para-
digms is the utilization of SCM and Internet technologies. The convergence
of these two critical enablers was defined as the networking of the collective
productive capacities and resources of cross-channel systems through the
application of Web-based technologies in the search for innovative solutions
and the synchronization of channel capabilities dedicated to the creation of
unique individualized sources of customer value. e-SCM provides today's
supply chain with the tools to reshape individual organizations and supply
channels flows in the search for global marketplace leadership .
With the basics of modern e-SCM defined, Unit 2 begins the discussion of
enterprise planning and control by examining the first step in the planning
flow: top management planning. Top management planning is concerned
with the formulation of the overall goals and strategic objectives of the firm.
Top management planning identifies the long-range financial, marketing,
98 TOP MANAGEMENT PLANNING
sales, and aggregate supply channel requirements necessary to satisfy these

corporate objectives . The goal is to ensure that the enterprise possess the ca-
pacities and capabilities to achieve the marketplace position and financial tar-
gets specified in the business plan. The formulation of effective top manage-
ment plans will, in tum, drive the operations plans of each business de-
partment.
Unit 2 opens with a review of the business planning process. Chapter 3
begins with a description of the contents of the business plan. Of primary im-
portance is the formulation of effective enterprise goals and their translation
into the operating strategies that will guide the firm's business functions.
Planning on this level consists of four essential activities: goal and mission
statement definition, creation of the business forecast, development of current
and long-term asset plans, and plan disaggregation. The success of the busi-
ness plan consists in the ability of top management to develop flexible organi-
zations to meet the needs of an ever-changing marketplace, the imple-
mentation of information, communications, and automation technologies de-
signed to network the entire supply chain, and leveraging strategic alliances
with channel partners and outside service providers that facilitate operational
flexibility and reduce channel costs.
Chapter 4 examines the role of forecasting in the business planning pro-
cess. Perhaps no other activity has as much immediate and long-range effect
on enterprise operations as forecasting. Effective forecasts are required on all
business planning levels. Long-range forecasts assist top management ana-
lyze the impact of strategic goals on the resource capacities and marketplace
position of the firm. Forecasts assist departmental managers match business
plan requirements with medium-range functional area capacities. Finally,
short-range forecasts assist operations managers and supervisors plan for
weekly and everyday requirements. Good forecasting assists companies by
eliminating waste in the form of excess inventory, by reducing shortages,
missed due dates, lost sales, and expensive expediting, and by providing visi-
bility to control capacity requirements such as plant size, labor, equipment,
and transportation.
Unit 2 concludes with a detailed discussion of the demand, operations, and
channel planning processes. Demand planning determines the sales potential
of the marketplace and the products, services, and channel structures required
to satisfy the revenue objectives identified in the business plan. Production
planning determines the finished goods targets, production rates, manufac-
turing capacities, and performance metrics necessary to ensure that manufac-
turing functions are responding in a cost effective manner to customer re-
quirements. Logistics planning determines the channel inventory plan, avail-
ability of aggregate inventory, transportation, warehouse, and labor and
equipment resources, the components of the value-added processing plan, and
TOP MANAGEMENT PLANNING 99
the shipment plan. Finally, the Supply channel plan identifies the overall
supply channel business mission, the design of the channel, the channel oper-
ations plan, and all global channel infrastructure and operations require-
ments. Each of the three chapters in Unit 2 attempts to provide companies
with the essential keys to solving the challenges posed by expanding products
and services, intensified competition, requirements for purposeful communi-
cations with manufacturers and retailers in the supply channel, and the pace
of changing marketplace needs characteristic of business in the twenty-first
century .
3
BUSINESS AND
STRATEGIC PLANNING
DEFINING BUSINESS GOALS Income Statement and Balance

AND STRATEGIES Sheet
Understanding Enterprise Goals Investment, Profit, Asset, and
Formulating Enterprise Capital Planning
Strategies Supply Chain Planning
The Strategic Planning Process
SUMMARY
DEVELOPING THE BUSINESS
PLAN QUESTIONS FOR REVIEW
During the quarter century after the conclusion of the Second World War,
U.S. manufacturers and distributors could achieve marketplace, profitability,
and performance objectives without serious attention to the strategic planning
needs of their individual enterprises or the supply chains in which they parti-
cipated. The decade of the 1970s, however, brought a series of upheavals
fueled by spiraling energy costs, economic inflation and uncertainty, and ex-
panding overseas competition that required companies to move beyond their
largely single-minded focus on operations planning and control. No longer
could U.S. industry take market dominance for granted. The result was a
growing interest in preparing the enterprise for change through a planning
process that not only focused on business strategic elements, such as cor-
porate objectives and resources, but also could guide the organization through
the shoals of shrinking margins, the synchronization of world economies, in-
creasing labor and materials costs, and the struggle for competitive advantage
that characterized the decades that followed. Instead of stagnant, hier-
archical, vertical organizations managing massive physical plant and produc-
tive assets, the paradigm rapidly shifted to highly agile, flexible organi-
zations, dependent on information technologies and collaborative supply

chain relationships centered on continuous cost reduction and optimization of
core and channel resources. Today, the rapidly expanding global economy is
requiring companies to acknowledge an entirely new set of dynamics based
on geopolitical change, the ability of communications technologies to access
labor pools from any place on earth, and new concepts of product develop-
ment, quality, and channels of distribution.
Chapter 3 is concerned with detailing the business and strategic planning
processes necessary to harness the forces of change confronting today's dis-
tribution industry. The chapter begins with a description of the nature of
business planning and strategic plan development. Following this section, at-
tention is given to the elements of the strategic planning process: strategy
formulation, developing the business forecast, creating the asset plan, and
business unit budget disaggregation. An examination of metrics necessary to
monitor an effective business plan follows. Among the performance mea-
surements detailed are the income statement and balance sheet; investment,
profit, asset, and capital planning; and supply chain key performance indi-
cators (KPls) that utilize computerized toolsets to gather, analyze, and dis-
seminate supply chain performance,
DEFINING BUSINESS GOALS AND STRATEGIES
The goal of all business enterprises resides in providing products and value -
added services that do not merely permit them to compete but that continually
win the customer's order. Whether it is a manufacturer of toasters or a travel
agency, successful companies develop winning strategies and execute finely-
tuned operations plans that assure the customer that the product or service re-
ceived possesses outstanding and unique value. This dynamic is graphically
portrayed in Figure 3.1. As can be seen, firms must approach the marketplace
on many levels. The needs and expectations of the customer must be known.
The marketing function must identify the proper mix of products and services
and what is the composition of the marketplace. Finally, the finn's opera-
tional functions (sales and order processing, logistics, manufacturing, and
finance) must be poised to satisfy the customer at a level that not just meets,
but far exceeds the competition. Enterprises that aspire to marketplace
leadership must begin by developing focused business goals and targeted
strategies that provide a single consistent and coherent direction guiding and
coordinating the company's operational activities. These two elements of top
management planning provide the finn with identity and define the objectives
and values by which the company will compete.
BUSINESS AND STRATEGIC PLANNING 103
Dynamic
Marketplace
Markcting
Strategy
Production and Tactics and

Operations Management Operations
FIGURE 3.1 Marketplace dynam ics.
UNDERSTANDING ENTERPRISE GOALS
The business planning process begins with the formulation and articulation of
the matrix of values, beliefs, and cultural attitudes that define the internal and
external direction of the enterprise. The development and implementation of
these organizational goals takes place over long periods of time, requires the
acceptance of all functions within the company, and are difficult to change
once in place. Hayes and Wheelwright [1] term these vague but powerful at-
titudes and values an enterprise's business philosophy, and define it as "the
set of guiding principles, driving forces, and ingrained attitudes that help
communicate goals, plans, and policies to all employees and that are re-
inforced through conscious and subconscious behavior at all levels of the or-
ganization." An enterprise's business philosophy provides the framework for
purposeful action and the grounds upon which competitive, marketplace,
governmental, and environmental norms are developed.
An enterprise's business philosophy usually consists of multiple goals.
Some are obvious financial goals such as profitability, corporate growth tar-
gets, and return on investment. Others focus on providing quality of work
life, service commitment, the furthering of community and societal object-
tives, the minimization of risks to promote orderly growth, and so on. Such
slogans as SAP's "The best-run businesses run SAP" and UPS's "What can
brown do for you?" are targeted at communicating basic enterprise values and
product and service commitments to the marketplace. Corporate goals serve
a multitude of purposes. They help focus corporate, business unit, and func-
tional business area strategies on a common game plan. They provide the
basis for operational decisions and establish the boundaries of strategic op-
tions available. Finally, corporate goals assist managers in making trade-off
decisions among performance measures such as cost, inventory investment,
delivery, serviceability, and between short-term and long-term strategies [2].
Business goals are defined by five interwoven elements that give the firm
its distinct character. The first element is the company's history. Every com-
pany has a record of past achievements, traditions, and policies that provide it
with a sense of continuity and identity. In redefining business goals, strate-
gists must ensure that new directions sought for the enterprise are a logical
extension of the past and supportive of long agreed upon objectives. The
second element arises from the current preferences of the owners/executives
charged with managing the business. A critical role of the firm's leadership is
formulating the vision of the business and the direction it would like the com-
pany to move. Third, environmental and social factors can have a dramatic
affect on the business. .For example, stricter air pollution laws have had an
enormous impact on the automotive and petroleum industries. The avail-
ability of the enterprise's financial and physical resources forms the fourth
element determining goal definition. A small pharmacy chain, for example,
could not hope to compete head to head with Walgreen's or Wal-Mart in
terms of price and product availability. Finally, companies structure their ap-
proach to the marketplace based on their distinctive competence. Maytag
uses its strong reputation with washing machines to spearhead their mar-
keting campaigns in the home appliance market [3].
Drafting business goals is an interactive, iterative exercise, culminating in
the formulation of concise mission statements that are to guide the firm for
years and maybe decades to come. These mission statements consist of the
vision and direction top management wishes the firm to take, the policies to
be followed by the organization relating to customers, products, services, and
business partners, the structure of the distribution channel, and the sense of
community of purpose and enthusiasm guiding everyone in the organization
in their endeavors to realize personal and, by extension, company goals.
FORMULATING ENTERPRISE STRATEGIES
Strategic planning can be described as the process of establishing the courses

of action an enterprise must follow if overall corporate goals are to be
achieved. Strategies differ from goals in several important ways. To begin

with, goals are defined as broad, long-term statements of what the enterprise
would like to achieve. Strategies, on the other hand, are more specific direc-
tives regarding a defined set of particular actions to be completed necessary
to accomplish detailed objectives. The firm's top management uses strategies
to assist in the realization of its goals. Strategies attempt to answer questions
ranging from asking: "What business should the company be in?" to issues
revolving around the definition of products and growth targets of the firm for
a specified time frame. Collectively, strategies encompass the general plans
directing the enterprise, and as such will remain in effect for long periods of
time.
In his book on the nature of management control, Anthony [4] feels that
companies develop strategies in response to threats or to capitalize on oppor-
tunities. Threats for the most part arise from attacks by competitors on mar-
ket position. Other examples of threats are product and/or process innova-
tion, information technologies, governmental policies, economic swings, and
changes in the public's buying habits. Opportunities, on the other hand, can
be found in the enabling capabilities of a new technology, evolution in the
wants and needs of the customer, and even improvements in the functioning
of the firm's organization. Effectively managing threats and opportunities re-
quires executive planners to respond by developing strategies that will seek to
dampen the impact of adverse conditions while leveraging company strengths
to take advantage of favorable circumstances.
The strategic planning process is an iterative task that involves the identi-
fication of threats and opportunities, problem solving to arrive at the best pos-
sible courses of action, evaluation of the consequences of possible solutions,
and selection of the direction the firm will take. Kotler defines strategic plan-
mngas
the managerial process of developing and maintaining a viable fit between an

organization's objectives and resources, and its changing market opportunities.
The aim of strategic planning is to shape and reshape the company's businesses
and products so that they continue to produce satisfactory profits and growth
[5].
Much in the fashion of a mechanical gear train, strategic planning provides

motion or objectives to the major business functions of the organization.
These gears, in tum, drive additional departmental gears, which in tum, drive
operational execution activities. The focus of the whole process is to answer
the central challenge facing the enterprise : how to improve profitability by in-
creasing productivity and optimizing the application of resources to capitalize

on the "best" marketplace opportunities.
As illustrated in Figure 3.2, the development of business strategies has four
I
I Cor porate "
Strategies e
,I - - - ~ - e-~ ~
411
I Business Unit I
Stra tegies I
- , __--=+ I
---
_ I-
,
~
I
....
~ us i n ess Area/

\ tra tegies
-
I
FIGURE 3.2 Enterprise strategies.
boundaries: enterprise goals, opportunities, constraints, and risks and uncer-

tainties . In effectively weighing the impact of each of these factors on busi-
ness strategies, corporate planners need to view the business on three levels
as exhibited in Figure 3.3. The first level can be termed corporate strategy.
Depending on the nature of the business, planning at this level will focuses on
five critical strategies as detailed in Table 3.1. Business planning begins with
concise definitions of the competitive positioning, profit, ROJ, and growth
strategies that are to govern enterprise direction. These goals in tum must be
supported by product mix and volume, services, channel distribution, and
technology enabler strategies that will describe the market potential and prod-
ucts that will mature the revenue plan. The competitive values chosen by the
firm will determine how orders are to be won in the marketplace, and will in
tum influence process and channel structure choices. For example, if a com-
Business nit A Busine Unit R Busine: Unit

tratcgy tratcgy tratcgy
Markctingl H uman
Financial C ha nncl Op erations
alcs Rc ources
trategy tratcgy tratcgy
trategy trategy
FIGURE 3.3 Three levels of business plannin g.
pany chooses to compete by offering a commodity-type product centered on

minimal product variation , then low price, processes supporting agile make-
to-stock, low cost, and LeanlJIT will be the optimal choices . In addition,
strategists would select complex channels of distribution , a heavy dependence
on channel partners , minimal product postponement , high levels of spatial
convenience, and intensive distribut ion.
TABLE 3.1 Strategic framework.
Corpo rate 1arketing Competitive C hannel tnlle gy

tratcgy trntcgy Values Proce ss Issue s Channel tructurc
Competitive Marketing plan Price Make-to-Stock Single channel

dilTerentiation Produet life eyele Quality Assemble-to-Order Complex channel
Profit plan Product range, Delivery Make-to-Order Postponement
Asset plan mix, volume lmagc strategy
Outsourcing
Earnings plan Channel Flexibility intensity Value-added
distribution processing strategy
Capital budgets Product Design Collaborative
Service goals intcnsity Intensity of channel
Service
Custornization/ Capacity depen dence
configurability management Basic service outputs
Usc of Lean/JIT/Agility definition
technology Levelof market
enablers Cost improvement
exposure
Globalization
Globalization
The second level of strategic planning is focused on the strategic business

units that make up the enterprise. Strategic business units can take a variety
of forms and may be described as subsidiaries, divisions, distribution centers,
warehouses, or even product lines. Business unit strategies can be viewed
from two perspectives. Strategists must first of all ascertain the extent to
which each business unit possesses the ability to succeed in the marketplace.
Planners must measure the product, market, and channel strength of each
business unit and ensure that the strategies formulated are in support of the
objectives of the corporation as a whole. Factors associated with business
unit strategy development are overall market size, annual growth rate, histori-
cal profit margins, technology requirements, competitive intensity, energy re-
quirements, and environmental impact.
Of equal importance in developing effective business unit strategies is
understanding the basis by which a competitive advantage will be achieved
and maintained. Porter [6] states that competitive advantage can be expres-
sed as three generic types. These types he defines as:
Cost Leadership. In this strategy, the firm seeks to offer goods and
services at the lowest cost in the industry. The source of cost advan-
tage may focus on economies of scale, proprietary technology, trans-
portation, geography, and other factors. Wal-Mart, Best Buy, and
Home Depot are examples of companies who pursue this strategy.
Differentiation. In this strategy, the firm seeks to offer some product or
service that is unique in the industry and is widely valued by the mar-
ketplace. Differentiation can be based on products, the delivery sys-
tems by which the product is transacted, marketing approach, and other
factors. Lexus and Volvo separate themselves from other automobiles
by offering superior quality, service, and safety.
Focus. In this strategy, the enterprise focuses on a particular cost or
product differentiation advantage in one or a selected number of target
market segments. Gucci and St. John's Knits seek to penetrate the
specialty clothing market by marketing high-quality goods and services
that discount stores do not offer.
Some of the factors associated with understanding business unit competi-
tiveness are market and product growth, product quality, brand reputation, the
distribution pipeline, promotional effectiveness, logistics efficiencies, cost-
ing, inventory position, and managerial personnel. In this area, business strat-
egies fostering growth are the most important. Growth can take the form of
increasing market share through market penetration, market development, and
product positioning. Growth can also take place through the acquisition of
suppliers at one end of the distribution pipeline, the creation of additional dis-
tribution points or the purchase of wholesalers or retailers downstream in the
pipeline, or the acquisition of competitors. Finally, a business unit strategy
might target growth through diversifying into new products or even new
industries .
The final level of strategic planning is concerned with the development of
functional business area strategi es. Once business unit strategies have been
formulated, operational and budgetary objectives need to be established that
will drive the functional business areas within each business unit. As illustra-
ted in Figure 3.3, functional areas found in most companies, such as market-
ing, sales, finance, and logistics, must each have operational strategies sup-
porting the overall business unit strategy. For example, decisions concerning
the location, size, staffing, inventory capacities, and costs of the distribution
network must promote competitive advantages specified in the business unit
strategy. Effective strategic planning occurs when the objectives of each
strategic planning level are executed in alignment with and in support of one
another. Strategic planning is an iterative process in which performance mea-
surements link each level together and assure that overall enterprise goals are
being accomplished.
The objective of functional business area strategies is to ensure that the ca-
pacities and capabilities of the organization are consistent with the competi-
tive advantages being sought. In translating the business plan, strategists
must match business unit objectives with those activities associated with the
physical acquisition or production of goods, warehousing, sales, and delivery
to the customer as well as after-sales service. Porter [7] identifies five gen-
eric categories involved in planning the functional business area environment:
Inbound Logistics. This category is associated with the acquisition and
storage of materials and components. External activities in this catego-
ry are associated with supplier negotiations, order management, sup-
plier scheduling, and delivery. Internal activities are comprised of re-
ceiving, quality, material handling, warehousing, inventory control, ve-
hicle scheduling , and supplier returns .
Operations. This category is associated with value-added processing.
Activities performed by distributors in this category consist of bulk
breaking, kitting, labeling, packaging, light assembly, and facilities op-
erations.
Outbound Logistics. This category is associated with the distribution
of goods. External activities in this category focus on wholesale and
retail channels , and transportation. Internal activities are concerned
with finished goods warehousing, material handling, replenishment
planning, delivery vehicle operations , and scheduling.
Marketing and Sales. This category is associated with product sales.

Activities include advertising, promotion, sales force management, ord-
er management, distribution channel selection, and pricing.
Service. This category is associated with pre-sales and post-sale ser-
vices. Activities in this category focus on product enhancement or
maintenance including installation , repair, training, warranty, and ser-
vice parts.
Although programs associated with inbound and outbound logistics are of
paramount importance, each category described above is critical in executing
the business plan. The functional business area planning process must weigh
the costs incurred in each category against the expected operational object-
tives. Selecting and measuring the generic distribution categories necessary
to execute the business plan must be accomplished by matching the proposed
overall distribution system benefits with the projected logistics cost. The
goal is to pursue programs that seek to minimize cost in each category while
optimizing existing capacities and resources .
THE STRATEGIC PLANNING PROCESS
The creation of a comprehensive business plan is the responsibility of the

firm's president, board of directors, and senior management staff. In a divi-
sional environment, the general managers and their staffs are also included.
The goal of the planning process is the drafting of the broad strategic object-
tives that will serve to drive the corporate mission as well as determine the
policies that will be communicated to the firm's business units as they derive
their individual operational strategies. The resulting plans should link the en-
terprise together through commonly determined sales, inventory, profit, and
return on investment targets. The resulting enterprise business plan should
clearly establish the competitive posture of each node in the channel structure
and provide the mechanism for overall performance measurement.
In developing effective business plans and strategies, the top management
team must determine answers to such questions as the following:
What are the long-range goals of the business?
How best should the enterprise manage its fixed and current assets?
What return on investment is expected in order to meet profit targets
and shareholder expectations?
What is the climate of the business economy?
What is the scope of the enterprise's competitive drivers today, and
what should they be in the future?
What markets should the enterprise target, with what products and
services?
What are the organization's competitive strengths and weaknesses?

What changes will be required to gain and maintain market
competitiveness today and in the future?
How should external and internal changes be measured to ensure that
corporate goals are being attained?
In answering these and other questions, corporate planners must seek to
align company goals, strategies, and ambitions with economic and market-
place realities . To stay competitive, the enterprise must be constantly reposi-
tioned to exploit marketplace changes and competitive advantages and to
identify shifts in economic conditions , products, and services, customer wants
and needs, technology enablers, and laws and government regulations. As is
illustrated in Figure 3.4, the business planning process begins with the defini-
[
Corporate Goals
I 1
4 Strategy
Formulation
..... Business
Forecast
.... Asset
Management
I-
Business
Unit
Budgets
~
Busines s Units
I
FIGURE 3.4 Business planning process.
tion of enterprise goals. As described earlier, goals are broad, long-range ob-
jectives and attitudes that guide the efforts of the organization as a whole as
well as the individual actions of all of its employees. Defining business goals
is an interactive process whereby the management team of the enterprise peri-
odically raises fundamental questions concerning the well-being of the enter-
prise and redirects the operating strategies of the firm necessary to meet the
challenges that emerge. In addition , business goals will define the boundaries
and set the parameters against which actual results can be measured, the con-
sistency of the plan validated, and necessary changes to the plan executed.
Overall, this step can be described as an attempt to pursue a balance, as il-

lustrated in Figure 3.5, between the corporate objectives focused on growth,
profitability, and return on investment and the strategies built on the enter-
prise's markets, products, and resources.
Channel Business
Strategies Objectives
Markets Growth
Products Profitability
Resources Return
FIGURE 3.5 Business strategy formulation,
The second step in the business planning process is the creation of the
business forecast. The business forecast seeks to detail expected enterprise
financial growth, return on investment, and total projected net income for a
specific time period, usually no less than one year and often for several years
into the future. In developing this portion of the business plan, corporate
planners must balance expected aggregate revenues arising from sales and
other sources with incurred costs and other liabilities, and weigh the impact
the revenue plan will have on company resources and stockholder investment.
In addition, business planners must review qualitative factors, such as eco-
nomic, political, social, environmental, technical, and competitive forces in
drafting the corporate forecast. This portion of the business plan takes the
form of a detailed statement of sales volumes, cost of goods sold, margins,
selling and operating expenses, and taxes. Once these estimates have been
defined, they will be passed over to the marketing, sales, production, and
channel operations functions, who will then translate them into market seg-
ment, product and services, and sales and distribution channel strategies.
The third step in the business planning process focuses on the current and
long-term assets necessary to support the revenue plans detailed in the busi-
ness forecast. A typical company's assets can be divided into two general
categories: current assets, normally described as available cash, open ac-
counts receivable, and merchandise inventory, and fixed or capital assets,
normally consisting of land, buildings, equipment, investment, and other tan-
gible and intangible resources. During this portion of the business planning
process, mangers must ascertain whether the enterprise possesses resources
sufficient to realize the revenue objectives and, if not, what must be done to
acquire those capacities that are currently not available.
The final step in the business planning process is the disaggregation of the
profit and liabilities plans down to the enterprise 's business units in the form
of the operating budget. These business units can take many forms. For ex-
ample, each business unit could be a separate financial and operating entity
possessing its own management, products, customers, competitors, business
plans, and performance measurements. On the other hand, the business might
consist of a channel of business entities having common products and com-
petitors but which are semi-independent, with different customers, business
objectives, and performance measurements. Regardless of business unit role,
the goal of the corporate business plan is to ensure that the firm's object-tives
can be realized by the existing business units found in the distribution
channel structure. In doing so, corporate planners must detail for each busi-
ness unit the objectives, strategies, and budgets required for that entity to re-
alize its portion of the overall company business plan. Kotler points out that
corporate planners will select from the following four strategies in defining
the business unit strategy: build the business unit to increase its market share,
hold its current market share and seek to prevent decay, harvest its market
position by focusing on short-term cash profits regardless of long-term af-
fects, or divest it through liquidation or sale [8].
An effective business plan is absolutely necessary to the survival and
growth of the enterprise. The business plan provides the following benefits:
Strategic Definition. The primary focus of the business plan is to iden-
tify the strategic objectives of the enterprise. These objectives range
from defining broadly the firm's markets, products and services, and
channel structures, to detailing the revenue, asset, and business unit
strategies necessary to achieve overall corporate goals.
Plan Integrity. A well-defined business plan seeks to establish a cor-
porate strategy that is compatible with the capabilities of the enterprise.
The result of the planning process is a series of operational directives
and metrics providing a method of performance measurement whereby
the efforts of the separate business units constituting the distribution
channel should add up to the aggregate numbers established in the cor-
porate plan.
Communication System. The business plan enables the top manage-
ment team to establish, broadcast, and maintain the detailed strategic
objectives for all levels within the enterprise and for associated units
and partners out in the channel network. The business plan provides
the input used by marketing, sales, and procurement management to
construct their operating plans. Finally, the business plan provides cor-
porate benchmarks to guide and measure how well the efforts of the
entire firm are realizing planned objectives.
DEVELOPING THE BUSINESS PLAN
Before a business plan can be communicated to the operations levels of the

enterprise, it must be verified to ensure that total income is sufficient not only
to pay cost of sales, operating expenses, and taxes but also enables the busi-
ness to achieve corporate growth, return on investment, and dividend payout
objectives. Ensuring that the business is generating the necessary financial
numbers requires effective reporting and analysis relating to progress on the
business forecast and how well productive assets are managed. The follow-
ing documents are normally used in measuring business plan progress.
INCOME STATEMENT AND BALANCE SHEET
Perhaps the most widely used documents in analyzing corporate strength are
the income statement and the balance sheet. These documents provide busi -
ness strategists with a widow into the business in order to evaluate historical
performance, current capabilities, and future opportunities.
The Income Statement. This document describes a firm's aggregate re-

venues and expenses. The income statement helps to answer such questions
as: Did the firm earn a profit or incur losses? Why? At what rate? What
contributed to the firm's success, and what impeded planned opportunities
from being realized? The income statement is calculated by summarizing
total sales and deducting costs, expenses, and taxes to determine net income
or loss . Wholesale distributors are particularly sensitive to gross profit. Be-
cause of the enormous investment in inventory, even a small change in gross
profit can have a disproportionate impact on net income. Consequently, the
statement of gross profit is a critical decision variable for wholesale distribu-
tors . The statement is compared to the results of one or more previous years
to indicate trends in performance. An example of the income statement for-
mat for a wholesale distributor appears in Figure 3.6.
The document begins with Sales and subtracts out Cost of Goods, which
includes inventory, labor, and overhead, to produce the Gross Margin. From
the Gross Margin, other expenses, which include Selling, Operating, and
Non-Operating expenses are subtracted to leave the Net Income . Finally,
Taxes and Dividends to stockholders are deducted from the Net Income,
leaving the Returned Earnings that can then be invested back into the busi-
ness. The Retained Earnings will end up appearing on the next critical docu-
ment, the balance sheet.
The Balance Sheet . The balance sheet describes a firm's financial position
by listing the balances of total assets, liabilities and stockholder's equity. The
Gross Sales
- Sales Returns
- Sales Discounts
= Net Sales
Less: Cost of Goods Sold
Opening Inventory Value
+ Purchases
- Goods Available for Sale
Less: Ending Inventory Valuation
- Cost ofGoods SaM
Less: ct ales
= Gross Margin
Less: Ending Inventory Valuation
Less: Operating Expenses
- Operating Income
l.ess : Non-operating Item
- Interest Charges
+ Interest Income
- Net Income Before Taxes
Less: IncomeTaxes
Net Income
Less: Dividends
- Retained Earnings
FIGURE 3.6 Income statement for a wholesale/distributor
left side of the balance sheet consists of a statement of company assets.

Assets are broken down into current assets, which include cash, accounts re-
ceivables, and inventory, and fixed assets, which include land, buildings, and
equipment. The other side of the balance sheet is the statement of the firm's
liabilities. This section consists of current liabilities, such as accounts pay-
able, salaries and wages, and taxes, and long-term liabilities, such as bonds,
notes, and mortgages . Included in the liabilities is a section illustrating stock-
holder's equity. Total assets must equal total liabilities plus stockholder's
equity. Growth in stockholder's equity is critical to the growth of the enter-
prise and is one of the primary financial goals of the company. An example
of the format of the balance sheet appears in Figure 3.7.
ASSETS LIABILITIES
Current Assets Current Liabilities

Cash AccountsPayable
Accounts Receivables Maturityof Long-Term Debt
MarketableSecurities Salariesand Wages
MerchandiseInventory Interest
Total Current Assets Taxes
Total Current Liabilities
Fixed Assets
Land Long Term Debt
Facilities SinkingFund Bonds
Equipment Promissory Notes
Intangibles Mortgages
Total Fixed Assets Total Liabilities
OtherAssets Stockholders' Equity
Investments Stock
DeferredCharges Retained Earnings
Total Current Assets Total Stockholders ' Equity
= Total Assets Total Liabilities and

Shareholders' Equity
FIGURE 3.7 Balance sheet example.
Return on Investment. The return on investment (ROI) is generally con-

sidered to be the best barometer of a company's financial performance . ROI
can be expressed two ways, depending on fiscal requirements. The first
method attempts to measure the return on assets (ROA) or return on total
capital. The technique attempts to separate investment return from the in-
come that has accrued from trading on the equity. ROA is calculated by
dividing the net operating income by the average total assets. For example, if
company XYZ's average total assets equaled $66 million, with total opera-
ting income of $9 million, the return on total assets would be 13.6 percent.
The second method of expressing ROI is return on stockholders' equity. This
technique attempts to demonstrate how profitable the company is to its
owners. The ratio is calculated by dividing net income by the average total
stockholders' equity. If company XYZ's net income is $6 million and the
average stockholders' equity is $52 million, then the return on stockholders'
equity would be 11.5 percent.
The real value of the ROI analysis can be found in assisting corporate
planners target one or more of the components of the ROI calculation for im-
provement. Growth in total sales can be achieved by developing new prod-
ucts and value-added services, opening new markets, pricing decisions, deep-
er penetration of the existing customer base, or attacking markets held by
competitors. Reductions in the cost of sales by decreasing purchasing costs
arising from JIT procedures, contract pricing, and improved inventory pro-
ductivity will increase gross margins. Operating costs can be lowered by de-
creasing stockable inventories, implementing information technologies tech-
niques like ERP and the Internet, and by relentlessly pursuing the elimination
of waste and improving the productivity of warehousing, transportation, and
labor functions. Improvements in net worth can be achieved by increased
turnover in asset investment which will reduce total capital investment and
provide resources for new development. Finally, liabilities can be reduced by
increasing or decreasing debt or equity, thereby increasing net worth.

Today's hottest financial idea is financial planners advocate assess-
termed EVA. Developed by con- ing a company's performance based
sulting finn Stern Stewart & Co. the on its return on capital or economic
method help planners ensure a given value-add. The EVA model attempts
business unit is adding to stock- to quantify the value created by
holder value. while providing inves- taking the after-tax operating profit of
tors with signals that a stock is likely a company and subtracting the annual
to increase in value. by measuring cost of all the capital the firm uses.
its true profitability. Companies can also apply the model
to measure their value-added contri-
One of the criticisms of traditional bution to total supply network profit.
accounting methods is that they tend A defect of the model is that, while
to favor short-term profits and reve- useful in assessing earnings above the
nues while neglecting the long-term cost of capital to be included in the
economic well-being and potential executive portion of a balanced
profitability of the enterprise. scorecard. it is less useful in
structuring detailed supply chain
To remedy this shortcoming. some metrics.
INVESTMENT, PROFIT, ASSET, AND CAPITAL PLANNING [9]
While the income statement, balance sheet, and ROIlROA will provide over-
all scoreboards as to the financial well-being of the enterprise, the business
planning process detailed above requires close management of more detailed
plans centered on investments , profits, assets, and capital.
Business Forecast Plans. As detailed above, the business forecast seeks to

detail the expected financial enterprise growth, return on investment, and
total projected net income. There are two critical plans found in this planning
area. The first, investment planning, determines the net earnings necessary to
support expected enterprise growth. Net earnings can be used for two pur-
poses: they can be paid out in the form of dividends to shareholders in the ex-
pectation of further stock purchase or they can be reinvested into the busi-
ness. An example of an investment plan is illustrated in Figure 3.8. The plan
begins by determining expected company growth by considering new market
strategies, historical performance, and current capabilities, and then
multiplying the percent of growth by the current Net Worth to arrive at the
Estimated Net Worth. Once this value has been calculated, the expected ROJ
percent is then determined and multiplied against the Estimated Net Worth to
arrive at the Net Earnings. The goal is to produce the Net Earnings. A
critical decision must at this point be made as to the disposition of the Net
Earnings. In the example, it has been decided to grant shareholders 16.6
percent of Net Earnings as a dividend, with the remaining balance returned to
the company as seed money to fund the Estimated Growth percentage.
SOOO. OOO
Description Target
BeginningNet Worth 17.5
Estimated Growth 15%
Estimated Net Worth 20.0
ROI Target 15%
Net Earnings 3.0
Dividend Target = 16.6% .5

Reinvested Earnings 2.5
FIGURE 3.8 Investment plan
Once the investment plan has been determined, the second forecast plan,
the profit plan, must be created. This plan seeks to determine the After Tax
Profit of the business driven by the sales effort. As illustrated in Figure 3.9,
the plan begins by taking the Net Earnings from the investment plan and de-
termining the percent of profit the Net Earnings represents to the company.
Once this percent objective has been set, the Sales Revenue can be calcu-
lating. If 5 percent after tax is 3 million, then lOO% equals $60 million. The
Sales Revenue target can then be passed to sales and marketing planners who
will have to determine whether they can realize the revenue goal. In conjun-
ction with manufacturing they must set the expected Cost of Goods to verify
if the company can produce, market, and sell the necessary products consti-
tuting the revenue plan while meeting the expected Gross Profit. Finally, the
Gross Profit is reduced by the tax rate and reconciled to the After Tax Profit
target.
SOOO,OOO
Description Percent Target

After-Tax Profit 5 3
Sales Revenue 100 60
Cost of Goods 90 54.0
Gross Profit 10 6.0
Taxes @50% 5 3.0
FIGURE 3.9 Profit plan
Asset Management Plan. As detailed above, the asset management plan is

concerned with defining the current and long-term assets necessary to support
the revenue plans detailed in the business forecast. There are two critical
plans found in this planning area. The first, asset planning, sets the financial
levels of the company's productive assets. As illustrated in Figure 3.10, the
core of asset planning is determining the investment in plant and equipment
necessary to actualize the sales revenue plan. As such, the planning process
begins by calculating the estimated average daily sales achieved by dividing
the Sales Revenue plan by the number of company working days. Once this
figure is attained, planners can then calculate the necessary current (cash, re-
ceivables, and inventory) and fixed (plant and equipment) assets. For ex-
ample, by first determining the daily cash flow arising from such elements as
receivables , payables, interest, and payroll resulting from the revenue plan, it
has been determined in Figure 3.10 that 10 days of cash or a total of $1.7 mil-
lion will be required . Similar judgments will have to be made for the number
of days of open receivables and inventory turns. Once the Current Assets
have been calculated, attention must be turned to the fixed assets. A simple
calculation is to determine the number of dollars needed to make each dollar
sold. In the example, it has been determined that it takes one dollar of plant
and equipment costs for every four dollars of sales. Dividing $60 million by
$4 indicates that fixed asset expenses will total about $15 million. By com-
bining the Total Current Assets and the fixed assets the Total Assets
necessary to support the revenue plan can be determined.
SOOO.OOO
Description Factor Target

Average Daily Demand = $60 /360 .166
Cash - Days of Sales on Hand 10 1.7
Receivables - Aged Days of Sales 60 10.0
Inventory - COG / Turns 3 13.3
Total Current Assets 25.0
Plant & Equipment - Sales / Avg. Cost $4 15.0
Total Current/Fixed Assets 40.0
FIGURE 3.10 Asset plan .
Determining the asset plan is one critical management step; figuring out
how the current and fixed assets are going to be paid for is the subject of the
final plan, capital planning. As illustrated in Figure 3.11, the plan begins by
000,000

Total Assets 40.0
Current Ratio / Liabilities 2.5 10.0
Total Available Capital 30.0
Investor Equity 17.5
Debt 12.5
Allowable Financing 40% 12.0
Debt Positioning + / - -.5
FIGURE 3.11 Capital plan .
identifying the Total Assets calculated in the asset plan. The next step is to
subtract the current liabilities from the current assets to provide how much
capital will have to be funded. This figure is attained by determining the
ratio of liabilities to assets which, in the example, has been set at 2.5 or $10
million in liabilities. This results in a debt of $30 million to be financed.
When investor equity is subtracted from this figure, the company is left with
a debt of $12.5 million to meet the asset plan. Management has determined
that unfinanced debt should not exceed 40 percent of Total Capital require-
ments or $12 million . In the example, this figure has been exceeded by $.5
million. Such a shortfall means that the company can not fund the excess
debt. Solving this problem will require a revision in the revenue or the asset
plans. For example, the shortage could be resolved through better cash man-
agement, reduction in open receivables, or an increase in inventory turns.
SUPPLY CHAIN PLANNING
In today's fast-paced environment strategic planners have become aware that

depending on metrics that focus solely on company performance are be-
coming increasingly inadequate in providing a complete perspective on busi-
ness planning . As discussed in Chapter I, companies have begun to see
themselves , not as individual players in the marketplace, but as components
in a supply chain ecosystem focused on total customer value. As such, it has
become imperative that executives dedicate a portion of their planning pro-
cesses to the development of supply chain strategies. Supply chain strategies
attempt to answer questions such as:
Has the supply channel been correctly structured to actualize the cor-
porate goals found in the business plans?
How is the supply chain enhancing or eroding profitability and share-
holder value?
How much current asset is tied-up in slow moving inventories located
in the supply chain?
What would be the impact on growth initiatives as well as customer
service if current assets were reduced across the supply channel?
Can supply chain trading partners provide targeted productive assets
that will free capital investment while simultaneously increase custom-
er value?
What are the service levels provided to channel customers and how can
they be adjusted to increase customer value while reducing costs?
How is information regarding profits and costs being passed back up
the channel to feed executive scoreboards detailing the on-going per-
formance of the business plan?
While recognizing the importance of finding answers to such questions,
many business planners have, however, historically neglected to formulate
satisfactory supply chain business plans. The reasons are many. To begin
with, supply chain business strategies require the creation and tracking of per-
fonnance metrics that are beyond the core business. Faced with the fact that
supply chains are inherently dynamic, consisting of often oscillating coaliti-
ons of trading partners (factories, transportation, wholesalers, retailers), de-
veloping performance tools to monitor the significant costs that pass through
each supply network node can be a complex process. Secondly, trading part-
ners may be reluctant to provide information on performance, Data may be
considered proprietary and not open to the eyes of outsiders. In addition,
many executives have a traditional view of supply channel functions and do
not realize its impact on all areas of financial performance. Supply chain per-
fonnance is narrowly focused on only one aspect of overall performance:
operating costs.
Key Performance Targets. Utilizing the supply chain as a source for total
shareholder return and customer value will require reformulation of the tradi-
tional place of the supply chain in the business plan. As stated above, the key
objective of the business plan is to identify three key performance targets:
How can the revenue plan be increased for the entire planning horizon?
What is the net income after deducting operating ex-penses. This is
often termed the operating p rofit margin?
What is the revenue return for each dollar invested in capital (current
and fixed assets)?
The goal is for strategists to determine the role of the supply chain in man-
aging these three critical financial performance drivers.
Growth: Supply chains can provide a variety of critical enablers that
directly impact profit and growth. Enablers, such as reducing channel-
wide stockouts, increasing customer service, facilitating new product
development and speed to market, increasing capital utilization, and
decreasing asset costs, can directly increase revenues. For example, in
Figure 3.12 improvements made by supply channel partners have
resulted in a 2 percent increase in revenues. By utilizing the profit plan
format discussed above, this increase in sales (assuming no increases in
Cost of Goods) will result in a 2 percent increase in Gross Profit and a
full percent in Revised After-Tax Profits.
Profitability. Profitability is the balance of revenue after paying all op-
erating expenses. Historically, planners have viewed enhancements to
the supply channel in terms of operating cost reduction. The manage-
ment of logistics costs (transportation, inventory, warehousing, admini-
stration) can reach nine to ten percent or more of the average compa-
ny's revenue dollar. The impact on profitability by a five percent re-
duction in supply channel current assets is illustrated in Figure 3.13.
The increase in market value can be used to fund new product develop-
ment, attract new shareholders, or even acquire another company.
BUSINESS AND STRATEGle PLANNING 123
SOOO,OOO
Description Percent Target

Sales Revenue 60 .0
Supp ly Chain Increase 2% 1.2
Cos t of Goods 90% 54.0
Gross Profit 12% 7.2
Taxes @50% 3.6

Original After-Tax Profit 5% 3.0
Revised After-Tax Pro fit 5.9% 3.6
FIGURE 3.12 Impact of SCM on revenue growth
Capital Utilization. This portion of supply chain management mea-

sures how efficiently a company utilizes capital to generate revenues.
SOOO.OOO

Average Daily Dem and = $60 /360 . 166
Cash - Days of Sa les on Hand 10 1.7
Receivables - Aged Days of Sa les 60 10.0
Invento ry - COG / Tu rns 3 13.3
Total Current Assets 25.0
Supply Cha in Cos t Reduction 5% 1.25

Adj usted Total Current Assets 23. 8
Plant & Equipment - Sales / Avg. Cost $4 15.0
Total Current/Fixed Assets 38.75
FIGURE 3.13 Asset plan.
Simplistically, this value is calculated as the revenue generated for

every dollar invested in capital. It can also be said that the more capital
intensive the investment, the lower the revenue expressed as a ratio to
capital. As a whole it can be stated that the faster revenue can be gen-
erated, the faster a business can grow, the higher its financial
performance, and, ultimately, the greater its returns to shareholders. In

Figure 3.14, a decision to increase inventory turns from three to four
has resulted in a drop of capital investment of $3.2 million. When
combined the new Current Assets is combined with the fixed assets for
plant and equipment, the new Total Available Capital and Debt drops
$2 million. The overall result is that financial planners are now $1.5
million under the Allowable Financing ceiling. While reducing current
capital is inherently good, the real benefit is that the company's stock
price or value has grown, permitting the execution of strategic plans to
fund another product line or even acquire another company.
s000.O(Jf)
Total Assets 40.0
Cash - Days of Sales on Hand 10 1.7
Receivables - Aged Days of Sales 60 10.0
Inventory - COG / Turns 4 10.0
Total Curr ent Assets 21.7
New Current Ratio / Liabilities 2.5 8.7
Old Current Ratio / Liabilities 2.5 10.0
Nell' Current Available Capital 13.0
Plant & Equipment 15.0
Nell' Total Available Capital 28.0
Investor Equity 17.5
Debt 10.5
Allowable Financing 40% 12.0
Debt Positioning + 1 - + 1.5
FIGURE 3.14 Capital utilization plan.
SCM Data Collection and Analysis. Utilizing the cross-channel business re-
porting described above requires the application of computerized toolsets that
enable supply chain partners to pass key performance indicators (KPIs) and
communicate with each other. While establishing a networked business in-
formation exchange complete with analytical tools for assembling opera-
tional and strategic information can appear at the outset to be an almost
impossible task, software architectures and even standardized packages are
available today. These systems utilize the connectivity power of the Internet
to create a network model and a common database so that channel members
can assemble data and monitor performance. These systems extract data
feeds from participating supply chain members, aggregate it, calculate per-
formance targets based on targeted KPIs, and provide a solution to all channel
partners . Some systems also provide an event-driven simulation that maps
how a given supply chain behaves over time and provides participating com-
panies opportunities to develop response strategies when unplanned events
occurring the supply channel. Often the statistics are posted on the network
so that all channel partners can view their performance relative to other chan-
nel members [10].
Another tool for managing inter-company business planning is to apply the
Balanced Scorecard to supply chain management. Developed by Kaplan and
Norton [11], the concept is designed to provide strategic planners with a
performance methodology designed to generate business plans from four
perspectives : financial results (return on capital employed, asset utilization,
profitability, growth), the customer (viability of the value proposition),
business processes (effectiveness of the quality, flexibility, productivity, and
costs accumulated by each business process), and innovation and learning
(core competencies and skills, access to strategic information, organizational
learning and growth).
While not directly created for supply network business planning, the meth-
od can be easily adapted to a supply chain environment. According to
Brewer and Speh [12] implementing a supply chain balanced scorecard re-
quires the following steps:
Step 1: Formulate Strategy and Build Consensus. The first step is for
each channel partner to define their supply chain strategic objectives
and understand where the strategies of each network participant con-
verge/diverge. This activity will drive the metric-selection process that
will permit definition of the parameters detailing optimal performance
for each supply chain participant.
Step 2: Select Metrics in Alignment with the Supply Chain Strategy.
The performance measurements selected should support the four score-
card perspectives described above. For example, supply chainfinancial
targets, such as increased market share, customer targets, such as on-
time delivery requiring increased channel velocity, business process
targets, such as facilitating the value chain from design through manu-
facturing, distribution, and delivery to the end customer, and innovation
and learning, such as integrating cross-enterprise design functions to
ensure the efficient generation of the next generation of products, could

be agreed upon by channel network partners.
Step 3: Integrate and Communicate the Metrics . The general statements
of desired performance must be disaggregated into detailed, under-
standable, and actionable metrics that can guide internal and well as
cross-channel daily operations.
Step 4: Drive the Organization to Maintain and Optimize the Desired
Results. Ensuring that the metrics detailed at the strategic and opera-
tionallevel of the supply chain scorecard are performed, accountability
for performance, targets for improvement, action plans, performance
progress reviews, and linkage to individual performance and reward
must be established and agreed to by all channel managers.
Figure 3.15 illustrates a supply chain balanced scorecard where network
Supply Chain Objective: Increased Channel Flexibility
Strategic Theme Strategic Objectives Strategic Measures
Financial Increased Supply Channel cost reduction Increased cash flow
Chain Flexibility Increased profit margins Reduced channel inventory
Revenue growth Improved fixed asset
High return on assets utilization
Customer Perception of Customers drive product Flexibility and agility of

flexible response fmalization the supply channel
to customers Service individualization Ability to deliver
Increased product variety customized solutions
Business Postponement and Increased synchronization Channel finished goods

Processes value-added Increased communication reduction
strategies Fast flow of inventories Increased inventory turns
Multi-purpose facilities Processing efficiencies
and utilizations
Optimize transportation
Warehouse storage
reduction
Innovation Increased material Increasing core competencies Employee survey

And handling and Motivating workers Personal balanced scorecard
processing Skilling workers Total supply chain
Learning
capabilities competency available
FIGURE 3.15 SCM balanced scorecard.

partners have selected increased channel flexibility as the critical success fac-
tor. The financial perspective opens the scorecard. The objectives to be pur-
sued are centered on total channel cost reduction and revenue growth by
leveraging material and conversion strategies. It has been determined that a
more flexible supply channel will cut finished goods inventories, improve
product throughput, and increase gross margins. Realizing this goal will re-
quire measures that demonstrate how well each channel partner's operating
costs and gross margins are progressing.
The purpose of emphasizing flexibility as the critical success factor is to
gain customers by permitting them to drive finalization of products in real
time and receive individualized service. Being able to meet this criteria rests
on the capabilities of the business processes. Increased postponement and
value-added processing will place a burden on channel nodes to increase the
variety of products available while simultaneously maintaining or decreasing
the time it takes for order configuration support. Realizing this goal will re-
quire measures that indicate the productivity of processing operations, total
dollar value of finished goods and how well warehousing and transportation
costs are being optimized. Finally, the innovation and learning perspective
can be critical in the execution of the flexibility strategy. Depending on the
level of skill of the workforces of each channel partner to perform value-
added process functions, effective execution of the strategy could be a dif-
ficult one. Core competencies might have to be built or attained from outside
the organization. New incentives and motivational programs might have to
be enacted.
Architecting a supply chain balanced scorecard provides strategic planners
will radically new and different challenges. Successful execution of the
methodology requires companies to move beyond simply measuring the pro-
gress of the internal business (often an enormous task in itself!) to a per-
spective that considers channel collaboration, consensus, and total supply
chain performance as the cornerstone of success. According to Brewer and
Speh [13], there are eight critical hurdles that must be spanned to make sup-
ply chain balanced scorecards a reality. They are: trust among channel mem-
bers in sharing data and measuring performance; understanding concerning
the impact of how multi-organizational measurements might invite individual
company negative consequences; lack of control over measures that depend
on inter-organization efforts; presence of different goals and objectives
among channel members; incompatible information systems that inhibit data
transfer and visibility; varying definition of the format, structure, and mea-
surement approach to performance measurements; difficulty in linking mea-
sures to customer value; and, deciding where to begin.
While a daunting task, the complexity should not dissuade companies from
taking up the challenge : there is just too much to be gained by harnessing the
productive power of collaborative supply chains. The first place to start is to
form cross-enterprise performance design teams. To begin with, these teams
will need to move beyond a concern with local function-based measurements,
which tend to splinter the performance development effort and focus on
I 1 ' 1
Cash Management
Days sales outstanding (l)SO) Iligh DSO includes too many invoice
errors. excessive delivery times. pay-
Accounts receivable x working days ment delays due to returns and re-
Total inventory invoicing. and customer dissatis faction
Cash 10 cycle 1;lIIe This metrics is designed to show how

fast cash is begin generated from the
Days sa les outstanding (DSO) + expenditures made in inventory and
Inventory days supply - production
Days Payable outstanding
Receivables turnover Low receivables indicates problems in
collections. credit management. Also
Total Revenue highlights possible slowing of sales.
Receivables
Asset Management
Asset turns I.ow turns indicates high level of fixed
assets and in vcn tory used to meet
Total revenue service target . Also. could indicate lack
TOlal aSSClS of collaborative relationships with chan-
ncl partners
RO..! - Return all assets Indicates low fixed and current asset
return. Indicates lack of collaborative
ct income partnerships with channel partners.
Total assets
Inventory Management
11I\'I!IIlory turns Large stockpiles necessary 10 meet

service targets. Wcakncs 'cs in channel
Cost of goods sold demand/supply communication. Poor
Total inventory forecasting. 'IPS/MRP planning. pur-
chasing. and fulfillment
inventorydays 011 hand Indicatcs excessive stockpiles to meet
service targets, Poor safety stock tar-
Working days gets. planning data. demand forecasting .
Inventory tum ratio In ability 10 meet supply chain demand
cross-functional processes and accompanying metrics that will crystallize ob-

jectives designed to increase cross-network channel integration. The goal is
not to eliminate function-based measurements, but rather to broaden their ef-
fectiveness by integrating them with supply chain level metrics that will re-
veal how well each network business node is individually working toward
goals that will improve not only their own performance but also the overall
performance of the entire supply chain. In addition, teams must be strong
enough to tackle several other critical problems inherent in determining sup-
ply chain metrics. The measures decided upon must be in synchronization
with individual company and total supply chain strategies. The tendency to
capture too many measurements must also be avoided. Participating compa-
nies must be encouraged to provide meaningful information on their perform-
ance. And finally, supply chain measurements can be beset by problems in
defining basic terminology necessary to ensure common understanding of
performance standards.
SUMMARY
The central challenge to distribution management in the twenty-first century

can be simply stated as the ability of the enterprise to establish and maintain a
competitive advantage through the effective allocation of productive re-
sources to capitalize on marketplace opportunities . The first step required to
meet this challenge is the establishment of an effective strategic business
plan. In developing plans and strategies, corporate planners must seek to
align company goals, strategies, and growth expectations with today's
economic and marketplace realities . The development of effective business
plans involves four essential activities . The first step in the business planning
process is the definition of the company goals and their translation into con-
cise mission statements . The second step is the creation of the business fore-
cast. This step seeks to detail expected enterprise financial growth, return on
investment, and total projected net income. In the third step, management
focuses on the current and long-term assets necessary to support the revenue
plans outlined in the firm's business forecast. Finally, in the last step, cor-
porate plans are disaggregated and passed down to the firm's business units.
The goal is to ensure that strategic objectives can be realized by the existing
business unit structure . The role of supply chain management planners in all
three levels of strategic planning is critical. Their input is not only pivotal in
the formulation of marketing, sales, and financial plans but also in allocating
the fixed and liquid capital necessary in business plan execution.
Before a business plan can be communicated to the operations levels of the
business, it must be verified to ensure that total income is sufficient not only
to pay for current and fixed assets, but also to support targeted corporate
growth, return on investment, and dividend payout objectives. Several criti-
cal performance documents are essential in validating the business plan. The
first is the income statement. This document describes a finn's aggregate re-
venues and expenses. It seeks to answers such questions as: Did the finn earn
a profit? What contributed to its success or failure? The second document,
the balance sheet, describes a finn's financial position by listing the balance
of total assets, liabilities, and stockholder equity in relation to the company's
assets. The final document is return on investment (ROI). ROI can be ex-
pressed in two ways: return on assets (ROA) and return on stockholders '
equity.
While the above documents will provide overall scorecards as to the
financial well-being of the enterprise, the utilization of more detailed plans is
necessary. The first set of business performance plans focuses on the busi-
ness forecast and consists of the investment plan (which determines the net
earnings necessary to support enterprise growth) and the profit plan (which
determines the after tax profit of the business driven by the sales effort.) The
second set of plans is centered on metrics associated with asset management
and consists of the asset plan (which sets the financial levels of the compa-
ny's productive assets) and the capital plan (which details how the current
and fixed assets are going to be paid for).
In today 's fast-paced environment strategic planners have become aware
that depending on metrics that focus solely on company performance are be-
coming increasingly inadequate in providing a complete perspective on busi-
ness planning. Increasingly, executive planners have come to view how criti-
cal the performance of growth, profitability, and capital utilization out in the
supply chain is to overall business success. Developing and communicating
cross-enterprise key performance factors (KPIs) has become the foremost
frontier in the creation and monitoring of a successful business plan. Tack-
ling this mission provides many challenges to supply chain business planners
involving the generation of supply chain partner trust, the creation of com-
mon, meaningful metrics, the accurate and timely passage of performance in-
formation from across the channel, and the joint implementation of toolsets,
like the supply chain balanced scorecard.
1. Why are effective business strategies essential for competitive success?

2. Properly aligned enterprise strategies are fundamental for effective top
management planning. Discuss.
3. Would you describe Wal-Mart as following a competitive strategy based on cost
leadership, differentiation , or focus? Explain your answer.
4. How have new management concepts centered on networking, tech-nology, and
virtual teams changed traditional strategic planning?
5. What is the role oflogistics management in business strategy de-velopment?
6. Detail how the logistics function can be used as a competitive weapon.
7. Firms seeking to improve cash flow and return on assets historically have
focused on reducing accounts receivables and investment in in-ventories. What
are the consequences of such actions without chang-ing the firm's logistics
systems?
8. Based on the data in Table 3.1, calculate the return on assets for a company with
the following year-end financial data (in $Millions) if the goal was to reduce
accounts receivables by 18% and inventory in-vestment by 25%.
Sales $50
Net Profit $3
Current Asset $25
Acct. Receivable $11
Inventory $13
9. Based on the calculation for Question 8, what percentage would an-nual sales
have to increase to attain the same return on assets?
REFERENCES
1. Hayes, Robert H. and Wheelwright, Steven C., Restoring Our Competitive Edge.
New York: John Wiley & Sons, 1984, p. 25.
2. Porter, Michael E., Competitive Strategy. New York: The Free Press, 1980, pp.
3-33.
3. These basic principles are elaborated by Kotler, Philip, Marketing Management,
6th ed. Englewood Cliffs, NJ: Prentice-Hall, 1988, p. 37.
4. Anthony, Robert N., The Management Control Function. Boston, MA: Harvard
Business School Press, 1988, pp. 31-34.
5. Kotler, p. 33.
6. Porter, Michael E., Competitive Advantage. New York: The Free Press, 1985,
pp.62-163 .
7. See the analysis in Porter, Competitive Advantage, p. 3.
8. Kotler, p. 42.
9. This section has been adapted from Schultz, Terry R., BRP: The Journey to
Excellence. Milwaukee, WI: The Forum Ltd, 1986, pp. 23-30.
10. See the commentary in Dilger, Karen Abramic, "Say Good-bye to the Weakest
Link with Supply-Chain Metrics," Global Logistics and Supply Chain Strategies,
5,6,2001, pp. 34-40 .
11. Kaplan, Robert S. and Norton, David P., "The Balanced Scorecard: Measures
That Drive Performance," Harvard Business Review, (January-February, 1992),
pp, 71-79; Kaplan, Robert S. and Norton, David P., The Balanced Scorecard:
Translating Strategy into Action . Boston: Harvard Business School Press, 1996;
and, Kaplan, Robert S. and Norton, David P., The Strategy-Focused
Organization: How Balanced Scorecard Companies Thrive in the New Business
Environment. Boston: Harvard Business School Press, 2001.
12. Brewer, Peter C. and Speh, Thomas W., "Adapting the Balanced Scorecard to
Supply Chain Management," Supply Chain Management Review, 5,2,2001, pp
48-56.
13. Ibid.
4
FORECASTING IN THE
SUPPLY CHAIN ENVIRONMENT
FORECASTING - AN OVERVIEW MANAGING THE FORECAST

Understanding Forecast Error
FORECASTING TYPES Why Forecasts Fail
Qualitative Techniques
Quantitative Techniques SUMMARY
Time-Series Analysis
Selecting Quantitative Forecasting QUESTIONS FOR REVIEW
Techniques
Causal Types PROBLEMS
Much of the success of enterprise planning and decision-making processes

depends on the formulation of accurate forecasts. Although it has often been
said that nothing really happens until a company receives a customer order,
unless the enterprise has developed sound plans that enable it to purchase the
proper inventory, establish the necessary supply channels, and deliver goods
on a competitive basis, the business cannot possibly hope to achieve corpo-
rate objectives . In addition, forecasting permits firms to establish perfor-
mance measurements for customer service, plan the level of total inventory
investment, choose between alternative operating strategies, and develop as-
sumptions about the ability of the business to respond to the future needs of
the marketplace . Effective forecasts can dramatically improve enterprise pro-
fitability, productivity, and customer service and ensure competitive
advantage. Good forecasting also assists strategic planners to eliminate waste
in the form of excess inventory, reduce lost sales and expensive expediting,
and control costs involved in maintaining plant size, labor, equipment, and
transportation. Finally, the communication of accurate and timely forecasts
enables entire supply chains to construct agile and scalable supply networks,
architect unique channels of collaborative, value-creating relationships, and

continuously align supply network capabilities with the requirements of the
customer.
Developing and maintaining accurate forecasts is critical to effective
decision making at all levels in the organization. All areas, from top manage-
ment planning to transportation and warehousing, require some level of fore-
casting for sound departmental planning and control. As the Internet and glo-
bal competition accelerate requirements for timely product introduction, sup-
ply chain management, and logistics accuracy, forecasting has taken on added
importance. In the past, many enterprises could be characterized as having
not one but several forecasts, each reflecting the narrow operational object-
tives of each functional business area. Sometimes the forecasts were out of
alignment with each other, projecting different sets of critical performance in-
dicators reflective of departmental goals. Today, supply chain strategists
conceive of forecasting as an integrative and iterative process whereby the
strategic goals are formulated, integrated with the capabilities of supply chain
partners, and then disaggregated down through the organization. As the fore-
cast unfolds through time, data concerning actual activity is utilized for fore-
cast revision and then communicated to channel partners. The objective of
the whole process is to ensure that each supply chain node is utilizing the
very latest data in the development of manufacturing, supply chain, and logis-
tics plans.
In this chapter, forecasting in today's supply chain environment will be ex-
plored . The chapter begins with an overview of forecasting as a tool for
enterprise planning. From this vantage point, the discussion will proceed to a
review of the forecasting types available: qualitative, quantitative, and causal
forecasting. Included will be an in-depth analysis of the short-term fore-
casting techniques available to distributors. Next, the steps necessary for ef-
fective forecast development and management will be detailed as well as a
discussion of why forecasts fail. Finally, the chapter concludes with a review
of the challenges of forecasting in the age of e-business.
FORECASTING - AN OVERVIEW
The APICS Dictionary defines forecasting as "the business function that

attempts to predict sales and use of products so they can be purchased or
manufactured in appropriate quantities in advance" [1]. Implicit in the de-
finition are two critical concepts:
1. A forecast is an objective estimate of future demand attained by pro-
jecting the pattern of the events of the past into the future. Literally,
FORECASTING IN THE SUPPLY CHAIN ENVIRONMENT 135
the word forecast means to "throw ahead," to continue what has histo-
rically been happening .
2. A prediction is a subjective estimate of what events will be happening
in the future, based on extrapolating or interpreting data that occurred
in the past. Prediction or "saying beforehand" is the process whereby
management uses subjective judgment to decide whether events will be
repeated based on past experience or to anticipate changes arising from
new environmental, geographical, political, or demand patterns.
Forecasting is fundamentally a calculative process whereby a sequence of
historical numeric values reflected of demand is first attained, to which vari-
ous statistical techniques are then applied in order to arrive at an estimate of
what the next number or the next several numbers in the sequence are most
likely going to be. A prediction, on the other hand, is a matter of judgment
that takes into account not only the quantitative values arising from a forecast
calculation but also qualitative data derived from events in the business en-
vironment for the purpose of determining the course of future events. If, for
example, a strike is anticipated in the plant of a competitor, a firm's man-
agement may very well predict that the demand on their products will rise
despite what the current forecast has calculated based on past history.
Forecasting is a necessity because the future is uncertain. In the physical
world where patterns are perfect and relationships are exact, mathematical
models can be developed that calculate the outcome of any occurrence. In the
business world, however, unless a company has a complete monopoly on an
unsaturated market, a similar degree of predictability cannot be achieved. To
begin with, instead of mathematically calculable factors, the world of human
affairs is marked by randomness and endless variation. Patterns and relation-
ships change, often dramatically. Therefore , instead of a process that will
pro-duce exact calculations that can be readily applied in management de-
cision making, forecasters will do well to begin with an understanding of the
limitations and uncertainties that reside at the core of forecasting. Strategic
planners must realize that forecasts will always be subject to error and that,
although there are techniques available to improve forecast accuracy, the
amount of effort expended soon reaches a point of diminishing returns.
Beyond this point, forecasters should concentrate more on coping with fore-
cast error than on architecting even more complex forecasting models [2].
In developing and deploying forecasting techniques, strategists must be
aware of the following general characteristics of forecasting [3]:
1. Forecasts will be wrong.
2. Forecasts are most useful when accompanied by a method for mea-
suring forecast error.
3. Forecasts are more accurate the larger the statistical population used.
4. Forecasts are more accurate for shorter periods of time.
In addition to the basic inability of forecasting to provide exact information

for decision making, many supply chain planners have cultures that militate
against forecast success. Common complaints range from laments that the
forecasting effort has been so splintered that it is meaningless and that no one
really understands the statistical mechanics, to problems in the collection of
accurate and forecastable data.
Although forecasting for supply chain management is often characterized
more as an art and less as a science, there are, nevertheless, principles and
statistical approaches that can be utilized to assist the forecaster. Like a
physical scientist attempting to understand all the forces acting on an experi-
ment, the forecaster can use known postulates and techniques to abstract gen-
eral principles from the apparent randomness occurring in the detail. The so-
lution to creating accurate forecasts is to develop a formal forecasting pro-
gram that uses relevant techniques and consists of an effective system that
detects, measures, and provides the mechanics to enable forecasters to react
quickly to discovered errors. The goal is to determine predictable data that
the business planning process can employ to assist in making good decisions
about the best marketplace alternatives available for the enterprise.
In their exhaustive study of forecasting, Makridakis and Wheelwright have
identified six characteristics or dimensions that play a critical role in de-
tennining the requirements necessary to establishing effective forecasting [4].
A short description of each follows:
1. Time Horizon. In formulating business plans strategists must forecast
the probable course of events that might occur over varying lengths of
time. Forecasting normally occurs on four levels. The critical factor
separating each level is the length ofthe forecast.
The highest level can be described as long-range forecasting.
This level has a time horizon of at least 1 year and is used in the
development of top management planning. Among the decisions
associated with this level of forecasting are developing corporate
goals and objectives, performing corporate capital budgeting,
planning for facilities, equipment and other fixed assets, and
structuring channel networks.
The next level, medium-range forecasting, has a time horizon of
six months to one year and is normally applied to operations
planning and control activities. Forecasting decisions on this
level impact sales planning, planning warehouse and trans-
portation capacities, business area capital planning, and contract-
ing for public warehousing and transportation services.
Short-range forecasting comprises the third level of forecast
planning. Business functions required to project operations ex-
ecution activities one to three months out into the future will use
this level of forecasting. Forecasting decisions on this level will
impact such activities as manufacturing scheduling, supplier
scheduling, inventory procurement plans, transportation plan-
ning, material handling equipment utilization, and detailed oper-
ating budgets.
Finally, immediate-range forecasting is used for everyday per-
formance of ongoing activities. Examples include transportation
scheduling, receiving, stock put away, shop floor and value-
added processing scheduling, order filling, and accounts receiv-
ables and payables flow through.
Each forecast level possesses its own unique characteristics relative to
the most appropriate forecasting method and data required. It would be
improper, for example, to employ a forecast method used to calculate
product demand on a weekly basis for the purpose of determining
yearly aggregate sales income.
2. Level of Aggregate Detail. Forecasting in the supply chain planning
environment occurs at many levels. Forecasts are used in the develop-
ment of business, marketing, sales, logistics, and detailed inventory
plans. Each forecastable area differs in two regards: the methods em-
ployed and the level of detail required. As strategists move from the
general to the specific, the level of forecast detail correspondingly
moves from a concern with aggregate data to gross detail. In selecting
the appropriate forecast for a specific plan, forecasters must be aware
of the level of detail required for that forecast if it is to be useful in
decision making. Corporate planners, for example, are usually con-
cerned with aggregate estimates of dollars and product groups and
would find a forecast of the weekly sales of a given item of little value.
Generally, as forecasts become more specific, the size of forecastable
data grows exponentially, necessitating the use of a computerized tech-
nique, and vice versa.
3. Size of the Forecastable Database. The number of elements in a fore-
castable population will have a direct impact on the forecasting meth-
ods employed. In general, as the number of occurrences to be calcu-
lated in a forecast grow, the simpler the forecasting method. The
reason is that the larger the number of occurrences, the more valid the
statistical mean. Conversely, the smaller the size of the data to be used
in a forecast, the more complex must be the forecasting technique if
variation is to be smoothed and accounted for. For example, a sales
manager forecasting the sales by week of an inventory of 1,000 end
items would not use the same techniques as another sales manager
charged with forecasting 100 product groups for a business quarter.
4. Forecasting Control. When forecasting, planners will need to utilize a

method that renders accurate and timely feedback to permit manage-
ment control. The method must indicate when the actual events have
moved beyond a predetermined acceptable forecast variance boundary
and to allow alteration to adjust for changes in basic patterns or re-
lationships. The objective is to provide forecasters with management
controls to ensure that business forecast decisions are being made that
are in alignment with actual events. An example would be a forecast of
sales established for a new product group. Because the new product
group lacks the historical data needed for fore-cast development, plan-
ners will have to frequently monitor the forecast to ensure that actual
sales supports the forecast, and if not, what pat-terns are emerging that
will permit the formulation of a more accurate forecast.
5. Constancy. Forecasting events or relationships of events that exhibit
great stability over time is quite different from calculating the future of
occurrences that demonstrate a wide range of variation. The principle
underlying this dimension is simply the more random variation that
occurs in the forecast, the more weight recent events and patterns must
have in forecast adjustment. In a stable environment, a quantitative
fore-cast based on historical data can be adopted and reviewed
periodically to confirm its appropriateness. On the other hand, when
there is great variation in forecastable data a method that reflects
current events, past history, and qualitative information is a better
choice.
6. Existing Planning Procedures. Forecasting methods should be chosen
that support the firm's planning and decision-making processes, as well
as enhance and improve upon existing operational norms. Companies
often confuse forecasting and planning. According to Armstrong [5],
strategists employ forecasting methods to simulate the outcomes of
plans. After possible results are validated, they can then revise plans,
obtain new forecasts, and repeat the process until the forecasted out-
comes are satisfactory. Once a forecast has been decided upon and as
actual events unfold, they can revise plans until the next forecasting
period. A common mistake of companies is that if events do not match
the expected outcome, they revise their forecasts and not their plans.
The supposition is that changing the forecast will change behavior.
There are undoubtedly other dimensions that exist that characterize specific
forecasting situations. Once these and other possible dimensions are under-
stood, forecasters can advance to an investigation of the basic types of fore-
casting.
~
Table 4.1. FOR ECA STING CLASSIFICATION 0
:;l:l
trl
Forecasting Accuracy Range Business Area Applicatio n o
Technique Short Medium Long Busi ness Strategy Ma rketing Procurement Sa les Inven tory Pricing >
rJJ
....,
L Judge mental .....
Z
Indiv idual Jud ge me nt X X X X X
C')
X X X X
Sal es Force Estimates X X X X X X
.....
Panel Co nse ns us X X X X X X X
Z
....,
Mar ket Reser ach X X X X X
Del phi X X X t!.'j
Visionary Forecas t X X ---- X ==
rJJ
II. Quantitative
e""0
""0
X X X ~
Simple Average X
Moving Ave rage X X X X X X -<
Exponentia l Smo ot hing X X X X X X ~
Decomposition X X X X X X
Focus Forecas ting X X X ~ X X X ==
>
Z
t!.'j
III. Causal
-
Z
Eco nometric X X X X X X X X -<
Regression Ana lysis X X X X X X X ~
Histori cal Anal ogy X X X
Leading Indicator X X X X X X X X
-
0
Z
Life Cy cle Analy sis X X X X X
a:
t!.'j
z
..,
.....
~
\0
FORECASTING TYPES
The variety of forecasting methods available can be organized into three basic
forecasting types: qualitative or judgmental, quantitative, and causal. Each
major type is composed of several techniques as summarized in Table 4.1.
The first type uses qualitative data such as expert judgment, intuition, and
subjective evaluation and is best used for forecasting marketing, product de-
velopment, and promotional strategies. The second type employs time-series
analysis and projection to search for historical patterns that can be extra-
polated into the future. The final forecasting type is the most sophisticated
type of forecasting tool. It attempts to express mathematically the relation-
ships between the forecast objective and factors such as technological, po-
litical, economic, and socioeconomic forces.
Figure 4.1 is a schematic flow of the forecasting function. Each of the
three forecasting types can be seen in their relationship to each other. Of
critical importance is the closed-loop nature of the forecasting process. Fore-
casts can originate using qualitative, quantitative, or causal methods. As
actual events occur, the forecast system must be able to provide forecasters
with the ability to respond to forecast error, evaluate variances, and make
informed changes to the current forecast.
.
Demand History
+ +
Judgmental Statistical Causal
.
Models Models Models
I Mo del election
I
.
& Calculation
Feedback Forecast Feedback
.
Forecast Error & Update
FIGURE 4.1 Forecasting model.

QUALITATIVE TECHNIQUES
Qualitative or judgmental techniqu es are generally used when data are scarce
or when developing aggregate sales or inventory forecasts . The objective is
to use human judgment based on analysis to convert collected data into a
forecast of probable events. In formulating qualitative forecasts historical
data mayor may not be utilized. Such techniques are frequently used in
creating forecasts in technology areas or when a completely new product is
being introduced into the market, especially when the relationship to histo-
rical data of analogous products is tenuous . A very simple example of quali-
tative forecasting is illustrated in Figure 4.2. The example demonstrates the
development of a forecast of monthly sales based on the projections of a
panel composed of three company executives .
Executive I Executive 2 Executive 3

Forecast + Forecast + Forecast
Monthly Forecast = --- ------------------------------------ - ---- - -----------
3
500 + 600 + 550

Monthly Forecast = -------------------- -------------------------- = 550
3
FIGURE 4.2 Three-executive panel forecast
The following points detail the standard types of qualitative forecasts in

use today.
Personal Insight . The most common technique used is individual judg-
ment based on intuition. In this method an industry expert is used who
employs personal knowledge and past experience to produce a forecast
based purely on subjective judgment. Advantages of this technique are
its relative low cost and speed of formulation. Drawbacks focus around
the fact that although the method may render some good forecasts, re-
suits are extremely variable. Besides, it has been demonstrated that
forecasters who follow a formal fore-casting process will always out-
perform forecasts based on subjective opinions .
Sales Force Estimates. This method represents an aggregate approach
to the individual judgment technique . The technique consists of the
projection of future sales compiled by the firm's sales force based on
individual salesperson estimates, management expertise, or surveys of
supply chain demand. The advantage of using this technique is that it
employs the speciali zed knowledge of those closest to the marketplace.
Panel Consensus. The panel consensus approach brings together ex-

perts from across the supply chain to review and estimate the optimal
forecast for a product, product group, or service. Advantages of this
technique are that it is quick and easy, requires minimal preparation of
statistical data, and pools the collective experience and judgment of ex-
perts from across the supply network.
Market Research. This technique attempts to forecast future demand
trends and activity levels by surveying a market segment whose past be-
havior and actions could indicate future buying patterns. The drawback
with using this technique is that market surveys are expensive and time-
consuming to execute and monitor. In addition, they rely on the ac-
curacy of the randomness of the sample and the conclusions drawn
from the analyses.
Visionary Forecasting. Another qualitative type is visionary fore-
casting. This technique is the most radical and consists of a prophecy
of the future based on personal insight, judgment, and, when available,
historical analogies that can be extrapolated into possible future fore-
casts. It is characterized by subjective guesswork and imagination, and,
in general, the methods used are nonscientific and non-quantitative.
Delphi Method. One of the most popular qualitative techniques is the
Delphi Method. In this approach, a panel of experts, who do not
physically meet, is interrogated by a sequence of questionnaires con-
cerning a new product, event, or process . Responses to the question-
naires are passed on to all the panel members for evaluation and rating
as to the likelihood of occurrence and are then used to produce the next
set of questionnaires. The object is to narrow down a field of opinions
that can be used as forecastable data.
Qualitative methods of forecasting have advantages and disadvantages. In
general, a critical advantage of this type lies in the ability of strategists to de-
velop forecastable data for products and services that lack initial quantifiable
data or when the variations in recorded occurrences are so dramatic that it is
impossible to determine stable patterns and relationships . In addition, fore-
casts using this type can be easily and quickly assembled without complex
statistical computation. Disadvantages can be summarized as follows:
1. Lack of supporting evidence for forecasting decisions
2. Overconfidence in the elements used and the results of the chosen fore-
cast
3. Possibility of over conformity of the individual to collective values and
attitudes when group qualitative types are used
4. High cost of development and maintenance when used in computerized
forecasting systems
Collectively, these limitations tend to create judgmental biases especially

when the forecast is dependent on established patterns or relationships of data
[7].
QUANTITATIVE TECHNIQUES
Quantitative techniques are best used for forecasting when there exist size-
able historical data and when the relationships and patterns of these data are
both clear and relatively stable. The fundamental assumption of quantitative
forecasting is that the future can be accurately extrapolated from the occur-
rences of the past. The operating principle is relatively simple. The fore-
caster should use the accumulated data on historical performance to attain a
reading on the current rate of activity (sales, for example) and how fast this
rate is increasing or decreasing. Once this rate is ascertained, various statis-
tical techniques can be employed to calculate the future based on the as-
sumption that existing demand patterns will continue into the future.
Unfortunately, it is very difficult to develop accurate forecasts using raw
data because changes in the rates of activity are not directly observable.
Cycles, trends, seasonality and other factors can create variations within the
data . In addition, patterns can be distorted by management decisions such as
a promotion or special pricing that cause abnormal spikes of data to occur
during select periods. Therefore, to use historical data effectively, forecasters
must massage the raw data by analyzing activity rates and uncovering pat-
terns and applying the proper statistical forecasting technique .
Much has been written concerning actual use of qualitative versus quanti-
tative types of forecasting. Some surveys reporting on the status of fore-
casting have found that managers utilize qualitative methods far more than
quantitative methods [8]. This fact is particularly true among distributors. In
a survey of managers from manufacturing and distribution, it was found that
only 69.8 percent of distribution managers versus 81.3 percent for manufac-
turing managers had a working knowledge of quantitative forecasting meth-
ods [9]. This conclusion would seem to be at odds with the fact that quantita-
tive techniques are superior to qualitative techniques in accuracy and time-
liness and that they are free of the biases inherent in judgmental forecasting .
Actually, both types of forecasting possess individual advantages and dis-
advantages. Quantitative forecasts are clearly more advantageous when it
comes to objectivity, consistency, repetitively calculating a large-sized task
(such as forecasting 10,000 items), and cost of execution. In contrast, quali-
tative forecasts are superior when historical data are lacking, inside infor-
mation or knowledge is critical, and ease of evaluation and modification is
paramount. In reality, even when established patterns or relationships are
constant, forecasters cannot blindly accept statistical output without analy-

zing the applicability of the data to the current environment and reviewing the
accuracy of the technique employed. In fact, both forecasting types are com-
plementary and must be integrated to produce accurate and usable forecasts.
TIME-SERIES ANALYSIS
In analyzing raw historical data, forecasters can utilize a wide range of pos-
sible quantitative forecasting models. By understanding the purposes and
characteristics of the techniques, planners can better analyze the nature of
raw forecastable data and be able to measure the advantages and dis-
advantages of employing a specific technique to match a specific situation.
For the most part, quantitative forecasting techniques utilize time-series
analysis. Collectively, these techniques attempt to use the time-sequenced
history of activity as the source data to forecast future activity. Examples of
time-series data are portrayed in Figure 4.3. As can be seen, time-series
analysis is composed of two elements: the data series and the time periods
used. Time-series techniques always assume that patterns of activity recur
over time. After establishing the time period to be used as the benchmark for
review, data are identified and calculated. The results are then extrapolated,
employing observable patterns, into future time periods as the forecast.
I. Weekly Demand for Sump Pump #401-325-01

Date Jan 7 Jan 14 Jan 21 Jan 28 Feb 4 Feb 11
Demand 21 28 30 26 24 33
II. Monthly Sales Forecast of Submersible Sump Pumps
Month Jan Feb March April May June
Demand 101 118 145 170 200 250
III. Quarterly Forecast of Shipped Dollars
Quarter Ist 2nd 3rd 4th lst 2nd
Dollars $235,000 $244,000 $310,000 $375,000 $421,000 $503,000
IV. Yearly Sales of ABC Company

Year 1997 1998 1999 2000 2001 2002
Sales (m) $145 $148 $151 $156 $162 $165
FIGURE 4.3 Timeseries examples.

FORECAST ING IN THE SUPPLY CHAIN ENVIRONMENT 145
Time-series analysis assists forecaste rs in isolating patterns that may be oc-

curring in the raw data. Some typical time-series patterns are illustrated in
Figure 4.4. Time-series patterns can be summarized into five groups: ( 1) hor-
~
Forecast
Varia ble Mean
Horizontal
Forecast
Varia ble
Months
Random
Forecast
Variable
Quarters
Seasonal
Forecast
Variable
Trend
Forecast
Variable
Years
Cyclical
FIGURE 4.4 Types of time series.
izontal, (2) trends, (3) seasonality, (4) cycles, and (5) random. Horizontal
patterns exhibit relative stability and consistency in actual occurrences in
comparison to the forecast. Such patterns are characteristic of products with
stable sales patterns or arising from aggregate forecast populations. Trends
are consistent upward or downward patterns observable in the occurrence of a
series of data values continuing for approximately seven or more periods.
Forecasters normally employ weighted moving averages, exponential smo-

othing, and regression techniques in calculating trends. Seasonality is de-
scribed as a consistent pattern of activity that occurs within a limited time
frame year after year. Examples would be demand for snow shovels during
the winter months and beach equipment during the summer months. Fore-
casters utilize time-series decomposition techniques when working with
seasonality . Cyclical patterns are used by forecasters to track long-range
trends in the overall economy that could have an impact on the firm's strat-
egies. Cyclical influences often last for one to five years and then recur.
Forecasting cycles is difficult because the data do not reoccur at constant in-
tervals of time and its duration is not uniform. Various qualitative and quan-
titative techniques are employed to forecast business cycles. Random patterns
of activities or outliers are the most difficult to forecast because they, in fact,
exhibit no historical pattern. Forecasters can use weighted moving averages,
exponential smoothing, and regression techniques in determining the forecast
of elements characterized by this type of pattern [10].
SELECTING QUANTITATIVE FORECASTING TECHNIQUES
When selecting forecast techniques, forecasters must search for the most ap-
propriate method that meets the enterprise's requirements. Forecasters must
ask themselves several questions:
What is the best forecast type - qualitative or quantitative - to use when
forecasting a given set of historical data?
If a quantitative method is selected, what will be the cost and the
amount of effort required to develop and execute the forecast?
What is the level of data accuracy required by the forecast technique
selected?
Which forecasting technique will best match historical issues such as
trend, seasonality, and so on?
Does the firm possess the necessary data processing tools for the
desired forecast computation?
In this section, the major quantitative forecasting techniques will be explored.
The goal is to equip the reader with a working knowledge of basic quantita-
tive methods to assist in answering the above questions.
Simple Models. The simplest form of forecasting is referred to as Naive

Forecast 1. The elements necessary for the calculation of are easy to
understand and apply. The equation on which the technique is based is
Ft+i=Xt (4.1)
where F t + i is the forecast for period t + i, t is the present period, i is the

number of periods ahead to be forecasted, and Xt is the latest actual value
(for period t).
This equation uses the most recent actual demand value, disregards the
value of the past forecast for the same period, and extrapolates it as the new
forecast for the next period(s). For example if the actual demand for period X
is 125 that value then becomes the forecast for the next period(s), and so on.
This technique could be used to forecast data where turning points indicating
error can not be predicted. For forecasts exhibiting seasonality Naive Fore-
cast 2 can be employed. This variation, which uses the same equation as
Naive Forecast 1, requires the forecaster to remove seasonality from the orig-
inal data in order to obtain seasonally adjusted data that in tum can be used as
a forecast for the next seasonally adjusted value [11].
Averages. Forecasts can be calculated by the use of several forms of aver-

age. The first is a simp le average. In this technique, the actual demand
found in the present period is added to the actual demand of the past period,
and the average is then calculated. The resulting value is the new forecast.
For example, if sales totaled 400 units for the past period and 420 units in the
current period, the new forecast would be calculated as (400 + 420) / 2 = 410 .
Another popular form of forecast average is the year-to-date average. In this
technique, actual demand is recorded as it occurs period by period and added
together. The calculated value is then divided by the number of periods used
with the resulting value being posted as the forecast for the next period. As
an example, say that the sales over a period of the last 3 months equaled 200,
210, and 190. The forecast would be determined as (200 + 210 + 190) / 3 =
200. If the sales for month four equaled 220, the forecast would be calculated
as (200 + 210 + 190 + 220) / 4 = 205. The value of these two forms of
forecasting is their simplicity and ease of use. Drawbacks are insensitivity to
variation and unavailability of turning points for forecast adjust -ment.
One of the main problems associated with using a simple average is that
the equation places equal weight on present and past data; year-to-date aver-
age places too much weight on past data, especially as time moves forward .
The result is that both techniques are insensitive to trends or outliers. One so-
lution is to use a moving average. This technique calculates the sum of his-
torical values for a set number of periods, finds their average, and then uses
the result as the forecast for the next period. The average is moving because
as time moves forward, the last period is dropped from the calculation and the
current period value is added. The number of periods used can range from 2
to 12 or more with 3 to 5 being the most common. The formula for the
moving average is
DI+D2+D3 (4.2)
DI,2,3 = ------------------------ = F4
3
D2+D3+D4
D2,3,4 = ------------------------ = F5 .
3
Although the moving average technique assists forecasters with solving the
problem of period weighting, it does not work very well if the forecast ex-
hibits trend or seasonality. In such cases the moving average will con-
sistently lag behind trends in actual demand [12].
Weighted Average . While the moving average will significantly assist fore-
casters to smooth past demand to ensure a more accurate forecast, the ability
to place a "weight" on instances of past demand will enable planners to deter-
mine how much of an influence the relationship of past demand will have in
the forecast calculation. Simply put, an "unweighted" time series of two in-
stances of demand assigns a 50 percent weight to each demand value. The
weighted moving average technique enables forecasters to "weight" each in-
stance of demand in the time series in an effort to determine a forecast that
more closely resembles reality. The formula for this calculation utilizes the
moving average technique plus the addition of a weighting factor that is mul-
tiplied by each instance of demand and then divided by the sum of all weight-
ing factors. The formula for the weighted three period moving average is
wDI + wD2 + wD3 (4.3)

DI,2,3 = ----------------------------- = F4
wl+w2+w3
wD2 + wD3 + wD4

D2,3,4 = ----------------------------- = F5 .
w2+w3 +w4
where D is the demand and w is the weight. For example, if the demand for
periods one through three were 200, 220, and 210 respectively and the
weights correspondingly assigned at 2, 3, and 4, then the calculation of the
new forecast would be as follows:
2(200) + 3(220) + 4(240) =2020 / 9 = 224.44
The weighted moving average can only be used when there are sufficient
periods of demand data available. The weighting factors applied can be any
values and are determined by the forecaster in relation to the relative impor-
tance of instance of past demand. While the weighted moving average will
produce a forecast that is more receptive to changes in demand patterns, it
will still lag behind possible trends. In the example above , the new forecast
is still considerably dampened in what appears to be an upward trend in sales .
Exponential Smoothing. The use of a moving average has at least three im-
portant limitations. To begin with, to calculate a moving average necessitates
the storage of an enormous amount of data, especially if the demand history is
significant. Second, as the amount of historical data grows, it becomes more
difficult to flag occurrences exhibiting trends or seasonality. Finally, the
moving average method gives equal weight to old and new observed values.
It can be argued that when preparing a forecast, the most recent events should
be given relatively more or less weight in the calculation than older ones. Ex-
ponential smoothing is a technique that offers a solution to these problems.
The advantages of exponential smoothing are that it permits forecasters to as-
sign weights to past historical and present period data to reflect demand pat-
tern realities such as trends and seasonality. In addition exponential smo-
othing requires only minimal computer space to store data .
The components of the exponential smoothing calculation consist of the
value of the old forecast, the value of the current observed data, and the per-
centage chosen to weight the equation. While there are several exponential
smoothing techniques, the most commonly used equation is expressed as
ESFt = a (Dt) + (1 - a) (Ft-l) (4.4)
where ESFt is the exponential smoothed new forecast, t is the current period
in which the most recent actual demand is known, D is the current period ac-
tual demand, Q- is the alpha fa ctor (forecast weight), and F is the exponential
smoothed forecast of one period past.
The key to exponential smoothing is the smoothing constant expressed as
a. The purpose of the constant is to give relative weights to the actual values
of the last past period and the historical forecasted values. If greater weight
is to be given to the most recent actual values, then a high smoothing constant
is chosen, and vice versa. Calculation of a or weight is normally based on
the number of periods the forecaster would use if a moving average was being
employed. The equation for calculating a is
2 (4.5)
a = ----------
(n + 1)
Example:
2
Calculation for a five period moving average: .33.
(5 + 1)
The exponential smoothing calculation using data for a sales forecast can be
seen in Figure 4.5. The calculation uses the value of the previous forecast
Average Weighted
Old Weekly Forecast = 500 x 0.5 = 250 x 0.8 = 400
Actual Sales = 450 x 0.5 = 225 x 0.2 = 90
New Weekly Forecast 475 490
FIGURE 4.5 Weighted calculation.
(500) and the actual value that occurred (450). The first calculation illus-
trates a straight average calculation and the resulting forecast. The second
calculation uses an alpha factor that places 80 percent weight on the old fore-
cast and 20 percent weight on the current actual value . The results of the
smoothed calculation show greater stability in the new forecast than the
straight average and permit forecasters to review the data to detect for trends
that might be occurring. When utilizing the formula (Eq. 4.4), the equation
for the same calculation would read:
a = .20(450) + I - a = .80 (500) = 490
The exponential smoothing equation (Eq. 4.4) is termed first-order smo-

othing. Although the equation functions well when demand is steady, the cal-
culated forecast will lag behind actual demand if a significant trend exits. To
use exponential smoothing to forecast using a trend a further calculation to
account for and smooth the trend must be added to the equation. Equation
(4.6) will calculate the base value of the previous forecast. The base value is
nothing more than the actual demand plus the trend. Notice that this
calculation requires the input of the trend.
Base valuet = a(Actual demand) + (1 - a) (Base valuet -1 + Trendt -1) (4.6)
where a is the smoothing factor, t is the current period, Base value t-I is the
base value computed one period previously, and Trendt-1 is the trend value
computed one period previously.
Once the new base value of the current period has been calculated , the new
trend can be formulated. This calculation (Eq 4.7) also includes the smo-
othing of the trend.
Trendt = P (Base valuet - Base valuet-i) + (1 - P) (Trendt) (4.7)
where P is the smoothing factor, Base valuet is the base value computed for
the current period , Base valuet-l is the base value for the previous period,
and Trendt-i is the trend value for the previous period.
Now that new base and trend values have been computed, the new forecast
calculation can be made. Notice that this equation can be used to calculate
forecasts for multiple future periods :
New Forecastt+X= Base Valuet+ X (Trendt) (4.8)
where X is the number of future periods, t is the current period, Base valuet is
the current exponentially smoothed base value, and Trendt is the current
exponentially smoothed trend.
A sample calculation of exponential smoothing employing a trend follows:
Data: a = 0.2; P= 0.1; Trendt -1 = 50; Base valuez-I = 500

Previous base value + trend = 500 + 50 = 550
Actual demand for current period = 560
New base value = 0.2 (560) + (1 - 0.2) (500 + 50) = 552
New trend = 0.1 (552 - 500) + (1 - 0.1) (50) = 50.2
Next period forecast = 552 + (1 period) 50.2 = 602.2
Forecast for three periods from now = 552 + (3) 50.2 = 702.6
The exponential smoothing techniques presented above are the most popu-
lar models in use. There are, however, a number of other smoothing techni-
ques of much greater complexity. Linear (Holt's) Exponential Smoothing is
used when data exhibits a constant trend. Winter's Linear and Seasonal Ex-
ponential Smoothing is useful when the data contains seasonality as well as
trend . Damped Trend Exponential Smoothing can be employed when trend
in demand does not extend over long forecast periods. When forecasters are
considering the use of exponential smoothing models they must be careful to
select techniques commiserate with the cost and complexity required [13].
Adaptive Exponential Smoothing. Choosing the correct smoothing/actor is

critical for exponential smoothing to provide the information necessary for
effective forecasting. According to DeLurgio and Bhame (14), the following

rule of thumb can be applied when selecting a smoothingfactor :
Use a low alpha for a very random series

Use a high alpha for a very smooth series
In general, when deciding upon a smoothing factor using heuristic methods,

the primary issue is deciding upon the number of periods to be used in the
computation. When calculating the alpha based on the number of desired
periods the following formula can be used:
0,= 2/(n + 1) or n = 2/0,- 1 4-9
Using this formula, the following chart can be produced:
For alpha of.l: n = 2/.1 - 1 = 19 period average

For alpha of .3: n = 2/.3 - 1 = 5.67 period average
For alpha of .6: n = 2/.6 - 1 = 2.33 period average
For alpha of .9: n = 2/ .9 - 1 = 1.22 period average
When choosing an alpha, the goal is to select a value that yields the most ac-
curate forecast and that value can best be described as the one that achieves
the lowest standard deviation of forecast error. In other words, when cho-
osing an alpha, the object is to reduce the standard deviation of the forecast
errors to as low as possible. To achieve this objective, simulation calcu-
lations can be used to determine the alpha exhibiting the lowest error. This
alpha would then be used in the next forecast generation. The goal is to have
the alpha be adaptive to the ratio of the absolute value of two averages: av-
erage error and average absolute forecast error.
The formula for calculating an alpha from forecast deviation is as follows:
Mean Error 4-10

alpha =
MAD
The alpha generated by the calculation is in reality a tracking signal that
demonstrates forecast error over time. For example, when a series moves
rapidly up or down, a high alpha is automatically used. In contrast, if the
series is consistent and has low forecast error, then a low alpha is used. Also,
if the model is systematically under or over the forecast then the alpha is im-
pacted. The value of the calculated alpha can never be greater than 1 or less
than O. Because it adapts to the magnitude of the errors, the alpha is referred
to as an adaptive alpha. Further discussion on calculating the mean error and
the MAD is found later in this chapter.
Seasonality. Many supply chains inventory products that are subject to sea-
sonal demand. A snow shovel will exhibit high sales in late autumn and early
winter, peak during the winter months, and decline dramatically in the spring
and summer. The key to forecasting seasonal products is using the proper
historical data. The most useful way to calculate a forecast exhibiting sea-
sonality is to employ a seasonal index. For example, a firm may sell 125
snow shovels a month on average. In reality, during the fall and winter sea-
sons, 200 are sold each month, and an average of 50 is sold during the war-
mer months of the year. Accordingly, during the peak season the index
would be 1.6(200/125), and 0.4(50/125) for the nonseasonal months. This
index ratio can then be used to adjust forecasts for seasonal patterns.
A simple calculation is to create a seasonal index based on a percent of
sales. In Table 4.2 data on snow shovel sales has been collected by month for
a given year. In preparing the index the actual sales are added and then
divided by 12 to arrive at a normalized average. For each month the actual
sales are then divided by the yearly average to attain the seasonal index. The
final step would be to multiply the new forecast by month by the correspond-
ing seasonal index.
TABLE 4.2 Calculating the SeasonalIndex for Snow Shovels
Month Demand Calculation Index
January 220 220/132 1.7

February 205 205/132 1.6
March 110 110/132 0.9
April 55 55/132 0.4
May 50 50/132 0.4
June 50 50/132 0.4
July 40 40/132 0.3
August 55 55/132 0.4
September 110 110/132 0.9
October 205 205/132 1.6
November 250 250/132 1.9
December 230 230/132 1.7
Average 1580/12 = 132
A more complicated calculation would be to use exponential smoothing

when forecasting with seasonality. Calculating seasonality utilizing a smo-
othing technique requires the use of a base value and a seasonal index. The
equation (4.11) consists of three parts: calculation of a new base value by
smoothing "deseasonalized" demand data, calculation of a smoothed seasonal
index, and calculation of the seasonalized forecast for next period [15].
Actual demandt (4.11)

Base valuet = a (---------------------------) + (1 - a) (Base valuet-l),
Old index
Actual demandt
New index = s (------------------------) + (1 - s) (Old index),
Base valuet
New seasonal forecast = New base value x New index,
where a is the smoothing factor for base value, s is the smoothing factor for
seasonal index, and Base valuet-l is the previous period base value.
A sample exponentially smoothed seasonal forecast for the snow shovel
example during the 6 months of high demand follows:
Data: a= 0.2, s = 0.3, old index (seasonal months) = 1.24

Base value (November) = 180; actual demand (December) = 210
1. 0.2 (210/1.24) + (1 - 0.2)(180) = 177.9,
2. 0.3 (210/177.9) + (1 - 0.3) (1.24) = 1.22,
3. Forecast for January = 177.9 (1.22) = 217.
Focus Forecasting. All quantitative forecasting systems depend on a statis-

tical concept called the normal distribution . Whether variants of the average
or exponential smoothing calculations, these techniques focus on forecasting
using an average value or mean, and the distribution of errors from the mean.
The problem with the use of the normal distribution is that, although it works
well when based on large volumes of transactions and long periods of time, it
functions poorly when the statistical population is intermittent or is character-
ized by low volume. In addition, most supply chains experience several kinds
of demand patterns, such as trend, seasonality, and so forth that require fore-
casters to employ several models based on the forecast objective. Finally,
following a Pareto distribution, only about 20 percent of a firm's inventory
possesses the volumes necessary for effective statistical forecasting. The re-
sult is that the vast majority of a distributor's inventory limps along under
forecasting models that poorly fit forecasting needs.
In 1978, an entirely new concept of forecasting, termed focus forecasting,
was introduced by Bernard T. Smith to address these problems. Focus fore-
casting can be defined as a computerized forecasting system that allows fore-
casters to simulate the effectiveness of a number of forecast rules and to cho-
ose the rule that best fits the historical data. Some forecasts work better for
some items than for others; some forecasts work better at certain times of the
year than others. The mechanics of focus forecasting allow calculation of the
future of an item using all the rules that have been successfully used in the
past. All of these rules are then simulated, permitting the forecaster to choose
the one that is the best choice for the item today. Some of the rules that can
be developed are the following:
1. We will probably have the average historical increase on this item.

2. We will probably sell what we sold last year at this time.
3. We will probably sell what we sold during the last 3 months.
4. We will probably sell half of what we sold during the last 6 months .
5. Whatever we sold last month, we will sell in the next 3 months.
In developing the formula to be fed into the computer, very simple com-
ponents are used. As an example, "we will probably sell in the second quar-
ter this year is what we sold during the first 3 months last year" would be ex-
pressed as A (actual demand) LY (last year) 1 through 3 (months) = F (fore-
cast) TY (this year) 4 through 6 (months) . An example of the forecast calcu-
lation using this formula follows :
Example:
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Last Year 100 95 90 95 105 110 105 115 120 115 125 130
This Year 105 100 95
(Last year = 100 + 95 + 90) = Forecast of 285 or 95 per month for April,
May, and June
In selecting the proper forecast the computer would need the forecaster to
tell the system what actual quarterly data to compare with the results of the
two forecast rules . Say the actual demand (found in the above example) of
first quarter this year was selected. The demand would be calculated as (105
+ 100 + 95) = 300. In the example there are only two rules:
1. We will probably sell in the second quarter this year what we sold in
the second quarter last year.
2. We will probably sell in the second quarter this year what we sold in
the last quarter oflast year.
Steps :
1. (95 + 105 + 110) = F (310)
2. (115 + 125 + 130) = F (370)
3. Forecast Rule #1 =310 - 300 (lstQuarterThisYear) = +10 .
4. Forecast Rule #2 = 370 - 300 = +70 .
5. Forecast Rule #1 would be selected because it is closest to
comparison quarter.
Focus forecasting provides forecasters with a powerful yet easy way to under-
stand techniques to forecast trends, seasonality, items with sporadic history,
and other demand conditions. The forecasting process works whether there
are 2 or 20 formulas . Beyond the fact that the software must be purchased,
all that forecasters are required to do is to monitor rule effectiveness and add
or delete rules that no longer provide adequate data to describe the firm's de-
mand patterns [16].
CAUSAL TYPES
The last forecasting type involves the use of causal models. Also known as
explanatory or extrinsic forecasting, these techniques seek to predict the
future by using additional related data beyond the time series data recorded
for a specific occurrence (say, weekly sales of a given product). The idea be-
hind the method is to leverage other occurrences in the marketplace up and
above historical data to attempt to predict more precisely the course of future
demand. Quantitative methods merely attempt to detail the mathematical re-
lationships of events occurring in the past. In contrast, causal methods try to
explain why these events occurred in the pattern in which they did. The in-
formation provided by causal forecasts can assist companies to better utilize
their quantitative forecasts by illuminating key insights into demand trends.
Another critical difference between quantitative and causal forecasting re-
lates to the size of the planning horizon and data sample. The quantitative
methods discussed above are primarily short-range to medium-range techni-
ques used to calculate discrete historical requirements. Causal methods, on
the other hand, focus on long-range forecasts that use qualitative and
quantitative macro measurements such as political, demographical, new
technology, and other forces to predict the future . In addition, they are best
employed when making projections of aggregate demand such as the total
sales demand of a company, sales of a product group, or sales in a specific
geographical region . Examples of possible causal forecasts would be

predicting when a new product or process will be available, what the impact
of new inventions or discoveries will have on the marketplace, or what effects
or changes might emerge as a result of developments in technology. An
example would be attempting to forecast the year's sales of sump pumps
based on the projected number of housing and commercial building starts. In
this causal forecast, building starts are referred to as predictor or independent
variables, and sump pump sales as the predicted or dependent variable.
The strength of explanatory methods lies in the use of a wide range of fore-
casts that can be formulated using a field of related variables. Drawbacks to
using this type are that it is useful only for aggregate forecasts, the data re-
quirements are larger than what is required for time-series models, it usually
takes longer to develop, and it is impacted more by changes in the underlying
relationships than would be the case employing a time-series model. In ad-
dition, causal methods are more costly to develop than intrinsic (quantitative)
methods due to the additional costs stemming from external data collection
and the time engaged in analysis. For the most part, causal methods are
rarely used in operational forecasting systems [17].
Simple Causal Model. Causal methods can use relatively simple or very
complex mathematical calculations. Equation (4.12) portrays a simple three-
variable model for calculating sump pump demand.
New forecast = New period forecast + O.2(LMS) + I(WC) + O.5(NHS) (4.12)

= 100 + 0.2(125) + 1(0.3) + 0.5(300) = 275
where LMS is the last month's sales, WC is the weather conditions, and NHS
is the new housing starts.
Beyond this simple model, there are a number of more complex techniques .
Regression analysis is a causal technique used for forecasting aggregate or
group demands such as company or product-line demands for the medium-
range to long-range term. This technique seeks to model past relationships
between dependent and independent variables. Another technique is the use
of historical analogies that employ comparative analysis in viewing the intro-
duction and growth of products or processes in the past with new entrants that
possess similar characteristics. Life-cycle analysis seeks to forecast new
product growth rates based on S curves. The object is to plot phases of prod-
uct acceptance by various groups such as innovators, early adapters, early ma-
jority, late majority, and laggards that can be used to project the demand
cycles of similar products [18].
Regression Analysis. Regression analysis distinguishes between the depen-

dent variable (commonly denoted by Y) and the independent variable (or X).
The formula used to denote regression analysis is as follows :
Y = A + BX (4.13)
Where Y is the value of the dependent variable, A is the Y-axis intercept, Bis
the slope of the regression line, and X is the independent variable.
The mechanics of the technique are as follows :
1. Identify the relationship between the dependent and the independent
variable
2. Measure the error in using that relationship to predict values of the
dependent variable
3. Measure the degree of association between the two variables
The following example will illustrate how regression analysis attempts to an-
swer these questions.
Acme Pump, Inc. has found that their volume of sales over time is depen-
dent on the number of new housing starts in their city. The following table
details sales and new housing starts over the past 5 years.
Yearly Sales Dollars Number of Housing Starts

($000,000), Y variable (0,000 of housing units), 13 variable
2.0 1
3.0 3
2.0 2
2.5 3
3.5 4
The first step is to determine the mathematical relationship between yearly

sales and the number of housing starts. This can be accomplished by follow-
ing the least -squares regression approach.
1. Relationship of X and Y
Yearly Sales, Y Housing Starts, X X XY

2.0 1 1 2.0
3.0 4 16 12.0
2.0 3 9 6.0
2.5 3 9 7.5
3.5 4 16 14.0
13.0 15 51 41.5
With these data in hand, the calculation is as follows:
2. Average values of X and Y
X 15
X - ------------------------- ------ - 3,
(n) number of years 5
Y 13
Y ------ = 2.6,
n 5
where n is the number of years.
3. Slope of the regression line
XY - nXY 41.5 - (5)(3)(2.6)

B - ---------- --------------- ---------------------------- = 0.42.
X - nX 51 - (5)(3)
4. Y-axis intercept
A = Y- ~X = 2.6 - (0.42)(3) = 1.34

5. The value of the dependent variable (Y)
y = 1.34 (sales) + .42 (housing starts).
6. If next year's anticipated housing starts will be 3000, then the

forecasted pump sales will be
Sales = 1.34 + 0.42(3) = 2.6($100,000) = $260,000.

Once the relationship between the dependent and independent variables
have been established, it is now possible to calculate the degree of forecast
error. The forecast of $260,000 is, in reality, the mean or expected value of
possible sales. To measure the error, it will be necessary to calculate the
standard error of the estimate (Sy,x) . A useful formula for computing this
error is as follows:
Sy,x =
-J
(y-yc)2
n-2
4-14
where y is the y-value of each data point, yc is the calculated value of the
dependent variable, from the regression equation, and n is the number of data
points.
By placing into the equation the data detailed above, the forecast error
would be calculated as
-/35.5 - 1.34(13.0) - 0.42(41.5)

S ,Jx =
/, 5-2
When multiplied by $ hundred thousands, the estimate of forecast error

would be $46,547.
Multiple Regression Analysis. In the above forecast of pump sales, only one
independent variable (housing starts) was used in the calculation. When con-
structing a regression analysis, forecasters should build in more than one in-
dependent variable. As an example, ACME Pump , Inc. might want to include
the average annual interest rate in its model. As such, the new equation
would be expressed as
Y = A + PlXl + p2X2 ... pnXn + e (4.15)
where Y is the dependent variable (pump sales), A is the Y-intercept, Xl is

the independent variable 1 (housing starts), and (31 is the independent
variable 2 (average annual interest rate) . The obvious negative of this techni-
que is the enormous computation involved, which is normally performed by a
computer. The benefit is that multiple regression measures the simultaneous
influence of several independent variables on the dependent variable to
broaden the forecasted value [19].
MANAGING THE FORECAST
In developing forecasts, planners must perform the following steps:
1. Define the purpose of the forecast

2. Select the appropriate forecasting model(s)
3. Prepare the statistical components
4. Ensure the interaction of the firm's functional area managers
5. Execute the forecast
6. Track and maintain the forecast through timely and accurate feedback
Before a forecasting technique can be chosen, forecasters must first de-

termine the purpose of the proposed forecast. In accomplishing this task
planners are faced with three critical tasks. To begin with, they must match
the proper forecasting method with the stated object-tives of the firm's busi-
ness units, ranging from long-term to short-term goals. Second, forecasters
must also utilize forecasting methods that can be easily integrated together to
provide the enterprise with a comprehensive game plan that is supportive of
both departmental as well as corporate performance tar-gets. Finally, the
forecasts must be capable of being communicated to supply chain partners.
Failure to integrate the various forecasts not only through each business unit
throughout the firm, but also externally with each trading partner, will result
in dysfunctional management decisions where business entities pursue sep-
arate objectives and potentially opposing measures of performance.
Once the purpose of the forecast has been defined, forecasters can then
proceed to the selection of the techniques necessary to fulfill the forecasting
objectives. Choosing the proper technique(s) is perhaps the most critical
stage in the forecasting process and consists of the following elements:
1. System Dynam ics. The first stage in forecast technique selection is to
determine the dynamics and components of the business system ele-
ments to be forecasted. This can be attained initially by clarifying the
relationships of the different elements of the enterprise, such as the
marketing and sales system, the procurement system, the distribution
system, and so on, and, secondly, by effectively mapping out the supply
chain structure. The forecasting system that is constructed should indi-
cate where input is controlled by the company and where input is in the
control of external forces. Such an analysis will provide forecasters
with the ability to match the technique with the source of input data.
The more the firm has control over input, the more quantitative the
forecast technique ; correspondingly, the less control, the more qualita-
tive the forecast method.
2. Technology Elements. The requirements for computational power, in-
tegration with backbone data warehouses, and electronic interoper-
ability with supply chain partners make the selection and application of
computerized forecasting systems a must before real forecasting strate-
gies can be developed. Today 's ERP, stand-alone applications, and In-
ternet enablers provide a wide-range of software capabilities targeted at
facilitating the gathering, analytical compilation, transmission, and re-
ceipt of forecasts in real-time from any node in the supply chain. The
choice of technologies must closely support the purpose of the forecast
as identified in the pervious step.
3. Time Horizon. Selection of the proper time horizon is critical in the de-
termination of the length of time to be considered by the forecast. Gen-
erally, qualitative methods are employed to calculate long-range fore-

casts, and quantitative methods are employed to calculate medium- to
short-range forecasts. In addition, the data of the proposed forecast is
also affected by the time horizon to be used. By using the requirements
of the functional business area as one dimension and the time horizon
for planning as the other, characteristics such as size of forecasted peri-
od (weekly, monthly, etc.), frequency of review, and unit of measure
can be determined. Purchasing, for example, has forecasting require-
ments that extend through all three time horizons. In the short range,
purchase order release, review, cash availability, and performance mea-
surement are the key elements in forecast selection. Medium-range
concerns focus on purchasing planning to support the inventory plan.
Finally, in the long range purchasers are concerned with supplier part-
nership management, contracts, and delivery scheduling that requires
aggregate business forecasts capable of being shared with upstream
supply points.
4. Data. In selecting forecasting techniques, strategists must understand
the nature of the data required and the availability and accuracy of that
data within the organization and outside in the supply chain. Funda-
mental to the appropriateness of the data is understanding the kinds of
patterns found in the existing data. Some data, for example, mayex-
hibit an average (mean) value with fairly limited random variation; on
the other hand, other data may contain an historical trend or seasonal
demand. Finally, other data may consist of combinations of these pat-
terns. Furthermore, a desired forecasting technique may require data
that the firm either does not possess or that has been poorly recorded.
In such an instance, forecasters may be required to use qualitative
rather than quantitative techniques in forecast creation. In the end,
techniques that match the objectives of the forecast with the existence
and observed patterns of the data to be employed in the calculations
must be carefully chosen.
5. Cost. As the utility of any forecast is reflected in the quality of the de-
cisions based on the forecast, ideally, selection of forecasting models
should be based on a simple correlation of forecast cost and the value
of the forecasted decision. Silver and Peterson suggest a basic formula
in which the total cost of using a technique is calculated by adding the
cost of operating a procedure to the cost of resulting forecast error [20].
One simple criterion for forecast selection would be to use as low a
cost as possible per forecast. As an example, the preparation of a fore-
cast necessary to calculate the future demand on thousands of items on
a weekly basis requires a technique that is simple, effective, and low
cost. In general, the shorter the range of the forecast, the more low-cost
forecast techniques should be used, with the more costly methods re-
served for aggregate long-range forecasts.
6. Accuracy. Besides appropriateness, the data used must be accurate if
forecast output is to be meaningful. Before a particular technique can
be selected, forecasters must understand how the data have been ob-
tained, verified, recorded, and transmitted . To ensure accuracy, fore-
casters must employ tools that control errors and provide for appro-
priate adjustment of nonrecurring events. Forecast alarms, for exam-
ple, can assist by focusing attention on occurrences outside a predeter-
mined band of high and low values. In summary, forecasters must ex-
amine the collection, calculation, completeness, source, and accuracy
of the data before selecting a forecast technique .
7. Ease of Use and Simplicity. Many planners make the mistake of over-
complicating their forecasts by trying to use complex mathematical for-
mulas to solve relatively simple business problems. The literature of
forecasting is filled with obtuse mathematical approaches. The prob-
lem with these techniques is that they are potentially very costly solu-
tions requiring computer disk space, manual coding and file mainten-
ance, and a trained expert to understand them. In reality, forecasters
should select techniques that are simplistic, minimize file maintenance,
and are easy for the user to understand.
The third step in forecast development is data preparation . It has already
been stated that accurate data must be available before a forecasting techni-
que is chosen. Data preparation, however, must extend beyond the subject of
the forecast (say, historical sales figures) to consider other data that has im-
pacted sales in the past. Looking purely at sales history without related in-
formation such as price increases, shortages, sales promotions, new products,
the impact of competitors, and other factors will produce a biased view of the
data. In addition, the forecaster must determine just what is to be forecasted.
For example, consider the forecaster who is attempting to derive product-
level forecasts summarized from four distribution centers. One approach
would be to forecast demand individually at each distribution center. If this
data set is used, forecasts will be affected by the variations experienced at
each distribution center. An alternative would be to calculate a product
national forecast and to reduce it to the SKU level on the basis of historical
percentages . Finally, time must be allotted for actual data preparation . As a
rule, the shorter the time frame to be forecast, the quicker the data must be
ready. For most forecasting methods, computer programs have been develop-
ed that can greatly increase the speed and accuracy in calculation. Urgency
and the length of time required for forecast preparation are key elements in
forecast technique selection.
Before the forecast can be executed, it must gain the consensus of the
finn's management team. A finn that blindly executes the statistical portion
of the forecast without soliciting the input of all impacted functional man-
agers, and sometimes channel partners, will get variable results. For ex-
ample, marketing and sales has decided to run a promotion on a specific prod-
uct group in an effort to increase market share. It is critical that expected
sales projections be communicated to logistics management, who, in tum,
must forecast purchasing, warehousing, and transportation requirements in
anticipation of the impact increased demand will have on company and sup-
porting channel partner resources. Without the proper communication and
alignment of forecasts between these entities, it is doubtful whether the finn
will be able to effective respond to the promotion and achieve the targeted
revenue and cost objectives. Other forms of marketing and sales intelligence
are critical to effective forecasting. Such factors as special pricing, loss of
market share, attempts to gain market share, introduction of new products,
changes to the supply chain structure, and others need to be communicated to
ensure the organization and its trading partners are pursuing a common plan.
When developing forecasts, inventory control and marketing should generate
a "first-cut" forecast that would then be reviewed by internal managers from
sales, purchasing, warehousing, manufacturing, and finance, as well as out-
side channel partners who can assist in evaluating the appropriateness of the
data before the final forecast is calculated.
Execution of the forecast can potentially be a difficult task. Many compa-
nies have products exhibiting several different historical demand patterns that
must be accounted for in the forecast calculation. For example, a distributor
may have demand that is widely varied. Some products have demand that is
horizontal : Sales are consistent over time with minimum variation. Older
items may exhibit intermittent demand where sales are very irregular. Still
other items might exhibit a trend. . To ensure the proper forecasting technique
is being applied to match demand patterns, forecasters need to employ sys-
tems that are flexible enough to satisfy the forecasting requirements of each
type of event. Supply chain strategists must always keep referring back to the
goals of the proposed forecast in guiding them in the selection and use of
forecasting systems.
The final step in forecast development is monitoring forecast feedback.
Forecasting should be conceived as a continuous process of measurement,
like statistical quality control. As such, monitoring feedback has two sepa-
rate but connected activities. To begin with, feedback alerts the forecaster
when the process is out of control. Second, feedback signals how far the pro-
cess is out of control and what must be done to regain forecast control. There
are several techniques revolving around the concept of a tracking signal that
can assist forecasters in monitoring feedback. A simple tool is the use of
forecast alarms whereby significant errors that exceed a predetermined range

are flagged for review.
UNDERSTANDING FORECAST ERROR
It can truly be said that every forecast is always correct - it is just that reality
is perverse and it is variation rather than constancy that subverts the accuracy
of every forecast. In a universe were patterns of occurrences were uniform
and predictable, forecasts would be unnecessary . Ensuring the correctness of
any forecast can, therefore, be said to be more of an exercise in determining
the degree of forecast error than in searching for the optimum forecast. Fore-
casting can be compared to searching for the philosopher's stone: the solution
always seems to be just in reach with the promise of turn-ing dismal compu-
tations concerning seemingly disparate atoms of data into gold.
To a surprising extent, the effectiveness of forecasting systems is depen-
dent on how well they handle stochastic demand. Consistent patterns in de-
mand are effectively handled by forecasting methods that model trend, sea-
sonality, and random components of demand. Unusual demands, or outliers,
present serious problems unless they are adjusted in the forecast. Detecting
when a forecast model is no longer representative of demand is an important
component of a good forecasting system. A model can go out of control be-
cause of large, one-time abnormal occurrences (outliers) or because several
minor events that cause the model to consistently over- or underforecast (Le.
bias) . These differences may result from problems in either the forecast or
actual demand. Figure 4.6 illustrates the mapping of such occurrences.
Sales ($m)
5
High Range
------------------------------------------------------
4
2 OutlierB
o 2 3 4 5 6 7 8 9 10 11 12
Months
FIGURE 4.6 Viewing forecast error.
Even if large outliers are eliminated, the forecasting process can go out of
control. Several techniques are available to assist forecasters to detect such
conditions. As mentioned above, simple tracking signals can be employed.
A simple tracking signal would be to arrive at a ratio determined by dividing
actual sales by the past average forecast over n periods. An instance of de-
mand outside of a range, say 0.8 to 1.2 would be marked for review. Table
4.3 illustrates the computation.
TABLE 4.3 Simple Forecast Error Tracking Signal
Period
2 3 4
Forecast Demand 1500 1600 1400 1500
Actual Demand 1600 1500 1300 1400
Last AD = 1400
TC = ----------------- - - - - - - -------- - - --------------------------- = 0.93
F(150 + 1600 + 1400 + 1500)/n(4) = 1500
where
TC = tracking signal
F = forecast
AD = actual demand
n = number of periods
A more complex example would be to compute the tracking signal as the

ratio of the running sum of forecast error to the average error. Perhaps the
most employed tracking signals are calculating the mean error and the mean
absolute deviation (MAD) by using exponential smoothing. The smoothing
constant permits the forecaster to weight forecast error. The larger the a the
more heavily weighted will be the value of the most recent forecast error.
The formula below illustrates the calculation [21].
1. Smoothed Error = a(Actual Demandt - Forecastt) + (1 - a (Smoothed

Errort -I)
2. Smoothed MAD = alActual Demandt - Forecastt/ + (1 - a (Smoothed
MADt -I)
3. Tracking Signal = Smoothed Errort
Smoothed MADt
As an example, take the following data :
Forecastt = 100, Actual Demandt = 90, a(alpha) = .1

Smoothed Errort -1 = -1, Smoothed MADt -1 = 5
1. Smoothed Error = .1(90 - 100) + (1 - .1) (-1) = -1.9
2. Smoothed MAD = .1190 - 1001 + (1 -.1) (5) = 5.5
3. Tracking Signal = -1.9/5.5 = -0.345
The second activity in forecast monitoring is adjusting the forecast to ac-

count for error. Forecast revision depends on determining the reason why the
error occurred. For a standard product, for example, if actual sales are less
than anticipated, forecasters must review past measurements to see if a down-
ward trend is occurring and make adjustments accordingly. On the other
hand , a forecast for a new product that shows an upward growth trend may
not only require a forecast change, but possibly also a new forecast technique.
In any case , changing the forecast requires the participation of key company
managers and supply chain partners. Continuous communication between
forecasters and users is critical in promoting better understanding, and en-
sures quick and authoritative response to changing conditions.
WHY FORECASTS FAIL
Developing, maintaining, and using forecasting techniques are critical func-

tions in the successful execution of the various planning processes of the en-
terprise. The following points attempt to illustrate the reasons why forecasts
fail [22].
Management Involvement. Effective forecasting is needed at the top
management, operations management, and operations execution levels
of the firm. What is more , these forecasts must be in alignment with
one another. Perhaps the foremost reason why forecasts fail is because
of a lack of participation by functional management both in the de-
velopment and in the execution of the forecast in process. To be suc-
cessful, forecasting should be viewed as a team effort and not be en-
trusted solely to an expert or "black box" approach.
Over-sophistication and Cost. Forecasting systems that are too dif-
ficult to understand are doomed to failure . Most organizations rely on
simple, yet effective, "rules of thumb" in developing a forecast. Com-
plex statistical techniques that require sophisticated calculations turn
forecasting into a "black box" activity that divorces users from the pro-
cess . In addit ion, the more complex the forecasting model , the more
forecasters will have to code and maintain system elements. Finally,

the more complex the system, the more costly it is to run and maintain.
Compatibility. Forecasts fail when there is a lack of compatibility be-
tween the forecasting system and the capabilities of the using organi-
zations. When internal managers and channel partners do not under-
stand the techniques employed nor trust the output produced, there is a
strong likelihood that they will not follow the forecast. The result is
that managers bypass the formal system in favor of their own informal
techniques. The unnecessary proliferation of separate functional fore-
casts produces a dysfunctional approach where values promoting align-
ment and team work are replaced by departmentalism and the uncou-
pling of the business planning process.
Data Accuracy. Although it is obvious that the data used by a fore-
casting technique must be accurate, errors do arise in the data col-
lection process. Data collection errors can arise in seven areas :
1. Sampling methods. Although an important tool in qualitative
forecasting, sampling can contain errors due to the size of the
sample and incorrect application in statistical calculations. In ad-
dition, the patterns and relationships of the data on which the
sample is based can change over time , also creat ing error.
2. Measurement errors. These errors occur in the collection, data
entry, and forecast calculation. The more these activities are
automated, the less the chance for error.
3. Hidden information. Sometimes information may be unintention-
ally left out or deliberately falsified or withheld.
4. Poorly designed questionnaires. Questionnaires can suffer from a
number of errors ranging from respondent misunderstanding to
lack of questionnaire comprehensiveness.
5. Data aggregates. Errors in aggregate data collection can occur as
a result of omitt ing or double-counting data elements.
6. Classification and definition. Data elements need to be as sharp -
ly defined as possible. Lack of definition causes data either to be
left out or double counted.
7. Time factors . It is critical that the time periods and the data col-
lected are in alignment. An example would be inventory trans-
action data that is not reported in the same time period as ac-
counting information.
Unnecessary Items. Often forecasts are developed for items that should
not be forecasted. One example is dependent demand item usage. In
this category can be found components within a Bill of Material. Fore-
casters, however, must be careful to create forecasts for dependent de-
mand items that may also be subject to independent demand, such as

service parts . Also, forecasts should not be established for final as-
sembled products that are the result of features and options. An ex-
ample is several models of bicycle that can be assembled from a com-
bination of modular subassembly, common parts, and individual items.
Forecasting such products should be done at the feature and option and
not at the end product level.
Lack of Management Control. Review and maintenance are critical to
forecast effectiveness. By its very nature, every forecast developed is
likely to be wrong. Forecasters must be diligent in mon-itoring the
forecast to ascertain the degree of error, when the forecast should be al-
tered, and what parameters should be used to guide forecast adjustment.
Ensuring forecast effectiveness is an ongoing process that requires the par-
ticipation not only of internal managers but also of the entire supply chain.
To guard against incorrect and misleading forecasts, planners must be careful
to select the proper forecasting techniques that fit the needs of the organiza-
tion and the supply channel, audit and maintain data accuracy, track closely
actual activities against forecasted results, and promptly update forecasts that
have exceeded acceptable boundaries .
SUMMARY
Forecasting is a necessary part of the business planning process. Perhaps no

other activity has as much immediate and long-range effect on the operations
of the supply chain as forecasting. An effective forecast can dramatically im-
prove channel-wide profitability, productivity, and customer service and en-
sure competitive advantage. Effective forecasting is also fundamental to the
well-being of individual enterprises and supply networks. Good forecasting
assists companies by eliminating waste in the form of excess inventory, by re-
ducing shortages, missed due dates, lost sales, lost customers, and expensive
expediting, and by providing visibility to control capacity requirements such
as plant size, labor, equipment, and transportation.
The various forecasting models available can be broken down into three
types. The first type employs qualitative models that combine human judg-
ment along with collected data. These techniques are best used when histori-
cal data are scarce or when developing aggregate forecasts. The second fore-
casting type utilizes quantitative models in forecast development. Quantita-
tive techniques are best used when there exists historical data and when the
relationships and historical patterns of these data are both clear and relatively
stable. The forecasting models in this type depend on statistical tools to ex-
trapolate the probable future from the occurrences of the past. The final fore-
casting type utilizes causal models focused primarily on developing long-

range forecasts that use qualitative and quantitative macro measure-ments
such as political, demographical, new technology, and other forces to predict
the future. Causal forecasts could be employed to predict the impact a new
invention or product or process discoveries would have on the market-place.
The forecast development process is a critical function that is guided by a
sequence of steps. To begin with, forecasters must be careful to define the
overall purpose and goal of the forecast. Next, forecasters can proceed to the
selection of the proper types, techniques, and computerized models necessary
to fulfill forecast objectives. The third step in forecast development is data
preparation . Critical activities in this step are auditing data accuracy, the
speed and accuracy of forecast calculation, and the urgency and length of
time required for forecast preparation. The fourth step consists in gaining the
consensus of the firm's management team. After these preparation steps have
been completed, the forecast can be executed. Forecasters can choose from a
variety of forecasting methods such as simple averages, moving averages, ex-
ponential smoothing regression, and focus forecasting. The final step in fore-
cast development is monitoring the feedback and performing appropriate
action to regain forecast control.
1. Why is effective forecasting so critical to the survival of the enterprise?

2. Briefly detail the steps used to develop a forecasting system.
3. Forecasting is more of an art than a science. Is this a true statement, and what
are the reasons.
4. The dynamics of forecasting method selection and control change as the time
horizon shrinks. Why is this the case ?
5. The sales staff of a major industrial supplies distributor has developed a product
group forecast for the company's entire inventory. How useful is this forecast to
the company? How must it be interpreted by the logistics division?
6. Discuss the advantages and disadvantages of using qualitative and quantitative
forecasting models.
7. Your company has just purchased a Focus Forecasting system. The sale
manager has ready about a new but complex calculation to help in sales
planning. What are your actions?
8. It is often said of forecasting , "Forecast only what you must; calculate whatever
you can ." Discuss this statement.
PROBLEMS
1. Using the moving average forecasting technique to determine the next period
forecast for an item with the following data elements.
Number of periods = 8
Previous demand by period = 232 ,242,223,221,226,234,244,255,260,265
After performing the calculation, how accurate do you think the new forecast
will be to the actual , and why?
2. Based on the following data , develop a three -period moving average forecast of
demand.
Period Demand
1 16
2 19
3 15
4 19
5 23
6 18
7 22
8 23
9 19
10 21
3. Using the same information, develop a four-period moving average.

4. Assuming the alpha factor was 0.2, calculate the forecast using exponential
smoothing. Based on the results of Questions 2 and 3, what would be the best
forecast for period II?
5. Using trend-adjusted exponential smoothing, what would the new forecast be for
the following data:
Period Demand
1 50
2 110
3 100
Base value smoothing factor: a = 0.1
Trend value smoothing factor: fJ = 0.2
6. Wholesale Distributors, a major home appliance distributor, has experienced the

following sales (in $Millions) during the past 6 years: $1.2, $1.24, $1.33, $1.31,
$1.36, and $1.40. A critical statistic is the credit card interest rate which, corres-
pondingly, has stood at 17.5%, 18.1%, 18.5%, 17.4%, 17.1%, and 16.8%.
Based on these data, construct the forecast for year 7. Also, calculate the
standard error of the estimate.
7. Develop a seasonal index for the following pattern of item demand:
Month Demand Month Demand

Jan. 65 July 35
Feb. 60 Aug. 50
Mar. 50 Sep. 60
Apr. 40 Oct. 70
May. 25 Nov. 75
June 30 Dec. 70
8. Demand for Product XYZ over the past 6 months is shown below.
Period Sales
June 140
July 170
Aug. 120
Sept. 140
Oct. 160
Nov. 110
(a) Assuming an initial forecast of 140 units, use an alpha factor of 0.2 to
calculate the forecasts of each month.
(b) What is the MAD for this product?
(c) Compute the RSFE and tracking signals. Are they within acceptable
limits?
REFERENCES
1. The APICS Dictionary . 9th ed. Falls Church, VA: American Production and
Inventory Control Society, 1998, p. 37 .
2. See the comment in Makridakis, Spyros and Wheelwright, Steven, Forecasting
Methods for Management . New York: John Wiley & Sons, 1989, pp. 12-13 ;
and Brown, Rob ert G., Statistical Forecasting f or Inventory Control. New
York: McGraw-Hill, 1959, pp . 1-25.
3. Plossl, George Production and Inventory Control: Principles and Techniques.
2nd ed. Englewood Cliffs : Prentice-Hall, 1985, pp . 62-68 .
4. Makridakis and Wheelwright, pp. 26-28.
5. Armstrong, l Scott, Principles of Forecasting: A Handbook for Researchers
and Practitioners. Boston: Kluwer Academic Publishers, 2001, pp. 2-3 .
6. Chambers, John C., Mullick, Santinder K., and Smith , Donald D., "How To
Choose The Right Forecasting Technique." Harvard Business Review, 55-64
(August-July, 1971) ; and Makridakis and Wheelwright, pp . 14-15.
7. Makridakis and Wheelwright, pp . 240-275 ; DeLurgio, Stephen A. and Bhame,
Carl D., Forecasting Systems for Inventory Management. Homewood, IL:
Business One Irwin , 1991, pp . 201-204; and Waters, C.D.l, Inventory Control
and Management. New York: John Wiley & Sons, 1992, pp . 176-179 .
8. Dalrymple, D.J., "Sales Forecasting Practices--Results from a United States
Survey." International Journal of Forecasting 379-381 (Summer 1987);
Mentzer, J. and Cox , L, "Familiarity, Application and Performance of Sales
Forecasting Techniques." Journal of Forecasting 227-236 (Summer 1984) ;
Murdick, R.G ., and Georgoff, D.M ., "How to Choose the Best Technique-or
Combination of Techniques--to Help Solve Your Particular Forecasting
Dilemma." Harvard Business Review 110-120 (January-February 1986) ;
Sanders, Nada R., "Corporate Forecasting Practices in the Manufacturing
Industry." Production and Inventory Management Journal, 54-57 (Third
Quarter, 1992) ; and , Wheelwright, Steven C. and Clarke, D.G. "Corporate
Forecasting: Promise and Reality," Harvard Business Review, 40-42
(November-December, 1976) .
9. Sanders,54-55 .
10. Makridakis and Wheelwright, pp . 61-63 and Waters, pp . 179-181 .
II. Makridakis and Wheelwright, pp. 49-65 ; Waters, pp . 194-201 ; Silver, Edward
A. and Petersen, Rein , Decision Systems for Inventory Management and
Production Control. 2nd ed. New York: John Wiley & Sons, 1985, pp . 103-105 .
12. Gill, Lynn E., "Demand Forecasting: A Vital Tool in Logistics Management," in
The Distribution Handbook. New York: The Free Press , 1985, pp. 455-458 ;
DeLurgio and Bhame, pp . 231-237; Waters, pp . 201-207 ; and, Silver and
Peters en, pp . 105-115 .
13. DeLurgio and Bhame, pp . 239-257, 311-351 ; Makridakis and Wheelwright, pp .
76-91 ; and, Waters, pp . 207 -214 .
14. DeLurgio and Bhame, pp. 244 -245 .
15. Vollmann, Thomas E., Beny, William Lee, and Whybark, D. Clay,
Manufacturing Planning and Control Systems. 2nd ed. Homewood, IL: Dow-
Jones Irwin, 1988, pp. 689-690.
16. Smith, Bernard T., Focus Forecasting: Computer Techniques for Inventory
Control. Essex Junction, VT: Oliver Wight Publications, 1984, pp. 1-33; and,
Smith, Bernard T., Focus Forecasting and DRP. New York: Vantage Press,
1991,pp.17-40.
17. DeLurgio and Bhame, pp. 198-201; Fogarty, Donald W., Blackstone, John H.,
and Hoffinann, Thomas R., Production and Inventory Management. 2nd ed.
Cincinnati,OH: South-Western Pub. Co., 1991, pp. 114-115; and, Makridakis
and Wheelwright, pp. 52-53.
18. DeLurgio and Bhame, pp. 198-201; and, Makridakis and Wheelwright, pp. 318-
336.
19. DeLurgio and Bhame, pp. 261-279; and, Heizer, Jay and Render, Barry,
Production and Operations Management . 3rd ed. (Boston: Allyn & Bacon,
1993), pp. 142-147.
20. Silver and Peterson, pp. 90-91.
21. Ibid, pp. 126-140.
22. Makridakis and Wheelwright, pp. 424-426.
5
DEMAND, OPERATIONS, AND
CHANNEL PLANNING
DEMAND, OPERATIONS, AND Production Plan Performance

CHANNEL PLANNING -
OVERVIEW ELEMENTS OF LOGISTICS
Components of DO&CP PLANNING
DO&CP Inputs and Outputs Logistics Resource Requirements
Planning
ELEMENTS OF MARKETING Value-Added Processing Plan
PLANNING
The Marketing Planning Process ELEMENTS OF SUPPLY
Products and Services CHANNEL PLANNING
Product Families Understanding Supply Channels -
The Product Life Cycle Overview
Understanding Services Defining the Supply Channel
Developing Markets Mission
Channel Design
ELEMENTS OF SALES Channel Operations
PLANNING
Developing the Sales Forecast INTEGRATING DEMAND, OPER-
Sales Forecast Tracking ATIONS, AND CHANNEL PLANS
ELEMENTS OF PRODUCTION SUMMARY

PLANNING
Creating the Production Plan QUESTIONS FOR REVIEW
The marketplace is comprised of four interdependent dimensions: the custom-

er, products and services, the capabilities of logistics, and supply chain de-
sign. How these dimensions are managed on the strategic level is the result
of the planning and execution activities of the enterprise's marketing, sales,

production, and logistics functions. As has been pointed out in Chapter 3, the
purpose of the business planning process is to define the marketplace object-
tives and operational strategies the firm must pursue if it is to achieve enter-
prise goals and sustain marketplace advantage. The business plan determines
how the company will be structured to leverage critical resources and what
are its competitive values. Once these enterprise plans have been formulated,
it is the responsib ility of the marketing, sales, production, and logistics func-
tions to develop supporting strategies detailing customer, product, manufac-
turing, supply channel, and service objectives. The demand, operations, and
channel planning processes attempt to answer such questions as: "Into what
markets does the firm plan to sell its products?" "What products and services
does it expect to sell?" "What resources are required to meet sales, produc-
tion, and inventory objectives?" "What should the supply chain look like?"
Chapter 5 will detail how demand, operations, and supply channel planning
address these and other long-range planning questions . The chapter begins
with a detailed description of the Demand, Operations, and Channel Plan-
ning (DO&CP) process. The goal of this process is the creation of a set of
highly integrated business functional plans that ensure that the five critical
plans constituting the core of the executive planning process - the marketing
plan, the sales plan, the production plan, the logistics plan, and the supply
chain plan - are in balance. Next, each one of these five plans is explored in
depth. A four-step planning methodology is suggested for each of these plans
and critical topics surrounding plan execution is covered. The chapter con-
cludes with a methodology for aggregating the five plans into a single DO&C
plan that can then be used by corporate strategists to measure plan success
and isolate areas for adjustment.
DEMAND, OPERATIONS, AND CHANNEL PLANNING -

OVERVIEW
Demand, Operations, and Channel Planning (DO&CP) is the culmination of

the top management planning process that began with the formulation of the
business plan. In the past, functional area managers often received their por-
tion of the business plan and formulated strategies that sought to optimize lo-
calized performance, often to the detriment of other business areas. Today,
this practice has largely been discredited and replaced with collaborative plan
development where functional executives works closely to-gether to produce
strategies that provide for a single, integrated demand management, resource,
and channel enterprise plan. Together, each functional plan must be feasible,
supportive of overall enterprise goals, and in alignment with the objectives of
DEMAND, OPERATIONS, AND CHANNEL PLANNING 177
the other area plans. The overall objective is to ensure expected demand and
available supply is in balance. The output of these plans then drives the op-
erations management planning processes that defines the finn's medium-range
inventory, production, and logistics support strategies.
Planning at the DO&CP level requires strategists to adjust their thinking to
focus on utilizing aggregate data in developing business area plans. .A key
distinction is understanding the difference between volume and mix planning.
Questions of volume center on strategic issues, such as determining the over-
all rates of product family sales and production, aggregate inventories, supply
chain value delivery, and logistic capacities. The planning time range ex-
tends for a minimum of a year and beyond, the focus is on product families,
and the review frequ ency is normally monthly. Planning at this level is the
reserve of DO&CP . In contrast, questions of product mix are concerned with
the execution of daily operations and consist in the identification of the actual
finished goods to make, inventory, and ship; the operations of individual
channel suppliers, manufacturers, wholesalers, and retailers; and the deploy-
ment of transportation and warehouse resources to satisfy product shipments.
The planning time range extends for six months to a year, the focus is on in-
dividual finished products , and the review frequency is normally weekly.
This area is properly the reserve of master scheduling and distribution re-
source planning.
When considering volume and mix it is critical that planners first find an-
swers to issues associated with volume. The development of effective vol-
ume or aggregate plans precede those of mix or operations plans. Simply, if
conflicts in demand and supply can be resolved on the aggregate level, plan-
ners will find that problems associated with operations (individual products
and orders) will be easier to resolve . The DO&CP process supports this ob-
jective by reconciling all demand, supply, new product, and channel manage-
ment plans at the aggregate level and ensures continuity with the business
plan. In addition , DO&CP enables operations execution performance mea-
surements and the development of strategic and detail efforts directed at con-
tinuous improvement.
In summary, DO&CP can be defined as a strategic planning process dedi-
cated to maintaining the balance between demand and supply up and down
the supply chain. By focusing on aggregate volumes, such as product fami-
lies, the capabilities of the supply chain, and overall logistics resources,
DO&CP enables the effective execution of daily operations functions center-
ed on mix issues relating to individual products and orders. DO&CP is a for-
mal process that is performed on a monthly basis and involves the collabora-
tive participation of executives from sales, marketing, product development,
operations, logistics, and finance, including the division president or CEO.

The goal of DO&CP is to bring together the business and functional area
strategic plans into an single integrated plan that, in tum, will drive the opera-
tions processes responsible for executing the day-to-day activities of demand
management, channel inventories, master scheduling, production scheduling,
purchasing, and logistics. A properly formulated DO&C plan will enable en-
tire supply chains to optimize channel inventories, production functions, and
channel fulfillment resources that enhance customer value, reduce channel
costs, and provide for superior competitive advantage [I].
COMPONENTS OF DO&CP
As illustrated in Figure 5.1, DO&CP consists of five interwoven components
FIGURE 5.1 Components of strategic planning.
linked together by the enterprise business plan. As discussed in the Chapter

3, the business strategy provides a comprehensive definition of enterprise
goals and performance measurement targets, the asset and investments plans
necessary to support the organization, and the projected profit plan. It is the
role of the business strategy to provide clear direction and enable the trans-
lation of the collective enterprise strategy into detailed mission statements for
each of the five supporting business areas. Once overall enterprise goals have
been established, it is then possible for the marketing plan to begin the pro-
cess of identifying the structure of the marketplace the firm intends work in,
the products and services to be sold, issues relating to price and promotions,
and the mechanics of the distribution channel. As the nature of the market-
place begins to emerge, it is the function of the sales plan to develop the fore-
casts of expected product sales, draft the sales campaign, ensure sales cap-
acities, and define sales performance metrics.
For businesses with manufacturing functions, the produ ction plan must be
established . The production plan determines the production rates and ag-
gregate resources required to satisfy the shipment, inventory, and cost of sales
objectives stated in the business and marketing plans. To effectively manage
fulfillment, it is then the goal of the logistics plan to ensure that inventory
storage capacities and transportation resources are sufficient to support plan-
ned levels of sales. Finally, an effective DO&C process would be incomplete
without a comprehens ive supply chain plan. This component defines how the
supply channel network is designed, how it is operated, and the nature of the
level of integration and collaboration existing between supplier, manufactur-
er, wholesaler, and retailer constituents. Each of these components of strate-
gic planning will be further described below.
DO&CP INPUTS AND OUTPUTS
The mechanics of effective DO&CP planning are driven by several critical

inputs and result in a series of accompanying planning outputs. The inputs to
the DO&CP process consist of the following:
Strategic targets. This input comes from the business plan and est-
ablishes the strategic targets to be met by the actual performance of all
business functions.
Product and service mix. This input comes from the marketing plan
and is composed of the range of products and services the enterprise
expects to sell through the supply channel. This driver also should con-
tain intelligence regarding the introduction of new products and prod-
uct changes that could impact the overall business strategy.
Marketing environmental scanning. This input contains intelligence
concerning the nature of external environmental factors occurring in
the marketplace that could impact product and service demand. Among
the possible elements is found general demand trends, the current state
of economic conditions, forecasts by market experts, potential govern-
ment and regulatory actions, new information technologies, and others.
Family levelforecasting. This input is one of the prime responsibilities
of sales and consists of the forecasts and forecast performance tools ne-
eded to keep the estimated marketplace demand and supplying capaci-

ties in balance. The family forecast is the prime driver of production,
inventory, and logistics planning.
Capacity and capability management. Once concise demand plans
have been formulated, they can, in turn, be used to calculate and pro-
vide for the continuous adjustment of manufacturing capacities and the
capability of the supply chain to deliver finished goods as required by
customer orders. This driver should also include the introduction of
new processes or changes to existing processes for product manufacture
or channel inventory distribution.
Channel network architecture. Supply chains are inherently dynamic.
The structure and functions of channel partners, availability of channel
resources, degree of dependence on channel participants , and the ro-
bustness of collaborative relationships are powerful drivers of all
DO&Cplans.
Financial resources. Besides overall strategic direction, the business
plan should provide information regarding the amount of funding avail-
able to support the execution of marketing, sales, production, logistics,
and supply chains and provide for the development of new initiatives
directed at continuing performance optimization.
The outputs from the DO&CP process consist of a series of detailed busi-
ness plans that are used to direct and determine the performance of everyday
operations. Among these plans can be found the
Marketing plan consisting of the marketplace, product, and distribution
strategy
Sales plan containing the product level forecast and sales campaign
strategy
Production plan detailing the product family priority plan
Resource capacity plan containing the calculation of available aggre-
gate capacities to meet the priority plan
Backlog plan determining production response to customer orders in
assemble-to-order and make-to-order environments
Channel inventory plan detailing finished goods levels, costs, and chan-
nel deployment
Supply chain plan illustrating the structure of the supply network, depth
of partner dependence, and level of collaboration
Logistics plan structuring the composition of transportation and ware-
house capacities
Product and process development plans describing the nature of the
impact of new products and processes on existing plans
Financial plan accounting for how asset, developmental funding, and

investment is to be performed and measured
Workforce plan describing how the necessary people resources are to
be assembled to meet all DO&C plans
ELEMENTS OF MARKETING PLANNING
The purpose of the marketing planning process is to determine what products

and services the firm is to offer its customers, the sales potential of the mar-
ketplace, and the mechanics of how the supply chain should operate. A suc-
cessful marketing plan seeks to reconcile enterprise strategic objectives with
the realities of current business trends, shifting marketplace segments, market
growth and decline, existing and planned products, the impact of environ-
mental, governmental, and information technology issues, and the scope of
channels of distribution. The marketing plan is the central instrument for di-
recting and coordinating the marketing effort. Without effective and closely
integrated marketing, sales, supply chain, and operations strategies the enter-
prise cannot hope to achieve the performance targets set forth in the corporate
business forecast.
Marketing planning is the collective responsibility of the marketing man-
agement team. With the assistance of sales, supply chain, and operations
management, the marketing function must determine answers to questions
such as the following :
Into what markets does the firm plan to sell its products and services?
What are the market entry and exit strategies?
What market trends are occurring, and how can they be leveraged to
create new business opportunities?
What products and services does the firm plan to sell?
What value-added services should be focused on to achieve and main-
tain competitive advantage?
At what stages in their life cycles are the company's products and
services?
What kind of delivery and transportation functions will be required?
What should be the size and location of the supply channel network?
What manufacturing/value-added processing activities should be per-
formed?
How do the company's products, services, and marketing channels com-
pare to the competition?
In answering these and other questions, marketers must seek to develop plans
that balance corporate strategies with the realities of marketplace demand.
THE MARKETING PLANNING PROCESS
As illustrated in Figure 5.2, the marketing planning process begins with a
r Business Plan
I 1
Products Pricing
.... Marketplace
Definition
f-+ and f-+ and 10-
erviccs Promotions
upply
Channel
Mechanics
1
DO&CP
1
FIGURE 5.2 Marketing planning proces s.
statement of the firm's marketplace. In this step, marketers must determine

whether they are pursuing either a "niched market" or a "mass market" ap-
proach, the Internet strategy, what market segments are to be targeted, the
size of the customer base, customer buying criteria (quality, price, service),
customer industry (manufacturers, retailers, other distributors, or mixed),
channel distribution point locations, and delivery requirements. Also, in this
step marketers must gain an understanding of customer needs and expecta-
tions and how they can build collaborative partnerships by enabling initia-
tives such as automating the exchange of information, training and sales as-
sistance, integrating the distribution chain closer together, and negotiating ca-
pacity scheduling. Finally, marketing planning evaluates the firm's compete-
tive strengths and weaknesses. Competitive advantage is weighed by bench-
marking each competitor's market strategies regarding pricing, discounting,
delivery, and old and new products, and how they compare to the firm's own
sales strategies and product and services offerings. Ultimately, it is market-
ing's responsibility to develop the product and services strategies that provide
customers with superior value that simply cannot be attained when dealing
with the competition.
The second step in the marketing planning process is assessing the com-
petitiveness of the company's products and services. A particularly useful
management model for ensuring that the firm is not only offering competitive
products but is also investing in the right products is to use product life cycle
analysis . The goal of the analysis is to determine the relative position of
products in their sales history. Products characterized by high profit growth
and market share should be protected from competitors and promoted with
continued investment. Conversely, products demonstrating low growth and
declining market share should be divested and the capital re-invested in new
or existing growth-oriented products. Product life cycle analysis will be fur-
ther described below. In addition, marketers must weigh the cost of the val-
ue-added services . The scope of services can be a significant competitive ad-
vantage, especially when businesses find their inventories stocked with a
large proportion of the same or similar products that their competitors are of-
fering to the same marketplace. Value-added services provide a basis for dif-
ferentiation by offering customers new avenues to meet expectations, reduce
costs, increase productivity, and increase sales.
The third step in the marketing planning process focuses on price and pro-
motion decisions. Although companies hope that the products and value-ad-
ded services they offer will be sufficient to maintain current marketplace
leadership or to gain entry into a new market, often special pricing or periodic
sales promotions are necessary to stave off competitors or to entice new cus-
tomers away from competitors. Pricing decisions will have a direct impact on
the volume of the profits the company must gain to meet business plan object-
tives. Marketing programs targeted at increasing profits through pricing de-
cisions can take the form of lowering fixed costs such as inventory, plant size,
and equipment while increasing productivity, and service and product quality.
In addition, increases in the number of deliveries can actually assist in lower-
ing prices by permitting companies to shrink inventory carrying costs.
Another option would be to reduce variable costs such as labor. Finally,
firms can increase profits by increasing prices. Promotion decisions also will
affect profitability. Trade advertising, sales promotions and deals, and pub-
licity can all be used to open markets and increase sales of targeted products
and value-added services.
The final step in the marketing planning process is structuring internal dis-
tribution channel operations. Simply having the right mixture of products
and services is insufficient to meet targeted sales and profit objectives. Com-
panies must have the delivery mechanisms in place to penetrate the market-
place and increase customer service. Options include building additional

warehouses close to the targeted market, renting space in public warehouses,
outsourcing logistics functions, and acquiring a competitor or a trading part-
ner positioned in the distribution pipeline. In mapping the channel network,
marketing planners must be careful to measure both the estimated costs as
well as the benefits. A distribution network must be designed that will pro-
vide the firm with sufficient return on investment by offsetting investment in
plant, equipment, staff, and inventory with increases in sales and profitability .
PRODUCTS AND SERVICES
Perhaps the prime focus of the marketing planning process is defining the
products and services the firm intends to compete with in the marketplace. A
product is a matrix of physical characteristics and customer perceptions . As
physical entities , products possess weight, volume, shape, functionality, cost,
and other attributes . As a customer perception, products possess intangible
features such as convenience? status, quality, usability, accessibility, and dis-
tinctiveness . In terms of a formal definition a product is a physical good of-
fered to the market for acquisition, use, or consumption that might satisfy a
want or need. Products can be broadly grouped as durable goods, products
that are designed to last for an extended period of time without rapid deterio-
ration or obsolescence, and non-durable goods, products that are consumed
or must be consumed quickly or that deteriorate rapidly. Products can range
from low-cost, high-volume goods such as Coca-Cola or Bic Pens, to high-
cost, low-volume goods such as industrial machinery and automobiles.
Products are best understood' when related to other products. One way to
view products is to position them in a product hierarchy . Products can be de-
fined in ascending order as belonging to a product type (individual items
within a product line sharing attributes common to a generic product), a prod-
uct line (individual items grouped together within a product class because of
functional, cost, or customer requirements similarities) , a product class (indi-
vidual items grouped together within a product family that fit broad func-
tional characteristics), and a productfamity (a general grouping of individual
items that satisfy a general need). As an example, a bicycle distributor would
consider men's trail bicycles as a product type; all adult-sized trail bikes as a
product line; and all trail bikes as a product class which belongs to a product
family called adult recreational bicycles. In addition, products are often de-
scribed as belonging to a product system . A product system can be defined as
a diverse set of products that are sold together as a set. As an example, hard-
ware stores stock fastener sets that consist of many kinds of bolts, nuts, wash-
ers, and nails packed in a variety of drawered cases that can easily be stored
on a workbench. Finally, products can be described as a produ ct mix or as-

sortment of all possible goods a distributor makes available to the
marketplace [2].
Products can be further classified into two major categories based on prod-
uct characteristics [3]. The first category is defined as industrial goods.
Products in this category can belong to three subcategories.
Raw materials and component parts. In this category is found farm and
natural products such as foodstuffs, lumber, petroleum and iron ore,
and fabricated or manufactured component materials. For the most
part, these products are distributed through source supplier channels
and are used by manufacturers who convert them into finished prod-
ucts. Supply channels for servicing this category tend to be limited to
one or two levels. Marketing considerations focus on price and service.
Capital goods . In this category can be found fixed and accessory
equipment such as generators, computers, automobiles, material hand-
ling equipment , and office furniture. Products in this category are con-
sidered finished goods and are not normally used to create other finish-
ed goods by purchasers . Manufacturers, for the most part, use channel
partners to distribute these products. Marketing considerations focus
on quality, price, product features, and service.
Maintenance. repair. and operating goods. In this category can be
found consumer type goods such as paint, nails, office supplies, small
tools, lubricants , and fuels. These products are, for the most part, dis-
tributed through a complex matrix of channel intermediaries who pro-
vide time and place utilities. Marketing considerations focus on price,
service, availability, and delivery.
The second major product category is defined as consumer goods. Prod-
ucts in this category can belong to three subcategories .
Convenience goods . In this category can be found products that are
usually purchased frequently, immediately, and with the minimum of
effort in comparison or buying. Examples include staples such as
bread, milk, and toothpaste , impulse goods such as chewing gum, can-
dy, and magazines, and emergency goods such as medical supplies,
snow shovels, and cold weather clothing . Distribution channels for
such products are very complex, focusing on volume to offset small
margins and high distribution costs which can be as high as one-third of
cost of sales. Marketing considerations are focused on availability and
price.
Shopping goods . In this category can be found products that customers
normally will shop for in many locations and compare such elements as
price, quality, performance, and suitability before a decision to pur-

chase is made. Examples include such products as fashion clothes, ap-
pliances, books, and home furnishings. Because customers are willing
to search for goods in this category, the distribution channel is designed
to have a limited number of outlets within a given geographical area.
In contrast to convenience goods, distribution costs for shopping goods
are approximately 15 percent of total sales costs. Marketing considera-
tions focus on quality, brand name considerations, availability, price,
and service warranty.
Specialty goods. In this category can be found products that possess
unique characteristics and/or brand recognition for which customers are
willing to expend a significant effort to acquire them. Examples in-
clude such products as art work and furs, and such brands as Mercedes
in automobiles and Armani in women's fashions. Distribution channels
for such products are normally restricted to specialized consumer mar-
kets and are usually characterized by lower service factors such as
availability and convenience. Marketing considerations are focused on
quality, warranty, and repair.
Although the above breakdown into groups of industrial and consumer
goods is a convenient way of organizing products, it has certain limitations
when used to aid marketing management. For example, the product categor-
ies are somewhat subjective and can be arguable from the stand-point of actu-
al buying behavior and method of distribution. Because the above classifi-
cations are subject to interpretation, the following five additional character-
istics of products should be observed when making marketing decisions [4]:
1. Replacement rate. This characteristic refers to the frequency with
which a product is purchased. This factor will have an impact on chan-
nel size and distribution costs.
2. Level ofservice. Some products require specific levels of service dur-
ing the distribution process necessary to meet customer expectations.
Such services may take the form of training, warranty, repair, or other
factors.
3. Time to product consumption. Although closely related to replace-
ment, this characteristic refers to how fast the product will be con-
sumed. A can of paint, for example, may be quickly used but would
not be replaced until a future redecorating project.
4. Search time. This characteristic refers to the average time the end cus-
tomer is willing to spend searching for a product.
5. Gross margin. Perhaps the fundamental measurement of a product is
calculating the difference between the total cost of distributing a prod-
uct from point of production to point of sale, and the selling price.
6. Perishability. Goods with short life cycles require very short distribu-
tion channels, the minimum of handling, and quick time to market.
7. Bulk. Goods handled in bulk are expensive to transport and store.
Products with this characteristic should be delivered directly from the
producer to the end customer.
8. Degree of customization. Nonstandardized products often require
special assistance for installation, training, or other forms of servicing
that must be performed by the producer. The level of contact between
producer and customer associated with standardized products is much
lower.
PRODUCT FAMILIES
The ability to apply the above classifications in the designation of product

families is critical to the development of DO&CP. Since the focus of
DO&CP is aggregate volumes, product families provide all areas of the plan-
ning process - marketing, sales, production, logistics, and supply chain man-
agement - with common product units permitting easy points of communi-
cation, transfer of data, and final plan consolidation. Meaningfully defined
product families enable senior managers to focus on the right level of product
data for effective decision making. Without a common nomenclature to
formulate individual DO&C plans, the effort will be stillborn due to mis-
matches relating to product family definition, unit of measure, budgeting, and
resource and capacity requirements .
For the most part, companies should be able to breakdown their actual
products into no more then perhaps a dozen product families. A number
greater than twelve begins to thwart the concept of aggregate planning and
will complicate the process of plan compilation and communication. While
most companies have historically defined their product families, newcomers
can begin the process by selecting from the following options [5]:
Product type (pumps, switches, hardware)
Product characteristics (cost, performance, grade)
Product size (large, medium, small)
Brand (Coca Cola, Pepsi, Royal Crown)
Market segment (consumer goods, industrial, government)
Customer
Two other components must be considered. The first is determination of
the unit of measure to be applied to the product families. There are many
choices: each, case, pounds, kilos, tons, and others. Often the nature of the
product families makes it difficult to assign a common unit of measure. In
such a case it might be convenient to use a higher level measurement, such as

dollars. This might require the use of conversion factors to calculate the
common unit of measure from original product group units of measure.
Another component to consider is ensuring that the product families match
the way the company acquires and presents its products to the marketplace.
Ideally, the product families that emerge should reflect either a common man-
ufacturing process or are purchased by family. The goal is to provide aggre-
gation models that can facilitate the planning processes of the five major
components of the DO&CP process.
THE PRODUCT LIFE CYCLE
One of the most important elements of product management is understanding

the product life cycle. The theory behind the product life cycle is that the
average product can be divided into distinct sales stages, each characterized
by differing marketing, investment, and distribution requirements. Although
the universality of the model can be debated, it does provide marketers with a
useful framework for linking a product's life cycle stage with marketing strat-
egies focusing on competition, product design, pricing, promotion, distribu-
tion, and informational requirements. Kotler [6] feels that there are four un-
derlying assumptions in understanding the product life cycle-concept.
1. Products have a limited life. Changes in taste and technology dictate
that no product will remain in demand by customers indefinitely.
2. Products pass through distinct stages. These stages can be described as
introductory, rapid growth, maturation , and decline (Figure 5.3).
3. Profits rise and fall at different stages in the product life cycle.
4. A firm's marketing effort, sales volume, distribution channel size, and
financial investment is impacted by a product's life-cycle stage.
Table 5.1 suggests how the position a product occupies in its product life
cycle will impact supply chain elements such as product availability, product
volume in the channel, sales volume, form of distribution structure, enterprise
inventory and marketing investment, and nature of competition. In the intro-
ductory stage, companies are reluctant to stock large volumes of inventory.
Because the new product has not yet received market acceptance, sales vol-
ume is low. In contrast, research and development costs are high as product
bugs are fixed and features solidified. Channel product availability is re-
stricted to a few targeted locations and market areas capable of generating
margins high enough to support heavy promotional spending. In addition, lo-
gistics management must be integrated early in the process to guarantee ef-
fective product rollout. At this stage, the competitive strategy is to offer cus-
tomers products and features not generally available in the marketplace.
High TEW GROWTH
Invest
&
Grow
Market
Growth
Re-invest
&
Divest
DE LI E MAT RE
Low High
Market Share
FIGURE 5.3 Product life cycle.
If the product begins to acquire customer acceptance, the growth in sales

volumes will require companies to increase inventory investment and product
availability. In addition, expanded transportation and storage, promotional
expenses, aggressive discounting, and competitive pricing will increase costs.
TABLE 5.1 Stages of supply chain collaboration
Characteristic Introduction Growth Mature Decline
Product availability Low Increase Level Low

Product volume Low Increase Level Low
Sales volume Low Increase Level Low
Form of distribution
structure Minimum Increase Complex Minimum
Investment High High Level Low
Form of competition Product features Quality, Price, Availability
Availability Dependability
Decisions regarding the structure of the distribution channel are particularly

difficult in this growth stage. Although product demand is much greater, it is
still too irregular, rendering sales and marketing information often unreliable
as a source for channel planning. Judgmental methods in forecasting are

mostly employed in this stage in determining the depth and volume of inven-
tory stocked at supply network nodes. Competitive strategies are designed to
capitalize on growing market demand by focusing on attributes relating to
product quality and availability.
The growth stage can be long or short depending on the extent of the com-
petitive turbulence arising from the marketplace. Success will generate ag-
gressive emulators who will contest for established market niches and cus-
tomer loyalty through price and distribution counter strategies. During the
maturity stage that follows, product and sales volume is no longer experi-
encing the same dramatic percentage increase and can be forecasted and plan-
ned using accumulated historical usage. At this point, product demand has
reached its highest point, normally requiring companies to maintain high in-
ventory and promotional investment to remain competitive. The distribution
structure can be characterized as intensive and extensive, with a strong em-
phasis on keeping delivery points as fully stocked as possible while trying to
minimize inventory investment. Competitive strategies focus on competitor
activities, cost and price decisions, maintaining brand and customer loyalty,
and product and value-added service dependability.
During the final product life-cycle stage, sales volumes decline as a result
of changes in technology, competition, or customer interest. As sales reven-
ues decline, so does investment in inventory and promotional activities. At
this point, planners usually begin to scale back general inventory availability
throughout the channel, restricting product to centralized warehouses or to
targeted locations with enough residual customer demand. Finally, planners
must develop effective strategies to discontinue "dead stock" clogging the
distribution pipeline, plan for market exit, and redirect resources to more pro-
fitable products. Competitive strategies at this point focus on price and avail-
ability as competitors also phase out the product and increase prices to cover
inventory storage and services costs.
Besides providing a window into product and marketplace dynamics, the
product life cycle presents marketers with a tool to assist in making channel
support decisions. To begin with, whereas companies need to continually
promote existing products, they must also focus on the introduction of new
products. Second, the product life cycle indicates that marketers need to
create separate strategies for products as they enter differing product life cy-
cles. Finally, the product development life cycle illustrates the importance of
planning for new products as they are being introduced. Without effective
product planning, estimated and actual long-run profitability and return on in-
vestment may vary dramatically. Similarly, the product development life cy-
cle permits marketers to review the profitability of older products. What ap-
pears to be a "star" may, after closer analysis, be, in reality, a liability drain-
ing away critical resources. The effective management of old products can
have as great a financial impact on the enterprise as the introduction of new
products with high current profits [7].
UNDERSTANDING SERVICES
Most companies not only market products but they also offer customers ser-
vices that add value to goods purchased. Service can be defined as any prod-
uct-oriented activity or performance provided by a firm that does not involve
the transfer ofownership oftangible goods . For the most, part companies of-
fer tangible goods accompanied by one or more services targeted at en-
hancing product appeal. These product services can take the form of pre-
sales services such as supplier contracts, technical advice, discounting, qual-
ityand delivery reliability, sales representative availability, and credit. In ad-
dition, businesses often offer after-sales services such as transportation, war-
ranty, repair, technical support, trade-in allowances, product guaranties, and
user training.
Services differ from products in several different ways. To begin with, a
service is usually an intangible exchange of value, in contrast to tangible val-
ue as found in a physical product. Second, services are often produced and
consumed simultaneously. In this sense, services can be perceived as provid-
ing value that extends beyond the product itself. The service value found in
product delivery, for instance, is value received with the activity of the deliv-
ery process. Third, the services received by a customer are often unique to
that customer. For example, the education services provided by a software
firm for their customer base will always be adapted to accommodate the par-
ticular needs of each customer even though the entire customer base is re-
ceiving the same software product. The factor that makes each service
unique is found in the fourth characteristic: high customer-service interaction.
Service uniqueness arises out of the particular needs communicated by each
customer and how the product and standard services offerings are shaped to
respond to those needs. The last characteristic of services can be found in
their lack of precise definition. While products are rigorously defined as to
form and function, services normally consist of a core value around which a
variety of different outcomes can occur. A discount, for example, may not
only differ between customers, but may also be different with each sale, even
for the same customer [8].
The services companies offer their customers have two dimensions. Many
of the traditional services can be described as being almost "commodity" in
nature because they directly accompany the product. Such services as war-
ranty, packaging, rebates, and training allow customers to receive additional

value with the receipt of the tangible product. Such intrinsic services have
become so commonplace that most customers assume that suppliers will auto-
matically provide them. There are, however, other services that are extrinsic
to the product. Such services as discounting, improved supply channel effi-
ciency, credit, product assortment, and others add value to products by re-
ducing customer internal costs, facilitating the flow of business information,
and improving productivity. In a marketplace in which competitors provide a
large proportion of the same products, extrinsic value-added services have be-
come a competitive advantage, differentiating one distributor from another.
Like products, value-added services can also be viewed as possessing a life
cycle. In the development stage, marketers will experiment with new forms
of value-added services that they anticipate will provide a point of differenti-
ation separating their firms from the competition. Costs for development and
delivery are high, although the customer perceives the value to be low. Dur-
ing the growth stage, planners are still investing in services development, but
customers are beginning to see that the new service is providing sufficient
value to persuade them to purchase the product. During the maturity stage,
investment declines as the service becomes standardized, while increasing
customer market demand for the product and accompanying service allows
cost recovery and profit. As competitors begin to copy the new service in an
effort to decrease competitive differentiation, the service enters the saturation
stage. Customers feel the service is part of the product offering, often re-
quiring that it be offered with little or no charge attached. At this point, the
service migrates from a value-add to a requirement if the product is to re-
main competitive, but in itself offers little or no competitive advantage. In
developing product value-added services strategies, marketers need to plot the
life cycles of both product and services offerings and forecast to determine
the trade-off of cost and potential sales.
DEVELOPING MARKETS
To be successful, marketers must constantly search for ways to recognize the

unique requirements of their markets and customers. The value of effectively
structured supply channels and focused products and services are accentuated
by marketing strategies that competitively meet the specific needs of custom-
ers while avoiding the trap of trying to offer all things to all people. The
fundamental goal overall of DO&CP is the effective management of a firm's
portfolio of organizational, product, and service investments to achieve opti-
mal profit return from the customer base. In pursuing such objectives, mar-
keters must have strategies in place that identify the most attractive market
segment s available and measure individual customer profitability.
In viewing the marketplace, marketers must perform three activities:
1. Segment the potential customer base according to wants, resources ,
geographical locations, buying attitudes, and practices.
2. Target those market segments that manifest the proper size and growth,
are attractive in regard to a lack of competitors, match existing products
and services, and leverage the business's internal and external strengths
and resources .
3. Position the company's image, products , and value-added services so
that customers within selected market segments understand the firm's
competitive value .
Once the market segment has been targeted, and products and services
identified, marketers can then develop a strategy to optimize market niche . A
market niche can be defined as a target market demonstrating a specialized
need that is differentiated from the broader market in which a firm can
achie ve a low-cost and/or a unique capability for servicing that market.
Within each market niche are leaders , challengers, and followers . The goal is
to create such a strong niche presence that competitors could not justify entry
due to the meager return s expected. Rolls Royce, for example , enjoys a glo-
bal automotive market niche. Timex uses low-priced , quality watches avail-
able through mass-merchandizing channels to maintain its market niche. The
elements of an effective niche market center on customer growth potential ,
lack of interest by compet itors, possession of special skills and resources re-
quired by niche customers, and brand recognition or customer loyalty. Niche
marketing should provide the firm with a lasting opportunity and is structured
around stable demographic, cultural and technological wants and needs.
As illustrated in Figure 5.4, an effective market niche strategy attempts to
"Cs" "Ps"
Customer (needs) --------+~ Product (solution)
Cost -. .; , . . . . - - - - - - - - - - -~. Pnee

.
Channel
Competition
..,......-------- Promotion
FIGURE 5.4 Factors of marketing strategy.

align the three "Ps" of a successful marketing plan (product, price, and pro-
motion) with the four "Cs" (customer, cost, channels, and competition).
Well-defined and articulated customer needs should be satisfied with the
proper products and value-added services at a cost that matches or exceeds
the value of what the customer expects and will pay for. The strategy will be
successful if the cost to distribute and promote the product is less than the re-
venue generated in the face of the competition.
As the changing markets of the 1990s had forced companies to abandon the
mass-marketing approach in favor of market niches, so in the twenty-first
century the maturing of the global marketplace and acceleration of the rate of
change in technology, product services, and market demand are forcing entire
supply chains to work closely with each customer on an individual basis,
matching their concerns with a specific set of products and services that re-
spond directly to those concerns. Activated by enabling technologies like the
Internet, supply chains are rapidly moving beyond the mass market and mar-
ket niche models to a market segment ofone approach. This strategy requires
that marketers first have a firm grasp of the product and service strengths that
give them a competitive advantage. Once this is done, they must advance to a
position that views each customer as if they were a separate market. Such a
view requires sales and service functions to know the key strategic issues not
for a group of customers , but for each individual customer. This involves a
process of continually evaluating supplier and customer performance, quanti-
fying value-added services against cost, and communicating this information
back to the customer. In addition, managers of product and service functions
must know the requirements of each customer, and each employee, in turn,
must understand how their actions are the foundations of "world-class" cus-
tomer service. A marketing strategy of one approach requires that the entire
business understands the investment and market potential of each new prod-
uct and service required by the customer and how to develop strategies to
build the business to a critical mass.
In managing customers, marketers must be careful to measure customer
profitability. In every customer base are "stars" that provide the bulk of the
firm's sales, a broad mass of customers whose revenue contribution varies
from good to fair, and a group of "dogs" that are not only a severe drain on
resources but also divert effort away from servicing the "stars" and expose
them to be lost to competitors. One way to rank customers is to calculate an
operating profit contribution for each. A first-cut equation follows.
Gross profit ( 12 months) - [Invoices ( 12 months) x Avg Cost Per

Invoice] = Operating profit contribution.
The average cost per invoice is calculated by taking the entire operating cost
of running the business for the year and dividing it by the grand total of in-
voices for the same period .
The next step would be to rank all of the accounts from high to low by
their estimated profit contribution and then to calculate cumulative percent-
ages for customers and profits . A possib le breakdown for one company is il-
lustrated as follows:
Customers in top 10 percent provide 90 percent of the profits

Customers in bottom 60 percent provide (- 40 percent) of the profits
This analysis suggests that the top 40 percent of the customer base generates
140 percent of the profits, whereas the bottom 40 percent actually results in a
loss of 40 percent. Marketing and sales management should identify and de-
velop strategies to protect the top 20 percent , cultivate the 60 percent in the
middle, and individually review and eliminate losers residing at the bottom 20
percent. Another reporting mechanism would be to rank all customers by
their ratio of credits issued divided by the number of invoices billed for a
twelve month period. Exception ranking for slow-paying customers can also
assist in pinpointing losing accounts.
The ability of the marketing and sales force to understand the composition
and needs of the customer base is the key to the DO&CP process. As compa-
nies are increasingly forced to tum to growing profits and market share by
finding new customers in existing markets and better penetrating existing ac-
counts, customer channel relationships are becoming more critical. Funda-
mental to survival is therefore the ability to understand who the best custom-
ers are and what extra steps should be taken to further secure and proactively
anticipate their changing needs.
ELEMENTS OF SALES PLANNING
The objective of the sales planning process is to drive the business strategy
down through the field sales organization and to reconcile the demands to
achieve corporate goals with the company's sales resources. In formulating
effective plans, sales management must ensure that sales objectives match the
goais of the marketing plan, the capabilities of manufacturing to make the
necessary products , and the logistics capacities necessary to execute delivery
expectations. Where capacities are insufficient, the business plan must either
be changed or the enterprise must explore other avenues in order to gain the
required resources . In addition, the effective utilization of the sales force is
fundamental not only to a competitive position but also to organizational effi-
ciency. After transportation and inventory, the cost of performing sales func-
tions is the second largest source of expenditure, averaging 25 to 30 percent
of gross margin and can range as high as 40 percent for some commodity
lines such as paper. Sales planning must find answers to such questions as
the following:
What forecasts are to be used to drive the sales and product procure-
ment effort?
What are the sales quotas to be set to support the business plan?
How should the marketplace be segmented to optimize the sales effort?
What kinds of techniques should be used to find new customers and
how can existing accounts be better penetrated?
What kinds of compensation should be offered to motivate the sales
force?
What kinds of relationships should the sales force develop with the cus-
tomerbase?
How should customer profitability, account penetration, and sales force
productivity be measured?
In answering these and other questions, sales management must develop a
comprehensive plan that details sales objectives and goals. As illustrated in
Figure 5.5, the sales planning process begins with the translation of the busi-
I
I
Bu siness Plan ]
4
Product
Fa mily
Forces t
... ales
tra tegy
... a les
Ca pa cities
-
Sa les
Perform an ce
!
DO&CP ]
FIGURE 5.5 Sales planning process
ness plan into a forecast of product group sales. Marketing is the intelligence
side of sales assisting with market research, product information, pricing, pro-
motions, and deployment of the sales force. Past sales histories should be
meticulously "mined" to assist in the conversion of business revenue plans
into product group forecasts in units and/or dollars by time period. For the
most part, product groups are employed simply because the total number of
products may be quantitatively too large to be manage effectively. An aggre-
gate sales plan may be developed for a product group, a distribution center,
division, or the whole enterprise , or a geographical area. Disaggregating the
sales forecast into item-level forecasts is the responsibility of the supply
chain inventory planning process described in Chapter 6. Calculating the ex-
pected demand for each product group will result in a statement of aggregate
sales demand. This summary figure can then be compared to the total sales
plan required to support the revenue objectives detailed in the business plan.
The second step in the sales planning process is determining the sales strat-
egy. There are several elements composing the sales strategy. The first is de-
fining the market segments or territories and aligning them with the sales
force and supply channels . Another key element is knowledge of and com-
munication to operations management regarding any upcoming promotions,
changes in product pricing, the beginning and end of any special deals, and
the introduction or discontinuance of products. A new and increasingly im-
portant element is the degree of technology investment necessary to handle
order processing and information needs and any training required to retool
the sales force. Finally, the sales strategy should define the compensation
techniques to be implemented to motivate the sales force. Decisions as to the
blend of salary and commission should be made on the basis of the product
life cycle and the objectives specified in the sales quota.
Aligning available sales force resources with the sales and revenue cam-
paign takes place in the third step of the sales planning process. Once sales
market segmentation and product group forecasts have been developed, sales
management must ensure that both the sales force and the existing distri-
bution channel possess the capacity to realize the anticipated aggregate sales
demand. Where direct sales capacities are insufficient to meet expected de-
mand, the corporate revenue plans must be revised downward, the sales force
expanded, or the contracting of outside agents and representatives explored.
Similarly, ifthe sales plan calls for a supply channel network to meet delivery
strategies that exceed current capacities, then either the channel sales plan
needs to be changed or the firm must rent additional space, acquire new fa-
cilities, or locate new supply channel partners.
The final step in the sales planning process is sales performance. To be ef-
fective, sales planning must be compared to actual performance. Sales per-
fonnance can be measured through the use of a number of reporting techni-
ques. Whereas actual sales compared to forecast is the most obvious, en-
hanced performance systems must be architected that measure customer po-
tential, customer profitability contribution, account penetration, and sales
force productivity. In addition, a mechanism is needed that can not only pin-
point when sales patterns deviate from the forecast but also communicate de-
mand changes through the DO&CP process to other parts of the supply chain
in as expeditiously a manner as possible so that supporting resources can be
effectively realigned.
DEVELOPING THE SALES FORECAST
One of the most important functions of the sales planning process is the de-
velopment of the product family forecast. As was stated in Chapter 4, the
forecasting process occurs at various levels and time horizons. The goal is to
select the proper level that enables forecasting to provide meaningful data to
the DO&CP process. Forecasting at the business plan level, for example, is
too high a level. Its purpose is to provide a single set of numbers that can be
used by the entire company and is not specific enough in terms of products
and processes to provide enough detail to permit meaningful sales, opera-
tions, and supply chain planning. Conversely, forecasting down on the SKU
level, while providing massive detail about individual products, is not aggre-
gate enough to allow for effective management planning. As the principles of
forecasting state, the more detailed the level of forecastable elements, the
shorter the time horizon, the greater the need for massive data handling and
frequent review, and the greater the probability of error.
The solution to forecasting at the sales planning level is to utilize product
families. As discussed above, effectively constructed product families pro-
vide a variety of benefits. To begin with, product families should be orga-
nized to match the actual SKUs the supply channel sells to the marketplace as
well as how they are processed or purchased. Secondly, since product fami-
lies should never exceed more than perhaps a dozen, they are easily identi-
fiable by all DO&CP planners. Third, product families pennit sales to use
detailed financial and demand history data. This data can be "rolled-up" from
actual SKUs and summarized into the product families to which they belong.
Finally, as actual sales occurs through time and the data is rolled-up into the
appropriate product families, sales is provided with a more accurate view of
the viability of their forecasts. For example, while the actual mix of SKUs
constituting a product family may deviate from the forecast, aggregate sales
dollars may show that the product family is on target to meet forecasted sales
revenues .
Pyramid Forecasting. When developing the sales forecast, forecasters can

derive information for use in forecast development from many sources. Qual-
itative techniques, such as personal insight, sales force estimates, and market
research, can be used . Causal methods that attempt to factor in economic
trends, changes in technology, or political forces can also be used. Perhaps
the best source, however, is to roll-up the detailed forecasts located at the
actual SKU level in both units sold and revenues gained into their respective
product families to provide a summarized view. Once the aggregate total has
been calculated, forecasters can then utilize qualitative decisions to massage
the forecast numbers, and then pass them back down to the SKU level where
they will then be input into the demand portion of the Master Schedule.
Monthly Forecast - July 2003
Product Family: PC-ISOI PC Computers
Step 1: SKU Forecasted Quantity Price
PC-1501 -00 1 3,250 $1,245.00
PC-150 1-002 2,450 $1,255.00
PC-150 1-003 2,750 $1,275.00
PC-1501-004 3,150 $1,285 .00
Totals: lJ,600 Avg. price $1,265.09
Step 2: Sales Family Forecast Adjustment: 12,500

Step 3: New SKU Forecast - July 2003
Adjustment Factor: L~~~Qg = 1.08 (rounded)
11,600
Step 4 : SKU Factor Old Forecast New Forecast Price
PC-1501 -00 1 1.08 x 3,250 3,510 $1,245.00
PC-150 1-002 1.08 x 2,450 2,646 $1,255.00
PC-1501-003 1.08 x 2,750 2,970 $1,245.00
PC-1501 -00 1 1.08 x 3,150 3,402 $1,245.00
Totals: 11,600 12,528 Avg. $1,247.11
FIGURE 5.6 Pyramid forecast - by quantity.

Figure 5.6 provides a simplified example of the calculation. In Step 1, the

four items constituting product group PC-ISO1 have been forecasted using
historical sales data. In Step 2, sales and marketing planners have determined
that the PC Computer family can be expected to sell 12,500 in total for the
next month. In Step 3 the ratio of forecasted family sales to the sales estimate
is determined. Finally, in Step 4 this ratio is applied to the original base fore-
cast to provide the new forecast. This value is then passed down to the Mas-
ter Schedule as the total forecasted quantity for each PC-ISO 1 SKU. Often,
the sales product forecast is expressed not in units but in revenue dollars. As
illustrated in Figure 5.7, this can be easily accomplished by using the basic
forecast found in Figure 5.6 and extending unit values by dollars. In the il-
lustration sales has decided to establish the sales forecast for family PC-I500
at $15 million for the month of July. By calculating and applying the ratio
between forecasted dollars and the new revenue target, a new per-unit level
forecast can be developed and transferred to the Master Schedule.
Monthly Forecast - July 2003

Step 1: SKU Forecasted Quantity Price Cum Price
PC-1501-001 3,250 $1,245 .00 $4,046,250
PC-150 1-002 2,450 $1,255 .00 $3,074 ,750
PC-150 1-003 2,750 $1,275.00 $3,506,250
PC-150 1-004 3,150 $1,285 .00 $4,047,750
Totals: Il,600 Total Dollars $14,675,000
Step 2: Sales Family Forecast Adjustment: $15,000,000

Step 3: New SKU Forecast - July 2003
Adjustment Factor: _~~.?-:.~9..~!~.Q~_ = 1.02 (rounded)

$14,675,000
Step 4: SKU Factor Old Forecast New Forecast Cum Price

PC-1501-001 1.02 x 3,250 3,315 $4,127,175
PC-150 1-002 1.02 x 2,450 2,499 $3,136,245
PC-1501-003 1.02 x 2,750 2,805 $3,576,375
PC-1501-001 1.02 x 3,150 3,213 $4,128,705
Totals: 11,600 11,832 Total$14,968,500
FIGURE 5.7 Pyramid forecast - by dollars.

DEMAND, OPERAnONS, AND CHANNEL PLANNING 201
SALES FORECAST TRACKING
Once the sales forecast plan has been created, it is critical that the statement
of actual sales be tracked against the forecast estimates. Figure 5.8 illustrates
a typical time-phased grid portraying visually the interplay of actual sales
against planned for each product family. A critical decision to be made by
planners is determining the size and number of periods to be used in the grid.
This decision is dependent on several factors including the nature of the prod-
uct, constancy of the marketplace, accuracy of the forecast, the length of the
sales campaign, and other factors. In Figure 5.8 the size of the first nine
periods are one month long, after which the plan continues on for two ad-
ditional years consisting of calendar quarters . Finally, the grid displays the
forecast to actual sales history of the first four periods of the year.
Product fami ly: PC-ISOI PC Computers (in thousandsi

Period Jan Feb Mar Apr May lun lui Aug Sep 4lhQI IstQt
Sal es Plan 13.4 13.2 12.9 12.5 12. 1 11.8 11.4 I I.I 12.3 38.2 39.6
Actual Sal es 12.9 13.4 12.8 12.7
Variance -.5 +.2 -.1 +.2
C /t lll ' ar. -.5 -.3 -.4 -.2
FIGURE 5.8 Sales plan actual to forecast.
The detail of the sales plan grid contains the following elements:
Sales plan . This row contains the estimated sales forecast developed
by applying the pyramid forecasting technique to product family sales
history. Each period contains the projected anticipated sales volume
for the product family. In the example, the forecast demand has been
expressed in units.
Actual sales. This row displays the shipped and booked customer or-
ders occurring during the first three periods of the year. The values ex-
pressed are in units and are used to calculate the variance between the
expected and the actual sales.
Variance. This row contains the variance between forecasted and
actual sales by period. A positive sign indicates that sales exceeded
plan, while conversely a negative sign indicates below expected perfor-
mance.
Cum variance. This final row provides a running total of the variances
occurring in each period beginning with January sales. This value will
demonstrate such forecasting measurements as out-of-bounds condi-
tions, trending, seasonality, or other forecast biases.
As an example of how the sales plan grid can yield statistics, it is evident
that a lack of sales in the first period has dampened slightly the actual sales to
the plan over the course of the first four periods. While February and April
exhibited less than a two percent growth in sales, March experienced a slight
decline. If anything can be said, the sales effort is performing below par.
May appears to be a pivotal month to keep sales moving in a positive
direction.
ELEMENTS OF PRODUCTION PLANNING
The production plan is a component of the DO&CP process normally de-

veloped for companies that have manufacturing functions. Pure distributors
would be focused on developing the procurement plan for finished goods that
will be covered below in the logistics planning process. The objective of the
production planning process is to drive the business strategy down through
the manufacturing organization and ensure that aggregate product family pro-
duction rates match the goals of the sales and finished goods plans. A critical
component of the production plan is the availability ofproduction resources
capable of producing the volume of product family quantities necessary to
meet aggregate demand. Where capacities are insufficient, the business plan
must either be changed or the enterprise must explore other avenues in order
to gain the required resources. Production planning must find answers to
such questions as the following:
What production rates are required to support the business plan?
How much finished goods should there be at the end of each planning
period?
How are planners to utilize the sales forecast plan?
Is there sufficient capacity to realize the production plan?
What will it cost to build the production plan?
What strategies should production use in managing production rates to
meet demand?
How is the production plan to be integrated into the sales, logistics, and
supply chain plans?
Providing answers to these questions requires the formulation of manufac-
turing plans that enable the pursuit of detailed, measurable objectives and
goals. As illustrated in Figure 5.9, the production planning process begins
with the development of the finished goods inventory plan. In make-to-stock
I
I
Business Plan
I
Finished
1.+ Goods f+
Production
Rates
r+ Manufacturing
Ca pacities
I-
Plan
Production
Performance
!
DO&CP ]
FIGURE 5.9 Production planning proce ss.
environments , management policy will normally specify a targeted product

group inventory quantity that should be on-hand at all times to support de-
mand. Calculating this quantity is a function of several variables including
the size of the planning period , opening product group inventory balance,
family average sales, and a decision as to the targeted inventory balance. The
first calculation is to determine the average sales by product family by plan-
ning period. For example , for product group PC-1501 the sales over the past
twelve periods totaled 157,200. When divided by twelve periods, average
sales per period was 13,100. Management has decided it required ten days of
inventory available at all times . Since there was a total of 261 working days
in the calendar, dividing 13,100 by 261 produced the average daily demand of
50 units (rounded) . By multiplying the 50 units per ten days, the ending in-
ventory balance should be placed at 500 units per period.
The second step in the production planning process is to establish the rate
of production. Since most manufacturing environments must produce a mini-
mum quantity of products to remain cost positive while also recognizing max-
imum output levels, a viable production plan must establish production levels
that never exceed these boundaries while ensuring product is available to
meet demand. In addition, since dramatic changes to the shop floor even
within defined low/high boundaries is expensive, an level production rate en-
ables planners to optimize productive resources while minimizing ramp-up
and ramp-down costs .
Once the rates of production have been established, the production plan-
ning process shifts to calculating the aggregate capacity necessary to build the
production rate. While the production rate satisfies the priority plan neces-
sary to match forecast demand, planners must also convert the production rate
into a load plan that can be matched against aggregate capacities. In perform-
ing this activity, planners must first determine an aggregate planning work
center/resource that is representative of the actual workcenters needed to pro-
duce all of the SKUs in the product family. This resource capacity profile
must be expressed in a common production unit of measure and contain re-
source characteristics such as the amount of capacity available in a time peri-
od (usually a day), number of productive units (people/machines), efficien-
cies, and utilizations. Next, the product family plan must be converted into
the resource capacity unit of measure. This is accomplished through a re-
source load profile which serves as a sort of aggregate process routing. Mul-
tiplying the load profile by the production rate will produce a load value that
can then be compared to available resource capacity.
The final step in the production planning process is production perfor-
mance. Production performance can be measured through the use of a num-
ber of reporting techniques. Probably the most obvious is the variance be-
tween planned and actual production. Besides providing a metric on how
well the plan is progressing, the variances can be used to monitor the impact
on the sales and inventory plans. Production performance thus provides a
critical component in the mechanisms used to communicate changes through
the DO&CP process to other parts of the supply chain.
CREATING THE PRODUCTION PLAN
Before planners can begin production plan development, several critical pre-
requisites must be in place. Among these can be found the following:
A detailed product and sales plan existing at the product family level
A statement of aggregate product family on hand balance
A planning horizon that extends at least one year into the future
Agreed upon common planning unit of measure
Detailed load profiles for each product family
Detailed capacity profiles for each aggregate work center, including de-
sired efficiencies and utilizations
Defined aggregate production planning objective
Compatibility with the MPS
Once these elements have been completed, calculating the production plan
components is a fairly easy process. The first task is to define the production
strategy by choosing from one of the following :
Level production rate. The goal of this strategy is to produce inven-

tory, regardless of changes in actual demand, according to as level a
production rate as possible to meet average demand. Excess invento-
ries built during slow demand periods are assumed to cover for periods
of excess demand.
Demand matching (Chase strategy). This strategy seeks to produce in-
ventory in exact quantities to meet demand through time. The objective
of this strategy is to avoid high inventory costs by varying production
rates and employee levels. This strategy requires highly flexible pro-
duction resources that are capable of being easily idled and restarted.
Combination. Often production management will seek to use a level
production rate with the option of switching to a chase strategy based
on certain sales volume or production or inventory cost benchmarks.
For example, during periods where demand remains fairly consistent a
level rate strategy could be used. As variability grows in demand, plan-
ners might switch over to a chase strategy to avoid excess costs.
An graphic example of these strategies can be seen in Figure 5.10.
Sales ($millions)
5 Sales = ---
2
Level
Chase - - --
Combo = _ . -
o
2 3 4 5 6 7 8 9 10 II
FIGURE 5.10 Types of Production Plan strategies.
Determining the Production Rate. Once the planning strategy has been
selected the production plan can be established. The production plan actu-
ally consists of two interrelated plans : the production rate plan and a re-
source requirements plan . The production rate plan is created by perfor-

ming the following steps :
1. Review the detailed sales product group forecast.

2. Load the product group forecast into a time-phased format by period.
3. The planning horizon should extend out into the future for at least one
year.
4. Determine the aggregate beginning on-hand balance for the product
family .
5. Determine the target ending inventory.
6. Determine all inventory and/or production changes by volume con-
straints.
7. Calculate the production plan for each product group by period.
An example of this procedure is illustrated by starting with the sales fore-

cast exhibited in Figure 5.8. The sales forecast is the main driver for the pro-
duction plan. Two other critical decisions have to be made: the targeted in-
ventory balance and the production rate strategy to be used per product group.
In the example, it has been determined that for product group PC-1501 a
minimum of 250 SKUs must be on-hand at all times , and that the targeted on-
hand is to be 500 SKUs . Also, it has been determined that production plan-
ning will follow a level rate strategy and that it will extend for three periods,
after which it will be recalculated.
The results of the calculation can be seen in Figure 5.11. In Plan A, the
sales plan has been loaded by time period. A cumulative on-hand beginning
balance of 700 PC-ISO 1 has been identified. The production plan has then
been computed by following a simple formula expressed as
E -B+F
P = ------------------------
N
where P is the total inventory to be purchased during the planning period, E is

the product group ending inventory, B is the product group starting inventory,
F is the sales forecast for the product group by period, and, N is the number
of periods in the planning period.
As an example, product group PC-ISO 1 is calculated as follows :
1. Starting inventory is 700 units.

2. Targeted ending inventory at the end of the planning period January,
February, and March is 500.
3. Sales forecasts customer demand of39,300.
Then
500 - 700 + 39,300
P = -------------------------------- = 13,100.
3
4. This process is continued through the planning horizon.
Plan A: Original Production Plan
Product Family: PC-ISOI PC Computers tin thousands';

Period Jan Feb Mar Apr May Jun Jul Aug Scp ~thQt
Sales Plan 13 04 13.2 12.9 12.5 12.1 11.8 1104 I 1.1 12.3 38.2
Production Plan 13.1 13.1 13.1 12.13 12.13 12.14 11.6 11.6 11.6 38.2
lnventory Plan .7 A .3 .5 .133 . 166 .5 .7 1.2 .5 .5
Plan B: Adjusted F
Product Family: PC- ISOI PC Computers (ln thousandsy

Sales Plan 1304 13.2 12.9 12.5 12.1 11.8 1104 11.1 12.3 38.2
Production Plan 13.1 13.1 13.1 12.25 12.25 12.25 11048 11048 11048 38.2
.7 A .3 .5 .25 A .85 .933 1.316 .5 .5
FIGURE 5.11 Production and inventory plan .
When the plan has been completed, it must then be viewed for any con-
straints that emerge. Such a constraint appears in April where the ending
period inventory balance falls below the required 250 SKU limit. In this
case, a higher production rate for the second quarter must be calculated to ac-
count for the shortfall as illustrated in Plan B (Figure 5.11). The new rate en-
ables the planner to accomplish two objectives: the minimum balance is pre-
served and inventory can be efficiently built to cover the ramp-up in sales in
September. Often when creating a production plan planners must be careful
to validate that the changes in production rate between periods can be ac-
complished. For example, in each quarter the production rate is dropping by
about 6.5 percent. Planners would have to investigate the impact on person-
nel and plant utilization before actually decreasing the production rates.
Calculating the Resource Requirements Plan. While the production plan

sets the aggregate levels of production and inventories over the product fam-
ily planning horizon, planners must also match the plan against the aggregate
capacity needed to manufacture the products. The steps necessary to create
the resource capacity plan can be stated as follows:
1. Creation and authorization of a production rate plan for each product

family extending at least one year into the future.
2. Determination of the load profile for each product family.
3. Determination of the resource profile for each product family.
4. Calculation of the resource capacity plan by matching load require-
ments against available capacity.
5. Validation of the resource plan and solve all periods with excess load.
Beyond Step J, the next activity in capacity plan development is determine-

ing the load profile for each product family. This "aggregate routing" is the
common time required to produce any individual SKU within the product
family and is composed of the processing time of all subassemblies and final
assembly. Calculating the product family load profile can be performed by
determining the historical percentage of sales of each SKU in the product
family, multiplying this value by the actual process routing of the SKU, and
adding each processing time to attain the average product family processing
time as shown in Table 5.2. The average assembly time is then multiplied by
TABLE 5.2 Product Family Load Profile

Sales Standard (hrs) Average
SKU Percentage Processing Time Assembly Time
PC-ISO 1-001 35% 1.50 .525
PC-ISO 1-002 43% 1.45 .625
PC-ISO 1-003 13% 1.75 .228
PC-ISO 1-004 9% 1.65 .149
Average Process Time: 1.527
the period production plan (Production Plan B, Figure 5.11) to produce the
aggregate hours ofload for the product family as shown in Figure 5.12.
The next step is to define the resource work centers that are used to build
the product family. NonnaIly, resource work centers are used for planning
only. Their capacity is calculated used the same elements (daily capacity, ef-
ficiency, utilization, number of work units, and shifts) as actual work centers.
Product Family: PC-ISOI PC Computers Work Center: Assemb ly

Period Jan Feb Mar Apr May Jun
Produ ction Plan 13, 100 13,100 13, 100 12.250 12,250 12,250
Family Load (hrs) 20,003 20.003 20,003 18.706 18,706 18.706
Resource Capacity 19,000 19,000 19.000 19.000 19.000 19,000
Cum Variance -1,003 -2.006 -3,006 -2.712 -2,418 -2.124
FIGURE 5.12 Capacity plan .
In the example used to create the capacity used in Figure 5.12, work center
capacity by period has been calculated by multiplying the daily capacity of
950 hours by the number of days in the week (five days is being used) by four
(average number of weeks in a month) to arrive at the aggregate available ca-
pacity of 19,000 hours a month or a little under 12,500 a period.
Once these figures have been compiled, it is fairly easy to generate a re-
source capacity plan (Figure 5.12). Production Plan B has been multiplied
by the load profile of 1.527 hours a unit (Table 5.2) to arrive at the total hours
of load by period found in row Family Load. Next, the Resource Capacity by
period is entered in each period . Finally, the variance between load and capa-
city is calculated . In the example, the first three periods have excess load that
will have to be resolved by the planners if the plan is to succeed. Starting the
period in April there is over-capacity that can be used to factor in the re-
sponse to the early over-load condition of the work center.
PRODUCTION PLAN PERFORMANCE
Once the production plan has been created, it is critical that actual production
be tracked against the original estimates. Figure 5.13 presents the time-
phased grid illustrating actual production against actual sales for product fam-
ily PC-ISO 1. In addition, the grid also tracks how closely actual production
output is meeting ending inventory requirements. The calculation is simple.
The opening Actual Inventory of 700 units is added to the Actual Production
of 12,800 units in the first period and then subtracted from the Actual Sales of
12,900. The ending Actual Inventory for the first period is calculated at 600
units. This calculation is then performed for all subsequent periods.
As an example of how the production plan grid can yield data for decision
making, it is evident that the high sales in the first three periods have
significantly driven the production department to produce beyond current
demonstrated capacity. While working overtime in the first three periods has
enabled finished goods to stay close to the target ending inventory, an in-
crease in sales in April has actually driven the ending inventory target to zero
balance. Based on the new demand from actual sales, planners can now ad-
just production plan rates to be able to handle the short term increase in sales
while observing the planned increases in inventories expected in the late sum-
mer and autumn periods.
Product Family: PC-ISOl PC Co mpute rs (ill IhouSal1cl\')
Period Jan Feb Mar Apr May Jun Jul Aug Sep 4thQt
A ctuul Sales 12.9 13.4 12.8 12.7
Production Plan 13.1 13.1 13.1 12.25 12.25 12.25 11.48 11 .48 11 .48 38.2
Actual Production 12.8 12.9 12.9 12.6
Variance -.3 -.2 -.2 .35
CII/ll Variance -.3 -.5 -.7 .35
In ventory Pia 11 .7 .4 .3 .5 .25 .4 .85 .933 1.3 16 .5 .5
Actual Inventory .7 .6 .1 .2 .1
Cum Variance +.2 0 -.3 -.45
ELEMENTS OF LOGISTICS PLANNING
Regardless of whether the enterprise manufactures their own products or pur-

chases them from suppliers for resale, it is the responsibility of the logistics
function to establish the supply channel inventory levels and determine the
logistics capacities necessary to support projected channel network demand.
In developing the logistics plan, planners must find solutions to such
questions as the following:
How much channel inventory should be available to support the sales
plan?
What should be the deployment of inventories to supply chain loca-
tions?
What is the monthly channel shipment plan necessary to satisfy busi-
ness plan revenue targets?
How much capital will be required to meet inventory replenishment re-
quirements?
What are the storage requirements necessary to house the inventory?

What should be the size of the workforce necessary for efficient ma-
terial handling?
What type and how much material handling equipment will be re-
quired?
What impact will customer delivery strategies have on the existing
transportation structure?
In answering these and other questions, logistics planners must determine
what resources need to be in place to support the sales plan and provide the
necessary input to drive detail product replenishment, storage, and delivery
resources . As is illustrated in Figure 5.14, the logistics planning process be-
r Business Plan
I 1
Channel Logistics Value-Added

4 Inventory f.+ Capacity 1-+ Processing f-
Pllln Plan Plan
hipment
Plan
!
DO&CP
1
FIGURE 5.14 Logistics planning process .
gins with the translation of the aggregate sales forecast into product family
channel stocking requirements. The objective of the inventory channel plan
is to provide the finn with an aggregate schedule of product group require-
ments that can be matched against expected channel level sales and ending in-
ventory targets. Similar to the production plan, the output is generally speci-
fied in aggregate units of measure such as dollars or total units. The channel
inventory plan should be established at least once a year and reviewed and
updated on a periodic basis (at least quarterly and, preferably, monthly). To
be effective, it should be consistent with marketing and sales plans, as well as
with the company budgets set forth in the business plan. Once the plan has
been completed, however, it is the responsibility of logistics management to

achieve the plan: that is, having product and transportation capacities avail-
able as planned.
The second step in the logistics planning process is determining the total
logistics resource requirements plan. Capacity planning at this level is con-
cerned with the aggregate resources required to support sales, shipping, and
inventory targets. Resources in the typical enterprise can be categorized into
four components: inventory investment, transportation costs, warehouse
space capacities, and labor and equipment needs. The mechanics involved in
establishing aggregate logistics capacities are to obtain the planned procure-
ment for each product group by period, determine the resource profiles re-
quired of the four capacity components, and then to compare calculated re-
source needs with existing capacities .
In today's fast paced channel networks, the ability of supply nodes to delay
product differentiation to the very last moment before actual customer sale is
absolutely critical to marketplace success. Known as product postponement,
the object is to place value-added processing capabilities at various key po-
sitions in the supply chain. In many ways today's distribution center is look-
ing more and more like a manufacturing facility. Rather than fulfilling simp-
ly a product storage function, the channel warehouse is rapidly evolving into
a fast-paced operations center, return goods depot, or fulfillment repository
focused on inventory velocity and product process enhancement. Designing
the strategy for value-added processing comprises the third step in the logis-
tics planning process.
Finally, the most critical planning performance measurement in logistics
planning is developing and monitoring the product-level shipping plan. The
contents of the shipping plan are expressed in the same product groups, units
of measure, and time periods as the sales plan and are composed of the fol-
lowing elements: the current customer order backlog, current customer back-
orders, and forecast by product group. This shipment plan is a critical part of
the DO&C plan and should be combined with the detailed sales, production,
and inventory plans to provide a balanced view of how well the company and
the entire supply chain is progressing.
Drafting the formal logistics plan provides channel strategists with a road
map detailing the direction of logistics activities and how well they are
meeting the needs of the demand and channel supply plans. The plan estab-
lishes future objectives and goals outlining performance expectations, tech-
nology adoption, workforce attitudes, and enterprise culture. Far from being
just a "budget" specifying costs and revenues, the logistics plan is, more im-
portantly, a long-term statement delineating the human, material, and infor-
mational resources required of the whole supply chains. Finally, the formal
logistics strategic plan links and aligns logistics with the overall business ,
marketing, sales, and production strategic plans.
LOGISTICS RESOURCE REQUIREMENTS PLANNING
The logistics planning process can be used to calculate the logistic resources
required to execute the aggregate channel inventory and shipment plans. The
logistics plan should cover a specified planning horizon extending at least
one year into the future and should be reviewed and updated at least on a
quarterly, but preferably a monthly, basis. The output of the logistics plan-
ning process is composed of the aggregate inventories, shipments, and ware-
house and transportation capacities necessary to support the marketing and
sales plans. It is the responsibility of sales to actualize the demand side of the
shipment plan by attaining sales plan objectives; it is the responsibility of lo-
gistics management to have sufficient inventories and delivery capacities to
meet shipment objectives. The actual shipments and available inventory form
the scorecard tracking the overall success of the DO&CP process.
The Inventory Replenishment Plan . Developing the channel inventory plan

is an iterative, highly structured process that closely resembles the develop-
ment of the production rate in manufacturing. The planning process begins
by receiving the product family aggregate sales forecast and all company op-
en order demand covering one year or more into the future. In some planning
environments this will mean summarizing local forecasts and open orders to
achieve a single corporate statement of channel demand. The aggregate de-
mand for each product family should be expressed in total units and then
spread over the planning horizon. Planners must be careful to respond to sea-
sonality, sales cycles , or peaks produced by sales promotions . Next, any tar-
get increases or decreases in inventory or backlog levels are established. The
inventory levels defined are usually determined in the business plan and can
be used as benchmarks to measure actual sales and procurement performance .
Finally, the opening balance for each product family should be calculated.
Once these steps have been completed, planners can apply simple time
phased computer processing logic to generate the actual replenishment plan.
Safety stock can be used to indicate an ending balance target. For example,
assume the sales forecast for product family PC-ISOI (Figure 5.8) represents
total expected channel demand. The planning elements are as follows:
I. Starting cum channel inventory is 700 units.

2. Ending cum channel inventory is 500 units .
3. The minimum order quantity is 200 units.

4. Since inventory distribution occurs through interbranch resupply, the
lead time is negligent.
The calculation is straightforward (Figure 5.15): in January the forecast of

13,400 units is added to the ending balance of 500. The resulting 13,900 is
then reduced by the opening balance of 700 to produce a net requirement of
13,200. Since the requirement is evenly divisible by the minimum order
quantity of 200 units, the planned replenishment requirement would be
13,200. This replenishment quantity satisfies the demand plan, while leaving
an ending balance of 500 units.
Product Family: PC-I SOI PC Com puters (in thousandsy

Demand Plan 13.4 13.2 12.9 12.5 12.1 11.8 11.4 I 1.1 12.3 38.2
End On-hand 801 .7 .5 .5 .6 .5 .6 .6 .6 .5 .6 .5
Net Requirements -13.2 -13.2 -12.9 -12.4 -12.1 -11.7 -11.3 -11.0 -12.3 -39. 1
Replenishment Ord. 13.2 13.2 13.0 12.4 12.2 11.8 11.4 11.0 12.4 39.2
FIGURE 5.15 Channel inventory replenishment planning.
Once aggregate channel product family replenishment totals have been

compiled, the output can be used to calculate other logistics capacity require-
ments for inventory investment, transportation cost, warehouse space, and la-
bor and equipment needs. In addition, the requirements plan can be easily
disaggregated into individual channel warehouse plans. This can be done by
assigning a percentage value to each warehouse stocking the product family
and dividing by the aggregate replenishment totals. For example if the chan-
nel was composed of three warehouses with a split of 60 percent, 25 percent,
and 15 percent, the replenishment plan would post 7,920 units to the first
warehouse, 3,300 to the second, and 1,980 to the third.
Inventory Investment. If the total logistics plan is to be successfully execu-

ted, planners must ensure that the firm possesses sufficient financial re-
sources to support inventory acquisition, storage, and material handling re-
quirements. Historically, companies have used turnover ratios, inventory as a
percentage of sales (the inverse of turnover), or some other theoretical macro
technique to measure total inventory investment. Obviously, factors such as
mid-stream changes in products, markets, customer service policies, the dis-
tribution network, and other events could negate the validity of such a mea-
surement standard.
A much more effective method of projecting aggregate inventory costs is to

utilize a Replenishment Input/Output Report . The report uses planned and ac-
tual replenishment, shipment, and inventory balances to calculate projected
inventory costs. The planned replenishment and shipment figures are gather-
ed from each product family's DO&C plans. Actual replenishment and ship-
ment figures are accumulated and entered through time. Figure 5.16 illus-
trates a Replenishment Input/Output Report utilizing the sales information
from Figure 5.8 and replenishment information from Figure 5.15. The use of
such an Input/Output Report not only presents managers with an analysis of
the financial position of the inventory of the firm, it also permits visibility to
out of bounds situations and provides a mechanism to ensure that the compa-
ny is effectively executing the sales and replenishment plans necessary to
support business objectives.
Product Family: PC-I SOI PC Computers (jn thousandsv

Avg. Price (per unit): SI,265.00
Avg, Cost (per unit): SI ,075.00
Per. S Replenishment S Ship Inventory Inventory Cost
p A V P A V P A V P A V
Jan 1-1.190 )-I. 19(J U 16.951 16.3 19 -632 13.7 13.1 (J 1-I.12X 1-I.12X 0
Feb 1-I.19() 13.975 -215 16.6'lX 16.951 +253 13.7 13.5 -.2 1-I.12X 1-1.5 13 -215
Mar 13.975 I3.X6S -107 16.3 19 16. 192 -127 13.6 13.5 -.1 1-1.620 1-1.513 101
Apr 13.330 13.5-15 +:!15 15.X13 16.066 +253 12.9 13. 1 +.2 13.86X 1-1.083 +2 15
May 15.307 I2.S 13.760
-
13.115
_ _ _ I - - P _ Plan
A = Actual
:..-- --'---
- _l.---
V = Variance
FIGURE 5.16 Replenishment input-output report .
Transportation, An effective logistics plan provides traffic planners with a

window into the transportation requirements necessary to ensure that inven-
tory is available at channel distribution points. Calculating transportation
needs is critical. In many companies, the cost for transportation is the largest
single logistics cost, accounting in some instances for more than half of the
total cost. Although the most obvious benefit of transportation planning is to
measure actual costs to budgets, it also provides planners with the ability to
negotiate freight rates, make intelligent decisions as to the use of company-
owned transportation versus contractors, and view areas for transportation

cost savings.
The most effective tool for calculating aggregate transportation require-
ments is the Transportation Planning Report. The report is a combination of
the following elements:
1. Transportation unit factors. In developing transportation unit factors,
planners must first identify the normal units of transportation by which
their products are shipped. Possible units may be number of pallets,
weight, and storage volume.
2. Calculation of transportation unit costs. Once transportation units
have been identified, the cost of transporting products can be deter-
mined. Costs must be calculated for the shipment of goods from sup-
plying warehouses to each stocking warehouse in the distribution chan-
nel. As an example, a company transports PCs from the Chicago distri-
bution center to the Los Angeles field warehouse by rail. Each rail car
holds 100,000 pounds of goods and contains 2500 cubic feet of volume.
The rail company offers the follows rates:
Car Weight Avg. Cost per CWT

oto 1,000 lbs $IO.OO/cwt
1,001 to 8,000 lbs $9.00/cwt
8,001 to 12,000 lbs $8 .00/cwt
12,001 to 15,0001bs $6.00/cwt
3. Product group transportation profiles. The transportation elements of

each product group in the procurement plan must be assigned a val-ue.
For example, the standard weight of PC-1501 is six pounds and is
stacked 30 boxed units on pallet requiring 64 cubic feet of space.
Once these elements have been determined, it is relatively easy to calculate
the aggregate cost of transportation. A sample Transportation Planning Re-
port appears in Figure 5.17. The supply channel replenishment quantity for
product PC-1501 has been extended first by the product family transportation
profile values, and then by the associated transportation costs for shipping an
average load of 1,000 units a week from Chicago to Los Angeles by the rail
rates detailed above. By adding the totals of each product family and ship-
ping location, planners can review total transportation costs and other ship-
ping elements necessary to execute the shipping plan.
Warehouse Space Requirements. Once inventory and transportation plans

have been established, planners can calculate the total warehouse space nec-
essary to house the aggregate inventory plan. As a whole, warehousing ac-
tivities account for roughly one-fifth oflogistics expenditure. Executing the
Product Family: PC-ISO I Weight: 61bs Cube Space: 64 ft

Period Quantity Weight Cube S Cost
Jan 4.000 /1.000 avg. 24.000 /6.000 avg. 8.534/2.134 avg. 2. 160/540 avg.
Feb 4.400 /1.100 avg. 26.400/6.600 avg. 9.387 _.347 avg. 2.376/594 avg.
----
Mar 4.200 /1.050 avg. 25.200/6,300 avg. 8.960/2.240 avg. 2.268/567 avg,
Apr 4.600 /1.150 avg. 27.600/6.900 avg, 9.814/2.454 avg, 2.484/621 avg.
L---L---
FIGURE 5.17 Transportation planning report
aggregate inventory plan without effective warehouse plans can be expensive,

resulting in such problems as unnecessary material handling costs, product
damage and obsolescence, record keeping redundancies and errors, time
wasted in product search, excess transportation costs, and the expense for
public warehousing or other extra storage facilities.
Logistics management can plan for aggregate warehouse space require-
ments in much the same fashion as they plan for transportation requirements .
In developing the Warehouse Space Requirements Report, the following ele-
ments can be used:
1. Product group storage profiles. For each product group, an aggregate
weight, number of pallets, and volume space requirements are deter-
mined. These figures represent the basic storage characteristics of the
product family to house the stocking unit of measure. Products can be
stored in bins, racks, barrels, pallets, and so on.
2. Total warehouse space. The total space in the warehouse must be de-
termined by the storage area unit of measure. Logistics must calculate
how many cubic feet of shelf space, pallet racking, floor space, barrels,
and so on, are available per warehouse .
3. Warehouse space calculation . The aggregate warehouse space re-
quirements are calculated by extending the average stocked quantity
during the replenishment lead time plus safety stock for each product
family by the storage profiles established for each product family.
These aggregate space requirements are then netted against total avail-
able warehouse space by storage area to reveal both filled and open
space.
An example of a Warehouse Space Requirements Report appears in Figure
5.18. The calculations use the same quantities, weight, and cube specified in
Figure 5.17. Warehouse planners would need to calculate the space require-
ments for each product group for each warehouse in the distribution network.
Although actual space requirements for products will vary due to sales
growth, shifts in sales patterns, geography, new product introduction, and
other factors, aggregate space estimates should be accurate enough in general
to support the procurement plan.
Product Family : PC-l SO I Weight: 61bs Cube Spa ce: 64 ft

Period Quantity Weight Cube No. Pallets
Jan 1.250 7.500 2,688 42
Feb 1.350 8. 100 2,880 45
----
Mar 1.500 9,000 3,200 50
Apr 1,400 8,400 3.008 47
l---L..---
FIGURE 5.18 Product family space requirements report .
Labor and Equipment Needs. Effective logistics planning requires that plan-
ners be able to determine the aggregate manpower and equipment needs of
each warehouse in the distribution channel. Too much or too little manpower
can be expensive, as can the fixed asset costs of unused equipment or lost
productivity due to equipment shortages. In addition, labor and equipment
planning is even more essential for distributors with seasonal peaks and
valleys.
Much in the fashion of a manufacturing routing, logistics planners can de-
velop aggregate labor and equipment processing work standards per product
group . Routings in a manufacturing environment specify the operations to be
performed, the equipment to be used, and the number of hours required to
build a specific lot size of a product. By using the same principles, logistics
planners can develop product family labor and equipment work standards.
These standards should detail labor hours and equipment needs for the two
main distribution activities: product receiving and material put-away, and
order picking and shipping. The first standard encompasses determining the
work requirements needed to load and unload trucks or railcars, and material
put-away. The second can be calculated by developing standards for order
picking and shipping. Capacity requirements can then be calculated by ex-
tending processing times by the aggregate totals found in the inventory and
shipping plans. The results of the calculation should yield an aggregate state-
ment of manpower and capacity required to actualize DO&CP objectives.
An example of a Labor and Equipment Capacity Report appears in Figure
5.19. Across the top can be found the standard labor and equipment times to
handle a lot size of 500 units of Product Family PC-ISOI at the Chicago
warehouse. The detail labor and equipment times can be attained by dividing
the expected inventory quantity by the lot size and then extending the value
by the detail standard for labor and equipment. After each product family ca-
pacity requirements are compiled , they can then be summarized to provide
the total product family required labor and equipment times for the ware-
house in each period .
Routin g Detail :
1. Lot Size: 500 units
2. Labor Requirements 3. Equipment Requirements
Receiving and Putaway : 20 hrs Fork Lift: 19 hrs
Picking and Shipping : 10 hrs Picker Vehicle : 12 hrs
Product Family: PC -I SOI PC Computers Warehouse: Chicago
Labor (hrs) Equipment (hrs)

Period Quantity Rcc/Putaway Pic ' . hip Pork un Picker Vehicle
Jan 1.250 50 25 4& 30
Feb 1.350 54 27 52 33
--.-- ---
Mar 1.:00 60 30 57 36
Apr 10400 56 2& 54 34
FIGURE 5.19 Labor and equipment capacity report.
VALUE-ADD ED PROCESSING P LAN
A key element in the logistics plan is determining if stocking points in the

supply channel are going to further process received products and materials
into final configured finished goods. Historically, distribution channels have
been unconcerned with forms of manufacturing. Today, increasing customer
demands for perfect orders, increasing speed, decreasing costs, continuous
improvement, and greater selection and customization are requiring compa-
nies to delay product differentiation (postponement) to the customer-facing
node in the supply chain. In fact, the concept of the warehouse as a storage
function is being replaced by a new concept that requires the warehouse to be
increasingly focused on value-added services such as product configuration,
packaging, labeling, cross-docking, pricing, and merchandizing. Designing a
strategy to manage collectivel y these value-added pro cessing functions is a
critical component in logistics plan development.
Advantages of value-added processing. There are several reasons for this

growing interest in value-added processing .
Reducing Channel Costs. Traditionally, as products moved from the
manufacturer out into the distribution pipeline, value was often added
by channel partners who performed quantity, packaging, or other value-
added activities as products passed through the supply chain. The
problem with this arrangement is that at each node in the channel net-
work cost was added to the product that was subsequently passed on to
the next channel level. In an effort to offer the same product at lower
prices, many companies have decided to eliminate costly upstream
channel partners and perform the value-added processing themselves.
Although they will have to bear additional costs for plant, equipment,
and personnel, the expense is more than offset by reductions in chan-
nel-wide finished goods inventories and lower transportation costs.
Lead-Time Reduction. By eliminating channel stocking point redun-
dancies, network supply nodes can increase the velocity of product to
market. As products no longer have to proceed through costly and time
consuming processes as they pass from one channel level to the next,
delivery time to the customer from the originating manufacturer can be
significantly reduced.
Inventory Reduction . Because the number of stocking points in the net-
work are reduced, so is the total value of stocked inventory in the pipe-
line. Besides reducing channel carrying costs, reduced inventories en-
able better control of product obsolescence and spoilage.
Customer Response and Flexibility. Because downstream channel net-
work nodes can now receive products in bulk or in an unassembled
state, their ability to respond to customer requests is increased. In the
past, distribution points received goods in a finished assembly quantity
or prepackaged state. By buying goods, for example, in bulk and pack-
aging them per customer order, response flexibility can be expanded
without increasing inventory investment.
Material Handling. Value-added processing targeted at unitization can
help reduce labor and material handling costs while accelerating prod-
uct movement. Unitization can be defined as the consolidation of prod-
uct into units of measure that facilitate warehouse and transportation
handling. An example would be palletizing many small units to reduce
the number of pieces handled.
Elements of value-added processing. The economic justification for value-

added processing rests on the Principle of Postponement. The objective of
this principle is to explore inventory management strategies that can assist
both internal company distribution facilities and channel partners minimize

the risk of carrying finished products in downstream channel nodes by delay-
ing product differentiation to the latest possible moment before customer pur-
chase. Stocking and transportation cost savings are attained by keeping base
product at the highest level possible in the supply chain and by moving gen-
eric goods through the pipeline in large quantities . Obviously, the key to
postponement strategies is the ability of supply channel locations to convert
undifferentiated goods and bulk quantities quickly and inexpensively into fin-
ished product as close as possible to the time and place required by the cus-
tomer. This process of adding final value to the product is fundamental to un-
derstanding and leveraging value-added processing to create a unique com-
petitive advantage .
When developing a value-added processing policy, channel planners are
faced with a number of critical questions:
What is the cost of value-added processing at various stocking points in
the distribution network?
When should value-added processing activities occur?
At what stocking point should generic products be converted into
brands?
What is the cost advantage of bulk shipment of the product?
What are the quality risks involved in remote value-added processing?
Can the product skip one or more points in the channel of distribution?
What postponement strategies are being pursued by the competition?
What is the level of customer service attained by the postponement
strategy?
Once answers to these and other questions have been made, strategists
must decide on the processing methods to be deployed by selecting from the
following list of processing alternatives :
Sorting . In this activity, a heterogeneous supply of a particular product
is organized into distinct finished goods that are relatively homo-
geneous. This form of processing is normally identified with certain
raw materials and agricultural products, such as grading eggs according
to size, and beef as either choice or prime.
Bulk breaking (allocation). Economies in transportation, handling,
storage, and other related costs can often be achieved by shipping prod-
ucts through the supply channel network in large quantities and then
breaking them down into several smaller stockkeeping units (SKUs).
For example, a large Midwest manufacturer of hardware products pur-
chases various types of fasteners by the keg from Far Eastern sources.
Afterwards, the fasteners are processed into smaller finished goods
packaged sizes, or the contents are mixed with other fasteners manu-
factured by the company to form end-product assortments sold to retail
outlets.
Labeling. This form of value-added processing is used most often in
differentiating generic products through a labeling or branding process.
As an example, a large Midwestern fruit juice bottler produces various
sizes of bottled but unlabeled product. The product is shipped in bulk
to the distribution points in the channel and left unlabeled until the re-
ceipt of a customer order for a specific brand and container size. Pro-
cessing steps involve issuing the required common product size from
stock, labeling, packaging, and shipping to the customer.
Blending. Petroleum, paint, pharmaceuticals, and other process-manu-
factured products can be shipped and stored in the distribution channel
in an unblended state. Once actual orders are received, the proper
blend to match finished goods specifications is processed. Similar to
labeling postponement, delaying the commitment of inventories until
the actual customer order is received reduces inventory carrying costs
and spoilage. An example would be a paint distributor who blends base
colors to customer order specification.
Kitting (assorting). This value-added processing activity is used to as-
semble heterogeneous items and materials linked by functional use into
finished products sold as a group. An example would be assembling an
automotive brake kit composed of various tools and accessories. The
kitting process enables customers to purchase an assembled unit rather
than having to choose each of the components separately. Kits can
both be preassembled and inventoried, or they can be assembled per
customer order.
Packaging. Although all products are packaged in some manner, chan-
nel distributors may choose to repackage the products they receive for
the following four reasons: (1) protection, (2) containment, (3) informa-
tion, and (4) utility. Less than adequate packaging can lead to exces-
sive costs due to damage and redundancies in handling. Excessive
packaging, on the other hand, can lead to additional costs associated
with bulk breaking and storage and equipment requirements. In ad-
dition, repackaging may occur to assist in unitization and identification.
Light final assembly. Performing light assembly of products is the
closest channel warehouses come to true manufacturing. Light assem-
bly requires such activities as snapping, bolting, gluing, or wiring com-
ponents together, label stamping or other forms of product identifi-
cation, and painting . For the most part, light assembly consists of high-
ly labor intensive, but low-skill and low-cost processes. Light assem-
bly requires channel distributors to make significant financial commit-

ments in equipment, level of employee skill, facilities , and information
systems.
Contrasts with manufacturing. The use of the term "value-added process-

sing" as opposed to "manufacturing" is meant to communicate an important
difference. Although it is true that kitting and light assembly come close to
manufacturing, these functions are distinctly different from those performed
by manufacturers. One of the key differences relates to the product position-
ing strategy. Distributors basically maintain one type of inventory: finished
goods normally purchased from sources outside the enterprise or transferred
from upstream manufacturing plants. When value-added processing does
occur, it is usually confined to manipulating the unit of measure of a product
or grouping it with other products. In contrast, manufacturers normally alter
fundamentally the form, fit, and function of item components in the process
of manufacturing conversion.
Another contrasting point can be found in the production process design
strategy . For the most part, distributors have simple value-added processes
geared tow ard manipulating the quantity and not the nature of the product.
The investment in manufacturing assets, therefore, is minimal , the labor force
needs only basic skills , and simple, even manual, process control systems are
often sufficient to execute build priorities. Manufacturers, on the other hand,
design their manufacturing processes to transform materials and components
into fundamentally new products. Processes are usually characterized by the
use of highly skilled labor, complex machinery, and sophisticated information
systems that plan , track, and record performance and costing data.
ELEMENTS OF SUPPLY CHANNEL PLANNING
In Chapter 2 the supply channel was defined from several perspectives. It

was compared as a pipeline through which the flow of products and informa-
tion from the supply source to the point of customer sales was planned and
controlled. The supply channel was also conceived as a partnership of sup-
pliers, manufacturers, distributors, retailers, and customers who were linked
as integrated nodes in a distribution system. Finally, the supply channel was
portrayed as the medium by which the activities of ownership, title transfer,
promotions, negotiations, ordering, and payment flows were performed. The
focus of supply chann el management is delivery, and can be summarized as
the process ofmaking a product or service available fo r use or consump tion.
Designing effective channel strategies requires planners to find answers to

such questions as the following:
What is the physical structure of the supply channel?
What is the optimum channel structure to deliver the necessary value
demanded by the customer?
What marketing and logistics functions are to be performed by the sup-
ply channel?
What are the value-producing attributes (such as speed, reliability,
price, best value, service, depth of available products/services, techno-
logy tools) that are to guide channel operations?
What impact will postponement and value-added strategies have upon
the supply channel?
What types of relationship are required to achieve the desired level of
channel collaboration?
Providing answers to these questions requires the formulation of channel
management plans capable of laying the foundation for tactical activities,
such as basic channel and marketing functions, as well as operational and
partnership strategies. As illustrated in Figure 5.20, the channel planning
r
I
Business Plan
I
Channel Channel Channel
4 Business
Mission
r+ Design
Plan
r+ Operations
Plan
-
Global
Channel
Plan
~
DO&CP ]
FIGURE 5.20 Channel planning proces s.
process begins with the development of the channel business mission state-
ment. The objective of this step is to define how the supply chain is going to
compete in the marketplace. Although the nature and function of supply
channels will vary by industry, they all have a common business mission: to
continuously create superlative, customer-winning product and service value
at the lowest possible operating and investment cost. An effective mission

statement will determine how the five critical elements of the supply channel
- the customer, the service strategy, people resources, trading partners, and
information technologies - are to be integrated into a seamless, highly com-
petitive value chain.
The second step in the channel planning process is the construction of the
supply channel system. Distribution systems provide the medium by which
products are moved from the point of origin to the point of consumption.
There are two critical elements that must be considered when designing the
channel to accomplish this basic objective. The first centers on the com-
plexity of produ ct delivery. Several critical question come to mind: How
deep and how broad is the targeted market penetration? Does the nature of
the product require special transportation, storage, and handling? How exten-
sively does the firm want to control these functions? The second critical ele-
ment influencing the supply channel structure rests upon the degree of chan-
nel partner dependence. The more extensive the channel, normally the more
dependency grows on trading partners for cooperation and sharing of critical
functions and processes .
Once the design of the channel has been determined, channel network par-
ticipants must define the processes capable of creating unique and unas-
sailable value to the customer. The operational imperatives must realize the
following market-winning objectives: superior customer service, continuous
reduction of all forms of cycle time, high levels of channel performance, and
reduced costs. Besides defining core competitive guidelines, such as com-
pleteness and reliability of delivery, high product/service quality, speed and
frequency of deliveries, and least total delivered cost, planners should strive
to continuously compress cycle times in manufacturing, distribution, and cus-
tomer delivery. The final topic in this area is tackling total supply network
costs. Supply channel operating costs are complex and consist of a matrix of
drivers such as labor, facilities operations , inventory investment, transpor-
tation , and long-term asset investment.
In many supply channels planners are increasingly have to come to grips
with establishing global supply channels. Even mature supply chains must
expend significant effort at developing channel structures and product and
service mixes that will appeal to a global market. Often new core compe-
tencies will have to be built or acquired in foreign countries, new mechanisms
for the performance of global trade functions constructed, and new partner-
ships architected capable of handling the flow of products and services
through global trading networks . In addition, less strategic issues such as in-
termodal transport, government regulations, tariffs, environmental concerns,
and local labor force and cultural issues will have to be reviewed. A full
treatment of global trading channels is found in Chapter 13.
UNDERSTANDING SUPPLY CHANNELS - OVERVIEW
Few products are sold by their producers directly to the end customer. For
the most part, products travel through one or more intermediaries, such as
company-owned distribution functions, wholesalers, dealers, brokers, and re-
tailers. The channels that emerge out of these trading relationships are gov-
erned by the transfer of ownership and the flow of goods and information as
they make their way through the distribution system. The structure of supply
channels can be viewed from either an institutional or a functional approach.
Institutionally, supply channels can be described as confederations of aligned
companies that participate in a interconnected process of buying and selling
products and services. On the other hand, a supply channel could also be a
group composed of geographically dispersed warehouses owned by a single
corporate parent. Finally, the channel could be a mixture of internal and trad-
ing partner inventory storage or distribution points. Channel structures can
take a number of forms based on corporate goals, operating paradigms, chan-
nel strengths and weaknesses, and customer expectations. Some distributors
can have multiple structures based on market segment. Zenith, for example,
will sell television sets through large retail outlets like Best Buy, small retail
electronic appliance stores, and a network of distributors and dealers.
Supply channels, however, can also be defined by the functions executed
by channel partners associated with the movement of product through the dis-
tribution pipeline. As illustrated in Figure 5.21, some channels are single
level: The manufacturer performs all the functions relating to marketing,
products and services, transportation, and warehousing. Other channels are
composed of multiple levels of manufacturers, distributors, and retailers, each
performing some or all of the marketing and logistics functions and the cost
of operations. The level of integration and cooperation depends largely on
the nature of the product and market objectives. For example, a fresh vegeta-
ble distribution channel requires a tightly knit linkage of channel partners
who depend on speedy delivery, communications, title transfer, and financing
flows to bring product to market.
In practice, it is almost impossible to separate the institutional from the
functional activities performed by the members of a supply channel. Still, it
is far more useful to describe channel agents by the activities they perform
than by attaching institutional nomenclature, such as "producer," "whole-
saler," or "retailer." Such an approach assists channel strategists in focusing
on the actual mechanics of the supply channel rather than a strictly organi-
zational view. This factor also recognizes that the institutional structure of a
supply channel can remain constant even though responsibility for perform-
ing channe l functions may shift between channel members.
Complex
Channel
Simple
Channel
FIGURE 5.21 Types of supply channel structures
DEFINING THE SUPPLY CHANNEL MISSION
The objective of the channel business mission is to determine how to arrange

internal channel functions and external partners into a highly competitive value
chain. Although the structure of supply channels will vary by industry, they can
all be said to have a basic business mission: to continuously create superlative,
customer-winning product and service value at the lowest possible operating
and investment cost. The core components of the channel mission statement are
revealing. The first component, continuously create, implies that productive
processes within the channel must be constantly focused and refocused on a
ceaseless search for innovation both in the products and services the channel of-
fers and in the way they are delivered to the marketplace. This component de-
scribes the strategy by which the channel is going to compete. Customer value
refers to the mix of products and services to be presented to the marketplace.
Defining key attributes, such as quality, price, delivery, product robustness and
configurability, and level of service, illuminates performance goals and unifies
channel participants and directs them toward a common objective. This com-
ponent describes who is the target of the channel. Finally, the operating and in-
vestment cost of achieving channel objectives provides the financial perform-

ance measurements and necessary channel organizational mechanisms guiding
operations. This element describes how the channel is going to compete.
A useful framework for developing the channel mission statement is to
identify the strategies to manage the five critical dimensions of channel man-
agement: the customer, the service strategy, the workforce, channel partners,
and technologies systems strategy. These areas are portrayed in Figure 5.22.
At the center of the supply channel mission stands the customer. It is customer
wants, needs, and expectations that drive channel objectives and define channel
structure and marketplace values. Responding to this central channel compon-
ent will impact the core channel functions of the following:
FIGURE 5.22 Channel mission components
Marketing. Identifies the products and services that meets customer

wants and needs. Market foresight teams will also be responsible for lo-
cating tomorrow's newest and most profitable industries and identifying
the skills and competencies required for effective participation.
Supplier management. Integrates with each upstream supply node to en-
sure the timely delivery of quality materials and components at the lowest
possible cost.
Product development. Develops products and services that possess un-
paralleled customer value in the shortest cycle time possible and at the
lowest cost.
Production operations. Creates the highest quality products through the
use of flexible processes and quick response that enable custom manu-
facture while decreasing lot sizes and cost.
Demand management. Provides short order cycle times and responsive
service and delivery through the use of computerized information systems
and electronic commerce.
Channel management. Integrates products and information to ensure

their rapid flow through the supply pipeline to the customer at the short-
est possible time and lowest cost.
Clearly identifying the channel's customer service mission forms the founda-
tion for the formulation and implementation of the channel's service strategy.
The service strategy consists of an internal commitment to service centered on
the formal channel mission statement and an external commitment to executing
those service attributes promised to the customer through the sales cycle.
The collective management of the human resources comprising the channel is
the third critical dimension of the channel mission. Human resources provide
the central competencies that drive each business and remedying deficiencies is
a fundamental role of channel partners. The fact that this area is connected to
the service strategy means that there must be a shared vision if service values
are to penneate not only each enterprise but the whole supply channel. The link
between people resources and service represents the everyday communication
that occurs between the channel's work force and the customer.
Perhaps the central pillar of the supply chain management concept is the
utilization of business partners to create tightly integrated business channels.
This means more than just outsourcing a peripheral channel function: it is about
architecting a collaborative community of trading partners collectively driven
by a common mission to deliver the highest level of customer service possible.
The realization of inter-enterprise structures capable of mutually supporting ob-
jectives and synchronous information flows will require the following process
and strategic attributes :
1. A shared inter-enterprise vision. The goal is not only to establish a
mechanism for cross-channel business, but also to use the framework to
leverage the product, services, and competencies of the entire channel
ecosystem to deliver breakthrough customer value.
2. Inter-enterprise channel model. The channel model provides a high-level
description of how the network is constructed, including the loca-tion of
inter-enterprise integration points. The model should detail mar-keting
and customer management goals, product/service mix, product
development roles, financial measurements, and logistics management
requirements.
3. Inter-enterprise process modeling. Once the channel vision and struc-
tural model have been detailed, a channel process map needs to created
defining which channel functions are going to be inter-enterprise pro-
cesses, what technologies must be in place, and how supporting internal
and external organizational infrastructures are to be established.
The final component of the channel mission is the channel's information sys-
tems. The role of information systems is to link the other components of the
channel framework. People resources utilize the channel's systems to execute
functions, record information, and communicate with each other and with cus-
tomers. These systems are multidimensional and are composed of management
systems that determine channel goals, internal and externally devised rules and
regulations systems, the mechanical technical systems, and the channel's col-
lective social systems that guide problem solving, teamwork, and service val-
ues. The customer must use the systems employed by their suppliers to make
their wishes, needs, and expectations known. Finally, information systems can
be heavily influenced by the customer-service-centered culture strategy.
CHANNEL DESIGN
Once the channel business mission has been defined, planners must tum their
attention to channel design. The output from this planning process is usually
defined as the channel structure design. The task of keeping the channel fo-
cused on competitive goals and objectives is termed channel leadership. The
combined tasks of designing the channel structure and providing leadership is
referred to as channel management [9]. In deciding on the structure of the
channel network, firms must align products and services with the time, place,
and delivery needs of the marketplace. One method used in defining the mar-
keting channel is to gauge the marketing flow functions in terms of service
outputs. There are four basic service outputs to be considered:
Product Variety. The depth and breath of a supplier's product assort-
ment reduces the need for buyers to search the marketplace to meet
product and service requirements . Robustness of product variety re-
duces buyer costs associated with order placement, receiving, ware-
housing, and accounts payable.
Waiting Time. This is the time intervening between order placement
and delivery of goods and services. The faster the delivery time, the
less customers have to stock safety inventories and extend their plan-
ning horizons out into the future.
Lot Size. The size of the required purchase quantity directly affects
customer service levels. The smaller the lot size and the faster the de-
livery, the greater the level of service. Small lot sizes pennit customers
to reduce payables cash flow, reduce the need for storage, and help
contain costs stemming from damage and obsolescence.
Spatial Convenience. This service output refers to the degree of chan-
nel decentralization. Time and place utilities are critical to customers.
The closer the outlet to the customer, the more costs associated with
supplier search and transportation can be reduced.
How service outputs will be used in channel design depends to a large ex-
tent on the degree of market exposure companies seek for their products.
Kotler [10] differentiates three levels of market exposure :
I. Intensive distribution. In this strategy, producers typically seek to dis-
tribute their products through as many distribution points as possible to
maximize product availability in the marketplace. Companies distrib-
uting low-cost consumer goods, such as candy and .soft drinks that re-
quire little customer service and whose quality is not associated with
the nature of the outlet, will use this method of channel organization.
2. Exclusive distribution. Some producers will deliberately limit the
number of channel partners handling their products. The most extreme
manifestation of this strategy is exclusive distribution, where a limited
number of intermediaries are granted exclusive right to distribute cer-
tain products. Often producers will also mandate exclusive dealing,
where dealers cannot stock competitor product lines. Examples of
products in this category are new automobiles and some appliances and
fashion apparel. The goal of exclusive distribution is to gain more con-
trol over the channel in regard to sales, marketing, promotion, price,
credit, and other value-added services.
3. Selective distribution . Some producers may follow a market exposure
strategy that confines the sale of products to a selected group of target-
ed intermediaries capable of providing a specified level of customer
service, marketing, and other service criteria. The objective is to win
reputable dealers and retailers through a promise of exclusive product
distribution. In return, the producer can gain significant market pene-
tration while achieving more control and reduced cost than what can be
obtained through intensive distribution.
The second element of channel design revolves around the degree of the ac-
knowledged dependence of channel participants. The more channel members
are dependent on one another, the greater the need for cooperation and sharing
of critical information and processes. The less the dependence, the more in-
dividual companies must depend on their own competencies and vertically in-
tegrated resources to sustain competitive advantage. According to Bowersox
and Cooper [II], channel structures are grouped around the following classi-
fications, ranging from least to most open acknowledgment of dependence:
Single-transaction channels. A great many marketing transactions oc-cur
in supply channels that are considered onetime and nonrepeatable.
Examples of single-transaction arrangements can be found in real estate,
construction, international trading, and the purchase of capital equipment.

Normally, supply channels in such environments are transitory and
founded for the sole purpose of facilitating a unique transaction. Once
the requirements originally agreed to by the channel participants have
been completed, the basis for the channel ceases to exist.
Conventional channels. This category of channel arrangement is also
known as a free-flow channel. The main characteristic of this type of
channel is the comparatively high degree of independence maintained by
channel participants. The reason why they participate in the channel at
all is to leverage the different forms of specialization they can offer the
marketplace. The motive is purely opportunistic: they seek to attain
channel efficiencies without becoming fully committed members of a net-
worked channel system. Despite the benefits, there are certain draw-
backs. Free-flow channels will, over time, be more volatile than depen-
dent channel systems, as members move freely between multiple chan-
nels in the pursuit of short-term efficiencies and opportunities. Second,
relations between members are typically adversarial, as members continu-
ously maneuver for cost and price benefits. Finally, channel arrange-
ments can be terminated abruptly by either party if and when once per-
ceived advantages disappear.
Networked supply channel systems. This type is characterized by the fact
that channel members both acknowledge and desire interdependence. As
such, these organizations feel that short-term ability to maximize op-
erational efficiencies and marketplace exposure and their long-term capa-
bility to maintain competitive advantage depend on their participation
and close integration with partner companies in a networked channel sys-
tem. The basic advantage of this form of channel arrangement is the
ability of individual companies to achieve a level of performance and
capability for innovation far above what they could achieve acting on
their own. Although there is the potential for conflict among channel
members, the value of the synergy engendered by the networked channel
provides strong inducements for conflict resolution and convergence of
objectives.
When considered together the above elements can be used to create a channel
attribute matrix (Figure 5.23) to guide planners in channel design. Across the
top of the matrix is arrayed the various levels of market exposure, starting with
a very limited direct channel approach on the left and a very robust intensive
distribution approach on the far right. Down the vertical side of the matrix can
be found the various service outputs. Across the bottom is found the channel
values. Channels that focus on capital (industrial) or specialty (commercial)
buying will normally consider distribution flexibility and dependence on quality
related differentiators such as image, flexibility, product design, and service.
On the other hand, channels that focus on MRO (industrial) or convenience

(commercial) buying will rely on competitive attributes centered on price, de-
livery, and availability.
Direct Internal I Exclusive/Selective I Intense

I I
Channel Channel I Distribution I Distribution
I I
Product Capitall Marerials & Components/ I

I
MRO/
Type Specialty I
I Shopping I
I Convenience
I I
Prod uct I I
High Medi um I Medium I Low
Variety I
I
Wait I
High Hig h I
I Medium Low
Time I
I
Lot Size Low Medium I
I
Med ium High
Spatial I
Low Low
I
I Medium High
Conv ience I
I
I
Cost High High I

I
Medi um Low
~ Flex ibility/Qualit y S tandard iza t ion/Cos t ~
FIGURE 5.2 3 Channel attribute matrix
CHANNEL OPERATIONS [12]
The primary purpose of the integrated supply channel network is to facilitate

the fundamental operations activities of manufacturing, distribution, and cus-
tomer delivery . The objective of these three channel processes is to create
unique and unassailable value to the customer that cannot be copied by the
competition . In accomplishing this mission , the supply channel must activate
the following critical customer-satisfying drivers: superior customer service,
decreased channel cycle times, high levels of channel performance, and reduced
costs. Today's best supply channels seek to leverage operational excellence,
strive for quality and continuous improvement, and foster the creation of new,
innovative techniques possessed by their members to achieve superlative, cus-
tomer-winning processes unmatched by the competition .
Continuously executing value-added operations requires the channel-wide
performance of those critical metrics most valued by the customer. Some of
these values center on the fulfillment process and consist of such deliverables
as completeness and reliability of deliveries, high product/service quality, best
value for the price, speed/frequency of deliveries, breadth and depth of avail-
able products/services , and use of electronic commerce technologies. To these
"basic" elements can be added other values. Among these can be found the ap-
pearance the whole channel projects to the customer through such tangibles as
new facilities, state-of-the-art technology, commitment to quality, and highly
qualified personnel. In addition, other elements such as reliability, responsive-
ness, and competence project to the customer a sense of dealing with acknowl-
edged and measurable standards of service, a supply partner who can respond
quickly and concisely to their needs, and confidence that their product and ser-
vice issues will be satisfied by a supplier who possesses the necessary skills and
knowledge. Finally, other service attributes can be found in the courtesy by
which customers are treated, the feeling of credibility and honesty when dealing
with the supplier, a sense of security and peace of mind when the transaction is
completed, and the degree of communication and ability of the service provider
to unearth and respond purposefully to their needs, desires, and expectations.
Perhaps the key to achieving superlative customer service is controlling the
total time it takes goods and services to move from the point of manufacture to
the point of customer delivery. The effective management of cycle times re-
sults in high customer service, greater operational flexibility, lower investments
in working capital tied up in inventories, and lower operating costs. Managing
the cycle times of the three fundamental supply channel operations processes
can briefly be described as follows:
Manufacturing process cycle times. Production processes stand at the
gateway to channel cycle time management. The ability of manufactur-
ing to quickly convert raw materials and components into the finished
goods the market wants requires the establishment of agile and flexible
processes. The goal of supply channel manufacturing cycle time manage-
ment is to improve planning and scheduling, continuously shrink setup
and processing times, produce in lot sizes identical to actual customer de-
mand, achieve the highest possible product quality, and move goods as
rapidly as possible to the distribution functions in the supply channel.
Distribution process cycle times. The time it takes products to move
through the distribution portion of the supply pipeline is directly related
to the geographical size and number of transfer nodes found within the
supply network. Three critical elements dominate cycle time manage-
ment in distribution: the speed of the transportation services used, the ca-
pacity of supply point nodes to move goods through their processing op-
erations, and the speed and accuracy of information transfer.
Customer delivery cycle times. Cycle time management in this area re-
volves around the effective management of the order process. Order
management requires the channel to ensure the timely and accurate
movement of both internal supply channel orders as well as orders that
are delivered to the end customer. Besides the timely delivery of product,
delivery cycle time management is also concerned with triggering ac-

curate resupply information back through the channel to the source of
manufacture .
Another critical area of supply channel operations is the development and
monitoring of performance levels. Although each supply channel may focus on
a specific performance objective, there are essentially six major performance
areas to consider [13]:
Customer satisfaction . In this area can be found metrics associated with
customer delivery, such as product availability, ease of order processing,
order information, delivery timeliness, delivery completeness, number of
customer complaints, and customer rating.
Quality. This area of performance has several attributes. Some refer to
product issues such as reliability, conformance to standards, durability,
and serviceability. Other metrics focus on service issues such as errors in
order contents, incomplete orders, late shipments, and poor inventory re-
plenishment planning.
Asset utilization. This metric attempts to assess the competitive advan-
tage gained for each physical asset possessed by the channel and con-
siders such measurements as inventory turnover, return on assets employ-
ed, and working capital employed. Although this measurement focuses
primarily on each channel participant's asset utilization, the collective
productivity of total channel assets will have a direct impact on such is-
sues as price and operating cost that invariably make their way down the
channel pipeline .
Operating costs. This area of performance measurement covers the ex-
pense incurred by each member in operating the channel. Among the
metrics to be monitored are cost of labor, transportation, maintenance,
taxes and insurance, information services, and rentals.
Cycle time. As detailed above, the measurement of the time between op-
erations cycles, such as production processing times, order processing,
picking and shipping, and delivery, is critical to the competitive position
of the entire channel.
Productivity. This final metric attempts to measure performance against
some critical channel benchmark. These metrics are fairly detailed and
consist of such goals as orders processed per unit of time, shipments per
facility, operating costs per asset and process unit, and network costs per
sales unit.
Although it may be difficult to gather the data occurring throughout the supply
channel necessary to compile the above metrics, accurate and complete per-
fonnance measurements can significantly assist channel planners in making the

right decisions concerning network design, operation, and investment.
The final area comprising channel operations is understanding total supply
network costs. The objectives of the supply channel are straightforward: total
customer satisfaction, high profitability, and low operating cost. Achieving
these goals requires channel members to make correct trade-off decisions be-
tween costs and expected benefits. Supply channel operating and investment
costs are complex and can consist of a matrix of possible cost and investment
drivers. The critical components of supply channel costs are comprised of sev-
eral internal fixed and variable cost elements, such as labor, facilities operation,
inventory investment, and transportation, and short-term and long-term invest-
ment arising from facilities expansion and improvement, information and com-
munications equipment, and other capital outlays. The key is to make decisions
that provide not only individual enterprise but also channel-wide competitive
advantage.
INTEGRATING DEMAND, OPERATIONS, AND CHANNEL

PLANS
The purpose of the DO&CP process is to develop a set of aggregate enter-

prise plans that can be integrated together to provide corporate decision
makers with a medium- to long-range "rough-cut" window into demand and
corresponding resources required to meet the overall business plan. How
complex the factors used in developing these plans depends on the business
environment, the availability of the data, and the objectives of the manage-
ment planning team. The data elements outlined above are simplistic and
probably should be used as a basis to construct more realistic plans.
Once the DO&CP process has been completed, strategists can develop a
single integrated top management plan that will illustrate the aggregate esti-
mates of the channel revenues, production requirements, total operations
costs, and inventories for the next twelve months or longer. The DO&C plan
should be reviewed preferably monthly, to reflect changing marketplace,
product, and channel management situations. Figure 5.24 illustrates an inte-
grated top management aggregate plan for a single product group. The plan
is stated in monthly periods for the first nine months and in quarterly periods
for the remainder of a two year plan . Each product group would have to be
calculated and then summed together to provide planners with a total picture
of the over supply chain plan.
The purpose of the integrated DO&C plan is to assist the business and
channel management teams in making informed decisions as part of the pro-
cess of aligning the resources of the entire supply chain with the objectives
Product Family: PC-I SOI PC Co mputers (jn thousandsi
Period Jan Feb Mar Apr May Jun Jul Aug Sep I4thQt
S ales Plan 13.4 13.2 12.9 12.5 12.1 11.8 11.4 I 1.1 12.3 38.2
Actual Sales 12.9 13.4 12.8 12.7
(' 11111 Variance -.5 -.3 -.4 -.2
Prtulu ction Plan 13.1 13.1 13. 1 12.25 12.25 12.25 11.48 11.48 11.48 38 .2
ACII/al Production 12.8 12.9 12.9 12.6
Variance -.3 -.2 -.2 .35
(' 11111 Variance -.3 -.5 -.7 .35
In vent ory Plan .7 .4 .3 .5 .25 .4 .85 .933 1.3 16 .5 .5
Act ual lnventory .7 .6 .1 .2 .1
.,
Variance +.2 0 - .J -.45
Channel Demand 13.4 13.2 12.9 12.5 12.1 11.8 11.4 I 1.1 12.3 38.2
Plan Replen Ord. 13.2 13.2 13.0 12.4 12.2 11.8 11.4 11.0 12.4 39 .2
Actual Demand 12.9 13.4 12.8 12.7

Actual Replen Ord. 12.8 12.9 12.9 12.6
Plan OHB .7 .5 .5 .6 .5 .6 .6 .6 .5 .6 .5
Actual OHB .7 .6 .1 .2 .1
(' 11111 Variance .1 -.3 -.7 -1.1
FIGURE 5.24 DO&C plan - summary.
stated in the Business Plan. The DO&C plan provides a window into supply
channel revenue and replenishment costs while assuring sufficient inventory,
financial resources, transportation, warehouse space, and labor and equip-
ment necessary to meet aggregate product and value-added services require-
ments. The plan, furthermore, is critical in providing planners with the data
necessary to help solve problems in the aggregate plan due to variation in
customer ordering caused by changes in demand patterns , seasonality, new
production introduction, or competitive pressures .
For example, the PC-ISO I product group indicates that the sales forecast
and actual sales are fairly close to plan with a slight negative variance of only
200 units. Most likely it could be said that original promotions, advertising,
and price incentives campaigns to stimulate customer sales have been suc-
cessful to date. At this point there would be nothing to recommend a change
in the original sales forecast. The only issue is that sales managers will have
to be careful to manage the product line during the slow summer months
ahead.
On the supply side, the level production plan strategy has been not been
successful even though the inventory plan balances are not showing a short-
age during the first four periods. During the first three periods actual produc-
tion to plan was 700 units short. This caused actual ending inventory balance
to slip significantly below that target of 500 units. The result would have
been a change in the planned production rate in period four to make up for the
failure of the first quarter. Even the increase of 350 in production in April
has still left the actual inventory plan some 450 units short of the original
ending plan. On the other hand, the product family is moving into its slow
sales period and a solid performance over the next several months should pro-
vide sufficient stock. Production planners, however, must be careful to start
building inventories to meet the increasing sales that begin with the autumn
quarter. A careful review of the capacity plan will be critical in ensuring the
availability of sufficient resources.
Finally, the performance of the channel demand plan has been dismal. The
shortage of inventories caused by the production plan has put a significant
squeeze on channel stocks. The unexpectedly high order total of 13,400 in
February drained channel inventories far below the desired ending balance
level of 500 units, and the lack of production over the subsequent periods has
resulted in a cumulative variance of over 1,100 units. While the channel had
been lucky to escape stockout over the first quarter, even a slight increase in
sales could result in lost sales. While not exhibited, it would be fairly ease to
perform the channel plan for each product group by channel warehouse. The
goal would be to see the impact of the lack of inventory in each location and
the cost of channel inventory balancing as possible demand shortages
threaten.
SUMMARY
Demand, Operations, and Channel Planning (DO&CP) is the culmination of

the enterprise planning process that began with the formulation of the busi-
ness plan. The object of the DO&CP process is to develop aggregate plans
spanning that span the key business areas of the enterprise. Individually,
each of these plans attempts to define the strategies and operations decisions
that must occur if the overall business mission is to be achieved. Collective-
ly, these plans should be closely integrated and mutually supportive. In de-
tail, these plans center on strategic operations issues, such as determining the
overall rates of product family sales and production, aggregate inventories,
supply chain value delivery, and logistics capacities. The planning time
range extends for a minimum of a year and beyond, the focus is on product
families, and the review frequency is normally monthly. If conflicts in chan-
nel demand and supply can be resolved on the aggregate level, planners will
find that problems associated with detailed operations will be easier to re-
solve. The DO&CP process supports this objective by reconciling all de-
mand, supply, new product, and channel management plans at both the detail
and aggregate levels and ensures continuity with the business plan. In ad-
dition, DO&CP enables operations performance measurement and the de-
velopment of strategic and detail efforts directed at continuous improvement.
As illustrated in Figure 5.1, the DO&CP process consists of five inter-
woven components linked together by the enterprise business plan. The busi-
ness strat egy provides a comprehensive definition of enterprise goals and per-
fonnance measurement targets, the asset and investments plans necessary to
support the organization , and the projected profit plan. It is the role of the
business strategy to provide clear direction and enable the translation of the
collective enterprise strategy into detailed mission statements for each of the
five supporting business areas. Once overall enterprise goals have been es-
tablished , it is then possible for the marketing plan to begin the process of
identifying the structure of the marketplace the finn intends work in, the
products and services to be sold, issues relating to price and promotions, and
the mechanics of the distribution channel. As the nature of the marketplace
begins to emerge, it is the function of the sales plan to develop the forecasts
of expected product sales, draft the sales campaign, ensure sales capacities ,
and define sales performance metrics.
For businesses with manufacturing functions, the production plan must be
established. The production plan determines the production rates and ag-
gregate resources required to satisfy the shipment, inventory, and cost of sales
objectives stated in the business and marketing plans. To effectively manage
fulfillment, it is then the goal of the logistics plan to ensure that inventory
storage capacities and transportation resources are sufficient to support plan-
ned levels of sales. Finally, effective DO&C planning would be incomplete
without a comprehensive supp ly chain plan . This planning component de-
fines how the supply channel network is designed, how it is operated, and the
nature of the level of integration and collaboration existing between supplier,
manufacturer, wholesaler , and retailer constituents.
Once each of these aggregate plans has been developed, they can be inte-
grated together to provide corporate decision makers with a medium- to long-
range "rough-cut" window into how well individual enterprises and whole
supply chains are responding to meet the overall business plans. The aggre-
gate DO&C plan will illustrate the aggregate estimates of the channel reve-
nues, production requirements , total operations costs, and inventories for the
next twelve months or longer. In addition, the aggregate DO&C plan will as-
sist in charting supply channel requirements for financial resources, transpor-
tation, warehouse space, and labor and equipment necessary to meet aggre-
gate product and value-added services requirements .
1. Best Buy, Circuit City, and Sears all sell personal computers (PCs). Discuss
the competitive strategies used by these companies in marketing PCs.
2. Marketing planning has been described as a strategic exercise which
determines the tactical direction of sales and logistics planning. Explain.
3. Compare and contrast a "niched market" approach, a "mass market"
approach, and a "market segment of one" approach to marketing planning.
4. A distributor's marketing plan calls for an increase in sales of$120,000. The
plan will mean that the firm's current investment in inventory will have to
increase from $400,000 to $500,000 . If the inventory carrying cost is 22%
and the gross profit on sales is 20%, is it wise to increase the firm's inventory
investment?
5. A national home appliance distributor is contemplating offering a new line of
microwave ovens. Develop a product life-cycle analysis for the product line
and the likely policies regarding price, quantity, advertising, promotional
selling, and channels of distribution.
6. Companies offering high customer service must bear high distribution
channel costs in relation to sales. Do you agree, and why?
7. What are the basic outputs guiding the structuring of a marketing channel?
8. Why are the product and services life cycles of critical importance to
distributors?
9. Should a distributor treat all customers equally? Defend your reasoning.
10. Describe the various aggregate planning processes found in the text. Why
are they so essential for enterprise strategic and operational survival?
REFERENCES
1. This paragraph has been adapted from Wallace, Thomas F., Sales & Operations
Planning. Cincinnati, Ohio: T.F. Wallace & Co., 2000, p. 7.
2. For additional discussion reference Ballou, Ronald H., Business Logistics
Management : Planning and Control, 2nd ed. Englewood Cliffs, NJ: Prentice-
Hall, 1985, pp. 110-112; and Kotler, Philip, Marketing Management. 6th ed.,
Englewood Cliffs, NJ: Prentice-Hall, 1988, p. 447-448.
3. Additional definitions on product nomenclature can be found in Marketing
Definitions : A Glossary of Marketing Terms. Chicago: American Marketing
Association, 1960; Kotler, pp. 448-451; and Ballou, pp. 111-112.
4. These points have been summarized from McKinnon, Alan C., Physical
Distribution Systems. New York: Routledge, 1989, pp. 39-41.
5. This list is abstracted from Wallace, p. 70.
6. Philip Kotler, pp. 347-349.
7. For more discussion on these critical elements of product life cycle analysis see
Hayes, Robert H., and Wheelwright, Steven C., Restoring Our Competitive Edge.
New York: John Wiley & Sons, 1984, pp. 199-204; Kotler, pp. 347-368; and,
Webster, Frederick, Industrial Marketing Strategy. New York: John Wiley &
Sons, 1984, pp. 106-109.
8. For more information of the nature of services see Heizer, Jay and Render, Barry,
Production and Operations Management . 3rd ed., Boston: Allyn and Bacon,
1993, p. 265.
9. These terms can be found in Bowersox and Cooper, p. 17.
10. Kotler, Marketing Management, p. 533.
11. Bowersox and Cooper, pp. 102-108.
12. This section is summarized from Ross, David Frederick, Competing Through
Supply Chain Management: Creating Market-Winning Strategies Through
Supply Chain Partnerships, New York: Chapman & Hall, 1998, pp. 162-166.
13. These measurements have been abstracted from Gopal, Christopher and Cypress,
Harold, Integrated Distribution Management. Homewood, IL: Business One
Irwin, 1993, pp. 135-142.
UNIT 3
DISTRIBUTION OPERATIONS
PLANNING
CHAPTERS:
6. Managing Supply Chain Inventories

7. Replenishment Inventory Planning
8. Distribution Requirements Planning
Unit 2 explored planning in the enterprise from the top management or strate-
gic perspective. The focus of the planning process was the formulation of the
strategic objectives that are to guide company operations planning and ex-
ecution. In developing the business plan corporate planners seek to align the
company mission statements with economic and marketplace realities and
with the capacities and capabilities of the firm. Once these objectives have
been established, they can then be translated into more detailed plans concern-
ing investment, physical plant, inventory positioning, transportation, and staf-
fing resources to be followed by the firm's associated business units. Ef-
fective strategic business planning occurs when the objectives of corporate,
business unit, and business functional areas are executed in alignment with
and in support of one another.
Unit 3 continues the discussion of enterprise planning by examining the
next step in the planning flow: distribution operations planning. Operations
planning is concerned with the translation of strategic financial, marketing,
sales, and aggregate supply channel plans into medium-range inventory pro-
curement and logistics capacity plans. The goal is to ensure that sufficient in-
ventory and logistics capacities are available to support strategic planning ob-
jectives. The formulation of effective distribution operations plans will, in
tum, drive the detailed short-range distribution operations execution activities
associated with functions such as customer order processing, product procure-
ment, transportation, and warehousing.
244 DISTRIBUTION OPERATIONS PLANNING
Unit 3 begins with a review of the nature and function of inventory in the dis-
tribution environment. Chapter 6 examines the key role that inventory plays
in assisting the enterprise gain and maintain competitive advantage. Histori-
cally, decisions concerning inventory have been executed in isolation from the
strategic objectives of the firm. The requirements of integrated supply chain
distribution, however, are forcing planners to reevaluate this traditional de-
cision process . Effective inventory planning in the twenty-first century re-
quires that not just individual companies but the entire supply network opti-
mize the ability to respond rapidly to changes in shorter product life cycles
and product proliferation, increased customer service levels and product and
service expectations, advances in technology, globalization of the market-
place, and increased competition and pressure on margins. The new impera-
tives for inventory planning can be summarized as the ceaseless improvement
and maintenance of the highest level of customer service, the reduction of
overall distribution cycle times, commitment to value-added services, and
finally, reduction oftotal distribution costs.
Chapter 7 is concerned with a detailed review of statistical inventory plan-
ning techniques . Because most distribution inventories are exposed to inde-
pendent demand, traditional statistical tools for inventory planning and order-
ing are widely used by distributors. This chapter details the statistical inven-
tory planning process and explores, in depth, replenishment methods and their
application . Among the topics covered are calculating the order point, satis-
fying customer service levels, understanding the economic order point, and
using alternative order quantity methods. The chapter will also discuss in-
ventory decision rules for item ABC Classes and working with replenishment
planning in single and multiechelon environments .
The availability of computerized Distribution Requirements Planning
(DRP) has provided distributors with an integrative tool to better plan and
control inventories in a multi-echelon environment. By linking logistics op-
erations planning with top management planning DRP presents the distri-
bution enterprise with the ability to integrate the firm's planning, operations,
and execution functions, thereby optimizing company resources, channel ef-
ficiencies, and customer service requirements. Finally, DRP provides the
mechanism for detailed transportation, warehousing, and staffing capacity re-
quirements.
These elements ofDRP are examined in depth in Chapter 8. After detail-
ing the logic and functions ofDRP, the chapter proceeds to a discussion of the
avenues DRP presents distributors for not only efficiently planning invento-
ries but, more importantly, connecting the enterprise with its channel business
partners. DRP is seen as an effective mechanism for the close integration of
the distribution channel necessary to attain competitive objectives. The chap-
ter concludes with the formulation of the materials acquisition, transportation,
warehousing, and staffing plans necessary for logistics execution.
6
MANAGING SUPPLY
CHAIN INVENTORIES
ELEMENTS OF SUPPLY CHAIN INVENTORY COSTS

INVENTORY MANAGEMENT Elements of Inventory Cost
What is Supply Chain Inventory ? Operational Costs
The Magnitude of Inventory Inventory Decision Costs
Nature of Inventory Inventory Valuation
Functions of Inventory
INVENTORY CONTROL
PRINCIPLES OF SUPPLY CHAIN ABC Analysis and Cycle
INVENTORY MANAGEMENT Counting
Understanding Supply Chain Performance Measurement
Inventory Value
Substituting Information for SUMMARY
Inventory
Managing Inventor ies in an Era of QUESTIONS FOR REVIEW
Uncertainty
PROBLEMS
THE INVENTORY MANAGEMENT
PROCESS
One of the most important challenges facing supply chain managers is the ef-
fective control of inventory. Supply chain inventories consist of the raw ma-
terials , components, assemblies, and finished goods necessary to support de-
mand throughout the supply channel pipeline. At the core of inventory man-
agement resides a fundamental dilemma. When it comes to the timely fulfill-
ment of customer requirements, inventory is necessary and useful; however,
too much or the wrong inventory at the wrong place is destructive of corpor-
ate well-being. Inventory ties up capital, incurs carrying costs, needs to be
transported, requires receiving and material handling, needs to be ware-
housed, and can become obsolete over time. When it is improperly con-
trolled, inventory can become a significant liability, a huge financial mill-
stone around the neck of the enterprise, reducing profitability and sapping
away the vitality of strategic supply chain initiatives targeted at increasing
competitive advantage or exploring new markets. On the other hand, the val-
ue of a properly managed inventory exceeds its cost. Product availability at
the time, location, quantity, quality, and price desired by the customer not
only provides immediate profits but also secures long-term customer alle-
giance and market segment leadership. When it is effectively controlled, in-
ventory management enables the realization of channel marketing, sales, and
logistics strategies and provides the lubricant for the smooth flow of product
and service value from supplier to the customer.
Chapter 6 describes the role of inventory in the supply chain environment.
The chapter begins by defining the nature and function of supply chain in-
ventories. Following these introductory comments, the chapter proceeds to a
discussion of the impact of current trends in inventory and supply chain man-
agement and how they are revolutionizing past principles of the inventory
function. The chapter then continues with a detailed discussion of the inven-
tory planning process. Inventory planning requires the enterprise to establish
the inventory management strategy necessary to support the marketing and
sales plans not only of individual companies but of the supply chains in
which they are entwined. Afterward, attention is shifted to defining inven-
tory costs and how they can be effectively managed. Among the topics re-
viewed are the elements of inventory cost, costs relating to inventory opera-
tions and decisions, and the various methods of valuing inventory. The chap-
ter concludes with a discussion of item classification models and cycle count-
ing, and a review of inventory performance measurements.
ELEMENTS OF SUPPLY CHAIN INVENTORY

MANAGEMENT
The proper planning and control of inventories resides at the very core of sup-
ply chain management. The prime purpose of inventory is to provide any
trading partner in the supply chain network with the ability to satisfy any cus-
tomer with the desired product at the time and place required. Unfortunately,
whereas everyone can agree on the purpose of inventories, there has been
considerable disagreement in regard to how best it should be managed. The
sales department, for example, considers inventory availability as funda-
mental to customer service and views the ratio between customer orders filled
and lost as the prime measurement of enterprise success. Finance, on the
other hand, while accounting for inventories on the asset side of the balance
MANAGING SUPPLY CHAIN INVENTORIES 247
sheet, nevertheless considers inventories as a necessary evil that ties up capi-

tal and should be eliminated whenever possible. Finally, operations is caught
somewhere in between . Inventory management must walk a thin line be-
tween two contradictory measurements : They must continually search for
ways to reduce inventory costs while at the same time stocking just the right
quantity of products to satisfy targeted customer service levels.
In responding to these apparent dichotomies residing at the heart of supply
chain inventory management, inventory planners must strike an effective bal-
ance between inventory and demand . This balancing requires answers to six
major questions [1]:
1. What is the optimal balance between inventory and customer service?
As a general principle, it can be stated that the higher the stocked in-
ventory and the wider the variety of product selection, the higher the
customer service level, and vice versa. Although today's Enterprise
Resource Planning (ERP) and Supply Chain Planning (SCP) systems
provide new technologies to better manage inventories in the face of in-
creased demand variability, determining the level of inventory neces-
sary to meet customer service targets constitutes the fundamental de-
cision facing planners across the supply chain.
2. What is the level of control an enterp rise should establish over its chan-
nel inventories? Large corporations tend to favor vertical integration in
an effort to remove channel redundancies, leverage economies of scale,
and maintain specific performance levels, whereas small companies and
niche players require a network of strong supporting players positioned at
key points in the supply channel.
3. Under what circumstances should control over inventories be changed?
Changes in markets, technologies, channel direction, government regula-
tion, and the status of supply network alliances can alter channel equi-
librium and cause once profitable channel inventory strategies to loose
their value. In addition, trading partners should always be searching for
new opportunities to reduce total supply chain inventory costs by either
assuming channel inventory management functions or off-loading them to
new partners who can perform non-core functions more efficiently and at
lower cost.
4. What is the optimum balance between inventory investment and associ-
ated carrying costs? As inventory grows in response to better customer
service, the carrying cost will grow proportionately. Inventory planners
must be careful to ensure that costs resulting from decisions calling for
incremental increases in inventory levels do not nullify expected sales
profits.
5. What is the optimum balance between inventory investment and re-
plenishment costs? The size of the replenishment order quantity will
have a direct impact on both inventory and procurement costs. Gen-

erally, as the purchasing lot size decreases, the inventory carrying cost
decreases. However, as the lot size decreases, purchasers must order
more frequently, thereby driving up ordering, receiving, stock put-away
and payables costs. Increases in lot sizes will have an opposite effect.
While ordering costs will decline, inventory carrying costs will in-
crease.
6. What is the optimum balance between inventory investment and trans-
portation costs? As the replenishment lot size decreases, the cost of
more frequent deliveries in less than truckload quantities will increase.
Because many firms are turning to intermodal methods, supplier
scheduling, innovations in transport vehicle designs and capabilities,
and computerization, planners must thoroughly research the cost of
product transportation decisions when exploring inventory ordering
strategies.
Determining the optimal balance between the value of holding inventory and
the costs incurred requires supply chain planners to possess a complete un-
derstanding of the deployment, function, and expected value of inventories as
they appear across the supply channel network.
WHAT IS SUPPLY CHAIN INVENTORY?
Inventory can be found throughout the supply chain in various forms and
quantities based on strategic and operational objectives. As illustrated in Fig-
ure 6.1, the physical flow of supply chain inventories can be said to progress
Stage 1 Stage 2 Stage 3 Stage 4 Stage 5 Stage 6
Primary Wholesale
Final
Supplier Manu- Distribu- Retailer Customer
Assembly
facture tion
Raw Bulk Finished Distribution Comsu-
Channels Sales mption
Materials Processing Goods
I I I I I
Materials and Finished Goods
I I I I
Transportation and Delivery
FIGURE 6.1 Supply channel mat eri als flow

through six stages. The origins of the channel pipeline can be said to begin
with the extraction and refinement of raw materials. The key inventory man-
agement issues during this stage revolve around production processes, supplier
selection and qualification, contract partnerships, supplier scheduling, trans-
portation and delivery, and performance measurement.
In stages 2 and 3, raw materials are transformed into semifinished and fin-
ished products through the manufacturing process. Stage 2, termed primary
manufacturing, is focused on the conversion of basic raw materials into com-
ponents through the process of fabrication. An example would be a manu-
facturer who converts steel rods into nuts, bolts, and twist drills. In stage 3, raw
materials and fabricated components are final assembled into finished products
for end customers. Production processes at this level can follow a single or
mixed mode manufacturing strategy determined by how inventory is to be man-
aged: make-to-stock, assemble-to-order, or make-to-order. The choice of manu-
facturing strategy is determined by such factors as product characteristics, depth
of marketplace demand, strength of the competition, transportation, and ware-
housing requirements. Critical inventory decisions in these two stages center
on volume and variety issues. Products produced in volume tend to be in-
ventoried, whereas products with intermittent demand tend to be produced to
order and are rarely stocked in anticipation of sales.
Stage 4 marks the beginning of the physical distribution channel flow. Per-
haps the most critical decision to be made in this stage is the determination of
the structure of the supply chain. As illustrated in Figure 6.2, there are three
possible supply channels that can be constructed. In the first, product is sold di-
rectly by the manufacturer to the end customer. The second channel type repre-
sents a more complex, multiechelon channel comprised of field warehouses
who sell to the customer. The warehouses could be company owned or they
could be public warehouses. This type of channel is much more expensive and
difficult to control than factory direct distribution. Finally, in the last type, the
channel is characterized by extreme complexity and consists of multiple levels
of manufacturing plants, field warehouses, and retailers. Critical inventory is-
sues include channel marketing strategies, total logistics costs, the number, lo-
cation, and size of distribution centers, channel inventory levels, order process-
sing, postponement strategies, and customer service. Finally, in stages 5 and 6,
products are conveyed to the retail portion of the supply channel for eventual
delivery to the customer. The exact configuration of the supply chain can vary
widely by channel network. In some supply pipelines, the flow is dominated by
a single company, such as a Sears or an Abbott Laboratories, who performs
most of the functions necessary to move products to the end customer. Wal-
Mart, on the other hand, prefers to buy directly from the manufacturer, thereby
reducing the number of levels in the supply network.
250 DISTRIBUTION OPERATIONS PLAl~NING
Complex Stmct"re
FIGURE 6.2 Channel structures .
THE MAGNITUDE OF INVENTORY
One of the best ways to understand the impact of inventory, not only on a
given channel system but on the economy as a whole, is to examine inventory
statistics. Today, inventories can represent anywhere from 40 to 80 percent
of a typical company's sales dollar. Effectively managing this huge invest-
ment is critical to the financial well-being of the entire supply chain. The fol~
lowing figures provide a quick reference to the sheer financial investment in
inventory and related logistics costs. In 2002, the average inventory invest-
ment by all U.S. businesses, including agriculture, mining, construction,
utilities, services, manufacturing, wholesale, and retail trade, was $1.44 tril-
lion. This figure alone was equivalent to 13.7 percent of the entire U.S. GNP.
The cost of carrying inventory during 2002 was 20.6 percent, or $298 billion.
In addition, U.S. firms spent $612 billion for transportation and admi-
nistration associated with moving this inventory through the distribution pipe-
line [2].
NATURE OF INVENTORY
Inventory can come in a variety of forms. A firm that distributes home appli-
ances will purchase, store, and sell inventory in quite a different physical
state than a petroleum distributor. In addition, not all companies sell inven-
tory in exactly the same form as they build or acquire it. Product quantities
may be broken down into smaller lots, relabeled , repackaged, assembled, or
kitted to form new end assemblies. Classically, inventory has been classified
as residing in four possible forms.
Raw materials. Products classified as raw materials are normally ex-
tracted from nature . Examples include steel, wood, certain chemicals,
paper, grains, cloth, and other unfinished commodities . Although these
products can be sold as received, normally they are not useful until they
have been fabricated into semi-finished or component products.
Compon ents. For the most part, components are finished items that are
consumed in a higher final assembly process. Components that are also
sold as service parts fall within this category when they are used in
manufacturing but are properly classified as finished goods when sold
stand-alone .
Work-in-process. Inventory in this category can be classified as raw
materials , components, and subassemblies that are in the process of
being or are waiting to be transformed through manufacturing into as-
semblies or finished goods. Although distributors historically stock lit-
tle or no manufacturing inventory, marketing and cost requirements for
economies and value-added services have forced many firms into per-
forming light assembly, repackaging, kitting, labeling, and other post-
ponement techniques to remain competitive.
Finished goods. Products classified as finished goods can be defined as
purchased items, assemblies , or service parts whose demand comes
from a customer order or sales forecast.
The value of classifying inventory by its processing state is that it allows des-
ignation of which products are available for customer order, assists in deci-
sion making in production planning and inventory management, and facili-
tates record keeping and costing .
FUNCTIONS OF INVENTORY
The fundamental function of inventory is to act as a buffer that decouples the

organization from the discontinuousness of customer demand on the one hand
and limitations in supplier delivery capacities on the other. Optimally, busi-
nesses would like to carry as little inventory as possible, preferring to move
purchase order receipts directly to the shipping dock to be met just-in-time
with customer orders. In reality, the firm needs inventory to buffer it from
the uncertainties of supply and demand.
Inventory control literature has traditionally identified five general func-
tions for holding inventory: Cycle stock (or lot-size), safety stock, antici-
pation, transportation, and hedge (or speculative). A review of these func-
tions is as follows:
Cycle (or lot-size) inventory. This class of inventory is the result of or-
dering requirements that force planners to purchase, manufacture, and
transport inventory in batches that exceed the original demand quantity.
The basic reason why cycle stock inventory exists is because of econo-
mies realized by trading-off the cost of ordering or producing and the
cost of carrying the inventory. In addition, cost trade-off economies
occur for several other reasons. The frequency of item order cycles
also may require the stocking of inventory in large lots. As the rate of
the receipt of customer orders increases for a given product, planners
normally will increase the acquisition lot size versus increase the re-
plenishment order cycle. Finally, those channel nodes that perform
manufacturing functions often will produce lot-size inventory due to
the cost of setting up a production line and gains in productivity at-
tained by producing larger inventory quantities than required.
Safety stocks. This type of inventory is held on hand to cover unplan-
ned fluctuations in customer demand and the uncertainty of supply. If
demand was to remain constant, inventory planners could rely on cycle
stock to guarantee that there would always be sufficient stock on hand
to meet demand. However, because products subject to independent
demand can expect random periods of above average demand to occur,
cycle stocks function best when there is a safety stock buffer. The
amount of safety stock depends on the degree of random variation in
demand, the lead time required to replenish stock, and the service reli-
ability policy established at the stocking point. The larger the safety
stock, relative to demand variation, the higher the percentage of cus-
tomer serviceability. Figure 6.3 illustrates the function of safety stock.
Anticipation inventory. Often inventories will be built in advance of
demand to enable effective response to seasonal sales, a marketing pro-
Purchase
Lot Size
Reorder
Point
S;'~: {~t~i:
FIGURE 6.3 Safety stock function.
motional campaign, or problems in supplier delivery. A sporting goods

distributor, for example, may begin to warehouse winter sports equip-
ment during the summer months to take advantage of sales discounts
from manufacturers and to avoid higher prices and potential stockouts
as the winter season approaches.
Transportation inventory. Inventory in this category can be defined as
products in transit (for example, in ships, railcars, or truck transport)
from one node in the channel network to another. Transportation in-
ventory exist because time is required to physically move stock through
the channel. Supply chain nodes must plan to have additional inven-
tories on hand to cover demand while inventories are in transit. As an
example, if delivery of a product takes 3 weeks, and sales average 1000
units a week, normally a total of 3000 units would reside in the channel
pipeline. Transportation inventory costs must be carefully examined
when structuring a supply channel. The following formula can be used
in calculating a critical performance metric: the yearly transportation
inventory cost (TIC):
TIC = C x D x UC x T
where C is the transportation carrying cost, D is the demand require-

ments per period, UC is the item unit cost, and T is the transportation
time. For example, in calculating the yearly transportation inventory
cost for the 3000 units in transit described above, the unit cost is $20
each and the carrying cost is 15 percent. Then
TIC = 15% x 1000 per week x $20 x 3 weeks $9,000 per year.
Management could reduce the transportation inventory cost by

changing the mode of transportation or switching to a supplier closer to
the plant. If 1 week of transit time was eliminated, the cost savings
would amount to $3000 per year. On the other hand, another approach
might be to gain economies by reducing the lot size of inventory re-
ceived. Although this might mean more frequent deliveries and higher
transportation costs, the overall decline in inventory carrying costs
might justify the approach.
Work-in-process (WIP) is a form of transportation inventory associated
with manufacturing. The size of WIP inventory depends on such fac-
tors as the length of the process, nature of the product, and volume and
variety decisions. In practice, the size of WIP is governed by company
policies and decisions regarding the appropriate trade-off between car-
rying and acquisition costs. MRP, JIT, quality management, and other
inventory management practices have directly focused on reducing WIP
inventories while increasing throughput and customer service.
Hedge inventory. The final function of inventory is to provide planners
with the opportunity to purchase large quantities of raw materials or
components to take advantage of temporarily low replenishment prices,
the possibility of a strike, or other opportunities. The critical element
in purchasing speculation inventory is knowledge of price trends, risk
of spoilage or obsolescence, and handling commodity futures. The
utility of hedge stocks is measured by the resulting percent of profit or
return on investment.
The primary function of inventory is to have products available to meet
customer demand as it occurs in the supply channel while minimizing total
carrying cost. The existence of pools of inventory located at strategic points
in the channel pipeline provide essential buffers protecting network nodes
from the occurrence of unplanned variance in demand and supply or enable
pursuit of quick-response opportunities to meet unexpected customer de-
mand. On the other hand, inventory buffers inherently contain several serious
drawbacks. To begin with, buffer inventories can potentially incur more cost
in the form of obsolescence, material handling, and storage than the value
they create. Second, they hinder the velocity by which products move
through the supply chain. Finally, buffer inventories mask the true nature of
channel demand and supply, conceal channel inventory management inef-
ficiencies, and gloss over costly channel inventory and capacity imbalances.
Recently, JIT/Lean Manufacturing techniques have prompted manufac-
turers and distributors to rethink the role of inventory in their organizations.
No matter how it is accounted for, inventories add cost to the firm. Inventory
can divert capital badly needed for improvement elsewhere; it creates costs
necessary to maintain record accuracy; it must be moved and stored; often it
needs to be sorted, packaged, and re-containerized; and staff must be avail-
able to expedite, search for, and inspect it. Poorly managed inventories can
double or triple the cost of maintenance and destroy profitability. The chal-
lenge to both individual firms and the entire supply chain is to develop pro-
grams that cut inventories by eliminating "dead stock," improving quality, in-
ventory planning, and ordering practices, and increasing organizational and
supply channel flexibility while maintaining customer serviceability levels
that exceed the competition.
PRINCIPLES OF SUPPLY CHAIN INVENTORY

MANAGEMENT
The overriding objective of inventory management in the twentieth century

was the creation of mass-production and mass-distribution infrastructures that
served as a conduit for the flow of standardized goods and services from the
manufacturer to the mass market. Based on the assumption that the market-
place consisted of a few archetypal customers, whose needs and desires could
be determined by marketing analysis, the supply system's role was to push non-
customized products utilizing mass-production era advertising, media, and dis-
tribution channels out to the consumer. Buyers, in tum, searched available sup-
pliers to locate product and service offerings that came closest to matching their
needs or desires. In such a supply system, consumers had little linkage with
producers whose channel systems focused on moving large, unsynchronized
batches of rigidly defined products serially from supply node to supply node
through the channel network. Customized products, where there was parti-
cipation by the customer in the design and manufacturing process, were con-
sidered to be very costly and the reserve of specialized supply channels.
Today, this view of supply channel management has largely been exploded.
In the place of "push" systems focused on distributing a narrow range of highly
standardized products, supply chain processes today are being restructured to
accommodate product proliferation, dramatic declines in product life cycles,
high velocity response necessary for high customer service, universal commit-
ment to quality, and ability to customize products at the last stages in the fulfill-
ment cycle characteristic of the marketplace of the twenty-first century. Unlike
the passive supplier-customer relationship of the past, today's dynamic supply
channels provide for a high level of interaction and partnership between pro-
ducer and consumer to ensure the production and timely delivery of configured,
customized goods based on the unique needs of the customer.
UNDERSTANDING SUPPLY CHAIN INVENTORY VALUE
This dramatic shift in the role of the supply chain is directly attributable to
changing views of inventory value . Although JIT/Lean philosophies require
trading partners at all points in the supply channel to continuously reduce in-
ventories, stock buffers do exist. Simply stated as a fundamental SCM postu-
late, the challenge of effective channel inventory management is to identify new
planning and control methods by which the ratio of value-added to cost-added
elements of channel inventory can be continuously improved. In its most basic
form, channel inventory management can then be defined as the cost-effective
and purposeful deployment and redistribution of raw materials, component
parts, work in process, and finished products across an integrated supply net-
work for the purpose of providing value to the customer.
The actual measure of the performance of channel inventories can, therefore,
be determined by understanding the two meanings associated with the concept
of "inventory value." For the supplier, inventories are valuable to the extent to
which associated costs diminish as their value increases. That value can be
simply stated as the level of satisfaction attained by the customer as measured
by such attributes as availability, immediacy of delivery, conformance to quali-
ty, and acceptability of price. Customers, on the other hand, perceive the value
they receive from the goods they purchase as providing them with unique solu-
tions to their immediate needs or desires, or enabling them to pursue new op-
portunities, the benefits of which exceed the original cost of the purchase. In
this light, the question becomes not how much inventory or where inventory
buffers are held in the supply pipeline, but what customer-satisfying processes
are being used to increase its value while continuously decreasing its cost.
The value principle specified above has become even more important in the
increasingly complex supply chains of today. Formerly, planners focused on
managing and controlling inventory costs and serviceability solely within their
own companies. Now, planners are often involved in managing channel inven-
tories that span both their customers' inventory as well as the inventories of
their suppliers and suppliers' suppliers. Supply chain inventories provide value
through the following five service elements:
1. Lowest cost for value received. The effective management of inventory
costs enables supply chains to maintain market leadership by keeping
prices low, ensuring depth of product assortment and quality, and expan-
ding on capabilities to mass produce customized products. Some of the
techniques used to achieve these service attributes are creating channel
and cross-channel partnerships that shrink buffers and accelerate invento-
ry flows, utilizing alternate channel formats like warehouse/wholesale
clubs, participating in e-marketplace exchanges, selling manufacturer
direct, and pursuing JIT contracts that guarantee fixed prices and service
levels.
2. Improved channel efficiency. By removing excess channel inventory
buffers, reengineering distribution processes, implementing JIT, deploy-
ing planning tools that provide for real-time cross-channel information
management, and streamlining inventory flows, supply channels can sig-

nificantly diminish total pipeline costs while ensuring the right product is
in the right place to capitalize on marketplace opportunities. Above all,
service efficiencies increase product access. Access means the degree of
ease by which customers can purchase products or contact sales and ser-
vice functions. Access can also mean the availability of goods within
parameters generally accepted by the industry. Finally, access can mean
the speed by which after-sales replacement parts and services can be de-
livered. Customer convenience and access to goods and services are fun-
damental to competitive advantage.
3. Improved quality. Reducing the occurrence of inventory stock-outs,
product defects, order fill inaccuracies, and other related inventory man-
agement errors can significantly decrease operating costs while in-
creasing customer service. The focal point is service reliability. Supply
chains must continually deliver the promised product dependably and ac-
curately each and every time. Reliability of service permits channel sup-
pliers to "lock in" their customers who will gladly pay premium prices for
delivered quality and service.
InventorY Visibility at
~ . F.. Bra4f1 ~ _Sons
The ability to gain visibility to the report left the company already 30
supply chain is critical for J.F. days behind.
Braun & Sons, an importer of dried
fruits and nuts. Braun sells goods The solution was the implemen-
on contract that it does not yet have. tation of a supply chain management
promising to deliver a specified system. Now, Braun has up to the
quantity over a set period of time. minute information. Planners can
According to a Braun executive, "If see on one screen outstanding sales,
it is going to take 45 days to get here commitments against the product.
from Asia and we have a contract inbound inventory and where that is
for delivery in June, then we need to in the process, and what is on hand.
know at the end of April that those
goods are on the water," In the past, Source: Murphy, Jean V., "Seeing
the only visibility to shipments was Inventory in Real Time Lets you
a report run at month-end, which Have and NOT Hold." Global
meant that in a business where the Logistics and S/lPP~I' Chain
transit time was 30 to 45 days, the Strategies. 6, 5, 2002, 34-40.
4. Supply network simplification. Removing inventory flow bottlenecks and

redundant channel functions simplifies and makes all supply channel
activities transparent. Increased visibility expands the capability of chan-
nel suppliers to be more responsive to the demands of the marketplace.

Simplification can take the form of intense process reengineering at the
enterprise level, the discontinuance of channel functions whose costs ex-
ceed their value-enhancing capacities, or the use of third party services
for inventory and transportation management and accompanying trans-
action processing.
5. Improved channel inventory information. Accurate and accessible infor-
mation concerning products , stocking levels, location, and order status
constitutes the foundation for inventory service value. Internally, infor-
mation enables network suppliers to control inventory levels, ensure
timely and accurate stock replenishment, and leverage price and delivery
economies from upstream sources of supply. Externally, information re-
duces the occurrence of missed customer activities that have a rippling ef-
fect back through the entire supply channel (3)
SUBSTITUTING INFORMATION FOR INVENTORY
One of the fundamental postulates of supply channel management is that as un-

certainty concerning the status of demand and supply grows, so does pipeline
inventory. The roots of channel uncertainty consist of such conditions as unre-
liable suppliers, poorly developed and communicated forecasts, ineffective
scheduling, poor quality, process variability, long cycle times, inaccurate met-
rics, and others. These problems cascade through each level of the supply net-
work, adding buffer stocks at each channel node. The solution to breaking this
cycle of using inventory as a means to counteract uncertainty is to increase the
timeliness and bandwidth of the information about what products are really ne-
eded and when. The principle is simple: The more information channel nodes
have about total supply network needs the better they are able to produce and
stock products to respond to the pull of demand requirements in the quantities
and at the time they are needed [Figure 6.4]. In this way, timely and accurate
supply channel information concerning customer and interchannel demand be-
comes a substitute for inventory buffers.
For such a supply network to work, several conditions are necessary. To be-
gin with supply nodes must continually search for methods to optimize channel
inventories by optimizing the total investment of material and process costs for
every product stocked in the supply chain, from raw materials to finished
goods. Second, supply chains must pursue increased "real-time" visibility to
demand and supply conditions throughout the supply network. In the past,
trading partners rarely communicated with each other concerning inventory
needs except when a replenishment order was launched. Today, breakthroughs
in supply chain planning and event management technologies provide channel
partners with Internet tools that activate the potential to share demand and sup-
ply information within and across enterprises, along with exception manage-
ment capabilities.
Next-tier
Customer Supplier Service Provider .Supplier
I
I
I
Requirement I
I
--_ ...
,,
--'
FIGURE 6.4 Order information in the supply channel.
Third, channels must utilize alternative methods of stocking inventories that

link suppliers and customers more closely together. For example, various forms
of supplier managed inventory (SMI) enable suppliers to placed consigned in-
ventories at the customer site where they hold ownership until the moment of
sale. Another method is to utilize e-procurement systems that enable custom-
ers, through Internet-enabled trading exchanges, to buy and sell on-line. Again,
channel partners can station planners and supply storerooms at the customer's
site to eliminate the time necessary for the communication of inventory re-
plenishment needs.
Viewing supply chain inventories as if they were a single integrated supply
function is the foremost challenge of channel inventory management. Realizing
this challenge will require meaningful responses to the following issues:
Supply chain integration. Not just point-of-sale nodes but all channel
strategies and processes , beginning with suppliers and manufacturers and
progressing through wholesalers and retailers, must be integrated with the
needs of the marketplace . Achieving strategic and tactical integration is,
by far, the most difficult of the challenges facing channel constituents.
Increased flexibility. The effective management of inventories requires
flexible and agile processes that accelerate and add value to materials as
they flow through the network. Flexibility goals can be achieved by re-
ducing the size of the pipeline, eliminating channel bottlenecks, shrinking
production and distribution lot sizes, building to customer order, and en-
hancing postponement strategies.
Various forms of SMI or VMI are work, and physical storage.

becoming standard for supply chain In the concept of JIT II, the sup-
inventory management. For ex- plier not only is responsible for
ample: inventory costs and replenish-
ment, but is expected to physically
Retailers such as Wal-Mart want station employees at their supplier
to sell 100 percent of their facilities.
products before the supplier pay-
ment process will begin. These and other forms of inventory
Some retailers actually rent space management are dramatically re-
and the product is owned by the shaping the nature of supply chain
supplier until it is actually sold. inventory management. For custom-
Many distributors are carrying the ers, the expectations and aruicipated
inventories of manufacturers, but results are lower inventories, lower
are not paying for it until it is operational costs, and uninterrupted
actually shipped to the customer. supply. For suppliers, the expecta-
In a growing number of man- tion is single-source supply. new
ufacturing companies the control customers. lower production costs.
and management of inventories is and less competition.
the sole responsibility of the sup-
plier. who is responsible for re- Source: Landis, Gary A., "The
stocking and physical inventory, Changing Role of Inventory in an
In JIT point-of-use environments, Integrated Supply Chain: ' APICS
inventory is controlled by the sup- International Conference Proce-
plier. The goal is to reduce plan- edings. Falls Church WV, APICS.
ning, handling, inspection, paper- 2001.
Lower costs . By considering all channel inventories as functioning as a

single supply pipeline, unnecessary buffers that add carrying costs and
risk obsolescence can be removed throughout the network. Supply chain
planning and event management technologies can assist in matching
channel supply to exact demand and reducing finished goods overstocks
and distribution point stocking imbalances while increasing product
variety.
Time-based competition. Response to today's customer is measured not
in weeks, but in days and sometimes hours. Every day that inventories
spend in the pipeline adds carrying costs. Every day of lead time re-
quired to get the right product in the right place means slower response to
customer requirements. As the importance of delivery speed in today's
global environment increases, the combination of high costs and lack of
responsiveness risks competitive disaster.
Telescoping the supply pipeline. Competitive supply chains are concern-

ed about the length of the supply pipeline. As channel networks grow in
length , so inevitably do transit times and buffer inventories. Today's best
supply chains seek to continuously shrink pipeline size and shave time
and inventory from the channel network through the use of JIT, supplier
management, and information technology techniques.
Channel performance measurements . Metrics that document indepen-
dently the performance of each channel supply node yield little valuable
information about the performance of the channel as a whole. Customer
service metrics should primarily be based on how productive the entire
channel is from raw materials acquisition to customer delivery.
MANAGING INVENTORIES IN AN ERA OF UNCERTAINTY
Much of the changes in supply chain inventory management over the past de-
cade have focused on applying JIT concepts to eliminate inventory redun-
dancies in the supply channel, utilize technology and new management toolsets
to provide visibility and collaborative relationships, and accelerate the velocity
by which inventory flows through the supply channel. A series of dramatic in-
cidents, including the September 11, 2001 terrorist attacks and the U.S. West
coast dock strike in 2002, have, however, exposed the limitations of a total
zero-inventories approach , The results have been significant increases in de-
livery times and potential stockouts due to the growing complexity of security,
customs , and inspection activities. Once a universal approach to channel in-
ventory management, JIT concepts are now being tempered by the realities of
limitations to the velocity of channel management flows.
While JIT is definitely here to stay, many companies are moving away from a
total reliance on a universal low-inventory strategy where product is shipped
solely on an as-needed basis . Several new approaches can expect to gain favor
as the decade of the 2000s proceeds. According to one expert [4], supply
chains will depend more heavily on a game plan that utilizes a limited number
of strategically located regional warehouses and distribution centers to hold ad-
ditional inventories to buffer anticipated future shocks to the supply chain. As a
whole, these approaches will expand as companies seek to protect their supply
chains from the impact of terrorist attacks , natural disasters, and other economic
dislocations by ensuring shipment over relatively short distances at a moment 's
notice.
In addition, it is expected that companies will be rethinking their approach to
supply chain strategies by basing them on mathematical formulas that relate a
product's value to its distribution cost. The goal is to determine which products
can be economically stocked and which should follow JlT principles and be
passed as quickly through the supply chain as possible. As a rule, the higher the
value of the goods the more likely they will support direct, long-haul, high
speed distribution. Conversely, lower-valued products will be managed by a
strategy that seeks to optimize stored inventory and short-haul distribution. Re-
gardless of the actual strategy selected, the ominous beginnings to the twenty-
first century have dispelled a blind adherence to pure JIT channel inventory
management practices.
THE INVENTORY MANAGEMENT PROCESS
In a perfect supply chain, there would be no need for buffers of inventory. Cus-
tomers would receive the goods they wanted simply by triggering ordering
mechanisms that would design desired finished goods configurations, transmit
the exact product specifications to the factory where they would be made, and
arrange for delivery as close as possible to the moment of order request. In re-
ality, the existence of channel inventories assist companies to deliver the prod-
ucts customers want as close as possible to when they are wanted. As discussed
earlier, inventory buffers exist because of batching or lot-size economies,
timing issues such as geographical movement or the duration of the manufac-
turing process, planned overstocks due to seasonality or speculation, and avail-
ability uncertainties due to variances in inventory demand and supply. In any
case, inventory constitutes the single largest financial investment to be found in
the typical supply channel and its effective management is critical in meeting
the needs of customers while reducing costs as much as possible.
Effective inventory management requires supply chain planners to closely
define the physical and financial boundaries surrounding channel inventories .
The objective of the planning process is the definition of control functions
that ensure the accuracy, financial accounting, and timely status reporting of
inventory throughout the network pipeline. In addition, the inventory control
plan must specify the appropriate ordering techniques and policies necessary
for the efficient flow of goods through the supply channel and out to the cus-
tomer. Ultimately, inventory performance is measured by the ability of each
channel trading partner to realize the best return on total inventory invest-
ment.
When developing the strategic channel inventory plan, supply chain plan-
ners must determine answers to such questions as the following:
What is the aggregate level of inventory necessary to support expected
customer demand?
What service levels are being achieved by the competition?
What is the total working capital needed to meet channel inventory de-
ploymenttargets?
What are the aggregate operating costs associated with channel service
objectives?
How large should channel supply node buffers be to achieve service-
ability targets?
What is the optimum ratio between channel inventory and transportation
costs?
What information and communications technologies should be imple-
mented that will network channel members closer together and provide
for "real-time" information?
The channel inventory planning process, as illustrated in Figure 6.5, begins
r
l DO& CP ]
Marketing! Networ k
.... Invent ory
Strategy
r+ S upply r+ Design -
Strategy trategy
Invent ory
Manage ment
Strategies
~
Performance Mana gement
1
FIGURE 6.5 Supply chain inventory planning process.
with the formulation of the enterprise's inventory strategy. Inventory strate-

gic planning can be defined as
planning that seeks to optimize customersatisfaction through changes in any or

all components of the integrated network, including manufacturing processes,
distribution and customer delivery locations, and product flow management
processes, rules and policies [5].
Such a strategy involves the identification and implementation of critical capa-

city changes in any or all components of the supply chain, the physical location
of distribution supply nodes, size and location of buffer stocks, transportation
capabilities, technologies available for the communication of forecasts and in-
ventory event management focused on mitigating the impact of demand and
supply uncertainties, and collaborative sharing of demand information such as

promotions, seasonality, and speculation inventories. When designing, concur-
rently, supply chain inventory goals, each channel partner must be able to res-
pond to the potential dichotomies that exist between each channel level. Byex-
ploiting the natural linkages drawing channel businesses together, companies
can overcome areas of possible conflict by leveraging information alliances that
make transparent an awareness of interconnectedness, facilitate collaborate ef-
forts, multiply efficiencies across the entire pipeline, and synchronize indi-
vidual competitive goals and capacities.
The second step in the strategic channel inventory planning process consists
of two activities: first, assessing the success of existing levels of channel cus-
tomer satisfaction that have been achieved with current inventory strategies,
and second, determining the projected inventories necessary to realize new mar-
ketplace strategies. Determining customer satisfaction depends on a matrix of
inventory management factors. Some cluster around indicators that measure the
success of how the supply channel as a whole has presented and customers ac-
cepted product offerings, product pricing, the success of promotions and adver-
tising, and the impact of customer service strategies that govern the sale from
pretransactional to posttransactional activities. Other issues center on product
delivery and quality. Timely product delivery is the result of having the right
product at the right channel location or available through other media such as
catalogs, brochures, or e-business marketplaces . The compilation of such met-
rics must also consider the impact of strategic trade-offs between service levels
and inventory investment. While providing critical internal information, such
trade-offs must be determined in light of total channel service objectives.
Architecting the most effective physical supply chain network constitutes the
third step in the channel inventory planning process. Network design has the
potential of having a significant impact on channel inventory planning. Nega-
tively, the number and location of supply channel nodes can be a severe drain
on channel costs as excess buffers of inventories build up in the pipeline. In ad-
dition, poorly designed supply networks can actually inhibit the creation of cus-
tomer-winning service value by supporting uncompetitive channel place and
timing decisions. Well-designed internal and trading partner supply chains, on
the other hand, enable each channel node to stock the proper inventory buffers
necessary to support overall network service levels. Effective supply networks
also make it easier for planners to determine changes to inventory levels due to
the growth or contraction of markets. As the number of channel locations
grows to meet rising customer demand, effectively organized supply channels
permit planners to determine accurate inventory investment costs.
The fourth step in the strategic channel inventory planning process is estab-
lishing the mechanisms to ensure inventory accuracy. This step consists of
three basic functions. The first centers on the choice of inventory accuracy
methods and involves the design of transaction flows, procedures to formalize

data input and the necessary output status inquiry and reporting, identification,
authorization, and training of appropriate management and line staff in trans-
action control, and the implementation of inventory accuracy tools such as ABC
analysis and cycle counting. Controlling inventory costs constitutes the second
function. Decisions concerning costs can be roughly divided into operational
costs, such as sunk costs, cost of capital, and indirect, direct, and overhead
costs, and inventory decision costs, such as transportation, warehousing, order
processing, obsolescence and damage, lot sizing, and inventory control main-
tenance. The final function in the planning process is the selection of the in-
ventory ordering policy. As demand consumes channel inventories, inventory
planners can use one or a combination of the following two techniques : sta-
tistical order point and order quantity or time-phased MRP/DRP . A full dis-
cussion of the nature , selection, and use of inventory ordering policies takes
place in Chapters 7 and 8.
The final step in the channel inventory planning process is the development
of adequate performance measurements that ensure that every customer, both
external and internal to the pipeline, is consistently receiving the level of ser-
vice value and quality necessary to meet demand requirements. Channel in-
ventory performance can be measured from two interrelated perspectives: cus-
tomer service and inventory investment. Performance metrics oriented around
the customer assist in managing uncertainties due to timing and accuracy fac-
tors. Timing factors are focused on the interval required for inventory re-
plenishment activities to be completed; accuracy factors are concerned with or-
der contents and quantity, order completeness, and inventory record accuracy.
Performance related to inventory investment is concerned with tracking the im-
pact of inventory costs across the channel network. "World-class" channel sys-
tems know that high inventory levels translate into increased probabilities of
obsolete and damaged stock as well as loss of operating cash committed to
pipeline inventories. Effective network performance require that channel mem-
bers know both the costs in serving their own segment of the channel's market
as well as the total inventory costs of the entire supply network.
The development and continuous updating of the supply chain inventory
plan is fundamental to the successful execution of the overall financial, mar-
keting, sales, and logistics plans . Without an effective mechanism to control
inventory accuracy , accounting and decision trade-off costs, and techniques
for inventory replenishment, a supply chain cannot possibly hope to attain its
objectives. Resources in most companies are limited. Capital invested need-
lessly in inventory drains resources necessary for promoting current and new
products , facilities , equipment and staff improvement, collaborative channel
partner development, and the implementation of information technologies .
INVENTORY COSTS
The cost of inventory has a direct impact on the competitive capabilities of

the supply chain. Several critical factors are apparent. To begin with, the
cost of inventory often constitutes the largest portion of a typical company's
assets. The objective of this investment is to meet or exceed expected cus-
tomer service levels. The level of inventory that individual companies station
at various points in the supply channel determines the level of serviceability
offered to its customers. The capability to calculate the trade-off costs be-
tween inventory investment and service levels is critical. By preserving cost
history, planners can use the financial consequences of past inventory de-
cisions to assist them in determining the expected cost results of future
actions. Poor control over inventories can affect company profitability in two
ways. To begin with, net profit is reduced not only through direct purchase
but also for ongoing expenditures associated with a range of inventory car-
rying costs. Second, the value of the inventory investment must be added to
the firm's total assets. As inventory grows, total company asset turnover de-
creases, resulting in a reduction in return on assets and net worth.
Understanding inventory costs assists supply chain planners answer such
questions as:
What is the appropriate level of inventory and cost to be carried by
each supply channel node?
What are the inventory costs necessary to support customer service, and
how can levels be improved while reducing inventory investment?
Is the selling price too high or too low?
What will it cost to transport inventory through the supply chain?
How many supply channel points should there be and what should be
their inventory levels?
What will be the cost of channel postponement and value-added pro-
cessing strategies?
Finding solutions to these and other questions requires supply chain planners
to have a detailed knowledge of inventory cost elements. Accurate inventory
cost information is paramount if companies are to exploit new markets, opti-
mize information and communications systems, explore new forms of trans-
portation, and strengthen the integration of the entire supply chain.
ELEMENTS OF INVENTORY COST
The decision to stock inventories requires planners to understand and manage

several dimensions of inventory cost. Waters [6] divides inventory costs into
the following four basic elements:
Unit cost. Perhaps the most fundamental cost associated with a prod-
uct is the acquisition cost of the product itself. This cost can be defined
as the value charged by the supplier in exchange for ownership of the
product, or the material, labor, and overhead costs incurred in pro-
ducing the product. The unit cost can be determined by reviewing sup-
plier quotations or invoices, or by collecting production cost data. In
developing the unit cost, several factors are necessary. To begin with,
the costing unit of measure must be known. Establishing the unit of
measure can sometimes appear to be a variable, especially if the prod-
uct is purchased, stocked, and sold in different units of measure. In de-
termining the unit of measure, planners should always use the unit of
measure in which a given product is stocked. When a product is manu-
factured, the unit cost will be the sum not only of the material, but also
the processing cost. Take the following cost calculation as an example:
If:
Total quantity of an item assembled 500 units
Total manufacturing cost incurred $3500
then
Unit cost = $3500 / 500 units = $7.00 per unit.
Unit costs are averages and must be viewed in that light. For example,
using the same data for the product calculated above, if the total cost
decreased to $5000 when produced in a lot size of 1000 pieces, then the
unit cost would drop to $5.00 per unit. In determining the proper lot
size for value-added processing or purchasing, planners must make ef-
fective inventory cost trade-off decisions [7].
Cost of reordering. Once it is determined that a product needs to be
replenished, there are several costs associated with order generation.
For purchased items, this cost includes such elements as order prepa-
ration (checking, authorization, research, and administration), order
entry and verification time, document preparation, communications, re-
ceiving, material handling and storage equipment, and stock put-away.
Sometimes, receiving incurs additional costs for quality control, inter-
branch transfer, sorting, and bulk breaking. Finally, when ordering new
products, there will be costs associated with sourcing, supplier negoti-
ations, quality assessment, and quotation review. When products are
produced by the company, the replenishment cost is composed of ele-
ments such as order research and release, shop order documentation,
process setup, labor and overhead, WIP maintenance, scrap, and order
completion .
Carrying cost. This is the cost of holding product in stock over a peri-
od of time. The most obvious carrying cost component is the money
tied up in stocks which has either been borrowed or directly spent in
exchange for the inventory. Other costs center on insurance, taxes,
storage, damage, obsolescence, and shrinkage. The contents of car-
rying costs will be discussed in detail later in this chapter.
Shortage costs. Of the four cost elements, determining the cost of
product shortages is the most difficult to quantify. Everyone can agree
that when a sale is lost because of a stockout, it has cost the business
direct revenue. The problem involves quantifying exactly what this
cost is. Shortages can result in hard to quantify cost such as the loss of
customer goodwill and marketplace reputation. In addition, shortages
may cause extra costs involved in expediting or using premium sup-
pliers.
In the past, most literature on inventory cost has focused on calculating the
trade-off between meeting a certain level of customer service and the inven-
tory it would cost to maintain that level. Although determining what a tar-
geted service level will cost is certainly an important exercise, planners must
understand that it is in reality a hypothetical calculation that considers service
and the elements of inventory cost as absolutes. Therefore, it has been as-
sumed that as service levels increase, so will costs. However, as JIT and
quick response (QR) philosophies have demonstrated, the real goal of inven-
tory management has little to do with manipulating stagnant models of cost.
In today's supply chain environment, managing inventories is a process by
which supply chain planners search for ways to increase service levels while
simultaneously reducing costs. As the velocity of inventory increases as it
moves through the distribution pipeline, performance based on inventory cost
in relation to service begins to lose meaning.
OPERATIONAL COSTS
Inventory costs can perhaps best be understood by dividing them into two
general classes: operational costs and inventory decision costs. Operational
costs refer to costs incurred to support general inventory acquisition, storage,
and fulfillment activities. For the most part, operational costs are confined to
relevant costs or costs incurred as a direct result of an inventory management
decision. Costs the firm has already incurred and are unaffected by future in-
ventory decisions are referred to as sunk costs. Capital expenditure for land,
plant, equipment, transportation, and personnel are examples of sunk costs.
An important perspective from which to view operational costs relates to
how costs arise in relation to inventory activities. Direct costs can be directly
traced to inventory acquisition. For manufacturing operations direct costs

take the form of raw and component materials and labor consumed during
product conversion. For purchased inventories, direct costs are traced to such
activities as stock receipt, quality review, and inventory putaway. Indirect
costs also arise from the inventory acquisition process and can be assigned to
such functions as plant supervision , tooling, and operating processing equip-
ment. In addition, all companies are subject to overhead costs. These costs
are the result of expenditures for building maintenance and operations, equip-
ment, management salaries, information processing, transportation , and other
activities. A common method of allocating these costs is to apply a percent-
age burden based on the material or labor content of a product. A more mod-
ern tool is the use of activity based costing (ABC). This method seeks to
utilize the actual source of the overhead cost rather than simply applying an
aggregate percentage to a direct cost driver such as purchase or labor cost.
Each cost that occurs needs to be traced back as closely as possible to what
activity was performed or what material was consumed during the trans-
action. Activities such as ordering, receiving, material conversion, material
handling, shipping, and customer order processing can be used to determine
the level of cost necessary to execute these activities. Fixed costs are expen-
ditures that do not vary with the level of activity. As an example, the initial
cost expended to acquire material handling equipment does not vary with its
use. Variable costs, on the other hand, normally vary in proportion to chan-
ges in usage volume. Whereas the asset cost of a fork lift is fixed, the costs
associated with its use are dependent on its level of activity. Finally, costs
may be incurred for inventory that is difficult to quantify or is expressed in
values not readily applied to cost categories. Among such intangible costs
can be found the cost of incomplete information and inefficient operations.
One of the most common intangible costs is dealing with customer satis-
faction. As mentioned above, quantifying the effect of inventory shortages or
poor product quality on customer satisfaction and likelihood of return busi-
ness is an extremely difficult yet important cost measurement.
INVENTORY DECISION COSTS
The second class of inventory cost arises when making inventory decisions.
It is clear that supply chains can benefit by having inventory; the cost of
maintaining that inventory, however, is not so easily identified. Everyday de-
cisions concerning inventory, can dramatically impact overall enterprise costs
and long-term profitability. There are several cost factors that are not part of
the traditional aggregate inventory measurement tools employed by manage-
ment but, nevertheless, need to be considered when making inventory de-

cisions .
The first of these elements is the cost involved in inventory procurement.
Procurement costs can be divided into two groups: order preparation and or-
der execution costs. Once it has been determined that a product needs to be
ordered, a number of order preparation costs are incurred relative to the pro-
cessing of the order. These costs include the cost of researching the supplier,
reviewing pricing , writing up the order or entering it into a computer, printing
and transmission of the order to the supplier, and order follow-up and repor-
ting. Order execution costs include transportation, material handling and pro-
cessing at the receiving dock, activities such as inspection, bulk breaking, and
vendor return, the processing of supplier invoices, and the preparation of ac-
counts payable records and payments. For products requiring manufacture,
process order costs will also include the preparation of routing specifications
and work center operations setup. In making inventory ordering decisions,
planners can use work measurement techniques, such as time study methods,
to calculate the labor content of production costs. Another possibility would
be to divide the cost of the order processing functions of the firm by the num-
ber of orders processed. In any case, cost analysts must be careful to separate
the fixed costs of ordering from those costs, such as transportation, process-
sing, and material handling, which vary with order size.
One of the single largest inventory decision cost relates to transportation.
Transportation costs are for the most part subject to procurement delivery fre-
quency and volume. In addition, transportation speed will impact cost. The
velocity by which goods move through the distribution channel will have a
direct impact on the rate charged, the size of the order quantity, and the
amount of time goods spend in transit. Finally, transportation costs also grow
as the number of nodes in the supply chain expands. A computer can assist in
establishing transportation standards and grouping deliveries to minimize
freight expense. In addition, reporting can assist in isolating shipping vari-
ances and identifying opportunities for transportation cost savings.
The inventory decision cost associated with holding inventory is inventory
carrying cost. Inventory carrying cost is composed of several expenses.
These costs are directly related to the size and value of the inventory and to
the length of time the inventory is carried . The value of inventory can range
anywhere from 30 to 70 percent of a typical company's current assets and up
to 50 percent or more of total assets. In 2003 carrying costs were estimated at
around 23 percent. In 1981, for comparison, the carrying cost was almost 35
percent. Literally, if the average annual value of a product was $1000, a car-
rying cost of 25 percent would mean that the firm spent $250 annually just to
hold this single product in stock. In analyzing the carrying cost of inventory,
it is useful to divide the cost into four components: capital costs, service
costs, risk costs, and storage costs.
Capital Costs. The most significant element in inventory carrying cost is the
value of capital tied up in inventory. By committing caoital to inventory, the
firm forfeits the use of this capital for future investment in the hope of
earning a profit when the inventory is sold. Consequently, when planning in-
ventories, executives need to determine return on inventory investment hur-
dles as they would any other investment venture. For example, a firm might
group inventories into high-, medium-, and low-risk categories. High-risk in-
ventories may include new products or goods subject to fashion or seasonality
that management targets to receive a 25 percent after-tax return. Products in
the medium range normally consist of the company's "bread-and-butter" items
that need a 15 percent return. At the bottom is to be found slow-moving
items needing only a 10 percent return.
Although the cost of capital can account for as much as 80 percent of t'ie
total inventory carrying cost, it is perhaps the most intangible and subjective
of all the carrying cost elements. When balancing the cost of capital and the
size of the inventory investment, planners must find answers to such ques-
tions as "What would be the rate of return if capital was invested in other pro-
jects instead of inventory?" "If money needs to be borrowed to attain tar-
geted inventory levels, how much will it cost the firm?" Usually most com-
panies will calculate the cost of capital by referencing the prime rate, the in-
terest rate on short-term securities, or the expected ROI from projects the
company is unable to execute because the money has been spent on inven-
tory.
Service Costs. Service costs represent direct cash expenditures necessary to

support inventories. An example would be insurance coverage required as a
protection against fire, theft, or natural disaster. As inventory is considered
an asset, taxes are levied on the physical inventory quantities on hand on the
day of assessment. Although insurance and taxes represent only a small fra-
ction of total carrying costs, nevertheless, they represent direct cash flow out
of the firm. Like the cost of capital, the cost of insurance and taxes is directly
proportional to the level of inventory. Unlike the cost of capital, exact in-
formation concerning these two forms of cost is easily obtained for inventory
decision making. Expenses for service costs can be calculated as a percen-
tage of that year's inventory value and added to the cost of money component
of the total carrying cost. Unless a company undergoes dramatic expansion
or downsizing, service costs remain fairly consistent over time.
Risk Costs. Companies always have some form of risk when stocking inven-
tories. All products risk obsolescence. Changes in the tastes of the public
and in technology are two of the most common reasons why inventory be-
comes obsolete and can no longer be sold at its original price. Often such in-
ventory is salvaged or sold at a discounted price, the variance showing up in
the profit and loss statement as a separate item. The faster inventory turns
over, the less a risk for obsolescence.
Damage and shrinkage are also elements of inventory risk. Spoilage can
happen as a result of natural processes characteristic of products such as
foodstuffs and chemicals. Companies also risk inventory loss due to damage.
Damage during production, lack of quality and effective training of the com-
pany's staff, material handling equipment employed, packaging used, and
storage practices are instances of where inventory loss can occur. Incoming
inspection is a key element in reducing hidden damage or spoilage. Further-
more, theft is an unfortunate, yet real cost. Pilferage can be reduced through
tighter company security measures.
A potentially large area of risk is balancing inventory levels among several
channel stocking locations. Relocation costs occur because of poor planning
and lack of management visibility into the inventories of the warehouses con-
stituting the distribution network. For the most part, the inventory is relo-
cated in the channel to avoid the possibility of stockout, to reduce channel
stocking level imbalances, and to reduce field level replacement purchase or-
ders. Such movement risks further damage and pilferage and cause more cost
in the form of interbranch transportation.
Storage Costs. Costs for holding inventory can also be found in warehouse
space and material handling costs. Inventory can be stored in four possible
types of facilities: company warehouses, public warehouses, rented ware-
houses, and inventory intransit. The costs associated with company-owned
warehouses and the accompanying material handling equipment are primarily
fixed in nature and are not part of inventory carrying costs. Any variable
costs, however, that change with the level of inventory, such as record keep-
ing, should be considered part of carrying costs. As an example, the annual
carrying costs for a given warehouse are the following:
Utilities $65,000
Personnel 1,400,000
Equipment maintenance 415,000
Plant maintenance 323,000
Security 225,000
Total $2,428,000
If the average value of the inventory is $18 million, dividing these variable
costs by the average inventory will result in the percentage of carrying cost
for this cost type or 13.4 percent.
The carrying costs incurred for the use of public, rented, and private ware-
houses is similarly easy to attain. Only those charges for recurring inventory
storage that are explicitly included in the warehouse rates or those costs that
are variable with the quantity of inventory held should be considered as car-
rying cost. As an example, the rate charged by a public warehouse to handle
a pallet is $5.00 per month or $60 per year. If 100 pallets are handled during
a single month, the charge would be $500.00. The last type of warehouse, in-
ventory intransit, consists of goods that have been shipped from the supplier
but have not as yet arrived at the purchasing facility. If the purchaser has ac-
cepted ownership at the time of shipment, these goods must be carefully
tracked and accounted for until delivery.
Carrying Cost Calculation. Determining the cost of carrying inventory is

achieved by combining the relevant expenses specified above for each of the
four cost types. The costs for each type are expressed as a percentage of in-
ventory value. Assume the following figures:
Cost of capital (13%) 0.130

Insurance costs (0.7% of value) 0.007
Taxes (3% of value) 0.030
Damage and theft 0.013
Obsolescence 0.020
Storage and handling 0.060
Carrying cost 26%
The calculation of the inventory carrying cost with even the most accurate in-
formation is at best an estimate. In reality, the actual costs accumulated are
subject to interpretation and management policy. The carrying cost is calcu-
lated by multiplying the carrying cost percentage by the average value of the
items being stored.
Stockout Costs. A stockout occurs when customer demand for a product ex-
ceeds the available inventory. When an item stocks out, two possible con-
ditions may ensue. In the first, the customer order is taken and the stocked-
out product is placed on backorder. This means that when the inventory be-
comes available it will be shipped against the customer order. A backorder
condition will remain until the original product on the customer order is com-
pleted in full. If the customer chooses not to place the product in a backorder
status, the order is lost. The customer mayor may not attempt to reorder at a
future date. When viewing the cost of a backorder, two issues are present. In
the immediate term, the cost of processing a backorder often requires an ex-
pedite replenishment order and premium delivery. Such costs may actually
exceed the expected sales revenue of the original order. In the long run, how-
ever, the cost involved in lost orders is even more damaging to the enterprise.
Poor customer service can cost a company dearly in lost future opportunities,
customer goodwill, and marketplace reputation.
Although the total impact of stockout costs is difficult to calculate, they
are, nevertheless, critical when making inventory decisions. The most fre-
quently used method of calculating stockout cost is to arrive at the carrying
cost of inventory necessary to maintain a certain level of customer service-
ability. The targeted level of customer service is set by management and can
be expressed as the percentage of units available to ship upon the receipt of a
customer order, the average length of time to fill complete open backorders,
or the percentage of replenishment order cycles in which a backorder occurs.
The cost of a stockout can be calculated as follows:
1. The inventory cost of a given product to maintain a targeted customer

service level = $350 .00.
2. The calculated inventory carrying cost = 26%.
3. The total cost ofa stock out = 0.26 x $350 = $91.
This formula can also be used to calculate the inventory investment necessary
to support a given customer service level. As is illustrated in Figure 6.6, as
Carrying
Cost
OrderCost
OrderSize
FIGURE 6.6 Inventory and sales trade-off costs.
the cost of inventory grows to support higher customer service levels, the cost
of lost sales decreases. However, as customer service increases, the costs of
carrying the accompanying inventory increases correspondingly. By calcu-
lating stockout costs for several proposed customer service levels, logistics
managers will be able to execute informed inventory cost/customer service

trade-off decisions.
Incremental Costs. The final cost category involved when making inventory
decisions is incremental cost. Basically, incremental costs occur when chan-
ges in the actual cost, actual expenditure, or a forfeited profit occurs because
of an inventory management decision . As an example, if the rise in aggregate
inventory unit volume causes relevant costs to increase from $100,000 to
$120,000, then $20,000 is the incremental cost of the decision to stock more
units . Executives must be careful when determining these costs to separate
costs that vary because of increases in unit volume from those that do not.
The cost, for example, of maintaining the purchasing staff remains relatively
constant regardless of the volume of orders processed through the depart-
ment. However, paying for over-time, hiring and training more purchasers
and supervisors, temporary help, and acquiring additional computer terminals
because of an increase in order volume are incremental costs. Measuring the
impact of inventory decis ions can often be a time-consuming affair, requiring
precise definition of relevant costs.
INVENTORY VALUATION
The process of determining the value of supply chain inventories requires a

number of critical decisions . Such factors as how inventory is to be recorded,
how fixed and variable costs are to be used, and what inventory accounting
method is to be applied require serious consideration and need to be in align-
ment with overall corporate objective s and goals.
Physical Accounting Systems. Before inventory can be valued, the quantity

of each product must be known. There are two common methods for de-
termining the size of a company's inventory as a prelude to valuation: the
periodic inventory system and the perpetual inventory system . The use of one
or both methods depends on company decisions as to the purpose of inven-
tory transaction data collection. In the periodic inventory system, the size of
the inventory is determined by an actual physical count of stocked balances at
specific dates, normally no later than year-end. The most significant advan-
tage of this method is ease of record keeping. No daily inventory transactions
to balances on hand for receiving, in-transit, scrap, or sales are maintained.
The disadvantages are that the firm does not know exact inventory quantities
or total value until the physical inventory is performed . In addition, a com-
plete physical is an expensive, time-consuming process . Companies stocking
products that are of relativel y low value or are slow moving use periodic in-
ventory systems because of the high cost of maintaining detailed records ver-
sus the benefit.
Perpetual inventory systems, on the other hand, are characterized by a care-
ful and timely recording of each inventory transaction as it occurs. In this
system, each time a purchase order receipt, adjustment, scrap, movement, is-
sue, in-transit, or sales transaction occurs, the value is recorded and the in-
ventory balance on hand is adjusted. The advantages of the perpetual inven-
tory system are that exact information concerning inventory movement and
on-hand balances is available at all times. In addition, through the use of an
effective cycle count program, the annual physical inventory in most cases
can be eliminated. Finally, this method allows financial managers to cal-
culate the value of the inventory at any given time. The disadvantages of the
method are that the maintenance cost of the system is very high and it usually
requires a computer. Businesses that carry high to medium cost products
with constant to high transaction volumes are most likely to use some form of
perpetual inventory system to track and value their inventories.
Direct Versus Absorption Costing. Although the term valuation is common-

ly used when discussing inventory, in reality inventory accounting considers
the value of inventory as a reflection of cost. As a prelude to the use of in-
ventory valuation methods, firms must determine whether they are using vari-
able costing (also known as direct costing) to determine the value of inven-
tory or some form of absorption costing . Definitions of these two methods
are [8]:
Variable costing is a method of inventory costing in which all direct
costs, such as material or purchase price, and all variable overhead
costs, such as labor, transportation, direct machine, and setup, are com-
bined to provide inventoriable costs. Fixed overhead costs, such as
plant and equipment, are excluded and are considered costs of the peri-
od in which they are incurred.
Absorption costing is a method of inventory costing in which all direct,
variable overhead, and fixed costs are considered as inventoriable
costs. In other words the total cost of a product is attained by "ab-
sorbing" all these costs.
The application of absorption versus direct costing is critical in making in-
ventory decisions. Elements involved in fixed costs will not change as a re-
sult of inventory policy, whereas variations in direct costs will have an impact
on carrying costs and cash flow.
Inventory Valuation Methods. Once accounting management has deter-

mined the components of inventory costing, inventory value can then be de-
termined. Inventory valuation is important for several reasons. To begin
with, good inventory accountability is necessary to assure correct reporting of

interim and yearly profits. Accurate inventory valuation ensures that the dif-
ference between booked and physical inventories is as small as possible .
Also, proper inventory accountability is a requirement for quarterly submis-
sion to the Securities and Exchanges Commission. This reporting is funda-
mental for assessing the profitability of publicly traded companies. There are
five recognized methods by which a company can value its inventory:
1. Standard cost. This method of determining inventory value is deter-
mined by assigning cost standards to manufactured and purchased prod-
ucts. A standard is defined as a good or best level of performance for a
process. Inventory standards serve as benchmarks permitting managers
to determine what inventory costs should be and to measure actual
costs against budgets. The standard is computed by using elements
such as the purchased materials cost, direct labor expended in opera-
tional activities such as receiving, stock put-away, manufacturing, order
picking and packing, and shipping, and overhead costs such as man-
agement salaries and carrying costs. Inventory at any point in the year
up to creation of a new standard is valued at the given standard regard-
less of actual costs incurred. One of the advantages of standard costing
is that the company needs to revalue inventory usually only once a year.
Furthermore, the cost standard permits managers to calculate ongoing
cost variances to the standard occurring in material, labor, or over-
heads. Variance analysis enables managers to investigate root causes
of cost change and to take remedial action when necessary. While pri-
marily used by manufacturers, distributors can easily prepare labor and
overhead costs as portrayed in Figure 6.7
2. First-in-jirst-out (FIFO). This method of inventory valuation assumes
that the cost of items sold in a period consists of the oldest inventory
cost just prior to sales. By charging the oldest costs in inventory to the
sale, FIFO assumes that inventory at the end of the period consists of
the most recent costs incurred. The rationale behind FIFO is that it re-
flects the fact that companies generally use the oldest items in inven-
tory first so that they can continually tum over stock and prevent deteri-
oration or obsolescence . FIFO is widely used in times of stable pricing.
However, in periods of continuous inflation, FIFO tends to result in
"inventory profits" stemming from lower fixed inventory cost and in-
creasing sales margins. FIFO methods of inventory are commonly used
to inventory perishable goods, such as foods, pharmaceuticals, or other
products with short shelf lives. Stockkeeping in a FIFO system re-
quires that the oldest product always be rotated to the front upon the re-
ceipt of a new inventory lot.
I. Determination of Direct Labor Standard

Function UIM Labor hr Std $ Laborhr Std Cost UIM
Receiving SKU 400 hrs $16.00 $0.04
Stocking SKU 400 hrs $16.00 $0.04
Ordering SKU 100 hrs $16.00 $0.16
Picking SKU 160 hrs $16.00 $0.10
Shipping SKU 50 hrs $16.00 $0.32
Std LaborCost per UIM $0.66
II. Determination of StandardCost for Product#1-100

a. SupplierInvoice Cost $2.35
b. Overhead Burden 25%
c. Direct Labor Cost $0.66
d. (Labor ($0.66) x Overhead(25% + Labor ($0.66) +

InvoiceCost ($2.35) = $3.175 Std Cost per Unit
e. Inventory Valuation = 354 (OHB) x $3.175 = $1123.95
FIGURE 6.7 Standard cost calculation.
3. Last-in-first-out (LIFO). This method of inventory valuation assumes

that the cost most recently incurred in the acquisition of a product is the
cost used for sales during that period. By charging current costs to
sales, LIFO assumes that inventory at the end of a period reflects the
oldest costs incurred to acquire inventory to its current level. A key
goal of LIFO is to achieve a better match between costs and revenues.
The computation of LIFO can perhaps best be seen when compared to
FIFO. Assume that at the beginning of a period a company starts with
five SKUs purchased at $100 and sold at $150 per SKU. During the
period five units are sold. Finally, assume that the cost of replenish-
ment during the period has increased to $110 per SKU. The result of
the selection of FIFO or LIFO is indicated in Figure 6.8. The Gross
Profit difference of $50 constitutes the FIFO profit. Because LIFO
considers the increased cost of $10 per SKU, current costs are matched
closer to sales, and therefore inventory profits are not reported.
Under LIFO, inventory levels are carried on the balance sheet at the
original LIFO cost until they are decreased. Increases are added at the
current cost in the year the inventory is acquired. In the above ex-
ample, the ending inventory would be priced at $500 (five units at
$100) even though the current cost is $550. As long as the inventory
level remains above five units, the first five units in the closing in-
ventory would continue to be carried at $100 in succeeding periods.
LIFO FIFO
Sales $750 $750
Cost of Sales --..2Q.Q.. --..lli..
Gross Profit 250 200
Operating Expense 100 100
Income Before Taxes 150 100
Taxes at Assumed Rate of 5% 75 ~
Net Income 75 50
FIGURE 6.8 LIFO versus FIFO valuation.
Any increases in inventory at inventory close would be priced using

current costs and "layered" on top of the original cost. For example, if
the inventory closed at ten units the cost would be
(5 units x $100) + (5 units x $110) = $1050.
The advantage or disadvantage of LIFO costing depends on whether

the economy is experiencing a period of inflation or deflation. When
prices are rising, LIFO will result in lower inventory valuation, high
cost of goods sold, and lower profits. When prices are declining, the
opposite will be true. In addition, it reduces taxes and increases cash
flow. Disadvantages are that after many years of use, inventory
amounts in the balance sheet may be much lower than current inventory
assets. Also, if inventory levels are reduced, older LIFO costs are mat-
ched with current revenues and reported income becomes inflated [9].
Average cost. This method of valuation references the current cost of
the existing inventory and the cost of the newest supplier invoice, and
then uses some form of average to calculate the new inventory value
from these two costs. Usually, firms will use some type of weighted
moving average in which inventory invoice cost will be weighted by
the quantity of the item received. This form of inventory costing is
often used with periodic inventory systems. An example of the average
cost method using a straight average is illustrated in Figure 6.9.
Actual cost. In this costing method, a specific received quantity and
invoiced price for a given product are linked together and differentiated
from other stocked quantities of the same item by associating the re-
ceipt with a unique identifier, usually a lot number. When an inventory
transaction for the product occurs, it would be necessary for the lot
number to be part of the transaction detail. In this way, the discrete
cost associated with the lot can be captured along with the quantity
transacted. An example of actual costing using the same detail as Fig-
I. Ending Balance ':" 354 units
II. Prior Item Receipts

1. 200 at $2.35 = $470.00
2. 245 at $2.48 = $607.60
3. 235 at $2.50 = $587.50
III. Calculation:
$470.00 + $607.60 + $587.50
= $2.4486764 per unit
680 (total quantity received)
IV. Ending Inventory Cost:
Ending Inventory = 354 x $2.4486764 = $866.83
FIGURE 6.9 Weighted average cost calculation .
ure 6.9 appears in Table 6.1. Actual costing is used by firms that ex-
perience dramatic fluctuations in the acquisition cost of products. By cap-
turing the actual cost, the firm can calculate the actual cost of sales and the
earned margin when a specific lot of an item is shipped.
TABLE 6.1 Actual Cost Inventory Calculation

Recpt/ Recpt Date/ Invoice $ OnHandl Inventory
Ship Qty Ship Date Per Unit Lot# Value
200 03/01103 $2.35 200/Lot 123 $470.00
150 03/13/03 SO/Lot 123 $117.50
245 04/01103 $2.48 245/Lot :345 $607.60
176 04/25/03 69/Lot 345 $171.12
235 05/01103 $2.50 235/Lot 543 $587.50
SO/Lot 123 $117.50

On Hand inventory - 05/01103 69/LOt 345 $171.12
235/Lot 543 $587.50
Total value $876.12
If it were possible to continually acquire inventory at the same price, the

choice of a costing method would make no difference on either reported in-
come or the balance sheet. However, because costs do change, the choice of
an appropriate costing method is critical in effectively managing inventory in-
vestment. The choice of the proper inventory valuation method depends on a
matrix of factors such as the general economic environment, the velocity of
how fast inventory moves through the supply pipeline, and the financial re-
porting motives of individual companies.
INVENTORY CONTROL
As previously stated, inventory is perhaps the largest single financial invest-

ment for most companies. Unless the firm's management undertakes a serious
and detailed plan to control the physical movement and costs of inventories,
inaccuracies can drain away profitability and inhibit effective performance.
Many companies, after the annual physical inventory, experience a large vari-
ance between the physical and booked values of their inventories. In ad-
dition, manufacturers have found their costs for labor and overhead severely
understated or overstated. Such discrepancies usually send a tidal wave of
concern through the firm. Accurate inventories are essential to assure correct
reporting of profits. Investors and shareholders can become apprehensive
about profits that do not appear because of poor inventory management. Ex-
ecutives can be surprisingly disappointed to see that business plan goals are
unattainable because of negative inventory variances.
In addition to the impact on financial measurements, poor customer ser-
viceability usually accompanies inaccurate inventories. The litany of per-
formance problems is familiar: declining order volumes and high customer
turnover, increasing backorders and order cancellations, increasing inven-
tories and expediting costs, significant inventory inequalities in the supply
channel, growing inventory obsolescence, and increases in premium purchase
order and freight costs. Ineffective inventory control destroys the confidence
of the firm to establish meaningful plans and performance measurements and
to respond effectively to the competitive challenges of the marketplace.
Inventory discrepanc ies happen for a variety of reasons. Loss of inventory
through theft is a common, although regrettable, occurrence. Although theft
accounts for a small fraction of inventory variance, it represents a true loss to
the company. Techniques such as employing a security staff, enclosing in-
ventories within a fenced stockroom, maintaining a perpetual inventory, and
documenting inventory transactions will greatly assist in decreasing inventory
pilferage . Most firms will closely monitor total inventory shrinkage. A com-
monly used formula and example to calculate inventory shrinkage is
$4,500,000 (total physical inventory value)

Shrinkage ratio = --------------------------------------------------------- = 98.9%,
$4,550,000 (total inventory investment)
Percentage of shrinkage = 100 - 98.8 = 1.1%.
One of the ways companies can reduce inventory loss and vastly improve
accuracies is by clearly defining the transaction control points as inventory
flows through the channel. Accurate inventory records must be kept from the
moment inventory is received to the moment it is shipped to the customer.
Figure 6.10 illustrates the typical control points found in a distribution chan-
Purchase Order
ComponentStorage
ProductionOrder
FinishedGoods
In-Transit Order
Regional Warehouse
In-Transit Order
Field Warehouse
In-Transit Order
Retail Store
ShipmentOrder
FIGURE 6.10 Inventory transaction flow.
nel. In the example, there are 11 inventory control points. Control points 1-5
represent physical locations . Inventory in physical locations can be defined
as at rest in a stockroom where on-hand balances for raw materials, compon-
ents, finished assemblies, and finished goods are maintained. Inventory, fur-
thermore, that is in physical locations can be allocated, counted, and shipped.
Control points A-F represent logical locations. Inventory in logical locations
can be described as in motion, yet can be held in discrete repositories such as
purchase orders, inspection locations, production orders, in-transit, and ship-
ping orders. Inventory in logical locations cannot be allocated, counted, or
shipped to a customer.
The key to clearly identifying inventory control points is to determine
those places in the inventory flow where transactions take place. Essentially,
there are two types of inventory transaction that can occur: physical and ac-
counting. Depending on the degree of physical control required by the firm,
each time inventory moves from one location to another, an inventory trans-
action describing the location from, location to, and quantity must be perfor-
med. Sometimes the movement of inventory has not only a physical but also
a financial effect on inventory value. An example would be a stock adjust-
ment where inventory is transacted either to or from a physical location and
to or from an inventory adjustment general ledger account number. Effective
transaction control must follow inventory through the distribution channel in
order to keep the inventory and the accounting systems in alignment with one
another . In designing a company's inventory flow transaction system, man-
agers must focus on thoroughness, simplicity, and timeliness.
The final reason why inventory discrepancies occur is improper accounting
techniques . Essentially, improper techniques can be grouped into two basic
categories: overstatement ofinput and understatement ofrelief Inaccuracies
accompanying the transaction of goods into inventory occur due to poor pur-
chase order receiving practices, incorrect WIP issue reporting, improper
handling of customer returns, and improperly designed transactions and valu-
ation . Shortages in inventory often occur because of understatement of in-
ventory relief. Failure to report issues to WIP, scrap, and incorrect Bills of
Material are examples . A well-designed inventory transaction system, ac-
companied by an effective Cycle Count program and a fully-trained and dili-
gent staff, will significantly reduce inventory physical-to-book variances.
ABC ANALYSIS AND CYCLE COUNTING
Two tools commonly employed to ensure inventory accuracy and control are
ABC Analysis and Cycle Counting. Supply chain inventories can consist of
thousands, maybe hundreds of thousands, of products . When it comes to pro-
curement and sales, it would be unrealistic to say that each product is re-
viewed and shipped at the same rate. In fact, the usage rates of a typical com-
pany's inventory follows a statistical principle formulated by the 19th-century
Italian social scientist, Vilfredo Pareto, termed the "Management Principle of
Materiality." Simplistically, the principle states that in any given statistical
population, 20 percent of the elements in that population will account for 80
percent of the data occurrences.
When applied to inventory, the principle states that statistically 20 percent
of a firm's active products will account for 80 percent of the inventory trans-
actions . The operating principle that can be extended from this statistical law
is simple: By dividing the inventory into classes, analysts can focus on those
products that account for the bulk of the company's inventory flow. Planning
and controlling inventories, even though they can be computerized, still re-
quire a great deal of manual effort to input data, check values, update supplier
details, confirm orders, make subjective judgments, monitor operations, and
other activities . Clearly, the larger an inventory becomes, the less planners
will be able to work effectively with the entire inventory. Because the firm
possesses limited resources, classifying inventory by transaction value can
greatly assist in ascertaining the level of control to be exercised over each
product.
For the most part, a typical ABC Classification would seek to break a com-
pany's inventory into the following three divisions:
A items would be classified as expensive, high-transaction items

needing special attention.
B items would be classified as the bulk of the firm's inventory requiring
standard attention.
C items would be classified as relatively inexpensive or low-transaction
items requiring minimal attention.
In inventory planning, Class A products would be under close computer con-

trol, with balance and reordering decisions made by inventory planners after a
thorough review of transaction and planning data. Class B products, on the
other hand, would typically be controlled automatically by a computer. Re-
plenishment and data element update would normally be performed auto-
matically by the computer without planner intervention. Finally, Class C
products mayor may not be included in the computer system. Such items
could be satisfactorily controlled through periodic review control systems.
The procedure for developing an ABC analysis begins by determining the
content of the classification scheme. Among the most commonly used factors
can be found product annual dollar usage, transaction usage, unit cost, lead
time, and quality. In developing product classifications, planners must be
careful to use more than one of the above criteria. Although the most com-
mon method is annual dollar and transaction usage, other criteria can be used
depending on inventory characteristics. One technique is to use a two-digit
coding system that differentiates between dollar value and actual usage. The
first digit determines the class based on descending dollar value. The second
code is based on descending usage, serving as an indicator of actual sales
usage. For example, an A-I (with I being the highest value) would require
close planner review, whereas a C-3 would require minimal review. How-
ever, a C-l would be given much greater attention than an A-3. Planners
would use this two-part classification by designating the first digit as the
method to control inventory replenishment, and the second, safety stock and
forecast management policies. Table 6.2 illustrates an ABC distribution by
value report calculated by ranking inventory by transaction and by value.
The results of the ABC Classification detailed in Table 6.2 indicate that the
first three products represent 74.7 percent of the firm's total sales and have
TABLE 6.2 ABC Distribution by Value Report
Annual Cumulative Annual Dollar Cummulate % ABC

Item Unit Cost Usage % Usage Usage Dollar Usage Classification
i.ioo $.0074 5,750,000 63.9 $42,550.00 4 1.3 A

1-500 $.0203 1,265,000 78.0 $25,679.50 66.2 A
2-300 $.0800 110,000 79.2 $8,800.00 74.7 A
1-200 $.0800 105,00 80.4 $8,400.00 82.9 B

2-100 $1.0173 7,500 80.4 $7,629.75 90.3 B
2-600 $.0200 115,000 81.7 $2,300.00 92.5 B
1-300 $1.1438 1,500 81.7 $1,715.70 94.2 B
1-400 $3.1999 500 81.7 $1,599.95 96.8 C

3-100 $.0125 110,000 83.0 $1,375.00 97.1 C
3-200 $.0300 25,300 83.2 $759.00 97.8 C
2-700 $.0200 25,300 83.5 $506.00 98.3 C
4-100 $.0799 500 83.5 $439.95 98.8 C
5-100 $4.5438 70 83.5 $318.06 99.1 C
4-200 $.3000 1,000 83.5 $300.00 99.4 C
3-300 $.0100 25,300 83.8 $253.00 99.6 C
4-300 $.3000 600 83.8 $100.00 99.8 C
6-100 $.0050 25,300 84.1 $126.50 99.9 C
7-100 $.2000 126 84.1 $25.30 99.9 C
6-500 $.0200 1,000 84.1 $20.00 99.9 C
5-500 $.0200 500 84.1 $10.00 99.9 C
4-700 $.0010 525 84.1 $0.52 100 C
5-600 $.0000 o 84.1 $0.00 100 C
2-800 $.0000 o 84.1 $0.00 100 C
4-900 $.0000 o 84.1 $0.00 100 C
5-900 $.0000 o 84.1 $0.00 100 C
6-900 $.0000 1,419,400 99.9 $0.00 100 C
Totals 8,991,491.50 $102,988.23
been classified as Class A. The next four products represent about 15 percent
of total sales and have been assigned to Class B. Finally, the remainder of the
inventory accounts for about 5 percent of total sales and have been assigned
to Class C. The report also shows four products with no transaction detail at
all. These products should be classified as "dead stock" and reviewed for
possible removal from active inventory. The last product, #6-900, has a large
usage, but because no cost has been applied, the report cannot calculate its
dollar usage. This product should be reviewed and action taken accordingly.
Figure 6.11 illustrates graphicall y the distribution by value principle used to
determine the classification in Table 6.2.
Once determined, an ABC classificat ion can assist planners assign the pro-
per resources to attain the optimum maintenance of the inventory. For ex-
ample, Class A products may have their inventory status reviewed weekly,
5%
15%
80%
Percent
Of C
Vallie
20% 40% 40%
FIGURE 6.11 Distribution by value.
possess tight accuracy tolerances, a 98 percent order fill rate, a high safety
stock percentage , and close follow-up and possible expediting of replenish-
ment orders. In contrast, Class Band C products would require less review,
safety stock, and expediting . In addition, in a distribution network almost all
of the Class C and some of the Class B items would be stocked in central dis-
tribution centers only, thereby diminishing the amount of low-value products
in the pipeline.
A critical management focus of Class C items should be the elimination of
surplus and obsolete inventory. Many companies actually stock about 40 per-
cent more products than they really need. Although periodic sales seem to
validate stocking this inventory, in reality the resulting small stream of reven-
ue does not generate enough profit to justify the dollars invested in inventory
and is the major reason for low aggregate inventory turnover. Essentially,
this inventory falls into the following categories: excess, damaged, recall, re-
work, outdated, shortdated (will soon become outdated), expired, and dead
stock. The elimination of these inventories is critical if supply chains are to
improve on inventory investment and turnover rates. An effective excess and
dead-stock program consists of the following steps:
1. Prevention. In this phase, planners should deploy effective inventory
planning tools to eliminate the ordering of excess and dead-stock in-
ventories. Effective prevention also requires a tough attitude toward
customers, salesmen, and suppliers .
2. Identification. In this phase, the creation of effective inventory trans-
action/usage reporting is critical. Reporting will assist planners to
quickly focus in on products with low to null cost/usage value but have
inventory on-hand or zero balances, and a low ratio of cost/usage and
available on hand.
3. Coordination. In this step, an excess or "dead-stock" project team

should be defined to tackle the problem.
4. Disposal. Once excess and obsolete inventory has been identified, the
project team must develop a program to (1) dispose of the inventory,
and (2) maximize the dollars generated from the disposition. Such
methods as sell at any price above cost, return to supplier, sell at a cer-
tain percentage below cost, sell at any price, sell to a reseller or broker,
and scrap can be used to dispose of inventory.
Another method commonly used to control inventory and maintain ac-
curate records is Cycle Counting. The APICS Dictionary defines cycle
counting as "an inventory accuracy audit technique where inventory is count-
ed on a cyclic schedule rather than once a year [10]." Some of the possible
techniques used for Cycle Counting are controlled sample, occurrence of pur-
chase order receipt, and product negative balance. By far, the most used tech-
nique is Period ABC. Fundamental to this cycle count method is the estab-
lishment of an effective ABC classification. Because the mechanics of Cycle
Counting provide on a predetermined periodic basis a verification of actual-
to-book on-hand counts, the technique enables inventory control to review
more frequently high-value or fast-moving products while postponing review
of low-value or slow-moving products. An example of the Period ABC ap-
proach would be to count all Class A products monthly, all Class B's quarter-
ly, and all Class C's twice a year. Often exception or special situation counts
are integrated with the Period ABC method.
Once the parameters of the cycle count technique have been formalized, ef-
fective execution will require the counting of a certain number of products
every workday with each product counted at a proscribed frequency. Once
counting has been completed, the count sheets results need to be verified and
variances examined. When variances occur, products can either be recounted
or their book inventory values adjusted depending on management policy.
Once a week the results of the cycle count program should be reported, and a
summary report by ABC class prepared at least monthly.
An effective cycle count program provides a number of significant advan-
tages. To begin with, Cycle Counting assists in the maintenance of a high
level of inventory accuracy. When the firm depends on a yearly physical to
adjust inventory, variances can go unadjusted for long periods of time. Be-
cause the focus of the cycle count program is on those products with the most
transactions, repeated review will ensure a high level of accuracy. Addition-
ally, an effective Cycle Counting program enables companies to abolish the
expense and operations disruption of the annual physical inventory. Finally,
the real benefit of Cycle Counting is the information provided to inventory
controllers to investigate and eliminate the root cause of why inventory vari-
ances occur at all in the transaction flow. This Total Quality Managem ent
(TQM) approach focuses the entire inventory control function on continuous

performance excellence.
PERFORMANCE MEASUREMENT
Supply chain inventory performance can be measured from two perspectives:

customer service and inventory investment. Neither of these two measure-
ments can be considered outside of one another. Customer service perfor-
mance is meaningless without an understanding of its financial affect on in-
ventories; inventory performance measurements are likewise meaningless
without reference to the level of customer service they are designed to sup-
port. Figure 6.12 illustrates this relation. Inventory investment is shown
along the vertical axis, and customer service is shown along the horizontal
axis. In describing a single product, the downward slope of the curve indi-
cates that additional inventory will increase the level of customer service.
Determination of the effectiveness of inventory/service trade-off strategies is
the subject of inventory performance management.
High
Inventory
Investment
Low
Good Poor
Service
FIGURE 6.12 Inventory customer/service trade-off.
Customer Service. Earlier in this chapter it was stated that the strategic ob-
jective of inventory is to provide supply chains with the ability to optimize
customer service throughout the entire marketing channel. But while efforts
to optimize customer service are the focal point of inventory strategies, cho-
osing the proper measurement criteria to validate objectives is not always
easy. For example, a distributor receives the following two orders: four each
of product #1-100 at a cost each of$25 and a second line calling for four each
of product #2-100 at a cost each of $10 for a total value of $120; and an order
for two each product #2-100. There are four each #1-100 on hand, but #2-
100 is stocked out. In determining the customer service measurement for this
scenario , there are four possible service measurements :
50% piece fill rate

71% dollar fill rate
33% line fill rate
0% order fill rate
The selection of the appropriate performance measurement depends on the

marketplace, the nature of the products sold, and the ramifications of the sup-
ply channel 's inability to completely fill customer orders.
According to Bowersox and Closs [11], the development and implemen-
tation of performance measurements utilizes three measurement toolsets. The
first seeks to monitor performance by tracking and reporting on historical
occurrences. Typical monitoring metrics include service level and supply
chain cost components. The second measurement tool is controlling. Met-
rics captured can be used to track ongoing performance and ensure channel
processes are operating within boundaries or to improve channel processes al-
together. For example , if products are continuously delivered damaged, the
shipping process might be examined and the root cause of error eliminated.
Finally, the third toolset involves directing performance measurements. The
goal of these metrics is to motivate personnel to achieve higher productivity
or quality levels through bonuses or other incentives.
In selecting the most appropriate measurements , managers have the option
of selecting from a wide range of activity-based (which focus on the ef-
ficiency and effectiveness of specific work tasks) to entirely process-based
(which focus on the performance of the whole supply chain) measurements.
Activity based metrics revolve around the performance of processes. Among
these metrics can be found percentage or value type measurements such as
1. Customer orders shipped on schedule

2. Line items shipped on schedule
3. Total units shipped on schedule
4. Dollar volume shipped on schedule
5. Working days not out of stock
6. Backorders shipped within a specified number of days
7. Order days out of stock
8. Total item days out of stock
9. Average number of days to ship a backorder
10. Backorder aging
Besides the above measurements, which are concerned with customer ser-
vice and quality performance, business are normally concerned with other
metrics that impact inventory management. One of these is the cost the com-
pany has incurred to meet targeted service goals. Normally, this measure-
ment is used in relation to the budgeting process and is measured in terms of
total dollars, as a percent of sales, or as a cost per unit. Another measurement
can be found in how well overall supply chain assets are meeting budgetary
objectives. In this area can be found aggregated costs for facilities, equip-
ment, personnel, and inventory and how effectively expenditures are meeting
ROI objectives. Finally, quality must be measured. Quality can refer to the
effectiveness of how well processes are being executed to the standard and
how much expediting, exception processing, or manual intervention must be
performed . Quality measurement can also be applied to the fitness of the
product itself and can take the form of recorded defects, failures, and returns.
Inventory Measurements. Measuring inventory is fundamentally a process

of determining how quickly inventory cycles through the business and out to
the customer. Inventory planners must be careful to ensure that inventory
costs are not unduly increased in expectation of future sales revenue. An in-
ventory policy that builds stocks simply to raise customer service levels is
usually courting financial disaster. High inventory levels translate into in-
creased probabilities of obsolescence and damage. What is worse, the greater
the inventory value, the less operating cash is available to improve channel
operations, buy new equipment, train employees, and invest in new products.
Maintaining firm controls on inventory investment should, perhaps, be the
most important measurement in the company.
The most commonly used inventory measurement technique is to view the
aggregate value of inventory investment on a periodic basis. Periodic reviews
provide timely data for the analysis and comparison of actual inventory in-
vestment to inventory budgets. Resulting variances can then be used to in-
vestigate root causes and to effect corrective action. In addition, a periodic
review will assist inventory planners in pinpointing inventory out-of-bounds
situations caused by seasonal fluctuations and unusual inventory usage
trends. Finally, the periodic inventory measurement provides top manage-
ment planners with an opportunity to realign projected inventory investment
with the business's financial capabilities.
Once the firm has an accurate valuation of inventory, there are several
measures that can be used to gauge aggregate performance. One of the most
popular is inventory turnover. Inventory turnover is an expression of how
many times per year the aggregate inventory is moved in and out of the ware-
house. The formula for this measurement is found in Figure 6.13.
I. Inventory turnover formula:

Cost of inventory sold
Inventory turnover =
Inventory investment
II. Example
Annualproductsales $lOOM
Margin 50%
Cost of goods sold (CGS) $50M
Cost of inventory $30 M (60% ofCGS)

Labor and overhead $20 M (40% ofCGS)
Average annual inventory investment $8M

III. Calculation :
$30M
Inventory turnover = = 3.75 turns per year
$8M
FIGURE 6.13 Inventory turns calculation.
There is no standard inventory turns formula that is valid for every com-
pany. In fact, inventory turnover calculations have little meaning when used
as a comparison even for two companies within the same industry. For ex-
ample, auto assembly plants and oil refiners achieve turnover ratios of fifty or
more , whereas department stores and electrical suppliers will generally have
stock turnovers below five. What is more , different turn ratio objectives can
be developed by inventory class for products within the same inventory. Var-
ious other factors can be used in the calculation of the turnover formula.
Sales can be expressed as gross sales, net sales, sales at standard cost, sales at
actual cost, or annualized forecast cost of sales. In developing an inventory
ratio , planners must discern the purpose of the ratio, who will be using it, the
accuracy of company accounting data, the profile of the inventory segment to
be measured (i.e., product lines, warehouses, classes), and a plan for imple-
mentation. Inventory turn measurements must be used with caution. As
purely a means of control , they place emphasis on reducing inventories only
at the possible expense of customer service.
In addition to inventory sales-based turnover ratios, there are other perfor-
mance measurements that can be employed under the proper circumstances.
These techniques can be described as follows :
Inventory to current assets. Broadly speaking, a finn 's current assets
can be divided into cash, accounts receivable, and inventory. This mea-
surement seeks to calculate the ratio of inventory to total current assets.
Companies using this technique must be careful to measure the impact
of variations in accounting periods or seasonality and economies on

total assets.
Inventory to total assets. This method is an extension of the current
assets ratio. Assets included are all current assets, plus plant and
equipment. These asset elements are combined to calculate a return on
assets ratio by comparing totals to profits.
Number of month's supply. In this method, the total amount of in-
ventory is expressed in terms of the amount of supply necessary to sup-
port current inventory sales rates. For example, if inventory turns four
times a year, the average amount on hand is 3 months' worth. This ratio
is most often used to calculate turns for raw materials and component
inventories.
Number of days' supply. This is same concept as above but is cal-
culated in the number of days' worth of inventory. This ratio is most
often used with finished goods.
Inventory to net working capital. "Net working capital" is expressed as
the difference between current assets and current liabilities. The ratio
calculated between inventory investment and net working capital will
demonstrate the amount of cash available in the short run. If the value
of inventory is equal to or greater than the net working capital, then
inventories are probably too high and are squeezing cash flow. The
ratio calculated should be less than one, indicating that cash and
receivables are available for short-term investment [12].
Similar to other measurement tools, inventory performance ratios can be
abused and misapplied to produce the wrong decision based on incorrect as-
sumptions. Nevertheless, the techniques outlined above can provide compa-
nies with effective measurement tools if used carefully.
SUMMARY
During the past decade, the role of inventory in the manufacturing, distribu-
tion, and retail environments has undergone drastic change. Inventory man-
agement is no longer viewed as a narrow discipline centered on ca1cu-lating
lot sizes and economic order quantities, and expediting replenishment and
customer orders. Increasingly, academics and practitioners alike have be-gun
to see effective inventory management as the key to marketplace leader-ship
and to integrate it with strategic and competitive planning. Effective in-
ventory management in the twenty-first century is concerned with overall in-
ventory performance and customer service levels as they impact not just in-
dividual companies, but the entire supply chain. Decisions concerning in-
ventory cannot be made in isolation from strategic channel network objec-
tives. Instead, inventory must be seen as an aggregate resource that spans and
connects all nodes in the supply chain network and directs them to aggregate
customer service goals.
Reevaluating the role of inventory requires a thorough understanding of the
nature, functions, ann costs associated with inventory. Inventory can be
stocked as raw materials, components used in the assembly process, and
finished goods. The fundamental reason why inventory is held is to serve as
a buffer that decouples supply nodes from the vagaries of customer demand
on the one hand and limitations in the delivery capacities of suppliers on the
other. In managing inventory buffers, planners must be diligent in deter-
mining and tracking costs arising out of both operations and inventory de-
cisions. Informed inventory cost decisions are necessary if the firm is to be
run effectively and efficiently. Control of inventory cost is paramount if sup-
ply channels are to exploit new markets, optimize information and com-
munications systems, explore new forms of transportation, and strengthen the
integration of the supply chain.
Without effective inventory control, the supply channel network will ex-
perience cost discrepancies and poor customer serviceability. Individual
companies can vastly improve inventory accuracies with the use of several
control tools. Fundamental is the clear definition of transaction control
points in the flow of inventory as it moves through the supply channel.
Transaction control will not only ensure that material is properly accounted
for, but it also serves as a gateway to minimizing inventory shrinkage and the
mismatching of material and costs as they flow through the system. ABC
Classification and Cycle Counting are additional tools that can be employed
by inventory managers. Finally, the true test of channel inventory is how
well it measures up to customer service and inventory investment perfor-
mance objectives. The ability to provide the right product at the time and
place desired by the customer at the lowest possible inventory investment is
the foremost objective of every node in the channel network. In developing
effective customer service performance measurements, companies must be
precise in defining the relation of perceived customer wants and the ability of
their channel of supply to match those wants. In the final analysis, customer
service and inventory performance measurements cannot be considered in-
dependently of each other.
1. Discuss the nature and functions of inventory in today's enterprise.

2. Based on statistical evidence, why have inventory investment costs been steadily
declining over the past 5 years?
3. Analyze the elements of inventory carrying cost.
4. Discuss the financial difference between a periodic review system and a per-
petual inventory system.
5. What are the five inventory valuation methods. Explain why companies would
use one method over another.
6. Why is inventory transaction control absolutely essential to effective inventory
management?
7. Explain the uses of ABC Analysis and Cycle Counting.
8. It has been said that customer service and inventory investment are two measure-
ments that cannot be considered outside of one another. Explain.
PROBLEMS
1. M & K distributors stocks about 5000 SKUs in their finished goods inventory.
After a recent ABC Classification report was run, it was determined that the firm
had 500 A items, 1750 B items, and 2750 C items. If the Cycle Counting pro-
gram required that A items be counted complete monthly (every 20 working
days), B items quarterly (every 60 working days), and C items biannually (every
120 working days), how many items will cycle counters have to count each day?
2. Develop an ABC classification for the following 10 items.
Item Annual Demand Cost/Unit
AI00-100 4000 $ 50
A200-100 5000 13
A300-200 2000 45
BI00-100 7000 9
B300-220 900 22
C350-200 400 525
D250-450 500 1300
E400-300 700 15
F500-200 2200 9
G200-450 3000 4
3. Based on the data below, calculate the inventory turnover ratio at the end of
period 3.
Period Forecast Demand Inventory
I 7.3 7.2 9.1

2 7.4 7.3 10.3
3 7.5 7.6 10.9
4 8.5
5 10.1
6 11.3
4. In examining the cost to stock the following three product lines, the following
data has been collected . What is the carrying cost for each of the product
groups?
ProdGrpI Prod Grp II Prod Grp III
Cost of capital 0.9 0.9 0.9

Insurance 0.4 0.4 0.4
Taxes 1.5 1.5 1.5
Damage and theft 2.5 0.3 1.5
Obsolescence 3.0 0.2 0.8
Storage and handling 6.5 10.5 5.0
5. The accounts payable file for Product AIOO-125 shows the following four
purchase order receipts:
1. 1250 units at $4.55 received l/23 /95

2. 2500 units at $4.65 received 2/27/95
After examining theses past receipts, calculate what the average cost would be.
What would the average cost be if receipts were weighted by a 40% ratio?
6. A distributor receives the following two orders. The first order consists of the
following line items: 10 each #AI00-100 at a price of$22.50, 7 each #B200-220
at a price of $10.50, and 23 each #C I00-450 at a price of $15.45. The second
order consists of 12 each #A I00-100 and 18 each #C100-450. The on-hand
balance for these items is as follows: #AI00-100 = II units, #B200-220 = 25
units and #CI00-450 = 12 units. Calculate the following:
I. The piece fill rate

2. The dollar fill rate
3. The line fill rate
4. The order fill rate
REFERENCES
1. See the discussion in Plossl, George, Production and Inventory Control:

Principles and Techniques. 2nd ed. Englewood Cliffs, NJ: Prentice Hall, 1985,
p. 18 and Ross, David Frederick, Competing Through Supply Chain
Management. Boston: Kluwer, 1998, pp. 197-198.
2. Delaney, Robert V., 14th Annual State ofLogistics Report. St. Louis, MO: Cass
ProLogis, June 2003, Fig. 8, The Cost of the Business Logistics System in
Relation to Gross Domestic Product.
3. This postulate is expressed in Ross, Competing Through Supply Chain
Management, pp. 201-204.
4. Editor, "Protecting Inventory During Supply Chain Disruptions," Inbound
Logistics, 22, 11,2002, pp. 18-19.
5. Gopal, Christopher and Cypress, Harold, Integrated Distribution Management .
Homewood, IL: Business One Irwin, 1993, pp. 109-117.
6. Water, C.D.J., Inventory Control and Management. New York: John Wiley &
Sons, 1992, pp. 18-21.
7. Homgren, Charles T., Foster, George, and Datar, Srikant, Cost Accounting: A
Managerial Emphasis. 8th ed., Englewood Cliffs NJ: Prentice-Hall, 1994, pp.
33-34.
8. These definitions have been modified from Homgren, et al., PP 388-189.
9. For more information on these methods see Dudick, Thomas, Cost Accounting
Desk Reference Book. New York: Van Nostrand Reinhold, 1986, pp. 161-194;
Coughlan, Joseph D., "Inventories." In Handbook ofModern Accounting, 3rd
ed. New York: McGraw-Hill, 1983, pp. 16-23 - 16-37, and Homgren, et al., pp.
606-610,620.
10. APICS Dictionary, 9th ed. Falls Church, VA: American Production and
Inventory Control Society, 1998, pp. 21-22.
11. Bowersox, Donald J. and Close, David J., Logistical Management : The
Integrated Supply Chain Process. New York: McGraw-Hill, 1996, pp. 670-672.
12. Bonsack, Robert A, "Inventory Ratios: Reader Beware," In Inventory
Management Reprints. Falls Church, VA: American Production and Inventory
Control Society, 1986, pp. 92-100.
7
REPLENISHMENT INVENTORY
PLANNING
INVENTORY PLANNING TECH- JUST-IN-TIME

IQUES JIT in Supply Chain Management
Understanding Inventory Demand JIT Mechanics
Inventory Ordering Techniques The Future of Supply Chain JIT
INVENTORY REPLENISHMENT INVENTORY REPLENISHMENT

TECHNIQUES - AN OVERVIEW PLANNING PROCESS
Concept of Stock Replenishm ent
Replenishment Review Interval INVENTORY OPERATIONS IN
THE SUPPLY CHAIN ENVIRON-
DEFINING THE ORDER POINT MENT
Defining Inventory Replenish- Concept of "Push" and "Pull"
ment Terms Stocking Multiechelon Warehouse
Reorder Point Basics
Order Point Methods SUMMARY
ORDER QUANTITY TECHNIQUES QUESTIONS FOR REVIEW

The Economic Order Quantity
Replenishment by Item Class PROBLEMS
The final step in the inventory control planning process outlined in Chapter 6
is the selection of the inventory ordering policies that are to guide in deter-
mining what products need to be ordered, when orders should be released ,
and what should be the order quantity. In selecting the proper ordering meth-
od, inventory management has the choice of using two basic techniques :
some form of statistical inventory replenishment or time-phased order point
(TPOP) . The decision to use one or a combination of these techniques is
based on a number of factors, such as the nature of customer demand, me-

chanics of the inventory control system employed, characteristics of the prod-
ucts to be ordered, existence of a distribution channel, availability and type of
enterprise business system possessed by the firm, and how easily information
can be transmitted to and from supply chain trading partners. Determining
the proper replenishment techniques is one of a company's most important
tasks, requiring a firm understanding and application knowledge of both gen-
eral inventory concepts and detailed mathematical models and formulas.
This chapter details the concepts and elements of statistical inventory re-
plenishment. Inventory planners have a wide spectrum of replenishment
techniques available. The first section in the chapter details the contents of
these techniques. From simple heuristic methods, such as visual and period
review, to sophisticated computerized applications, such as Distribution Re-
quirements Planning (DRP) and supply chain optimization, each technique
can be used effectively, given the proper inventory environment. Following
the general overview, the chapter proceeds to a detailed discussion of statis-
tical inventory replenishment, and an in-depth exploration of order point and
order quantity methods. Particular attention is paid to illustrating the relevant
mathematical formulas and their proper application. Once the basics of sta-
tistical inventory control have been reviewed, the chapter goes on to outline
the inventory planning process linking the inventory plan to the purchasing
and value-added processing execution functions to be covered in Chapter 10.
The chapter concludes with an analysis of inventory planning in a supply
chain environment. Topics include deploying inventory in the supply chan-
nel, reviewing the mechanics of push and pull channel inventory management
systems, and correcting channel inventory imbalances. This chapter sets the
stage for the discussion of DRP and supply chain optimization, planning, and
event management computerized techniques found in Chapter 8.
INVENTORY PLANNING TECHNIQUES
Inventory represents perhaps the single largest investment made by the typi-
cal company. Effectively managing this huge investment enables firms to
pursue targeted customer service levels and corporate profitability objectives
and to utilize the capabilities and capacities of the enterprise to attain and
sustain competitive advantage. Fundamental to leveraging inventory is deter-
mining when procurement orders are to be released and what the order quan-
tity should be. Selecting the proper ordering technique is the primary re-
sponsibility of inventory management who must facilitate the actualization of
business objectives while executing inventory planning and control functions
REPLENISHMENT INVENTORY PLANNING 299
designed to achieve least total cost and high serviceability for inventory,
transportation, warehousing, and staffing.
UNDERSTANDING INVENTORY DEMAND
Before a planning method can be selected, inventory planners must determine

the nature of item demand. According to Orlicky [1], the nature (or source)
of item demand provides the key to inventory ordering technique selection
and applicability. The principle guiding inventory management can be found
in the concept of independent versus dependent demand. Demand for a given
item is independent when such demand is unrelated to demand for other
items. The source of independent item demand comes from direct orders
arising from customer and interbranch requirements. For the most part, de-
mand for products in the distribution environment can be described as in-
dependent demand . Inventory is usually received as a finished product from
the manufacturer, warehoused, and then sold directly to the customer. The
prime characteristics of independent demand are the following:
Demand for these items is independent of company inventory decisions
Demand for these items is subject to a level of random variation
These items are usually planned and managed without reference to
other items
Planning for these items usually involves the use of forecasting tech-
niques designed to foretell future demand based on past historical usage
These items are best planned with some form of safety or reserve stock
to counterbalance forecast error
The critical question for inventory availability is one of quantity rather
than timing
Conversely, an item is subject to dependent demand when it is directly re-
lated to, or derived from, demand for another part. Item dependencies can be
described as vertical, such as when a component is required to build a subas-
sembly or finished product, or horizontal, as in the case of an accessory that
must accompany the product. Dependent demand is characteristic of produc-
tion inventories in a typical manufacturing company. Manufacturers will pur-
chase raw materials , components, or subassemblies that are never sold as re-
ceived but are stocked and then issued in matched sets to build the finished
products the firm does sell. This demand can be conceived as being created
internally as a function of scheduling items to be converted into higher-level
assemblies and finished products. Dependent items can be described as
follows:
Dependent items are always planned and managed in relation to other
items as detailed in the Bills of Material in which they are specified
Replenishment quantities for production inventories can be precisely

determined by referencing the source of the demand
Future demand for production inventories should never be forecasted
Management inventory planning decisions directly impact the demand
for these items
Dependent demand items rarely us ~ safety or reserve stocks
The critical question for inventory availability is one of timing rather
than quantity
In some cases, a given raw material item, component, or subassembly can be
subject to both independent as well as dependent demand. Dual demand can
exist for components sold separately in spare-part service. Figure 7.1 pro-
vides a simple example of a Bill of Material structure containing items sub-
ject to both independent and dependent demand. In such cases, the portion of
the demand on the item that is subject to independent demand must be plan-
ned by using some form of forecast. This forecasted demand is then added to
the item's calculated dependent demand to provide the total demand.
Independent Demand A
I I
Dependent I
Independent Demand B C
Demand '\. I Dependent
(Service Part) ':ll I I
Demand
D E
Dependent Dependent
Demand Demand
FIGURE 7.1 Independent versus dependent demand .
Determination of item demand status is the first step in selecting the appro-
priate inventory planning technique . Independent demand items are best
planned using ordering methods that utilize forecasts to project demand into
future periods. Such techniques plan products based on individual item de-
mand magnitude without reference to other items. Dependent demand items,
on the other hand, are best planned using time-phased inventory planning
techniques (like Material Requirements Planning (MRP that link items to-
gether so that matched sets of components can be ordered together and in the
proper quantities as specified in the product structures to which they belong.
INVENTORY ORDERING TECHNIQUES
In a business environment where the demand is constant and goods arrive in

small lots just as they are needed to satisfy customer requirements, companies
can function with little or almost no stocked inventories. In most environ-
ments, however, neither of these two constants are possible. The small quan-
tity of cycle stock that would be available could not guarantee that adequate
stock would always be on hand to satisfy customer demand. Inventory plan-
ners, therefore, must use replenishment techniques that provide sufficient
coverage of demand requirements while constantly searching for methods to
reduce carrying costs. There are many types of systems for planning and con-
trolling inventories . Some are very simple techniques that utilize rule-of-
thumb heuristics . Other systems require complex mathematical and com-
puterized models. Regardless of their sophistication, all ordering techniques
attempt to answer the following fundamental questions:
What is the demand?
What is currently available?
What is on order?
What will need to be ordered?
When will orders need to be released?
How much should be ordered?
How a firm seeks to answer these questions is critical in selecting the pro-
per inventory management method . Replenishment decision models for prod-
ucts subject to independent demand can take many forms, but they are all re-
lated to one of the following:
Visual Review System. This method consists of a relatively simple inven-

tory control technique in which replenishment is determined by physically re-
viewing the quantity of inventory on hand. If replenishment is required, a tar-
get quantity is ordered that restores balances to a preestablished stocking lev-
el. Replenishment levels are determined by such simple decision rules as re-
order when the bin is half-full, or when there are two pallets of stock re-
maining. Visual review systems can be used effectively for very low-volume
or low-cost items with short lead times and for controlling floor stocks lo-
cated near the point of use. The prime advantages of this system are that the
cost for record keeping and the training level for employees are minimal. The
disadvantages are that there is no way to ensure items are being reviewed on a
timely basis, random storage may make it difficult to view all of the stocked
inventory on a given item, and reordering rules are rarely updated to reflect
changes in current demand, supply, and lead-time patterns resulting in either
overstocks or shortages.
Two-Bin System. Classically, this technique is a fixed order system in which

inventory is carried in two bins (or some other form of container), one of
which is located in the picking area and the other is held in reserve in a non-
picking location in the stockroom. Procedurally, when the picking bin is
emptied, the reserve bin is brought forward to service demand. The empty
bin serves as the trigger for replenishment. The quantity required per bin is
calculated as the minimum stock necessary to service demand while waiting
for the arrival of the replenishment stock from the supplier. When the pur-
chased quantity arrives, it is placed in the empty bin and stocked in a non-
picking location until the picking bin's inventory is depleted. The advantages
of a two-bin system are ease of record keeping and physical control. The dis-
advantages are the system requires procedural training and discipline. In ad-
dition, bin quantities are rarely adjusted properly to keep pace with changing
demand patterns.
Visual review and two-bin systems are widely used for inventory control.
These techniques are easy to understand and implement and cost very little to
operate. Because they are so easy to use, however, they can be abused and
misapplied. The following points must be taken into consideration when
using these two techniques :
They are best used for very low-cost, bulk or low-volume items whose
replenishment lead times are short. Items using these methods for the
most part would be classified as C items in an ABC Classification dis-
tribution.
These techniques require carrying relatively high levels of inventory on
low-value items. Because stocking levels are not tied directly to cus-
tomer demand, these two methods will result in needlessly high levels
of inventory.
These techniques are insensitive to changes in demand patterns. Both
methods require that a specific order quantity be established. For the
most part, the quantity determined is made using demand character-
istics of the inventory at the time the decision rule is calculated. Rarely
are these quantities adjusted to reflect actual demand through time.
The advantage of using these techniques is discounted if the time and
money saved is not used to establish tighter controls over high-value,
high-volume items.
The use of visual controls is usually associated with loose transaction
control, whereas perpetual record keeping is associated with tight con-
trols over inventory. Neither is necessarily true. The key to selecting
an inventory ordering technique is to match the level of cost control re-
quired with the inventory value of each stock item. As an example, be-
cause of its very high usage, a low-cost item, such as a fastener, may be
classified as an A item. Using a visual control technique would be the
appropriate choice for this item because it would ensure required avail-
ability while eliminating needless record-keeping costs.
For those companies involved in manufacture or value-added pro-

cessing, the assembly of a finished good item requires the availability
of Class C as well as Class A items. Poorly controlled C items will re-
sult in item shortages, preventing the completion of manufactured prod-
ucts. The basic rule for managing low-cost items using a two-bin sys-
tem is to "have plenty on-hand".
Periodic Review. In this ordering system, afixed review cycle is established

for each product, and replenishment orders are generated at the conclusion of
the review to meet a predetermined max stock level. The review cycle can be
established in days, weeks, months, or quarters, whichever best satisfies the
demand requirements . This method is also called a fixed-cycle/variable-or-
der quantity system . There are several advantages to using this method. It
does not require perpetual inventory record keeping and is inexpensive to use.
The system, also, can be maintained manually without the use of a computer.
Periodic review is best used to control large inventories characterized by
many small issues, such as occurs in a grocery store or an automotive small
parts service business.
Order Point. In this ordering system, a targeted stocked quantity is deter-

mined that is used as the order point. When the inventory position falls be-
low this stocking point, reorder action must be taken to replenish quantities
back above the order point. The quantity to order can be manually deter-
mined, or some form of economic order quantity (EOQ) can be used. This
method is also called a fixed-order quantity/variable-cycle system. Unlike
visual review, two-bin, and periodic review methods, the order point tech-
nique requires close perpetual inventory transaction control. As receipts, ad-
justments, scrap, shipments, transfers , and so on occur, the inventory control
function must perform record keeping activities that enable planners to deter-
mine whether resulting balances have fallen below the assigned stock trigger
levels and warrant replenishment action.
Time Phased Order Point (TPOP). Whereas the replenishment review and
action mechanisms of the four methods discussed above are different, con-
ceptually they are all closely related. Each attempts to establish the point
when a replenishment order needs to be generated to prevent stockout in the
face of normal demand and then to suggest an economic or target order quan-
tity to be purchased. In contrast to these systems, TPOP is a computerized
management tool that plans inventory needs in a priority-sequenced, time-
phased manner to meet customer and forecast demand as it occurs. This tech-
nique is at the heart of MRP and DRP systems used for the control of manu-
facturing and distribution channel inventories . The major advantage of the
TPOP method is that inventory order action is triggered by matching supply

with anticipated demand as it occurs in time. At the point where demand ex-
ceeds the supply, the system will alert the inventory planner to order the item
according to a predetermined lot size and to have it available at the antici-
pated date on which stockout will occur. In addition, each time the TPOP is
generated, the system will resequence demand and supply relationships and
suggest a new set of required order actions for the order planner. This meth-
od will be reviewed in detail in Chapter 8.
Just-In-Time (JIT). During the past decade, the use of JIT techniques to run
supply chain inventories has been growing. Although the technique origi-
nated on the manufacturing floor as a way to eliminate waste in the produc-
tion process, supply chain planners have found that JIT offers them an ap-
proach targeted at eliminating waste in such logistics system functions as
transportation, warehousing, and quality control. In addition, JIT provides
supply channels with new opportunities for inventory control, purchasing
management, and buyer-supplier relationships . JIT techniques can be found
in the use of such tools as Kanban cards to trigger inventory replenishment
and the development and execution of purchasing contracts that ensure prod-
uct quality and delivery.
Supply Chain Optimization. Increasingly, inventory management in the

twenty-first century will require planning systems that enable the optimi-
zation of inventory, not just within an individual company, but within entire
supply chains. As product life cycles continue to shrink and global sourcing,
spurred on by the Internet, expands, it will be the ability of whole supply
chains to rapidly and efficiently move product through the supply channel
network that will determine market leadership. Based on TPOP application
logic and JIT principles, a new breed of inventory control system termed sup-
ply chain planning (SCP) has begun to supplant the primacy of former meth-
ods of inventory management that were restricted to the four walls of the en-
terprise . Utilizing sets of optimization rules and driven by individual compa-
ny MRP/DRP business applications, these supply management systems en-
compass a variety of critical functions including demand planning, supply
planning, strategic network optimization, fulfillment scheduling, and col-
laborative forecast and replenishment management. The goal of the whole
process is to utilize optimization formulas to determine the best possible dis-
tribution of inventories across the supply channel that meets criteria for the
lowest total cost while responding to forecasted and actual demand. These
advanced SCM toolsets will be reviewed in detail in Chapter 8.
Each of these inventory ordering techniques can be used effectively by
supply chain planners for stock replenishment. In fact, all of the techniques
address the ordering needs of products that are subject to fairly continuous
and independent demand, such as finished goods and service parts inven-
tories. With the exception of TPOP and JIT, these techniques are not in-
tended for component and subassembly items where demand is subject to lot
sizes and is dependent on higher-level assemblies. In choosing one or a com-
bination of these techniques , channel planners need to examine such elements
as the level of planning and control desired, item cost, item physical charac-
teristics, resupply lead time, continuousness of demand, dollar-value usage,
storage and handling requirements, shipping characteristics, and the avail-
ability of data processing systems.
INVENTORY REPLENISHMENT TECHNIQUES - AN

OVERVIEW
Before the mechanics of the various forms of statistical inventory replenish-

ment are explored in detail, it is useful is describe the scope and elements
common to the available methods.
CONCEPT OF STOCK REPLENISHMENT
Of the inventory planning techniques described above, visual review, two-bin

system, periodic review, and order point are defined as belonging broadly to
the concept of stock replenishment. The theory behind stock replenishment is
that for each item, an optimal stocking and ordering quantity can be deter-
mined either statistically or through some form of validated heuristic. Re-
plenishment means to become full again; to restore to a state of original ful-
lness. Simplistically, the object of stock replenishment techniques is to en-
sure that the optimum stocking level for each item is maintained at a targeted
service level. Stock replenishment techniques are structured to compensate
for the inability of planners to determine the precise timing and quantity of
demand in the short-term future. As it is often difficult to calculate exactly
when a customer order will arrive, planners using replenishment techniques
must project the anticipated demand and always have sufficient on-hand stock
to satisfy the customer orders that do materialize. Incorrectly determined in-
ventory levels or failure to resupply on a timely basis risks item stockout.
When viewed from the standpoint of planning, inventory balances can be
said to consist of two functions. The first function, termed cycle or working
stock, can be described as inventory that provides the firm with the ability to
respond to the average level of customer demand occurring during the period
between replenishment order release and receipt. The second function of in-
ventory, termed safe ty or buffer stock, is to provide additional inventory that
is added to cycle stock in the event of variance in the normal distribution of

demand. The critical factor is determining when resupply order action should
occur to preserve the integrity of inventory serviceability.
The triggering mechanism that alerts planners to that a stockout is eminent
is some form of order point. Whether it is derived using a mathematical
model or rule of thumb, the order point provides the planner with a message
to order that must be acted on to avoid a stockout. Order points attempt to
estimate demand during the replenishment lead time, to which is added a
calculated safety stock to compensate for possible fluctuation in demand.
Once the order point has been tripped, an appropriate stock replenishment
order needs to be created. The calculation of the exact quantity to order has
historically been a hotly debated topic. Whether it be a simple or complex or-
dering technique , each attempts to strike a balance between the cost of or-
dering and the cost of stocking inventory. The more an item is ordered, the
less the stocking cost but the greater the overall cost of ordering. Conversely,
the less an item is ordered, the less the ordering cost, but the greater the
stocking cost. Choosing a replenishment technique is, therefore, more than
selecting the appropriate models; it is also a strategic decision to choose an
inventory planning concept that requires planners to structure customer ser-
vice and inventory control around how costs are to be accumulated.
Visually, the inventory replenishment concept can be illustrated through
the use of a saw tooth chart (Figure 7.2). The chart illustrates for a given
Review Cycle
Quantity I 1 --+-- 2 3 ---;
,-,-,-,-,..,-.
Order
Point
-!- -L;:; - j- - - - - - - - - - - - -
! Time ~ Safety Stock
FIGURE 7.2 Basic order point model.

product the relationship of the critical replenishment elements such as safety

stock, stocked balance, order point, and order quantity. Mechanically, the
model functions as such. At a given moment in time, the quantity of the
product in inventory is indicated by A . At this point, the quantity is suf-
ficiently large enough to satisfy the normal anticipated demand through time.
As customer orders consume inventory, the stocked quantity is reduced, as
shown by the downward-sloping line. When the inventory reaches the pre-
determined order point, the system alerts the inventory planner to release a re-
plenishment order that will restore the stock level to some point above the or-
der point. The remaining inventory continues to be consumed by customer
demand during the replenishment lead time until the supply order is re-
ceived. Because in real situations it is extremely difficult to calculate with a
great degree of precision customer demand, the replenishment technique is
best used with some form of reserve or safety stock. Whether or not this in-
ventory is actually consumed depends on random variations in the pattern of
demand and supply. In the first two replenishment cycles as shown in Figure
7.2 the safety stock was not impacted by demand. In the third cycle, how-
ever, demand drove available inventory below the safety stock level, and
safety stock was consumed. Once the replenishment order is received, it is
added to the remaining quantity, and the replenishment cycle begins once
again.
In using stock replenishment techniques the following principles should be
understood:
1. The basic components of the method (order points, replenishment quan-
tities, lead times, and safety stock) are fixed, do not reflect short-term
variations, and need to be recalculated and reimplemented to match the
changing dynamics of demand and supply.
2. Exactly when an item will trip its order point is unknown until the ac-
tual moment it occurs.
3. The size of the replenishment order quantity usually corresponds to
some calculation that balances the cost of ordering and the cost of
stocking a given item.
4. With the exception of the fixed order review technique, the interval be-
tween replenishment ordering is variable. The higher the usage, the
shorter the order interval, and vice versa.
5. The reserve or safety stock inventory is considered to be on-hand at all
times to guard against demand and supply variation.
6. Statistically, the inventory balance of a given item will be equal to one-
half the order point quantity plus the required safety stock [2].
REPLENISHMENT REVIEW INTERVAL
One of the fundamental decisions that must be made when using inventory re-
plenishment techniques is determining when an item's inventory position
should be reviewed. The inventory review interval can be viewed from two
perspectives. As described above, replenishment models can be described as
subject to continuous (variable-cycle/fixed-order quantity) or periodic (fixed-
cycle/variable-order quantity) review. If demand is constant, these two mod-
els will produce similar results. Differences occur when demand is uncertain.
Replenishment techniques utilizing a continuous review cycle correspond
closely to the example illustrated in Figure 7.2. Order points and variants
like min/max are examples of replenishment systems that require continuous
review to function properly. When using these techniques, planners continu-
ously record inventory transactions that either add or subtract item quantities
from on-hand stock. Each item's quantity level must be examined after each
transaction and matched against the item's established order point. Order re-
plenishment action occurs at the unplanned occasion when the order point is
tripped. Exactly when the order point will be triggered is, therefore, a vari-
able based on actual demand. Continuous review systems do not necessarily
need a computer system to function. Manual perpetual inventory systems
such as "Kardex" or "VISI-Record" have, for years, been used successfully to
control and replenish inventories (Figure 7.3). The availability of affordable
Part Number: A I00-021 I Description : Yz hp Sump Pump

Min Inv: 100 Order Point: 100 Order Quantity: 250
Unit Price: 10.03 Lead Time : 5 days Notes: Boxed Unit
Date PO Quantity Quantity Order Quantity Balance

Number Ordered Received Number Issued Quantity
011303 95
011703 12356 250 250 345
012003 4985 35 310
012203 4993 56 254
V ~
FIGURE 7.3 Kardex card.
computers and software, however, have all but made manual methods obso-
lete. Tools such as bar code readers and wireless scanners are pushing in-
ventory accuracy and timeliness of reporting to new dimensions necessary to

profitably manage the inventory systems of the twenty-first century.
The mechanics of a periodic review system, on the other hand, are very dif-
ferent from continuous review. There are two critical components of periodic
review that need to be established by inventory planners on an item-by-item
basis: an order-up-to inventory level and a fixed review interval. As the re-
view interval date for each item arrives, inventory planners will order for
each item under review sufficient quantities to raise the inventory position to
the order-up-to point. During the period in between order intervals, inventory
stocking level records are not reviewed, resulting in considerable uncertainty
as to the actual inventory balance. Sufficient inventories are assumed to have
been ordered at the time of the previous review to last until the next interval
without stockout.
The use of continuous and periodic review systems pose several distinct
advantages and disadvantages as illustrated in Table 7.1. The most obvious
TABLE 7.1: Continuous Versus Period Review Systems
Issue Continuous Periodic

Maintenance expense x
Ordering by item family X
Lower inventory investment X
Replenishment predictability X
Overall control X
Fast moving items X
Slow moving items X
Higher customer service X
Computerization X
Lower purchasing costs X
distinction between the two systems is operational expense. Continuous re-

view requires significant manpower and computerized resources to analyze
and keep inventory balance records accurate. A periodic review system, on
the other hand, does not need ongoing transaction control and requires item
review only when the order interval occurs. Whereas continuous review sys-
tems permit greater overall inventory and item cost control, periodic systems
provide planners with replenishment predictability. Because the review cycle
is fixed, inventory management can plan resources and budgets for inventory
review at minimum cost. In regard to item control, continuous review is best
used to control fast-moving products, whereas periodic review is best used
for slow-moving items and for products ordered together in product families.
Finally, continuous review systems provide for higher levels of customer ser-
viceability by providing timely on-hand balance status and safety stock pro-
tection against random variation in demand. The choice of continuous or
period review systems depends on several factors such as customer satis-
faction strategies , product cost, storage and transportation, and the avail-
ability of information systems and support staffs.
DEFINING THE ORDER POINT
This section is concerned with the anatomy of the order point technique.
Order points attempt to answer two key questions:
1. When should the inventory balance of a given product be reviewed for
possible replenishment action?
2. When should a stock replenishment order be released?
In answering these two questions, several possible techniques can be used.
During the course of the section to follow, the most commonly used methods
and their calculation components will be discussed.
DEFINING INVENTORY REPLENISHMENT TERMS
Although Figure 7.2 illustrates the basic mechanics of the inventory replen-
ishment model, it may be useful at this juncture to define in detail each of the
components of the model.
On-hand inventory. This is the quantity that the perpetual inventory
system shows as being physically in stock regardless of open orders and
allocations . This value should never be negative. The on-hand inven-
tory is the starting point for the replenishment calculation.
Available inventory. The available inventory value is calculated by
subtracting from on-hand inventory all order demand quantities,
whether allocated or unallocated . The balance remaining is the quan-
tity available to immediately satisfy new customer demands. This va-
lue can be negative if open customer orders exceed on-hand inventory.
Inventory position. This quantity is a logical value that is determined
for a given item by subtracting the inventory requirements generated by
open customer and interbranch transfer orders, allocated (committed),
and backorders from the total on-hand stock and expected on-order in-
ventory. Determination of this value is one of the fundamental ele-
ments of the inventory replenishment calculation.
On-order inventory. On-order inventory is replenishment stock that has
been ordered but has not yet been received. Although the inventory
position calculation considers on-order inventory as if it were on-hand,
this stock should not be allocated to open customer orders or existing

backorders within the replenishment lead time.
Safety stock. This is a quantity of inventory added to the calculated in-
ventory balance to support unplanned variances in demand during the
replenishment cycle. If available inventory was planned to be at zero
just as the replenishment order is received, then the safety stock would
be set to zero. Safety stock provides a buffer guarding against possible
stockout caused by variations in demand and supply. Calculating the
size of a safety stock value is normally dependent on the desired level
of customer serviceability without incurring a stockout.
REORDER POINT BASICS
The replenishment order point (OP) is classically expressed by the following

formula:
OP = Anticipated demand during lead time + Safety stock.
For example, if the average historical usage (sales) for a given item is 100
units a week, the replenishment lead time from the supplier is 2 weeks, and
the safety stock is 50,
then:
OP = 100 (usage) x 2 (weeks) + 50 (safety stock) = 250 units.
In other words, the order point consists of sufficient inventory to satisfy pro-
jected customer demand (usage) while waiting for stock replenishment orders
to arrive (lead time), plus a quantity of reserve inventory (safety stock) to ac-
count for variation in supply and demand. Before proceeding further, it is im-
portant to review in detail each of the elements of the order point calculation.
Item Usage. Of the elements of the order point formula, calculation of usage
is perhaps the most important. Usage can be defined as the quantity con-
sumed by demand for a designated period of time. Demand originates from a
number of sources. It can come from actual customer orders, interbranch re-
supply requirements originating from satellite warehouses in the distribution
network, production processing, and internal company needs. In calculating
order point usage, planners must first be certain that all demand transactions
are posted. Inventory history is recorded for all types of transactions from re-
ceipts and adjustments to transfers and scrap. In compiling historical usage
used in the order point calculation, only valid demand should be considered.
Customer orders, for example, are always considered as historical usage.
On the other hand, transactions created by interplant transfers and inven-
tory expended for internal use, such as assembly, kits, and so on, need to be
closely examined before being counted as order point usage. Normally, trans-
actions generated by interplant transfers from the manufacturing plant or the
central ordering warehouse to satellite warehouses should be considered as
valid order point usage. In this case, the satellite warehouse should be con-
sidered as an internal customer whose requirements are as important as the
supplying warehouse's external customers. When, however, a satellite ware-
house transfers goods to another satellite warehouse, the transactions should
not be considered as order point usage. The reason for this is simple. When
the collective demand for both warehouses is calculated and orders placed on
the supplying warehouse , the demand will be overstated by the satellite-to-
satellite warehouse transfers . Replenishment inventory planning in a supply
chain environment will be further discussed later in this chapter. Finally, all
forms of internal usage, that is, for components consumed in the production
pro-cess, should never be included as part of order point usage. Such items,
in fact, are really subject to dependent demand and are best planned through
the use of Material Requirements Planning (MRP).
Accurately estimating usage is a critical part of the replenishment system.
According to Graham [3], calculating usage has three requirements:
1. Usage must be developed for each inventory product independently.
2. Usage must be expressed as a specific number of units.
3. Usage must be related to a defined time period.
All three of these requirements rest on a simple assumption: The actual de-
mandfor inventory that occurred in the immediate past will most likely be re-
peated in the immediate future. In other words, if sales for the past 6 months
of a given product averaged 225 a month, then it can be safely assumed that
sales for the next month will also average the same amount.
Obviously, even though this assumption must be used with caution. When
demand for a given product during replenishment lead time is, indeed, level
or deterministic, inventory planners can safely assume that future demand
will be similar to the past. In reality, planners can rarely count on products
having such predictable and constant demand. As a result, order points are
best planned by determining the past demand usage combined with either his-
torical or forecasted estimates of the fluctuations around that expected usage.
Adding additional inventory to meet the expected deviation from a product 's
historical demand will permit planners to avoid possible stockout.
Often inventory planners will observe upward or downward trends in de-
mand for a given product through time. Although the calculation of a new us-
age average, say on a monthly basis, will adjust the current usage to accom-
modate trend variations in the past usage average, the new value will lag be-
hind actual demand. A simple calculation that adjusts expected usage during
lead time for trend is expressed as:
New order point usage = (Expected usage demand) x (Lead time).
Calculating a trend p ercentage to be factored against the current usage is the

key to the formula. Determining the exp ected usage demand involves a three-
step process. In the first step, the current trend must be computed as
exhibited by
Current trend = New usage average - Old average.
In order to eliminate random variations in the demand, the current trend needs
to be smoothed by using
New trend = a (current trend) + (l - a)(old trend).
Once the correction for trend lag has been determined, the new expected
order point usage can be computed as
I -a
New order point usage = New average + (new trend).
a
The result of these calculations will permit the planner to determine expected
usage based on actual versus estimated trends occurring through time. Peri-
odically, the usage for all products would have to be updated so that valid or-
der points could be recalculated .
In addition to products exhibiting trend usage, inventory planners are often
required to calculate usage for items exhibiting random demand patterns.
Random demand means that values of demand examined at selected points
through time exhibit little or no correlation with past values. The best way to
calculate random demand usage is to use as much historical data as possible
to arrive at the new expected usage. The formula is
Newaverage = a (current demand) + (l - a) (old average).
Finally, many companies have inventory subject to cyclical or seasonality

patterns. As time passes, demand usage for such products rises and declines
according to regularly expected cycles. Planning such products involves two
calculations. The first seeks to arrive at a ratio of the current month's demand
and the previous period demand, and then computing the new order point by
comparing the ratio with the demand in a corresponding period the previous
year or several previous years. This ratio is expressed as
Demand in the current month

Demand ratio == ----------------------------------------------------------
Value of the base series for the previous month
For example, if the demand at the end of February of a given year was 100
and the base series for January was 95, the demand ratio would be 1.05. If a
given item had a three month lead time, determining the new order point at
the beginning of March this year would be calculated based on the base series
of the demand from the same 3 months (March, April, and May) occurring
last year. If the base series for these months were respectively 110, 125, and
130, the expected demand during the lead time would be
110 + 125 + 130 == 365,

Demand during lead time == 365 (1.05) == 383.25.
The variations in demand usage detailed above all represent various meth-
ods of calculating maximum reasonable demand during replenishment lead
time. Selecting the appropriate formula for each stocked product is a time-
consuming affair that must bear the proof of correlation to actual demand
through time. The most appropriate test is to simulate each before one is
finally selected. Usually, the choice comes down to either a technique that
focuses on inventory cost or on customer service. In the final analysis, the
choice depends on the strategic inventory objectives of the firm [4].
Lead Time. While not as complex a concept as demand usage, the identi-
fication of lead-time values necessary for the order point calculation can be a
slippery affair. Lead time can be defined as:
the total amount of time that spans the period beginning from the date an
inventory replenishment order is identified until the date the stock is received,
located, recorded in the inventory control system, and available for sale.
As is emphasized above, valid lead times provide the buyer with the total
time it will take to identify, order, and have inventory ready for sale. The ele-
ments of distribution lead time are the following:
Replenishment order action identification. The time it takes for the in-
ventory planner to review and select products for replenishment order
action. Time elements at this stage are composed of such activities as
visually reviewing stock levels or analyzing an order point status
report.
Order preparation. Once products to be ordered have been identified ,

time must be allocated for such order preparation actions as purchase
order entry or grouping product lines to meet supplier discount require-
ments. Another important element at this stage is the time it takes to
search and select the proper supplier, as well as any pricing or trans-
portation negotiation that must transpire.
Order transmission. Purchase orders need to be printed, verified and
transmitted to the appropriate supplier. Technology tools, such as EDI
and the Internet, have significantly reduced the time required for order
transmission almost to a matter of moments.
Supplier processing time. This is the total time required for the sup-
plier to process the order, pick and pack it, and transport it to the cus-
tomer.
Receiving. Once the replenishment order arrives, time is spent in such
activities as receiving and checking, quality control, and staging.
Item restocking. This final element of lead time is composed of receipt
movement, put-away, and any final information recording. Once the re-
ceipt quantity has been recorded as being available for customer ship-
ment, the product 's lead-time cycle can be considered as being com-
pleted.
Lead times are notorious for being approximations or estimates rather than
a precise value that inventory planners can consider as fixed constants. When
determining lead times exhibiting variability, several techniques can be used.
In one method, planners could designate a lead time for a product long
enough to include all reasonable resupply timing occurrences . Another tech-
nique is to average the actual recorded lead times and use that value, or a
smoothed value, as the valid lead time for the next order. In today's fast past
environments, approximations and rule-of-thumb techniques are falling into
disfavor. Customer service strategies are not only demanding firm lead times
but also process improvement programs aimed at continuously shortening
every step in the fulfillment process.
Safety Stock. If a company had a totally captive marketplace where cus-

tomer demand was deterministic , historical usage during lead time could be
calculated accurately with a great deal of certainty. In such an environment,
safety stock would be unnecessary. Supply orders would arrive just in time
to replenish stock to meet new demand. In reality, demand usage is subject to
uncertainties . A wide variety of factors, such as prevailing economic con-
ditions, cycles in popular taste, government regulation, technology, and
changes in customer buying habits, transit times, order processing times, and
production schedules, can cause wide variances in demand. In addition, un-
certainties caused by variations in supplier lead times and delivery quantity

and quality can expose the firm to potential stockout. Of these elements,
variances in demand and lead time have the most unfavorable impact on sta-
tistical planning models.
Table 7.2 provides an example of the average weekly demand for a product
for a 10 week time period. Lead time is 1 week, and demand has normally
averaged around 1000 units per week. The order point calculation would
place the order point for this product at 1000 units (1 week lead time x 1000
average usage = 1000 units). Actual customer orders for the item during the
past 10 weeks, however, have ranged from as small as 550 units to as large as
1425 units a week. Whereas it is true the 1000 unit order point satisfies the
average demand, there were occasions when actual orders exceeded the avail-
able inventory and the item was stocked out. In fact, 4 out of the 10 weeks ex-
perienced demand that exceeded the average inventory. In order to protect
against stockout, the order point could be augmented with an additional safe-
ty stock quantity of 425 units. Historically this inventory buffer should then
prevent a future stockout from occurring. However, by stocking the max
quantity the firm would incur excess inventory carrying costs during the 6
weeks when demand was either at or below the weekly average.
TABLE 7.2 Instance of Item Demand
Week Quantity Average Deviation
1 550 1000 450

2 1350 1000 -350
3 1175 1000 -175
4 1000 1000
5 750 1000 250
6 1425 1000 -425
7 675 1000 325
8 1000 1000
9 1300 1000 -300
10 875 1000 125
Absolute deviation 2400
In calculating safety stocks, inventory planners must decide on just how

much of an inventory buffer is to be kept on-hand. A firm, obviously, could
not possibly carry inventory to cover all probable levels of demand for all the
products stocked. If demand is lower than the expected demand, the firm can
expect high customer service levels but accompanying high inventory
stocking costs. Conversely, if demand is higher than expected, inventory car-
rying costs will drop, but so will customer service.
There are several methods of determining just how much safety stock
should be kept. Traditionally, inventory planners have used a number of
rules of thumb for determining safety stock quantities. One method is to keep
a month's supply as reserve. Graham recommends that 50 percent of the us-
age times the lead time be used as safety stock [5]. Another popular method
is to determine safety stock based on safety days or a safety percent. The
formula for the first is expressed as: number of safety stock days times the
daily average demand. The second formula is stated as: safety stock percent
times lead time times the daily average demand. Regardless of the technique,
determination of the safety days or percent variable is based on a manage-
ment decision. A negative to these approaches is that while the management
policy variable may be set high enough to give acceptable service to products
with a high standard deviation , unfortunately there will also be considerable
wasted safety stock on products whose usage patterns permit the application
of more precise forecasts.
More sophisticated models of safety stock calculation attempt to determine
safety stock by utilizing the standard deviation of forecast errors. Basically,
the calculation utilizes a management policy regarding a desired service-
ability percent that is matched to a table of standard deviations of forecast er-
ror (usually between zero and three) times the square root of replenishment
lead time. The first step in calculating safety stock is computing the normal
distribution of demand. Statistically, the instances of demand tend to cluster
around the average demand and are measured by the deviation from the mean.
The assumption of normality makes it possible to establish a direct relation-
ship between the extent to which demand deviates from the mean and the pro-
bability of a stockout occurring. Figure 7.4 illustrates this concept using the
1000
I 10 = 300 unit s 870 1175
1300
750
1350
675
1425
550 I
I
I
I I
I I
I I
400: :1600
I
, .
+ / 10
68.26%
\ .
+ / - 20
95.44%
I
............ . ... . . . ... ... . .. . . . ... . . . . ... ... .... . . . . .. . . . . .. .. ... 1
Figure 7.4. The normal distr ibution.

demand history for the product described above. The key mathematical com-
ponent in working with normal distribution is the application of the standard
deviation (CT, or sigma) from the mean . Statistically, one standard deviation
(or 10-) accounts for +/- 34.13 percent of the deviation from the mean. A
standard deviation of 20- would add an additional +/- 13.59 percent, and 30-
would add +/- 2.15 percent to the mean. Calculation of the actual standard
deviation from the average for the product appearing in Table 7.2 is compu-
ted by dividing the absolute deviation by the number of periods to attain the
mean absolute deviation and then multiplying this figure by the mean abso-
lute deviation safety factor comparable to the standard deviation as found in
Table 7.3. The calculation using the data from Table 7.2 is as follows:
TABLE 7.3. Table of Safety Factors
Service Level Standard Mean Absolute

(w/o stockout Deviation Deviation
50% 0.00 0.00
75% 0.67 0.84
80% 0.84 1.05
84.13% 1.00 1.25
85% 1.04 1.30
89.44% 1.25 1.56
90% 1.28 1.60
93.32% 1.50 1.88
94% 1.56 1.95
95% 1.65 2.06
96% 1.75 2.19
97% 1.88 2.35
98% 2.05 2.56
99% 2.33 2.91
99.5% 2.57 3.20
99.6% 2.65 3.31
99.7% 2.75 3.44
99.8% 2.88 3.60
99.9% 3.09 3.85
99.93% 3.20 4.00
99.99% 4.00 5.00
1. Mean absolute deviation (MAD) = Absolute deviation (2400)/10

weeks = 240.
2. Standard deviation = MAD x 1.25 = 240 x 1.25 = 300.
In other words, l er for the part number as illustrated in Figure 7.4 equals +/-
300 units from the mean of 1000.
Once the safety standard deviation has been calculated, it is fairly easy to
adjust the order point to attain a targeted service level. When computing the
safety stock, planners obviously focus on those periods when demand exce-
eded the order point. According to Figure 7.4, a given product subject to pro-
babilistic demand without safety stock can be expected to provide a 50 per-
cent customer service level over the long run. If the planner calculates a safe-
ty stock quantity based on one standard deviation, sufficient inventory will be
stocked to cover an additional 34.13 percent or a total of approximately 84
percent of demand during replenishment lead time. For the product detailed
in Table 7.2, one standard deviation equals 300 units. When combined with
the current average usage of 1000, the new order point would equal 1300
units. If two standard deviations were used in the calculation, the new order
point would be around 1600 units, providing a serviceability level of approxi-
mately 98 percent. This relation is illustrated in Figure 7.5. In using the
MAD safety stock calculation , inventory planners must be careful to ensure
that the actual average demand and the historical usage are equal. For ex-
ample, if the item's demand was consistently above the forecast, the average
historical usage element in the order point should be recalculated. The result-
ing new order point would reduce the amount of deviation during replenish-
ment lead time and, therefore, reduce the amount of safety stock required.
Safety Stock
900 ~ '
, :
",,' l
.. ....... .. ......... ......................... ............... ...~.:;.," !
, :
600
"," !
494 . . ... .. . . .... . .. ........ . . . . . ...~~~~~>i" : ij
384 :;. .. 1 1 1
30o -~~;'1
"" 1
-' -: Ii.
1
.i i
l
. :.1
50% 84% 90% 95% 98% 99.86

FIGURE 7.5 Safety stockserviceability
Another method of computing safety stocks is possible when the cost of a
stockout is known. The objective of the exercise is to find a safety stock that
minimizes the total cost of carrying inventory above the order point, as well
as the cost of incurring a stockout on an annual basis. The cost of calculating
the holding cost is straightforward . If the annual carrying cost of a unit is
$2.50 per year and a safety stock of 20 units was determined, the annual car-
rying cost of the safety stock quantity would be $50. To compute the cost of
a stockout, the expected number of shortages for a given safety stock level is
multiplied by the stockout cost by the number of times per year the stockout
can occur. Finally, the stockout cost for each safety stock level is combined.
As an example, assume the following for a given product: The order point
(demand x lead time) is 100 units, the carrying cost per unit is $2.50, and the
stockout cost is $50. The product is ordered monthly. In addition, the prod-
uct has been experiencing the following demand patterns:
Number of Units Probability of Stockout
80 .2
90 .2
Order Point 100 .3
110 .2
120 .1
Following the above formula, the choice of the proper safety stock would be
calculated as such:
Safety Stock Additional Holding Cost Stockout Cost Total Cost
20 (20 units)($2 .50) = $50 $0 $100
10 (10 units)($2.50) = $25 (10)(.1)($50)(12) = $600 $625
o $0 (10)(.1)($50)(12) +
(10)(.1)($50)(12) = $1800 $1800
When analyzing the safety stock calculation, planners would choose the safe-
ty stock with the lowest total cost. In the above computation, a safety stock of
20 would be chosen. The new order point for the item would therefore be 100
+ 20 = 120 units .
The objective of the safety stock computation is to ensure that targeted cus-
tomer service levels can be achieved. Brown [6] feels that customer service
can be measured several different ways. The first is to determine stocking
levels in terms of the expected value of demand (usually in dollars) that will
be filled from available stock. Another metric is the expected number of oc-
casions when orders must be backordered due to shortages. Finally, still
another measurement seeks to establish the expected cost of expediting resup-
ply orders to respond to emergency demand using stock from the best lo-
cation. Basically, service level is determined as the proportion of occur-
rences of customer demand satisfied from stock. This measurement can be
performed several ways, including the following:
Percentage of orders completely satisfied from stock
Percentage of units required filled from stock
Percentage of units required delivered on time

Percentage of item stockout
Percentage of stock cycles without shortages
Percentage of item-months without stockout
Each of these measurements is calculated against a desired percent of ser-
vice. Obviously, such a percentage could be used effectively in calculating
an order point that would minimize stockouts, assist in the control of inven-
tories, and contribute to overall profitability. A commonly used formula for
calculating safety stock based on the extent to which demand varies about the
mean and the desired level of safety stock is expressed in the following
formula :
SS = ka ~LT
where k is the number of standard deviations above mean demand corre-

sponding to the desired service level, (J is the standard deviation of the level
of demand, and LT is the item lead time.
To compute the new order point when safety stock is required the fol-
lowing formula can be used :
OP ULT + ka ~LT
where U is the usage .

Inventory planners must be careful when calculating safety stocks for a
single site versus a multiechelon channel environment. When calculating
safety stock for a satellite warehouse in a distribution network, the formula
would be based on the standard deviation of the variances in demand occur-
ring in its own usage history. By centralizing safety stock and servicing the
channel from a single location, individual satellite warehouse inventory vari-
ances in demand can be aggregated. Because the standard deviation does not
increase in direct proportion to the aggregated demand, less safety stock
would be carried. In a centralized environment, safety stock would grow
equivalent to the square root of the number of satellite warehouse in the chan-
nel network. The ratio of safety stock in a centralized versus a decentralized
channel system can be expressed as
SSd / SSe = {il

where SSd is the level of safety stock in the decentralized system, SSe is the
level of safety stock in the centralized system, and n is the number of ware-
houses in the decentralized system . The reduction in safety stock resulting
from centralization can be calculated by formula:
SS = SSd [1 - (1 /V1)]
Because the number of warehouses in the channel is greater than one, a cen-
tralized system will always result in less safety stock being carried than in a
decentralized system. Mathematically, the amount of safety stock carried in a
distribution channel would decline by 68 percent by centralizing the com-
bined safety stock inventories from 10 satellite warehouses into just one
national supplying warehouse .
ORDER POINT METHODS
Once the components of statistical replenishment have been determined for

each product, inventory planners have the option of selecting from four basic
order point techniques . These methods can be divided into two types based
on the point when items are reviewed for possible replenishment. Two of the
techniques (order point and min/max) are dependent on a continuous review
cycle, whereas the remaining two (period order quantity and line point) are
considered as periodic review ordering systems. Later in this chapter, the or-
der quantity techniques used by these order point systems will be discussed.
Statistical Order Point. As detailed above, the order point under conditions
of demand uncertainty is determined through the following calculation:
OP = Anticipated demand during lead time + Safety stock.
Visually, the order point system is illustrated in Figure 7.6. When the inven-
tory position for a given item drops below the order point, a fixed replenish-
ment quantity is ordered. Because of the condition of uncertainty of demand,
the actual point that the order point is tripped is determined by actual demand
occurring through time rather than a fixed cycle as it would be if the demand
were certain . Note that the inventory position rather than the net stock is
used as the triggering mechanism. The inventory position is the correct quan-
tity because it includes the available inventory plus all on-order inventory. If
available inventory only was used, replenishment orders could be placed for
stock already ordered, thereby overstating supply.
Statistical order point is best used with independent demand items exhib-
iting little usage variability . The basis of the method focuses on the simple
assumption that future customer demand will closely resemble past demand.
The technique requires that inventory planners continually review both his-
torical usage and lead times so that changes in demand caused by trends,
seasonality, sales promotions, and general economic conditions can be re-

flected in the elements of the order point calculation.
Quan tity
Delyand
~ Potential for
Demand
Order Variation
Point
Safety
Stock
Potential for Stockout
if Safety Stock is not
Carried
Tillie 4
Reple nishment Lead T ime
FIGURE 7 .6 Order point system.
Minimum/Maximum. This ordering technique requires continuous review

and identification of a replenishment order whenever the inventory position
drops below the defined minimum order point. In contrast to the fixed order
quantity found in the statistical order point, the order quantity in this tech-
nique is a variable, sufficient to raise the inventory level to a predetermined
maximum quantity . The technique is called a min/max system because the in-
ventory position should always be a quantity located between the minimum
and maximum stocking values. The minimum quantity can be calculated
using the standard order point formula.
Determining the maximum inventory quantity is a function of demand and
the optimum replenishment order cost. The max quantity can be calculated
for a given item as the order point (minimum) plus the quantity required
during the replenishment lead time. When the minimum's quantity is trig-
gered, the order quantity used in the calculation is always a variable because
it represents the minimum quantity plus the quantity below the targeted maxi-
mum quantity .
Planners often misuse the min/max technique and confuse it with the statis-
tical order point. Min/max should never be used to order from an outside
supplier. Statistical order points are equipped to handle the problems caused
by variations found in historical usage, lead times, and order quantity unit-
cost issues. Min/max, on the other hand, should be used only by satellite
warehouses that receive their inventories from a supplying distribution center.
Interbranch resupply is not subject to the same variations as supply from a
supplier. First of all, the lead time between supply nodes in an internal sup-
ply chain network is usually very short with little or no variation. In addition,
because lead times are short, the satellite warehouse does not have to order as
large a lot as would be necessary if inventory was ordered from a supplier.
The calculations for min/max are designed to assist satellite warehouse plan-
ners keep inventories within restricted stocking space, avoid stockouts, and
maximize inventory turns by setting appropriate upper and lower control
limits .
Joint Replenishment. Often inventory planners are faced with the problem
of buying products that are sold only in a product group (such as an assort-
ment) in order to take advantage of economies arising from reductions in unit
purchase and transportation costs. Literally, when a given product is re-
quired, the supplier will only sell it as part of group of related products and
the planner will have to purchase the entire family consisting of some prod-
ucts that are not yet ready to be reordered. Joint replenishment poses a
unique challenge to the reorder point method . Normally, an individual prod-
uct is flagged for replenishment when the order point is tripped . But, because
all products using statistical replenishment are independent of one another,
their order points are usually triggered at different times, making it impos-
sible to group products together for purchasing purposes. In addition, items
within product families usually experience very different demand usages,
making it even more difficult to link fast-moving items that need to be or-
dered and slow movers that do not. Often planners will purchase product
families regardless of the actual replenishment needs of individual items.
The result is that inventory becomes imbalanced, as fast movers stockout
waiting for slow movers, and slow movers become overstocked as they are
prematurely purchased to prevent stockout of fast-moving items.
The solution to the product line buying problem is the use of an upper con-
trollimit above the normal order point. Joint replenishment ordering invol-
ves determining a common inventory review time for a given product line and
then finding the maximum order point level for each item dictated by its costs
and customer service level. Graham [7J feels that a simple set of calculations
will solve the line buying problem. The concept behind the line point tech-
nique is that the upper control limit for the product line can be statistically
calculated from demand usage during the review cycle and combined with
each associated item's normal order point. The formula for the line point is
Line point = Order point + Usage during the review cycle.
At this point , it may be worthwhile to investigate the contents of this formula.

Because of the diverse usage patterns of items within a given product line ,
they are usually purchased together in fairly regular "cycles." For the most
part, inventory planners have developed a total-order purchasing product line
target, usually expressed in dollars that they use to guide replenishment. This
target could be determined by quantity discounts, shipping minimums, order
dollar minimums, or other criteria. Once the ordering target has been
defined, it is easy to calculate the review cycle by dividing the last 12 months'
total dollars purchase for the product line by the purchase target. The fol-
lowing is an example for a product line :
Last 12 months purchase = $3600

Dollar value required for vendor discount = $150
3600 /$150 = 24 purchases a year (order cycle).
Nonstock items can also be placed in the calculation to assist in qualifying

the purchase. For items subject to seasonality, only periods in season are
used for the computation and are calculated by using demand data from the
same cycle the previous year.
Once the review cycle has been determined, the line point can be calcu-
lated for each item within the product line . The formula is a two-part compu-
tation where an item's order point is first determined and then combined with
the usage quantity during the product line review cycle. An example of the
full line point calculation for a given item is as follows :
1. Usage During Review Cycle Quantity:

a. Average monthly usage = 100 units
b. Review cycle = 0.5 month
c. Usage During Review Cycle Quantity =
100 (monthly usage) / 0.5 month (review cycle) = 50 units .
2. Line point calculation:

a. Factors: Usage rate = 100 units per month
Lead time = 1 month
Safety stock = 50 units
Review cycle quantity: 50 units
b. Order point calculation:
(100 usage x 1 month) + Safety stock = 150 Units .
c. Line point calculation:
150 (OP) + 50 (review cycle quantity) = 200 units.
When the fixed review cycle occurs, all items whose inventory positions are
below both their order points and their line points will be ordered. Items
above the line point will be excluded. Because replenishment orders are only
triggered when they exceed their review cycles, buyers are always assured of
the most economic purchase. Obviously, inventory planners must use the line
point technique with a great deal of caution. The data elements of the formu-
la must be continually updated at least monthly to prevent time and demand
drift. In addition, product lines that have review cycles longer than a month
need to be closely examined to prevent excess inventory buildup.
Periodic Review. Often supply chain planners are faced with replenishing
products that do not lend themselves to continuous review techniques.
Usually, these products are characterized by the following conditions:
1. It is difficult to record withdrawals and additions to and from stock on
a continuous basis . Process-type products, such as liquids or bulk ma-
terials, fall within this category.
2. Items are ordered in product families where economies of scale in order
preparation and supplier discounting make it economical to combine
items in one order. Fasteners, small tools , and office supplies are prod-
ucts that fit this category.
3. Items that have a limited shelf life. Farm produce, chemicals, and food
products are in this class .
4. Significant economies can be gained by ordering full carloads [8].
Such products are managed best by a periodic review system . Products uti-
lizing this method are reviewed periodically and replenishment orders are
launched for each product at each review. The order quantity contains suf-
ficient stock to bring the inventory position up to a predetermined quantity
level.
The periodic review system has often been called the fixed-cycle technique.
Figure 7.7 presents a visual representation of the mechanics of the technique.
Mathematically, the periodic review technique is governed by two formulas:
one to determine the optimal order review cycle and the other to determine
the target inventory level. The review period can be easily calculated by
dividing a product's annually units sold by the EOQ . For example, if the an-
nual usage was 1000 units and the EOQ was 100, then the optimum review
period would be 36.5 days [365 I (1,0001100)]. The formula for calculating
the inventory target level would be expressed as
TI = D(RP + LT) + SS
and
OQ = TI -I,
where TI is the target inventory level, LT is the item lead time, D is the de-
mand rate, RP is the review period, SS is the safety stock, and OQ is the
order
Review Cycle
Target
Inventory 1---- 2 3
jr .. ,.
Demand
~.- Order
I Quantity Replenishment
Receipt
AI it'"
Quantity
SafetyStock
FIGURE 7.7 Periodic reviewsystem.
quantity, and I is the inventory position. For example, the normal weekly us-
age is 1000 units, the review period is every four weeks, the lead time from
the supplier is two weeks, and the safety stock is 500 units. Currently, the in-
ventory position stands at 2250 units. Using the above formula, the target in-
ventory level and the order quantity would be calculated as follows:
TI = D(RP + LT) + SS
1000 (4 + 2) + 500 = 6500
and
OQ = TI - I
6500 - 2250 = 4250 units.
The inventory planner would release a replenishment order for 4250 units .
Combining Techniques. On occasion, supply chain planners may combine

aspects of continuous and periodic review systems to resolve distinct inven-
tory control problems. As an example, for expensive products that ex-
perience excessive lead-time variation, planners can use a mixture of order
point and periodic review techniques . Procedurally, as inventory is deducted

and the order point is tripped , planners will buy up to the maximum quantity.
If the order point is not triggered, the planner has the option of replenishing
stock up to the target inventory level at cycle review time. The only require-
ment for the effective use of such a hybrid system is an inventory control
mechanism that provides for perpetual inventory control.
Another combination is to use the inverse of the above. An order point and
a maximum target inventory level are established, and a perpetual inventory
record is kept of each transaction. If the inventory quantity trips the order
point before the review cycle is reached, a replenishment order is generated
restoring the item balance back to the inventory target. If, on the other hand,
the quantity is greater than the order point at review cycle time, no replenish-
ment order is created even though the inventory position is less than the target
maximum.
ORDER QUANTITY TECHNIQUES
The objective of the order point is to provide inventory planners with answers
to such questions as "When should the inventory position of a given product
be determined?" and "When should a replenishment order be released?" The
key question the order point does not answer is, "What quantity should be or-
dered once the order point has been triggered?" Although it is true that such
techniques as periodic review and min/max provide for the replenishment or-
der quantity based on calculating the variance of the inventory position from
the target inventory level, companies stock many products that require other
methods if inventory is to be replenished effectively and economically. Prod-
ucts subject to lumpy, deterministic, and erratic demand are best controlled
by fixed order quantity systems. Those products, however, that have constant
but varying demand are best replenished through ordering techniques that
seek to balance ordering and stocking costs while maintaining targeted ser-
viceability levels.
In making inventory replenishment ordering decisions, the fundamental re-
sponsibility of planners is to constantly seek ways to reduce relevant costs.
Costs in ordering are, indeed, relevant costs because the size of the replenish-
ment quantity will directly impact the firm's operational costs. There are two
critical costs involved in inventory replenishment. The first relates to pur-
chase order costs. There are several costs related to the frequency inventory
replenishment orders are placed. Some of the costs incurred include the
maintenance of the firm's perpetual inventory system and salaries for plan-
ners. Other costs are incurred with purchasing activities such as supplier ne-
gotianons, purchase order preparation, order transmission, order status

tracking , receiving, inspection, and stock put-away.
The second cost area consists of inventory carrying costs. The decision to
stock inventory commits the firm to costs arising from the size, value, and
length of time that inventory is stocked. Capital invested in inventory, taxes,
insurance , obsolescence, facilities , and handling are all forms of cost that
mount as the level of inventory rises. Other costing issues revolve around
shortage or stockout costs and incremental costs. The latter results from de-
cisions to increase inventory quantities that will require the firm to incur
costs above normal overhead costs. For example, a decision to increase in-
ventories may require hiring a new purchaser, improving existing inventory
control systems, or buying additional material handling equipment.
THE ECONOMIC ORDER QUANTITY
The affect of inventory decisions on costs can be demonstrated by the fol-

lowing example . The annual usage of a given product is 24,000 units. If the
standard cost is $0.25 per unit then the annual purchase cost equals $6000.
The purchasing manager of the firm has calculated that the cost of re-
searching and launching a purchase order is $20. Finally, the accounting de-
partment has established that the cost of carrying inventory is 24%. Based on
these data elements, several possible replenishment quantities could be used
when a purchase order is created . The problem facing the planner is what
should be the optimum quantity used in the order. The optimum quantity is
defined as the quantity that provides sufficient inventory to satisfy projected
demand while minimizing ordering and carrying costs. As illustrated in Ta-
ble 7.4, if, for example, the item was ordered 12 times a year, the annual cost
TABLE 7.4 EOQ Calculation
Order Orders Carrying Reorder Total

Quantity Per Year Cost Cost Cost
2,000 12 $60 $240 $300
4,000 6 $120 $120 $240
8,000 3 $240 $60 $300
12,000 2 $360 $40 $400
24,000 1 $720 $20 $740
of carrying the resultant inventory would be $60 and the annual cost of or-
dering the item would be $240, for a total annual cost of $300. The cost of
carrying inventory is calculated by multiplying the proposed order quantity,
annual carrying cost percent, and the item cost, and then computing the aver-
age. The cost of ordering is determined by multiplying the cost of order prep-
aration by the annual usage, divided by the proposed order quantity. The
equations are
Carrying cost = (QkUC) / 2
Ordering cost = (OCR) / Q,
where Q is the order quantity, k is the inventory carrying cost percent, UC is

the item unit cost, OC is the cost of ordering, and R is the item annual usage.
Figure 7.8 attempts to illustrate graphically the calculations found in Table
7.4. In the example above, ordering the item six times a year would provide
the optimum replenishment quantity.
800
. .....
700
Total Cost .
600 .......... ....
500
-a. .
.
'
400 \>_ . _ op,;m~/.:".~~ . _ / . ~'

.......... . . . . . .
300
200
...
.......... -.. ...
100
50
2000 4000 8000 12000 24000

FIGURE 7.8 EOQ graph.
Obviously, to calculate and graph the economic order quantity (EOQ) in this
manner for a typical firm's inventory is clearly impossible . Fortunately, there
is a square root formula that will significantly speed up the process [9]. Us-
ing the data elements in Table 7.4, the EOQ calculation can be performed as
follows:
2 x Cost of ordering (OC) x Usage (R)

EOQ =
Carrying cost (k) x Unit cost (DC)
When applying the EOQ calculation to the item detailed above, the results
would be as follows
2 x $20 x 24,000 units

EOQ = = 4000 units
24% x $.25
The EOQ formula expressed above uses the average usage history for a whole
year. Graham [10] feels that too much variation can occur by using a year's
worth of history and recommends applying a rolling monthly average of the
past contiguous 12 months. In calculating the EOQ with a rolling monthly
usage, a constant of 24 instead of 2 would be used . The usage then would re-
flect the average rolling monthly usage for a year rather than simply aver-
aging the usage for a calendar year. The EOQ formula can also provide infor-
mation relating to optimal order interval, associated variable cost, and total
annual cost. The optimal order interval (01) would be calculated using the
above values as follows :
2 x OC
R(k x UC)
2 x $20
24,000(24% x $.25)
The associated variable cost (VC) is:
VC = -V 2 x OC x (kUC)R
= -V 2 x 20(24% x $.25)24,000 = $240 a year
By inserting the variable cost into the following equation, the total yearly cost
(TC) can be attained:
TC = UC x R + VC = $.25 x 24,000 + $240 = $6240 a year.
Quantity Discounts. Often planners are required to calculate a replenish-

ment order quantity where the supplier offers discounts based on quantity or
transportation factors. In determining discounted order quantities, trade-offs
between ordering and item costs must be weighed against increases in inven-
tory carrying cost when the replenishment quantity is increased and vice ver-
sa. As an example, for the product detailed above, the vendor has quoted a
$0.05 reduction per piece when a quantity of 6000 units is purchased. The
problem facing planners is that the computed EOQ for the product is 4000
units. Although the unit cost has dropped to $0.20 per piece, a decision must
be made as to whether or not the firm should take advantage of the discount.
The determination of a replenishment quantity involving discounting re-
quires several calculations and ultimately rests on a management decision.
Magee and Boodman [11] suggest a five-step process:
1. Calculate the EOQ using the discounted quantity and unit cost. If the
quantity is within range of the EOQ order minimum, it should be ac-
cepted. The calculation for the item and quantity discount detailed
above would be
EOQ = --V 2(24,000) ($20) / (24%) $0.20 = 4472 units
2. As the quantity computed is less than the supplier's required quantity of

6000 units, the next step would be to calculate the total annual cost for
the discounted quantity. If there were multiple price breaks each would
be calculated .
Total annual cost = $0.20 x 24,000 + $20(24,000/6000) + 24% x

$0.20(6000/2) = $5024
3. Calculate the EOQ for each $0.25 unit price.
EOQ = --V 2(24,000) ($20) / (24%) $0.25 = 4000 units
4. Calculate the total annual cost for each EOQ determined in step 3.
Total annual cost = $0.25 x 24,0000 + $20 x (24,00014000) + 24% x $0.25 x

(4000/2) = $6240.
5. Select the lowest cost from either step 2 or step 4. The minimum cost
order quantity is 6000 units.
EOQ Assumptions. The effective utilization of the EOQ technique rests on

certain assumptions concerning item usage and costs. In the example in Ta-
ble 7.4, the calculated EOQ results in an inventory turnover of about six times
per year (24,000/4000). If the annual usage and the unit cost of the item
dropped to 1200 units and $0.10, respectively, the EOQ would provide far
different results. The EOQ would be as follows:
EOQ = -V 2(12,000) ($20) / (24%) $0.10 = 1414 units

Such a replenishment quantity means that the inventory would turn over once
every 14 months. Although the total cost of the replenishment quantity is
only $141.42, multiplying excess inventory cost by thousands of items is
clearly a negative feature of the EOQ under certain circumstances .
The following are the basic assumptions underlying the effective use of the
EOQ technique :
The cost of the product does not depend on the replenishment quantity.
This means that the cost quoted by the supplier is not impacted by the
purchase quantity or the unit transportation cost.
There are no minimum or maximum restrictions on the replenishment
quantity.
Items considered are totally independent of other items. This means
that the items are not subject to dependent demand, nor do they enjoy
any benefits from joint replenishment.
Lead time is zero (delivery is received as soon as the order is placed).
No shortages are permitted, and the entire order quantity is delivered at
the same time.
The minimum purchase quantity from the supplier is not three or four
times the calculated EOQ.
Purchase order preparation and carrying costs are known and are con-
stant.
Very high or very low product usage needs to be reviewed in relation to
unit costs before applying the EOQ technique [12].
Many of the finished goods inventory carried in the typical supply channel,
maybe as high as 30 percent, has difficulty using the EOQ when determining
the replenishment quantity. In addition, the natures of other products make
the application of EOQ difficult. Products manufactured in a process en-
vironment, such as petroleum and chemicals and items with short shelf life,
are examples.
REPLENISHMENT BY ITEM CLASS
Another approach in ascertaining the replenishment quantity is to use the out-

put from item ABC Classification. In Chapter 6, it was stated that products in
a given inventory could be separated into classes based on transaction, cost,
or other factors. Statistically, the fast-selling products would constitute about
20 percent of the total products and would account for about 80 percent of to-
tal sales. Products in this category would form the Class A items. The next
20 percent of the items would fall within Class B, and about 50 percent
would fall within Class C. The remainder of the products, for the most part,
is composed of dead and obsolete stock that should be reviewed for possible
removal.
The steps in using the ABC Classification for replenishment are as follows :
1. Divide the inventory into classes based on usage/dollar value or other
targets.
2. For each inventory class, assign a target turnover value.
3. Determine the level below which only dead and obsolete products re-
side. Eliminate this class from the procedure.
4. Establish the replenishment quantity for each class by dividing the turn-
over value by 12. If an item turned 12 times a year, the inventory sys-
tem should recommend that the planner purchase 1 month's worth of
stock whenever the order point is tripped .
5. Recalculate the inventory classification scheme for all items at least
once a month, depending on the expected inventory turnover [13].
As an example, Graham [14] suggests the following classification (Table
7.5).
TABLE 7.5. Usage Class Replenishment
ABC %of Expected Quantity to

Class Total Items Turns Purchase
1 7.5 12 1 month
2 7.5 6 2 months
3 10 4 3 months
4 10 3 4 months
5 8 2.4 5 months
6 8 2 6 months
7 8 1.7 7 months
8 8 1.5 8 months
9 8 1.3 9 months
10 8 1.2 10 months
11 8 1.1 11 months
12 9 1 12 months
An alternate method would be to determine the order interval through a

derivation of the EOQ formula. The calculation is as follows :
01 = -V 2 x OC / R (kUC)
01 = ,; 2 x $20/24,000(24% x $0.25) = 0.173 years = 2 months

Annual usage . .
----~- = Order quantity = 24,000/6 = 4000 umts
Order interval
The advantages of using the ABC Classification as an order quantity tech-

nique are readily apparent. To begin with, the method is easy to understand
and manipulate . Furthermore, although not as exact as the EOQ, it does pro-
vide for effective replenishment based on past usage. When it is considered
that the first four classes statistically account for about 90 percent of a firm's
active stocked items, the ABC Classification technique can significantly as-
sist planners in focusing their energies on the firm's critical products.
JUST-IN-TIME
Originally Just-In-Time (JIT) was developed as an operations planning and

control philosophy focused on assisting manufacturers attain continuous im-
provements in product quality and process productivity. Terms such as zero
inventories and stockless production are usually employed when discussing
JIT. In a broader context, JIT has been identified with company programs fo-
cused on eliminating waste throughout the organization: waste from over-
production, waiting time, transportation, processing, inventory, motion, and
product defects . In practice, JIT is the name given to a set of principles that
collectively define a comprehensive approach to business management. Al-
though an important element in JIT, inventory is but one facet of a total man-
agement philosophy. JIT philosophy encompasses the following paradigms:
Operations excellence. In its broadest context, this principle requires
the enterprise to be dedicated to continuous product and process im-
provement at all levels, focused on total customer service.
Value-added processes. This principle requires companies to critically
examine and eliminate all business functions and activities that do not
add value to the product or the customer . Such non-value-added pro-
cesses simply add cost to the enterprise and erode company and supply
chain competitive advantage.
Continuous improvement. Increases in productivity and decreases in
cost are considered to be continuous . This means that every aspect of
manufacturing, logistics support, and supply chain throughput must be
dedicated to incremental improvement in ways great and small.
JIT/TQM This abbreviation suggests a combination of JIT techniques
focused on productivity, total quality management (TQM), and people
empowerment. The abbreviation encapsulates the need for enterprise
dedication to customer service, elimination of wastes, simplification,
flexibility in responding to customer and channel demands, and enter-
prise centered performance measurements.
JIT IN SUPPLY CHAIN MANAGEMENT
Although JIT was originally developed for manufacturing, JIT can easily be
used to govern inventory flow through any supply chain pipeline. According
to Hall (15), inventory in the supply chain should be related to its rate of
flow, using the smallest time intervals possible. If channel inventories are
moving across the supply network in perfect flow, then
Throughput time = Supply chain stock x Cycle time of use
In reality, channel pipelines are often marked by discontinuous flows and can
be expressed by the equation,
Period ofstock on hand = Balance on hand x (1 / Expected usage during

period)
For example, if the balance on hand was 100 and the weekly usage was 50,
there would be 2 weeks of inventory in the supply pipeline.
Being able, however, to describe the supply chain flow in an equation and
actually controlling the velocity of product flow are two different things.
Supply channel planners are very cognizant that achieving the optimal flow
of product to the end customer requires the timely and detailed synchroni-
zation of each distribution, manufacturing, and materials supply node
throughout the channel pipeline. In the past each network trading partner was
responsible for their own performance as demand information serially moved
up and corresponding product quantities moved down the supply channel.
However, as the velocity of channel inventory increases, it correspondingly
becomes more difficult for each node in the supply network to act inde-
pendently of the channel as a whole. JIT attempts to solve this problem by
providing an approach to inventory management that not only shrinks wastes
in the form of excess lead times, channel stocks, and related distribution
costs, but also provides for the establishment of increasingly agile and flexi-
ble supply chains capable of achieving dramatically higher levels of customer
service than the competition.
The critical factor in JIT supply chain management is to regard the volume
of inventory as a measurement of how much waste is in the channel delivery
system. Rather than an asset buffering functions from variation in demand,
the size of channel inventories are directly correlated to such problems as
poor product quality, poor production processes, disconnected demand plan-
ning, and inefficient logistics systems that require trading partners every-
where in the supply channel to hold costly safety stocks. As JIT continuous
improvement solves these problems on the company and supply chain levels,
the need for inventory buffers will grow less and less, thereby speeding up
the velocity of channel throughput time as expressed in the above equation.
This phenomenon can be seen in the following illustration (Figure 7.9). Be-
fore removing the obstacles preventing the smooth and rapid flow of water
(inventory) through the channel, pools (safety buffers) accumulate around the
obstructions . Once the obstacles are removed, not only is there less water (in-
ventory), but the speed of the flow is equally fast at all points even though the
total volume of the input remains constant.
........................................\{~\ ........:.~:~:::..SUPPlyChannel
.........................................................................
......................\
l.~.,
\:f\
.\.}:& Open Supply Channel
" ,..:
if~
.
---.
FIGURE 7.9 Inventory flow analogy
JIT MECHANICS
JIT operates in a manner very similar to the two bin system described earlier
in the chapter. The technique begins with the recognition of demand at some
supply point in the distribution channel. As inventory is pulled for order ful-
fillment, a trigger, in the form of a replenishment signal, will eventually be
tripped, alerting planners that replenishment from suppliers is necessary to
avoid future stockout. An order is then placed utilizing some form of authori-
zation such as a simple replenishment card or even empty containers that are
picked up by the supplier , filled to specification, and returned . The assump-
tion is that the entire channel inventory system works the same way from cus-
tomer to supplier to manufacturer, and, eventually, raw materials acquisition .
Instead of elaborate computer systems or complicated EOQs that create safety
buffers to guard against unplanned demand, the replenishment signal deter-
mines when order action should occur. In addition, since product must be
consumed in order to release a replenishment signal, the system responds to

real-world changes and is self-regulating.
A distributor carried a steel casting The following data was identified:

that was purchased from a single Demand (D) = 80 castings a day.
supplier and sold to a narrow market Castings per container (Q) = 16.
segment. Over the past year demand Deliveries per day (TI') = I.
on the item averaged around 1600 Transit delay (Tel) = 2 days.
SKUs a month. or about 80 a day. Safety stock (S) = 2 percent.
Due to stocking and transportation
economies the casting was received Using the formula would reveal the
in containers carrying 16 SKUs. answer:
Due to a requirement to move to a
J IT replenishment ystem arising 80 (2 + 2)(1 + .2) 384
from the company's largest cus- = ----- = 24
tomer. the distributor decided to I x 16 16
enact a J IT pull-system both for
internal stocking and replenishment The answer shows that a total of 24
from the foundry. Inventor)' plan- containers (384 SKUs) should be in
ners determined that the container it- the system to service the daily
self would act as a perfect pull demand. If a quality improvement
signal. The challenge was to deter- program was put in place that
mine how the containers should be eliminated the safety percent. the
stocked. number of containers in the system
would drop to 20. and would result
Planners solved the problem by ap- in a drop of 64 SKUs in total
plying the JIT signal formula. carrying costs.
To make a JIT supply channel system function, planners must determine

just how much inventory should be stocked and what devices are going to be
used to alert supply nodes that replenishment is required. To calculate chan-
nel inventory levels, supply chain planners can utilize a simple formula, with
a few modifications, to determine JIT production and withdrawal signals.
The number of signals, whether cards or some other device, is directly related
to the total number of containers of a defined quantity of a single product that
are in the system. The number of these signals can be expressed by the fol-
lowing formula (16).
D (2 + Td) (1 + S)
# Signals
Tp xQ
where D is the average customer daily demand, 2 is the minimum number of

scheduled trips (one to pick up the replenishment signal and one to return
with the product), Td is the transit delay or the number of additional
scheduled trips between the one when the replenishment signal (move card or
empty container) is picked up and the product is delivered, S is the safety
stock , Tp is the deliveries per day currently scheduled, and Q is the container
quantity.
Using JIT to manage inventories in a supply chain requires that demand
and supply be synchronized at each stage of the supply pipeline. The key is
to regard the entire supply network as a single customer satisfying entity . In-
stead of each supply node planning and executing demand plans in isolation,
each chann el entity pulls inventories from their supplying partners driven by
the drum beat of the pull of actual demand beginning with the customer and
ending with materials suppliers. Safety or signal inventories (such as kanban
containers) and manufacturing buffer capacities are found at each supply
node to absorb possible variability in the system (Figure 7.10). The key to
the synchronized supply chain is communication of demand and replenish-
ment requirements as close to real-time as possible. In addition, the pursuit
of continuous improvement objectives dedicated to removing wastes and
maximizing the velocity of channel product flow would tame the bull-whip
effect and ever more closely link the entire supply chain to the end customer.
,--_.\
i KI r-j('!
~------i' a I 1 1
.---------1 a i
Manufact urer
nl
u i 0 I" tributer
u
I1 i
1
I
I
Reta il
i ' I '----~. I
L~J L~J
'---------=-:~----::;-----..
Replenishment Flow
FIGURE 7.10 JIT synchronized supply chain,
The advantages of such a control system are obvious. Beyond its apparent
simplicity, however, reside a number of critical assumptions. To begin with ,
the system demands 100 percent quality. Without large inventory buffers at
every channel node, defective products will quickly result in stockout. Se-
cond, a very close collaborative relationship must exist between channel part-
ners . This element requires consensus on a range of issues such as standard-
ization of processes and equipment and agreed upon levels of service and
flexibility, to a mutual sharing of benefits and risks . Finally, JIT requires
channel partners to jointly undertake programs designed at the continuous im-

provement of the system. While JIT does resemble a two bin system, the
differences between the two are dramatic. Two bin techniques seek to arrive
at a stable system that mechanically services demand. JIT continuous im-
provement, on the other hand, seeks to disrupt the stasis of a control system,
identify the problem areas that arise, determine a solution, and evolve to a
new stasis. Once this occurs, however, it is time to upset the system and be-
gin the improvement process all over again with the eventual objective of
minimizing or eliminating channel inventories altogether. In the sidebar ex-
ample, destabilizing the system would occur simply by the removal of a few
containers and then responding in a problem-solving mode to the constraints
that emerge.
THE FUTURE OF SUPPLY CHAIN JIT
During the 1990s, companies were increasingly faced with the requirement
not only to deliver but also to purchase using lIT methods. As JIT began to
evolve into what is now termed Lean Manufacturing practices, all supply
channel nodes found themselves under increasing pressure to architect agile,
responsive organizations capable of meeting specific customer schedules,
supplying exact quantities, supplying quality products, adjusting quickly to
changes in pipeline deliveries and inventories, and performing all of these ac-
tivities with a minimum of paperwork. JIT practices were seen as the best
way to eliminate waste in the form of excess inventory buffers and product
movement that simply clogged the channel pipeline, delayed customer ser-
vice, and unnecessarily increased supply chain costs.
As the new century began, however, the JIT/Lean philosophy received sev-
eral "shocks" that have dampened down a once unbridled, almost doctrinaire
enthusiasm. With the September II, 200 I terrorist attacks, fractious labor-
management relations at U.S. West Coast ports, and international troubles in
Iraq, Korea, and Venezuela, whole supply chains suddenly found once free-
flowing JIT supply pipelines clogged by security requirements, strikes,
spiraling fuel costs, and increased red tape. To meet the increased, and se-
emingly permanent, growth of supply channel uncertainty, companies have
begun to boost inventories and depend more heavily on regional warehouses
and distribution centers. While JIT/Lean concepts are far from dead, the un-
certainties in the business climate of the early twenty-first century have
caused supply chains to temper their impulse toward JIT.
INVENTORY REPLENISHMENT PLANNING PROCESS
Now that the concepts and elements of inventory replenishment have been ex-
plored, it is possible to define the planning process to be used by material
control. In general, the object of the process is to ensure that the firm has suf-
ficient inventories to meet customer service targets, is minimizing costs as
much as possible , and is communicating effectively with supply chain part-
ners. In developing effective inventory replenishment plans, the firm's mate-
rials management function must answer such questions as the following:
What is the current status of each stocked item?
Are inventory records being updated correctly and with the minimum
of delay?
Is the current on-hand balance sufficient to cover anticipated customer
demand?
Have the order points, order quantities, target inventory levels, and
periodic review cycles been calculated correctly.
Have safety stocks been calculated correctly?
How is actual demand to be monitored and used to recalculate replen-
ishment data elements?
In answering these and other questions, planners must first begin with an
accurate determination of the firm's inventory balances. This requirement
forms the first step in the replenishment planning process (Figure 7.11). For
r
I
Logistics Plan
I
Inventory Order
.... Balance
Accuracy
Lead Timcs!
f+ Safety Stock f+ Point
Accuracy
-
Order
Quantity
Accuracy
!
Procurement Plan
I
FIGURE 7.11 Replenishment inventory planning process.
products subject to continuous review systems, inventory control must ensure

that the on-hand and on-order quantities (the elements constituting the in-
ventory position) are accurate and up to date. Tools like ABC Analysis, Cy-
cle Counting, and effective inventory control procedures will significantly as-
sist in ensuring perpetual inventory accuracy. For products subject to peri-
odic review systems, it is critical that a thorough physical be conducted on a
periodic basis so that ordering techniques can begin regularly with accurate
on-hand inventory quantities . Fundamental to good inventory accuracy is the
execution of the three P's (people, places and procedures) of inventory con-
trol. Of the three, people is the most important. Has the staff who works
with the inventory been fully trained and have the regions of responsibility
and authority been fully established? Next, have warehouses and stocking
areas been defined along with the necessary controlled access requirements?
Finally, have well-documented procedures been put into place that facilitate
and explain inventory transaction control?
The second step in the replenishment planning process is ensuring that re-
plenishment lead times and safety stock calculations reflect accurate infor-
mation. Lead time is basically the offset time that separates the point from
when a replenishment requirement is identified to the moment the ordered
quantity is in the stocking position ready for the next customer order. Safety
stock, in general, is a reserve quantity of stock designed to protect against
fluctuations in demand and supply. It has already been stated how difficult it
is to control in detail these two elements. Planners must constantly be ex-
amining lead times and safety stocks with an eye not only toward accuracy
but also how these two critical elements can be reduced. Planners must resist
the temptation to buffer products from potential stockout by adding extra lead
time or safety stock.
After replenishment timing safety factors have been verified, planners must
review the accuracy and timeliness of order points. Several factors need to be
considered. To begin with, inventory control should be aware of the mechan-
ics of the various order point techniques available and when to apply them so
that the various item classes and types can be ordered to attain the optimum
balance between ordering and carrying costs. For products controlled by con-
tinuous review, planners need to continually update the order point calcu-
lation to reflect changes in demand usage and supplier lead times. Finally,
for inventory using periodic review techniques, maximum inventory targets
and review cycles need to be recalculated regularly. It is recommended that
all the order points in a given inventory be updated at least every 90 days, and
preferably every 30 days. Computerized planning systems that calculate
order points dynamically will significantly assist in ensuring that proper
stocking levels are being maintained to support customer demand.
The final step in the inventory replenishment process is reviewing and re-
setting order quantities. Most business computer systems have the ability to
calculate and update EOQs dynamically. The problem with the technique is
not the calculation but the elements of the EOQ formula. Other than the peri-
od constant , the other four elements (the cost of ordering, demand usage, the
carrying cost, and the unit cost) are all variables. This means that the EOQ
calculation must be continually examined andadjusted to prevent significant
drift in order quantities that could result in overstock or shortage conditions.
Finally , the EOQ assumes discrete linear usage. In reality, every planner
knows that stocked quantities are often consumed in large discontinuous lot
sizes caused by lumpy demand or joint replenishment requirements . As with
the order point, all order quantities need to be updated and reviewed at least
once a month.
Effective inventory management is the culmination of a dedicated program
designed to provide the highest level of customer service possible while con-
tinually reducing ordering and carrying costs. Excessive inventories cover up
the real problems facing supply chain planners--Iack of management controls,
long lead times, inaccurate order points and order quantities, inadequate
warehousing, poor .employee training, poor quality, and low productivity. Ef-
fective inventory planning seeks to eliminate such obstacles to performance
in the stockroom, in the inventory control tools, and in the entire distribution
network.
INVENTORY OPERATIONS IN THE SUPPLY CHAIN

ENVIRONMENT
Up to this point, the discussion of statistical inventory replenishment has

assumed that stock is warehoused at a single location. Many firms, however,
must contend with the planning and deployment of products in a supply chain
environment. Perhaps the critical characteristics of supply channel planning
is the fact that products are stocked at more than one location and that many
are dependent on one or more supplying locations in the channel for replen-
ishment. Distribution network structures can be expressed in much the same
manner as manufacturing Bills of Material. Warehouse dependencies are
shown as being linked by level to their respective parent supplying ware-
houses that, in tum, may be dependent on still higher levels of warehouses for
resupply . The highest level in the structure is the supplier or product manu-
facturer. Figure 7.12 illustrates a three-echelon supply channel network. The
central warehouse (third echelon) acts as a supply center for inventory replen-
ishment for the branch warehouses (second echelon), which, in tum , act as
the supply source for the retail outlets (first echelon).
r>; r>.
o ..Outlets
Retail
-. \V
FIGURE 7.12 Supply chain structure.
CONCEPT OF "PUSH" AND "PULL"

Resupply in a supply chain network can be described as being determined by
either a "push" or a "pull" system. In channel networks characterized by an
independent deployment ("pull") system, inventory planning is decentralized.
Each stocking location maintains its own inventory management system and
determines its own replenishment requirements . When the planning system
indicates that inventory is below order point, a resupply order is placed on the
supplying location . On the other hand, in a coupled deployment ("push") sys-
tem, all channel resupply activities are conducted by the central supplying lo-
cation. Based on the demand patterns of satellite locations or the total net-
work aggregate demand, replenishment planning and execution is centralized
with actual inventory disbursement made to each satellite location targeted at
meeting corporate turnover targets . Finally, aspects of the two systems can
be combined to respond to unique network needs. Factors influencing the
choice of an independent deployment system are the existence of value-added
processing, short lead times between the satellite and the supplying ware-
house, and stocks composed of moderate- to slow-moving items. Factors
favoring a coupled system are long procurement lead times, fast-moving
items, and significant economies in procurement and transportation [17].
Independent Deployment ("Pull") Systems. Under an independent deploy-

ment system, each location in the supply channel is responsible for determine-
ing its own ordering techniques, cost factors, service objectives, and resupply
lead times. The mechanics of the system are quite simple. Each location cal-
culates its own replenishment requirements and then draws inventory through
the network by requisition or actual purchase order from the supplying loca-
tion, often a regional or central distribution center. The branch location de-
tennines order timing, which products are to be ordered, and what are to be
the resupply order quantities and delivery requirements. The distribution
centers, in tum, will receive a sequence of resupply orders from their
branches and attempt to fill and ship them according to some priority rule,
usually first-come first-s erve. Finally, the distribution centers acquire their re-
supply inventory directly from the manufacturer or the supplier. The "pull"
system is illustrated in Figure 7.13. The advantages of a "pull" system are the
following:
Branch
Customer
Stock
Requirements
Status
MinIMax
In-Transit Order Point
Inventory
Resupply Requisition!
Order Purchase Order
Dist ribution
Order Points Center
EOQs tock
Distribution
Purchase
Center
Receipt
Stock
FIGURE 7.13 "Pull" system.
1. Planning simplicity. "Pull" systems are easy to operate. Because each

supply node is responsible for inventory planning, central functions do
not have to perform laborious channel demand analysis. They only
have to plan for the total requirements placed on them by the locations
in the channel they resupply.
2. Turnover. Because the central location is responsible for product ac-
quisition, channel supply, and deployment, satellite locations can draw
exactly the necessary resupply quantities. Branches, therefore, can op-
erate with lower stock levels, turning inventory faster than would be
possible if inventory had to be ordered directly from the supplier or
manufacturer .
3. Overhead cost reduction. Branch locations in a "pull" system can lev-

erage the economies of scale resulting from lower inventory acquisition
and material distribution costs incurred by central functions in planning
for the entire supply channel while receiving the benefits of short de-
livery, storage, and procurement discounting.
4. Use ofreplenishment and DRP ordering techniques. Standard re-order
point and DRP computer system logic provide excellent tools to operate
pull systems. Both techniques enable local warehouses to de-termine
the exact timing and quantities of replenishment orders. Once these
requirements have been calculated, the computer system can then pass
the orders through the bill of distribution (BOD) directly to the
supplying warehouse or manufacturing facilities so that resupply can
then be passed back down the channel to respond to the pull of the de-
mand source.
The disadvantages of a "pull" system, for the most part, center on overall
inventory carrying costs and deficiencies in information flows, particularly in
a supply chain driven by statistical replenishment techniques. Although it is
true that branch inventory turns will be high and overhead costs low, the ex-
act opposite can be said of the profitability of the central supplying facilities
who must shoulder the cost. Channel systems using a "pull" system must be
sure that aggregate costs incurred are offset by higher inventory turns in the
branch locations. Furthermore, because each location in the network is re-
sponsible for their own service levels, there is a tendency to unnecessarily du-
plicate safety stock at multiple levels in the channel. In addition, because
each location pulls inventory from their supplying location, information con-
cerning downstream inventory requirements is not available to regional and
national locations in the network. Supplying warehouses are usually unaware
of branch requirements until the order arrives. Finally, the objectives and
performance measurements inherent in a "pull" system may actually militate
against overall corporate profitability by inflating channel inventories in an
effort to improve branch sales levels. As will be discussed in Chapter 8,
many of these drawbacks are negated with the use ofDRP systems.
To counterbalance "pull" system deficiencies, a number of techniques may
be employed. Inventory planning can be governed by implementing a chan-
nelwide periodic review system. Operationally, branch warehouse inven-
tories would be reviewed periodically and resupply orders generated with suf-
ficient quantities necessary to restore channelwide stock to a targeted level.
Another technique would be to utilize a double order point. Each branch's in-
ventory would have its order point set by calculating the normal order point
plus the average demand during the central warehouse's procurement, trans-
portation, and manufacturing lead time. Theoretically, this technique would
enable the central supplying location to review its inventory levels relative to
anticipated branch orders and plan acquisition and transportation accordingly.
Another method, the base stock system, requires each location in the chan-
nel to maintain a base level of inventory determined as the facility's statis-
tically computed demand plus stock at all upstream warehouses. The inven-
tory position at each level is indicated by
IP = ES + RO,
where IP is the echelon inventory position, ES is the echelon stock, and RO is

the replenishment order. For example, branch facility A is resupplied from
warehouse 1. For a given product, branch facility A stocks 100 units and
warehouse 1 stocks 300 units. There are also 50 units intransit to branch fa-
cility A, and warehouse I has an unfilled replenishment order from the sup-
plier for 100 units. Finally, branch facility A has a customer order backlog of
125 units. Then, warehouse 1's inventory position would be
IP = (100 + 300 + 50 - 125) + 100 = 425 units.
Either on a periodic basis or after each transaction, the branch location com-
pares the inventory position to the order point (usually a minimum), and
when the order point is tripped , inventory is ordered to raise the inventory
position to the base stock level. On the part of the supplying warehouse, total
demand from all satellite warehouses can be planned and economical ship-
ping quantities accumulated for transfer to meet channel requirements.
Coupled Deployment ("Push") Systems. The basic mechanism driving the

independent deployment system is each location in the distribution channel
pulling (ordering) stock from the next higher echelon. In contrast, inventory
resupply in a coupled deployment system is pushed through the channel.
Where, in a "pull" system, branch locations have the authority to determine
the timing and quantity of replenishment , in a "push" system the supplying lo-
cation possesses resupply authority . In addition, they also have the ability to
adjust the actual replenishment sequence to improve overall channel service
or reduce costs. The key to successfully executing a "push" system is ef-
fective central inventory planning. Inventory managers must have accurate
and timely information as to the stock status of all satellite locations.
Whether gathered on a transaction-by-transaction basis or periodically, chan-
nel inventory requirements provide the data necessary for aggregate planning
and efficient resupply allocation . Functionally, whether using min/max rules,
order point, or other techniques , each satellite warehouse's inventory is con-
trolled by a combination of cycle stock used to cover customer demand
during replenishment lead time and a safety stock level to provide for usage
error.
The role of central deployment locations is to calculate and resupply in-
ventory requirements for the whole channel in accordance with the company's
customer satisfaction policies. The "push" system is illustrated in Figure
7.14. The advantages ofa "push" system can be described as follows:
Branch tock Branch Stock

Status tatus
.
Central Invcntory
Planning
YES ~ NO Resuppl y
OK? Order
Inventory Review Branch

!
Supplier
Allocation Order Points
Shipment
"Fair hares"
Allocation
!
Order
Receipt ~
Branch
hipmcnt
FIGURE 7. 14 "Pu sh" system.
1. Performance measurement. The "push" system enables corporate plan-

ners to leverage the total inventory in the channel to attain global cus-
tomer service and return on investment goals. Performance is measured
not just on the success of discrete stocking points but on how well the
whole channel is meeting corporate sales and asset management targets.
2. Central planning. By centralizing all inventory planning and resupply
allocation, channel planners can create a single inventory plan for the
ongoing ordering and deployment of total inventory. Central planning
enables planners to evaluate globally channel inventories and to remove
the normal supply point stock redundancies caused by inaccuracies in
local replenishment decision making. In addition, by strategically de-
ploying inventory resources through the channel, stocking inequalities
among branches can be reduced, further cutting costs arising from in-
terbranch transfer and lost customer sales.
3. Cost reductions. By centralizing inventory planning and deployment,
companies can reduce the total working capital necessary to stock the
channel. In addition , operating costs can be reduced by economies at-
tained in transportation and purchasing. Instead of ordering products to
satisfy individual branch demand, central purchasing can combine re-
quirements from all branches , thereby reducing transportation and ac-
quisition costs while gaining possible quantity price break discounts.
4. Safety stock control. Whereas safety stock is a permanent feature of
inventories subject to independent demand, a "push" system enables
planners to centralize safety stocks at the branch having the highest us-
age of the particular product. Centralization assists in eliminating un-
necessary safety stock carried by each channel location characteristic of
"pull" systems, thereby reducing inventory costs while providing for
high channel serviceability.
Disadvantages of a "push" system center on organizational issues. An ef-
fective "push" system requires a professionally trained central planning staff
that can work with aggregate data and demand forecasting techniques. In ad-
dition, inventory accuracy and timely transaction record posting normally re-
quire a computer system that can combine the inventory planning data infor-
mation of each location in the channel. Finally, the introduction of a "push"
system requires changes in operational roles. As central planning is now re-
sponsible for resupply planning and execution, branch management's role will
migrate from focusing on replenishment triggering to ensuring transmission
of accurate stock status and sales usage information to the channel's central
planning functions.
STOCKING MULTIECHELON WAREHOUSES
Once the number and size of the channel's distribution points have been
established, the next problem facing planners is determining which products
should be stocked at each warehouse and in what quantities. Obviously, not
every product the firm offers can be stored at the same inventory level at
every location in the network. By using a technique known as selective
stocking, planners can maximize available warehouse space in the channel by
determining which products are to be stocked at what echelon level based on
item ABC Classification. As an example, Class A products might be carried
by all locations in the channel. Class B products , on the other hand, might re-
side at strategically positioned regional distribution centers. Finally, Class C
products might only be stocked at the firm's national distribution center. In
determining stocking levels, planners must be careful not to inadvertently in-
crease other logistics costs in an attempt to keep stocking costs low. Savings
realized by centralizing certain classes of product might be lost to increased
transportation costs.
Calculating inventory channel trade-off costs can be computed by using the
square root rule. This technique seeks to determine the optimal level of in-
ventory to be stocked at a consolidated location based on the inventory value
and existing number of distribution points . The formula can be expressed as
CI = SI.y;;
where CI is the inventory value if the entire network stock was to be central-
ized at one stocking location, SI is the amount of a class of inventory stocked
at each distribution location, and n is the number of stocking points in the
channel. If, for example, each of the 25 locations in a distribution network
carrying an annual average of $200,000 Class C products were to be con-
solidated into a single supply center, the annual savings to the company
would be calculated as
CI = $200,000 -V 25 locations = $1,000,000
When it is considered that the total annual cost to stock Class C products at
each location totals $5,000,000, consolidation might appear a sensible choice.
But before the decision is made, planners need to weigh the potential savings
against the added cost of transportation and delivery. If centralization meant
that transportation costs to supply the channel with Class C products in-
creased by $93,000 annually and the use of added air freight to maintain the
current delivery time equaled $110,000 annually, the inventory/transportation
trade-off would be calculated as follows:
Distribution channel inventory reduction $4,000,000

Inventory carrying cost x 22%
Annual cost of carrying inventory reduction $880,000
Increase in annual transportation cost - $93,000
$787,000
Cost to maintain current service level - $110,000
Net annual savings $677,000
Clearly, a total annual savings of $677,000 would warrant serious review of

the possible centralization of Class C items at a national distribution center.
Adjusting Channel Imbalances. From time to time, available inventory in

the channel network will get out of balance. Because of variances in demand
and supply over time, some locations will have excess quantities of a product
while other warehouses may be out of stock. Normally, there is a group of
corporate planners whose job it is to monitor channelwide stocking imbal-
ances and then generate interbranch transfers to redistribute inventory ex-
cesses in the channel rather than purchasing or manufacturing more inven-
tory. This function requires the existence of inventory control systems that
permit visibility into both aggregate inventory levels and the detail plans of
each channel location. Currently, there are a number of computerized appli-
cations available that not only provide for the timely update of local inven-
tory records but also present corporate planners with the timely and accurate
information necessary to keep channel inventories in balance.
One method of countering channel inventory imbalances is called least-
cost redistribution. Assume that a distribution channel consists of a central
warehouse in Chicago and satellite warehouses in New York, Dallas, Denver,
and Los Angeles. For a given product, also assume that the Dallas and Los
Angeles warehouses are stocked out and have open customer backorders for
200 and 300 units, respectively. In contrast, the Chicago distribution center
(DC) has 225 units extra, New York 220, and Denver 190. To summarize,
the channel has open customer orders totaling 500 units that cannot be filled
from the current warehouses, but an excess of 635 units in other warehouses
in the channel. The goal of the exercise is to redistribute the inventory im-
balance in as cost-effective a manner as possible.
A common technique used to address this problem is to set up a sequence
of default interbranch transfer relationships. For example, Denver would
always attempt to replenish shortages by first ordering from the Los Angeles
warehouse, then from Dallas, Chicago, and lastly from New York. The re-
supply sequence is determined by comparing the normal transportation cost
from the source to the destination, the cheapest being the first in the sequence
and so on. The problem with the technique is that when more than one chan-
nel warehouse requires inventory and excesses exist in several other ware-
houses, it becomes difficult to determine the least-cost interbranch transfer.
A more effective method is to develop a simple linear program or even a
spread sheet that will calculate the least-cost redistribution of product.
Visually, the method can be illustrated through the use of a channel trans-
portation cost matrix. A sample matrix with the cost of transporting product
by pound from and to each warehouse in the above distribution channel is il-
lustrated (Table 7.6). The cost is computed in dollars per pound.
The object of the procedure is to redistribute excess inventories among
channel warehouses in such a way as to minimize total transportation costs.
TABLE 7.6 Price/DeliveryMatrix
Los
On-Hand Warehouse Chicago New York Dallas Denver Angles
225 Chicago $0.00 $1.35 $1.63 $1.70 $2.10
220 New York 1.45 0.00 1.82 1.80 2.40
-300 Dallas 1.65 1.85 0.00 1.70 2.00
190 Denver 1.75 1.95 1.65 0.00 1.10
-200 Los Angles 2.05 2.25 2.03 1.25 0.00
Assuming that the product that is in imbalance in the channel is one pound
per unit, the results of the calculation would be as follows (Table 7.7).
TABLE7.7 Delivery/Cost Solution
Los
On-Hand Warehouse Chicago New York Dallas Denver Angles
225 Chicago
220 New York
-300 Dallas $371.25 $407.00 $323.00
190 Denver
-200 Los Angles $410.00 $450.00 $235.00
The results of the computation would indicate that the Dallas warehouse
requirement would most economically be satisfied by shipping all of the 225
units from Chicago and 75 units from New York for a total shipment cost of
$510. The Los Angeles shortage would best be filled with a shipment of all
of the Denver warehouse excess, plus lO units from Chicago for a total de-
livery cost of $258 . In is important to note that interbranch shipments de-
signed to remedy channel inventory imbalances should not be posted as de-
mand in the computation of sales usage used in developing warehouse level
forecasts. Although it is true that the stock will be deducted from the sup-
plying warehouse's inventory balance, the interbranch inventory transaction
must be coded so as not to post such shipments in those demand files used to
compute forecasts [18].
"Fair Shares" Techniques. Despite the added control offered by centralized

channel planning, there are often occasions when distribution centers possess
in-sufficient stock to fill the inventory needs of the entire distribution net-
work. Such an event could occur because of the normal lag time in channel
information and material flows or because of unplanned demand or vendor
stockout . In responding to such a problem, inventory managers often will use
a technique called "fair shares ." The basis of this technique is to provide
branch locations with equal runout replenishment resupply that should be suf-
ficient to prevent stock out during lead time until supplier receipts arrive at
the deployment warehouses.
An example of "fair shares" is illustrated as follows . Say, for example, that
the deployment location has 200 units of Product A and the resupply order is
not expected for another 10 days. Current on-hand and projected weekly re-
quirements for the three branch locations in the channel are as follows:
Location On-Hand Weekly Requirements Daily Usage
Branch A 30 40 40 40 40 40 40 8
Branch B 37 50 50 50 50 50 50 10
Branch C 33 60 60 60 60 60 60 12
100 150 150 150 150 150 150 30
Altogether the channel contains 300 units, 200 at the central warehouse and
100 cumulatively in the branches. Because the branches sell an average of 30
units each day, there is a lO-day supply of inventory in the channel. The "fair
shares" deployment calculation computed for each branch is
Q = diCS - Ii,
where Q is the runout quantity, di is the daily demand for branch location i,
CS is the total daily channel supply, and Ii is the on-hand inventory at branch
location i.
Using this allocation method, each branch location would receive the
follow stock allotment of Product A:
Branch location A 50 units

Branch location B 63 units
Branch location C 87 units
The inventory shipped to each branch location hopefully will cover demand
during replenishment lead time. Branch location C, for example, should have
sufficient stock on Product A to last for 10 days ([33 + 87] /12) [19].
SUMMARY
Solving the crucial problems surrounding inventory replenishment is one of

the most important tasks of supply chain management. Answering effectively
the critical inventory planning questions of what products to review for re-
supply, the precise timing of when resupply order release should take place
before stock out occurs, and how much inventory should be ordered when re-
plenishment is triggered is essential if each channel partner is to leverage the
resources of the entire supply channel to gain and sustain competitive ad-
vantage. The responsibility for effective inventory planning and execution
resides with inventory management who must facilitate the attainment of cus-
tomer service targets while simultaneously achieving least total cost for in-
ventory, transportation , warehousing, and staffing.
At the core of all statistical replenishment systems resides a very simple
principle: For each product, there is an optimal stocking and ordering quan-
tity in which the total cost of carrying inventory is balanced against the cost
of ordering. By calculating optimal order point and order quantities through a
variety of statistical replenishment techniques, planners are provided with a
triggering mechanism alerting them on a product-by-product basis when order
action needs to occur and what the resultant order quantities should be. The
effective use of statistical inventory replenishment methods involves a
thorough understanding of the elements necessary to calculate order points
and order quantities. A firsthand knowledge of such components as demand
usage, lead time, and safety stock are critical for the effective use of such or-
dering techniques as statistical order point, minimax, joint replenishment, and
periodic review. Equally important is a knowledge of the components of
various order quantity techniques. Computing the Economic Order Quantity
(EOQ), determining order size when there are quantity discounts, and replen-
ishing by ABC Classification are examples.
Often planners are faced with planning inventories in a multiechelon en-
vironment. Resupply in a supply chain network can be described as being
dominated by either a "push" or a "pull" system. In a "push" system, all in-
ventory planning is centralized. Corporate planners determine resupply order
size and timing based on channel stocking balances and demand usage re-
quirements . In contrast, in a "pull" system, each branch location is respon-
sible for determining resupply order quantities and delivery timing. When re-
plenishment conditions are identified, branches pull inventory from supplying
locations that, in tum, attempt to fill branch requests as they are received.
There are advantages and disadvantages to both methods. The choice of a
system ultimately depends on such factors as product characteristics, carrying
cost, transportation, stocking capacities, location, and the availability of in-
formation processing tools.
1. Discuss the two forms of inventory demand. Why are they so important to in-
ventory planners?
2. Explain the concept of stock replenislunent. Why is it fundamental to statistical
replenislunent techniques of inventory management?
3. Explain the mechanics of the periodic review method of inventory control.
4. Why is the EOQ such a valuable tool for calculating order quantities?
5. What are the assumptions of the EOQ model?
6. What is the purpose of carrying safety stock?
7. Why is the EOQ such a valuable tool for calculating order quantities?
8. Explain the concepts of "push" and "pull" in a multiechelon supply channel en-
vironment.
9. Describe the difference between a fixed-quantity and a fixed-period inventory
planning system.
PROBLEMS
1. A purchased product stocked by ABC Distribution, Inc. has a constant annual

demand of25,000 units. The product costs $1.25. It costs $10.00 to order the
item, and inventory carrying costs are estimated to be at 22%.
1. How many times a year would a replenislunent order be placed for this
product?
2. What are the total annual inventory costs?
3. What should be the economic order quantity?
2. A purchased product has a demand of 14,000 units per year. The distributor
has 200 working days a year. If the lead time to acquire the product is 4 days,
what would be the order point?
3. A supplier offers the following pricing on a given inventory item: $50/unit on
orders less than 2000 units and $43.50 for orders of 2001 or greater. If the
annual usage of the item is 4000, the carrying cost is 20%, and the cost of
ordering is $50, then what is the total annual cost of the minimum cost order
quantity?
4. A given product has a demand of 5000 units per year. The item costs $6.40
each, the carrying cost is 25 percent, and the cost of ordering is $25. If a new
supplier offers to sell you the same product for $6.00 per unit if you purchase at
least 2500 units per order, should you go with the new supplier or not?
5. A purchased product stocked by a retail outlet has average sales of 200 units a
day with an average deviation of 110 units per day. A 1 week's supply of the
item is usually ordered at a time. Lead time is 1 day. There is currently 210
units on hand.
(a) If the store is open 5 days a week, what should be the item's order
quantity.
(b) How much safety stock would be required to provide a 98%

serviceability level?
6. Based on the following data, compute the new order point (reference Table 7.3
above) .
Weekly forecast usage 250 units

Lead time 2 weeks
MAD 100 units
Targeted service level 98%
Order quantity 200 units
7. A product has an order point without safety stock of 200 units. The inventory
carrying cost for the item is $50 per unit and the cost of a stockout is $50 per
year. The item is order four times a year. Based on the following demand
occurring during the reorder period, what would be the new order point?
Demand Instances Probability
50 .1
100 .2
Order Point 200 .3
250 .2
300 .1
350 .1
1.0
REFERENCES
1. Orlicky, Joseph, Material Requirements Planning. New York: McGraw-Hill,

1975, pp. 22-25 .
2. Orlicky, pp. 5-10 ; Plossl , George W., Production and Inventory Control:
Principles and Techniques, 2nd ed. Englewood Cliffs, NJ: Prentice Hall, 1985,
pp . 98-100; and, Waters, C.DJ., Inventory Control and Management. New
York: John Wiley & Sons, 1992, pp . 4-26 .
3. Graham, Gordon, Distribution Inventory Management for the 1990s.
Richardson, TX : Inventory Management Press , 1987, p. 67.
4. Brown, Robert G., Statistical Forecasting For Inventory Control. New York:
McGraw Hill , 1959, pp . 136-147 .
5. Graham, p. 67.
6. Brown, Robert G., Advanced Service Parts Inventory Control. Norwich, VT:
Materials Management Systems, Inc., 1982, p. 344.
7. Graham, pp . 129-142 .
8. Fogarty, Donald W., Blackstone, John H., and Hoffinann , Thomas R.,
Production and Inventory Management, 2nd ed. Cincinnati, OH: South-Western
Publishing Co., 1991, p.228 .
9. See in the discussion in Brown , Robert G., Decision Rules For Inventory
Management . New York: Holt, Rinehart & Winston, 1967, pp. 5-17; Waters ,
pp . 37-48, Fredendall, Lawrence D. and Hill, Ed, Basics of Supply Chain
Management. Boca Raton : FL, St. Lucie Press, 2001 , pp . 189-193, and, Coyle,
John 1., Bardi , Edward 1., and Langley, John C., The Management of Business
Logistics, 7th ed. Mason, Ohio : South-Western, 2003, pp . 227-234,270-281.
10. Graham , p. 147.
11. See the discussion in Magee , John F. and Boodman, D.M., Production Planning
and Inventory Control. 2nd ed., New York: McGraw-Hill, 1967, p. 210;
Vollmann, Thomas E., Berry, William L., and Whybark, D. Clay,
Manufacturing Planning and Control Systems. 2nd ed. Homewood IL: Dow
Jones Irwin, 1988, pp. 728-730; and, Waters, pp. 77-84 .
12. See the discussion in Waters , pp. 33-34 ; Silver, Edward A. and Peterson, Rein,
Decision Systems for Inventory Management And Production Control. 2nd ed.
New York: John Wiley & Sons, 1985, p. 174; Graham , p. 149-151; Fogarty,
Blackstone and Hoffinann, p. 208 .
13. See the discussion in Silver and Peterson, pp. 173-214 ; and, Vollmann, Berry,
and Whybark, pp. 723-730.
14. Graham, pp . 152-155 .
15. Hall, Robert W., Zero Inventories. Homewood, IL: Business One Irwin, 1983,
p.232.
16. This formula has been modified from Hall, pp. 235-241 and Wantuck, Kenneth ,
Just In Time For America: A Common Sense Production Strategy . Milwaukee,
WI : The Forum , 1989, pp. 275-280.
17. See Magee, John F., Copacino , William c., and Rosenfield, Donald B., Modern
Logistics Management. New York: John Wiley & Sons, 1985, pp. 98-100 ;
Pyke, David F. and Cohen, Morris A., "Push and Pull in Manufacturing and
Distribution Systems." Journal ofOperations Management, 9 (1), 24-43 (1990);
and, Silver and Peterson, pp. 483-487.
18. Brown, Materials Management Systems, pp. 340-345 .
19. See Silver and Peterson, pp. 483-487; Fogarty, Blackstone and Hoffmann , pp.
313-315 ; and, Brown, Materials Management Systems, pp. 351-356 .
8
DISTRIBUTION REQUIREMENTS
PLANNING
PROBLEMS WITH STATISTICAL DETAILED LOGISTICS CAPACI-

TECHNIQUES TYPLANNING
Financial Estimating
HISTORICAL VIEW Transportation Planning
Perpetual Inventory Control Warehouse Space Planning
Origins ofDRP Labor and Equipment Capacity
Basics of DRP Manufacturing System Interface
DRP PROCESSING DRP AND SUPPLY CHAIN

Data Elements MANAGEMENT SYSTEMS
The DRP Calculation Supply Chain Planning Tech-
nologies
DRP IN A SUPPLY CHAIN Supply Chain Event Management
ENVIRONMENT
DRP Versus Statistical Order Point SUMMARY
Bill of Distribution
Supply Chain DRP QUESTIONS FOR REVIEW
DRP PLANNING PROCESS PROBL EMS
In the previous chapter, it was stated that inventory planners had their choice
of two basic inventory ordering techniques: statistical replenishment and Dis-
tribution Requirements Planning (DRP). Chapter 7 focused on the various
methods, elements, and application of statistical tools for inventory ordering,
such as order point and economic order quantity (EOQ). In this chapter, the
system logic, application, and benefits of using DRP to plan inventory re-
supply will be examined. Unlike replenishment methods that utilize statis-

tical calculations to determine when orders should be released and what order
quantities should be, DRP determines resupply by time-phasing supply to
meet demand for each product at each warehouse in the distribution channel.
Utilizing the same computerized logic as Material Requirements Planning
(MRP), DRP performs a gross-to-net requirem ents calculation of demand and
supply in each time period. When demand exceeds supply, the system gen-
erates a planned resupply order and alerts the planner that replenishment ac-
tion is required if stockout is to be avoided. What is more, through the Bill of
Distribution (BOD), DRP implodes the time-phased requirements up through
the distribution network, thereby revealing and linking together the replenish-
ment needs of both supplying and satellite warehouses. The choice of using
DRP or combining it with statistical replenishment techniques for product re-
plenishment is a management decision requiring an understanding of the na-
ture of customer demand, the dynamics of the distribution channel, inventory
and supplier characteristics, and the application of the necessary computer-
ized tools .
The chapter begins with a review of the limitations associated with the use
of statistical inventory replenishment methods and their impact on inventory
planning. Following this general overview, the chapter then proceeds to a
discussion of the theory and processing logic of DRP. After detailing the
data elements and format ofDRP, the mechanics of the DRP computer logic
are reviewed. Particular attention is paid to analyzing how DRP uses time-
phased demand and supply input to generate output information that can be
used by the inventory planner to guide resupply order action. Now that the
concepts and processing logic of DRP have been explored, the focus shifts to
outlining the DRP inventory planning process. The chapter concludes with a
brief review of the application of supply chain planning (SCP) and supply
chain event management (SCEM) technologies to supply chain management.
Based on the inventory planning tools found in DRP, the purpose and content
of SCP and SCEM are detailed as prime drivers of today's advanced virtual
supply chains.
PROBLEMS WITH STATISTICAL TECHNIQUES
Statistical methods of planning for inventory replenishment have been in use

for over a century. In the days before computers and the ability to process
large amounts oftransaction data on a timely basis, using mathematical calcu-
lations and formulas based on statistical averages were the only tools avail-
able to inventory planners . Although statistical replenishment models remain
a valid technique for controlling inventories subject to independent demand,
DISTRIBUTION REQUIREMENTS PLANNING 361
inventory control professionals, nevertheless, have long been aware of severe

limitations lurking beneath the "scientific" image the techniques evoke. As
Orlicky [l] has pointed out, statistical methods have never really provided the
timely and accurate information necessary for effective inventory manage-
ment. In fact, the seemingly inescapable logic of the mathematical calcu-
lations are, in reality, little more than crutches supplying summary, approxi-
mated information often based on unpractical assumptions, sometimes force-
fitting replenishment patterns so as to validate the use of a technique. As a
result, practitioners continue to be plagued by the planning, functional inte-
gration, and performance measurements deficiencies that have long ac-
companied the use of statistical inventory control methods.
Problems associated with the use of statistical methods of inventory replen-
ishment can be divided into two major categories. The first has to deal with
inherent shortcomings found at the core of the technique; the second category
relates to resulting organizational difficulties caused by the use of replen-
ishment models. The salient points relating to the former can be outlined as
follows:
Decisions Based on Statistical Calculations. All inventory replenishment

techniques based on statistics seek to arrive at the most probable course of
future demand usage by determining patterns in the stream of historical data.
Statistical models work best when inventory transactions recur consistently
with minimal variation; they are less useful when demand and supply infor-
mation is characterized by random variation in timing and order quantities.
Obviously, the vulnerability of statistical approaches resides in the as-
sumption that reality will conform to the elements used in the mathematical
model. For example, the order point assumes that inventory demand during
the replenishment lead time will match the average past usage. Experience
demonstrates, however, that actual usage variation can and does occur despite
the most sophisticated mathematical models, resulting in either overstock or
stockout. In the final analysis, all statistical replenishment techniques are
purely ordering systems. As such, they provide no window into the future
and lag behind changing customer, product, delivery, and supplier realities.
Difficult to Use. One of the most important issues associated with the use of
statistical models is the difficulty planners and, especially, other members of
the enterprise have in understanding the mechanics of the various techniques.
For the most part, company members involved with statistical models require
formal training to effectively select and apply reorder and order quantity
methods. As computerized distribution systems become increasingly auto-
mated, even to the point where the software actually performs automatic pur-
chase order release, companies must be on guard against surrendering control

and isolating individuals from understanding how the system works.
Safety Stock. Because even the best statistical technique cannot predict with
certainty when existing stocks will run out, order points are best used with a
targeted quantity of safety stock. The problem with safety stock is that, theo-
retically, if the order point is accurate, safety stock becomes merely an un-
used buffer forcing companies to carry inventory that is never intended to be
sold. What is more, as the level of customer serviceability increases, the re-
quired level of safety stock and accompanying inventory cost increases ex-
ponentially with no assurance that unexpected demand will still not drive in-
ventory to stockout.
The Order Point Revisited. The formula for calculating the order point is
OP = (Item usage x Lead time) + Safety stock
Although a time-proven technique, each of the elements of the order point is

subject to variation. To begin with, item usage, no matter how it is com-
puted, is always an average calculated by dividing demand over a specific
number of past periods. In reality, actual usage for an item in any future peri-
od may be below or above the average demand, forcing planners to carry
stock in some periods that does not sell, while stocking out in others. Al-
though modem computer systems can dynamically update item usage, it,
nevertheless, is still an average.
Lead times are notorious for being inaccurate. A myriad of factors can
alter lead time: using an alternate supplier, rush orders, changes in lot size, al-
ternate forms of transportation, time-saving computer automation, supplier re-
location, and others. Inaccurate lead time data can have a significant impact
on inventories. Say, for example, that the average usage for a given item was
1000 units a month, the standard cost $2.35, and the lead time from the sup-
plier 15 days. The order point would be calculated as 1000 x 0.5 = 500
pieces at a stocking cost of $1175. If the supplier cut the lead time in half,
the new order point would drop from 500 pieces to 250 (1000 x .25 = 250). If
the inventory planners did not update the item record, the firm would be
stocking $587.50 of needless inventory. When multiplied by possibly thou-
sands of items, enormous savings in inventory costs could be gained simply
by the continuous reduction and updating oflead times [2].
The EOQ Revisited. The classic formula for calculating the EOQ IS
expressed as
Period constant x Order cost x Item usage

EOQ =
Carrying cost x Unit cost
As is the case with the order point formula, each of the elements of the EOQ
calculation is subject to variation. To begin with, unit cost must be con-
stantly updated to reflect all cost changes. Next, Woolsey [3] argues that the
carrying cost, usually expressed as a percentage of item unit cost per unit
time, is subject to significant variance and has been severely understated in
the traditional calculation. Normally, firms compute the carrying cost as the
cost of money at prime rate plus points. This calculation results in a flat-
tening out of the total cost in the area of the optimal order quantity. In prac-
tice, few firms will run their business with the objective of returning only the
prime rate of interest. The real cost of carrying inventory is lower bound by
the rate of return earned by the best selling items characterized by high mark-
up and high market demand. If the best mover in the product line had a mark-
up of 65 percent , the total cost of carrying inventory would be significantly
higher, with a much smaller band of error surrounding the optimum cost
point.
The validity of historical usage has already been discussed earlier. If us-
age is determined by a sales forecast, its chance of accuracy is even less. As
was pointed out in Chapter 4, the two things known for sure about a forecast
is that it will be wrong and that it will change. Finally, the period constant
assumes that demand is continuous and incremental. In reality, demand, no
matter how marketing attempts to channel and position it, can exhibit signifi-
cant variance in any given period.
In addition to potential inaccuracies within the formula, the EOQ is
founded on a number of tenuous assumptions . Silver and Peterson [4] point
out the following assumptions integral to the EOQ technique:
Customer demand is constant and deterministic
The order quantity is neither restricted by a lot size or minimums or
maximums on order quantity size
The item unit variable cost does not depend on the order quantity, and
there are no discounts
Item unit variable cost remains fairly constant over time.
Benefits attained from joint replenishment are negligible.
The entire order quantity is delivered at the same time.
These assumptions point to the fact that the statistical calculations required
for the EOQ perform best when the coefficients are static and not susceptible
to variation.
The Problem of Lumpy Demand. Besides randomness in customer buying

habits, actual inventory demand is often driven radically upward and down-
ward by lumpiness in actual order quantities. Lumpy demand can be broken
down into two categories. The first is lumpiness caused by quantity-driven
factors, such as lot-size requirements resulting from purchasing, manufac-
turing, packaging, shipping, selling, and stocking. In addition, batch order
picking, the number of stocking locations, and company inventory stocking
policies can also produce lumpy demand. Lumpiness is also caused by time-
driven factors, such as seasonality, promotions and deals, price changes,
product and packaging changes, and lead times for order processing, purchase
order receipt, and shipping. Although promotions and seasonality cause the
most nervousness, both quantity- and time-related factors will have an effect
that can ripple up and down the distribution network.
Effects on the Distribution Channel. Order point systems provide supplying

warehouses in the channel with little visibility into satellite warehouse in-
ventory requirements. In fact, statistical techniques trigger replenishment or-
ders and place them on supplying warehouses with no advanced warning, in-
dependent of supply point inventory availability or the needs of other satellite
warehouses in the network. In addition, the random arrival of resupply orders
makes it difficult for supplying warehouses to plan for cost-effective picking
and shipping.
Beyond these core problems at the heart of statistical inventory control

techniques can be found even more serious deficiencies that significantly im-
pact negatively the entire supply channel. Supply chain inventory manage-
ment in the twenty-first century requires real-time, responsive inventory plan-
ning systems capable of aligning the changing needs of the customer with the
inventory resources of the entire distribution channel network. Statistical
methods of running the business result in the application of static operational
tools to solve the problems of today's dynamic distribution environment.
Some of the major obstacles associated with statistical inventory techniques
affecting the achievement of more agile and real-time supply chains are as
follows:
Lack of Integration. Because the successful supply chains of the twenty-first

century will be those that can rapidly deploy inventory to meet customer ser-
vice targets, it is imperative that channel inventory planning systems be sup-
portive and closely integrated with the core business functions of the enter-
prise. Unfortunately, although statistical approaches to inventory control pro-
vide satisfactory tactical tools, they lack the capacity to provide the necessary
strategic linkages to draw together and keep in alignment the enterprise's
long-range business plans with everyday order processing and inventory pro-
curement activities . Statistical inventory methods determine inventory action
based on summary demand information, provide limited simulation capa-
bilities for charting alternative courses of action, are insensitive to capacity
issues such as cost, warehouse space, and transportation, calculate inventory
replenishment action in isolation from business, marketing, and sales re-
alities, and provide little information that can be utilized to determine the per-
formance of individual companies and the supply chain as a whole. In ad-
dition, statistical inventory control techniques lack the mechanism to ef-
fectively couple business functions and channel partners together. The lack
of internal and external integration draws the firm's energies away from pur-
poseful planning to be focused on reflex reactions to the problems caused by
the decoupling of strategic objec-tives, operations plans, and operations ex-
ecution functions.
Response to Change. If a single word can be used to describe distribution in

today's business climate, it is change. However, statistical approaches to
business management are, by their very natures, reactive rather than pro-
active to change. By depending on the occurrences of the past to predict the
course of the future, statistical methods cannot hope to provide distribution
managers with the timely information necessary to integrate the resources of
their businesses with the demands of their marketing channels .
Channel Management. Inventories in a distribution channel determined by

statistical methods are normally managed in a vacuum. Each stocking point
calculates its own resupply requirements independent of the aggregate flow
of information and material as it moves through the channel from supplier to
customer. In such an environment, the ability of planners to integrate supply
point forecasts with the corporate forecast is seriously diminished. The
absence of effective external integration renders the distribution enterprise
powerless to respond to the constant changes occurring in marketplace
demand and supply patterns .
Supplier Negotiations. Because statistical replenishment systems fail to pro-

vide a window into future demand requirements, purchasers using such tech-
niques have had a great deal of trouble negotiating long-term contracts with
suppliers. For the most part, purchasing methods driven by order points and
order quantities consider the purchase order as a unique, one-time contract for
specific goods at a determined delivery date. When long-term supplier agre-
ements have occurred, they have traditionally been based on aggregate in-
ventory models determined by historical usage. What is really needed for ef-
fective supplier negotiating and contracting is not faster purchase order gen-
eration but a way to schedule supplier capacity out through time. In reality,
customer demand changes frequently, forcing planners to rely on quick re-
sponse on the part of their suppliers. Traditional purchasing is concerned
with price; world-class purchasing is concerned with quality and timely de-
livery .
Excess Inventory. Statistical methods of inventory replenishment force com-

panies to carry excess inventory. As was stated in Chapter 7, the objective of
stock replenishment techniques is to restore inventory quantities to a pre-
determined level sufficient to respond to anticipated demand. The optimal
level of stocked inventory is necessary to compensate for the inability of
planners to determine the precise timing and quantity of customer demand in
the immediate future. Line points and safety stocks provide order points with
even higher inventory thresholds before order action is triggered. On the
other hand, academics, consultants, and practitioners alike are firm in the be-
lief that zero inventories and the elimination of all lead times constitutes the
ideal inventory planning environment. In contrast, statistical replenishment
techniques require stocked inventory because they suffer from false as-
sumptions about the demand environment, tend to misinterpret observed de-
mand behavior, and lack the ability to determine the specific timing of future
demand [5].
Performance Measurement. Traditionally, in statistical replenishment the

inventory size, cost, turnover, and service levels of each stocking point are
measured separately and in isolation from the performance of the channel as a
whole. However, uncoupled inventory and customer service plans, no matter
how successful at the branch level, may actually foster a decline in channel-
wide effectiveness. Statistical methods cause higher but avoidable inventory
costs, slow down the flow of products to the customer, and conceal opera-
tional efficiencies and unbalanced capacities among channel partners. These
results are squarely at odds with today's SCM inventory management objec-
tives that require the distribution function to be able to leverage and rapidly
deploy the totality of its inventory and working capital to achieve and main-
tain the competitiveness not only of individual companies, but of the entire
supply chain matrix.
HISTORICAL VIEW
Up until the advent of the computer, planners had no choice but to use the
traditional statistical methods for inventory planning and control. The size
and scope of a firm's daily transactions made detail analysis of inventory de-
mand usage and supply requirements virtually impossible . The development

of perpetual inventory systems and the advent of the computer permitted in-
ventory planners to move to a new dimension.
PERPETUAL INVENTORY CONTROL
The use of statistical ordering techniques was provided with a new dimension
around 1950 with the introduction of the concept of perpetual inventory con-
trol. Through the use of inventory management systems like "Kardex" and
advances in office automation, such as punch-card data processing tools, in-
ventory planners were presented with the opportunity to move beyond plan-
ning inventory levels through the use of summary data and review the impact
of inventory transactions in detail as they occurred in time . Perpetual inven-
tory control seemed to offer the answer to the problems facing statistical re-
pleni shment. Inventory status information could be vastly expanded by pro-
gramming computers to continuously calculate the difference between cus-
tomer demand and on-hand stock plus open purchase order quantities and
then suggest new replenishment orders when necessary. The inventory status
equation is expressed as
OH + 00 - QR = QA,
where OR is the quantity on-hand, 00 is the quantity on order, QR is the

quantity required, and QA is the quantity available . This equation seemed to
work well with statistical replenishment elements. A positive quantity avail-
able indicates that a given item had sufficient inventory ; a negative indicates
that the planner should release a resupply order in the form of the order
quantity.
Although the perpetual inventory record did provide planners with better
information that answered the questions of what item needed to be order and
in what quantities, it was incapable of answering the simple question of when
will customer demand exceed available and planned supply? No matter how
sophisticated the techn ique, the statistical order point cannot provide in-
formation determining what will be the projected inventory balance of a giv-
en item a quarter, a month, even a week from now. The system simply alerts
the planner that the quantity necessary to satisfy the demand during the re-
plenishment lead time has fallen below the order point and that resupply or-
der action must occur if a stockout is to be prevented. In addition, because
order point techniques are basically due date insensitive, the planner may be
given erroneous data. Say, for example, that the inventory position is cal-
culated from the following data elements:
Order point 75 units

Current on-hand + 100 units
Open purchase order + 200 units
Open customer order - 200 units
Inventory position 100 units
Because the inventory position at the end of the calculation is 25 units above
the order point, the planner would not be prompted to order additional stock.
Once, however, due dates for the sales and purchase orders are entered into
the equation as illustrated below, the situation radically changes.
Current date August 28

Current on-hand 100 units
Open purchase order 200 units due September 15
Open customer order 200 units due September 1
Although the inventory position is above the order point, the actual dates the
orders are due indicates that the customer order will be short 100 units and
will actually have to wait an additional 15 days until the purchase order is re-
ceived. Everyone knows what will happen in the above situation: The cus-
tomer's order will be short at shipment time and the buyer/planner will have
to call the supplier and expedite the open purchase order to arrive as soon as
possible.
Equally as bad is the reverse of the above timing conditions. Using the
data from the same equation, but with different order dates, different results
will occur.
Current on-hand 100 units

Open purchase order 200 units due September 1
Open customer orders 100 units due September 1
100 units due October 10
Without calculating the timing of order due dates, what appears to be a satis-
factory situation will actually result in needlessly stocking a whole month's
worth of inventory. In both instances, the stock coverage is adequate in terms
of quantity, but the timing is out of synchronization with actual customer de-
mand. In reality, the order action messages to the planner should have been
in the first example to "expedite the purchase order in 15 days," and for the
latter, "reschedule the purchased quantity of 100 out to October 10."
The above examples illustrate the fundamental weaknesses that reside at
the core of statistical replenishment techniques. Essentially, there are three
critical areas: (1) information on demand and supply timing is missing, (2)
the data on customer and purchase orders represent summaries, and (3) the
calculation does not provide for planned (future) requirements. The order
point and order quantity formulas are concerned solely with manipulating in-
ventory quantities. In reality, what inventory planners are concerned about is
managing time. When will stock need to be on hand to cover customer orders
and anticipated forecast demand? If the firm is planning a promotion, when
will additional inventory quantities be needed to prevent stockout? When
must open purchase orders be received to satisfy changing customer demand.
When should new purchase orders be planned? By focusing on the issue of
time rather than on quantity, the basis of inventory planning shifts from a
concern with arithmetic al calculations to forecast, sales, and purchase order
priority management.
ORIGINS OF DRP
When computers became commercially available, businesses naturally

sought to utilize the significant increase in data processing speed and ac-
curacy to solve the host of problems inherent in the statistical techniques. It
was reasoned that if information concerning inventory balances, lead times,
safety stocks, costs, and customer demand could be processed faster, the per-
sistent problems found in replenishment methods could be eliminated. Inven-
tory planners soon discovered, however, that simply calculating mathematical
formulas faster only made more evident the planning, supply channel integra-
tion, and performance measurement deficiencies that had long characterized
statistical methods. What planners really needed were computerized tools
that changed significantly not only the quantitative but also the qualitative
na-ture of the information used to guide the inventory planning process. Sta-
tistical replenishment models provided tools for the tactical control of inven-
tories. It soon became evident that planners needed information tools that en-
abled them to leverage inventory planning and control as a strategic resource,
integrated with top management planning and, in tum, driving the supply
channel's execution functions . The breakthrough occurred with the extension
of the time-phase order point as found in MRP logic to channel inventory
management.
The ability to time-phase the interplay of supply and demand is the very
foundation of DRP - Distribution Requirements Planning. According to
Andre Martin, the application of DRP to the distribution environment was
first implemented in 1975 at Abbott Laboratories, Montreal, Canada [6].
During the years following, the basic concept of DRP was expanded to em-
brace not only inventory planning and control but also logistics functions. By
the early 1980s, DRP, renamed Distribution Resource Planning, was being
championed by consultants as the standard approach to be used for planning

and controlling the matrix of distribution logistics activities. Since that time,
the concept has been expanded to embrace not just inventory and logistics but
also the business functions of the whole supply channel. Termed DRP II, the
basic mechanics of DRP form the core of a business philosophy for "planning
the utilization of the totality of a distribution enterprise's resources, while
providing for the execution and performance measurement of material pro-
curement, distribution and financial accounting [7]."
BASICS OF DRP
Adding the element of time to the basic perpetual inventory equation requires
that the inventory planning system be able to record and store the specific due
dates and quantities of forecasts and open customer and supply orders . In ad-
dition, the system must be able to time-phase by due date on-hand, demand
requirements and resupply stock on order, and calculate the inventory equa-
tion each time an order due date appears. This means that the system must be
able to subtract the supply from the demand, or add on-order quantities to on-
hand quantities, as the due dates of each are referenced through time. If suf-
ficient inventory remains after each calculation, then there is no resupply ac-
tion to perform. If, on the other hand, the result is a negative, the system
should alert the planner that a potential stockout will occur at that point in
time so that a counterbalancing planned order quantity can be placed in anti-
cipation of a future shortage. Although, in reality, DRP reviews by due date
each occasion of item demand and the corresponding availability of supply
stock, a visual format, as portrayed in Figure 8.1, can significantly assist in
On-Hand = 1000 units

Lead Time = 2 Periods
Order Quantity = 500
Periods 1 2 3 4 5 6 7 8
Demand 300 300 300 300 300 300 300 300
Supply 700 400 100 300 0 200 400 100
Net Reqs 200 300 100
Plan Ord Recpts 500 500 500
Plan Ord Rei 500 500 500
FIGURE 8.1 . Time-phased format.

making the computation. The contents of the format can be described as the
following:
1. Time Periods. The time-phased inventory equation is associated with
specific time periods or buckets . A period can be as short as a minute
or day, or as long as a week, a month , or even longer. The exact size of
the period and the placement of inventory data within it are governed
by several system conventions. Period size is usually determined by
the user and can consist of an array of buckets all with the same size, or
a mixture of sizes (Figure 8.2). Once the size of the period has been
Week Month Quarter

I 2 3 4 2 3 4 5 2 3 4 5
IRegs 5 5 5 5 20 20 20 20 60 60 60 60
FIGURE 8.2 Time bucket variation.
determined, the next decision is to determine exactly when an order re-

quirement is due within the period. If the period is of 1 day in duration,
this is not an issue. For periods of longer duration, however, it must be
determined whether customer and supply orders are due on the first day
of the period, midpoint in the period, on the last day of the period , or
anytime during the period but no later than the last day. For the most
part, the convention is to use the first day of the period. Finally, when
the DRP generates a planned supp ly order in response to an impending
shortage, the system must place both the planned order's due date and
release date in the appropriate time buckets . The difference between
the due date and the release date is the item's lead time (Figure 8.3).
The point where the planned order falls due within the bucket is not an
optional decision but must always follow the same convention as used
for positioning customer and interbranch supply orders .
Periods I 2 3 4 5 6 7 8
Plan Ord Recpts 20 40
I I
Plan Ord Rei 2..0 I \0 I
IL _I I I
L _
FIGURE 8.3 Two week lead time offset
2. Gross Requirements. This term defines the quantity of an item that will
have to be issued from inventory to support demand. Demand on an
item originates essentially from three sources: the backlog of open cus-
tomer orders, forecasts, and interbranch resupply orders. Each form of
gross requirement must contain the following data elements for the
DRP to function properly: a discrete item number, the required quan-
tity, and the date each requirement is due. Time-phasing summarizes
the required quantity of each of these sources of demand by due date
and then places the total in the appropriate time bucket. The content of
the gross requirements is normally determined by the type of distri-
bution activity. For a retail distributor, forecasts form the gross re-
quirements. A regional distribution center's gross requirements, on the
other hand, may consist solely of interbranch resupply orders from
satellite warehouses. Finally, a regional distribution center that also
services customers may have all three types of gross requirements.
3. Scheduled Receipts. This term defines the total quantity of open re-
plenishment orders for an item. Replenishment orders in the distri-
bution environment can take three forms: supplier purchase, value-ad-
ded processing, and interbranch resupply orders. Purchase orders
specify products and inventory quantities that must be purchased from
the firm's suppliers. If a distributor has value-added processing func-
tions, inventory could be restocked by bulk breaking, sorting, kitting,
light assembly, and other processing activities. Finally, for companies
with distribution channels, branch warehouses will draw needed inven-
tory from their parent warehouses through the use of a resupply order.
In addition, inventory in-transit from one warehouse to another is also
considered as a form of resupply order. Each of the forms of replenish-
ment order must contain the following elements for DRP to function: a
discrete order number, the products to be resupplied, the quantities re-
quired, and the date the order is due. Once orders have been released,
they represent firm commitments on the part of the supply source to de-
liver the orders complete on the date required. As such, DRP considers
on-order quantities as available inventory in the calculation of
projected on-hand quantities in that time period.
4. On-Hand Balance. Unlike the statistical replenishment calculation,
which is a straight arithmetical computation, DRP provides the planner
visibility to projected on-hand quantities by time period after supply
has been subtracted from the demand. The assumption is that forecasts
and future open customer and supply orders are firm and will occur
when their due dates are reached. The logic of the on-hand com-
putation can be expressed as
Balance on hand at the end of the current period

plus The total of scheduled receipts due in the succeeding period
minus The total of gross requirements of the succeeding period
equals The projected on-hand balance at the end of the succeeding
period
If no inventory activity occurs in a period, the projected on-hand

balance from the previous period is carried forward to the next. The
projected on-hand balance calculation is illustrated in Figure 8.4.
Periods 1 2 3 4 5 6 7 8
Gross Reqs 300 300 300 300 300 300 300 300
Sch Recpts 200
POH 1000 700 400 100 -300 -600 -900
Net Reqs 300 300 300
FIGURE 8.4 Projected on-hand balance.
5. Planned Order Receipt. When demand exceeds supply forcing the on-
hand quantities in a particular time period to go negative, the system re-
cords the negative amount as a net requirement. In a DRP system, all
net requirements are covered by system generated planned orders. A
planned order is an unreleased supply order. The generation of a plan-
ned order is governed by the following elements:
1. The date when the net requirement is recorded.
2. The order policy rule which determines the lot-size quantity
necessary to satisfy the net requirement.
The replenishment lot-size quantity must equal or exceed the net re-
quirement in the first period in which a projected negative on-hand is
found. The due date of the planned order is the required date of the
source of the demand that triggered the net requirement. The planned
order should provide sufficient inventory to cover all actual customer
orders and unconsumed forecast in the period starting with the due date
of the first demand and ending at the date of the last day of the period.
Because of the quantity of the lot size, it may be large enough to cover
the net requirements of one or more subsequent time periods.
6. Plann ed Order Release. Once a planned order has been generated, the
DRP system will seek to determine the release date of the order. The
date a planned order is to be released is calculated by subtracting the
value of the product's replenishment lead time from the planned order
receipt date. As an example,
Planned order receipt date Week 7

Lead time (weeks) -2
Planned order release date Week 5
After the release date has been determined for the product, the DRP
system will reference the item's order policy code. This code will tell
the system how the actual replenishment quantity will be calculated.
Once these data elements have been generated, the planner will be
alerted to transform the planned order into an actual resupply order.
The DRP time-phased format outlined above is designed to assist the in-
ventory planner in visually understanding the interaction of supply and de-
mand. The computer system will populate each time bucket with the appro-
priate customer and purchase orders by due date and then calculate the re-
quired planned orders. The planner, in tum , must be able to interpret the data
and respond with the recommended resupply order action.
DRP PROCESSING
The advantage of DRP over order point techniques resides in the ability of
the inventory planner to see the relationship of supply and demand, not just as
it occurs in the current planning period, but also as it is projected out through
time. The time-phasing technique permits the user to be proactive to poten-
tial inventory shortages before they occur to ensure the highest service level
at the least inventory cost.
DATA ELEMENTS
Before the DRP system can effectively process demand and supply data, sev-
eral other key pieces of additional item-level information must be added to
the equation . In the standard DRP system, these data would be input into
each product's planning data master file.
Order Policies. When resupply order action is triggered for an item, the sys-
tem must know the replenishment lot-size quantity associated with the prod-
uct. The most common order policies used in DRP systems are the following:
1. Discrete (lot-for-lot). This order policy will recommend a resupply
quantity that matches exactly each item's net requirements by due date.
This technique must be used with caution. It will generate a planned

order pegged to each requirement.
2. Fixed period requirements. In this technique, the system will calculate
the replenishment quantity based on a simple rule of ordering n peri-
od's supply. A field in the item record is input with a value represent-
ing the number of forward periods the DRP looks when processing be-
gins. All the net requirements spanning the periods defined are then
summed, and a discrete planned order quantity matching this sum is
placed in the Planned Order Release row in the first of the defined set
of periods.
3. Discrete above the standard lot size. Often an item is to be resupplied
in quantities of a certain lot size because of discounting or shipping
purposes . This order policy requires the user to set the required lot-size
quantity in the product master record. In the first period in which the
product has a net requirement the system will recommend purchase of
at least the lot size plus additional quantity sufficient to cover exactly
the remaining net requirement. If the net requirement is less than the
lot size, then only the lot size is purchased.
4. Incremental above the standard lot size. This order policy is based on
two values entered in the product master record: the lot size and an
incremental quantity that is to be added to the lot size when the net re-
quirement is greater than the lot size. For example, if the lot size is 100
units and the incremental quantity is 25 units, a net requirement for 130
units will result in the system calculating a planned order quantity of
150 units.
5. Multipl es ofa standard lot size. When using this order policy, the sys-
tem will attempt to satisfy the net requirement with the product's re-
plenishment lot size. If the requirement is greater than the lot size, the
system will counter with multiples of the lot size until the planned or-
der quantity covers the net requirement. For example, if the lot size is
100 units, a net requirement for 130 units will result in the generation
of a planned order for 200 units.
6. EOQ models. The use of an order quantity derived from the standard
EOO calculation discussed in Chapter 7 can also be used to determine
order quantities. Although never intended for a time phased require-
ments planning environment, an EOO can be easily incorporated into
the DRP logic. The steps would be first to determine the EOO for each
product. Then, when the DRP performs the gross-to-net calculation,
the planned order quantities that would be generated in response to a
net requirement would be expressed in lot sizes of the EOO. Use of an
EOQ in a DRP system can only be justified when the demand for
stocked product s is both continuous and governed by a steady rate. The
more a company's demand is discontinuous and nonuniform, the less

applicable an EOQ order policy will be.
7. Lot costing models. The final order policy model is to use some form
of lot size that, like the EOQ, seeks to minimize the sum of inventory
carrying costs. Least unit cost, least total cost, and various forms of
mathematical or computerized lot sizing techniques, such as the
Wagner- Whitin algorithm, fall with this model.
Lead Time. Lead time enables the DRP system to backschedule order release
based on the planned receipt date. The content of a product's lead time is
composed of several elements, including planning time, supplier search and
order generation, supplier picking, preparation, and transportation activities,
and receiving and stock put-away. Although critical to the effective function-
ing of DRP, absolute lead-time accuracy is not crucial. In the final analysis,
empirically derived lead-time values are sufficient for the ef-fective func-
tioning of DRP. As will be pointed out in Chapter 10, purchasers would be
far better off concentrating their energies on building collaborative partner-
ships and negotiating supplier scheduling than chasing lead-time accuracy.
Forecast Demand Type. For those distribution points that utilize fore-
casting, the DRP system should provide the user with the option of choosing
how the system is to use the relationship between forecasts and booked cus-
tomer orders when determining an item's gross requirements. There are four
possible options.
1. Customer orders consume forecast. This option is the most widely
used of the four. In this technique, the computer is programmed to re-
duce the period product forecast by the total quantity of customer or-
ders due in that same period. For example, if the original forecast for a
product in a given period was 100 units and the customer orders booked
in that period totaled 80 units, the system would recalculate the new
forecast as 20 units. If the quantity of booked customer orders for a
time bucket exceeded the product forecast, then the order total would
be used as the period's total demand requirement. In addition, pro-
vision must be made for forecast that is unrealized and falls past due.
Should unsold forecast be simply forgotten, or should it be added to the
forecast of the current period in anticipation of late customer orders
that should have matured in the previous period.
2. Forecast only. When this option is chosen, only the forecast is used to
determine a product's gross requirements . Although customer orders
are tracked, they do not influence gross requirement quantities. This
option, for instance, would be used by distributors who want to drive
resupply from a buy plan.
3. Customer orders only. This is the inverse of the above option. It

would be chosen by distributors who have very short replenishment
lead times and the ability to respond quickly to customer orders.
4. Customer orders plus forecast. This option would provide an extreme-
ly conservative approach to managing inventories. The gross require-
ments for products using this technique would be calculated by adding
customer order quantities to the forecast as they occur in each period.
Distributors inventorying products with very long replenishment lead
times might employ this option.
Safety Stock. The use of safety stock is critical when statistical replenish-
ment techniques are used in an environment of probabilistic demand. DRP
can also use safety stock to provide a buffer against uncertainty in customer
demand. When the DRP processes, it will seek to preserve the integrity of
the safety quantity so that it is always on hand (Figure 8.5). As safety stock
creates in essence "dead stock" that is never intended to be used, it should be
kept to the absolute minimum.

Safety Stock = 125
Periods 1 2 3 4 5 6 7 8
Gross Reqs 300 300 300 300 300 300 300 300
Sch Recpts 200
POH 1000 700 400 300 -300 -600 -900
Net Reqs 125 300 300 300
FIGURE 8.5 Safety stock calculation.
Planning Horizon. For purposes of inventory replenishment, the length of the

planning horizon should at least equal the longest resupply product lead time.
If the horizon is too short, the DRP system will not be able to respond in time
to prevent product stockout. In addition, too short a planning horizon di-
minishes the visibility necessary for planning logistics capacity requirements.
For the sake of transparency, planners can alter the size ofDRP time periods,
starting with weeks, then months, then quarters or even years.
THE DRP CALCULATION
The generation of planned orders to cover all future product net requirements
is the cornerstone of the DRP planning process. For each product with a net
requirement, DRP develops a schedule of planned replenishment orders nec-

essary to cover all net requirements out through the planning horizon. Final-
ly, the DRP schedules inventory resupply action that will have to be taken in
the future if stockout is to be avoided.
The DRP process is derived from input from the following sources:
Product forecasts by due date
Forecast demand code
Open customer orders by product by due date
Beginning on-hand quantities by product
Open purchase, interbranch, and value-added processing orders by
product by due date
Replenishment lead times by product
Safety stock by product
Order policy codes by product
Size of the planning buckets
Once these data elements have been collected by the DRP processor, the sys-
tem will begin to populate the contents of each planning bucket by refer-
encing forecast, customer, and resupply order due dates and then performing
the gross-to-net requirements calculation. When the first net requirement ap-
pears, the system will generate a matching planned order with a quantity de-
termined by the product's order policy code. An example of the full DRP pro-
cessing logic appears in Figure 8.6.

Lead Time = 2 Periods
Safety Stock = 125
Periods 1 2 3 4 5 6 7 8
Gross Reqs 300 300 300 300 300 300 300 300
SchRecpts 500
POH 700 400 600 300 0 -100
Net Reqs 125
Plan Ord Recpts 500
Plan OrdRel 500
FIGURE 8.6 Full DRP calculation.

When the DRP calculation is complete, the inventory planner will be pro-
vided with output information that can be used to guide resupply order action.
The outputs from the DRP calculation are the following:
1. Exception reporting. Current commercial DRP systems provide the
user with the ability to see the results of the entire DRP run or to print
only those products that require order action. An exception report will
greatly assist planners in focusing in on critical inventory problems and
will provide the basis for constructive supplier scheduling. Many DRP
systems have sophisticated workbench maintenance screens on which
planners can review, change resupply recommendations, and generate
purchase orders automatically.
2. Planned orders. The DRP generation will provide the planner with a
window into the schedule of product planned order release. At a mini-
mum, the planner must release planned orders into actual resupply or-
ders for all products that have a value greater than zero in their current
period planned order release bucket. If order action is not taken, the
product will slip inside its replenishment lead time, causing expediting
and possible premium purchase costs . This first period is called the ac-
tion bucket period. Planned orders are the essence of the DRP system,
illuminating future product requirements and forming the basis for such
projections as on-hand inventory, supplier scheduling, and logistic ca-
pacity planning.
3. Action messages. As an aid to the planner in interpreting the exception
report and performing order maintenance, most commercial DRP sys-
tems provide planning action messages . The following are core action
messages.
a Release planned order. The planned order has reached the replen-
ishment lead time and must be converted into a purchase order.
b Lead-time violation. The planned order has slipped inside the re-
plenishment lead time . Immediate order action should be taken and
the order expedited.
c Expedite in scheduled receipt. The due date of an open resupply or-
der should be scheduled in to cover a new net requirement. De-ex-
pedite a scheduled receipt. The due date of an open resupply order
should be moved back because of changes in net requirements.
d Cancel. An open supply order should be canceled due to changes in
net requirements.
4. Pegged requirements. The pegging of requirements provides the plan-
ner with the ability to trace product gross requirements to their sources.
Because the value in the gross requirements bucket is a summary fig-
ure, this feature will pinpoint the actual sources of demand.
Bucketless DRP. Although DRP permits the planner to define system output
time periods (buckets), in reality the system records net requirements by due
date. Time buckets are merely a convenient way to aggregate demand and
supply data for viewing purposes. Most commercial DRP systems provide a
bucketless display, permitting the planner to see the projected on-hand bal-
ance based on the daily relationship of demand and supply. Table 8.1 pro-
vides an example of a bucketless display. Note that released and planned
supply orders are included in the on-hand balance calculation. The bucket-
less format provides a more efficient display of product status in that it pro-
vides full visibility to net requirements when they actually occur. A little
more skill is required to use this format than the bucketed approach, but it
provides the planner with the ability to exercise more detail control over
product planning.
TABLE 8.1 Bucketless DRP Display
Product #: 1425-100 1I2hp Sump Pump SS = 125

Lead Time = 2 weeks ORB = 1300 OQ = 1000
Date Gross Ref# Scheduled Ref# ORB
Reqs Receipts
01115/03 300 FOR 1000
01117/03 300 FOR 700
01120/03 200 FOR 500
100 C0123 400
01/23 /03 200 P0467 600
300 FOR 300
01127/03 1000 PlnOrder 1300
300 FOR 700
01130/03 300 FOR 400
DRP Regeneration Frequency. The frequency ofDRP regeneration is a criti-

cal element in system use and needs to be set as a policy standard by each
planning organization. Each DRP regeneration represents a complete repo-
sitioning of requirements and supply orders and the deletion and recalculation
of all planned orders. Although some DRP systems can recalculate product
statuses, such as open order and on-hand balances, dynamically in between
regenerations, planned order creation is reserved for the actual DRP proces-
sor. As a general rule, the more dynamic the planning environment, the more
frequently the DRP will have to be regenerated to keep product demand and
supply in balance. As a rule of thumb, the DRP processor should never be re-
run until all actions messages generated from the previous run are reviewed
and cleaned-up. Failure to satisfy all action messages will result in a per-
sistent demand/supply imbalance. Normally, most firms using DRP generate
the system weekly. In addition, DRP is essentially a continuous rather than a

cyclical planning tool. The DRP planning information is in reality a snapshot
of current product availability. However, because product status accuracy be-
gins to deteriorate immediately after generation , frequent regeneration will
constantly realign product priorities necessary for timely order action.
DRP Compared to Statistical Order Point. Probably the best way to under-
stand the advantages planner enjoy when using DRP is to contrast the tech-
nique with conventional statistical replenishment methods. For example, a
product has the following planning factors:
Lead time 2 weeks

Safety stock 125 units
Product usage forecast 300 units per week
Order quantity 1000 units
On-hand 1300 units
The order point for this item would be calculated as follows:
OP = (300 x 2) + 125 = 725 units .
When the existing on-hand balance for this product falls below 725 units, the
system would prompt the planner to purchase an order quantity of 1000 units.
The same planning data is portrayed in a DRP weekly time-phased format
in Figure 8.7. The forecasted usage of 300 units has been projected over the
Periods 1 2 3 4 5 6 7 8
Gross Reqs 300 300 300 300 300 300 300 300
Sch Recpts
POH 1000 700 400 1100 800 500 200 900
Net Reqs 25 225
Plan Ord Recpts 1000 1000
Plan Ord Rei 1000 1000
FIGURE 8.7 DRP calculation.
length of the planning horizon and is the only source of the product's gross re-
quirements. The gross-to-net requirements calculation indicates that the cur-
rent on-hand quantities will drop below the safety stock of 125 units in period
4. Accordingly, a planned order receipt for 1000 units is planned to arrive at
that time to prevent a shortage. Offsetting for the lead time of 2 weeks, the
system has posted a planned order release in period 2. In period 8, the pro-
jected quantity will again be less than the safety stock, and a planned order
release for 1000 units will be scheduled for period 6.
In the example, the results of using DRP and the statistical order point are
identical. The reorder point of 725 units is tripped in period 2, at which time
the order quantity of 1000 units would have been generated. DRP, however,
does a great deal more than the order point to assist the planner. To begin
with, the DRP format develops an entire schedule of planned replenishment
orders for the planner. Statistical order point, on the other hand, only alerts
the planner to release one order at a time. Second, the point in time when
forecast demand is expected to drive the inventory below safety stock is
transparent to the planner in DRP. Under statistical replenishment, the plan-
ner never knows when the order point will be tripped until it actually hap-
pens. Third, the DRP format is easy to understand and manipulate. There are
no complicated formulas to memorize. Fourth, although there are no open or-
ders in Figure 8.7, DRP will assist in keeping open supply order due dates
valid. Unlike statistical replenishment, DRP will continually reschedule open
orders to align them with projected requirements and keep their relative pri-
orities valid. Fifth, DRP can effectively respond to the problems associated
with lumpy demand. As irregular demand arising from lot sizes, promotions,
as so forth occurs, the gross-to-net requirements calculation provides the
planner with the ability to respond quickly with targeted order action to avoid
stockout while keeping inventory levels in line with future demand. Finally,
as will be illustrated later in this chapter, DRP provides planners with a win-
dow into detailed logistics capacities.
In addition, DRP has the ability to overcome forecasting and lead-time in-
accuracies, two critical problems that plague traditional statistical replenish-
ment. No matter how erroneous the forecast, DRP can replan quickly, ac-
curately, automatically. Regardless of whether poor forecasts or a variance
between forecast and actual demand caused the error, DRP can replan with
equal ease. In fact, the self-adjusting nature of DRP renders absolute forecast
accuracy unimportant. For example, using the data in Figure 8.7, actual de-
mand in period I turns out to be zero instead of 300. In such an event, on-
hand quantities in period 2 would then be 1300 rather than 1000. In this case,
the system would simply schedule the planned order release from period 2 to
period 3 to meet the new expected demand projected to occur in period 5. In-
versely, if actual demand in period I turned out to be 600 units instead of
300, the system would reschedule the planned order release from period 2 to
period I and give the planner a message to release the order. .No matter how
large the forecast error, DRP provides the mechanism for automatic adjust-
ment of demand and supply and timely resupply order action.
Finally, DRP is also able to work with inaccurate lead times. Statistical or-
dering techniques are totally dependent on accurate forecast usages and lead
times for their validity and accuracy. The problem is that both ofthese values
are volatile by nature. In contrast, DRP uses lead times as a reference point.
When actual purchase order receipt occurs, DRP can quickly adjust and plan
for the new net requirements that are calculated. In this sense, DRP tech-
niques enable the inventory planner to adjust quickly to what is actually hap-
pening, rather than what was planned to happen.
DRP IN A SUPPLY CHAIN ENVIRONMENT
Up to this point, the discussion of DRP has focused around inventory plan-
ning in a single facility environment. Although it is clear that DRP possesses
several advantages over statistical replenishment models, the real power of
the technique can be seen when planning inventories for a supply channel.
The problems associated with statistical inventory control noted above are
heightened when warehouse dependencies exist. Martin [8] has explored this
point extensively.
DRP VERSUS STATISTICAL ORDER POINT
Assume that Company XYZ possesses a distribution channel structure as

follows: From a central corporate warehouse in Chicago, three regional ware-
houses located in New York, Kansas City, and Los Angeles, who distribute
directly to the customer, are supplied with identical products. Using conven-
tional statistical replenishment techniques, the inventory planning data for a
given item inventories throughout the distribution channel is portrayed in
Figure 8.8.
When the inventory status of the Chicago warehouse is reviewed, say on
the first Monday of the month, the planner would not be prompted to take any
action. The order point quantity of 2260 units is below the on-hand quantity
of 2300. On the same day, the inventory status of the distribution channel is
reviewed. From the data, it is evident that both the New York and Los
Angeles warehouses require replenishment orders to be placed, whereas Kan-
sas City appears to have sufficient stock. The New York and Los Angeles re-
supply orders totaling 2100 units are transmitted to Chicago where they are
received, picked, packed, and shipped by the end of Thursday that same
week. On Friday morning, the planner in Chicago reviews the inventory and
finds a remaining balance of 200 units on hand. Accordingly, a resupply
order for 4000 units is placed with the supplier to arrive in three weeks. On
the following Monday, the Kansas City warehouse, which appeared to have
sufficient inventory the week before but had experienced sales in excess of its
normal average usage, has tripped its order point and now sends a replenish-
ment order request to Chicago for 400 units. Even though the planner in Chi-
cago had taken the necessary order action the week before, the unexpected
demand on the Kansas City warehouse has not only consumed the remaining
200 units but has resulted in a backorder for the remaining 200 units. Most
likely the 200 units will be shipped and the supply order for 4000 units will
have to be expedited.
Supply Warehouse
Chicago Warehouse
On-Hand Balance = 2300
Order Point = 2260
Supplier Lead Time = 3 weeks
Safety Stock = 565
Satellite Warehouses
New York Kansas City Los Angles
On-Hand Balance 550 275 750
Forecast Usage 2 IO/week 80/week 275/week
Order Point 630 240 825
Order Quantity 1100 400 1000
Interbranch Lead Time 2 weeks 2 weeks 2 weeks
Safety Stock 210 80 275
FIGURE 8.8 Order point channel supply model.
The above scenario is commonplace in most distribution channel environ-

ments. The problem is not poor planning or a lack of effort on the part of the
planners but the normal variation that products subject to independent de-
mand experience . Order point techniques simply are not flexible enough to
respond to the constant changes in demand and supply. The real culprit is the
assumption that lead times and product usage during the replenishment lead
time are fixed and constant. To counter random variation, most companies
carry safety stock. But safety stock, no matter how sophisticated the calcu-
lation, is not the answer to the problem; indeed, it is actually part of the order
point calculation! As Martin points out [9], order points fail to solve every-
day problems because they are essentially designed as ordering systems, not
scheduling systems like DRP. Statistical replenishment techniques simply
cannot reschedule replenishment quantities as everyday supply and demand
conditions change.
BILL OF DISTRIBUTION
Before the application of DRP to the multiechelon environment can be ex-

plored, it is essential to begin the discussion by detailing one of the funda-
mental requirements of the technique--the Bill of Distribution (BOD). Uti-
lizing the structure and mechanics of the manufacturing Bill of Material
(BaM), the BOD links supplying and satellite warehouses together similar to
the way the BaM links component items to their assembly parents (Figure
8.9). The difference between the two is subtle but critical. When demand is
Bill of Material
Component A Component C
Warehouse I Warehouse 3
Bill of Distribution
FIGURE 8.9 BOMs and BODs
posted on a parent assembly item, the MRP processor references the as-
sembly's BOM and "explodes" the requirement through the product structure,
placing demand on the component parts. The structure of the BOD, on the
other hand, has been designed to facilitate the transfer of requirements from
the components (the dependent supply warehouses) to the parent (the sup-
plying warehouse). This structure, often called an inverted BOM, performs
an implosion where requirements are passed up the structure rather than
down. The exact structure of a BOD can be configured to match a variety of
channel inventory flows. For example, not all items may be stocked in every
warehouse. Again, a mixture of products might be sold to the customer from
the central warehouse or from several regional or even local distribution
points. In any case, for the DRP implosion to work effectively, the proper
BODs must be structured detailing the flow of each and every product in the
distribution channel [10].
The benefits of using the BOD can be summarized as follows:
A comprehensive distribution channel can be structured, that can guide
the computerized implosion process and provide planners with full visi-
bility of supply and demand relationships up and down the channel
Supplying and satellite warehouse dependencies are clearly established

The DRP processor can begin its low level coding by beginning with
the last warehouse(s) in the channel and progressing up through each
level to the appropriate supplying warehouse
The BOD establishes the framework for total logistics control from the
distributor, up the network, and out to the supplier
55 = 210 New York Wareho use

LT = 2 weers
k
OQ = 1100 PO I 2 3 4 5 6 7 8
Gross Reqs 210 210 210 210 210 210 210 210
Sell Recp ts
POH 550 340 1230 1020 810 600 390 1280 1070
PIli Ord Recpts 1100 11 00
Plall Ord Rei 11 00 1100
55 = 80 Kansas City Warehouse

LT= 2 weeks
OQ=4 00 PO 1 2 3 4 '5 6 7 8
Gross Reqs 80 80 80 80 80 80 80 80
Sell Recpts
POH 275 195 115 435 355 275 195 11 5 435
PIli Ord Recp ts 400 400
55 = 275 Los Angles Warehouse

LT = 2 weeks
OQ = 1000 PO I 2 3 4 5 6 7 8
Gross Reqs 275 275 275 275 275 275 275 275
Sell Recp ts
POH 750 475 1200 925 650 375 1100 825 550
PIli Ord Recpts 1000 1000
D
Gross Reqs
FIGURE 8.10 Branch DRP calculations.

SUPPLY CHAIN DRP
The functioning of DRP in a supply chain environment can be clearly demon-

strated by driving the same demand and supply conditions detailed in Figure
8.8 through the DRP process . After the dependent supply warehouses in New
York, Kansas City, and Los Angeles have been linked through the BOD to
the central supplying warehouse in Chicago, DRP logic will start time-
phasing supply and demand by going to the warehouse at the lowest level in
the BOD structure and performing the gross-to-net requirements calculation.
As the process at each level in the structure is completed, the net require-
ments in the form of planned resupply orders are input by due date into the
gross requirements buckets of the supplying warehouse, and the process be-
gins again on that level. The DRP processor is completed when all levels in
the BOD structure have been reviewed .
The results of the DRP process for the BOD detailed above are illustrated
in Figure 8.10 . As can be seen, the New York and Los Angles warehouses
each have Planned Order Release quantities that have fallen past due. In nor-
mal circumstances, the planner would have reacted to both requirements
when they had reached the action bucket period and would not be past due.
In contrast , when the order point system is used, the fact that the order action
requirement is within the vendor lead time is not shown. The problem with
order points becomes even more visible in resupplying the Kansas City ware-
house . The order point indicates that the warehouse possesses sufficient in-
ventory and require s no order action . The DRP calculation , on the other
hand, indicates that a replenishment order for 400 units is in the action bucket
period and needs to be released .
ss = 565 Chicago Central Warehouse
LT - 3 weeks
oQ = 4000 PO I 2 3 4 5 6 7 8
Gross Reqs 2100 400 1000 1100 400
Sch Recpts
POH 2300 200 -200 -200 3800 2800 1700 1300 1300 1300
Pin Ord Recpts 4000
Plan Ord Rei 4000
FIGURE 8.1 1 Supply warehouse summary.
Although the advantages of using DRP in planning the inventory require-

ments for each warehouse is significant, the real impact of the technique is
evident when planning information is driven up to the channel's supplying
warehou se. As can be seen in Figure 8.11, the system would have alerted the
planner 4 weeks earlier that the projected demand from the channel would
drive on-hand quantities below safety stock. The use of order points shows
that before the order from the Kansas City warehouse arrived, the planner at
the supplying warehouse would not have been prompted to reorder. What is
worse, once the order point was tripped, the planner would have been inside
the 3-week lead time and would have had to expedite the replenishment
order.
The ability of DRP to provide the inventory planner with effective order
action information can be seen more clearly by rolling back the calendar used
in the above illustrations. Table 8.2 details the sales history for the same dis-
TABLE 8.2 Channel Sales History
Warehouse Weekly Actual Sales Current Adjusted

Forecast Past 4 Weeks On-Hand On-Hand
New York 210 705 550 1255
Kansas City 80 305 275 580
Los Angles 285 1105 705 1855
tribution channel as it would have occurred 4 weeks previously. Based on the

BOD, the planned order requirements for each of the three dependent supply
warehouses (Figure 8.12) have been passed up to the Chicago warehouse, and
the DRP gross-to-net requirements calculation performed (Figure 8.13). As
can be seen, DRP would have alerted the corporate planner at the Chicago
distribution center that projected channel demand had created a net require-
ment in period 4. By backscheduling the Planned Order Receipt by the sup-
plier lead time of 3 weeks, the DRP system has placed a Planned Order Re-
lease in the first period. By releasing a purchase order for 4000 units with the
supplier, the Chicago distribution center would have had sufficient inven-
tories to meet total channel demand as it occurred.
DRP is a superior tool in comparison to statistical order point for the man-
agement of inventory in a distribution channel because it makes the changing
requirements of channel demand and supply visible. Regardless of variances
in customer and resupply orders, DRP monitors future requirements to assist
planners in maintaining schedule priorities and preserving lead times to en-
sure product delivery. The order point technique simply could not project the
timing of future demand and supply relationships, and when the order point
was tripped, the planner had to expedite an already serious out-of-stock
situation.
ss = 210 New York Warehouse

LT = 2 wee.s
k
OQ = 1100 PO I 2 3 4 5 6 7 8
Gross Reqs 210 210 210 210 210 210 210 210
Sell Recp ts
POH 1255 1045 835 625 415 1305 1095 885 675
Pill Ord Recp ts 1100
Plall Ord ReI 1100
SS = 80 Kansas City Warehouse

LT = 2 weeks
OQ = 400 PO I 2 3 4 5 6 7 8
Gross Reqs 80 80 80 80 80 80 80 80
Sell Recp ts
POH 580 500 420 340 260 180 100 420 340
PIll Ord Recpts 400
Plan Ord Rei 400
SS = 275 Los Angles Warehouse

LT= 2 weeks
OQ = 1000 PO I 2 3 4 5 6 7 8
Gross Reqs 275 275 275 275 275 275 275 275
Sell Recpts
POH 1855 1580 1305 1030 755 480 1205 930 655
Pin Ord Recp ts 1000
Plan Ord Rei 1000
D
Supply Chain Requ irements Summary
Gross Reqs
FIGURE 8.12 Channel revised summary.
DRP PLANNING PROCESS
Now that the concepts and processing logic of DRP have been described, it is
possible to explore the management process to be used by inventory planners.
In general, the objectives of DRP are the same as statistical replenishment:
the creation of an efficient inventory procurement plan that optimizes tar-
ss =565 Chicago Central Warehouse

- 3 weeks
LT-
OQ=4000 PD I 2 3 4 5 6 7 8
Gross Reqs 1100 1000 400
Sch Recpts
POH 2300 2300 2300 1200 4200 3800 3800 3800 3800
PIn Ord Recpts 4000
Plan Ord ReI 4000
FIGURE 8.13 Revised supplywarehouse summary.

geted customer service levels while minimizing inventory cost. In developing
the DRP plan, inventory planners must answer questions such as the fol-
lowing:
Is the planning data for each DRP planned product accurate and up to
date?
Have BODs been created that accurately reflect the structure of the dis-
tribution channel?
Are on-hand balances being updated accurately and on a timely basis?
Are open customer and purchase order due dates and quantities ac-
curate?
Have replenishment order policies been accurately defined?
Do product replenishment lead times reflect current delivery realities?
Have safety stocks been calculated correctly?
Have DRP regeneration and planning procedures been formalized?
The development of the channel replenishment plan begins by sum-
marizing the total demand for each stocked product. This calculation forms
the first step in the DRP planning process (Figure 8.14). To be effective it is
necessary for all sources of product demand to be available for the DRP gross
requirements computation. Demand can consist of actual customer orders
and or forecast. Each requirement must be pegged to a demand source and
have a defined due date and quantity . For firms with distribution channels,
the system will also record planned interbranch order requirements as gross
requirements in the demand records of supplying warehouses at each level of
the BOD.
The second step in the DRP planning process focuses on executing the
DRP processor and reviewing of the resulting net requirements and generated
planned orders . This step is the core of DRP and should be closely monitored
by inventory planners. Net requirements occur in a given period when the an-
ticipated gross requirements for a product exceed projected available supply.
Each time a net requirement occurs and there are no or insufficient open re-
plenishment orders in the planning horizon, DRP will generate a planned or-
r
l
Logi tic Plan
I
ummarize et Re chedule
4 Gro r+ Requi rements f-+ Open -
Requirements Calculation Orders
Resc hedule
Open
Orders
~
Procurement Plan ]
FIGURE 8.14 DRP planning process
der dictated by replenislunent order policies and align the order by due date
with demand. In addition , the order's release date will be determined by
backdating the product's resupply lead time from the due date. The schedule
of Planned Order Releases defines the scope of replenishment order action to
be performed by the planner. Most commercial DRP systems provide on-line
workbenches and output reports advising planners of required order release
and reschedule activities (Figure 8.15). The generation of net requirements
has often been compared to using a shortage list. The critical difference is
that products appear on a shortage list when there are customer orders and no
available stock. DRP, on the other hand, provides a window into projected
shortages before they occur.
Once net requirements have been identified, DRP will reference each prod-
uct's Scheduled Receipts to ensure that the replenislunent order due dates are
correctly scheduled to demand. If a particular order's due date does not cor-
respond to a planning period's gross requirements, the order needs to be re-
scheduled in or out. For example, if a new customer order caused a net re-
quirement to occur in a period before a previously released resupply order,
DRP would prompt the planner to exp edite the order to meet the new state-
ment of demand. If the scheduled order quantity was insufficient to cover the
new demand, the system would generate a planned order quantity determined
by the replenishment order policy to cover the balance of the requirement.
Likewise, if a demand was canceled or moved back, DRP would respond by
prompting the planner to deexpedite the order to a future period or even to
cancel it if not needed. DRP's ability to provide the planner with timely order
action information necessary for effective open supply orders rescheduling is

one of the technique's most powerful features that is lacking in statistical re-
plenishment planning.
Product # Order # Order Summary Revised Action

Quantity Release Due Due Message
1425 Plan 5000 01/01/03 01/14/03 Release
1551 Plan 5000 01/07/03 01/14/03 No Action
2300 1234 345 01/24/03 01/07/03 Expedite
4110 Plan 4500 01/07/03 01/14/03 Release
3320 1267 1234 01/23/03 De-Exped
3345 1275 4567 01/25/03 Cancel

.............................................. .......................... .................... .................. ...........................................
FIGURE 8.15 DRP order action report
The final step in the DRP planning process is the calculation and review of
the detailed logistics capacities necessary to meet the schedule of Planned
Orders . Logistics capacities are composed of four elements: inventory in-
vestment, transportation, warehouse space, and labor and equipment. If the
priority plan of inventory requirements established by the DRP process is to
be executed successfully, it is essential that planners ensure that logistics
functions have the required capacities . By extending the schedule of Planned
Orders by the planning factors found in each capacity area, planners can re-
view the viability of the inventory plan. If insufficient capacities are found in
any of the four areas, either the inventory plan must be changed or additional
resources must be acquired to supplement the shortfall. Once the priority and
the capacity plans are in place, planners can confidently begin the process of
inventory procurement.
DRP offers the distribution enterprise a new horizon for attaining the high-
est levels of customer service while maintaining low inventory costs. By il-
luminating the relationship of supply and demand through the planning hori-
zon, the DRP planning process provides inventory planners at all levels in the
distribution network with a detailed window into the status of inventory in the
channel. By effectively linking together marketing and sales planning with
inventory investment, warehouse size, labor and equipment, and existing
transportation capacities, DRP offers distribution functions an effective meth-
od of integrating the resources of the entire channel with the requirements of

the marketplace .
DETAILED LOGISTICS CAPACITY PLANNING
The capability to maintain effective inventory control is only half of the bene-
fit a DRP system offers supply chain planners. Just as important as main-
taining the critical balance between supply and demand is the balance that
must be maintained between demand requirements and supply chain capa-
cities . A distribution channel that blindly pursues a policy of demand man-
agement without critical attention to enterprise capacities is courting disaster.
The following scenario is all too familiar: Marketing and sales embarks on
an ambitious campaign that calls for significant growth in inventories. Un-
fortunately, no one explores the effect this strategy will have on logistics
capacities. The result is that existing warehouses are unable to store the new
inventory quantities, resulting in the rental of costly alternative warehousing
and extra overhead costs. In addition, the existing company-owned trans-
portation fleet cannot keep up with the demand, and other, more costly car-
riers have to be contracted. What profits the new sales strategy initially in-
tended to realize are soon consumed in added logistics costs.
While the effective management of inventory is fundamental in assuring
channel responsiveness, the ability to also effectively manage supply chain
constraints is absolutely critical for a competitive supply chain network. To-
day, manufacturers have computerized tools, such as Capacity Requirements
Planning (CRP), Advan ced Planning Systems (APS), Theory of Constraints
(TOC), and Constraint Programming (CP) technologies, to assist in man-
aging production bottlenecks. Distribution planners have similar toolsets to
assist in removing capacity constraints in channel product deployment by pro-
viding visibility to possible constraints in capital, the work force, equipment,
and space availability. Being able to optimize the supply chain means that
distribution points anywhere in the channel network are agile enough to over-
come current and future constraints that threaten to impede the flow of goods
through the distribution pipeline. Achieving these goals requires that supply
chain planners possess information systems that provide a schedule of pri-
ority requirements that can be translated quickly and accurately into detailed
capacity planning elements. DRP provides planners with such a window into
required logistics capacities (11).
FINANCIAL ESTIMATING
The fundamental responsibility of inventory management is to ensure that in-

ventory is on hand to respond to customer demand. But in planning for in-
ventory it is also important that companies possess sufficient capital to fund
the replenishment plan. Although inventory is considered a current asset on
the financial statement, it is not cash, and poor inventory planning can drive a
company to financial ruin. In the past, businesses utilizing statistical replen-
ishment techniques have had difficulty estimating the investment necessary to
support marketing and sales plans. For the most part, estimates were made
using spread-sheet simulators based on aggregate product usage histories.
With the use of DRP, on the other hand, inventory planners now have the
ability to view as part of the DRP process output the projected financial in-
vestment necessary to support the inventory stocking plan. This process
could be performed by individual warehouse as well as for the whole dis-
tribution channel. The steps in developing a DRP inventory asset plan are
relatively simple. To begin with, the size of the DRP planning horizon needs
to be defined. The length should correspond to the financial time period de-
sired, for example 6 months or I year. Second, expected forecasts should be
developed for each product matching the length of the planning horizon.
Finally, the cost of each product determined by the firm's costing method
should be calculated. Once these elements have been defined, the DRP pro-
cessor can then be run.
The results of the DRP generation can be easily turned into a projected cost
report by multiplying each product's generated planned order quantity by the
cost. Figure 8.16 illustrates a projected inventory cost report. Notice that the
report lists the cost of each product by product family, a cost summary by
product family, and, finally, a summary cost by warehouse.
The advantages of using DRP in developing inventory asset planning are
the following:
1. Ease of planning. Instead of laborious data calculation and spread-
sheet development, DRP provides planners with the ability to view pro-
jected costs in detail and in the aggregate with relatively little effort.
The system, in fact, will calculate the necessary data elements as part of
the normal DRP generation. Planners merely have to format the re-
quired output reporting.
2. Accuracy. DRP provides planners with an extremely accurate calcu-
lation of projected inventory costs. By extending each product's plan-
ned orders by the cost, DRP can provide a window into the financial as-
sets necessary to respond to each product's schedule of net require-
ments. The more accurate the forecast, obviously the more accurate the
financial projection.
Warehouse: Chicago Date From: 01/01/03 Date To: 12/31/03

Product # On Hand Planned Orders Cost Projected $
1425 100 15,000 $2.25 $33,975.00
1551 200 22,000 $1.35 $29,970.00
2300 125 19,000 $1.45 $22,731.25
4110 50 12,000 $2.57 $30,969.50
3320 25 900 $3.10 $2,867.50
Family $$ Total 120,513.25

.................................................................................................................................................................
Warehouse $$ Total $22,235 ,125.00
FIGURE 8.16 Costed DRP inventory report
3. Simulation . By inputting alternate forecasts into the system , DRP pro-

vides planners with the ability to simulate product level, individual
warehouse, and aggregate channel costs. By analyzing each iteration,
the proper forecast that fits both the inventory plan and the firm's asset
budget can be selected.
4. Productivity. The choice of the right inventory plan is critical for the
success of the enterprise. DRP permits planners to make the right in-
ventory decisions so that targeted customer service levels can be met
while reducing inventory costs .
TRANSPORTATION PLANNING
Perhaps the single most important factor inhibiting transportation planners

from effectively controlling transportation costs is lack of visibility into fu-
ture shipping requirements. Often firms are faced with the problem of having
to ship products in quantities that do not take full advantage of rate structures.
For example, transportation is forced to ship partial truckloads because the to-
tal of current shippable demand is less than a full truck. What transportation
planners really need is to be able to view not only current but also the antici-
pated shipping requirements of future periods when developing a cost-effec-
tive shipping plan. Instead of just shipping those products that happen to be
available at the time, by having visibility into the schedule of demand for the
next couple of days or weeks, future requirements could be moved in and
combined with current requirements so that full truckloads can be shipped.
Because of its ability to time-phase supply and demand, DRP provides
transportation planners with a window into both current and future shipping
requirements . By referencing individual product master information relating
to weight, volume, and number of pallets, DRP can easily convert each prod-
uct's schedule of planned orders into transportation planning data elements.
Figure 8.17 provides an example of a shipping schedule by weight, volume,
and number of pallets derived from combining planned orders to be shipped
from a distribution center to its satellite warehouses.
Warehouse: Chicago Date From : 01/01/03
Period Total Weight (lbs) Volume Number of Pallets

I 500,000 31,000 2935
2 615,000 36,500 3554
3 550,000 33,300 3256
4 470,000 28,200 2805
5 525,000 31,500 3103
................................................................... ............................................................................................
FIGURE 8.17 Transportation report .
The above shipping schedule could be used by transportation planners in

the following manner. Say that the distribution center ships products by
truck. The standard trailer has the following capacity: maximum weight is
25,000 pounds, with a volume of 1500 cubic feet, and a max of 15 pallets.
The goal is to develop a shipping schedule that optimizes truck capacities. In
period 1, the shipping schedule indicates that, by weight, 20 trucks will be
necessary (500,000/25,000). In addition, by rounding the necessary volume
and number of pallets, 20 trucks appears to be the optimal shipping schedule.
In the second period, however, the schedule indicates that by weight 24.6
trucks will be required, by volume 24.3, and by pallet 23.6. Once these com-
putations have been done, it would be quite easy for the transportation plan-
ner to go to the third period and expedite-in the necessary orders to bring the
shipment up to 25 full truck loads. By examining the contents of period three
through a detail shipping schedule (Figure 8.18), the planner could select
those products to be combined with period 2 orders to maximize on trans-
portation capacities .
The advantages provided by DRP in assisting the firm plan and control
transportation capacities are significant. There are four key areas to review
[12]:
Warehouse: Chicago Date From: 01 /01103 Date To : 02/28/03
Week Product # Quantity Order Type Weight Volume Cube Pallets

1 1425 5000 PLN 128,000 8500 45
1551 12,000 PLN 125,000 7300 61
2300 1800 PLN 85,000 6500 75
4110 1340 PLN 75,000 5200 79
3320 3260 PLN 87,000 3500 33
500,000 31,000 293
Weekly Totals
Week Product # Quantity Order Type Weight Volume Cube Pallets
2 1425 7200 PLN 111,000 7200 55

1551 8,200 PLN 89,000 8200 43
...........................................................................................................................................................
FIGURE 8.18 Detailed shipping schedule.
The transportation planner has the critical information necessary to

schedule effective transportation and loading. DRP provides a window
into future requirements , permitting planners vision to develop
transportation plans that extend beyond current shipping requirements.
Through the use of simulation, planners would have the ability to see
the impact of different forecast plans and provide essential input into
selecting the optimal forecast to the firm's transportation management.
For example, planners may total the shipping requirements for the en-
tire year and then contrast them against available capacity. This would
be particularly important if the firm possessed its own carrier fleet.
The aggregate shipping schedule could also assist in planning other
critical logistics elements. It could be used to develop transportation
freight budgets, negotiate freight rates, and justify the acquisition of ad-
ditional equipment such as trucks, trailers, and rail cars.
Because the schedule of planned orders generated by DRP is truly a
schedule of what is going to happen, the shipping plan represents what
the firm is going to ship and when it must be shipped. This information
can be used by other business functions, such as accounting and sales,
in their planning processes.
WAREHOUSE SPACE PLANNING
Calculating warehouse capacities is one of the most neglected of the four

areas of logistics capacity planning. The failure to effectively plan ware-
house space can have an enormous financial impact on the whole distribution
channel. Ballou [13] estimates that warehousing activities account for rough-
ly one-fifth of a typical distributor's logistics expenditure. Poor warehouse
planning can result is such problems as unnecessary material handling costs,
product damage and obsolescence, record-keeping redundancies and errors,
time wasted in product search, excess transportation costs, and the cost of
public warehousing or other extra storage facilities.
Generating warehouse capacities from DRP output involves the addition of
a few data elements to the system. The elements consist of the following:
1. Product level storage profile. The starting point of the capacity calcu-
lation is defining the weight, volume, and number of pallets required to
store the stocking unit of measure for each product in the distribution
channel. Most commercial DRP systems provide these data elements
as part of the computerized item master record. Planners must make
sure that the data are loaded correctly and that there is an audit program
in place to keep storage values up to date.
2. Warehouse storage capacities. Each storage type in the warehouse
must be defined in the DRP system's location master record. Shelf
racks, bins, bin boxes, barrels, floor space, and pallets are possible ex-
amples of storage types. Next, each of these storage types must be as-
signed a stocking volume based on space dimensions and allowable
weight capacities. Finally, each stocked item would be assigned a stor-
age-type code based on its size and projected stocked quantities. The
result of the process would be a list of total available locations in the
warehouse broken down by type, weight, and volume (Figure 8.19).
3. Warehouse space calculation. Computing storage space requirements
from DRP output consists of two calculations. In the first, the capacity
requirements for each product would be calculated by extending the
schedule of planned orders by the product's storage profile. Next, the
storage requirements would be computed by dividing each product's ca-
pacity requirements by time period by the storage type. For example, a
given product's storage volume requirements total 192 cubic feet. The
product is stored in an area in the warehouse composed of 4 feet x 8
feet x 4 feet shelf racks. By dividing the requirement by the storage
type, the product would require 1.5, 4 x 8 shelf racks.
By reviewing warehouse space capacities each time the DRP is generated,
logistics planners can plan for both long- and short-term capacity require-
Warehouse: Chicago Date From: 01/01/03 Date To: 12/31/03

StorageType Location Code Weight Dimension (ft) Volume (ft3)
Shelf 7010101 SR4 1500 4x8x4 128
Shelf 7010102 SR4 1500 4x8x4 128
.. .. .. .
~h~n 7010103 SR2 1500 2x8x4 64
........ ....................... .................................. ................................... ...................................
Total 425,000
...............................................................
0 . . . . . . . . . . . . . . . . . . . . .. ..... ..... . ...
Bin 6210101 8.5 450 .5x3x3 4.5

Bin 6210102 8.5 450 .5x3x3 4.5
.. Bin 6210103 Bl 450 lx3x3 9
........................... ....................... ........... ........................................................ ................................... ,
Total 123,000
FIGURE 8.19 Warehouse capacity report by type.
ments . As the schedule of planned orders changes, DRP will assist planners
in viewing the ability of existing warehouses to meet storage requirements,
and to reveal serious undercapacity and overcapacity conditions. Effective
capacity reporting will assist planners in controlling storage costs and
improving overall operating efficiency and profitability.
LABOR AND EQUIPMENT CAPACITY
Effective logistics planning requires that planners be able to predict man-

power and equipment capacities. Too much or too little manpower can be ex-
pensive, as can the cost of unused equipment or poor customer service due to
equipment shortage. DRP can significantly assist logistics managers keep
their labor and equipment needs in balance with demand requirements. The
schedule of planned orders will provide managers with a statement of which
and when products will have to be ordered, received, put-away, picked, and
shipped. Warehouse managers, in tum, will have to develop material han-
dling standards for these critical warehouse functions. As an example, after a
time study was performed, one distributor set the order picking standard in
their bin warehouse to be 60 lines per operator-hour, and the stock put-away
in the same area to 30 receipts per operator-hour. By matching the schedule
of planned order requirements by time period to standard labor and equip-
ment capacities, warehouse managers can readily ascertain each warehouse's
total daily, weekly, and period capacities, identify capacity constraints and
excesses, and plan accordingly.
MANUFACTURING SYSTEM INTERFACE
DRP provides supply chain companies with a set of computerized applica-

tions that easily integrates with enterprise business systems like ERP. As
portrayed in Figure 8.20, most ERP-type systems contain a DRP module that
up ply C ha in Dema nd
ERP Plann ing ystem
DRP MP
Production MRP
FIGURE 8.20 DRP/MRP integration.
is part of the standard MPS/MRP applications. The functioning of a DRP

system is relatively simple. Forecast, interbranch, and customer demands are
reviewed by the DRP processor at each channel warehouse when the time-
phased net requirements implosion occurs. The net requirements, in tum, fil-
ter down through the BOD until they arrive at the manufacturing warehouse.
The final statement of product requirements originating from the supply chan-
nel is then communicated to the master production schedule (MPS) of the
manufacturing warehouse in the form of scheduled interbranch resupply or-
ders and placed within the appropriate gross requirements buckets. When the
MPS processor is executed, the production master scheduler is provided with
a window into the collective channel demand placed on each MPS finished
product. After review, the authorized MPS provides the input of finished
goods requirements used to generate Material Requirements Planning
(MRP). Finally, the MRP drives the schedule for all raw material and com-
ponent part procurement and shop order release and is used to calculate man-
ufacturing capacities. As demand and supply elements change, the MPS has
the ability to preserve or recalculate order priorities to keep the entire enter-
prise on track.
The DRP display and the MPS display work in the same fashion. Because
both use the same period calendar, DRP planned orders can easily be placed
within the correct MPS gross requirements planning buckets. As DRP, MPS,
and MRP perform their processing activities, planners in purchasing, manu-
facturing, and logistics are provided with integrated information relating to
demand and supply requirements within the entire enterprise. The logic and
terminology for all three are identical and many of the computerized reports
and screen displays are identical or very similar. In a way that statistical re-
plenishment techniques cannot possibly hope to achieve, the integration of
DRP and MRP provides for the implementation of a common system that can
be used across the entire enterprise. Such visibility promotes the organiza-
tional objectives of the successful supply chain supplier of the first decade of
2000: collaboration, a common solution to problem solving, and a unified fo-
cus on customer service and logistics costs.
DRP AND SUPPLY CHAIN MANAGEMENT SYSTEMS
When DRP was first introduced, it was directed at assisting companies to

more effectively control their internal distribution channels. As companies
began to realize that the real benefits of applying DRP occurred when the
technique was applied outside channel boundaries to the suppliers and cus-
tomers that constituted their extended supply chain universes, several critical
obstacles began to appear. Perhaps the most glaring issue resided around
how information and inventory data found in local planning systems scattered
throughout the supply network could be integrated and optimized to respond
to customer service goals at all points in the channel. Achieving such an ob-
jective is indeed a daunting one. Today, companies faced with the task of
linking internal planning systems with outside supply chain partners often en-
counter the following realities .
Different business objectives. Businesses often are faced with man-
aging supply chain activities that span many different types of enter-
prise. A typical channel may contain manufacturers, distributors, third
parties, and retailers. These trading partners may have their own set of
corporate objectives and supply chain strategies that can conflict with
each other and require channel planners to develop not one, but multi-
ple approaches to the task of integrating information and inventories.
Different business environments. The heterogeneous composition of the
supply chain also means that there can be wide disconnects stemming
from industry specific business practices, productive processes, and

cultural attitudes. What may be critical to one channel node occupying
one point in the supply chain may be actually antithetical to the objec-
tives of another node located somewhere else in the channel.
The problem of interoperability. As the number of trading partners
grows in the supply chain the capability of channel information to be
easily communicated begins to diminish exponentially. Information
architectures can run the gamut from highly sophisticated e-business
solutions encapsulated within an advanced ERP system on the one end
to manual information management on the other. Even among com-
panies with sophisticated enterprise solutions, issues arising from hard-
ware, software, and connectivity mechanisms can retard the timely flow
of the planning and execution decisions originating in DRP systems
anywhere along the supply chain continuum.
The above points have historically inhibited the development of plans that
synchronize the capabilities of chains of trading partners and guide them to
collaborative relationships. However, the rise of new information technolo-
gies over the past several years have provided supply chains with radically
new avenues to effect the kind of real-time integration that is necessary to
shrink cost and lead times from the supply channel and accelerate the flow of
goods and services to the customer. Today, these SCM systems, capable of
tapping into Internet technologies, have been expanding to include a variety
of supply chain functions such as demand and forecast management, supply
planning, network optimization, fulfillment scheduling, transportation plan-
ning, and transaction event management that enables entire supply chains to
move beyond their internal boarders and generate the type of collaborative
value chains that are required to compete in today's global market place
(Figure 8.21). In the discussion below, two of today's most cutting-edge
SCM applications, supply chain planning (SCP) and supply chain event
management (SCEM) will be explored.
SUPPLY CHAIN PLANNING TECHNOLOGIES
While DRP has for decades provided companies with the tools to effectively
transmit and time-phase the interplay of channel supply and demand, supply
chain planning (SCP) systems have recently been deployed to enhance supply
chain interoperability and collaboration. SCP can be described as the appli-
cation of advanced planning and scheduling (APS) concepts to supply chain
management. Developed during the 1990's, the mission of APS systems is to
assist manufacturing planners to more effectively shrink production costs and
respond to market demand by applying theory of constraints (TOe) planning
and optimization techniques to the management of manufacturing resources.

Functionally, an APS system seeks to utilize information regarding the plan-
ned orders and productive resources necessary to calculate a simulation of the
actual delivery capabilities and possible plant constraints of a planned
schedule of production. In isolation, APS systems were never designed to
provide continuously synchronized plans outside an individual plant and pre-
sented a purely asynchronous approach to supply chain planning.
Collaborative
Collaborative e-Comrnerce Value Chains
Optimized SCM
Integrated ERP
Quick
Response
Just-In-Time Internal Opt imizati on

I
1980 1990 2000
FIGURE 8.21 Stages of supplychainmanagement techniques.
By 2000 the APS concept had been significantly expanded to embrace the
need to apply optimization techniques to incorporate supply chain trading
partners and synergize the operations of the entire channel network. Today,
these SCP systems have tapped into the interoperable power of the Internet in
order to create virtual supply chains networks enabling seamless collabor-
ation on all requirements affecting the supply channel. Collaborative demand
management has enabled planners to architect supply chain planning and
execution cycles fully consistent with customer demand and total channel
productive resources . Daily transactional events can be monitored and used
to trigger changes in operational plans. According to AMR Research, over
$14.9 billion of SCP software has been sold over the period 1999 to 2001,
and the market is expected to grow by 20 percent in 2002 to around $7 bil-
lion. Similarly, in a survey by industry analysts, 48 percent of companies
sampled said that in 2003 they planned to deploy advanced demand!
forecasting, optimization, and supply chain network design computerized

technologies (14).
The rise of the SCM concept has 3. Business system integration.

driven the growth of new compu- SCP/ 'CEM applications are today
terized toolsets. Originating as basic fully integrated with backbone ERP,
AI'S techniques for production CRM. PRM, e-business, and data
scheduling. these CM applications warehouse so ft w are suites.
have grown to encompass several
supply chain functions, including 4. Broadening t!( SC M scope. Com-
demand planning. supply planning, panies beyond initial manufacturing
strategic network optimization, ful- and distribution have begun to rc-
fillment scheduling. and CPFR. The alize the benefits of effective supply
integration of these channel func- chain planning and execution and
tions enables planners to structure arc looking to integrate SCP/SCEM
an optimized synergy across the en- into their suite of information tools.
tirc supply network that permits
trading partners to bener plan their 5. Cost Competitive. Aggressive
production plants and distribution pricing by software suppliers has
facilities and to reduce total channel made SCM planning tools available
inventory and transportation costs. to the small to medium company.
The critical drivers of this move- 6. Global Viewpoint. SCM suites

ment to SCM systems can be de- assist in entry to international mar-
tailed as follows: kets by providing global visibility.
multi-modal transportation manage-
I. Visibility and Collaboration. The ment. and regulatory compliance
ability to collaboratively plan de- data.
mand and optimize productive func-
tions and inventories with channel 7. int ernet lnteroperability. The
trading partners has become the use of Internet and application ser-
critical concern of today' s ex- vice pro vider (ASP) technologies
ecutive. has provided companies with a cost-
effective approach to integrating
2. End-to-End Solutions. SCM visi- channel partner databases and real-
bility requires the implementation of time event man agem ent.
information systems that integrate
and synchronize planning and con- So urce: Jill Jenkin, "Supply-Chain
trol data from all levels of the supply Planning Build on Its Success,"
chain. SUPp~\ 'Chain e-Business, 2. 7,
(200). 26-28
The objective of SCP systems is to provide supply chain planners with opti-
mization capabilities that positions manufacturers and distributors across the
channel network to achieve the following objectives:
Provide answers to such critical questions as what should be the design
of the supply channel? How many manufacturing plants and distribu-
tion facilities are required? Where should they be located? What prod-
ucts should be made and what are the inventory levels?
Enable the construction of supply chain communities in order to man-
age channel complexities through the engineering of enhanced planning
and decision-making capabilities, starting with internal ERP systems
and extending connectivity to Internet-linked channel trading partners.
Ensure that channel network costs are minimized and that they are, as
much as possible, the most competitive across supply chains.
Identify the most profitable customers at all locations in the supply
chain by creating more compelling, value-based relationships than com-
peting supply channel networks .
Secure access to the most value-added suppliers on a global basis by
establishing collaborative, interoperable supply chains that offer B2B
technology and trading partner relationships.
Engineer flexible, agile organizations and supply channels that can lev-
erage an array of connectivity technologies , ranging from collaborative
product commerce to multichannel e-information visibility, to capital-
ize on opportunities engendered by customer demand changes and
shifts in supply-side dynamics.
Overall, an effective SCP system should meet the needs of the following
supply chain functions.
Collaborative forecast/demand planning. The SCP architecture should
provide for the integration of individual company forecasts, pro-
motions, planned demand schedules, and customer order requirements
resident on their enterprise backbone systems (ERP) with the SCP sys-
tem. This information provides the raw data for the SCP optimization
engines. In turn, the optimized plan can then be communicated and up-
dated interactively through tools, such as the Internet, in order to
achieve consensus on a shared demand plan. As demand events impact
the plan, changes to data can be checked simultaneously and out-of-
bound notification provided to channel network planners (Figure 8.22).
Collaborative supp ly and distribution planning. Besides demand, an
SCP system should contain tools to assist supply chain planners con-
currently plan for procurement, manufacturing, and transportation re-
quirements . Supply planning attempts to reconcile the demand for
components and raw materials arising from the MRP generation occur-
Demand Pull
Supply
C usto mer tore ~ T ra ns po r t Product Materia ls
han nel ~
Reqs Req s Req s Req s Req s
Req s
: : : : I I
:
I nlrror:c ~;\biliIY
TO ll r ~ rto i n ls
Co~l~borativc : PFR Sys~~ms I
I
I
I
Tra saction SYsl{m
Store
PO S Delivery Production Purcha sin g
DRP C P/SCE
Data Plan ystems Sy stems
Data
FIGURE 8.22 Supply chain integrated planning and execution.
ring within each network node with the total capabilities of upstream
supply partners. The SCP system must employ optimization heuristics
that utilize such constraints as quota agreements, lead times, calendars,
and lot-sizing rules, to make visible to supply nodes calculations of re-
quirements , sourcing decisions, supply chain capability to promise, and
purchasing schedules for production inventories. Distribution planning
attempts to reconcile the transportation requirements to satisfy channel
inventory deployment and transport capacities. The goal is to utilize
load algorithms to optimize volume, weight, and number of pallet capa-
cities in order to minimize transportation costs across the channel.
Collaborative sales planning. Normally , each channel trading partner
will develop their own sales plan . The sales plan is usually constructed
using the firm's internal enterprise business system and will consist of
critical initiatives such as sales promotions , special pricing, Internet
sales strategies, and critical sales targets by time period . These and
other elements of the sales plan are in tum used in the construction of
collaborative demand, supply, and distribution plans communicated to
the entire supply channel. The goal is to provide data input into supply
chain optimizers that can simulate a variety of possible scenarios based
on trading partners' basic sales plans and on-going monitoring of alerts
and key performance indicators as actual sales cascade through the sup-
ply chain network. ,
While SCP systems provide supply chains with radically new collaborative
toolsets to manage the complex and changing flow of supply channel infor-
mation, establishing a SCP environment across a channel network requires
enormous effort involving both operational reengineering and technology
acquisttion. Regardless of the actual SCP solution eventually implemented,

today 's SCP architecture must contain the following components (15).
Database Management. The most important requirement of a SCP solution

is that it provides for the seamless, inter-active communication of demand
and supply information across the supply network . Timely and accurate in-
formation is required to ensure the SCP optimization engines are calculating
meaningful outputs In addition, a technology architecture must be as-
sembled , such as the Internet, which provides for database interoperability
among all channel partners' enterprise business systems . Among the most
important data are to be found the following :
Supply chain confi guration. The composition of the actual supply
chain must be available to all trading partners. Exactly who is in the
supply network, what is their role in the channel, and what are their col-
laborative capabilities is critical. Answers to such questions determine
the effectiveness by which supply chain information, such as demand
patters , forecasts, replenishment, and transportation, can be utilized for
simulation and transfer back-out to the supply network.
Product data. Th is data area contains information relating to in-
dividual product records and includes such information as product lead
times and structures, MRP/DRP generated demand for forecasts , in-
ventory fulfillment, production, warehouse space, and transportation re-
quirements.
Supply chain capability-to-promise. Channel SCP demand and replen-
ishment data will be used to drive the capability of the entire supply
chain . The following metrics can be utilized to determine capacity re-
quirements: for purchasing, capacity is measured in the number of item
units that can be supplied per planning bucket ; transport is measured in
weight or volume units per planning bucket ; production is based on ca-
pacity plans measured in hours per planning bucket; receiving is mea-
sured in weight or volume units; dispatch are the resources that repre-
sent equipment/personnel for shipping measured in weight or volume;
and stock area is the volume or weight for each stock area resource
Costs. The data used for demand and supply must contain sufficient
costing information to provide supply chain planners with a basis to
determine costs for purchasing, transportation, production, and in-
ventory during simulation.
Penalties. The timely replenishment and delivery of inventory often is
ensured by the imposition of penalties for poor performance on the part
of individual channel partners . Penalties can consist of two types : mis-
sed delivery penalties and bucket production penalties (failure to
achieve production optimization by grouping production into fewer

periods to produce larger quantities .)
Forecasts for end products. Estimates of future demand can be com-
municated to the supply chain in the form of either a SCP simulated de-
mand schedule or sales forecasts for markets and customers and must
be capable of being transferred directly into the ERP/Server systems of
each channel partner on a real-time basis.
Feedback to enterprise business systems (ERP). The simulated sched-
ules and information status data that is generated and communicated
through the supply channel network must be capable of being input in
real-time into the planning systems of each channel business node.
Planning Timeframe. SCP enables planning on three levels:

Strategic - this level is concerned with corporate decisions relating to
where company distribution centers should be located or what ca-
pacities are need from the supply channel.
Tactical - this level involves optimizing the flow of goods through a
given supply chain configuration over a time horizon and executing
sourcing, production, resource deployment, and distribution plans.
Operational - this level is largely involved with detailed scheduling,
rescheduling, and execution of production and is usually equated with
internal APS planning tools.
Planning Model. Channel planners have the choice of several models that
can be used depending on the desired planning timeframe. For example, sup-
ply chain planning can proceed from the sources of demand originating with
product forecasts and open orders and then progressing up the supply channel
through retail, distribution, logistics, and production trading partners, ending
with suppliers of raw materials and components at the beginning of the sup-
ply network. At each step the demand is driven through optimization plan-
ning models and concludes with an synchronized schedule of manufacture
and distribution. Another possible model reverses the direction of planning,
beginning with MRPIDRP generation at each supply chain node, progressing
to detail scheduling, and, finally, to aggregate supply chain planning.
Optimization Techniques. A critical objective of SCP is to provide opti-

mized simulations that can guide planners in achieving the best balance be-
tween high throughput, minimum inventories, and low operations costs when
making supply chain decisions. Basically, SCP systems utilize one or all of
the following optimization teclmiques:
Mathematical models. These techniques attempt to describe the supply

chain environment mathematically and consist of a range of linear and
mixed integer programming models. This alternative is best suited to
stable, repetit ive supply chain demand and supply relationships.
Heuristic models. Models in this group are best deployed by supply
chains characterized by complex trading environments where the lack
or non-linearity of data negate the use of mathematical techniques. Ex-
amples of these models include theory of constraints (TOC) and pro-
cess network-based systems that attempt to connect customer demand
with the supply capabilities of pipeline trading partners.
Simulation. This model is characteristic of the earliest types of APS/
SCP systems. Founded upon queuing theory, simulation attempts to
optimize total supply chain capabilities by driving customer demand up
through the supply network in an effort to uncover constraints and pro-
vide possible alternatives to ensure the best solution. This method is
the one selected when performing strategic planning scenarios.
Supply Chain Schedule Management. The objective of the SCP planning

process is the generation of a supply chain plan that can be communicated to
collaborative channel partners. The interoperability of the SCP solutions em-
ployed will permit trans-channel planners to import demand schedules and
supply capacities from across the network and then to manipulate through op-
timization and simulation techniques the optimal channel response to the cus-
tomer. If the best case scenario still contains bottlenecks, the prioritization
algorithms in the optimization technique can assist planners to determine
which demands are to be satisfied first. In the process, the channel schedule
respects all capacity constraints and the supply chain network structure. The
overall goal of the entire process is to architect and communicate to each sup-
ply network node a cost-optimized, fully synchronized supply chain schedule
capable of meeting any customer demand before the competition.
SUPPLY CHAIN EVENT MANAGEMENT
Despite the best constructed supply chain plans, unplanned occurrences in de-
mand and supply are a costly reality of supply network management.
Bridging this gap between planning and execution is a new set of applications
termed supply chain event management (SCEM). The mission of SCEM is to
provide supply chain planners with advanced warnings of impending network
constraints by providing a real-time window into key events occurring across
the supply chain. The software utilizes series of increasingly urgent alarms
that automatically inform affected trading partners that a threshold event has
occurred or a target has been missed. Customized response rules can be at-
tached to the event that automatically suggest or initiate corrective action to
prevent a channel bottleneck from occurring. SCEM provides planners visi-
bility to supply chain event exceptions while trusting that normal events are
proceeding as planned.
SCEM systems are applicable to Such timely information provides

manufacturers, distributors - anyone Andersen time to recover and poten-
involved in the supply chain, partially modify their synchronized
ticularly if they are interested in col- manufacturing process.
laborating with channel partners and
developing the kind of collaboration Lucent Technologies utilizes their
necessary in today's fast-paced event-management software to ag-
world. gregate purchasing information and
provide complete visibility to open
Cardinal Glass supplies glass to orders. When Lucent receives an
Andersen Windows on a just-in-time order from a company like AT&T or
basis. In the past Cardinal had Verizon it can consist of more than
trouble balancing production sched- 200 lines that will be sourced from
uling with incoming orders and still various suppliers within Lucent's
be able to respond to Andersen's network. When the order arrives. it
short lead times. After imple- is broken apart into multiple POs
menting a SCM system with SCEM placed with key and occasionally
capabilities. when Andersen places small specialized suppliers. The
an order. the event management sys- SCEM system is used to track these
tem checks that there is inventory various orders as they move through
available to make the items ordered. the picking process. shipment. bill of
If not. an e-mail response im- lading, carton content list. etc., until
mediately is sent to Andersen it reaches a merge-in-transit center
warning that there is a chance operated by a 3PL. The 3PL col-
Cardinal will not be able to meet the lects these different orders and de-
order request. If the missing inven- livers them together to an installer at
tory is already scheduled to be re- the job site.
ceived or produced and there is an
estimated time of arrival, Andersen Source: Kurt C. Hoffman, "Hate
receives that estimated data. If the Surprises? SCEM Tech Helps You
item is still unavailable when the or- Deal With Them." Global Logistics
der is actually picked. Andersen & Supply Chain Strategies. 6, 2.
receives an alert that the item will (2002), 58.62.
not be part of the shipment.
SCEM can be described as an application integration layer that stan-

dardizes and integrates supply chain information between channel trading
partners. SCEM is normally integrated with individual ERP and SCP systems
and has the potential to be linked to e-market trading exchanges. Today's
SCEM system provides channel planners with the following toolsets:
Monitoring. Capability for order and shipment tracking, workflow
management, alert messaging/notification, personalized information
portals , and channel event escalation processes .
Performance. Feedback to measure, compare, and report on supply
channel performance over time against specific metrics and per-
formance objectives.
Planning. Ability to monitor channel events in real-time, from the
point of customer order and demand flow into the supply network to in-
ventory allocation and eventual fulfillment.
Controlling. Use of real-time, computer generated signals that pro-
actively notify channel planners, through Internet technologies, that an
action might have to be taken in response to a transaction occurring at
some point in the supply channel.
Simulating. Capability to utilize simulation models for issue resolution
based on current or expected events occurring in the supply chain.
Strategic management. Enable channel planners at all nodes in the
supply network to collectively control the entire supply chain through
timely decision making before costly bottlenecks appear.
How does SCEM work? Basically, the system is engaged when an un-
planned event occurs in the supply network requiring planner intervention .
Depending on the potential severity of the event, the system will trigger a sig-
nal, often using Boolean-type logic, to alert planners through a generic work-
flow process that an occurrence in the fulfillment pipeline has violated pre-
determined event boundaries. However, while SCEM provides visibility into
current events and permits planners to execute operational corrections, the
system's real value is to be found on the strategic level where pre-defined
KPls , performance scorecards, and executive dashboards can detail long-term
costs and potential bottlenecks in production, inventories, and transportation
capabilities anywhere in the channel.
When combined with effective internal systems like ERP, SCP, and CPFR,
SCEM can provide supply chain planners with critical tools to assist in the
development of new methods to reduce costs, increase efficiencies, reinvent
channel models, engineer collaborative relationships, and span supply chain
functional, cultural, and personal boundaries . SCP optimization applications
enable planners to concentrate on evaluating and making the best channel de-
cisions, while the optimizer does the complex and detailed number crunching .
The "best" solution is the one with the lowest total cost for meeting fore-
casted demand and the one that follows the selected optimization strategy.
The result of an effective SCP system is a feasible and optimized plan that
can be communicated to channel partners. SCEM provides planners with an
automatic alert to impending channel constraints and the ability to utilize sys-
tem rules that ensure .the smooth and least cost transfer of inventory through
the supply chain and out to the customer. Together SCP, CPFR, and SCEM
enable today's supply chain manager to dramatically shrink the gap between
planning and execution and to drive individual companies and entire supply
chains to new levels of productivity and competitiveness.
SUMMARY
As the competition for the global marketplace intensifies, companies and

their supply chains are increasingly faced with the dilemma of how to re-
spond even more quickly to ever increasing levels of customer service while
decreasing supply channel costs. Effective planning and control of inventory
is fundamental if supply chain managers are to achieve these two seemingly
opposing goals simultaneously. Traditionally, distributors have focused on
the utilization of statistical planning techniques to control inventories. But,
although statistical inventory replenishment techniques provide valid methods
for controlling inventories subject to independent demand, they, nevertheless,
contain inherent flaws. Problems associated with the use of statistical meth-
ods can be divided into two major categories: dependence on statistically de-
rived summaries to drive inventory reorder action and the adverse affect these
techniques have on organizational optimization. The first set of problems re-
side in the fact that statistical techniques depend on mathematical averages to
arrive at the most probable course of customer demand. Furthermore, tech-
niques such as order point and EOQs rest on assumptions concerning de-
mand, lead time, costs, and safety stock that are tenuous. Second, the use of
statistical methods of running the business result in the application of static
operational tools to solve the problem of today's dynamic supply chain en-
vironment. Although providing satisfactory tactical tools for inventory con-
trol, statistical methods lack the necessary strategic linkages to integrate and
keep in alignment long-range supply chain business plans with everyday or-
der processing and inventory execution activities.
In the past, inventory planners had but little choice other than.to use statis-
tical approaches when planning and controlling inventories. The break-
through came with the ability of the computer to time-phase supply and de-
mand. The logic of time-phasing is at the very foundation of Distribution Re-
quirements Planning (DRP). Through the use of a computer system, DRP re-
trieves key input from such data source files as forecast, open customer order,
open replenishment order, on-hand balance, supplier lead times, order policy
codes. and safety stock. Once these data elements have been collected, the
DRP processor will begin the process of populating the contents of each time
period in the planning horizon by referencing forecast, customer, and replen-
ishment order due dates. The system then performs a gross-to-net require-
ments calculation , time period by time period. When the first net requirement
appears , the system will generate a planned order with a quantity sufficient to
cover the demand based on the item's order policy code. Finally, once the
schedule of planned orders for all items has been compiled, DRP provides
action messages to guide the inventory planner in making effective replen-
ishment order decisions .
The advantages of DRP over statistical replenishment methods are obvious.
Statistical techniques are actually little more than order launching systems.
In contrast , DRP is, first and foremost, an inventory scheduling system de-
signed to align the firm's resources with customer demands. As marketplace
patterns change, DRP provides planners with the ability to be proactive in
handling potential stockouts as well as excessive inventories before they oc-
cur. Furthermore, by generating a schedule of supply, DRP can facilitate
product delivery. The results are increased supplier communications and
teamwork and reductions in costs, paperwork, expediting, and lead times. In
addition, DRP is particularly effective in a multiechelon environment. Not
only does DRP illuminate the inventory requirements at each level in the dis-
tribution channel, it also drives these resupply needs up through the network
based on warehouse dependencies established in the Bill of Distribution
(BOD). In this sense, the mechanics of DRP permit planners to have inven-
tory available to respond effectively to customer needs while minimizing in-
ventory costs throughout the entire distribution channel.
While originally designed to plan internal channel resupply, DRP stands as
the foundation for today 's advanced supply chain planning (SCP) and supply
chain event management (SCEM) systems. The goal of these systems is to
effect the collaborative linkage of each trading partner in the supply chain to
achieve a single, real-time approach to planning and fulfillment execution
that results in an extremely agile supply network capable of optimizing and
synchronizing individual plant and supply channel network resources to ef-
fectively manage channel constraints, search for optimal costs, secure access
to the most value-added suppliers , and assemble flexible, agile networks that
can meet the challenge of changing customer requirements. Utilizing inter-
operable tools like the Internet, channel partners can pass interactively the
planning information necessary to solve the twin problems of forecast inac-
curacy and the capability to utilize exception messaging to notify channel
members of impending con-straints in supply and demand.
1. Although statistical inventory planning is a valid technique for planning products

subject to independent demand, they present certain problems to the inventory
planner. Discuss these problems.
2. What advantages did the application of perpetual inventory systems offer plan-
ners?
3. Describe the elements of the DRP time-phased format.
4. Detail the mechanics of the DRP calculation.
5. Why is DRP a superior tool in contrast to statistical inventory techniques for
planning inventories in a multiechelon environment?
6. What is the function of the Bill of Distribution?
7. Describe how DRP can assist planners effectively manage the capacity require-
ments of the enterprise.
8. Describe how DRP and MRP II systems work together.
9. How can retailers apply DRP to their businesses?
10. In what ways can event-driven concepts be applied to the distribution environ-
ment?
PROBLEMS
1. Reference the inventory and inventory planning data for the warehouse supply
channel described below. Calculate the requirements on the central warehouse if
warehouse A was to received an order for 55 units and warehouse C was to re-
ceive an order for 15 units.
Warehouse
A B C D
On hand 272 150 370 1145
Forecast per week 100 50 125 275
Order point 240 120 360 1100
Order quantity 550 225 750 2000
Lead time (days) 5 7 10 15
2. Calculate the Projected On Hand, Planned Order Receipt and Planned Order
Release for the item illustrated below. Safety stock = 20 units, order quantity =
20 units, and the lead time = 2 periods.
2 3 4 5 6 7
Gross requirements 20 20 20 20 30 30 30
Scheduled receipts 60
Projected on-hand 45
Planned order receipt
Planned order release
3. A warehouse channel consists of two satellite warehouses and a central

warehouse. Product #AI-IOO is stocked in each warehouse. After a DRP
generation , warehouse A has planned order releases of 20 units of product #AI -
100 in periods I, 3, and 5. Warehouse B has planned order releases of 40 each in
periods 3, 5, and 7. Based on these requirements, complete the DRP calculation
for the supplying warehouse as detailed below. Safety stock = 50 units, order
quantity = 75 units, and the lead time = two periods.
2 3 4 5 6 7
Gross requirements
Scheduled receipts 75
Projected on-hand 55
Planned order receipt
Planned order release
4. Calculate the effect on the results of the above exercise if the demand coming
from warehouse A in period 3 increased to 95 units and a new demand for 63
units appeared from warehouse B in period 4.
5. Referencing the results in Problem 3, what would be the results if the supplier
only shipped 50 units of the scheduled receipt of 75 units due in period I?
6. The unit cost of Product #Al-lOO used in Problem 3 has a unit cost of $125.
Construct a graph illustrating the anticipated total channel cost by period of
Product #A I- lOO.
REFERENCES
I. Orlicky, Joseph, Material Requirements Planning. New York: McGraw-Hill,
1975, p. 4.
2. Woolsey, Gene "The Never-Fail Spare-Parts Reduction Method: An Editorial,"
Production and Inventory Management Journal (Fourth Quarter, 1988), pp. 64-
66.
3. Woolsey, Gene, "A Requiem For The EOQ: An Editorial." Production and
Inventory Management Journal (Third Quarter, 1988), pp. 68-72.
4. Silver, Edward A. and Peterson, Rein Decision Systems For Inventory
Management and Production Planning, 2nd ed., New York: John Wiley &
Sons, 1985,p. 174.
5. Orlicky, pp. 5-10; Schaeffer, Randall, "A New View Of Inventory
Management," APICS: The Performan ce Advantage, 3, 1, 1993, pp. 21-24.
6. Andre Martin, "Distribution Resource Planning," in Production and Inventory
Control Handbook (James H. Green, ed.) New York: McGraw-Hill, 1987, p.
22.1.
7. Ross, David F., "DRP II: Connecting the Distribution Enterprise." APICS: The
Performance Advantage, 3,3,1993, p. 61.
8. Martin, Andre J., DRP: Distribution Resource Planning. Essex Junction, VT:
Oliver Wight Publications, 1990, pp. 62-77; Martin, "Distribution Resource
Planning," p. 22.3-22.11; Martin, Andre J., "DRP - A Profitable New Corporate
Planning Tool," Canadian Transportation and Distribution Management,
(November 1980), pp. 45-53.
9. Martin, DRP: Distribution Resourc e Planning, p. 44.
10. Martin, "Distribution Resource Planning," pp. 22.22-22.3.
II . Martin, Andre J., "Capacity Planning: The Antidote to Supply Chain
Constraints," Supply Chain Management Review, 6, 5, 2001, pp. 62-67.
12. Martin, DRP: Distribution Resource Planning, p. 226.
13. Ballou, Ronald J., Business Logistics Management: Planning and Control, 2nd
ed. Englewood Cliffs, NJ: Prentice-Hall, 1985, pp. 495-498.
14. See O'Brien, David and McNerney, Gerald, Supply Chain Software Yields ROI-
But It Takes Time, AMR Research, January 2002, and Jill Rose, ed., Supply
Chain Management Report 2002, Fall, 2002, p. 14.
15. These points have been summarized from David F. Ross, Introduction to e-
Supply Chain Management, Boca Raton, FL: St. Lucie Press, 2003, p. 230.
UNIT 4
DISTRIBUTION OPERATIONS
EXECUTION
CHAPTERS:
9. Customer Relationship Management

10. Supplier Relationship Management
11. Warehousing
12. Transportation
Unit 3 was concerned with exploring the components of distribution opera-

tions planning. The goal of the planning process reviewed was to translate
overall business objectives and strategies into medium-range inventory re-
plenishment and logistics capacity plans. Of utmost importance was ensuring
that sufficient inventory and logistics capacities were available to support the
firm's Demand, Operations, and Channel Planning strategies. The resulting
distribution operations plans act, in tum, as a driver to guide sales, inventory
management, warehousing, and traffic management functions as they respond
to the every-day flow of customer and supplier orders.
Unit 4 continues the discussion of distribution management by examining
the next step in the channel network process: logistics operations execution.
Distribution operations execution focuses on the short- to immediate-range
activities associated with servicing the customer, acquiring and warehousing
inventory in the supply channel network, and transportation. The goal of the
execution processes is to ensure that the entire supply channel network is
capable of realizing revenue, cost, and total customer service objectives.
Unit 4 begins with a detailed analysis of the critical role played by Cus-
tomer Relationship Managem ent (CRM) functions (Chapter 9). Today's mar-
ketplace leaders have found that to be successful, the enterprise must be com-
mitted to quality and productivity techniques that enable the entire supply
chain to respond quickly to ongoing changes in customer product and service
418 DISTRIBUTION OPERATIONS EXECUTION
needs. Such a philosophy means that the entire enterprise must be diligent in
measuring customer perceptions of service quality, identifying shortfalls, and
responding decisively to service gaps. Fundamental to the achievement of
these goals is superior order processing functions that provide for the speedy
and accurate transference of goods, services, and order information through
the supply channel network. The chapter concludes with a discussion of how
breakthroughs in Internet technologies are changing forever the processes of
customer order and service management, performance measurement, and
sales force automation.
The functions of Supplier Relationship Management (SRM) are the focus
of Chapter 10. The chapter begins by exploring the essential activities per-
formed by purchasing, such as the inventory planning interface, supplier se-
lection, purchase order generation, and receiving. After a detailed discussion
on the development of effective procurement strategies, the chapter proceeds
to outline the purchase order management process. Next, the role of effective
purchasing performance measurements is detailed. The chapter concludes
with an in-depth analysis ofthe impact of e-business tools on purchasing.
Chapter 11 is concerned with warehousing. Warehousing is an integral part
of every distribution system. Warehousing enables channel systems to fulfill
the time and place utilities necessary to satisfy customer delivery and product
availability expectations. The chapter begins with a review of the nature and
types of warehousing, and then progresses to a discussion of the development
of effective warehouse strategies, facility location, and design. The chapter
concludes with a review of warehouse operations, equipment, and warehouse
productivity measurements.
Transportation plays one of the key roles in distribution. Without efficient
transportation functions, time and place utilities cannot be realized. In Cha-
pter 12, the elements of transportation are discussed. The chapter begins with
a discussion of the principles, scope of operations, and interaction of trans-
portation with other enterprise functions. Next, the various legal forms, per-
formance characteristics, and modes of transportation are discussed. Of crit-
ical importance is the transportation management process, beginning with the
establishment of internal and public carrier cost and price standards, and con-
cluding with the development of effective performance measurement stan-
dards. The chapter concludes with a review of the impact of logistics service
providers (LSP) and transportation management systems on contemporary
transportation.
9
CUSTOMER RELATIONSHIP
MANAGEMENT
DEFINING CUSTOMER Managing Customer Service

RELATIONSHIP MANAGEMENT Elements of Effective Service
Defining Today's Customer Management
Management Dynamics Identifying Performance Gaps
CRM Definitions Analyzing Total Cost-Service
Creating the CRM-Centric Organi- Level Trade-Offs
zation Identifying CSM Technologies
Developing and Implementing the
DEMAND MANAGEMENT Services Strategy
Demand Management Strategies Performance Measurements
Forecasting Demand
THE INTERNET-ENABLED CRM
ORDER MANAGEMENT AND ENVIRONMENT
FULFILLMENT CRM and Internet Sales
The Order Management Planning Sales Force Automation
Process e-CRM Marketing
The Order Management Cycle Partnership Relationship
Fulfillment Management
CUSTOMER CARE MANAGE- SUMMARY

MENT
Defining Customer Service QUESTIONS FOR REVIEW
Management
The relentless search for new ways of providing value to the customer has be-
come the dominant objective for firms seeking to utilize the supply chain to
sustain leadership in their markets and industries. Historically, the strategies
used to manage customer service centered on expanding productive capaci-
ties, gaining market share, penetrating new markets, and offering new prod-
ucts. Although critical, companies in the twenty-first century have found that
these objectives constitute the bare minimum of competitiveness. With their
expectations set by radically new and exciting buying experiences led by
world class companies like Wal-Mart, Dell Computer, and Amazon.com, to-
day's customers are demanding to be treated as unique individuals and re-
quiring their supply chains to consistently provide high-quality, configurable
combinations of products, services, and information available through ever-
more responsive, interactive marketing, order management, and customer ser-
vice technologies . Companies today are under no illusion that unless they
can structure the agile infrastructures and interoperable supply chains neces-
sary to guarantee personalized, quick-response delivery and the ability to pro-
vide unique sources of marketplace value even their best customers will not
hesitate to search the Internet for a global supplier who will provide the ser-
vice value they desire.
The immense growth in the power of the customer to determine the shape
and mechanics of the marketplace is being accelerated and amplified by the
Internet revolution. The ubiquitous presence of the Web implies that whole
supply chains are expected to provide all around 7x24x365 service and fulfill-
ment value. Customers now assume that they can click on Internet-enabled
product and service sites, or peer through portals, and view marketing mate-
rials, catalogs, and price lists, and place orders as well as comparison shop,
execute aggregate buys, participate in on-line auctions, receive a variety of
information from product specifications to training, review delivery status,
and check on invoicing and payment information. Responding to the im-
mediacy of these customer-driven requirements has forced companies to re-
examine the place and importance of their supply chains and explore radically
new ways to reach and understand their customers. This movement has ne-
cessitated the complete overhaul of the past science of customer management
and spawned an entirely new and more comprehensive approach termed cus-
tomer relationship management (CRM) while simultaneously transforming
and posing radically new challenges to how supply chains should be struc-
tured to execute the functions of marketing, sales, and service.
Chapter 9 explores the components of CRM in the age of the Internet. The
chapter begins by defining the prominent characteristics and primary mission
of CRM. Achieving the goals of CRM requires that all companies along the
supply chain network focus on the development of true customer-centric or-
ganizations and develop detailed solutions to demand management. Fol-
lowing this review of CRM, the chapter turns to an analysis of order and ful-
fillment management. In contrast to traditional treatments of the subject, or-
der management is seen as the avenue to align the resources of the entire sup-
ply channel in the pursuit of total service value. Next, the chapter discusses
CUSTOMER RELATIONSHIP MANAGEMENT 421
the elements of effective customer care management. The discussion focuses

on the organizational requirements necessary for "world-class" service leader-
ship, defining performance gaps, determining cost trade-offs, developing the
service strategy, utilization of Web-based tools, and establishing perform-
ance benchmarks. The chapter concludes with an overview of the application
of today 's technologies to customer management. Among the technologies
covered are Internet sales, sales force automation, customer service, partner-
ship relationship management, electronic billing and payment, and marketing
and demand analytics.
DEFINING CUSTOMER RELATIONSHIP MANAGEMENT
Until recently, the benchmark used to determine whether a company and its
supply chain partners were providing competitive value was measured by
how well they were delivering the right product to the right place at the right
time at the right price. At the dawn of the twenty-first century, while these
fundamental marketing utilities have lost none of their importance , what con-
stitutes the "right way" to respond to the customer has dramatically changed.
In the past companies competed by optimizing economies of scale and scope,
pushin g standardized, mass-distributed products into the marketplace regard-
less of actual customer wants and needs. Today, instead of constructing rigid
supply chains focused solely on volume and throughput, responsiveness to
the customer has become the fundamental criteria of channel design. In place
of acceptable levels of product and service value, supply chains have had to
reinvent themselve s around capabilities such as flexibility , scalability, collab-
oration, fast flow, and Internet-enabled interoperability that provide custom-
ers with unique opportunities for total service.
Meeting the requirements of today's marketplace requires companies and
their supply channel partners to continuously develop more responsive supply
chain models that bring them closer to the customer by enabling the right
mechanisms to attract and build sustainable customer loyalty. Effective cus-
tomer management means finding answers to such questions as
Who are the supply chain 's current and potential customers?
What level of product and service value can customers currently ex-
pect, and what would they like to have?
How much will it cost to increase supply chain quality and service
levels?
What will be the acceptable trade-offs in price, quality , and service?
What is the level of quality and service value being offered by the com-
petition ?
What levels of value must the supply chain achieve to maintain com-
petitive advantage?
How can the entire supply channel be committed to an operating phil-
osophy of continuous improvement in product quality and customer
service value?
The development of a winning customer service strategy designed to answer
these questions will have a direct impact on how the goals of the value chain
business strategy are to be attained, what will be the impact on product and
sales positioning, how the supply channel will be constructed, what commit-
ments will be required from channel resources, and, finally, how the entire
supply chain will gain and maintain competitive advantage.
DEFINING lODAY'S CUSTOMER MANAGEMENT DYNAMICS
There can be little doubt that a new model of customer management is emer-
ging. The power of the customer to drive the marketplace has become the
overriding reality for producers and suppliers of goods and services. Over the
past half decade a group of new buzzwords has become the rubric for the gen-
eration of service value. Businesses must be able to position products and
services that meet customers' demands, such as configurability, personali-
zation, super service; convenience in ordering, solutions orientation, and fast
flow fulfillment. Increasingly customers are also requiring that service mod-
els use digital information to move products rapidly, bypassing costly distri-
bution layers. Finally, customers are also demanding the ability to use inter-
active tools, like the Internet, to configure their own orders, perform self-ser-
vice inquires regarding order maintenance and status review, and supervise
the delivery process without hassles or mistakes.
The increasing power of the customer can be distilled down two critical
points. First, today's customer is value driven . While tools such as Internet-
enabled trading exchanges and auctions provide radically new and powerful
avenues to search globally for suppliers that can meet cost, product and ser-
vice solution, and delivery requirements , it does not mean that customers will
become increasing fickle and move away from business partnerships. It does
mean, however, that opportunities for service value provided by the Internet
will be factoring in new alternatives in the search to match available options
with requirements for individual value. Today's supply chain must move be-
yond just knowing and responding to past customer profiles and buying pat-
terns to the engineering of service models that continuously create new op-
portunities to reinvent what constitutes value for each customer.
Second, despite the growing capability to change suppliers based on price
and delivery criteria, today's customer is more than ever searching to build
strong partnerships with their supply chains. In the past, product and service
branding drove customer purchases and cemented loyalties. Today, custom-
ers are looking beyond just products, prices, and delivery to the capability of
their suppliers to provide participative product development, collaborate on
sales and demand forecasting, integrate channel resources and competencies
to synchronize competitive strengths, and enable the creation of supply chains
sensitive enough to be able to respond to changes occurring any place, at any
time in the supply network. Ultimately, the goal is to create the opportunity
for linked competitive visioning, whereby collaborative partners will pursue
joint marketplace development, shared resources, and trust driven by a com-
mon strategic vision.
Supply chains can not afford to ignore these growing customer expecta-
tions for value and collaborative relationships . In today 's Internet-enabled
environment customer are very aware of the matrix of product, service, price,
and delivery values that they have received and what is available elsewhere in
the marketplace . A single unfavorable experience provides customers with
every reason to search for new partners . Unsatisfied customers can be a sig-
nificant negative force in today 's Internet-empowered environment, de-
stroying time-tested relationships and scrambling formerly successful supply
channels . The opposite is also true. Companies that consistently succeed in
meeting the individual needs of their customers are communicating their wil-
lingness to generate new forms of service value and new collaborative possi-
bilities. Such a strategy is fundamental in building the partnerships capable
of withstanding the centripetal forces of an uncertain economy and the en-
croachment of global competitors [l].
CRM DEFINITIONS
Effectively responding to the dynamics of today's marketplace has required

supply chains to radically rethink their approach to managing the customer.
In the past, customer management was primarily concerned with managing
the transaction . Concepts of brand and mass marketing meant standardi-
zation of products and services, as well as pricing, and assumed uniformity of
customer wants and needs. The principles of customer management were
considered to consist of five critical concepts [2]:
1. The production concept held that customers were always predisposed
to products that are always available, delivered when needed, and are
low in cost.
2. The product concept held that customers would always choose products
that possessed the most quality, performance, and features.
3. The selling concept held that customers were primarily passive and that
if left alone would not buy enough of a company's products and ser-
vices. As a result businesses needed to continually devise effective
sales, promotions, and advertising campaigns that presented their prod-
uct/service value story to the marketplace.
4. The marketing concept held that the strategic goal of the business con-
sisted in determining the needs and wants of target markets and de-
livering the desired satisfactions more effectively and efficiently than
the competition.
5. The societal marketing concept held that the organization's task was to
determine customer wants and needs in a way that preserved or en-
hanced the well-being of the customer or of society.
While the core elements of these five pillars of customer management are
still valid, today 's dynamic marketplace has witnessed a redefinition of the
customer from a passive recipient of standardized goods and services to an
active participator in product/service sourcing, configuration and design, pri-
cing, and the establishment of interactive, one-to-one relationships focused on
attaining customized solutions tailored to their personal interests and needs.
Past concepts of customer service focused narrowly on formulas for front-end
functions such as forecasting, promotions, and marketing. Customer manage-
ment in the twenty-first century requires companies to continually create, en-
hance, and manage customer equity, or the value of customers to the enter-
prise, by establishing collaborative partnerships available through such touch
points as traditional marketing campaigns, direct sales, the Internet, and e-
mail.
In defining customer relationship management (CRM) it can be said that
customer management can be viewed from three critical perspectives [3].
Customer management as an activity. In this perspective customer
management is considered purely as a transactional function. Among
the activities are quotations management, pricing, order processing,
proof of delivery, billing and invoicing, and product returns and claims
processing. Basic customer services functions, such as handling com-
plaints, training, and documentation are also included.
Customer performance measurement. The second perspective con-
siders customer management from the viewpoint of performance mea-
surement. In this area can be found the development of service metrics
such as "percent of orders delivered to the customer within ten days of
order receipt" or "percent of orders received and processed in 48 hours
with no back orders." The goal is to provide benchmarks on how well
the supply chain system is responding to the customer. While critical,
this perspective is insufficient for effective customer management.
Customer management as a philosophy. The final perspective attempts

to position customer management as an element within the overall cor-
porate strategy of the enterprise. While considering transactional and
performance management as essential pillars, this perspective seeks to
converge marketing, sales, production, distribution, and supply chain
partners into a real-time, synchronized customer satisfaction system
that enables the development of close participative relationships
through personal marketing.
An effective definition of CRM must contain all three of the above per-
spectives. Because it encapsulates such a wide spectrum of customer
management functions, there is wide divergence between practitioners, ana-
lysts, and consultant as to a precise definition of the full meaning of CRM.
Some feel that it is a business strategy. Others think it is a methodology fo-
cused on a set of Internet-enabled processes. Still others consider it an inte-
grated extension of the ERP philosophy.
Perhaps the best way to understand CRM would be to view some of the
leading definitions. According to Greenberg [4],
CRM is a complete system that (l) provides a means and method to enhance
the experience of the individual customers so that they will remain customers
for life, (2) provides both technological and functional means of identifying,
capturing, and retaining customers, and (3) provides a unified view of the
customer across an enterprise.
Dyche feels that CRM can be defined as "The infrastructure that enables de-
lineation of and increase in customer value, and the correct means by which
to motivate valuable customers to remain loyal - indeed to buy again [5]."
The final definition comes from Renner, Accenture's global CRM practice
managing partner, who sees CRM as encompassing "all of the activities that
go into identifying, attracting, and retaining customers, and focuses on
aligning the whole organization to building profitable, lasting relationships
with customers [6]."
Another way to approach to defining CRM is to break it into its constituent
parts. CRM can be characterized as follows [7]:
CRM is supportive of the firm's strategic mission. Much of today's
thinking perceives CRM as a technology toolset that utilizes Internet-
enabled functions to facilitate the order and service function. In reality
CRM is a supply chain philosophy focused on the architecting of value-
generating productivities of whole supply channel networks in the
search to build profitable, sustainable relationships with customers.
CRM is focused on facilitating the customer management process.
Being more responsive to the customer requires sales and service func-
tions to make effective customer management decisions based on their

capability to identify what brings value to the customer. Often success
requires the availability of metrics and analytical tools that provide a
comprehensive, cohesive, and centralized portrait of the customer that
in turn can drive customer acquisition and retention programs.
CRM is focused on optimizing the customer's experience. CRM is con-
cerned with the goal of "owning the customer experience." CRM ini-
tiatives that continually win the customer can span objectives from pro-
viding a level of personalized service and customized products to uti-
lizing advertising, ease in ordering a product, or ensuring a service call-
back that will positively influence a customer's perception of the
buying experience. The end result is to make customers feel good and
personally connected to their supplier.
CRM opens a window into the customer. The goal of a CRM system is
to provide everyone in the supply chain who can influence the customer
experience with a comprehensive marketing profile that includes de-
tailing what service values the customer considers the most important
and how they can ensure the customer has a positive buying experience.
Access to customer-winning attributes, such as buying habits, pricing
and promotions, channel preferences, and historical contact infor-
mation, must be all-pervasive, integrated, and insightful.
CRM assists suppliers to measure customer profitability. An effective
CRM system enables customer management functions to determine
which customers are profitable and which are not, what values drive
profitability for each customer, and how the entire supply chain can ar-
chitect sales and marketing processes that consistently deliver to each
customer the values they desire the most.
CRM is about partnership management. While utilizing technology
tools such as the Internet to facilitate and provide new avenues for cus-
tomer service management is certainly important, the real value of
CRM is ascertaining and satisfying the needs, values, and visions of
each customer. CRM is about nurturing mutually beneficial, long-term
relationships intimate enough to provide on-going improvement oppor-
tunities and tailored solutions to meet mutual needs beyond physical
product and service delivery.
CRM is a major facilitator of supply chain collaboration. No indi-
vidual customer transaction can be executed in a vacuum. Customer
product and service delivery must be considered as actually a single oc-
currence in what is often a complex set of actions that ripple up and
down the supply chain. Businesses capable of architecting integrated,
synchronized supply chain processes that can provide a seamless ap-
CUST OME R RELAT IONSHIP MANAGEMENT 427
pearance to the customer will be the ones that will have sustainable
The goal of CRM is to provide a 360 degree perspective of the customer.
CRM is a radically enhanced view of traditiona l customer management that
seeks to employ today 's Internet -enabled technology toolsets to create an in-
frastructure that spans supply chain boundaries in the search to identify, cap-
ture, and retain customers. Besides creating channel processes that accurately
determine customers' behaviors, preferences, and sales history, CRM also un-
derstands customers to be value chain collaborators who regard their sup-
pliers as the primary contact node in an extended, integrated supply chain as-
sembled to provide the highest level of service and value.
CREATING THE CRM-CENTRIC ORGANIZATION
The emergence of CRM has required a redefinition of the organizational and

supply chain structures formerly used to manage the customer. In the past the
"supply chain" was narrowly conceived as a pipeline where products and in-
formation flowed sequentially from source to customer. The traditional sup-
ply chain manufactured standardized, relatively undifferentiated products that
in tum were "pushed" through distribut ion channels whose missions were to
provide cost efficiency and acceptable service. Supply chain management
was regarded as a tactical activity termed logistics management, a back-office
function concerned purely with transportation rate management and order
chasing . The ability to manage the customer was dramatically impacted by
these constraints . Products moved slowly and serially through each channel
node, with buffer inventories massed as a safeguard against poorly under-
stood demand in downstream nodes and uncertain supply from suppliers lo-
cated at the source. Finally, information regarding changes to supply and de-
mand was inaccurate and erratic , causing further chaos in the supply chain.
The dynamics of managing today's customer has obsoleted this archaic
view of the supply chain . In place of static, rigid supply channels, meeting
the demands of customers in the twenty-first century requires fast, flexible,
agile supply networks capab le of providing technologies that enable customer
self-service, the configuration of customized product/service wraps that
realize individualized value-solutions, and fulfillment functions responsive to
the demand pull of the marketplace. Actualizing such value-attributes re-
quires re-drafting of the basic structure and purpose of the supply chain.
CRM requires the architecting of supply chains possessed of the following
business and organizational values [8]:
Strategic advantage. Supply chains provide strategic as well as tactical
value. In the "Internet Age" value is driven by the interoperability of
all levels of business processes across supply network partners. Lev-

eraging channel value requires elevating supply chain management to
the prime position in the development of business strategy.
Customer-centric. Today's supply chains are no longer simply pipe-
lines of product and information populated by passive customers, but
should be conceived as dynamic, high-performance networks respon-
sive to the demand pull of the marketplace. In place of a one-size-fits-
all strategy, the goal is to produce and deliver products at the time and
in the quantity desired by the customer without costly inventory
buffers.
Collaboration . Competing in today's business environment requires
supply chain partners to engage in the generation of networks capable
of unique value-creating partnerships . The goal is to seek out and de-
velop channel competencies capable of performing specialized func-
tions that will facilitate over-all supply chain processes.
Agile and scalable. The ability to effectively respond to customer-driv-
en changes in product/service mix, channel design, and fulfillment con-
stitutes the foundation of CRM-responsive supply chains. Being agile
in this context means being able to respond as quickly as possible to de-
mand through the establishment of flexible production, distribution,
and information flow processes. Service attributes in this area refer to
the capability of organizations to reduce or eliminate physical plant,
processing times, unnecessary vertical integration, large R&D invest-
ment, and high technology investment hurdles. As the nature of de-
mand changes, supply chains must be able to quickly scale internal and
external resources to solve particular volume and variety imperatives.
Fast flow. The basis of demand management today is the rapid ful-
fillment of individualized customer solutions anywhere, any time on the
globe. The ability of customers to access competing suppliers through
the Internet has placed a premium on compressing and accelerating
supply chain throughput, reliable and convenient ordering and delivery,
and availability of supporting services. Fast flow espouses the attri-
butes of Lean Thinking, requiring the elimination of all forms of chan-
nel waste, optimizing the value stream, increase of the transparency be-
tween channel network nodes, dramatic reduction in batch production
and inventory buffers, and ability to design, schedule, build, and deliver
to exact customer demand.
Migration to e-Commerce. The universal access to and interoperability
of information through digital tools like the Internet resides at the heart
of today's revolution in customer relationship management. The goal
is to leverage the continuing explosion in integrative computerized
toolsets to provide the pathways linking and coordinating the demand

and supply activities of channel network trading partners. Contempo-
rary supply chain systems seek to integrate ERP backbones, fore-
casting, order management, and supply chain event-driven applications
to enable real-time linkages to critical databases as well as impending
channel constraints threatening the alignment of information and ma-
terial flows and customer service needs and fulfillment priorities .
Today , many organizations have invested heavily in computerized tools,
such as enterprise resource planning (ERP), supply chain planning (SCP),
and CRM in the search to become more customer oriented. While these ap-
plication toolsets have significantly assisted companies to rationalize and sys-
tematize enterprise operations, their true value can only be realized when or-
ganizational structures are truly demand-driven . Customer-centric organi-
zations can be seen as developing through four distinct stages [9]. In the first
stage, company-focused enterprises utilize Lean Thinking techniques to ex-
ecute service improvements that seek to eliminate internal wastes and barriers
that inhibit the pursuit of customer-focused operational processes, technolo-
gies, and fulfillment. Once companies have become inwardly customer-fo-
cused, they can then proceed to become supply chain focused. In this stage,
companies seek out existing supply chain partners to establish collaborative
initiatives on such inter-company processes as forecasting, planning, fulfill-
ment, product development, marketing, and logistics. In stage three, virtual
organization focus ed, channel trading partners seek to synchronize and inte-
grate productive functions, such as marketing, sales, product development, fi-
nance, and manufacturing, based on joint channel demand-driven decisions.
In the final stage, market focused, all channel decision-making and productive
processes both within and in the supply chain are reconstructed to provide a
single, seamless response to the marketplace . In this stage, channel constitu-
ents continually structure supply chain models providing for the interactive,
proactive, real-time deployment of strategic, tactical, and operational re-
sources capable of meeting any customer opportunity before the competition.
DEMAND MANAGEMENT
In today's highly competitive environment the effective management of the

customer has progressed beyond narrow attempts to influence marketplace
demand by focusing solely on marketing techniques such as promotions, ad-
vertising, and the annual sales campaign. Market-winning CRM requires a
new perspective that has coalesced around the concept of demand manage-
ment. While forecasting and traditional marketing remain central, demand
management denotes a much broader set of activities that seek to integrate
and optimize the totality of supply and demand satisfying functions, including
replenishment, sales and operations planning, marketing, and order and cus-
tomer management. Instead of belonging only to the marketing and sales
function, demand management is also the responsibility of multiple disci-
plines and departments , including production, logistics, supply chain, plan-
ning, and finance. Although the concept is, in fact, still evolving, it can be
said that the objective of demand management is to enable the "demand
chain," beginning with product manufacture and concluding with customer
delivery, to develop closely synchronized, collaborative strategies and pro-
cesses that dramatically increase the velocity of inventory, services, infonna-
tion, and capital through the supply chain and out to the customer. Figure 9.1
attempts to visually display the components of demand management.
FIGURE 9.1 Components of demand management.
DEMAND MANAGEMENT STRATEGIES
The nature, intensity, and distribution of marketplace demand will directly in-
fluence the scope, objectives, and resource requirements of any supply chain.
Traditionally, companies have sought to leverage the science of marketing to
uncover as well as influence patterns of customer demand. Businesses usual-
ly begin with a value proposition surrounded by strategic decisions associated
with such factors as the type of market to be pursued, its geographical scope,
the mix of products and services offered, and the capabilities of resources to
be deployed. Once the demand strategy has been assembled, the marketplace,
in tum, reacts over time to the value proposition, transmitting transactions, in-
formation, and behavioral patterns as to the effectiveness of the original prod-
uct/service value wrap. As demand feedback returns to each supply chain
constituent , strategic planners can then re-evaluate the original value propo-
sition and supply chain capabilities and execute necessary changes.
The strategic response to demand management input can be grouped into
four areas [10].
Growth strategies are focused around determining how companies can
develop competencies and synergies through merger or acquisition.
Demand management assists corporate strategists to build value propo-
sition models that enable it to leverage new resources to drive as well
as capitalize on marketplace statements regarding product/service
mixes, pricing and promotions , delivery chain structures, and tech-
nology enablers.
Portfolio strategies are concerned with the type, scope, nature, and life
cycles of the range of product/services offerings constituting the value
proposition. Based on demand feedback, portfolio management is con-
cerned with four critical criteria. Design focuses around the capability
of product offerings to meet existing standards for quality, usability,
life cycle positioning, and opportunity to wrap intelligent services and
activate logistics functions to speed supply chain fulfillment. Cost re-
quires planners not only to pursue opportunities for process improve-
ment and cost reduction , but also to continuously squeeze the time it
takes from product idea conception to sales. Services provide new
tools to deliver product-enhancing values such as self-service, real-time
pricing, credit management, documentation, even classroom and e-
learning opportunities. Finally, quality enables supply chains to be
more responsive not just to base expectations of performance, reli-
ability, conformance , etc., but also to the ability to assist customers in
selecting the right combination of product/service wrap, and then con-
figuring the solution to meet individual requirements . Effectively man-
aging these dimensions will ensure strategic diversification of the prod-
uct portfolio to match demand expectations.
Positioning strategies seek to continuously architect the supply chain
structure necessary to effectively determine product/service placement
within the various supply channel networks based on demand and oper-
ating economics. Among the most important activities can be found de-
termining the optimal placement of the highest value-producing pro-
ducts in the most strategic channels, determination of postponement
strategies, utilization of geographical deployment, and enhancement of
logistics capabilities.
Investm ent strategies are concerned with the creation of a flexible port-
folio of assets that provide strategic planners with the capability to
managing capital, research and development budgets, marketing expen-
ditures, and human and physical plant resources that optimize the de-
mand forecast of potential product/service wraps and delivery func-
tions. Based on demand feedback, this area would be critical in deter-
mining which products, services, channel structures, network partner-
ships, and human and physical assets should be invested in to support
overall competitive advantage.
Demand management has dramatically changed from being a narrow, tac-
tical tool that estimates, coordinates, and oversees the efficient flow of goods
and services through the supply chain to a dynamic, strategic function cap-
able of continuously determining and optimizing the relationship between a
company's value proposition, its product/service wrap portfolio, and its
ability to continuously respond to the nature, intensity, and distribution of the
marketplace's demand for increased value.
FORECASTING DEMAND
Once supply chains have architected a comprehensive demand management

strategy, businesses must tum their attention to the process of converting cus-
tomer, product, marketing channel, and sales positioning into estimates of de-
mand that can be used to plan operations, execute decisions, and serve as a
source of performance measurement. The basics, techniques, and scope of
traditional forecasting were covered in detail in Chapter 4. Historically, the
approaches and methods described have provided companies with inexpen-
sive and relatively effective processes to generate forecasts that can be used
to guide demand and supply planning and decision making. Whether simple
or complex, forecasting application tools seek to automate the tasks of pro-
viding visibility to past patterns and demand relationships, thereby assisting
strategists to better understanding the future.
While traditional forecasting methods provide the foundation for modem
demand management, it has become increasingly clear that they are becoming
unresponsive to today's demand management requirements. Forecasts work
well when demand patterns are stable and can be easily manipulated by statis-
tical techniques, there is a large repository of historical data available, and or-
ganizations possess significant continuity in regards to product, processes,
and approaches to the marketplace. These forecasting tools work best with
relatively long-lived products and stable demand environments where stan-
dardized products are "pushed" repetitively through the marketplace.
In contrast the demand for highly flexible, agile product design and fulfill-
ment structures capable of more frequent new product introduction, shorter
lifecycles, and individualized configurability has rendered past "passive" ap-
proaches to forecasting of decreasing value and engendered a number of de-
mand management alternatives [11]. Today's marketplace requires demand
forecasting tools that can provide for the development of a consensus forecast
in which multiple supply chain partners share and reconcile forecasts to
create a single supply chain plan. Demand-planning toolsets utilize algo-
rithms to incorporate expected demand data, such as promotions, incentives,
or even climate projections, to create a plan that can be utilized by each chan-
nel constituent to respond to local demand by brand or sales territory. Such
dynamic planning tools facilitate the activation of demand and supply balan-
cing strategies by tracking the impact of pricing and promotions, providing
visibility to supply in real time, enabling response to unexpected demand sig-
nals, and seamlessly integrating channel enterprise business systems.
Among the more "dynamic models" for demand management can be found
supply chain engineering (SCE). This radical method ignores the traditional
statistical forecasting elements altogether and seeks to determine demand by
removing channel barriers to the real-time flow of customer information. By
focusing on making the supply chain more flexible and agile, channel part-
ners have the ability to capture demand as it is actually occurring, thereby
linking fulfillment functions directly with customer requirements as they
occur. Instead of forecasting tools that calculate abstract patterns of expected
demand, SCE attempts to compress the time it takes to identify and fulfill de-
mand by concentrating supply capabilities directly on the customer demand
pull.
The demand smoothing (DS) approach is founded on the assumption that
smooth demand patterns can be forecasted with greater accuracy than patterns
subject to wide variation . The objective of forecasters employing this model
is to actively pursue channel management techniques that smooth demand,
rather than depend on traditional passive forecasting tools that accept demand
patterns as given. Under the DS approach, planners are constantly reviewing
and making changes to existing standardized practices in sales, marketing,
promotions, distribution, and transportation that cause forecast variation. Ex-
amples would be requirements that product be manufactured and shipped in
large lot sizes or the use of specific pricing models that encourage end-of-
month sales cycles.
A third alternative to traditional statistical forecasting is customer col-
laboration (CC). This model seeks to leverage the synergy and synchroni-
zation between buyer and seller achievable only through close demand and
fulfillment collaboration. By utilizing interoperable technologies and integra-
tive practices, this model seeks to establish an open, real-time sharing of de-
mand-related information. In utilizing this method forecasters must recognize

that achieving results can be difficult and expensive. Normally this method
would be used only when a single customer dominates demand and they can
provide a very stable forecast. Also, while very desirable, collaborative alli-
ances are time consuming, and the value of its pursuit must be borne out by
the value ofthe forecast management it provides.
By far, the most talked about alternative to traditional forecasting is col-
laborative planning, forecasting, and replenishment (CPFR). Historically,
forecasters have tried to apply a variety of channel management philosophies
and technolog ies to provide more active methods of linking directly with cus-
tomer demand. Beginning in mid-1980 with electronic data interchange
(EDI), companies sought in tum to deploy integration initiatives such as
quick response (QR), vendor-managed inventories (VMI), continuous-replen-
ishment planning (CPR), and efficient consumer response (ECR) to scale the
barriers inhibiting channel information and inventory integration. Unfortu-
nately, while achieving inventory reductions, none of these techniques really
addressed the critical issue: how could channel trading partners achieve the
level of continuous, systematic collaboration necessary to link total channel
demand and supply. Over the past decade CPFR has been deployed to re-
spond to this gap in channel demand management.
What is CPFR? GPFR can be defined as the implementation of data and
information transfer tools that facilitate the timely, interactive communication
of demand forecasts and inventory statuses among a chain of trading partners.
The objective of CPFR is to enable channel retailers, distributors, transporta-
tion providers , and manufacturers with the capability to synchronize total
supply with total network demand from one end of the channel to the other.
In the past, supply chains were burdened by forecast, planning, and inventory
systems that were disconnected from each other, lacked accurate and timely
demand information, and clouded visibility beyond immediate trading part-
ners. CPFR simplifies and connects overall channel demand planning by pro-
viding a single, real-time plan of forecast and supply.
CPFR is reported to have begun in the consumer goods industry in the mid-
1990s as an integrative toolset to increase forecast accuracy and synchronize
product inventories with demand requirements. Since that time CPFR has
emerged as a strategic initiative assisting today 's leading corporations in the
quest for lower costs and higher customer service. In 1996 the CPFR concept
was institutionalized with the formation of the Voluntary Inter-Industry Com-
merce Standards Association (VICS) which was invested with the task of de-
fining CPFR supply chain business process, organizational, and technology
standards. While primarily targeted at the consumer goods industry, CPFR
concepts have come to form the foundation for the communication of fore-
casting and channel inventories for all industry sectors.
How does CPFR work? The overriding objective of CPFR is to directly

link the consumer with the entire supply chain. While management toolsets
such as CRP, VMI, and QR were employed to remove excess inventory from
the supply channel and smooth out demand variances, they were incapable of
solving the twin problems residing at the core of channel management: the
timely communication of forecast inaccuracies and the capability to utilize
exception messaging that alerted channel partners of impeding bumps in net-
work supply and demand. A CPFR initiative begins with the establishment of
a collaborative partnership between two or more members of a supply chain
(retailers, transport planners, distributors, and manufacturers) with the intent
of creating the technical and operations management architectures necessary
to address the existing gaps impeding the synchronization of critical supply
chain information. Next, CPFR partners agree to share critical demand infor-
mation detailing what products are going to be marketed, how they are going
to be promoted and merchandized, and when sales cycles are to begin. Using
DRP-like software, a unified channel forecast by stock keeping unit (SKU) by
time period and quantity is communicated to the supply network.
Finally, each partner agrees to implement techniques that provide for the
real-time sharing of channel inventory levels, point of sales (POS) trans-
actions, and internal supply chain constraints . In addition, each trading part-
ner is responsible for ensuring continuous forecast and inventory accuracy as
well as database update . When these requirements have been fulfilled, the il-
lumination of unnecessary inventory buffers and hidden bottlenecks in the
network flow should be revealed and initiatives put in place to eliminate
them. Furthermore, by establishing interoperable technology toolsets that
promote the timely communication of total channel supply and demand,
CPFR makes visible all plans and ongoing planning variances, thereby as-
sisting companies to improve forecasting and replenishment decisions that
yield optimal results .
Demand forecasting in the twenty-first century is really composed of three
interrelated elements : the forecast, inventory management, and revenue man-
agement. More and more, companies have come to realize that demand fore-
casting is really a continuous process whereby the sales plan is integrally
linked with channel inventory management and how sales issues like pricing
and promotions are going to impact revenues . For example, a change in
pricing or unplanned demand can cause an unforeseen inventory excess re-
gardless of the original accuracy of the forecast. Today 's solutions providers
are responding to this need by developing Web-based applications, termed
Adaptive Logistics Management, that attempt to track in real-time supply
chain variables, such as forecasting, product movement, inventories, service
levels, revenue streams, and other supply chain components, so supply chan-
nel nodes can adapt and optimize fulfillment strategies as the actually occur.

In the late 1990s. Henkel KGaA, a tion with trading partners out in the
German-based maker of household supply chain.
cleaners, toiletries and other home
care products watched profitability By 2000 Henkel had enlisted its first
dramatically fall due to serious CPFR partner, Grupo Eroski. the
flaws in its forecasting and ex- Spanish grocery chain. Eroski was a
ccution methods. Inventory levels natural candidate with a range of
were high and so were stockouts, distribution functions from large
delivery errors and invoicing com- warehouses to thousands of mini-
plaints: transportation was inef- markets. The partners began ex-
ficient and costly. Forecasts were changing information once a day on
not synchronized with production at outgoing stock, inventories and or-
one end of the company and cus- ders; once a week on order fore-
tomer demand at the other end. casts; every 15 days on sales fore-
casts, and every four months on the
Part of the solution came with the promotional events calendar. Using
implementation of a demand plan- the Internet. the companies develo-
ning system and a wholesale re- ped common business and promo-
engineering of Henkel's internal tional plans, compared sales
business processes. However, while forecasts and channel exceptions.
shipments increased, lead times and and exchanged information on
costs decreased. and production ca- changes in promotions and product
pacity. product availability. and re- availability. They also established a
plenishment functions became better series of key measurements to en-
managed. Henkel became aware that sure performance.
their real problems stemmed from a
lack of elTective connectivity with After two years, the results of the
their supply chain. Visibility to CPFR project were dramatic: a 98
channel demand. pipeline inventory percent increase in customer service
positions, efficient logistics. promo- levels, 2 percent stockout rate, ex-
tional activity, and supply channel cess of 85 percent forecast re-
structure began to surface as critical liability. 98 percent truck fill rate.
requirements for competitiveness. and an increase in new product in-
troduction success ratios.
To solve this problem Ilenkel began
a process of implementing CPFR, a Source : Robert J. Bowman.
set of collaborative processes that " European Grocery Supplier Shows
would enable the company to more How CPFR Really Works," Global
effectively communicate its require- Logistics & SupplyChain Strategies.
ments and synchronize its organiza- 6. 12. (2002). 24-28
ORDER MANAGEMENT AND FULFILLMENT
Perhaps the most pivotal set of CRM functions can be found in the capability
of the supply chain to execute order management and fulfillment process in a
manner that meets the expectations of the customer. The order processing
function is the primary contact between customer and the supply chain. Its
purpose is to serve as the gateway into which orders are placed, priced, allo-
cated, and tracked, and from which goods and services are delivered to the
customer. Customer demand can be regarded as the prime mover that sets the
whole logistics process into motion. As such, the quality, speed, and ac-
curacy of the order processing function will have a fundamental impact on
the cost and efficiency of all supply channel elements. Order processing
functions that provide for the speedy and accurate transference of goods, ser-
vices, and order information will facilitate the customer service function and
act as the foundation for competitive advantage. Ineffective, inaccurate, and
unresponsive order processing functions add cost to the customer, build ex-
cess inventories in the distribution channel, result in higher transportation and
storage costs, and mask poor quality and performance measurements.
Researchers have identified several fundamental dimensions commonly as-
sociated with world-class order management. These dimensions are detailed
below [12]:
Cycle time. Perhaps one of the most critical features of effective order
fulfillment is the management of order cycle times. Cycle time can be
defined as the total elapsed time from the moment the customer identi-
fies a product or service need to the moment stock is placed into the
customer's inventory or the service is rendered. Normally order cycle
time is divided into the following subprocesses : order transmission is
concerned with the time it takes for a customer to transmit an order to a
supplier; order entry is the time required for the supplier to enter an
order into their business system; order allocation and picking is the
time required to verify product availability and to perform picking
functions; order packing is the time it takes to package the order; order
delivery is the time required to perform logistics functions such as car-
rier selection, documentation, transport, and delivery; and, order invoi-
cing and payment is the time necessary to generate payment docu-
mentation, billing transmission, and actual payment.
Continuously reducing these cycle times is critical to effective cus-
tomer service management (CSM). Cycle times can be attacked from
two angles: the application of JIT methods and the implementation of
information technology tools. JIT programs targeted at the elimination
of waste in each of the order processing steps are an inexpensive yet
powerful method for cycle time reduction. By eliminating redun-

dancies in the order flow, useless paperwork, procedures, red tape, in-
accuracies in information, costly order handling, checking and re-
checking, and a host of other snags that add time to order processing,
cycle times can be reduced. Also, computer tools such as Web-based
order entry, EDI, bar coding, carton labeling, and others can eliminate
cycle time by facilitating speedy and accurate information flows.
Availability. This order management dimension refers to the capacity
of the supply chain to have the products or services available when de-
sired by the customer. Several inventory strategies can be followed de-
pending on competitive marketplace cycle times and logistics objec-
tives. One method is to stock products in anticipation of customer or-
ders. This model requires decisions regarding the size and value of in-
ventory and the number, location, and stocking policies of channel
warehouses . Another model, followed by many manufacturers, is as-
semble-to-order or make-to-order based on actual order configuration.
Such a decision dramatically cuts inventory and warehousing costs. A
negative is that it can add considerably to order lead times and to pro-
cessing complexity.
Dep endability. Effective order management requires supply chains to
match actual cycle times, inventory availability, and operational perfor-
mance with published service standards. In many cases, customers may
consider dependability as their most sought after service value. The
timely receipt of replenishment orders enables customers to continu-
ously reduce their dependence on internal buffer inventories, and shrink
order processing and planning, and receiving and plant costs. In ad-
dition, increased supply reliability enables channel customers to better
service their own customers by reducing the chance of stockout.
Convenience. In the customer-centric business environment of today,
easy of order entry has become a critical value. In the past, customers
had to search through pre-printed documentation to find the suppliers
and products they needed. In addition, once located, they had to utilize
cumbersome and time consuming methods, such as ordering by phone,
fax, or EDI, to place orders. Often they had to wait for validation of re-
quested product configurations, quantities, delivery dates, associated
support services, and delivery options. Today's Internet-based solu-
tions have dramatically changed the customers' expectations regarding
ease of ordering. Web browsers enable customers to see on-line infor-
mation about supplier products and services, work with on-line cata-
logs, perform research and comparison shopping, configure and enter
orders directly on line, determine delivery options, and perform self-

service order tracking.
Performance. This final dimension of order management refers to the
ability of suppliers to perform within published and competitive order
management standards. There are four specific areas to consider. The
first refers to the speed of cy cle times necessary to meet customer ex-
pectations . Generally the shorter the order fulfillment cycle, the greater
the competitive edge. The second refers to the consistency with which
suppliers' order management and logistics functions execute accurate
orders and deliver products on time. The third performance standard
measures how agile and flexible are fulfillment functions to respond to
customer requirements , manage new product introduction as well as
product phase-out, customize logistics capabilities, and accommodate
reverse logistics requirements. Finally, CSM performance is concerned
with the ability of suppliers to handle out-of-bounds situations such as
massive logistics or system failures, quality problems, new technology
introduction, and contract changes.
THE ORDER MANAGEMENT PLANNING PROCESS
While the above critical attributes describe the environment for sound cus-
tomer management, the order management cycle is the place where these at-
tributes are activated. Order management is traditionally the responsibility of
Marketing or Sales whose job it is to maintain customer master records,
promise inventory to fulfill enterprise inventory demands, and release orders
for picking and shipping. It is also the responsibility of this function to main-
tain valid order due date priorities and quantities. The schedule of demand
that arises from the order processing function serves as the driver for the cal-
culation of product sales usage that is used in MRP/ROP/DRP inventory re-
supply computations. In planning and controlling the order management pro-
cess, the order processing department must determine answers to such
questions as the following:
Are customer master records accurate?
Have the proper prices for products been determined?
Are there any promotions or special prices in effect?
Is there sufficient inventory to meet order requirements?
When should inventory be allocated to open orders?
What are the policies governing returns and backorders?
How is customer credit being reviewed?
Are current open order due dates accurate?
How are order processing performance measurements to be deter-

mined?
The order management planning process as illustrated in Figure 9.2 begins
with the accurate maintenance of database elements necessary for timely and
accurate order processing. Among these databases is found the customer
master, price master, and the product available-to-promise files, as well as
variable database files such as customer quotations, open sales orders, and
sales history. The next step in the sales order management process is execu-
ting the order processing cycle. The processing of customer orders can be
viewed as belonging to three distinct cycles. These cycles can be described
respectively as order receipt and entry, inventory allocation and picking, and
order shipment and invoicing. Two external activities performed by the cus-
tomer also accompany this process: order preparation and transmittal at the
beginning of the process, and order receipt and stock disposition at the end.
I
I
Demand Planning
I
.. Data
Base
Maintenance
r+
O rd er
Processin g
Cycles
r+ C usto me r
erv ice
-
Perform ance
Measurem ent
!
Order Close
I
FIGURE 9.2 Ordermanagement planning process.
The third step in the order management process is monitoring order status.
Once orders have been entered into the open order file, customer service can
view order ship dates, backorders, and inventory quantities so that order pri-
orities are maintained. Once the order has been shipped, order history reports
can assist in tracking order delivery and quality related data. Order status re-
ports show the order due date, quantity required, and quantity shipped for
each open order. Timely and accurate customer order reporting is essential
for good customer service. Besides providing a window into current order
status, effective reporting enables customer service personnel to closely
monitor not only order priorities but the entire replenishment system and keep
it up to date.
The final step in the order management process is defining and monitoring
performance measurements. For the most part, order management perfor-
mance is concerned with process measurements. Among these metrics can be
found the number of lines and orders filled complete, shipment by customer
due date, percentage of stockouts, total order cycle time, billing adjustments,
administrative errors, and profit margins. While providing information on the
order process itself, performance measurements also provide data on how
well the entire supply channel is responding to customer requirements. The
ongoing benefits of a "world-class" order processing system are the fol-
lowing:
Continuous decline in average order cycle lead times. This is the span
of time from the moment an order arrives until it reaches the customer.
Improved customer relations . Effective systems provide customer ser-
vice with the critical information necessary to service the customer in
as expeditious a manner as possible.
Increased order accuracy. On-line data validation and system record
defaults not only improve accuracy but also speed up the order pro-
cessing cycle.
Decrease in operating costs. With the ability to process data quickly
and accurately, integrated order processing systems can eliminate inter-
nal costs associated with order review and expediting . What is more,
linking the entire distribution channel systems can eliminate costs as-
sociated with order processing redundancies, excess inventories, and
unprofitable transportation.
Timelier invoicing and accounting . Effective order processing systems
accelerate the transfer of accounts receivable data resulting from order
shipment. Improvements in order shipments decrease the occurrences
of invoice inaccuracies and improve on receivables collection.
THE ORDER MANAGEMENT CYCLE
The order management cycle is the key to effective customer service and de-
serves more attention. In a classic study by LaLonde and Zinszer [13], the or-
der management cycle was conceived of as consisting of three phases: pre-
transaction, transaction, and posttransaction. The argument is that each
phase usually requires the presence of specific customer quality and service
elements if the sale is to be successfully executed.
Pretransaction Elements. The service dimensions in this phase of the sales

cycle are, for the most part, focused on setting customer expectations and for-
malizing the sales and support structures of the firm. The specific elements
consist of the following.
Written customer service policy. A clear and concise definition of cus-
tomer service objectives provides a formalized approach that can guide
all service activities and be communicated to the customer. The con-
tents of the policy statement should consist at a minimum of a state-
ment of the service mission, detailed service standards, and a list of
quantifiable performance measurements . The goal of the policy state-
ment is to clearly delineate customer expectations and serve as a bench-
marking tool to measure ongoing service performance.
Serv ice policy communication. Once a detailed service policy has been
devised, it must be communicated to the customer. A formal service
policy will assist customers to formulate proper expectations as to the
level of performance they can expect as well as detail the proper chan-
nels to communicate with product/service providers if specific perfor-
mance standards are not being met.
Organization structure. Each channel partner must architect a service
organization capable of executing the mission statement and service
performance objectives. The goal of the organization is to facilitate
communication and cooperation between the customer and the firm's
product, sales, logistics, and financial functions. The identity of the
management and staff of the service organization must be communi-
cated to the customer base, as well as the means by which they can be
contacted .
System flexibility. The design of the service organization must be flexi-
ble enough to enable response to customer requirements regardless of
environmental factors.
Management services. The final pretransaction element of customer
service is the availability from the supplier of training and printed ma-
terials to assist customers in performing their own problem-solving di-
agnostics . Education courses, training seminars, and training manuals
are key components of management services. Functions in this area
have been greatly expanded by the use of Internet marketing and ser-
vice sites.
Transaction Elements. The service dimensions in this phase of the sales cy-
cle are focused on sales order execution. The specific elements consist of the
following:
Stockout level. The availability of products in the right quantity and at

the right place is fundamental to effective order management. Custom-
er serviceability levels are the key performance measurement for this
element. Serviceability is defined as the percentage of times customers'
product requirements were met without a stockout. Once a stockout
does occur, actions, such as offering a suitable substitute or expediting,
are also part of this service element.
Order information . This service element focuses on the ability of order
management to respond quickly and accurately to customer inquiries
during order placement. Order information consists of such data ele-
ments as inventory status, credit, pricing, shipping and handling costs,
delivery, and open order and backorder status.
Elements of order cycle time. The order cycle can be defined as the
time that transpires between the moment a order is placed until the date
it is delivered . In reality, there are three distinct subcycles that must be
completed during the full order cycle: order entry, order allocation and
picking, and order shipment and delivery. The contents of these cycles
will be explored later in this chapter. Fast and accurate order cycle pro-
cessing is fundamental to competitive advantage.
Expedite shipments . Expedited shipments fall into two categories. The
first is concerned with expediting through the order processing cycle
those customer orders that are to receive special handling. For the most
part, customers usually pay premium prices for expedited orders.
When suppliers absorb expediting costs, it is absolutely essential that
management not only review who is to receive this service but how fur-
ther expediting can be eliminated for future orders. The second cate-
gory of expediting occurs when a customer backorder occurs. Ex-
pediting in this instance encompasses swift resupply order action, re-
ceipt, and premium delivery to the customer. Service management
should be constantly vigilant in ways to eliminate expediting. Expe-
diting incurs costs that directly impact corporate profitability and are
symptomatic of deficiencies in inventory ordering and control, sales,
and delivery functions.
Transshipments. This service element refers to the transfer of inven-
tory between stocking points in the distribution channel necessary to
meet customer demand. While inventory inequalities will occur over
time in the supply chain network, planning tools like DRP should be
used to eliminate this often costly alternative to stockout.
System accuracy . Order processing inaccuracies, such as incorrect
items, prices, quantities , shipping information, due dates, and billing,
are costly to both the supply chain and the customer. Instances of order
cycle inaccuracy should be recorded and used as data in performance

measurement calculations.
Order convenience. This element refers to the degree of ease by which
customers can place orders and have access to open order information.
The Internet has dramatically changed this area. Service attributes such
as 24x7x365 service, real-time information, on-line customer support,
instantaneous availability of documentation, self-service, and Web-
page personalization enable today's Web-savvy customers to receive a
truly unique, interactive buying experience.
Product substitution . The ability of the supplier to offer and the cus-
tomer to accept product substitutes can have a dramatic impact on total
inventory investment as well as the level of attained customer service.
For example, by offering two substitutes for a given item, a company
found that a previous customer service level of 70 percent increased
dramatically to 97 percent with no additional inventory investment.
Posttransaction Elements. The service dimensions in the final area of the

sales cycle are concerned with after-sale product support. Specific elements
consist of the following:
Installation, warranty, alterations, repairs, and service parts. These
postsales elements are value-added to the product and are part of the
reason why customers will choose to purchase from a specific finn . A
company offering these services must have the following functions in
place: assurance that the product will function as documented, demon-
strated availability of service parts and support staff for advise or in-
stallation, full product documentation that explains product func-
tioning, troubleshooting tips, and parts lists, and a product and services
warranty administrative function that serves as a point of customer con-
tact and contract tracking.
Product tracing. Many products such as food, pharmaceuticals, medi-
cal supplies, and large-ticket items require maintenance of lot and/or
serial number tracing. The availability of such information enables
companies to recall products due to defect, spoilage, or obsolescence,
or to record historical information used in marketing and future product
design.
Customer claims, complaints, and returns. Factors concerning custom-
er claims, complaints, and returns should have been clearly defined in
the written customer service policy detailed above. In the after-sale en-
vironment, policies regarding these and other customer issues must be
rigorously followed if the finn's reliability, responsiveness, and credi-
bility is to be maintained. Information arising from this element pro-
vides valuable data that can be used for product redesign, marketing
programs, shipment and delivery, and other channel functions.
Product replacem ent. In some cases, products that are required but are
not in stock or that must be repaired require the firm to offer a tempo-
rary replacement. Costs borne by the supplier are considered part of
the warranty or of the presales arrangement.
FULFILLMENT
Regardless of the type of demand order management used, whether tra-

ditional , EDI, or Internet-based, today's customer is not only demanding an
integrated fulfillment approach that seeks to optimize the right warehousing,
transport, and service solutions, but also the deployment of new types of net-
worked relationships supported by new technologies and services. Histori-
cally, fulfillment was considered a "backoffice" function concerned with such
activities as telemarketing operations, customer service, warehousing and
shipping, procurement , inventory management, postponement processing, and
disposition of returns . It was the role of fulfillment to navigate often poorly
synchronized , inflexible supply chains and deliver products to the market-
place that met acceptable lead times and costs. Because fulfillment often
lacked visibility to the movement of goods and information across the supply
chain, lead times tended to elongate and inventory to accumulate to buffer
against random events impacting channel process flowthrough. Such dis-
continuities resulted in supply chains that lacked the integration and inter-
operability necessary to provide the level of operations efficiency and vel-
ocity required for the short delivery cycles, customized fulfillment capa-
bilities, and personalization demanded by customers increasingly acclimated
to the online, real-time capabilities of Internet trade.
Today's fulfillment systems must be designed to provide transparency of
supply chain data and events simultaneously to all regions of the channel net-
work, solving the critical issues of connectivity and visibility that have tra-
ditionally blocked effective fulfillment. Re-architecting the supply chain
around demand management principles and technology enablers provides in-
dividual channel partners with the capability to
Leverage information from beyond the "four walls" of the enterprise to
generate truly integrated fulfillment capabilities that dismantle the bar-
riers set by past information bottlenecks, redundant processes, and ex-
cess channel buffers
Improve inbound and outbound inventory visibility, thereby reducing
excess inventory costs, potential obsolescence, and cycle times
Expand outsourcing capabilities while enhancing the focus on internal

core competencies
Gain a better view on performance within the business and through the
fulfillment network
Engineer more fluid business relationships and accelerating infor-
mation and product flows
Achieve high-velocity, tightly synchronized business processes agile
enough to adapt to changing business conditions and objectives
Develop personalized service capabilities for customers [14].
Achieving such a radical redefinition of fulfillment management requires
whole supply chains to respond to three critical challenges [15]. To begin
with, fulfillment in the Internet Age requires the development of new types of
relationships to meet the needs of today's increasingly Web-enabled cus-
tomer. Critical attributes include more collaboration between network sup-
pliers and customers, the effective utilization of outsourced functions to en-
sure "best-of-breed" response centered on the unique service competencies of
channel partners, and the establishment of "win-win" commercial arrange-
ments that enhance the relationship between customers and fulfillment ser-
vice providers . Competitive leadership will go to those supply chains capable
of rapid deployment to meet change, creating new kinds of relationships, and
implementing radically new fulfillment solutions.
The second challenge is focused on an unbending dedication on the part of
all supply chain constituents to continuous operations excellence. While
technology interoperability and enablement has occupied much of the lime-
light in recent fulfillment literature, it has become clear that a "back-to-
basics" approach that emphasizes the development of new fulfillment net-
works and makelbuy strategies and the implementation of agile and flexible
channel facilities and processes is critical to engineering supply chains cap-
able of responding effectively to today's fast paced environment. Only those
supply networks capable of quickly customizing the logistics network, inte-
grating demand and supply planning, integrating product, information, and
financial flows, sourcing strategically, leveraging postponement strategies,
and establishing pan-supply chain performance metrics will be able to seize
and sustain competitive fulfillment leadership in their markets.
Finally, competitive fulfillment in the twenty-first century depends on the
deployment of new technologies and services. In the past, supply chains con-
sisted of individualized one dimensional service functions such as in-
bound/outbound freight, carrier management, total cost control, operations
outsourcing decisions, load planning, routing and scheduling, and execution
of administrative services. Today, emerging supply chain networks, utiliza-
tion of outsourcing strategies, and the continuous shortening of all cycle
times have generated the need for new types of services, while technologies
have enabled the exploration of new means of delivery. For example, many
companies are exploring the use of Web-based services, such as fulfillment
exchanges, auctions, and reverse auctions, for such functions as freight and
parcel carrier selection . Another area is the use of infomediaries who utilize
Internet technologies to facilitate the flow of fulfillment information such as
shipment track-and-trace, real-time alert messaging, supply channel mod-
eling, "what-if' simulation, and performance measurement tracking. Finally,
in another area can be found channel providers offering flow management
solutions that enable Web-based control of such fulfillment functions as
transaction management across multi-partner networks, expediting, and chan-
nel event management.
CUSTOMER CARE MANAGEMENT
Over the past twenty-five years the purpose, scope, and mission of customer
service management (CSM) has changed dramatically. In the beginning, cus-
tomer service consisted in receiving and answering personally correspond-
dence with customers who had questions or problems with products or ser-
vices. Next came the help desk where, instead of writing, customers could
talk directly to a service rep about their issues. By the 1990's the purpose
and function of CSM had evolved beyond just an 800 telephone number to
encompass a wide field of customer care objectives and activities. Known as
contact centers or customer interaction centers (CIC), service functions
sought to deploy a range of multimedia tools to not only relate order and ac-
count status, but also to manage every component affecting the customer
from product information to maintenance, warranties, and upgrades.
Today, the capabilities of CICs have been expanding into new dimensions
with the advent of exciting new toolsets, such as the Internet, wireless com-
munications, speech recognition, and video, to join older technologies such as
phone, caller-ill, fax, e-mail, and ED!. Such applications provide customers
with even more opportunities for control of service dimensions while en-
abling companies to integrate all avenues of customer interaction on a central
platform. Self-service opens a new dimension of customer service at less cost
while service databases improve knowledge of customer behavior that enable
the delivery of customized sales and service one customer at a time [16].
DEFINING CUSTOMER SERVICE MANAGEMENT
Although it can be said that CSM is perhaps the central activity of the every
business, few would be able to exactly define what it is or what it actually
does. CSM is commonly described by the use of two expressions: easy to do

business with and sensitive to customer needs. While these concepts are easy
to understand, they lack, however, detailed content. There are several valu-
able definitions available. LaLonde and Zinser [17] state that CSM can be
best understood when seen from three perspectives: as an activity consisting
of functions such as order processing, proof of delivery, invoicing accuracy,
timeliness of delivery, and others; as a set of performance related criteria foc-
used on service and satisfaction metrics; and, finally, as a corporate philos-
ophy concerned with imbedding CSM within the long-term strategies of the
enterprise .
Another definition describes customer service as a process that results in
A value added to the product or service exchanged. This value added in the
exchange process might be short term as in a single transaction or long term as
in a contractual relationship. The value added is also shared, in that each of the
parties to the transaction or contract are better off at the completion of the
transaction than they were before the transaction took place. Thus, in a process
view: Customer service is a process for providing significant value-added
benefits to the supply chain in a cost effective way [18J.
In a similar vein, Band [19] defines CSM as "the state in which customer
needs, wants, and expectations, through the transaction cycle, are met or ex-
ceeded, resulting in repurchase and continuing loyalty." In other words, if
customer satisfaction could be expressed as a ratio it would look as follows:
Perceived quality
Customer Satisfaction =
Needs, wants, and expectations
Another perspective on the meaning of CSM can be found by viewing its
fundamental elements. Perhaps the most concise list of service elements has
been formulated by Zeithaml, et al. [20]. These elements are:
Tangibles . This element refers to the appearance a firm's service func-
tions project to the customer. Often the image of quality a company
wishes to communicate to the marketplace includes such tangibles as
new facilities, state-of-the-art technology, highly qualified personnel,
and the latest equipment. Tangibles are designed to give the customer a
sense of confidence and assurance that the services they are receiving
are truly "world class."
Reliability. Once a company publishes their commitment to a specific
level of customer service, their ability to live up to that standard is the
measurement of their reliability . Service leaders must continually per-
form the promised service dependably and accurately each and every
time. Reliability of service permits supply chains to "lock-in" their

customers who will gladly pay premium prices for delivered quality.
Responsiveness. The ability of a supply chain to respond to customer
needs quickly and concisely lets customers know that their time and
costs are important. Whether it is in rendering prompt presales service
or a willingness to assist with product quality issues, a helpful attitude
and timely service will always leave the customer with the sense of
dealing with a winner.
Compe tence. When customers purchase goods and services, they need
to feel assured that the supplier possesses the required skills and know-
ledge to assist them when product or support issues arise. Firms that
back up their products with cost-effective and competent services will
always be leaders in their marketplace .
Courtesy. Many a sale is won or lost based on the way the customer is
treated in the presales and postsales cycles. Companies who do not re-
spond to their customers with politeness, respect, consideration, and
professionalism are destined to lose them to competitors who do.
Credibility. Service leaders base their success on high standards of
honesty, trustworthiness , and believability . Customers purchase prod-
ucts from firms that live up to claims of the best quality possible at the
lowest price.
Security. The delivery of products and services must be accompanied
by a sense of security on the part of the purchaser. Issues range from
Internet transaction security to confidence about the safety and value of
purchased products and services. Security frees customers from doubts
and provides "peace of mind" for the products and accompanying ser-
vices they purchase .
Access. This element of customer service has several facets. Foremost,
access means the degree of ease by which customers can purchase
products or contact sales and service functions. Access can mean the
availability of goods and services within a time limit generally accepted
by the industry. Access can also mean the speed by which after-sales
replacement parts and services can be delivered to the customer. Cus-
tomer convenience and access to goods and services are fundamental to
Communication. The availability of sales and services staff to respond
quickly and intelligently to customer questions concerning products,
services, account status, and the status of open orders is the primary tier
of a firm's customer communication function. Other communication
forms such as printed literature, manuals, product and service news-
letter updates, and advertising form the second tier . Effective customer
communication stands as a fundamental cornerstone for service leader-

ship.
Understanding the Customer. Unearthing and responding to the needs,
desires, and expectations of the customer is the first element in ef-
fective sales and service. Firms that provide the products and services
customers really want will always enjoy an edge over their competitors.
The above list of service dimensions is applicable to all types of businesses.
Even though specific targets of service quality may vary from industry to in-
dustry, the ten dimensions represent benchmarks by which supply chains can
measure themselves .
MANAGING CUSTOMER SERVICE
Problems in anyone of the dimensions of customer service can have an

enormous impact on customer satisfaction. Product quality, for example, is
usually singled out as the touchstone of customer satisfaction . Effective com-
munications, such as advertising, promotions, and in-store ambience also play
a key role in setting expectations. For other products, after-sales support,
warranties, training , and service part availability affect service satisfaction .
Although individually important, none of the service dimensions by them-
selves can completely determine the boundaries of customer satisfaction. In
reality, effective customer service must be managed. The expectations and
needs of each customer must, first of all, be discovered and defined, and then
weighed against channel service offerings, understanding which are essential
standards of service and which are secondary. A useful framework for man-
aging customer service divides the service dimensions into four distinct areas:
the customer, the service strategy, people resources, and information systems
[Figure 9.3].
At the center of the service framework stands the customer. It is customer
wants, needs, and expectations that drive the service function. As has been
pointed out, these aspects often change as the customer moves through the
sales cycle. Clearly identifying the service characteristics of the customer
forms the foundation for the formulation and implementation of the firm's
service strategy. The service strategy consists of two parts: an internal com-
mitment to service centered on the formal corporate service mission statement
and an external commitment to executing those service attributes promised to
the customer through the sales cycle. Positioned in the third area of the cus-
tomer service framework are the people, the management and staff of the or-
ganization. The fact that this area is connected to the service strategy means
that there must be a shared vision of service values that permeates the whole
company. In addition, the line connecting people resources to the customer
represent s the everyday communication that occurs between the firm's em-
ployees and the customer.
Customer
FIGURE 9. 3 CSM framework

The final area of the customer service framework is the enterprise's infor-
mation sys tems . As the diagram illustrates , information systems link the
other elements of the service framework. People resources utilize the com-
pany's systems to execute functions, record information, and communicate
with customers. These technologies are multidimensional and are composed
of management systems that determine enterprise goals, internal and exter-
nally devised rules and regulations systems, the mechanical technical sys-
tems, and the company's social systems that guide problem solving, team-
work, and service values. The customer must use the systems employed by
their suppliers to make their wishes, needs, and expectations known. Finally,
the information systems can be heavily influenced by the service strategy .
Strategic objectives shape the firm's matrix of systems as they seek to en-
gineer a customer service-centered culture .
ELEMENTS OF EFFECTIVE SERVICE MANAGEMENT
According to Gopal and Cahill [21], there are nine critical steps in effective
CSM (Figure 9.4). The first step is to establish and nurture a culture of con-
tinuous improvement through the supply chain. Customer service leaders of
the twenty-first century will be those supply channel networks that espouse
the concept of continuous incremental improvement at all levels in the or-
ganization . The ongoing ability to create value and deliver it to the customer
can only be achieved by responsive "world-class" performers who are tireless
in their examination of every aspect of channel operations in search of untap-
ped sources of quality and customer satisfaction . Band [22] feels that value
creation is strategic, systemic, and continuous. It is strategic because deliv-
ering quality to customers is at the very heart of supply chain strategy. It is
systemic because the information, planning, and execution systems utilized by
the organization must be continually refocused in the pursuit of customer val-
ue. Finally, it is continuous because the challenge of gaining and keeping
customers in today's marketplace requires an unrelenting dedication to
achieving continuous improvement in all levels of performance.
CSM performance measurement
Implement
Identify CSM technologies
Determine service/cost relationship
Identify gaps to be eliminated
Determine industry benchmarks
Identify and measure customer requirements and expectations 3

Measure current performance 2
Incorporate continuous improvement philosophy 1
FIGURE 9.4 Elements of CSM.
Following such a philosophy means managing the supply chain by continu-
ously aligning and realigning operations with corporate objectives and goals,
the institutionalization of shared values providing for quality, customer ori-
entation, and the on-going improvement of functional processes, problem sol-
ving at all levels, cross-functional operations, people empowerment, and two-
way continuous communications. In addition, a dedication to increasing ser-
vice quality and value means enabling a continuous process for measuring
customer perceptions of service quality, identifying service shortfalls, and re-
sponding to quality gaps with appropriate action to improve service metrics.
Without this management cornerstone in place, supply chains operating in the
2000s will find it difficult to achieve customer service excellence. The ele-
ments of creating value for customers are portrayed in Figure 9.5.
Once a strategy of process improvement is in place, supply chain constitu-
ents can begin detailing existing performance levels. Not only does this on-
going exercise provide management with a window to current service prob-
Measuring and Monitoring

Value Perceptions
Managing Customer Achieving High-Quality

Relations hips Operational Performance
Empowering People:
The Value Creators
FIGURE 9.5 Elements necessary for creating customer value.
lems, it also clearly marks the path on the way to competitive service leader-
ship. Measuring supply chain service effectiveness consists of two elements:
determining customer expectations and needs, and quantifying current service
practices and measuring the variance between existing levels and marketplace
expectations.
Measuring external service performance consists, first, in performing a
thorough marketing study of those elements perceived by the customer as a
requirement before and after the purchase, and, second, executing a bench-
marking analysis designed to determine customer perceptions of service of-
fered by competitors . The starting point is to identify and rank the relevant
customer service attributes . A possible method would be to create a survey
of service factors divided into three major areas: marketing (price, sales sup-
port, product mix, terms of sale, etc.), service (delivery performance, order
tum around, fill rates, accuracy, etc.), and product (quality, reliability, avail-
ability, documentation , etc.). In addition, most individual firms could engage
a corporate marketing staff, a marketing consulting firm, oreven a local uni-
versity to extend the depth and breadth of the study through the use of several
different forms of customer interview, such as telephone, intercept, op-
portunity, on site, and focus group. This discovery process should provide
answers to the following questions :
1. Who are the firm's customers?
2. What service attributes are pivotal in meeting their needs?
3. What service activities are currently being performed to meet these
needs?
Once the supply chain external services position has been detailed, an in-
ternal audit of actual service practices needs to be executed. The purpose of
the internal audit is to identify actual services and measurement systems. The
audit should provide answers to such questions as the following:
What is the prevailing corporate culture regarding customer service
excellence?
How do business units (Marketing, Sales, Finance, and Logistics) per-

ceive their role in providing customer service?
How is customer service measured within each business unit?
What are the performance standards and service objectives?
What are the internal customer service performance measuring systems,
and how are they integrated to provide a corporate viewpoint?
What are the current performance metrics?
How are these metrics used to increase service performance?
Answers .to these questions can arise by conducting an analysis of existing
service performance data and through departmental interviews. Performance
metrics can be attained from internal data relating to marketing, product, and
service attributes. Interviews conducted with managers, supervisors, and key
staff members of each department can also assist in the internal audit. Ele-
ments such as organizational structure, performance measurement systems,
problem-solving techniques, perception of customer needs, level of direct
customer contact, and plans for service improvements will detail current ser-
vice paradigms and interfaces with other functional departments.
High
Compet itive Compctit ivc
V ulnerability trcngt hs
Importance I 1
I Grcy Zonc J
To Customer
Relat ive I r rc lcva II t
Im po rta IICC up c ri o r ity
Low
Low Pelfo17I1QnCe High

FIGURE 9.6 CSM attribute matrix.
The results of the external and internal services audits can be used to de-
velop a services attribute matrix. The model of the matrix appears in Figure
9.6 [23]. The matrix permits the reviewer to rank each attribute by its relative
importance to the customer. The same method can be used for competitive
benchmarking by ranking the position of the competition contrasted to the
firm's performance. The matrix has five zones. The service rank for each at-
tribute is measured by determining the relative importance of the attribute to
the customer (or the strength of the competitor) to the actual performance of
the firm. By intersecting the lines, service managers can see the strengths or
weaknesses relative to customer expectations and the position of competitors.
Once each service attribute has been applied to the matrix, service man-
agement can begin the task of ranking each by level of importance. Attri-
butes that illustrate a competitive vulnerability require high priority in the
service strategy. Attributes, on the other hand, that indicate irrelevant superi-
ority are probably causing unnecessary service costs and should be elimi-
nated. Metrics that indicate that customer expectations (or competitive po-
sitioning), and the firm's corresponding performance intersect somewhere in
the middle range, means that the service attribute is located in the grey zone.
This zone indicates that the level of importance and performance are not of
significant strategic importance.
IDENTIFYING PERFORMANCE GAPS
Metrics illustrating performance gaps provide a clear understanding of the

level of current performance as opposed to both customer perceptions and ex-
pectations and to advantages enjoyed by industry leaders. Once these gaps
have been quantified, CSM can begin to redesign organizational and value
structures, refocusing them on continuous incremental improvements in pro-
cesses and operational performance. Zeithaml, et al. [24] have formulated a
service quality model that highlights the gaps between customer expectations
and actual service performance. The model, shown in Figure 9.7, identifies
Customer Customer Marketplace

Requirements Expectations Reputation
Gap 5
to
.1
I
I
.
ervice Expectations
I Perceived ervice I
Gap J Gap 4
Customer
Marketplace ................. Marketpl:acc
Expectations

Reputation Pcrccpti on
Gap 3
I
Conversion of Perception
Gap2 I
.
into Quality Specifications
I
Managcmcnt Perception of
I Customer Exnectations
FIGURE 9.7 Service quality model.

five gaps inhibiting "world-class" service delivery. Gaps I through 4 are

shortfalls that occur within the services organization; Gap 5 is a service-qual-
ity shortfall as perceived by the customer. The gaps are described as follows:
Gap 1: Customer expectations and management perception. Perhaps
the most fundamental service gap can be found in the variance that
exists between what customers expect from products and services and
what management perceives as customer requirements. Normally, there
is wide congruence between expectations and perceptions. However,
management might not always be completely aware of which service
attributes constitute high priorities for customers. ill addition, even
when key attributes are identified, it might be difficult to quantify what
exactly is the expected level of service. The external audit should pro-
vide service managers with a way of narrowing this gap by revealing
accurate information about customer's expectations . As an illustration,
a company may feel their customers buy because of low price, when, in
reality, it is product delivery that is driving expectations.
Gap 2: Management perception and service-quality specification. Al-
though service managers might formulate correct perceptions of cus-
tomer expectations, a gap can occur when a firm experiences difficulty
translating those expectations into service-quality specifications. These
difficulties usual result in the adoption of superficial specifications or
ones that are ill-defined. Sometimes managers believe, because of the
nature of the product and support, that it is simply impossible to set ser-
vice levels that will match customer expectations . Again, others feel
that the resources necessary are clearly beyond the company's compe-
tence. Finally, the most frustrating form of service-quality gap occurs
when there are clear specifications , but management is not committed
to enforcing them. For example, a firm pledges timely field support for
a product but does not hire sufficient staff to meet presales pledges, and
then does nothing to remedy the service deficiency.
Gap 3: Service quality specifications and service delivery. Even when
firms develop detailed quality-service standards and programs for cre-
ating a customer-centric organization , service leadership is not a cer-
tainty. A gap may exist and continue to widen based on such elements
as poorly trained customer-contact personnel, ineffective service-sup-
port systems, insufficient capacity, and contradictory performance mea-
surements . When service delivery quality falls short of the standard,
the result has a direct impact on what customer can expect (Gap 5).
Gap 4: Service delivery and external communications . A fundamental
element shaping customer expectations are service quality standards de-
tailed in advertising media, promised by the sales force, and found in
other communications. Take, for instance, a distributor that publishes

a 24-hour order turnaround time but lacks the information systems for
effective inventory accuracy and picklist generation to meet that ob-
jective. When the customer is told and expects next-day delivery of an
order and does not get it, the gap begins to widen between what sales
tells the customer and what logistics can deliver.
Gap 5: Perceived and expected service. The discrepancy that arises
between the expected and the perceived service(s) is detailed in Gap 5.
The content of this gap is gathered from the cumulative shortfalls found
in each of the four enterprise gaps. Determining this discrepancy is
more than just totaling the metrics of Gaps I through 4; often the cum-
ulative affect on customer perceptions of service delivery are greater
than the sum of the parts. The source of customer service expectations
can be found in word-of-mouth communications, past experiences, and
customer requirements .
Metrics illuminating performance gaps provide the supply chain with a
clear understanding of the level of current performance as opposed to "world-
class" leaders. Once these gaps have been quantified, management can then
develop an effective services strategy that focuses the organization on contin-
uous incremental improvements in processes and operational performance.
ANALYZING TOTAL COST-SERVICE LEVEL TRADE -OFFS
Defining service gaps and performing competitive benchmarking will assist

companies in determining customer service levels. Before, however, ef-
fective service strategies and measurement systems can be implemented, not
only the current actual cost of selling and servicing the product but also the
incremental cost of reaching the next level of service must be calculated.
Customer services costs for a typical distributor arise from the following
business functions:
Transportation . This is the cost incurred to transport products through
the distribution channel and out to the customer. Transportation by far
constitutes the largest portion of physical distribution costs.
Inventory carrying costs. The ability to service customer demand re-
quires the distributor to purchase and warehouse inventory. The costs
for warehouse facilities, material handling equipment, and personnel,
as well as the traditional elements such as the cost of capital, taxes, in-
surance, obsolescence, and deterioration must accompany all stocking
decisions.
Production and Purchasing. The cost of manufacturing and purchasing
inventory.
Product development. The costs associated with product development

design, prototyping, tooling, and conversion to production.
Marketing and Sales. The cost of marketing research, sales, pro-
motions, and advertising.
Order processing and Information Systems. The cost of processing or-
ders, order status inquiry and reporting, and computer system main-
tenance.
Customer Service. The cost of maintaining customer satisfaction
arising from after-sales service and support.
Indirect costs. Costs incurred for indirect support functions that assist
in the execution of logistics and service activities.
Obviously, attaining high levels of customer services cannot be achieved
without corresponding growths in performance in other parts of the organi-
zation. In the past, it was assumed that as the service level increased so did
the costs. As Figure 9.8 illustrates, companies often attempted to chart ex-
pected sales revenues and the cost of services and to calculate the optimum
service level. Once the increased level of service-logistics costs had been
justified, service management could then begin the process of cost-service
trade-off analysis. Such cost trade-offs took place in one or several areas
within the distribution pipeline: increased stocks and inventory deployment,
inbound, interbranch 'and outbound transportation, procurement and manufac-
turing processes, intra-organizational and extra-organizational communi-
cations facilities, information systems implementation, people empowerment,
and customer service systems [25].
Sales
..
.' .'
..
' .'
'
....................
.'
..............
Costs
Opt imum Service Level
FIGURE 9.8 Charting the optimum service level.

Although a time honored management method, when performing service-
cost trade-off analyses channel management must strive not to fall into the
fatal attitude of "we win, the customer loses." Regrettably, many a service
program devised from cost trade-offs has resulted in a justification for low
expectations and performance . For example, it is often said that "quality has
its price, and at some point the cost of quality will exceed its benefit." As the
quality revolution of the last decade has shown, however, quality pays for it-
self many times over. The same can be said for SCM initiatives that most
companies assume require increases in inventory, people, and expenditures.
In reality, management philosophies such as JIT increase the velocity and
flexibility of customer services while slashing excess inventories and re-
ducing the need for staff whose work revolves around delay management.
The goal of service-cost trade-offs analysis, therefore, is not to look for ways
to optimize customer satisfaction versus the anticipated costs but rather to
rank and prioritize competitive service elements, and to refocus supply chain
resources to continuously improve each service element. Service leaders seek
continuous improvement in cost, quality, response time, and flexibility
simultaneously .
IDENTIFYING CSM TECHNOLOGIES
Over the past few years, CSM has evolved from banks of service reps con-
nected to the customer by phone and fax to highly automated service centers.
The goal is to leverage technologies to activate open dialogues with the cus-
tomer that are personalized, in that they are capable of responding to indi-
vidual customer concerns; self-activating, in that they provide applications
for customers to self-service their questions ; with immediacy, in that critical
information can be conveyed in real time; and intimate. in that the customer
truly feels the supplier is concerned about their problems. When developing
the technology element of the CSM strategy, today's service departments can
utilize the following toolsets [26]:
Automatic call distribution (ACD). This technology provides for the
automatic routing of incoming customer calls to the proper service re-
sources based on call content. ACD seeks to minimize service call wait
and queues by automatically switching a call to an open resource,
matching call content with service rep expertise, and even prioritizing
the call by level of severity or service contract.
Interactive voice response (IVR). This toolsets enables 24x7x365 ser-
vice access by typing the appropriate keys on a telephone. The goal is
to provide access to service information or to qualify and route a call
without human interaction. More advanced applications provide auto-
mated speech recognition whereby customers can verbally communi-
cate their questions without cumbersome typing of keypad digits.
Internet call management. The use of Web-based self-service has en-

abled customers to escape from the tedious entry of data characteristic
of IVR systems. The advantage of Web-activated service is that cus-
tomers can enjoy a significant level of self-driven interaction with the
service system. Also customers can access proactively a wide range of
services ranging from order status tracking to new product introduction
to on-line forums.
Service cyberagents, bots, and avatars. While mostly futuristic, the use
of intelligent agents capable of performing automated service tasks is
expected to expand dramatically. The goal is to equip these tools with
specific expertise, instructability, simplified reasoning, and the capa-
bility to work with other cyberagents in solving service questions.
Call center analytics. Effective CSM requires a holistic view of the
customer. While CRM analytics focus on tracking the marketing side
of the customer, the capability to record and analyze the vast amount of
service-related data from each customer will be essential for CSM
leadership . Analytical data will assist in the selection of the appro-
priate CSM technologies, the overall corporate service strategy, and the
level and type of individualized service provided to each customer.
The power of the customer and enhancements in technologies have trans-
formed the traditional scope and mission of customer service. Until just re-
cently, customer service was considered as purely a cost center and a drain on
profitability. In contrast, today's customer service function is seen as abso-
lutely critical in cementing customer loyalties and assuring maximum cus-
tomer value.
DEVELOPING AND IMPLEMENTING THE SERVICES STRATEGY
In order to achieve superior customer service performance, the firm must do

more than establish service goals, understand the gaps in customer service
and competitive benchmarks, implement technologies, and set in motion an
action plan that will provide for continuous improvement in service levels
and corresponding decreases in costs. Service leadership in the Internet Age
means that whole supply chains must be concerned with the success of the to-
tal business process and not just solely with the satisfaction of the customer.
In managing the total business process, service strategies must be architected
that are in alignment not only with internal business goals and objectives but
also with the goals of the entire supply chain. Perhaps the most effective cus-
tomer service strategy is one that integrates and facilitates the four major
groups (Figure 9.9) impacting the external and internal functions of the enter-
prise. These groups can be called the customer, the firm's shareholders, the
employee, and the supplier channel.
FIGURE 9.9 Enterprise service groups .

The customer has by far the greatest impact on service strategy develop-
ent. Servicing their wants and needs is why the supply chain exists; revenues
from their purchases are the central growth variable; their feedback is the
only true voice guiding product and service direction. The customer side of
implementing an effective service strategy must be focused around the fol-
lowing key elements and accompanying questions:
Customer/channel relationship . What are the current levels of com-
munications and expectations between the customer and the supply
chain? Have customer product and service requirements been clearly
communicated, and what mechanisms are in place to ensure effective
and timely feedback? Has the supply chain established a product and
services value proposition that is fully compatible with network capa-
bilities, limitations, and customer expectations?
Product strategy. What is the product unit-cost strategy? Are channel
partners to concentrate on low-margin or high full-stream cost or a
mixed strategy? Is the product unique or is it highly interchangeable?
Is the supply chain offering standard or customized products or a
combination of both? What kind of packaging is to be used?
Services strategy. What services are to accompany the product in the
presales and postsales cycles? What are the response and mean time to
resolution performance targets? What are the return, warranty, and
field service policies?
Merchandising strategy. How are products to be marketed to the cus-

tomer? Is the focus to be on a direct sales force, catalogs, and so on,
and how are marketing tools such as promotions, deals, and special
pricing to be communicated to the customer? Does demand have
seasonality or trends, or is it stable for a given period of time? What
are the parameters of the order processing function? Are computerized
methods such as the Internet, EDI, direct contact, telemarketing, or
other forms to be used, and what are the service performance stan-
dards? What are the expected sales volumes per year, and is the supply
chain focusing predominantly on long-term customer relationships or is
it purely transaction based?
Delivery and order requirements. What are the standards for order re-
sponse times (hours, days, weeks)? What is the cost of a stockout?
What are the limits on order quantities, and how are transportation sys-
tems to be used for delivery?
Material handling. What are the handling and storage requirements of
the product? Is the product a discrete unit, liquid, or handled in bulk?
Stocking requirements. What should be the scope and structure of the
distribution channel? Are products and services to be delivered from a
central facility, clustered in specific geographical areas, or scattered to
leverage logistics economies?
Right behind the customer, the firm's shareholders are also important in
the formulation of the service strategy. In a very real sense, this group in-
fluences the vision and mission statement of each channel partner. The share-
holder objectives must be in alignment with and supportive of the objectives
set forth in the services strategy. For the most part, shareholders acknow-
ledge their secondary role in the enterprise behind the customer. Conflict
arises when this group begins to pursue goals antipodal to marketplace re-
quirements. The solution is to respond to shareholders as if they were also
customers. Instead of goods and services, the shareholder requires sufficient
return on investment, evidence of continued progress and growth, and defini-
tion of marketplace expectations. In return, the enterprise can expect contin-
ued support for products and programs. The same operational strategies cal-
ling for continued incremental improvements in product and service quality
need to be applied as well to the supplier-shareholder relationship.
Contemporary literature addressing the components of "world-class" CSM
also views the employee as a customer. In the traditional organization, divi-
ded by departmental budgets, narrow job descriptions, procedures, and per-
formance measurements, the vision of the employee as a customer is lost.
Not only are such organizations chronically out of alignment with the cus-
tomer, but they ignore both the creative abilities and needs of the firm's inter-
nat customer. To begin with, employee satisfaction should be seen as an ob-

jective as important as customer satisfaction. This satisfaction is attained by
streamlining work-flows and mandating internal performance measurements
that support the firm's dedication to continuous improvement. Second, em-
ployee potential is enabled when management provides ongoing training and
an atmosphere designed to promote self-empowerment. The company-em-
ployee relationship that emerges is defined on one side by management com-
mitment and a clear enunciation of expectations and performance objectives;
in turn, employees must be prepared to exercise and expand their skills and
contribute to superior service quality through continuous learning. As work
centered on narrow tasks and command and compliance management styles
give way to multidimensional focused teams responsible for performing
whole processes, the nature of work will become more value-added, self-di-
recting, and satisfying. In such an environment, success is measured by the
extent to which the entire organization meets the needs and expectations of
their internal as well as external customers.
The final component of the overall service strategy involves the level of
service found between the firm and its supplier chain. At the gateway in the
process of acquiring raw materials, components, and finished goods stands
the firm's suppliers. As such, the quality of products and services received
from the supplier has,a direct impact on a company's ability to respond to the
needs and expectations of its customers. If supplier product quality, on-time
delivery, replenishment order accuracy, financial transference, and service
support contain unacceptable performance gaps, the firm cannot help but re-
spond to its customers by passing on the excess costs, lack of quality, and
poor service. On the other hand, a superior supplier will enable the firm to
jump-start and sustain continuous improvement initiatives that can then be
communicated to the customer. When viewed as a customer, companies
should provide suppliers with a clear statement of product and service ex-
pectations, search to remove redundancies in material movement, delivery,
and paperwork, and implement ongoing improvements designed to eliminate
costs. On their part suppliers should provide preview of new product devel-
opment, participation in design, and a window into new market opportunities
and trends. Effective supplier partnerships provides a synergy in which both
parties can enjoy a level of quality, performance, and continuous improve-
ment unattainable by each working independently.
PERFORMANCE MEASUREMENTS
The last step in managing customer service is structuring a mechanism that

will provide ongoing service performance measurement. Just reviewing the
opinions and expectations of the customer once a year will hardly provide the
kind of metrics necessary for effective service management; there must be
flexible measurement tools in place that provide detailed information on an
ongoing basis and that change as marketplace expectations change. Once the
means to gauge service performance have been formalized, the results can be
measured against the standard and corrective action taken to eliminate the
variance.
Effective performance measurement of customer service involves imple-
menting programs that measure both internal and external metrics. Three
general areas of measurement can be used: process measurements, product
measurements, and satisfaction measurements. Process measurements are the
most common measurements employed. These measurements, such as cus-
tomer complaint statistics, billing adjustments, profit margins, productivity-
to-cost ratios, order cycle time, and others, provide metrics that assist in the
control of the process by which a product or service is created. Product mea-
surements are concerned with how well a product or service conforms to
specifications and standards, or the performance after purchase. Such ele-
ments as failure rate, service frequency, design, packaging, ease of use, and
attractiveness provide the core metrics for this set of measurements. Satis-
faction measurements utilize data directly from feedback that can be used to
assess customers' perceptions of product quality and service. Analysis of
complaints, periodic focus groups, toll-free telephone lines, customer com-
ment cards, and management visits are all geared toward gathering metrics re-
lating to performance satisfaction. Effective performance measurement en-
tails using all three of the above techniques. The goal is to ensure that the ob-
jectives embodied in the firm's customer value-creation strategies do, indeed,
match the expectations of the customer base.
Perhaps the best place to begin developing effective performance measure-
ments is to identify those key servic e attributes desired the most by the cus-
tomer and are being offered by the competition. The service attribute matrix
can be used to prioritize these attributes so that management attention can be
focused on the critical strengths and weaknesses in services offerings. Al-
though important, formal service metrics are not the sole source of measuring
service performance . Informal feedback, face-to-face communications, and
on-the-spot data collection all provide sources of customer opinion. Ad-
ditionally, the information attained from customer complaints is an important
source of service-quality measurement. In studies carried out by the United
States Office of Consumer Affairs, it has been proven that the average busi-
ness never hears from 96 percent of those customers dissatisfied with the
quality of the products and services they received. In addition, out of those
customers who are unhappy, 90 percent will simply stop buying from par-
ticular suppliers, never telling them the source of dissatisfaction. Such a high
statistic means that the CSM function must not just wait for the customer to
complain but take active steps from site visits to ongoing questionnaires to as-
certain the level of customer satisfaction.
Finally, the enterprise's performance must also be measured by the satis-
faction of the internal customer. Such metrics as vendor on-time delivery
and quality, the speed by which information and data moves through internal
systems, the on-time completion of internal due dates, the elimination of use-
less procedural red tape, the level of employee proficiency for problem sol-
ving, and others must be constantly monitored and steps taken to eliminate
variance. A comprehensive service strategy creates a total quality service at-
titude that enables the entire supply chain to sell better their products and ser-
vices, deliver them faster and cheaper, respond quicker to serious service-
quality gaps, develop service systems that are responsive to customer needs
and provide timely performance metrics, and attract and keep service-oriented
professionals who are dedicated to excellence and ongoing improvement.
THE INTERNET-ENABLED CRM ENVIRONMENT
While CRM practices have been used to management customers for many
years, the rise of Internet technologies have obsoleted many of the conven-
tional techniques and operating philosophies of service management. To-
day's Web-enabled applications are providing customer management func-
tions with radically new approaches to generate customer value and collabo-
ration, facilitate the sales process, enhance the customer service capabilities,
and architect highly integrated, customer-centric infrastructures. In fact, over
the past half-decade, CRM application suites have been perhaps the hottest
segment of the software marketplace with revenues projected to exceeding 6
billion in 2003. By way of illustration, Figure 9.10 details the possible com-
ponents of Internet-based or e-CRM software suites.
CRM AND INTERNET SALES
Internet-based selling and service management has opened the door to new
and exciting possibilities . Although the dot-com fizzle and the economic
slow down of the early 2000s have caused a deep decline in the development
of Internet technologies for buying and selling, there can be no denying its
potential to radically reshape the landscape of business. For customers, e-
CRM provides radically simple, self-directed methods for browsing and lo-
cating suppliers and their products, as well as simplified order entry and
open-order inquiry. Web-enabled communication tools have made it easy for
customers and suppliers to engage in bidirectional communication, a feature
FIGURE 9.10 CRM technology sphere .
that increases one-to-one personalization of the transaction experience. Attri-

butes such as 24x7x365 service, real-time information, on-line customer sup-
port, instantaneous availability of documentation, self-service, and Web-page
personalization offer customers new ways of realizing value propositions that
meet their individual needs.
For suppliers, Web-applications enable companies to sell directly to the
end-customer thereby by-passing costly channel intermediaries. Further, be-
cause the demand is placed in the system in real time, suppliers have en-
hanced visibility to improve the effectiveness and better utilize resources.
Finally, according to Sawhney and Zabin [27], "technology-enabled selling
will be used increasingly to synchronize and integrate all selling channels
used by the enterprise, including telesales, the Net, resellers, and the direct
sales force, through the use of a common customer relationship repository, a
common applications infrastructure, and a shared business process."
e-CRM databases can significantly assist suppliers to deliver tailored re-
sponses to their customers by effectively sorting good customers (profit-
able/valuable) from the bad (unprofitable/non-valuable). According to
Poirier and Bauer [28], customer ratings should be based on the following
criteria: volume of a customer's purchases, strategic value of the customer,
and profitability ofthe customer. Based on the ratings, customers then should
be arranged into a hierarchy, starting with the small number of super cus-
tomers located at the top who account for the majority of the business and
ending with "suspects" at the bottom who represent a very small proportion
of annual sales. Once stratification of the customer base is completed, sup-

pliers can then architect an individualized response commensurate with the
expected level of customer profitability potential.
On the invoicing and payment side of sales management, companies have
recently begun utilizing the Internet to facilitate payment processes. While
currently less than twenty percent of bill payment is handled electronically,
this percentage is expected to climb dramatically as increasingly more com-
panies combine it with their CRM toolsets . In general, e-billing utilizes the
Web to receive bills, authorize payments, match payments to purchase or-
ders, and download data into ERP and accounting systems in a digital format.
The obvious speed, easy of use, and accuracy gained bye-billing will enable
companies to offer greater convenience to their customers in their abilities to
access their accounts and view financial data and greater p ersonalization for
the biller to customize financial transactions and draw the customer to the
Web site. In addition, e-billing provides another avenue for Internet mar-
keting and cross-selling and will significantly assist CSM functions to handle
bill and statement information . Finally, e- billing provides customers with
further avenues for real-time self-service in the management and analysis of
financial data.
SALES FORCE AUTOMATION
Originating in the early 1990' s, sales force automation (SFA) was conceived
as an electronic method to collect and analyze customer information from
marketing and contact center organizations that in turn could be used to ad-
vance opportunities for customer retention and acquisition as well as enhance
marketplace relationships and revenues. In addition, SFA equipped field
sales with automation tools to more effectively manage existing accounts,
prospect for new customers , track the impact of pricing, promotions, cam-
paigns, forecasts, and other sales efforts on their pipelines, generate mean-
ingful analysis and statistics from their sales database, become more mobile,
organize their contact lists, and have real-time customer information in an
easily accessed presentation. According to Dyche [29], the mission of SFA
"was to put account information directly in the hands of field sales staff,
making them responsible for it, and ultimately rendering them (and the rest of
the company) more profitable."
Today's SFA systems are driven by technologies capable of synchronizing
data from unconnected sources, such as laptops, mobile devices, and desk-
tops, and utilizing flexible and scaleable databases, such as Microsoft SQL or
Oracle, and memory-resident PC applications equipped with scoreboards and
reporting functionality that can exploit powerful engines such as HTML and
Java to drive real-time information sharing. While the SFA marketplace con-
tains a number of software vendors and competing products, they all posses
to some degree or another the following functionality: contact management
tools that contain customer databases and automated workflows capable of
assigning and routing appointments; account management tools used to track
account and sales data activity; sales process/activity management tools that
predefine the procedures to be followed by the sales force during the sales cy-
cle, opportunity management tools providing for the automated distribution
of leads and assistance in lead conversion to sales; quotation management ap-
plications that enable entry, follow-up and conversion of quotes into orders;
and knowledge management software concerned with standardizing and auto-
mating sales processes by capturing information found in sales handbooks,
presentation materials, and fonns and templates.
e-CRM MARKETING
Up until fairly recently, marketing was concerned with the promotion of mass
produced products and services and assumed uniformity of customer wants
and needs. With the advent of Internet buying and selling, companies could
escape from the mass marketing approaches of the past and refocus on p er-
sonal marketing - Of. one-to-one buyer-seller contact. This approach can be
defined as the capability of companies to present their goods and services
customized to fit the distinct personal interests and needs of the customer.
According to Fingar, Kumar, and Sharma [30],
Customization is the byword of the 2151 century marketing revolution. By inter-

acting with customers electronically, their buying behavior can be evaluated
and responses to their needs can be tailored. Customization provides value to
customers by allowing them to find solutions that better fit their needs and
saves them time in searching for their solutions. . . . Not only can a solution be
pinpointed for a customer, but also as the relationship grows, the more a busi-
ness knows about individual buying behavior. As a result of the growing re-
lationship, cross-selling opportunities will abound. With the Net, the savvy
marketer can sense and respond to customer needs in real-time, one-to-one....
In the world of electronic consumer markets the success factor mantra is: re-
lationship, relationship, and relationship.
Leveraging the Internet for marketing requires the use of software appli-
cations that enable suppliers to compile, search, and utilize customer data-
bases to define who the customer is and then generate targeted marketing
campaigns via e-mail, e-fax, the Web, the telephone, or other technology
tools to reach the marketplace. The suite of toolsets available include cus-
tomer intelligence and data extraction, campaign definition, detailed cam-

paign planning and program launch , scheduling of activities and continuous
performance measurement, and response management. While many of the
activities appear similar to traditional marketing campaign processes, the ma-
jor difference is the use of the Internet to capture , extract, and analyze cam-
paign inputs. By tracking campaign results over time, marketers are then bet-
ter equipped to construct future campaigns that can enhance one-to-one mar-
keting relationships.
Today's CRM applications also contain analytical tools for data analysis.
CRM analytics provide suppliers with statistical, modeling, and optimization
toolsets that enable marketing organizations to analyze, combine, and stratify
data to better understand the status of overall marketing strategies and the sta-
tus and sales profiles of their customers. In more detail, CRM analytics could
be used to determine customer value measurement, risk scoring, campaign
measurement, channel analysis, chum analysis and prediction, personali-
zation and collaborative filtering , and revenue analysis. Finally, marketers
can also utilize CRM data to drive the development of programs designed to
pinpoint individual customer touch points. For example, interactive analytics
enable marketers to abstract and combine data to carry-out what-if scenarios
that could be used to create a promotions campaign.
PARTNERSHIP RELATIONSHIP MANAGEMENT
One of the cardinal advantages of supply chain management is the ability to

leverage the core competencies of channel partners to provide a level of ser-
vice unavailable by individual companies acting on their own. This reinter-
mediation of the supply channel through the application of new management
methods and Web-enabled connectivity has coalesced around a subset of
CRM termed PRM . PRM can be defined
as a business strategy and a set of application tools designed to increase the

long-term value of a finn's channel network by assisting companies to select
the right partners, supporting them by offering timely and accurate information
and knowledge management resources to deal successfully with channel cus-
tomers, collectively searching for ways to improve sales, productivity, and
competitiveness, and ensuring that each trading partnercontributes to customer
satisfaction [31].
PRM began as a means to facilitate channel sales and gather metrics based
on the marketing and sales efforts of supply chain partners. Until the advent
of Web-based connectivities, communication and assembly of sales capabili-
ties and statistics from all regions of the supply chain was extremely difficult.
Today, the Internet has enabled the growth of several PRM functions. Per-
haps the most critical - partner recruitment, development, and profiling - is
concerned with assembling and qualifying potential channel partners. PRM
tools can assist in establishing a partner profile database, ranking partner ca-
pabilities, ensuring certification, and determining risks and rewards. Another
critical function is marketing and sales management whereby companies can
use the Internet to network-in partners to sales campaigns and promotions and
to be able to measure results . A final function is to grow PRM Collaboration
to facilitate channel-wide codevelopment of market programs, joint business
plans, and the sharing of sales metrics, forecasts, and general customer
feedback.
SUMMARY
The changes brought about by the globalization of the marketplace, the

spread of Internet technology, and requirements for quality products and val-
ue-added services have forced supply chains to reexamine their traditional at-
titudes toward customer service. In the past, market share was gained by ex-
panding business capacities, introducing new products, and decreasing prod-
uct delivery lead times. In the twenty-first century, the search for competitive
advantage entails a broadening of this strategy to include a philosophy of con-
tinuous improvement dedicated to increasing quality and productivity and the
adoption of information tools that enable the firm to respond quickly to on-
going changes in customer product and service needs. "World-class" per-
formers are tireless in their examination of every aspect of their firm's oper-
ations in search of untapped sources of quality and customer satisfaction.
Activating such a vision means that the enterprise must constantly measure
customer perceptions of service quality, identify service shortfalls, and re-
spond to service gaps. Once these gaps have been quantified, management
can begin to redesign organizational and value structures, refocusing them on
continuous incremental improvements in process and informational perfor-
mance. Service leaders see quality as one of the fundamental building blocks
of market dominance, set levels of service that exceed their customer's ex-
pectations and surpass the standards set by the competition, have an action-
oriented attitude focused on teamwork and commitment to excellence, and
are ceaseless in their endeavor to satisfy the customer at all costs.
Superior customer service also requires order promising functions that pro-
vide for the speedy and accurate transference of goods, services, and order in-
formation. Order processing is the primary contact between customers and
suppliers. It serves as the gateway into which orders are placed, priced, in-
ventory allocated and tracked, and from which goods and services are de-
livered to the customer. It can also be argued that the requirements of high
velocity response driven by the Internet necessitate that the scope of order
management be expanded to encompass not only the demand on individual
enterprises, but also how that demand impacts the customer service capa-
bilities of the entire supply chain.
The customer order management process begins with the maintenance of
the database elements necessary for timely and accurate order processing.
Accurate customer master, pricing, and inventory files are absolutely critical
for the second step in the order management process : executing the sales or-
der processing cycle. This cycle consists of three separate but integrated ac-
tivities: order receipt and entry, inventory allocation and picking, and order
shipment and invoicing. The third step in the customer order management is
monitoring order status. The open order file provides customer service with a
window into order ship dates, backorders, and inventory quantities so that or-
der priorities can be maintained . Once the order has been shipped, order his-
tory reporting can assist customer service in tracking order delivery and qual-
ity-related issues. Finally, the last step in the order management process is
defining and maintaining performance measurements .
The rise of Internet commerce has recently provided fresh challenges to
customer service management. Today's Web-enabled applications offer com-
panies radically new. approaches to generate customer value and collabora-
tion, facilitate the sales process, enhance customer service capabilities, and
architect highly integrated, customer-centric infrastructures . For customers,
e-CRM provides radically simple, self-directed tools for browsing and lo-
cating suppliers and their products, as well as simplified order entry and
open-order inquiry. For suppliers, Web applications enable direct sales to the
end-customer, thereby by-passing costly channel intermediaries. Further, be-
cause demand is placed in the system in real-time, suppliers have enhanced
visibility to improve the effectiveness and better use of resources. In the suite
of e-CRM applications can be found sales force automation tools, new forms
of Internet-based marketing capabilities, and communications tools that de-
epen customer partnership management.
1. Define the meaning of CRM and how it impacts customer management.

2. Discuss the ten elements of customer service.
3. What are the three phases of sales cycle, and how can effective services facilitate
the successful completion of each cycle?
4. What the foundations for a successful customer service strategy?
5. Determining and measuring service gaps have been established as fundamental in
the development of an effective services strategy. Detail the mechanics of
determining service gaps.
6. Discuss the effective use of total cost-service level trade-offs.
7. Contemporary literature addressing the components of "world-class" services
views the employee also as a customer. Why is this point so important?
8. Why are performance measurements so important in constructing an effective
services strategy?
9. Why has the order management process grown in importance for distributors?
10. Discuss why supply chain order management is so critical to overall customer
service performance.
11. Detail the computerized tools available for the effective use of CRM.
REFERENCES
1. See the summary in Ross, David F., Introduction to e-Supply Chain

Management : Engaging Technology to Build Market-Winning Business
Partnerships. Coca Ratton: St Lucie Press, 2003, pp. 171-173.
2. For a complete review of the principles of modem marketing see Kotler, Philip,
Marketing Management: Analysis, Planning, Implementation, and Control. 6th
ed. Englewood Cliffs, NJ: Prentice Hall, 1'988, pp. 13-31.
3. This definition was first formulated by LaLonde, Bernard and Zinszer, Paul H.
Customer Service: Meaning and Measurement. Chicago: National Council of
Physical Distribution Management, 1976, pp. 203-217, and has been used by
many oftoday's texts on modem distribution and marketing.
4. Greenberg, Paul, CRM at the Speed ofLight: Capturing and Keeping Customers
in Internet Real Time. McGraw-Hill, Berkley, CA, 2001, p. xviii. Greenberg
also devotes 33 pages of his first chapter to detailing a variety of comprehensive
definitions coming from a number of CEOs and COOs from companies such as
PeopleSoft and Onyx Software.
5. Dyche, Jill, The CRM Handbook: A Business Guide to Customer Relationship
Management. Addison-Wesley, Boston, MA, 2002, p. 4.
6. Renner, Dale H., "Closer to the Customer: Customer Relationship Management
and the Supply Chain," in Achieving Supply Chain Excellence Through
Technology. 1, Anderson, David L., ed., Montgomery Research, San Francisco,

1999, p. 108.
7. This section is summarized from Ross , Introduction to e-Supply Chain
8. Some of these points have been adopted from Bovet, David and Martha, Joseph,
Value Nets: Breaking the Supply Chain to Unlock Hidden Profits. New York:
John Wiley & Sons, 2000, p. 1-17.
9. These points have been taken from Feldman, Bart, "Collaborative Demand
Management: A Solution for Changing Business Realities." Global Logistics &
Supply Chain Strategies, 5, 10,74-76.
10. These points can be found in Langabeer, James R., "Aligning Demand
Management with Business Strategy." Supply Chain Management Review, 4,2,
2000,68.
11. Some of these forecasting models can be found in Gilliland, Michael,
"Forecasting the Unforecastable: Dealing with Volatile Demand." 2001
International Conference Proceedings sponsored by APICS, October, 2001;
Falls Church, W.V.: APICS, 2001.
12. For more detail on this discussion see Bowersox, Donald J. and Closs, David J.,
Logistical Management : The Integrated Supply Chain Process . New York:
McGraw-Hill, 1996, pp. 67-75 and Coyle, John 1., Bardi, Edward J., and
Langley, C. John, The Management of Business Logistics: A Supply Chain
Perspective. Mason, Ohio: South-Western, 2003 , pp. 97-101.
13. LaLonde, Bernard and Zinszer, Paul H., Customer Service: Meaning and
Measurement. Chicago: National Council of Physical Distribution Management,
1976, pp . 272-282.
14. These points have been borrowed from Enslow, Beth, "Internet Fulfillment: the
Next Supply Chain Frontier," in Achieving Supply Chain Excellence Through
Technology, I, Anderson, David L., ed., San Francisco, CA: Montgomery
Research, 1999,251-257.
15. See the comments found in Hintlian, James T. and Churchan, Phil, "Integrated
Fulfillment: Bringing Together the Vision and Reality." Supply Chain
Management Review Global Suppiement . S, 1 (2001), pp. 16-20 ; and, Hintlian,
James T., Mann, Robert E., and Churchman, Phil, "E-Fulfillment Challenge -
The Holy Grail of B2C and B2B E-Commerce," in Achieving Supply Chain
Excellence Through Technology, 3, Anderson, David L., ed ., San Francisco,
CA: Montgomery Research, 2001 , 270-274.
16. Ross , Introduction to e-Supply Chain Management , p. 186.
17. See note 3 above.
18. LaLonde, Bernard, Cooper, Martha C., and Noordewier, Thomas G., Customer
Service: A Management Perspective . Chicago: Council of Logistics Manage-
ment, 1988, p. 5.
19. Band, William A., Creating Value For Customers. New York: John Wiley &
Sons , Inc, 1991, p. 80.
20 . Zeithaml, Valerie A, Parasuraman, A and Berry, Leonard L. Delivering Quality
Service. New York: The Free Press, 1990, pp . 20-23 ; Zeithaml, Valarie A ,
Parasuraman, A and Berry, Leonard L. "A Conceptual Model of Service
Quality and Its Implications for Future Research." Journal ofMarketing, 41-50
(Fall, 1985).
21. Gopal , Christopher and Cahill , Gerard, Logistics in Manufacturing. Home-
wood, IL: Business One Irwin , 1992, pp. 127-162 .
22. Band, William A., Creating Value For Customers. New York: John Wiley &
Sons, Inc, 1991, p. 21.
23. This matrix can be found in Albrecht, Karl and Bradford, Lawrence J, The
Service Advantage. Homewood, IL: Dow Jones-Irwin, 1990, p. 175.
24. Zeithaml, et aI., p. 9-13 .
25. See the discussion in Lambert, Douglas M. and Stock, James R., Strategic
Logistics Management. 3rd ed. Homewood, IL: Irwin, 1993, p. 124.
26. This section has been abstracted from Ross, Introduction to e-Supply Chain
27. Sawhney, Mohan and Zabin, Jeff, The Seven Steps to Nirvana: Strategic
Insights into e-Business Transformation. New York: McGraw-Hill, 2001, p.
181.
28. Poirier, Charles C. and Bauer, Michael J., E-Supply Chain: Using the Internet to
Revolutionize Your Supply Chain. San Franci sco: Berrett-Koehler Publishers,
Inc., 2000 , pp . 176-177 .
29. Dyche, p. 80.
30. Fingar, Peter, Kumar, Harsha, and Sharma, Tarun, Enterprise E-Commerce: The
Software Component Breakthrough for Business-to-Business Commerce,
Tampa, FL: Meghan-Kiffer Press, 2000 , pp. 89-90 .
31. Ross, Introduction to e-Supp /y Chain Management, p.189 .
10
SUPPLIER RELATIONSHIP
MANAGEMENT
DEFINING PURCHASING The Purchase Order Processing

Defining the Purchasing Function Cycle
Purchasing Responsibilities and Purchase Order Entry
Processes Transportation Decision
The Purchasing Organization Receiving and Order Closeout
Purchasing Objectives Status Reporting
DEFINING SUPPLIER RELATION- PERFORMANCE MEASURE-

SHIP MANAGEMENT MENT
Components of SRM Supplier Performance
Measurement
ANATOMY OF PURCHASING Purchasing Organization
STRATEGY Performance Measurements
Step I: Environmental Scanning
Step 2: Organizational Structure IMPACT OF e-BUSINESS ON
Step 3: Inventory Strategy SRM
Step 4: Supplier Relations e-Sourcing Functions
Step 5: Technology Enablers e-Procurement Functions
Step 6: Performance and Continuous Value-Added Services
Improvement e-Marketplace Exchanges
PURCHASE ORDER MANAGE- SUMMARY

MENT PROCESS
Assuring Database Accuracy QUESTIONS FOR REVIEW
PROBLEMS
The management of the processes for the acquisition of raw materials , com-
ponent parts, and finished goods to service the needs of the customer resides
at the very core of competitive supply chain management. Effectively de-

signed and executed procurement processes provide several direct advan-
tages. To begin with, procurement plays a fundamental role in actualizing
business and operations planning objectives concerning supply chain deliv-
ery, flexibility, quality, and costs. Secondly, the sheer size of procurement
directly affects the financial stability and profitability of virtually every tra-
ding partner in the channel. Depending on the nature of the product offering,
procurement costs alone can range from forty to over seventy percent of each
sales dollar. Thirdly, the efficiency and quality of procurement has a direct
influence on the capability of the entire supply chain to respond effectively to
marketplace demand. Because of its significant impact on revenues, costs,
and operational efficiencies, procurement has become a key enabler of supply
chain strategy.
Finally, effective procurement requires the structuring of strong partner-
ships. With the rise of Internet-driven tools opening dramatically new vistas
for sourcing, cost management, concurrent product development, quality, and
delivery, the need for close, highly integrated relationships between buyers
and suppliers has expanded concomitantly. In fact, the confluence of these
trends has revolutionized past concepts of purchasing and transformed it into
a new science: supplier relationship management (SRM). In today's fast past
environments, academics, consultants, and practitioners have come to under-
stand that while high quality and low cost are critical, it is the relationship
that exists between buyer and seller that determines the real value-added
component of procurement. The closer the demands and capabilities of cus-
tomer and supplier are synchronized, the more total costs decline, the more
agile suppliers become to meet complex demands, and the faster inventory
moves through the channel pipeline. In addition, the more integrated the sup-
ply chain, the more channel partners can truly fashion collaborative relation-
ships where core competencies can be merged to generate a common com-
petitive vision.
This chapter focuses on the procurement and supplier management func-
tions found in today's supply chain environment. The chapter begins by de-
fining the role of the purchasing function, purchasing responsibilities, organi-
zational structure, ongoing operational objectives, and requirements for ef-
fective supplier relationship management (SRM). After a detailed discussion
of the steps necessary to architect dynamic procurement and SRM strategies,
the chapter proceeds to outline the purchase order management process. The
elements of the procurement process - assuring database accuracy, under-
standing the purchase order processing cycle, transportation decisions, re-
ceiving and order closeout, and status reporting activities - are then reviewed
in detail. Next, the role of performance measurement in charting the effec-
tiveness and efficiency of the purchasing function is discussed. The chapter
SUPPLIER RELATIONSHIP MANAGEMENT 477
concludes with an in depth analysis of the impact of e-business tools on pur-

chasing. e-Sourcing, e-procurement, value-added services, and e-marketplace
exchanges are in turn examined.
DEFINING PURCHASING
The acquisition of materials, components, finished goods, and support ser-

vices is a fundamental activity found in all manufacturing, distribution, and
retailing companies. Procurement is concerned with acquiring the necessary
resources to satisfy customer, manufacturing, and supply chain demand as
determined by the inventory planning process. This process begins with the
translation and disaggregation of the enterprise business plan through mar-
keting and sales, manufacturing and distribution, logistics, and detail statis-
tical and MRP/DRP inventory management. In this section the procurement
function will be closely defined with a consideration of supplier management
to appear later in the chapter.
DEFINING THE PURCHASING FUNCTION
According to The Purchasing Handbook, purchasing can be defined as
the body of integrated activities that focuses on the purchasing of materials,

supplies, and services needed to reach organizational goals. In a narrow sense,
purchasing describes the process of buying; in a broader context, purchasing in-
volves determining the need; selecting the supplier; arriving at the appropriate
price, terms and conditions; issuing the contract or order; and following up to
ensure delivery. [1]
The APICS Dictionary defines purchasing in a much wider sense as
The integration and focusing of the business functions of procurement plan-

ning, purchasing, inventory control, traffic, receiving, incoming inspection, and
salvageoperations on inventory acquisition, receiving, material disposition, and
financial accounting. [2]
The purchasing function is normally responsible for the acquisition of all

products and services required by the organization. Broadly speaking, there
are three types of purchasing: purchasing for consumption or conversion,
purchasing for resale, and purchasing for goods and services consumed in
maintenance, repair, and operations functions. Purchasing for conversion or
consumption is the concern of industrial buyers and covers a wide spectrum
of activities beginning with a determination of what products the firm should
produce or outsource, progressing to raw materials and component sourcing,

negotiation , purchase order generation and status monitoring, and concluding
with materials receipt. Goods purchased for resale are the concern of dis-
tribution and retail buyers. In this area buyers determine what goods their
customers want, search and buy these goods based on targeted levels of qual-
ity, delivery, quantity, and price, and sell them competitively based on price,
quality, availability, and service. The final type of purchasing, maintenance,
repair, and operating (MRO) inventories, is concerned with the acquisition
of expensed items and services necessary for the efficient functioning of the
business .
The range of products purchased can be seen in the following categories:
Finished goods, component inventories, and raw materials. For the
most part, the purchasing organization focuses on the acquisition of
products that will be sold directly to the customer or used in production
processes to create finished goods which, in turn, will be sold to the
customer . This category has by far the largest impact on enterprise cus-
tomer service, inventory costs, storage requirements, cash flow, and
materials conversion processes.
Ma intenance, Repair, and Operating (MRO) inventories and services.
Another important activity of purchasing is the acquisition of standard
operating supply items and services. In this category can be found
office and general supplies such as copy paper, pens, paper towels, and
light bulbs. In addition, normal services such as equipment mainten-
ance, cleaning services, and facilities repair are also included. Once
satisfactory suppliers have been located, MRO purchasing is normally
an ongoing clerical responsibility , interrupted only by periodic review
of supplier performance and pricing changes.
Custom equipment and services. Finally, the purchasing department is
also responsible for the acquisition of specialty items and services. In
this category can be found products that must be specially designed or
fabricated to meet specific needs. Unique machinery, storage and ma-
terial handling equipment, and computerized information systems are
some of the products in this category. Special services such as training,
advertising, market research, and consulting services are also included.
Because of the uniqueness and cost of these products and services, pur-
chasing usually begins with a requirements definition, request for quote
(RFQ), and proposed budget that must be approved by company man-
agement before purchasing activities begin. Once approved, it is pur-
chasing's responsibility to support and oversee project development,
serve as the intermediary between technical personnel and suppliers,
and execute the actual purchase order process.
PURCHASING RESPONSIBILITIES AND PROCESSES
The management, planning, and execution of purchasing activities are nor-

mally the responsibility of the purchasing department. It is the job of this
function to communicate effectively the purchase requirements of the firm to
the right suppliers and to maintain open replenishment order status informa-
tion that can be used by other enterprise operations. The functions of pur-
chasing encompass a multitude of activities. These functions have been ar-
ranged below, starting with activities of strategic importance then progressing
to those performed on a daily basis:
Sourcing. This high value -added activity is concerned with matching
purchasing requirements with sources of supply, ensuring continuity of
supply, exploring alternative sources of supply, and validating the sup-
plier compliance necessary to meet or exceed buyer criteria for quality,
delivery, quantity, and price. For the past decade a critical component
of sourcing has been reducing needless redundancies in the supplier
base and increasing supplier collaborative partnering.
Value analysis. This set of functions is concerned with increasing the
value -added elements of the purchasing process. Value analysis can
consist of such components as price for quality received, financing, and
delivery. An example would be identifying less expensive goods and
services that could be used as substitutes at comparable quality and
value.
Supplier development. In today's environment, increasing collabora-
tion with suppliers has become a requirement for doing business. Pur-
suing capabilities that promote supplier partnering require buyers to be
knowledgeable of supplier capacities, resources, product lines, and de-
livery and information system capabilities. A key component in the
strengthening of this partnership is the development of pricing, tech-
nology, and information-sharing agreements that link supplier and
buyer together and provide for a continuous "win-win" environment.
Internal integration. Purchasing needs to be closely integrated with
other enterprise business areas such as marketing, sales, inventory plan-
ning , transportation, and quality management. By providing key infor-
mation and streamlining the acquisition process, the purchasing func-
tion can assist the enterprise to synchronize replenishment requirements
with the overall capacities of the supply network. Buyers should also
be members of product market, research, and engineering development
teams if the proper inventory at the best quality, delivery, and cost is to
be purchased.
Supplier scheduling. One of the keys to effective purchasing is the de-

velopment of a valid schedule of inventory replenishment. By sharing
the schedule of demand from MRPIROPIDRP techniques, firms can
provide detailed visibility to future requirements to supply chain part-
ners, who, in turn, can plan the necessary material and capacity re-
sources to support the schedule. In addition, the increased use of pur-
chasing portals and B2B marketplaces have dramatically expanded
buyers ' ability to search anywhere in the world for sources to meet
product and service replenishment needs.
Contracting. Critical functions in this area consist of the development
and analysis of request for quotation (RFQ), negotiation when pricing,
volume, length of contract time, or specific designs or specifications
are significant issues, and supplier selection and monitoring of perfor-
mance measurements.
Cost management. A critical function of purchasing is the continuous
search for ways to reduce administrative costs, purchase prices, and in-
ventory carrying costs while increasing value. The principle activities
utilized to accomplish these objectives are purchase cost reduction pro-
grams, price change management programs, volume and "stockless"
purchasing contracts, cash-flow forecasting, and strategic planning.
Purchasing and Receiving. Activities in this component include order
preparation, order entry, order transmission, status reporting, order re-
ceiving, quantity checking and stock put-away, invoice and discount re-
view, and order closeout.
Performance measurement. Monitoring the quality and delivery per-
formance of suppliers over time is an integral part of supplier "bench-
marking." The ability to measure performance is critical when evalu-
ating the capabilities of competing suppliers and ensuring that costs,
delivery, and collaborative targets are being attained [3].
THE PURCHASING ORGANIZATION
The ability to execute the functions of purchasing requires the establishment

of an effective purchasing organization. The structure of the purchasing
function is determined by how it is utilized by the rest of the organization.
Companies that consider purchasing of fundamental importance to the suc-
cess of the business view purchasing as a strategic advantage and provide it
with high-level decision-making power. Conversely, in those companies that
perceive purchasing as purely a tactical activity, it is treated as an admini-
strative function without much of a strategic impact on the business. The
relative position of purchasing in an organization is also revealed by its level
of interaction with other business functions. Purchasing management normal-

ly has close communication with Inventory Management, Transportation,
Sales, Product Design, Marketing, and Finance and should be an integral part
of the strategic planning processes of each of these business areas.
Dobler, et al [4] divide the functions found in the traditional purchasing
department into five distinct classifications, each of which encompasses a
wide range of activities. An effectively structured purchasing organization
must be able to execute these activities in as efficient and cost-effective a
manner as possible. The five classifications can be detailed as follows:
1. Management. Managing the purchasing function involves a matrix of
tasks and responsibilities. Foremost among these activities are devel-
oping and defining the content of operating procedures, developing the
necessary planning and execution controls, and engineering the
mechanics for coordinating purchasing operations with other business
functions .
2. Buying. The process of acquiring goods from suppliers involves such
activities as defining procurement requirements, reviewing product
specifications, supplier sourcing, performing value analysis, analyzing
bids, negotiating, supplier selection, and purchase order release.
3. Status Reporting and Expediting. Follow-up of open orders is a funda-
mental function of purchasing. This involves activities such as supplier
liaison, open order status tracking, supplier visits, and expediting late
or emergency purchase orders.
4. Research. Often purchasing is required to investigate new avenues of
supply or to buy products for special projects. Research activities en-
compass such tasks as value analysis, economic and market studies,
special cost analysis, sourcing, and systems research.
5. Clerical. Every purchasing department must perform a number of
clerical activities. These range from paperwork completion, filing, and
data maintenance to purchase order release and price and receipt qual-
ity tracking.
The keynote in designing an effective purchasing organization is to focus
on those activities that add value to the process while eliminating those that
merely add cost. For example, roles concerned with sourcing products and
supplier development are value-added; expediting and clerical administrative
activities, on the other hand, do not add value to the company and should be
kept to the bare minimum, if not eliminated altogether. Ideally, the structure
of the purchasing function should consist of four levels. As illustrated in Fig-
ure 10.1, on the first level can be found the Purchasing Manager . It is the re-
sponsibility of this individual to align the goals of the department with the
business plan, act as liaison to the other business departments in the firm, for-
mulate and review performance measurements, develop the purchasing staff,
Purchasing
Manager
Buyer Buyer Buyer Buyer
Planner ... Planner ... Planner ... Planner
I I
Adm ini strati ve upport ~
FIGURE 10.1 Standard purchasing organization.
and perform all required administrative functions. The buyer's role consists
of a number of tasks centered on the value-added work of purchasing. These
tasks consist of such activities as product sourcing, supplier development,
negotiating, value analysis, and contracting. Purchasing planners can be
found at the third level. It is the responsibility of this group to communicate
the replenishment purchasing schedule to the supplier, launch and expedite
orders, reduce order, and transportation costs, manage inventory purchase
investment, and communicate problems to the buyer and the inventory plan-
ning functions. At the fourth level of the purchasing function structure can be
found clerical support. The support staff assists the first three levels perform
administrative activities such as record keeping, paperwork, statistics, ex-
pediting, and data entry and maintenance.
The purchasing organization can be structured around three general ap-
proaches: commodity or function, project or product, and matrix. The com-
modity approach is the structure most commonly used by companies. In this
organization, the purchasing function is divided into spheres of buying re-
sponsibility such as production inventories, maintenance, repair, and opera-
ting (MRO) inventory and services, and capital and construction equipment.
In addition, other non-buying areas, such as acquisition research, administra-
tive support, and technical liaison, can be integrated into the model. The buy-
er within each commodity group is responsible for all sourcing, negotiating,
and purchase order releasing activities for that commodity area. The advan-
tage of this method of organization is that focused members of the purchasing
team are able to acquire specialized knowledge about products and suppliers,
serve as the communication point for purchase order requisition, and execute
acquisition activities while minimizing product and administrative costs.
For those firms whose products and services are focused on long-term pro-
jects, the purchasing function can be organized around specific projects or
programs. The goal of the purchasing group in such organizations is the ac-
quisition of the required materials and services necessary to meet project re-
quirements . The advantage of this form of organization is that certain buyers
can be linked to specific project segments, thereby ensuring that purchasing
requirements are kept within budget targets and scheduled time frames are
met. A matrix organization is a variation of the purchasing function organi-
zed around projects or products. In this structure, buyers are organized into
project teams charged with the responsibility of meeting the acquisition needs
of the entire project. In essence, these buyer-teams are part of each project or
project segment. Such an organizational structure streamlines the purchasing
process and eliminates possible redundancies .
Companies with multi-facilities are further faced with the decision of
whether to organize their purchasing functions around a centralized or decen-
traliz ed structure . In considering a centralized option, a number of critical
questions immediately come to mind: "How is the buying function to co-
ordinate the acquisition of products and services?" "Where in the organiza-
tion are buying decisions to be made?" "How are purchasing decisions and
activities to be split between corporate and local facilities?" The decision as
to the degree of centralization is weighed by several advantages and disad-
vantages. The arguments favoring centralization center on buyer "clout" and
economies of scale. .Centralized functions can often obtain large discounts,
better coordinate purchasing requirements through the creation of a single
supplier order, more efficiently utilize scarce resources among competing fa-
cility units, and develop a specialized professional staff. In contrast, argu-
ments favoring a decentralized purchasing option center on linking acqui-
sition authority with those company branches responsible for inventory avail-
ability, coupling specific product and services needs with the requisitioning
facility, providing supplier visibility to special product features, services, or
transportation needs, and being able to purchase from a local source. In the
final analysis, the decision to structure the purchasing function either one
way or another is often not clear-cut, with some commodities, such as bulk
items and widely used products being purchased by a centralized group, and
specialized products and services acquired locally [5].
PURCHASING OBJECTIVES
The most conventional response that is given to the question "What is the ob-
jective of purchasing?" is obtaining the right products or services, at the right
time, in the right quantities, delivered to the right place, at the right price with
perfect quality. As can be imagined from such an answer, the buyer is faced
with the task of pursuing not just one but a multitude of objectives, some of
which are contradictory. Buyers are continually faced with the dichotomies
arising from the often conflicting objectives of pursuing simultaneously opti-
mal quality, service, and price. Rarely will all three elements be obtainable
from a single supplier. Often a buyer must select a supplier based on balan-
cing all three of these cost elements or total cost.
Although total cost management is perhaps the most fundamental ongoing
activity of purchasing, there are several other key objectives. They are as fol-
lows:
Providing an uninterrupted flow of materials and services. One of the
most common sources oflost productivity and customer dissatis-faction
is the result of shortages in materials and service resources. Shortages
cause production downtime, interrupt the flow of product and cash
through the channel, impair communications between pur-chasing and
suppliers, and strain relations with customers on one end of the pipeline
and suppliers on the other. The foremost goal of the pur-chasing
function is to ensure that the company is not hindered by in-ventory and
service capacity shortages. Just buying inventory and other resources,
however, is not enough. In addition, purchasers must continually
search for methods of increasing the velocity of the flow of goods and
services through the distribution channel without accom-panying
increases in carrying costs.
Purchasing products competitively. This objective requires purchasers
to continuously search for supplier relationships that will provide the
best combination of quality, price, and service relative to the enter-
prise's needs. Pursuing this objective means that buyers must be infor-
med about market forces of demand and supply that regulate prices and
product availability. In addition, this objective requires purchasers to
understand the cost dynamics of their suppliers, and then to negotiate
quality, price, and service arrangements that achieve optimum value.
Keeping inventory investment to a minimum. Although the first pri-
ority of the supply chain is to have products available to meet any cus-
tomer requirement, the cost of maintaining large inventories can negate
sales profits. Effective inventory management requires that purchasing
does its part in achieving a reasonable balance between stocking levels
and the cost of carrying inventory. In addition, purchasing can signifi-
cantly assist the firm in reducing inventory loss due to spoilage, obso-
lescence, deterioration, and theft.
Developing the supplier base. Reliable, quality-oriented suppliers are
important company resources. Purchasers must continually search for
ways to enhance supplier relationships by developing mutually bene-
ficial value-added service, quality, and training programs that promote
supplier partnerships. In addition, buyers must continually search for

and evaluate new suppliers. Performance measurements and periodic
evaluations will ensure that suppliers are maintaining quality and re-
sponse objectives .
Provide consistent, quality purchased materials and services. Pur-
chasing in the 2000s requires buyers to explore all possible avenues to
ensure product and service quality. In the past, purchasers spent their
time calculating the trade-off costs between a desired quality level and
the cost of acquiring it. The result was often low prices with accom-
panying poor quality that caused expensive customer returns, product
rework, and lost customer confidence. Today, purchasers must bargain
for nothing short of total product quality while searching for methods
to reduce costs. Quality can be maintained by such activities as the
communication and continuous review with suppliers of specifications
and materials used for production , and close conformance to delivery
standards. Again, many customers require their suppliers to pass and
maintain specific quality certifications. "World-class" procurement re-
quires both the enterprise and the entire supply channel to follow JIT
tools for the elimination of material and operational wastes and to in-
crease the flexibility of material acquisition and service response, while
reducing inventories and non-value-added functions and staff.
Developing people resources and information tools for productivity
optimization. As the structure of the purchasing organization grows
ever leaner, the need for team-based management styles grows propor-
tionately. The continuous development and training of personnel at all
levels in the purchasing function results in the creation of a profes-
sional staff prepared to shoulder the responsibilities of decentralized
decision making, continuous search for improvement, and the acqui-
sition of the technical knowledge required of "world-class" purchasing.
In addition, the implementation of information systems that automate
clerical functions and provide timely inventory, order, and cost status
can also greatly assist in improving productivity and reducing costs [6].
One purchasing objective that is growing in importance is expanding the
scope of supplier value-added services. The goal of these functions is to re-
duce wastes in ordering and delivery, and facilitating the flow of goods and
information through the supply channel. Three critical flows can be identi-
fied:
Product flow. Accelerating the physical movement of goods from the
supply source to the point of consumption.
Information flow. Reducing redundancy in the transmission of critical
information up and down the channel, such as demand schedules, mar-
ket data, inventory supply levels, warranty and product information,

product specifications and application information, and postsales
support.
Service flow. Increasing value-added services that improve produc-
tivity and eliminate costs such as Internet order placement, advanced
shipping notices, order status tracking, electronic transfer of payables
and receivables, bar coding, packaging, and delivery.
The continuous development of value-added services is one of the most im-
portant objectives of the purchasing function in the 2000s .
DEFINING SUPPLIER RELATIONSHIP MANAGEMENT
The growing power of the customer and the ever-present necessity of continu-
ally reducing procurement costs has recently accentuated the importance of
the role of the supplier and spawned a new subset of supply chain manage-
ment: supp lier relationship management (SRM). Historically, relations with
suppliers have been marked by suspicion and focus on short-term partnership.
While recently the use of sales and operations planning (S&OP) and CFPR
toolsets have been increasing, often the only collaboration shared with sup-
pliers has consisted of RFQs and purchase orders . Similar to customer re-
lationship management (CRM), the growth of the SRM concept is today di-
rectly challenging this lack of cooperation, partnership, and communications.
As pressures for cost effective product and service procurement and channel
flow velocities accelerate, the need for collaborative supplier partnering has
migrated from an option to a strategic requirement for competitive advantage.
Enhanced by Internet technologies, SRM is providing trading partners with
dramatic breakthroughs in cost savings, collaborative product development,
new forms of sourcing, and real-time order management applications that
have generated new categories of strategic and operational supply chain val-
ue. Whatever the formal arrangement, SRM can be described as the creation
of cooperative alliances formed to exponentially expand the capabilities in-
volved in materials requisition, procurement procedures and efficiencies, and
product information exchange.
The increasing importance of synchronized, collaborative supplier relation-
ships is the product of several marketplace dynamics. As is illustrated in
Table 10.1, supplier relationship management has undergone dramatic modi-
fication and is accented by today's requirement for ever-closer working busi-
ness alliances. The overall goal is to transform suppliers from adversaries
into upstream channel partners where they act more like an ann of the pro-
curement organization rather than an outside entity. In such a view SRM is
about structuring win-win relationships, mutual commitment to sharing infor-
mation and resources to achieve common objectives, and engagement in a

long-term strategy for mutual competitive advantage. Finally, SRM often
means deconstructing traditional attitudes and practices concerning quality
and reliability, delivery, price, responsiveness, trust, the sharing of research
and development plans, and financial and business stability.
TABLE 10 .1 Traditional Purchasing vs. SRM
Traditional Approach SRM Partnerships
Adversarial relationships Collaborative partnerships

Many competing suppliers Small core of supply partners
Contracts focused on price Contracts focused on long term
quality, mutual benefits
Proprietary product information Collaborative sharing of information
Evaluation by bid Evaluation by commitmentto
partnership
Supplier excluded from design Real-time communicationof designs
process and specifications
Process improvements intermittent Close computer linkages for design
and unilateral and replenishment planning
Quality defects reside with the Mutual responsibility for total
supplier quality management
Clear boundaries of responsibility "Virtual" organizations
COMPONENTS OF SRM
The mission of today's procurement function is to activate the real-time syn-

chronization of inventory and service requirements with the capabilities of
supply chain partners in order to support customers' demand for customized,
high quality products while pursuing reductions in procurement costs and
sustainable improvements in supply performance. Reaching these objectives
requires the realization of several critical supplier management components
as illustrated in Figure 10.2. The first component can be described as the
SRM value discovery. This process is concerned with the drafting of a state-
ment detailing the value proposition to be gained by the establishment of ef-
fective supplier partnerships. The results of the analysis should consist of im-
mediate economic benefits as well as long-range strategic advantages.
Among the critical benchmarks should be found expected cost savings
through more effective procurement economies, enhanced process efficien-
cies attained through across the board reductions in replenishment cycle

times, inventory optimization achieved through a closer matching of demand
requirements with channel inventory stocks, and increased process optimi-
zation as a result of closer orchestration of collaboration on product design,
increase in visibility to demand requirements, and closer matching of ca-
pacities to total channel demands.
FIGURE 10 .2 SRM Components.
Once the value of a SRM initiative has been defined, strategists can pursue
the next SRM component: implementing a strategic sourcing program. In to-
day's high-velocity environments, the role of supplier management has taken
on additional importance beyond the everyday purchase of goods and services
and is termed strategic sourcing. Traditional sourcing was often focused on
haphazard make-or-buy decisions based on price and expediency. Today,
sourcing must be supportive of the strategic goals of the organization, efforts
to remove cycle time and performance barriers, programs to determine real
costs, and collaborative requirements to integrate design, quality manage-
ment, and immediate and long-term strategic goals. According to Hirsch and
Barbalho [7], strategic sourcing is a comprehensive supply management pro-
cess that involves
identifying the business requirements that cause you to purchase a good or ser-
vice in the first place, conducting market analysis to determine typical cost for
goods/services within a particular supply system, determining the universe of
suppliers that best meet your requirements, determining an overall strategy to
procure items in that category, and then selecting the strategic supplier(s).
Depending on the category or type of purchasing to be sourced, other factors,

such as the depth of supplier competencies, availability of required services,
level of desired product quality, capacity for innovative thinking, and wil-
lingness to collaborate , can also be considered key strategic components.
Pursuing strategic sourcing requires the development of cross-channel pro-
curement teams consisting of business and financial management, product
and process designers, marketing experts, and purchasing personnel respon-
sible for establishing procurement strategies as well as outsourcing decision
making. The activities of strategic sourcing are composed of several critical
steps. The first task is to determine the correct level or unit of analysis. This
means focusing the sourcing effort not on individual components in isolation
but rather on the systems, assemblies, and subassemblies located at the top of
product structures. The goal is to determine the competitive value of com-
ponent(s). Once classification of components into strategic and non-strategic
has been completed, the second task is to devise outsourcing programs to buy
the non-strategic components . Perhaps the most critical step will involve sup-
plier selection and the desired level of collaborative technical and commercial
cooperation. The third task involves attention to details regarding cost, com-
munication of documentation and specifications, creating the outsourcing
budget, performance expectations, communication of requirements, and logis-
tics functions. Finally the last task involves the establishment of processes
and benchmarks for continuous improvement in areas such as cost reduction,
delivery, and product quality.
The scope and depth of SRM initiatives are directly dependent on the third
component: the application of integrative technologies . Throughout history,
the ability of procurement functions to interact with suppliers has been di-
rectly driven by technology tools. The first major technology was the tele-
phone. This device made it possible forpurchasing to transcend the limits to
time and space imposed by the cumbersome processes of person-to-person
contact and mail correspondence . The arrival of the fax machine signifi-
cantly accelerated the possibilities of communications. The use of the fax
permitted the quick and easy performance of processes such as negotiating
contracts, sending specifications and orders, and verifying delivery status.
Electronic data interchange (EDI) further enabled trading partners to inter-
face internal planning systems so that demand, order and shipment transmis-
sion, and electronic bill payment could be performed in a paperless environ-
ment. Today, with the application of the Internet to SRM, purchasers have
been able to leverage new forms of procurement functions, such as on-line
catalogs, interactive auction sites, radically new opportunities for sourcing
and supplier management, and Web-based toolsets that provide for the real-
time, simultaneous synchronization of demand and supply from anywhere,
anytime in the supply chain network.
The application of e-business to the evolving SRM concept can be said to

have spawned a new form of procurement management: e-SRM. While still
in its infancy, business -to-business (B2B) purchasing transactions continue to
grow and are offering firms sustainable and meaningful procurement im-
provement opportunities from shorter sourcing and negotiation cycles, to re-
duced costs in ordering and more effective ways to ensure quality and de-
livery. As will be discussed later in this chapter, the concept of e-SRM has
come to coalesce around two Internet-driven functions: e-procurement, the
utilization of Web-toolsets to automate the activities association with pur-
chase order generation, order management, and procurement statistics, and e-
sourcing, the utilization of the Web to develop long-term supplier relation-
ships that will assist in the growth of collaborative approaches to joint prod-
uct development, negotiation, contract management, and CPFR. e-SRM can
truly be said to have enabled a whole new dimension to supplier management
by providing a radically new communication architecture for structuring sup-
ply chain relationships focused on facilitating the mechanisms oftoday's dy-
namic value-chains [8].
While e-business has generally been General communications 880/<1

perceived as part of the dot-com Product catalogues 53% 1
mania, there can be little doubt that
RFQs/RFPs 51% I
today's savvy businesses see it as
critical to their SRM strategies. Order status 38% 1
According to a 2003 survey from the Help/tech support 26%1
National Association of Manufac- Despite the reported increased use
turers and Ernst & Young LLP, the of e-business, companies remain
use of e-commerce by American pessimistic about expected returns.
manufacturers is on the rise. Nearly Today's difficult economic environ-
25 percent of about 500 manufac- ment has made cost and productivity
turers surveyed say they are selling the number one priority, rendering
six percent or more of their goods e-business investment of low priori-
via the Internet, a four-fold increase ty. Once times change, a renewed
over the previous year. The survey interest in the benefits of e-corn-
broke e-business use down into the merce are sure to follow.
following categories:
Source : Editors, "Recession, What
Recession"," Supply Chain Tech-
nology Neil'S, March. 2003, p. I.
The fourth and final component is architecting SRM driven infrastructures

and operations. Effective supplier management in the twenty-first century re-
quires the establishment of agile procurement functions capable of being ra-

pidly deconstructed and rebuilt to match changing customer requirements and
cost and continuous improvement imperatives. Requirements for ever more
flexible procurement environments capable of quickly integrating with com-
plimentary supplier organizations, technologies, and processes are essential if
customer performance is to be optimized up and down the supply channel.
One of the most critical impacts on the purchasing organization caused by
accelerating cost and competitive pressures has been the increased use of out-
sourcing. Companies have long turned to supply chain partners to leverage
their core competencies to perform work more economically, provide more
technical expertise , free internal resources, and reduce overhead costs. Tack-
ling these expanding responsibilities requires the procurement organization to
expand significantly their strategies, operations , and supplier relationships .
Effective outsourcing requires a variety of decisions.
Cost management. In this area, purchasers must thoroughly understand
their own internal cost structures before outsourcing products and ser-
vices. This means determining both the trade-off value of making the
product in house versus outsourced and the impact on the internal as-
sets that will go unused in an outsourcing effort.
Risk factor management. The use of supply partners requires that trust
and risk sharing must be factored into the outsourcing strategy. As the
cost of operations and innovation expand, partnership agreements that
provide for the equal sharing of risk grow in importance.
Supplier selection. The choice of an outsourcing partner requires due
diligence in the review of available quantitative and qualitative perfor-
mance factors. The goal is to devise a detailed supplier scorecard that
enables tracking of historic al performance indicators. With such per-
formance factors, procurement professionals and suppliers can col-
laboratively evaluate which processes can be effectively outsourced
and to which suppliers, which are to remain in-house, and how to
initiate corrective action and enhance overall performance. This step
should conclude with the outsourcing contract.
Performance expectations. Once the scope of outsourcing contract is
completed, a clear statement of expected performance expectations and
measurements needs to be drafted . These measurements should focus
on such things as expected cost reduction percentages , quality, and de-
livery performance.
Finally, procurement organizations must be able to operate in today's
emerging Internet-enabled supply chain environment. Purchasing profession-
als must learn how to integrate radically new procurement technologies such
as private trading exchanges (PTXs) and consortiums into their procurement
strategies. In addition, they have to learn how to work with new external
trading entities. For example, procurement functions have had to expand in-
ternal processes to accommodate working with third party organizations that
run e-marketplaces. Instead of directly providing goods and services, these e-
marketplaces act as brokers connecting buyers with multiple suppliers and
take responsibility for functions such as payment, credit, and delivery.
ANATOMY OF PURCHASING STRATEGY
In recent years, the need to develop an effective enterprise procurement strat-

egy has arisen in recognition of the impact purchasing has on competitive po-
sitioning. Companies that do not develop a comprehensive purchasing strate-
gy risk interruption in the stream of supply due to poorly executed product
and supplier planning and sourcing, misunderstood environmental or regula-
tory constraints, and uncertainty in price and delivery. The exact content of a
purchasing strategy can take many forms. From the outset, however, it can be
said that the best purchasing strategy is not necessarily the one that promises
to optimize efficiency or least total cost but the one that supports the compet-
itive objectives of the supply chain. Factors influencing purchasing strategy
development are sophistication of the corporate planning process, degree of
dependence of the enterprise on purchased products and services, top man-
agement's perception of the purchasing function, the availability of tech-
nology enablers, and state of the evolution of the purchasing function from
being tactically based to being strategically based. A possible model to
guide overall purchasing strategic development is illustrated in Figure 10.3.
STEP 1: ENVIRONMENTAL SCANNING
Once the corporate strategy has been defined, purchasing management must
align it with actual purchasing capabilities and functional objectives. The
first step in the process is to match the strategy with the dynamics found in
the internal company and the external marketplace environments. Internal
factors include such elements as the stage of enterprise technological devel-
opment and the nature of corporate culture and values, perception of supplier
partnering, outsourcing initiatives, and purchasing organizational structure.
External factors include mapping international sources of supply, techno-
logical communications capabilities, political and social issues, and govern-
ment and environmental regulations. The objective of this step is to provide
purchasing management with a complete understanding of how they are to
support the business's and, by extension, the supply chain's competitive
strategy.
Business Strategy
Step 1
Internal Environment External Environment
Step 2
Step 3 Inventory Strategy
Step 4 Supplier Relations
Step 5 Technology Enablers

Step 6
Performance
FIGURE 10.3 Purchasing strategy
STEP 2: ORGANIZATIONAL STRUCTURE
The second step in the strategic purchasing model involves identifying the ca-
pabilities of the purchasing organization to meet strategic objectives. Several
dimensions are present. To begin with, purchasers must review the organi-
zational structure. This step will detail the degree to which purchasing is
centralized, the geography of the organizational matrix in which task re-
sponsibility is assigned and actions are performed, how authority is delega-
ted, the level of strategic influence purchasing has in the business, and the
structure of communication flows both within the purchasing organization
and between purchasing and other business functions. In addition, employee
capabilities. determining the qualification of purchasing professionals to ex-
ecute the purchasing strategy, should also be apparent. Current purchasing
pra ctices should also be identified. This dimension will detail such work ele-
ments as the sophistication of existing purchasing control tools used in order
management, capability to perform strategic sourcing, use of technology tools
such as e-business and EDI, use of P-cards and supplier contracts, and use of
statistics to record and analyze supplier performance.
STEP 3: INVENTORY STRATEGY
Once the organization dynamics have been defined, strategists can move to
step three : the purchasing inventory strategy. Perhaps the first action will be
to conduct a spend analysis. The purpose of this activity is to conduct a thor-
ough analysis of all goods and services purchased across the enterprise in an
effort to determine the actual spend levels and the degree of supplier frag-
mentation. The analysis should document how much is being spent on indi-
vidual products as well as product families. Finally, the analysis should iden-
tify how much is being purchased, by category, of goods and type of service
from each supplier. The objective of the spend analysis is to unearth answers
to questions such as what is being purchased, from whom, from where, and
from what location .
A critical part of the purchasing strategy is mapping the make/buy decision.
This area relates to decisions regarding how extensive is the backward verti-
cal integration strategy. What is to be purchased and what made in house is
influenced by a number of factors such as delivery cycle time, current sup-
plier performance, cost advantages, process/technical capabilities, patents and
trade secrets, existing supplier contracts, and supplier manufacturing superi-
ority. Conditions impacting makelbuy decisions can be detailed as such:
Degree ofoperational change . If the firm decides to produce in-house,
does it currently possess the equipment, personnel, and process-sing
experience, so that only a small capital outlay for equipment and
personnel is necessary? Would, on the other hand, a decision to prod-
uce the product line require the expenditure of significant capital to ac-
quire the equipment, facilities, and know-how?
Cost. The following cost elements must be thoroughly investigated.
1. Cost of purchasing component parts versus buying the finished
products.
2. Receiving and inspection costs.
3. Direct labor required to handle components and to perform manu-
facturing processing.
4. Cost of purchasing production equipment.
5. Size of incremental increases in warehouse overhead, managerial,
inventory carrying, purchasing, and capital costs.
Produ ction processing control. There are several key elements as-
sociated with this factor. What technologies will be required to plan
for component requirements? How is order release and WIP mainten-
ance to be performed? What is to be the level of management control
over operations, and does that expertise exist within the firm or must it
be acquired from the outside?
Quality. How is quality to be measured during and after production

processing? What tools should be used and does the firm currently
have such expertise?
Risk managem ent. This is a strategic factor that must be resolved by
management. Typically risk is low when the enterprise currently pos-
sesses the expertise and facilities necessary to produce the desired
goods, and conversely high when the firm is venturing out into new
managerial, organizational, and operational environments.
Another issue relating to procurement inventory strategy is ranking ma-
terials and services to be acquired by their importance to the organization.
This principle recognizes that purchasing is not subject to a one-size-fits all
approach when it comes to procurement strategies, tactics, use of tech-
nologies, and application of resources. Purchasers actually need to develop a
strategy centered on two critical factors. The first, value, relates to the level
of importance the product/service has in ultimately servicing the customer.
The greater the value, the more detailed the procurement strategy and the
closer the control of the product/service. The other factor, risk, relates to the
potential damage to competitive positioning caused by product stockout or
quality failure. Simply put, as a product/service grows in importance in satis-
fying a customer, purchasers must exercise greater control to ensure avail-
ability and reliability. As illustrated in Figure lOA, an effective way to en-
sure high value and low risk is to divide purchased products into the fol-
lowing four distinct quadrants [9]:
Distinctives Criticals
High r isk IIiHighgh valr iskue

Low va lue niqu e item s
CDifficult to attain Cri tica l to final
ope ra tions
r itica l for
pro d uct
Risk
Generics Commodities
Low risk
Low va lue
Low r isk
Produvactilueon ite m
High
m.o
o n-p ro d uction ot uniqu e
products 1
olu me purchasin g
Value
FIGURE 10.4 Item purcha sing classification matrix
Generics. Purchased items in this quadrant are characterized as of low

strategic value and low cost to the organization. Maintenance, repair,
and operation (MRO) products can be placed in this area. For the most
part, products necessary for sales or production are never found in this
quadrant. Administratively, the goal is to pursue very low cost meth-
ods of sourcing and ordering these items. Recently, the application of
e-trading exchanges has been applied to this area to take advantage of
low cost procurement, auctions, and even barter.
Commodities. Products in this quadrant can be classified as possessing
low acquisition cost, but are often important to production and sales.
Because commodities are usually generic and can be acquired from a
wide variety of sources, they pose a low risk to organization strategies.
These products are also increasingly being sourced through the Internet
to attain low cost while ensuring timely delivery. Fasteners, packaging
material, paints and lubricants, and transportation services that add
direct value to finished goods are examples of commodities.
Distinctives. Products in this quadrant are normally of high risk to
competitive strategy, but are low in the value they provide to finished
goods. While these products are not outwardly of critical importance in
the form, fit, or function of the end item, they may be difficult to
source, are subject to long lead times, or are low cost substitutes for
very expensive components. Stockout of these items can stop produc-
tion and require time-consuming rescheduling of the manufacturing
floor. Sourcing and ordering distinctives are under the watchful eyes of
buyers and planners and normally maintained by MRP planning.
Criticals. In this quadrant can be found products that are of high risk
and high value. When used in manufacturing, these components often
provide competitive distinctiveness to the finished product and can not
be easily substituted for or omitted from the final product configure-
ation. Buyers and planners are very involved in the management of
these often unique purchased components, where such values as build
to exact specification, value analysis, high quality, cost management,
collaborative design, and the building of very close supplier partner-
ships is absolutely critical.
STEP 4: SUPPLIER RELATIONS
Alongside the formalization of the inventory strategy, supply chain planners

must be engaged in developing meaningful supplier partnerships. The goal of
collaborative SRM is to architect systems that enable the operations of supply
chain partners to be so closely merged that they appear as a single, seamless
supply engine. Instead of a relationship based solely on buyer-customer ser-
vice rep interaction, SRM collaboration requires a broadening of customer-
supplier relationships where, for instance, customers ' planners work directly
with suppliers ' planners to optimize product flows; supplier quality depart-
ments can also work closely with customers' design teams to improve product
and process quality . Achieving such a relationship requires procurement
managers to work closely with suppliers in cultivating partnerships that foster
the pursuit of common goals and reside on trust and mutual advantage.
Supplier partnership programs normally consist of several critical compon-
ents. To begin with , businesses must work with the supplier to identify
shared goals for tactical purchase order and receiving performance as well as
strategic issues such as linkage of supplier manufacturing processes and pur-
chasing requirements, identification of out-of-bounds situations, development
of continuous improvement programs, and the application of technology.
Once common ground has been documented, purchasers must achieve some
level of control over their supplier relationships. For the most part, this con-
trol can be lumped under the general category of quality management. This
category can consist of transaction performance issues such as on-time re-
ceipt, quantity completeness, and quality inspection. Another area may invol-
ve product and transportation cost control.
Once the basic ground rules for over all objectives and detailed operations
processing have been defined, suppliers can use other devices to communi-
cate purchasing expectations and enhance supplier partnerships. The use of
evaluation and certification programs, for instance, enables companies to en-
force the creation of product quality databases and assurance methods that
provide documentation of quality levels. Another tool is the use of supplier
rating systems based on actual supplier performance. Activities in this area
center on evaluating and ranking suppliers by different award levels based on
detailed criteria relating to on-going quality and delivery performance. Any
problems must be formally stated and must include a follow-up process to
document corrective action taken by the supplier. Finally, suppliers must
agree to submit their quality management systems to customer audit. The
goal of the audit is to verify supplier conformance of productive process and
output to meet the specifications and delivery needs of the purchaser. The
output of the audit is a certification that processes are conforming to docu-
mented standards while permitting the purchasing audit team to recommend
and oversee the necessary adjustments to guarantee future compliance. Audit
standards such as IS09000 or the Malcolm Baldridge Quality Award can be
used as models for the audit [10].
Actualizing an effective supplier management program requires multiple
levels of collaborative communication : business review meetings, supplier
collaboration, and supplier scheduling [11].
The goal of business review meetings is to integrate the long-range
business plans and supply chain requirements of customer and supplier.
Topics of discussion are concerned with functions such as supply pro-

cess optimization, handling of new product introduction, short- and
mid-term demand and capacity planning, flow of materials and infor-
mation, expected standards of quality and delivery, inventory levels,
and cash flow between partners. Discussion results should enable the
building of strategic consensus and joint ownership of channel pro-
cesses and flows.
Supplier collaboration meetings are mid-range planning events that
should occur at least monthly. In these meeting, demand planners and
buyers should work directly with supplier counterparts to address is-
sues such as production levels, required resources, capability-to-pro-
mise, inventory levels, obsolescence, concurrent quality/engineering
projects, and the capabilities of the existing supply chain. In addition,
the meetings should review methods to improve supply chain capabili-
ties relating to ongoing performance metrics, special projects, plant up-
grades/shutdowns, and future product/service projects.
On-going, detailed supplier scheduling involves the every-day inter-
action between buyers, planners, and service reps. The goal of this pro-
cess is to communicate actual requirements and capacities to guide the
sequencing of production and product delivery. The level of interoper-
ability of channel ERP and supply chain management systems can be of
dramatic importance in sharing of up-to-the-minute statuses of priori-
ties, production, and process issues and the confirmation of actual order
release and delivery and quality schedules.
A partnership communications structure that includes all three of the above
levels ensures that all purchasers and suppliers achieve the necessary flow of
information. Together, purchasers and suppliers can determine the partici-
pants, frequency, the data to be shared, and the output formats to be used at
each level. Once these structures are in place, the proper technologies that
will enable and enhance the process should be undertaken.
STEP 5: TECHNOLOGY ENABLERS
Over the past several decades purchasers have turned to information tech-
nology tools to assist in the development and realization of their procurement
strategies. Tools like the telephone, Fax, EDI, linkages between ERP sys-
tems, and recently, the Internet, have all been applied to bridge gaps in buyer-
supplier relationships . Essentially, technologies have historically been ap-
plied to solve several critical procurement requirements. The first, supplier
search, is concerned with how easily and effectively buyers can locate the
best suppliers. Critical dynamics here refer to the ease and comprehensive-
ness of supplier and product/service search, availability of procurement infor-

mation and documentation, quality assurance, and capability to buy at com-
petitive prices. The second, order management access, refers to how easily
buyers can gain access to order management functions to acquire the goods
and services they want or need. The third requirement, service management
availability, refers to how buyers can ensure they are receiving or have access
to necessary support capabilities such as communications, help line, docu-
mentation, and training. Finally, proper technologies must be deployed that
support strategic purchasing functions such as outsourcing, services acqui-
sition, and collaborative management.
. . .
The decision to deploy c-procure- auctions excess inventory and pur-
mcnt technologies oftcn starts with a chases some production components
desire to reduce indirect materials on the spot market.
purchase cost, but then quickly
spreads to production inventories. HI' plans to expand its strategy for
the usc of e-procurement tools
Keycha in, Hewlett-Packard's private across all its ope rations, including
c-procurcmcnt exchange went live those that have been acquired
in August 2000. In the first year of through its merger with Compaq.
operations HI' achieved avings of HI' management feels that they have
$33 million by aggregating internal received a great deal of value from
materials purchases companywide their e-procurcmcnt strategy and
and reducing by 30% the time they plan to usc further Internet-
employees spent in order manage- driven procurement tools 10 make
ment. Those savings alone more HI' as efficient a possible in the
than paid for the acquisition and future.
implementation cost of the software
solution. Source: Konicki. Steve, "Procure-
ment Power: Companies Slash
IIP also invested in the converge Order Times and Costs with Online
Global Trading Exchange. an indu- lnitiatives." lnformation Week.
stry exchange through which it August 5.2002.1'.48.
The goal of SRM technologies is simple: how to gain connectivity to sup-

pliers. In the past this objective was achieved by deploying manual or per-
son-to-person communication. Recently companies have attempted to use
computerized tools like EDI to transmit critical procurement data. Today,
purchasing functions are deploying Internet-based applications. The most
basic form is the use of a self-service supplier portal where the supplier pro-
vides access to buyers to information it wants to share. More sophisticated

connectivity can be achieved with a form of private trading network or even
direct links to the buyer. These connectivity technologies are available in a
wide spectrum of options to support a range of supplier technology capabili-
ties. Once connected, suppliers must be able to offer several electronic en-
ablers for such activities as Request for Information and RFQ, order entry and
self-service management, planning functions. These application toolsets per-
mit review of supplier capability-to-promise, channel inventory positions,
manufacturing schedules, and availability of real-time analytics and perfor-
mance scoreboards that empower planners to make rapid decisions on bids,
spot sourcing, and pricing and view performance statistics regarding contract
compliance and quality targets.
The SRM technology strategy should be formulated to support internal
buyer value producing processes and designed to assist procurement man-
agers consolidate and leverage their purchasing power. Exactly which and
how sophisticated the level of technology deployed is directly dependent on
how closely it is aligned with the over-all company strategy. Failure to im-
plement the proper toolsets will result in a visibility and control gap and will
cause the procurement function to fail to extract full value from their existing
supplier contracts and explore the depth of the supplier relationship . A com-
prehensive analysis of today's Internet-based procurement environment ap-
pears at the end of this chapter.
STEP 6: PERFORMANCE AND CONTINUOUS IMPROVEMENT
The final phase in the development of a comprehensive purchasing strategy is

establishing procurement performance standards and engineering an environ-
ment dedicated to continuous improvement. Fundamental to this phase is fo-
cusing the purchasing organization's attention on cultivating a "winning"
attitude. This can be accomplished by, first, communicating the value of con-
tinuous improvement initiatives and stimulating individual and team contri-
bution. Clear performance benchmarks must be accompanied by a review
mechanism designed to track progress and ensure that recognition is given for
achieved performance. Next, purchasing management must be able to sustain
enthusiasm by engineering new operational definitions as circum-stances
change. To respond to new challenges, the organization must be pro-vided
with necessary skills such as training in statistical quality techniques, prob-
lemsolving, value analysis, and team building. Finally, a dedication to con-
tinuous improvement means being able to effectively and consistently guide
resource allocation to respond to new business opportunities and challenges.
Quality
Productive
Tcchnology
1m provernent
oD 1_ _Velocity ------<----_>
FIGURE 10.5 Purchasing's strategic goals.
The goal of the whole purchasing strategy development process is to assist

the enterprise pursue and sustain competitive advantage. As illustrated in
Figure 10.5, this objective can be realized by the following:
1. Purchasing and producing defect free products and materials: Quality
2. Managing the inherent risks in the external material environment:
Risk Management
3. Reducing product, process, and channel costs: Productive Improve-
ment
4. Achieving and maintaining technological superiority: Technology
5. Exploiting time to competitive advantage: Velocity
An effective purchasing strategy aligns the goals and objectives of the pur-
chasing function with the firm's overall competitive strategy. By imple-
menting value-added philosophies that seek to remove redundancies and acti-
vate core capabilities, a comprehensive purchasing strategy can make a direct
contribution to the marketplace effectiveness of the firm.
PURCHASE ORDER MANAGEMENT PROCESS
Once the purchasing strategy has been defined, purchasing functions must fo-
cus on tactical execution. For tlie most, part the purchase order manage-
ment process is composed of a series of activities that begin with the identi-
fication of a replenishment requirement and end with receiving, put-away,
and purchase order closeout. In planning and controlling the purchase order
process, the purchasing must determine answers to such questions as follows:
Are the vendor master records accurate and up to date?
Have the appropriate purchase order requisitions and requests for quo-
tation been properly completed?
Have the best suppliers been selected and contacted in preparation for
purchase order release?
Are the quoted prices acceptable?
What will be the cost of freight and other miscellaneous charges?

Have open purchase order due dates been properly maintained?
What are the policies governing rejects, returns, and backorders?
How are supplier performance measurements to be determined?
Answering these and other questions is the purpose of the purchase order
management process illustrated in Figure 10.6.
r
l
Replenishment Plan ]
... Dat a
Maintenance
... Ord er
Processing
Cy cle
... Rep ortin g ~
Perfo rm an ce
Meas ure ment
!
Order C lose
1
FIGURE 10.6 Purchase order management process .
ASSURING DATABASE ACCURACY
The purchase order management process begins with the maintenance of

database elements necessary for effective and accurate purchase order release
and control. There are several key files that must be continuously main-
tained. The first is the item master file. This file not only contains a list of
the valid items in the stockable inventory, it is also where key planning ele-
ments such as supplier lead times, buyer codes, inventory planning codes, de-
fault suppliers, and costs are stored. Another key file is the supplier master
record. This file provides purchasing with essential supplier data such as the
supplier's name, ship-from and remittance addresses, contact personnel,
phone number, credit information, and payment terms codes. In addition, this
file also contains informational data such as ship-via codes, SIC codes, com-
modity codes, default buyers, default order types, and others.
Another important master file is the price master. In this file is kept the
current supplier prices for products, price breaks and discounting, promo-
tions, price effectivities, and price histories. The establishment of the base
purchase price is often a dynamic and can be achieved through a variety of

methods . The price may have been attained through a commodity market
price, competitive bid, a cost-plus contract, a specified percentage of the cost,
from a published price list, or a negotiated price. Each of these prices stems
from particular conditions and is used to purchase specific goods and ser-
vices. For example, commodity prices, applied to materials such as paper,
grains, oil, and natural products like wood and minerals, are determined by
market forces of global demand and supply. In contrast, prices stated in sup-
pliers' catalogs are normally standardized for a set period of time, but may be
subject to discounting . RFQs are often used to stimulate competitive bidding
by possible suppliers. Negotiated prices are used to establish a purchasing
contract , whereby the buyer agrees to purchase a defined quantity of product
over a specific time period as well as render any necessary assistance while
the supplier agrees to freeze the price and guarantee pre-determined quality
specifications and delivery targets as their part of the contract.
While one of the cardinal objectives of procurement is the purchase of
goods and services at the lowest competitive price, the decision to select a
supplier will often result in additional cost elements that will impact the total
price . Among the elements of price that must be considered are the following
[12]:
Base pri ce. This price is the base charged by the supplier for the acqui-
sition of products and services. Whether from a catalog, a bid, or a ne-
gotiation, this price serves as the base line on top of which are applied
other possible costs to the buyer.
Direct transaction costs. These costs are incurred with the perfor-
mance of such activities as inventory review, requisitioning , purchase
order entry and transmission, shipping documentation, order mon-
itoring and tracing, receiving and put-away, order close-out, and AP in-
voicing and payment. The use of electronic functions, such as EDI and
the Internet, can dramatically reduce costs in this area.
Supplier partn ership costs. Creating and nurturing supplier relation-
ships require a certain amount of cost. Supplier relationship programs
normally involve activities such as supplier visits, education and
training, and technology linkages facilitating procurement planning,
transportation, engineering and product development, and supplier cer-
tification . Sometimes buyers will assist suppliers in the acquisition of
specialized production or communications assets.
Transportation costs. The cost of transporting goods from supplier to
buyer must be added to the overall cost of the product. Costs incurred
for specialized value-added processing, packaging, and safety are in-
cluded in this category . While there a multitude of options, such as pri-
vate carrier, supplier-selected carrier, or buyer-selected carrier, the

choice of transportation should seek to minimize direct and indirect
costs while satisfying pre-determined levels of service.
Cost of quality. In today's business environment it is expected that
products and services will possess 100% quality. Very high levels of
conformance to specification might require some quality expense, but
this should be off-set in declines in product scrap and rejects.
Operations costs. In this final category of total purchase cost are
grouped expenses incurred for operational activities such as receiving,
sorting or grading, packaging, inspection, product staging, and product
put-away. Lot-sizing costs may also drive-up expenses for space re-
quirements, handling, and cash flow requirements.
In managing these costs companies normally employ two methods of alloc-
ating/absorbing these additional sources of total cost. One method is to accu-
mulate the total costs for each of these areas each financial posting period and
then post them to the general ledger as a mass entry. A more sophisticated
method is to employ ABC costing methods that "drive" the actual costs at the
exact time the product is individually transacted.
In addition to these static database files can be found variable database
files such as the open requisition, the open purchase order, and purchasing
history. In the requisition file can be found those company requirements for
resupply that have not as yet been reviewed and generated into purchase or-
ders. The open purchase order file contains a record of each released but not
yet received purchase order. Each purchase order consists of two separate
but related sections . The first section contains the order header where such
data values as the purchase order number, order status, supplier information,
and costs are maintained. The second section contains the line item detail
and consists of such data values as the purchased item number(s), item de-
scriptions, unit of measure, quantity, price, date required, and receiving infor-
mation. The final purchasing file, purchase history, contains the receiving in-
formation for closed purchase orders.
THE PURCHASE ORDER PROCESSING CYCLE
The second step in the purchase order management process [Fig. 10.6] is ex-
ecuting the order processing cycle. Essentially, there are five distinct com-
ponents required for successful purchase order processing. These segments
can be respectively described as order preparation, order entry, transporta-
tion, receiving, and order closeout. The purchase order processing cycle is il-
lustrated in Figure 10.7. This cycle can be complicated and requires consid-
erable inventory management, supplier research, and negotiating skills. Two
types of purchasing must be planned for during this stage. The first focuses
on the acquisition of general maintenance, repair, and operating (MRO) in-
ventories. Requirements for MRO products arise out of the everyday use of
supporting products and services. In most organizations, the purchase order
process commences with the completion by the requestor of a manual or com-
puterized requisition order. Once received by purchasing, requisitions must
pass through several processes, beginning with supplier sourcing, negotiation,
pricing, and authorization, and concluding with purchase order generation.
Planning M RP/ROP/DRP MRO

Requireme nts Requircments
-------~-- --------------~-- - ---- ------------------

Planned Order S upp lier
Requisition ing 1---+
.
Managemcnt So urcing
+
Execution PO
Authorization
.-
Release
PO
Monitoring
-------~-------- --- --------------------------------

Transpo rtation
Trans-
Decision
portation
----- -- ~------------ ---------- ---------------------
PO
Receiving
Receipt
-------~--------------------------------- -- -- - -----
Order Order
Closeout C loseout
FIGURE 10.7 Purchase order flow.
An important part of the requisition process is the task of selecting the best
supplier from among the pool available to the finn. In some environments,
this process is very complex, requiring a needs assessment, searching for sup-
pliers, negotiating price and usage criteria, developing contracts, buying,
evaluating, and other activities. In other organizations, many of these steps
have already been resolved because of long-standing customer-supplier part-
nerships or single-sourcing purchasing contracts. In evaluating suppliers,

purchasers will often use variables such as lead time, past record of on-time
delivery, ability to expedite, convenience in ordering/communication, quality,
technical and training services available, range of presales and postsales val-
ue-added services, competitiveness of price reputation and past experience
with the supplier, and availability of technology tools such as EDI and Web-
based ordering.
Successful purchasing in the twenty-first century mandates that customers
and suppliers think of themselves as business partners. As the requirements
for e-business, globalization, collaborative product development, and out-
sourcing accelerate, partnering is now no longer an optional but rather a man-
datory strategy. Like any partnership, the relationship between buyer and sel-
ler must be open and honest; there must be commitment to using available re-
sources to achieve common objectives; there must be an equal share in the
risks and the rewards; and it must be a long-term proposition meant to weath-
er the bad as well as the good times. Finally, SRM means redefining the
usual ways channel partners think about product quality and reliability, deliv-
ery, price, responsiveness, lead time, location, technical capabilities, research
and development investment plans, and financial and business stability.
Practically speaking, SRM involves a conscious effort on the part of both
purchaser and supplier that begins first with the establishment of a consistent
flow of internal communications and progresses to the use of techniques that
promote closer external communications and new opportunities for competi-
tive advantage. The process begins on the buyer's part by implementing a for-
mal inventory planning system that aligns business, marketing, and sales
needs with the firm's capabilities . Following, a working interface between
the scheduling system and the purchasing function must be established. Once
these steps have been completed, buyers can begin the task of reducing the
supplier base to essential partners. A smaller supplier base will shrink com-
munications and facilitate performance measurement and alignment with en-
terprise goals. Once these internal tasks have been completed, purchasers
will have the opportunity to institute supplier scheduling and capacity plan-
ning mechanisms. These techniques will increase the velocity of require-
ments transmission between buyer and supplier, as well as ensure supplier ca-
pacity to respond to these needs. Finally, these activities provide the grounds
for the establishment of a continuous search for new techniques, such as sup-
plier certification, Internet trade, and collaborative participation in product
design that will enhance the partnership.
Once the supplier has been selected, the next activity involves negotiating
the terms of purchase. Often the word "negotiate" is associated with "price
chiseling" and haggling and is seen as an adversarial affair where one side
wins and the other loses. In reality, purchasing negotiation should be a pro-
cess of planning, reviewing, and analyzing in which buyer and seller reach
acceptable and mutually beneficial agreement. Although the art and strategy
of negotiating is a science in itself, Dobler et al [13] have broken negotiating
down into five common objectives:
1. Obtaining an equitable and reasonable price for the quantity and quality
of the goods required
2. Ensuring that the supplier fulfills the terms of the purchase contract
3. Exerting some level of control over the manner in which the contract is
performed
4. Persuading the supplier to give maximum cooperation to the buyer's
company
5. Developing a continuous and mutually beneficial partnership with the
supplier base
The result of the negotiating process is the creation of a contract to buy.
Basically, a purchasing contract should not only detail what is to be pur-
chased but should also include the nature of the relationship between buyer
and seller, product/service quality, delivery timing, and current and future
pncmg.
Developing the plan for the purchase of production components and raw
materials and finished goods follows a different route than MRO procure-
ment. For the most part, the process begins with the identification of those
items to be resupplied based on data arising from the inventory planning sys-
tem. As detailed in Chapters 7 and 8, replenishment requirements are nor-
mally identified by the firm's MRP, statistical inventory planning, and/or
DRP systems. For the most part, issues relating to sourcing and pricing have
already been determined, leaving the focus on selecting the necessary items,
quantities, and required dates. Generally, buyers can utilize two possible
methods in developing the procurement plan: buying to requirements or for-
ward buying. The first method seeks to purchase materials based strictly on
the detailed schedule of requirements. Forward buying, on the other hand,
uses the requirements as a starting point and then seeks to volume purchase
based on speculation as to the state of future marketplace pricing and product
availability.
Another distinctive feature of this type of buying is that it is normally con-
ducted by the purchase planners rather than the buyers. It is the responsibility
of the inventory planners to review the planning system exception messaging,
develop the purchasing schedule, firm the order with the supplier, and author-
ize delivery. Once orders have been released, the planner is responsible for
maintaining the accuracy of system planning and open order data. If demand
changes, the planning system will alert the planner to contact the supplier and
alter quantities and due dates to keep priorities in balance. The buyer's role,
on the other hand, shifts from a concern with paperwork and expediting to
activating a range of value-add functions supportive of the supplier relation-

ship. The buyer must assure the timely supply of quality goods and services
achieved through close supplier selection, negotiation, pricing agreements,
value analysis, quality improvement, and alternate sourcing [Table 10.2].
The mechanics of the whole operation are determined by the requirements
output from the planning systems supported by the supplier agreement
fleshed out in advance by the buyer and the supplier's sales force.
TABLE 10.2 Buyer - Planner Roles

Buyer's Role Planner's Role
Negotiates supplier agreements Reviews planning system output

Executes changes to supplier Acts of system exception reporting
agreements messages
Explores alternative sourcing Communicates requirements schedule
Performs value analysis Manages inventory investment
Negotiates quality agreements Analyzes excess and obsolete
Develops long-term partnerships inventory
Performs supplier selection Reviews receiving quality rejects
Negotiates lead time reduction Plans new product introductions
Involved on an exception basis Reduces order and transportation costs
with day-to-day buying Executes day-to-day buying
Both
Organized by commodity/supplier Administration duties
Problem solving Forecasts and plans inventories
Integrates supplier into the Reports problem issues
business
PURCHASE ORDER ENTRY
Once order preparation activities have been completed, the purchasing flow
can move to purchase order entry. There are a number of different forms the
purchase order can take, depending on the nature of the goods and how they
are to be transferred . The most common form is the discrete purchase order.
This type of order is a one-time contract whereby the supplier promises to de-
liver specific products or services at a specified quantity, date, and price.
Discrete purchase orders are best used for limited MRO needs, special prod-
ucts or components with a specific quantity, and projects of limited duration.
They are not appropriate for the purchase of high-volume, high-usage prod-
ucts, service contracts , or capital equipment. Another form of purchase order
is the blanket order. This type of purchase order contains a fixed quantity of
units for specific items or total dollars that extends over a period of time.
When the quantity or dollar amount specified on the order is reached, the or-
der expires. Blanket orders are best used when the quantity required and de-
livery timing is known by the customer. They can assist buyers attain price
break quantity discounts, while ensuring delivery that matches the firm's pro-
jected inventory requirements .
A third type of purchase order is the requirements contract. In this type of
purchase order, the buyer commits to the supplier to purchase a fixed percent-
age of the company's requirements in exchange for quality, price, avail-
ability, and delivery considerations. Instead of a discrete quantity, the buyer
normally will furnish the supplier a short-range rolling forecast of require-
ments, as well as authorizing the supplier to buy and build inventory for a
specified number of forecasted periods. Systems contracting is another form
of purchase order that resembles the requirements contract. It has often been
called stockless purchasing. This type of order is normally used as a method
for automating the purchasing cycles of low-value, continuous usage products
and materials. Systems contracts are designed to facilitate the movement of
inventory and to reduce costs by eliminating formal requirements schedules,
paperwork flows, consolidating billings, delivering to the point of use, and re-
alization of the best possible price for the products required. A final form of
purchase order is the service contract. This type of order is used to purchase
nonproduct services or skills in response to a company requirement.
Finally, the use of direct-ship purchase orders is today becoming an im-
portant strategy by leveraging outsourcing advantages. Often, customers
wish to order products the business does not carry due to historically low us-
age. Instead of turning the order away, the products are ordered from a sup-
plier, who, in turn, ships directly to the customer, bypassing normal in-house
receiving, material handling, and shipping. Direct-ship purchasing only
works if agreed to by the customer, and the supplier can be quickly notified
of the order and can ship within a very short time frame.
Whatever the form selected, the focus of activities in this area is actual pur-
chase order release . For MRO purchases, most computer systems provide
functionality for easily converting the requisition into a PO. Similarly, most
of today ' s MRP/DRP systems provide sophisticated "workbench" applica-
tions that facilitate planned order release directly into POs. In addition, these
interactive computer screens provide buyers with the opportunity to examine
the contents of the proposed order before actual release. The buyer/planner
can analyze such elements as supplier lead times, proposed order quantity,
available discounts, and shipping costs. These steps are particularly impor-
tant for products to be replenished through a discrete purchase order. For re-
petitively purchased items the system-generated requisitions provide the buy-
er/planner with a window into future requirements that can be negotiated into
systems contracts. Once the purchase order type has been determined, the or-
der is entered into the system and transmitted to the supplier.
Recently, the transmission of the purchase order has moved from the de-
livery of a hard-copy document to computerized transmission. In the early
days of computerization, requirements orders were created within customers'
business systems, printed, and then sent to the supplier, who, in tum, entered
the order into their computer system. Such redundancies are now being elim-
inated with the rise of EDI and Web-based transmission . Considering the
vast amount of purely administrative work involved, streamlining processing
activities can significantly add to purchasing efficiency and effectiveness.
Emmelhainz [14] points out five major benefits computerization can bring to
the purchasing function.
1. Computerization reduces the amount of clerical effort required and de-
creases errors in order processing
2. Computerization allows for quick access to better, more accurate infor-
mation resulting in better negotiations in terms of reduced prices, and
improved quality
3. Value-added functions of purchasing personnel are increased by elim-
inating administrative, repetitive tasks
4. Computerized purchasing leads to better supplier relationships by re-
ducing order and documentation errors, providing better information to
assist in vendor scheduling, and reducing cycle times
5. The use of the computer also assists in integrating purchasing with
other enterprise functions such as logistics, accounting, and marketing.
TRANSPORTATION DECISION
The management of inbound freight for purchased goods has migrated today
from the purchase of a generic commodity to a complex decision involving a
landscape of price and service options. As a result of deregulation legislation
during the mid-1980s, companies today have recognized the need for closer
integration of purchasing and transportation departments if they are to attain
lower freight costs. In fact, some firms have combined the two functions into
a single department. Regardless of the organizational structure, all compa-
nies have become acutely aware that many of the techniques used by SRM
should also be applied to the selection of transportation partners. Careful
evaluation and selection, price analysis, aggressive negotiation, scope of val-
ue-added services offered, and a continuous search for cost reduction perfor-
med by knowledgeable personnel can effect substantial savings and improved

services in the management of inbound freight. Purchasers can no longer
simply specify "best way," "ship soon as possible," or leave it up to the sup-
plier. Competitive purchasing requires buyers to work closely with their traf-
fic management departments or utilize third party service (3PLs) providers.
One of the critical elements in inbound transportation is selection of the
most appropriate mode and carrier . Transportation modes consist of the fol-
lowing types of freight: rail, motor, air, and water. There are essentially four
categories of transportation operating in the United States: (1) Private--the
purchaser owns the transportation; (2) Common Carriers--for-hire trans-
portation that cannot discriminate in selecting shippers or receivers; (3) Con-
tract Carriers--for-hire transportation that moves freight under contract for
certain shippers or receivers; and, (4) Exempt Carriers--for-hire carriers that
are free from Interstate Commerce Commission (ICC) regulations such as
rates, routes, and services. In making in-bound transportation decisions, pur-
chasers must be careful to pick the mode and carrier type that best meets the
needs of the organization. Transportation purchasing decisions are influ-
enced by modal factors such as delivery due date, cost, reliability, size, trans-
it, and product type; carrier selection is influenced by on-time delivery, rates,
coverage, transit , care and handling, and tracing. By far most purchasers fo-
cus on the ability of carriers to deliver on time.
Another critical factor in transportation purchasing is determining the point
at which title to the merchandize is transferred. The time and place of title
transfer is critical because it defines the boundaries of owner responsibility
and risk. The transfer of ownership from a supplier to a purchaser is termed
F.O.B. (free on board) . If the goods are shipped FOB seller's location, the
buyer automatically acquires title at the moment the shipment is delivered to
the carrier. On the other hand, if the goods are shipped FOB. buyer's loc-
ation, title is transferred when the carrier delivers the goods to the buyer. Ob-
viously, purchasers must be cognizant of the ramifications of each method be-
cause of legal complications over such things as damage, loss, or breach of
contract. There are several variations of the terms of sale as listed below [15]:
FOB. Origin, Freight Collect. Title passes to purchaser at the seller's
facility. Purchaser owns the goods while in transit, pays freight char-
ges, and files any necessary claims.
F. OB. Origin, Freight Prepaid. Title passes to purchaser at the seller's
facility. Freight charges are paid by the seller, but the purchaser owns
the goods while in transit and files any necessary claims.
FOB. Origin, Freight Prepaid and Charged Back. Same as above, ex-
cept that seller collects freight charges from buyer by adding the
amount to the invoice.
F a .B. Destination, Freight Collect. Title passes to purchaser upon de-

livery to the purchaser's facility. The purchaser pays the freight charge,
but the seller owns the goods while in transit and files any necessary
claims.
F OB. Destination , Freight Prepaid. Seller pays the freight charges,
owns the goods while in transit, and files any necessary claims. Title
passes to purchaser upon delivery.
F o.B. Destination, Freight Collected and Allowed. Sellers owns the
goods while in transit and files any necessary claims. Buyer pays the
freight charges but bills them back to the seller by deducting the
amount from the invoice.
When making a selection of the above terms of sale, purchasers must be care-
ful to weight such elements as the trade custom, nature of the merchandize,
dollar amount of the order, and the possible savings gained by having the sup-
plier handle transportation administration .
RECEIVING AND ORDER CLOSEOUT
The culmination of the purchase order process is receiving and order close-
out. The overall responsibilities of the receiving function are to receive, iden-
tify, perform general material inspection, and confirm that the products re-
ceived from the supplier are what the planner ordered. As such, effective re-
ceiving can have a significant impact on costs and operational efficiencies.
When allowed to filter down through the organization, receiving errors will
result in increased costs, inefficiencies in other business functions, and
widening gaps in customer confidence. Typical receiving activities can be
described as follows:
Unloading. The first step in receiving is the actual unloading of the
material from the carrier. Efficient unloading often requires developing
balanced delivery schedules by working with carriers to maximize dock
capacities and minimizing manning requirements. Although most un-
loading is performed by manual handling, receivers can utilize material
handling equipment, conveyors, or unitized loads that permit mechanic-
zation of the unloading process.
Shipment verification. After unloading, receivers must verify the re-
ceipt by referencing the freight bill and the original purchase order. In
addition, an important check performed by receiving is verifying the
scheduled receipt date as indicated on the purchase order. If the receipt
is deemed too early, the material should be returned back to the sup-
plier, depending on company policy and the supplier contract. This
practice can significantly assist companies eliminate unnecessary in-

ventory carrying costs and stores congestion.
Unpacking and damage inspection. The receiver is responsible for
three verifications. To begin with, the material received is verified
against both the supplier's packing list and the company's purchase or-
der. Second, the quantity is checked in the same fashion. Finally, a
general inspection is performed to determine if any external damage
was sustained during delivery. If more detailed inspection is required,
the receipt would be moved to the inspection department. While in in-
spection, product s should not be allocatable to open orders until final
disposition.
Unitize materials. All received materials should be unitized to reduce
internal material handling. For example, loose cartons may be pal-
letized on the receiving dock to enable the efficient use of fork lifts and
other equipment.
Hot list review. Often newly received products are urgently needed for
internal production or to fill backorder conditions. Sometimes the
receipt is the result of an expedite order that has been purchased at pre-
mium cost to the company. By checking each receipt against a "hot
list" personnel can speed the flow of materials through the receiving
process.
Prepare receiving report. Most companies utilize standard multicopy
receiving forms, computer entry, or bar code readers to record material
receipts as well as quality, delivery, and other performance issues. The
resulting documentation is provided for accounting, who uses the infor-
mation when verifying payables invoicing, inventory control for ma-
terials disposition, purchasing for supplier performance evaluation, and
incoming inspection who will be inspecting the receipt.
Delivery of materials. Often receiving is responsible for transporting
materials to the proper stores location or, in the case of nonstock items,
directly to the requestor. Upon delivery of the materials, the recipient
signs off on the receiving traveler, thereby assuming full responsibility
for the inventory.
Once receipt has been completed, the original order must be reviewed for
possible closeout. All lines received complete or with open balances should
be so indicated on the order. Receivers and buyer/planners must be careful to
review any unreceived lines and make judgments as to line and overall order
status. Any open line balances, no matter how trivial, will remain as open re-
plenishment orders in the supply system and will have to be manually re-
scheduled to ensure they do not fall past due. Effective receiving procedures
will significantly reduce the acceptance of unordered inventories, inaccurate

quantities , and costly misidentification of materials .
STATUS REPORTING
The third step in the purchase order management process [Fig 10.6] is the
generation and interpretation of open order status tracking and internal per-
formance reporting. At any time in the purchase order life cycle purchasing
must be able to determine the status of every order and whether it is currently
open, received, or closed. The requisition and open purchase order file can
be used to create a variety of priority and status reports such as PO priority by
supplier and due date, or PO status by product or order number. Regardless
of the sort criteria, these reports should show critical information such as pur-
chase order number, scheduled due date, items and quantities ordered, current
receiving information, and balance open. Priority reports can be used by buy-
er/planners as a follow-up tool. In essence, they serve the function of an ad-
vanced shortage list that can assist planners in ensuring replenishment orders
are received on time without incurring costly expediting or possible material
shortages. In addition, a report of open purchase orders can be used as a ver-
ification list for communicating with the supplier. Such a practice will ensure
that the supplier's list of commitments matches the open purchase order list.
Effective reporting can also assist buyer/planners in maintaining the
schedule of open order priorities . The key element is ensuring that scheduled
receipt dates are met. The problem occurs when demand and supply circum-
stances change after the purchase order has been released. The cancellation
or postponement of a large customer order will require that the buyer/planner
review the status of open purchase orders and perform required order action.
There are four basic order actions that can occur due to changes in demand
and supply:
Generate a new purchase order. The planner should launch a new
purchase order to cover new anticipated requirements.
Expedite an existing order. The planner must communicate with the
supplier to see if an open purchase order can be expedited ahead of its
original scheduled receipt date.
Deexpedite an existing order. Due to a date change in demand re-
quirements, the original scheduled due date of an order should be
pushed back to a later date.
Cancel. Open purchase order(s) should be canceled with the supplier
due to a reduction in demand quantities. When performing such an ac-
tion, planners must be careful to review the cost of order cancellation
against possible inventory carrying costs and future requirements.
The ability to alter open purchase orders is critical to the cost-effective and
timely control of inventory. Without a MRP/ROP/DRP planning system,
which will actually provide these order action messages, buyer/planners can
have a difficult time keeping open order due date priorities current.
Finally, effective purchasing reporting is essential in providing the detailed
data necessary for enterprise purchasing planning and control. Management
reporting should take two forms. The first should provide a monthly or bi-
monthly window on purchasing's impact on enterprise operations controls and
future planning activities . The content of this report should consist of a sum-
mary of the general business climate, a list of specific price increases or de-
creases for major product lines or commodities, analysis of current lead times
for major materials and suppliers, and, finally, a list of possible material
shortages and purchasing's strategy to handle each shortage. The second type
of management report should provide a monthly or quarterly summary of the
state of the purchasing function and efforts to increase the company's profit-
ability and competit ive advantage. This report should consist of the fol-
lowing: a summary of quality, reliability, supplier, and cost improvements;
operational statistics such as number of employees, operating cost, dollar
commitments against budget, and number of purchase orders issued during
the period; a brief description of departmental efforts at continuous quality
improvements and elimination of wastes; and, a statement of future procure-
ment projects and administrative activities .
The final step in the purchase order management process is performance

measurement. Detailed performance metrics provide the enterprise with the
data necessary to chart the effectiveness and efficiency of the purchasing or-
ganization and highlight areas for improvement. There are two dimensions to
purchasing performance measurement: supplier performance and internal de-
partmental performance . Supplier performance measurement is concerned
with ensuring that the goals, expectations, and agreements contracted be-
tween the buyer and the supplier are being fulfilled. Regular evaluation of
the purchasing function is needed to ensure that departmental activities are
being optimized in the pursuit of value-added objectives. Permeating both
areas is a commitment to continuous improvement. Successful companies
consider continuous improvement as a way of life for suppliers, customers,
and employees alike. Integrating purchasing performance measurement pro-
grams and continuou s improvement objectives are fundamental building
blocks of competitive advantage.
SUPPLIER PERFORMANCE MEASUREMENT
The first step in defining supplier performance measurements is to establish,

with the supplier's participation, reasonable performance goals and then to
implement a realistic time table for reaching them. The focus of this exercise
is not to set up absolute metrics to be used as a punishment/reward tool;
rather, the objectives outlined represent an opportunity for buyer and supplier
to establish common ground and develop a better understanding of each
others needs.
Although quality, service (delivery), and price are normally the three per-
fonnance criteria used by most measurement systems, several others may be
used. Selecting the proper measurements is a critical process and should be
based on such elements as company objectives, product characteristics, de-
livery requirements, and others. The following are the most commonly used.
1. Quality. By far, quality is normally considered the most important.
There are several avenues customers can take with their suppliers to en-
sure quality. Quality requirements can be stated directly on the pur-
chase order or defined on a separate document negotiated between buy-
er and seller. Another excellent technique is for buyers to educate and
provide those tools to the supplier necessary to attain the desired stan-
dards. Often this involves training suppliers on the use of specific Sta-
tistical Process Control (SPC) techniques that enforce conformance to
quality specification, narrowing of process and product variation, and
identification of out-of-control processes. The following are examples
of possible quality measurements:
QL = number of lots rejected / number of lots received
QL = dollar value of rejected items / total dollar value of shipments
QL = number of parts received / number of parts rejected
QL = parts per million defective
2. Delivery. As a company's inventory planning systems become in-
creasingly focused on scheduled due dates, the requirements for on-
time delivery increase. Industry leaders today permit the supplier to
ship up to 2 days early, no days late. Furthermore, some firms actually
require their supply channel to respond at a specific time of day, not
just the day required. Possible delivery performance measurements can
be described as
DL = Purchase order request date versus actual ship date
DL = Supplier promise date versus actual ship date
DL = Supplier promise date versus actual receipt date
DL = Sum of actual delivery points earned / sum of possible deliv-

ery points where points equal brackets of days late tied to specific
points
3. Price. In the past , buying products at the best price was the key criteria
in measuring purchasing performance. Today, it does little good for in-
ventory to be purchased in economical lots only to add carrying costs
and experience lost sales due to poor quality and delivery. Some buy-
ers measure the cost of buying products against some form of bench-
mark cost. The problem with this approach is establishing the validity
of the standard and interpreting the meaning of price changes that are
beyond the purchaser's control. Most companies measure actual price
performance against a weighted price index of performance. This mea-
surement is computed first by establishing for each item the price index
as illustrated below:
Price at the start of the year $10.00
Price at the end of the year $11.00
Price varianc e $! .OO
Annual usage 5,000 nits
Summed price at $10.00 $50,000.00
Summed price at $11.00 $55,000 .00
Pric e index = $55,000 /$50,000 = 1.1
The price index is calculated for each item purchased from a given sup-
plier and a summed index derived . Competing suppliers can then be
analyzed by comparing their price indexes or by calculating in other
performance criteria, such as delivery and quality.
4. Lead times. There are two possible measurements regarding lead times .
The first is the percentage of times a supplier's delivery matched
expected lead times . Although a useful metric that ensures arrival of
products to sustain sales, this measurement is neutral. A far more im-
portant measurement is the percentage of lead time reduction for a giv-
en supplier. The use of this metric supports the philosophy of continu-
ous improvement.
5. Quantity received. Suppliers may deliver on time but deliver in quanti -
ties more or less than specified on the purchase order. The best mea-
surement for analyzing quantity receipt performance is to develop a
range of tolerances (+/-) associated with rating points. For example, a
100% delivered quantity rates 100 points; a +/- 5% deviation rates 95
points, and so on. Using this method, the performance percentage
would be calculated by dividing the sum of points earned by the sum of
possible points.
Other possible measurements are order accuracy, purchase order cycle time,
inventory investment, cost reduction/value analysis, inbound freight cost re-
duction, flexibility, and technical competence [16].
PURCHASING ORGANIZATION PERFORMANCE MEASUREMENTS
Besides charting supplier performance, it is critical that managers be able to

document the efficiency and effectiveness of the purchase organization. In
measuring and evaluating purchasing performance, managers must review the
level of departmental compliance to stated purchasing objectives, profes-
sionalism, development and updating of performance standards, control and
reporting systems, results evaluation, and parameters governing the corrective
action to be taken to adjust deficiencies. Ackerman [17] states that the key
reasons for evaluating internal purchasing performance are the following:
1. To direct attention to main purchasing performance areas and
objectives so that performance continually improves while objectives
are being met.
2. To improve purchasing department organizational structure, policies,
and procedures.
3. To identify those areas where additional training and educational
efforts may be required.
4. To provide data so that corrective action can be taken where necessary
5. To improve interrelations within purchasing, between purchasing and
other business functions, and between purchasing and the firm's sup-
pliers .
6. To evaluate departmental staffing requirements.
As a whole, the evaluation process must focus on the two critical elements of
management planning and control: problem detection, which illuminates or-
ganizational and process deficiencies and problem prevention, which seeks to
build fail-safe mechanisms into the policies and procedures before the action
occurs.
Before performance measurements can be developed, however, it is critical
that managers understand that even the most precise quantitative methods
may not provide the level of performance measurement their mathematical
character would seem to indicate. Say, for example, that a manager wants to
evaluate the pricing decisions of a buyer. Is the measurement to be calibrated
versus a departmental or industry standard, and how valid is that standard?
Does it reflect that products of lower quality and lower price are available?
Does it reflect the potential cost reduction if the buyer had negotiated a
detailed cost analysis negotiation with the supplier? Does it reflect econo-
mies of scale if the product had been purchased in a lot size? When estab-
lishing performance metrics it is critical that managers separate performance

that can be managed directly, such as departmental administrative efficien-
cies, from those procurement measurements that are dependent on ratios, cost
levels versus current market levels, adherence to budgets, and others. Fur-
thennore, it can be argued that the true meaning of purchasing measurements
are not found in individual or departmental achievement, but rather how
purchasing contributes to the enterprise's overall competitive advantage.
Purchasing literature perceives internal performance measurement as oc-
curring on three levels: departmental functional review, purchasing policy
and proc edural audits, and ongoing purchasing efficiency. The first mea-
surement consists of a broad appraisal of the purchasing function including
its policies, procedures, personnel, and interdepartmental relations. Because
of its subjectivity, usually the review is performed by someone outside of the
purchasing department, such as a private consulting finn or internal staff
auditors. Effective reviews attempt to provide answers to such basic ques-
tions as "How effective is the purchasing function?" "Has the department
been structured to support enterprise objectives?" "What are the future goals
of purchasing?" In pursuing answers to these questions, reviewers must fol-
low these general areas of inquiry:
What is the scope of the purchasing function? How important is it to
the enterprise and how well is it integrated into the competitive
strategy?
Has the organizational structure, job descriptions, and lines of com-
munication, responsibility, and authority been clearly defined?
What is the competency level of purchasing management? Are they
qualified administrators, do they have sufficient company and industry
experience, and are they knowledgeable about the markets and sup-
pliers with which they deal?
What is the operational and industry competency of purchasing per-
sonnel? What opportunities are there for training? Are there adequate
compensation plans, and is the employee turnover rate reasonable?
Are there formal operating policies outlining purchasing response-
bilities and authority and detailing sourcing research procedures, specu-
lative purchasing guidelines, supplier relations, and quality issues?
Are there formal operating procedures detailing purchase order ex-
ecution, integration with other business functions, searching for, de-
veloping and selecting suppliers, expediting, and performing receiving
and material disposition?
Are purchasing records being maintained in a accurate and timely
fashion? What reports are necessary and how are they being presented
to management?
In performing the functional review, the actual results are collected and com-
pared with expected performance standards. Variances that emerge form the
basis for the recommendations considered necessary to close the performance
gaps [18].
The second level of internal purchasing performance measurement, pur-
chasing policy and procedure audits, is targeted at measuring the level of
success purchasing has had in achieving targeted objectives. Performed at
least monthly, the goal is to ascertain how well the purchasing function
matches predetermined operational standards, and then to provide a basis for
corrective action to redirect purchasing activities that exhibit a wide variance
from allowable performance tolerances. Dobler et al [19] describe the pos-
sible criteria for evaluation at this level as follows:
Timing. This measurement focuses on how well purchasing is sup-
porting line operations. It includes metrics such as percentage of over-
due orders and stockouts caused by late delivery, number of production
stoppages caused by late delivery, actual versus budgeted expediting
expense, and premium transportation costs paid.
Quantity and inventory investment. In this category can be found the
percentage of stockouts and production stoppages caused by under-
buying, actual supply service level compared to the performance target,
actual inventory versus targeted inventory levels, value of dead stock,
and a list of negotiated supplier stocking arrangements and estimated
inventory savings.
Purchase price. Key factors in this measurement are actual price per-
fonnance charted against a standard, actual expenditure against a bud-
get, price indexes compared to national commodity prices indexes such
as the Producer Price Index, cost savings due to negotiation, cost analy-
sis, volume buying, long-term contracting, supplier changes, and trans-
portation cost reduction, and gains and losses from forward-buying
activities.
Material quality. Quality measurements can consist of the percentage
or number of orders receiving quality rejects, number of vendors who
have achieved "certified supplier" status, cost savings generated by
SPC, and other value analysis techniques achieved through joint ven-
tures with suppliers.
Source reliability. This category focuses on metrics relating to per-
centages of late delivery, rejected material, incorrect material, and split
shipments. In addition, transportation measurements such as transit
times, percentage of damaged shipments, quality, and cost improve-
ments are part of this category.
Supplier relations. Although this area is often difficult to quantify,

surveys targeted at compiling data relating to supplier friendliness,
helpful attitude , knowledge of company's product and service needs,
ability to expedite , ethical standards, and others will provide important
measurements.
Internal coordination. The ability to interact with other functional de-
partments is critical to purchasing success. Measurements in this area
deal with the degree of success characteristic of joint ventures such as
development of material standards with accounting, value analysis re-
views with marketing and sales, and order quantities with material
control.
In selecting these and other performance audit techniques , management must
be careful to accentuate those that seek to uncover operational deficiencies
and redundancies based on the nature of the business and the materials
purchased .
The last level found in internal purchasing performance measurement con-
sists of a series of metrics designed to reveal the magnitude of purchasing ef
fi ciency. Effective measurement on this level requires weekly or at least
monthly evaluation of day-to-day purchasing procedures and performance
results. Although the following list is by no means exhaustive, it does pro-
vide the techniques used by must organizations [20].
Workload management. This category contains a number of measure-
ments associated with the ability of the purchasing function to handle
by period such activities as timely purchase order issue, number of new
long-term contract s executed, average number of dollars expended per
purchase order, number of rush orders, and the number of changed
orders.
Departmental operating costs. In this category can be found metrics
such as departmental actual operating costs against budget per period,
number of employees , and turnover ratio. It is important to note that
these metrics by themselves mean very little. They are best used in
conjunction with trends arising from other efficiency and effectiveness
statistics that can assist managers in charting the relationship of de-
partmental costs to other business factors such as business volume,
product quality requirements , and total materials costs.
Personnel. Measurements in this area are designed to detail the perfor-
mance efficiency of purchasing personnel. Metrics employed focus
around performance standards for clerical, repetitive work, and time
utilization studies designed to pinpoint non-value-added effort. There
are a number of models available to assist managers in evaluating em-
ployees. The National Association of Purchasing Management, for ex-
ample, has developed a technique called PHASE. The goal of the

evaluation method is to detail the strengths and weaknesses of each in-
dividual through (1) job analysis, (2) diagnostic evaluation of em-
ployee's knowledge of duties, goals, and functions, and (3) employee
involvement in training.
The implementation of concise performance measurements is critical to the
control of the purchasing process. No matter how well purchasing planning
and procurement activities have been executed, much of the results will large-
ly be ineffectual without good performance controls. In developing perfor-
mance metrics, managers must understand that there is no comprehensive for-
mula, but rather each firm must develop measurements that, first, target those
activities deemed necessary for ongoing organization efficiency and ef-
fectiveness and second, are adaptive to changing circumstances. In addition,
the cost of performance measurement should be weighed against the benefits.
Finally, even the best set of performance measurements are no substitute for
good management. Managers must effectively communicate the purpose of
each measurement and use the entire program as a source to motivate and
direct behavior and never to punish individuals.
IMPACT OF e-BUSINESS ON SRM
Up until just a few years ago the purchasing management process was ex-
ecuted through time-honored techniques . Requirements were identified, sup-
pliers contacted, prices negotiated, and orders transmitted the old fashioned
way through personal meetings, phone calls, faxes, and mail delivery. While
some companies had access to ED! linkages that permitted the passing of pur-
chasing data between ERP systems, the automation of these back-end func-
tions were inward-facing and did little to enhance the integration and collabo-
rative relationships necessary to speed up the front-end processes that were
outside resident in the supply chain. With the application of the Internet to
SRM functionality, this gap in the automation of procurement as well as full
integration with supply chain partners is rapidly disappearing. Similar to
what e-CRM has done for customer management, e-SRM is permitting to-
day's cutting edge companies to assemble for the first time a complete picture
of their supply relationships, apply Web technologies to dramatically cut cost
and time out of sourcing and negotiating, and utilize real-time data to com-
municate requirements and make effective choices that result in real com-
petitive breakthroughs.
Although the business climate of the post-dot-com era is very cautious
about adopting what has come to be known as business-to-business (B2B)
commerce, the use of Internet-enabled SRM has been growing steadily. At
the beginning of 2002 Forrester Research reported, for example, that nearly
73% of the organizations surveyed used the Internet for indirect purchasing
and 54% for the purchase of production materials. Others report that e-SRM
initiatives have reduced the price of goods and services by five to ten percent
as compared to traditional methods. When all the figures are compiled, it is
clear that companies consider e-SRM to expand throughout the decade of the
2000s and provide the following benefits [21]:
Increased market supply and demand visibility. B2B e-marketplaces
provide customers with an ever-widening range of choices, an ex-
change point that enables the efficient matching of buyers and
product/service mixes, and a larger market for suppliers .
Price benefits from increased competition. Online buying and use of
auctions can be employed to increase price competition, thereby re-
sulting in dramatically lower prices.
Increased operational effi ciencies. B2B applications have the capa-
bility to increase the automation and efficiency of procurement proces-
ses through decreased cycle times for supplier sourcing, order pro-
cessing and management, and buying functions.
Enhanced customer management. e-Marketplaces assist marketers to
accumulate and utilize analytical tools that more sharply define
customer segmentation and develop new product/service value
packages that deepen and make more visible customer sales campaigns.
Improved supply chain collaboration. Today's B2B toolsets enable
buyers and sellers to structure enhanced avenues for collaboration for
product life cycle management, marketing campaigns, cross-channel
demand and supply planning, and logistics support.
Synchronized supply chain networks. The ability of e-markets to drive
the real-time interoperability of functions anywhere in the supply net-
work focused on merging information and providing for the execution
of optimal choices provides supply partners with the capability to real-
ize strategic and operations objectives. Among these can be included
shorter cycle times for new product development and delivery, in-
creased inventory turnover , lower WIP inventories, low-cost logistics,
and others.
Figure 10.8 is an attempt to visualize the array of today's Web-enabled
SRM functions. The first component, e-sourcing, consists of Web-driven ac-
tivities necessary to develop long-term supplier relationships that will assist
channel partners in architecting collaborative approaches to joint product de-
velopment , negotiation, contract management, and CPFR. The second com-
ponent , e-procurement, is comprised of a group of Internet-enabled toolsets
for automating the activities associated with purchase order generation, order
FIGURE 10.8 SRM Internet technology components.
management, and procurement statistics. The third component, value-added

services, utilizes the Internet to provide services that enhance e-SRM func-
tions such as financials and billing. The final component, e-marketplace ex-
changes, refers to the structure, players, and activities to be found in today's
Internet-enabled B2B marketplace.
e-SOURCING FUNCTIONS
The Internet provides procurement functions with radically new toolsets to

facilitate the processes preceding purchase order release. In the past, buyers
had to perform time-consuming searches through supplier registers and
catalogs for sources of products and services. In contrast, today's Web-based
browsers can significantly streamline this process. Among the capabilities
can be found:
Supplier search. Historically, the search for suppliers was often a frag-
mented and adversarial affair, marked by a laborious process of lo-
cating suppliers, opening up RFQs, pricing, quality, and delivery ne-
gotiations, and eventual contract agreement. e-Business tools, on the
other hand, provide for dramatic acceleration of these processes. Inter-
net search engines and buying exchanges can provide easy interactive
access between buyer and supplier. The real-time capabilities of B2B
can significantly cut the time for RFQ and negotiations. In addition,
buyers can explore dynamically new purchasing models such as on-line
auctions, for sourcing and spot buying.
Product search. Instead of cumbersome hard copy catalogs and price

sheets, the Internet provides buyers with real-time 24/7/365 access to
products. B2B marketplaces host electronic product searches for all
types of goods and services, including MRO, production, administra-
tive, and capital goods. According to Hoque [22], search functionality
"can range from a simple keyword search to complex product category
classification, parametric search functionality, automatic comparison
product offerings, bid-boards for collaborative buying, message boards
for posting buyer testimonials, real-time chat for negotiating flexible
pricing, and even bidding and auctioning." Effective Web-based ap-
plications should enable e-marketplaces to centralize product and ser-
vice content offerings, permit suppliers to host content on their own
sites, and enable buyers to develop customized catalogs.
Pre-purchasing services . The goal of e-SRM is to expand the capa-
bility of buyers to automate and optimize purchasing functions while at
the same time more fully integrating sourcing decisions with supply
chain planning (SCP) and ERP transaction engines. These applications
can be divided into two categories. The first, decision support tools,
include applications such as spend analysis to track spend by category,
supplier, and organizational unit; item rationalization to standardize
and eliminate redundant items; contract management to assist in RFQ,
bid analysis, negotiation, and contracting that result in lower oppor-
tunity, input, and quality costs and shorter product introduction time;
and supplier monitoring and improvement capabilities that enable real-
time measurement of supplier transaction, quality, and collaborative
performance. The second category provides negotiation automation
tools that streamline supplier databases for easy accessibility to sup-
plier capabilities and performance levels to cut the supplier RFQ search
effort; e-RFP providing Web-applications for electronic request for
proposals that link with bid analysis tools; and, e-Auctions that utilize
Web-based tools to facilitate and fully document auction events.
e-PROCUREMENT FUNCTIONS
The use of Internet tools for procurement processing represents a revolution

in the way order management has traditionally been carried out. The applica-
tion of e-procurement tools can be said to have a simple objective: the
streamlining and automation of purchasing tasks. From the beginning, it was
realized that the Web offered purchasers tremendous advantages in the acqui-
sition of products characterized by high standardization, high-volume pur-
chase, price as the prime decision point, minimal negotiation, and frequent
spot purchase. For suppliers, the process was fairly simple, often amounting
to little more than creating an on-line catalog capable of being accessed by
the Internet and equipped with order entry and payment instruments. For
buyers, all that was needed to gain easy access to a world of goods and
services was a good Web browser and a credit card.
Understandably, the first e-procurement efforts focused around the ac-
quisition of MRO and indirect materials that fit perfectly the original B2B
model. Recently, this model has increasingly been applied to the acquisition
of production inventories as well, but with a modification. Using the Web to
search and buy standardized products is one things; acquiring often unique
and proprietary components and raw materials from specialized vertical
industry suppliers is another. What is more, procurement of this class of
inventory is often preceded by complex negotiations regarding quality,
delivery, and price and a desire to sustain and develop the supplier
relationship. As will be discussed below, companies have turned to the de-
velopment of private B2B exchanges to solve these problems. This type of
exchange permits companies to create private communities of trading part-
ners who can utilize the Internet to facilitate such activities as RFQ, com-
petitive bidding, and order placement.
The key toolsets enabled e-procurement can be detailed as follows:
Catalog management. The center piece of B2B is effective presenta-
tion of goods and services to Internet buyers through easily accessible
and intelligible catalogs of products and services. Often called a
"virtual storefront," the goal is to provide Web buyers with "dynamic
content" that always possesses the most current pricing, product infor-
mation, and ordering techniques. Such catalogs not only provide in-
stant access to the supplier's store, but they also enable buyers to com-
parison shop for lowest price, highest quality, and desired delivery.
Requisitioning. Advanced e-SRM applications have the capability to
facilitate the requisitioning process by integrating Internet product!
service catalogs into a single "virtual" catalog. These tools also pro-
vide buyers with decision metrics about suppliers, such as comparative
pricing, quality performance history, commitment to collaboration, and
overall customer care rating. Finally, effective requisition tools will
contain other components, such as on-line documentation, chat rooms,
RFQ status review, and access to current supplier pricing, productive
capacity, and inventory availability.
Bid management. The use of the Internet can dramatically shrink the
time and cost found in the RFQ process. By opening up the bid to a
form of real-time auction, buyers can easily gain access to a global
community and increase marketplace competition. As bidding begins,
the Web provides for easy communication of product and contracting

information, and once a bid has been chosen, the RFQ can be quickly
passed to the PO-generation stage.
Shopping tools. While still in their infancy, purchasers can also utilize
automated shopping robots to perform many of the cumbersome and
time consuming tasks of Internet browsing. In the future these buying
"bots" will have the capability of interacting with other "bots" to locate
products and services on the Web, review availability, negotiate price
and delivery, and enter orders with a minimum of human intervention.
Auctioning. One of the most widely used applications of e-business is
the Web auction . This technique is used primarily as a means to buy
and sell products whose value is difficult to determine or are com-
modity in nature . While there are a variety of different types of
auctions, such as classical, reverse, Dutch, and stock market model,
based on the type of product offered, they all are focused on providing
on-line access to products and services dictated by the market price.
PO generation and logistics. Once the work of the RFQ or bidding is
completed, the PO can be generated. POs can be created in the cus-
tomer's ERP system and then communicated through the Internet or
placed directly in the Web site. Once entered, the Web site then acts as
a self-service tool for customer order tracking and follow-up. In ad-
dition, customers can also utilize an e-Logistics company. These logis-
tics service providers (LSP) can offer a wide variety of supporting
Web-based services such as inventory tracking, carrier selection, sup-
plier management, shipment management, and freight bill management.
V AlUE-ADDED SERVICES
While significantly accelerating procurement search and order entry func-

tions, e-SRM also is leveraging the Internet to activate a wide range of sup-
porting value-added functions. Among these services can be found [23]:
Financial and billing services, such as the use of payment cards, or P-
cards, credit approval, corporate check payment, clearinghouse func-
tions, and direct electronic billing
Comparison shopping functions
Collaborative design and configuration management functions for com-
plex, make-to-order production
Advertising, promotions, and dynamic pricing models based on market
demand and availability
Transportation and logistics support to facilitate product fulfillment
Synchronized supply chain procurement planning

Establishment of marketplace performance benchmarks and key indi-
cators
For the most part, these value-added services are normally focused on the
pursuit of short-term requirements for cost and inventory reduction and
synchronization of channel inventory plans. They also provide a new
dimension to e-SCM by providing the foundation for the collaboration of
supply chain competencies and network partner strategic visions that enable
them to evolve into true e-marketplaces communities.
e-MARKETPLACE EXCHANGES
The virtual explosion of the Internet as a method for the buying and selling of
products and services has generated a number of strategies and business
models as Web technical capabilities have matured. In fact, today's B2B
toolsets can be said to have emerged over three distinct periods [24]. In the
first, Web foundations, the basic components of B2B were established. In
this era, e-business was confined to the use of independent portals to offer
products and services through techniques such as aggregation, buyer-seller
matching, and hosting auctions centered on online catalog search, facilitating
the RFQ process, and providing real-time order transaction and management.
Overall, despite the immediate advantages, stage one B2B procurement re-
presented little more than moving catalog operations online and did not offer
the marketplace a new business model.
In the second period, termed collaborative commerce, e-marketplaces be-
came much more concerned with expanding the functions necessary to con-
duct collaborative procurement and address the issue of direct production ma-
terials. This period was short-lived as the field of trading exchanges became
dramatically overpopulated and buyers began to look beyond independent to
private and consortium exchanges where they had direct control over the
membership, security, and content of what was actually a private trading
community.
The third period, networked exchanges, represents the most advanced stage
of B2B and is currently at its opening stages. Perhaps it's central character-
istic is the transformation of private, independent, and consortia marketplaces
into fully networked exchanges featuring robust functions such as single-data
models and joint order management, procurement, financial services, logis-
tics, and network planning that facilitate multibuyer/multiseller interaction
and collaboration.
Today's e-marketplace can be divided into the following three models [25]:
Buyer-driven e-marketplaces: This simple B2B model is designed to

enable companies to optimize internal procurement by linking through
Internet tools divisions, partners , or companies. These toolsets usually
seek to facilitate RFQ and procurement functions by providing ag-
gregate catalogues either on their own systems or the Web-sites of ser-
vice providers that can be used in tum by network trading partners.
Vertical e-marketplaces: In this category are found marketplaces that
act as hubs servicing a single industry . These marketplaces are em-
ployed by industries marked by severe discontinuities or by fragmenta-
tion due to the lack of dominant suppliers or buyers. These suppliers
use the Internet as a medium to automate sourcing and procurement
processes and act as a clearinghouse for information regarding every-
thing from inventory to CPFR to logistics sourcing and contracting.
Horizontal e-marketplaces: B2B marketplaces in this area range from
simple portals to sophisticated collaboration hubs. The central function
of these marketplaces is to enable multi-buyer/multi-supplier inter-
action and collaboration. By providing a sort of virtual trading "hub"
where buyers and suppliers can be matched and conduct transactions ,
these Web sites enable manufacturers, distributors, buying groups, and
service providers to develop shared marketplaces that deliver real-time,
interactive commerce services through the Internet. Finally, because of
their role as a medium, these marketplaces enable trading communities
to facilitate the exchange of common information and knowledge.
In summary, the use of e-SRM applications is expected to increase with
time as supply chains search for solutions that go far beyond simply auto-
mating PO functions . While e-SRM began as a Web-based tool for facilita-
ting the search for and purchase of commodities, requirements for quick prod-
uct cycle times and close partnerships have pushed today's e-SRM functions
to evolve to new levels supporting the formation of collaborative marketplace
communities . e-SRM tools must be capable of not only supporting the ever-
increasing suite of Web-based procurement applications, but it must also
enable true customer-supplier collaboration across the supply chain.
SUMMARY
Effective procurement and supplier relationship management are fundamental

building blocks for supply chain success in the twenty-first century. The
management, planning, and execution of purchasing activities are the re-
sponsibility of the firm's purchasing department. It is the job of this function
to communicate effectively the company's inventory requirements to the right
suppliers , execute efficient item and supplier sourcing, scheduling, con-
tracting, negotiating, and partnership activities, as well as run the day-to-day

functions of launching purchase orders, performing receiving functions, and
assuring procurement performance measurement. In performing these func-
tions, the purchasing organization must be structured to leverage simultane-
ously continuous improvements in processes aimed at cost reduction and high
customer service. Integral to an effective purchasing function is the existence
of a comprehensive purchasing strategy. Companies that do not develop a
detailed purchasing strategy risk interruption in the stream of supply due to
poorly executed product and supplier sourcing, misunderstood environmental
or regulatory constraints, and uncertainty in price and delivery. The pur-
chasing strategy that emerges is not necessarily one that promises to optimize
efficiency or least total cost but one that supports the needs of the enterprise
and the competitive advantage sought by the entire supply chain.
Managing the purchasing process revolves around the effective planning
and control of the three cycles of purchase order management. The first cy-
cle, order preparation, involves developing a buying plan that meets the needs
of the finn, timely supplier selection, and negotiating the terms of purchase.
The second cycle, order entry, entails choosing the appropriate purchase
order type, order generation, and timely transmission of the order to the sup-
plier. The final cycle focuses on product receiving and final order closeout.
Both during and after purchase order receipt, the purchasing function is re-
sponsible for open order status tracking and internal performance. The final
step in the purchase order management process is performance measurement.
There are two dimensions to effective purchasing performance measurement:
supplier performance and internal departmental performance. In measuring
and evaluating purchasing performance, managers must review compliance to
stated purchasing objectives, departmental professionalism, control and
reporting systems, and commitments to continuous improvement. Integrating
supplier and departmental performance objectives is a fundamental building
block of competitive advantage.
With the advent of the Internet, the procurement function and the need for
close supplier relationships has grown dramatically. Similar to what e-CRM
has done for customer management, e-SRM is permitting today's cutting edge
purchasing departments to assemble a complete picture of their supply chan-
nel relationships, apply Web-based applications to cut cycle times and costs
for sourcing and negotiating, and utilize real-time data to communicate re-
quirements and make effective choices that offer real competitive advantage.
Internet tools have enabled purchasers to develop revolutionary methods to
drive sourcing, procurement , and value-added services that provide enhanced
supplier collaboration and supply chain synchronization. In addition, the
emergence of e-marketplace exchanges have provided a number of radically
new models for the buying and selling of products and services.
1. Detail the responsibilities of the purchasing department.

2. Discuss the variety of ways a purchasing organization can be structured.
3. Why is the development of an effective purchasing strategy so important?
4. Detail the activities required during the purchase order preparation cycle.
5. How can EDI significantly assist the execution of purchasing functions?
6. What is the central performance measurements needed for effective purchasing?
7. What are the characteristics of JIT purchasing?
8. How would forming close supplier partnerships result in higher-quality, lower-
cost products?
9. Explain the mechanics of vendor scheduling. Why is this role superior to the
organizational model of buyer and planner?
10. Why is the role of the supplier scheduler superior to older forms of purchasing
organization?
II . How can QR tools significantly facilitate the purchasing process.
12. Define the difference between manufacturing and value-added processing.
PROBLEMS
I. The Ajax Distribution Company is currently earning a $10 million profit arising
from sales of $50 million. The total cost of purchasing to support sales is $25
million. If the company wants to increase profits by 10%, how much must the
purchasing department reduce the cost of purchasing?
2. After a DRP generation, the planner report specified the following planned order
by week for three items ordered from the same supplier. If the supplier requires
payment within 2 weeks of receipt, what would be the time-phased cash
commitment?
Planned Orders
Cost Item 2 3 4 5 6 7 8 9
$15 A 25 25 25 25 25 25 25 25 25
$24 B o 23 35 45 23 16 3 o 0
$11 C 12 67 75 34 21 II 0 9 7
3. Part AIOO-IOO has been purchased from two vendors. The annual usage is 7500
units of which 4230 were purchased from vendor A and the balance from vendor
B. If vendor A's price at the beginning of the year was $11.24 and the last price
was $11.75 , and vendor B's was $11.45 at the beginning of the year and the last
price was 11.41, which vendor would be chosen if the finn decided to execute a
single-source contract based solely on price?
4. A value-added processing order needs to be released. The item has the
following data: monthly demand is 225 units; the cost to set up the production
area and prepare the order is $22.50; and the calculated cost of carrying
inventory on the part is $4.46. What would be the order quantity? How many
times a year will an order have to be placed?
5. Reference Problem 4, what would be the cost of a decision to build a month's
worth at a time?
REFERENCES
1. Williams, Alvin 1. and Dukes, Kathleen A, "The Purchasing Function," in The

Purchasing Handbook. 5th ed . New York: McGraw-Hill, 1993, p. 5.
2. APICS Dictionary, 9th ed. Falls Church, VA: American Production and
Inventory Control Society, 1998.
3. See Monczka, Robert M., "Managing the Purchasing Function," in The
Distribution Handbook. New York: Free Press, 1985, pp . 471-483 and
Williams and Dukes, pp. 7-8.
4. Dobler, Donald W., Burt , David N ., and Lee, Lamar, Purchasing and Materials
Management. 5th ed. New York: McGraw-Hill, 1990, pp . 97-98 . See also
Beckert, Norman c., Riley, L. Wayne, and Pratt, Keith , "Purchasing Organi-
zation," in The Purchasing Handbook. 5th ed. New York: McGraw-Hill, 1993,
pp .29-66.
5. For further discussion see Monczka, "Managing the Purchasing Function," p.
484 ; Vollmann, Thomas E., Berry, William L., and Whybark, D. Clay,
Manufacturing Planning and Control Systems. 2nd ed. Homewood, II: Dow
Jones -Irwin , 1988, pp. 227-228; and, Heinritz , Stuart, Farrell, Paul V.,
Giunipero, Larry c., and Kolchin, Michael G., Purchasing: Principles and
Applications. 8th ed. Englewood Cliffs, NJ: Prentice Hall, 1991, pp . 104-126 .
6. For further discussion see Leenders, Michael , Fearon, Harold E., and England,
Wilbur B., Purchasing and Inv entory Management. 9th ed. Homewood, IL:
Richard D. Irwin, 1989, pp . 24-27 ; Magad, Eugene L. and Amos , John M., Total
Materials Management . New York: Van Nostrand Reinhold, 1989, pp. 225-
230; Heinritz et al., pp. 10-25; and , Dobler et al., pp. 28-32 .
7. Hirsch, Chet and Barbalho, Marcos, "Toward World-Class Procurement,"
Supply Chain Management Review, 6,5 ,2001 , 74-80 .
8. For further discussion see Ross, David F., Introduction to e-Supply Chain
Management: Engaging Technology to Build Market-Winning Business
Partn erships. Boca Raton: St. Lucie Press , 2003, pp. 243-244.
9. These points have been adapted from Cavinato, Joseph, "Quadrant Technique:
Key to Effective Acquisition and Access," ARDC Spectrum, Report #11 ,
Acquisition Research and Development Center, State College, P A
10. For further information on supplier performance functions see Fredendall,
Lawrence D. and Hill, Ed, Basics of Supply Chain Management. Boca Raton :
St. Lucie Press, 2001 , pp. 147-155.
II . A deeper analysis of this approach to SRM collaboration can be found in
Wadovick, John D. and Basar, Steven G., "Using Collaboration to Improve
Supplier Relationships," APICS, 2002 International Conference Proceedings.
12. This section has been summarized from Coyle , John, 1., Bardi , Edward J., and
Langley, C. John Jr. , The Management of Business Logistics: A Supply Chain
th
Perspective. 7 ed., Mason, OH : South-Western, 2003, pp. 129-132 .
13. Dobler et al., pp. 297-317 .
14. Emmelhainz, Marg aret, "Computers in Purchasing/EDI," in The Purchas ing
Handbook. New York: McGraw-Hill, 1993, pp. 107-108 .
15. These terms can be found in Heintz , et al., pp . 315-317.
16. See the discussion in Schorr, John E., Purchasing in the 21st Century. Essex
Junction, VT: Oliver Wight Publications, 1992, pp. 155-172; and, Fogarty,
Donald W., Blackstone, John H., and Hoffinann, Thomas R., Production and
Inventory Management. 2nd ed. Cincinnati, OH: South-Western Publishing
Co., 1991, pp. 502-504.
17. Ackerman, Robert 8., "Evaluating Purchasing Performance," in The Purchasing
Handbook. New York: McGraw-Hill, 1993,pp. 316-317.
18. See the discussion in Ackerman, pp. 324-325 and, Dobler, et al., pp. 604-606.
19. Dobler, et al., pp. 606-613.
20. These points have been summarized from Ackerman, pp. 328-354 and, Dobler,
et al., pp. 613-617.
21. These benefits have been summarized from Ross, Introduction to e-Supply
Chain Management, pp. 249-250.
22. Hoque, Faisal, e-Enterprise: Business Models, Architecture, and Components.
Cambridge University Press, 2000, p. 97.
23. Ross, Introduction to e-Supply Chain Management, pp. 255.
24. The phases of B2B can be found in Hajibashi, Mohammed, "E-Marketplaces:
The Shape of the New Economy," in Achieving Supply Chain Excellence
Through Technology . 3, Anderson, David, L., ed. San Francisco: Montgomery
Research, 2001, 162-166; and, Temkin, Bruce, "Preparing for the Coming
Shake-Out in Online Markets," in Achieving Supply Chain Excellenc e Through
Technology . 3, Anderson, David, L., ed., San Francisco: Montgomery Research,
2001, 102-107.
25 . This section has been adapted from Ross, Introduction to e-Supply Chain
Management, pp. 263 -265 .
11
WAREHOUSING
DEFINING WAREHOUSING TRENDS IN MODERN WARE-

Warehousing Functions HOUSING
Types of Warehousing Nature of Modern Warehousing
Various Specialized Warehouse Technology Applications
Services Channel Partnerships
DEVELOPING WAREHOUSE DESIGNING THE WAREHOUSE

STRATEGIES NETWORK
Strategic Overview Opening Issues
Developing the Warehouse Strat- Size and Number of Warehouses
egic Plan Determining Warehouse
The Private, Public, and Contract Location
Warehouse Decision
Components of the Completed WAREHOUSE LAYOUT AND
Warehouse Strategy EQUIPMENT
Warehouse Layout
THE WAREHOUSE MANAGEMENT Types of Storage
PROCESS Warehouse Automation
Receiving and Shipping Functions Warehouse Management Systems
Order Picking
Performance Measurement SUMMARY
The key to understanding warehousing in the twenty-first century is to per-

ceive it as a component of several logistics functions that are integrated to-
gether to provide the supply chain with unique competitive advantage. In the
past, warehousing was looked upon as a tactical function concerned with the
long-term storage of raw materials and finished goods. Someone once de-
fined a warehouse as "inventory at zero velocity." The role of warehousing

was to ensure that individual companies possessed sufficient stock not only to
respond to anticipated customer requirements but also to act as a buffer
guarding against the "bullwhip effect" produced by uncertainties in supply
and demand characteristic of linear supply chains. As such, the operating
philosophy was to search for the appropriate trade-offs between storage, pur-
chasing, and transportation costs on the one hand, and customer serviceability
targets on the other.
In today's "Lean" and highly interoperable supply chains, this static per-
ception of warehousing has become obsolete and is being replaced by the
term distribution center. While, like all terms, the distinction between "ware-
house" and "distribution center" has become one of semantics whose mean-
ings have changed as their functions evolve through time, the differences be-
tween warehousing as the static storage of inventory and today's high-velo-
city customer service centers is dramatic. When it is considered that ware-
housing and logistics services now represent core value-added services, the
need to reposition warehouse functions as fundamental strategic sources of
competitive differentiation and marketplace leadership has grown. Instead of
a lumbering giant accounting for the bulk of the firm's costs and manpower
requirements , computerization, automation, and JIT philosophies accentu-
ating information flows and promoting quality and the elimination of wastes
have drawn the warehouse function within the sphere of competitive strategy.
Effective warehousing in the 2000s requires the enterprise to take an inte-
grative perspective focused on Internet-driven connectivity tools and in-
creased value-added services while simultaneously reducing costs and im-
pediments to service leadership.
The objective of this chapter is to detail the strategies and operational ac-
tivities associated with warehousing at the beginning of the twenty-first cen-
tury. The chapter begins by defining warehousing and the many roles perfor-
med by warehousing in the logistics system. The chapter then proceeds to a
discussion of the basic types and specialized services offered by warehousing.
Of critical importance is how globalization of the marketplace, evolution of
information technology, new views of customer service and the role of in-
ventory, and closer integration and partnering of the business units con-
stituting the supply chain are impacting traditional views of warehousing ob-
jectives and operations. Next, the chapter moves to a review of the ware-
house management process, which includes defining warehousing process
standards, establishing receiving and shipping functions, detailing the order
picking function, and establishing the necessary performance measurements
to guide quality and continuous improvement management. Following this
theme, the chapter then proceeds to examine the formulation of strategies tar-
geted at leveraging and continually refocusing the warehouse resources that
WAREHOUSING 537
will assist in the realizat ion of business unit and corporate objectives. At this
point, the chapter moves to a consideration of the trends impacting modern
warehouse management. Among the topics discussed are examining the na-
ture of warehousing in the post 9/11 and Internet environments, technology
applications, and growth of the concept of channel partnership management.
The chapter concludes with a detailed and comprehensive look at designing
the warehouse network, structuring the warehouse, physical layout, and
equipment and information technology selection .
DEFINING WAREHOUSING
The effective performance of warehousing activities is integral to the success

of supply chain functions . In many industries , product and market character-
istics, such as the discontinuity of demand and seasonal peaks and valleys,
make it almost impossible to fully synchronize the acquisition of goods with
actual demand, forcing companies to stockpile inventory buffers . While
many companies consider warehousing to be a negative function, which stops
or interrupts the flow of products through the supply chain continuum, others
consider the advantage to their marketplace value proposition that inventory
availability offers to be more advantageous than the cost. As a result, for
companies such as grocery stores, catalog distributors , wholesalers , and large
and small retailers from the corner drug store to Wal-Mart, the storage of in-
ventory and the ability to deliver it to the customer at the time, quantity, and
place desired provides value-added differentiation and defines marketplace
leadership.
In economic terms, the price of warehousing can be enormous and must al-
ways be properly balanced with necessary trade-offs in customer service and
competitive advantage. In terms of sheer size, warehouse space in the u.s.
total some 3.4 billion square feet in 2002. In 2001, the total cost of ware-
housing in the U.S. for all businesses amounted to over $78 billion. This fig-
ure represented a little over eight percent of total logistics costs [1]. Accord-
ing to an estimate by the Boyd Company, a site-location consult ing firm, the
cost of a typical 75,000 square foot supply chain facility employing 200 hour-
ly workers can run as high as $15.3 million in San Jose, California, and as
low as $7.4 million in New Brunswick, Canada [2]. Warehousing can be de-
fined as
that segment of an enterprise's logistics function responsible for the storage and
handling of inventories beginning with supplier receipt and ending at the point
of consumption. The management of this process includes the maintenance of
accurate and timely information relating to inventory status, location, condition,
and disbursement.
WAREHOUSING FUNCTIONS
Warehousing performs many roles in the typical distribution organization.
Warehousing can be said to perform the following four basic functions: ma-
terial handling, storage, order management, and information management.
Material handling consists of the following elements:
Receiving. This function is the gateway activity in the warehouse man-
agement process. The major operations performed by this function are
inbound carrier scheduling, order acceptance, material unloading, order
audit, inspection, and staging. Critical performance factors in receiving
are ensuring labor productivity, equipment utilization, product quality,
and unloading efficiency.
Sorting. In some stocking environments, warehousing must sort
received merchandise or unitize it as a prelude to stock put-away.
Often sorting will require activities such as grading, testing, and
grouping. This process will reduce stock handling and the chance of
location or picking error.
Value-Added Processing. Often warehouses are responsible for post-
ponement, or final product differentiation, through light assembly or
manufacturing. The activities associated with this functions are com-
ponent picking and staging, labor and machine allocation, processing,
labeling, and packaging. Value-added processing provides two essen-
tial values. In the first, finished good flexibility can be increased by
postponing the decision to produce the final product configuration until
actual demand requirements have been determined. A critical advan-
tage is that the chance of stockout is reduced, while the amount of base
inventory remains constant. Second, risk and total inventory invest-
ment can be reduced by keeping the product as base stock with actual
product differentiation not made until the sale is made. Disadvantages
are that expenses for production operators and equipment must be in-
curred, and, second, customers are willing to absorb the extra lead time
to complete final assembly processing.
The second basic function of warehousing is product storage. Companies
possess warehouse storage space for several reasons. To begin with, the de-
cision to store inventories may be the result of economies achieved by
trading-off the cost of transportation against the cost of carrying inventories.
This is particularly true of products that permit purchasers to leverage quan-
tity discounts by buying in bulk quantities. Another reason why companies
use storage is to assist the enterprise in balancing supply and demand over
time. Take, for instance, a company that distributes products subject to sea-
sonality and uncertain demand. Planned stocked inventories will smooth ac-
WAREHOUSING 539
quisition costs and ensure that customer orders are met without the excessive
costs normally involved with expediting and lost sales. Again, for companies
who purchase speculation inventories, like commodities, storage will enable
price economies that more than offset the cost of warehousing the extra in-
ventory. A third reason for warehouse storage is to assist in the production
process. Food products such as wine, cheese, and liquors often need to be
aged before sale. In addition, inventories stocked in warehouses can be se-
cured or "bonded." This technique allows distributors to defer paying tax on
the goods until actual sale. Finally, storage can provide value to marketing
by ensuring that inventory is available to satisfy place and delivery strategies.
Warehouse storage consists of the following functions:
Storing/Put-Away . These cardinal functions of warehousing consist of
housing received inventory in the proper storage locations in prep-
aration for order allocation and picking.
Stockpiling. Another important storage function is to provide for the
access to, protection, accuracy, and orderly stocking of products and
materials . Stockpiling can result from production overflows due to sea-
sonality and demand variability , or as a result of sales promotions or
deals. The span of time inventory is to be held often determines the
configuration and operations of the storage facility. Warehouses can
range from long-term, specialized storage (aging liquors, for example)
to general-purpose merchandise storage (products subject to season-
ality) to temporary storage (as in a consolidation terminal). In the last
case, products are stored until economic transportation quantities are
assembled .
Product rotation . Some companies stock products that are subject to
limited shelf life. A critical responsibility of warehousing is to ensure
that first-in-first-out rotation of products, such as foodstuffs, pharma-
ceuticals, and chemicals, is properly managed to avoid spoilage and
obsolescence.
Consolidation. Often companies must acquire products that are ship-
ped less-than-truckload (LTL). A method of economically converting
many small shipment into full carloads is to have products shipped to a
local or regional consolidation center. At the consolidation warehouse,
product can be broken down, repackaged, or simply combined with
other products that can be transported in full truckloads to the deploy-
ment warehouse. Obviously, the savings achieved from more cost-ef-
fective shipping must be large enough to justify the consolidation ware-
house.
Bulk breaking. This storage function is the direct opposite of product
consolidation. Often companies must purchase goods in bulk quantities
for pncmg or transportation cost purposes. These shipments are

received into the warehouse where they are repackaged into smaller
quantities necessary to meet customer requirements. Bulk breaking is
used most often when inbound transportation rates per unit exceed the
customer delivery rates per unit, when distributors sell products in LTL
quantities to meet customer demands, and when there is considerable
transit distance between manufacturer and distributor. Bulk breaking is
a common activity found in terminal or deployment warehouses. The
use of consolidation and bulk break is illustrated in Figure 11.1 .
Consolidation Function
Finished Goods
Consolidation
Product 1,2,3
Warehouse
Bulk Break Function

Custo mer 1
Bulk Break
Custo mer 2
Warehouse
Customer 3
FIGURE 11.1 Consolid ation and bulk break functions .

Product mixing. This storage function is used by companies who
produce or acquire a wide variety of products and convert them into
stocked assortments. When customers order these products they will
often request various goods from a product line. Because these
products are made or purchased from different acquisition locations,
establishing a local product mixing point where these lots can be
loaded in full car loads may produce both inbound and outbound
transportation economies [Figure 11.2].
Cross docking. This function is similar to product mixing in that a
mixing warehouse is used to consolidate deliveries (through sorting,
assembly, or packaging) from multiple sources into salable or useable
assortments. The major difference is that instead of locating these
assortments into a stockroom, they are literally moved directed to the
shipping dock and out to the customer, by-passing any form of storage.
The benefits of this function can be seen in reduced storage and
material handling costs, more effective use of the docking facilities,
shorter order fulfillment cycle times, and full truck load delivery.
WAREHOUSING 541
Product Mix ing Funct ion

Product Mix
Plant I
Product I f---
IJTIIT] .I ustomcr A I
Plant 2
Product 2
Plant 3
--- Mixing
Warehouse ~
[TIillJ1 u tomcr B
o::IillJ .1 ustomcr C I
I
f-
Product 3
Pla nt 4
- o::IillJ 1C ustomer () I
Prod uct 4
FIGURE 11.2 Produ ct assembly function s.
Spot stock. This function is most employed by distributors faced with

stocking finished goods subject to seasonality or limited product lines.
The mechanics of the technique are characterized by the "spot" acqui-
sition and storage of product s to fulfill customer requirements during a
particular marketing season or promotional period. For example, a
bathing suit distributor may "spot" inventories in warehouses close to
critical retail markets during the spring and early summer, and then,
once the season is over, pull inventories back to a regional warehouse.
Production support. In a manufacturing environment warehousing
takes on a dual role. It must not only perform finished goods ware-
housing to support customer sales, it must also provide raw material,
component , and subassembly inventories consumed during the pro-
duction process . Although Lean and flow production initiatives seek to
remove a dependence on stores by having production inventories
delivered directly to the processing line, long lead times and product lot
sizes often will force manufacturers to maintain production warehouse.
The objective of warehouse storage is to maximize on customer service by
improving product and location positioning. Success or failure is gauged by
weighing the trade-off costs between storage and transportation.
The third function of warehousing is to facilitate order management
processes. Among activities can be found the following :
Order pi cking. Order picking is the physical selection of products from
storage required to meet an order request. For the most part, order
picking is controlled through a pi ck list generated from the order detail.
The major elements of a pick list are the order number, the required
date, the items and quantit ies to be picked, and the picking location.
The pick list serves the purpose of an inventory control turnaround
document as well as an authorization to pick products for shipping.

Because of the quality and accuracy required to satisfy customer
expectations and the labor cost involved in handling small volumes of
orders, order picking is a critical material handling function.
Production order picking. Companies that both manufacture and
distribute their products normally use the warehousing function not
only as a storage point for finished goods but also as a storage point for
components and raw materials to be consumed by the manufacturing
unit of the firm. In such environments it is the responsibility of ware-
housing to receive, store, pick, and stage these items and deliver them
to production for fabrication or manufacture.
Traffic management. Warehousing should be responsible for selecting
the carriers to be used for product shipment, subject to review from
accounting and auditing. If the firm possesses a traffic management
department, warehousing should work closely with it and be responsive
to its recommendations. Over the past decade, warehousing and traffic
management have been working closely with their carriers to reduce
transportation costs. Most of the major freight traffic in the U.S. is
covered by master contracts negotiated with fine-tuned precision.
Shipping. Shipping functions are often performed by the warehouse
staff. Shipping activities can be divided into two components. The
first, shipment preparation, is concerned with the performance of any
necessary value-added processing and product staging at the outbound
dock. Once completed, the second function, shipping, can be perfor-
med. This functions contains activities such as carrier scheduling, rate
determination, loading transportation vehicles, and completing docu-
mentation such as bill of lading, packing lists, and record maintenance.
The fourth and final function of warehousing is information transfer.
Whenever products are received, moved from place to place, or shipped,
detailed information relating to the transaction must be captured. In addition
to inventory status, the warehouse also provides the firm with information
relating to throughput levels, space utilization, equipment and manpower
availability, and transportation capacities. For most companies, the admini-
strative/clerical activities associated with information transfer are consider-
able. Successful warehouses of the twenty-first century will be those that
learn how to leverage computerized techniques and Lean methods to auto-
mate and eliminate needless manual labor that must be performed in con-
junction with tracking warehouse activity. Without timely and accurate infor-
mation, the enterprise cannot possibly hope to achieve targeted marketing,
sales, and customer service objectives.
WAREHOUSING 543
TYPES OF WAREHOUSING
There are several types of warehousing alternatives that companies can

pursue. Choosing the appropriate type of warehouse consists of a matrix of
financial, organizational, and legal decisions. The object is to select a type
that provides the ability to achieve the least total cost necessary to efficiently
and effectively execute logistics functions while facilitating attainment of
enterprise strategic performance targets. The optimal warehouse decision
should permit the firm to leverage inventory levels and transportation modes
that effectively support marketing, sales, order processing, and inventory
planning in the quest for competitive advantage. Factors influencing ware-
house decisions include the type of industry, supply chain goals, financial ca-
pacities, product characteristics such as perishability, size, seasonality, intrin-
sic value, quantity, potential for obsolescence, strength of the competition,
and state of the general economy.
There are four basic forms of warehousing: private, public, contract, and
in-transit. Private warehousing is differentiated from the other three forms
by the fact that the property, facility, and accompanying storage and material
handling equipment are owned and operated by the firm. This form of ware-
house may be as small as a rack or a stockroom or as large as a network of
complex warehouses separated by continents and consisting of hundreds of
thousands of square feet of storage. The advantages of private warehousing
consist in the following:
1. Private warehousing enables the firm to exercise a high level of direct
control over warehouse operations. A high level of control is desirable
when dealing with special types of products, such as pharmaceuticals or
high-ticket goods, or when special handling or packaging is required.
The ability to directly control warehouse operations is also critical
when pursuing high levels of efficiency and performance.
2. Private ownership can be less expensive than the alternate types of
warehousing. This is particularly true when business operations are
characterized by high storage area utilization and volumes that are large
and continuous.
3. Real estate and fixed asset ownership may also provide the firm with
certain tax advantages or assist in projecting to the community and
customer base a sense of commitment and permanence.
4. Private warehouses simplify communication. Critical information re-
lating to such logistics elements as inventory stock status, receiving,
and shipping are available directly to the firm's management.
S. Unutilized space may be converted to other uses, such as support
function expansion or even value-added processing. In addition, space
may be rented out to other businesses or used to realize public storage

opportunities.
Perhaps the most important disadvantage to privately owned warehousing
is loss of flexibility. Because of its fixed size and cost, a private warehouse
cannot expand and contract to meet changing marketplace needs, nor can it
take advantage of possible strategic location options. In addition, when
employing private warehousing, companies must carry the burden of fixed
costs, risk of damage by fire or natural disaster, and exposure to labor
disputes. Finally, private warehousing requires the presence of a skilled man-
agement team to ensure optimal operational performance,
Public warehousing is a permanent feature in the physical distribution
strategies of many companies. In 2002 the public warehousing industry and
associated terminal services represented about 35 percent of total ware-
housing costs . The growing importance of public warehousing can be traced
to the changing nature of the marketplace. By offering a full range of storage,
material handling, clerical, and value-added services, public warehouses can
provide short- and long-term functions targeted at supporting the supply chain
requirements of their customers. The key characteristic of public warehousing
is that the facility, labor, and material handling equipment are owned by the
warehouse company, which , in turn, contracts warehousing services for a
month-to-month fee. In addition to providing rented storage space, public
warehousing firms may also perform operational activities, such as receiving,
material handling, value-added processing, shipping, and loading operations
on a unit-charge basis. Public warehouses normally specialize in handling
certain types of products lines, such as hazardous materials, foodstuffs, and
bulk storage. Public warehouses also target certain types of customers. Gro-
cery stores , for example, require special warehousing services that facilitate
product turnaround to minimize spoilage . Some public warehouses will also
provide clerical functions including ED! and Web-based order processing,
product inspection, marking, tagging and inspection, and transportation
dispatching, traffic accounting, and prepayment of freight charges. The
advantages of public warehousing consist of the following :
1. Capital investment. Perhaps the major advantage of public ware-
housing is that it requires no fixed capital investment. When using a
public warehouse, all costs are variable in that they are directly pro-
portional to the extent services are used. This factor may be highly
advantageous to a finn attempting to conserve capital expenditure
rather than having to invest in private plant and equipment to solve a
short-term, nonrepetitive stocking and material handling problem.
2. Facility obsolescence. Public warehousing reduces the risk of plant
facility and material handling technology obsolescence. When it is
considered that the normal operations plan for a warehouse extends out
WAREHOUSING 545
for 20-40 years, the use of public warehousing can assist planners
manage and chart the course of marketplace trends and volumes before
investing capital to expand their private warehouses.
3. Marketplace flexibility. Public warehouses can provide companies
with the flexibility to respond quickly to short-term marketplace re-
quirements without a corresponding rise in expenditure for fixed stor-
age. Whether a small company or a large international enterprise, busi-
nesses in an expanding market are wise to utilize public warehousing
while measuring whether the expansion is significant enough to justify
the acquisition of proprietary facilities. In addition, the services of-
fered by public warehousing enable smaller firms to target a national
market and provide the same level of customer service available to
much larger firms.
4. Transportation economies. The use of public warehousing to perform
shipping and transportation activities can provide significant cost
savings. Many companies can bear consolidated freight rates but not
the costs required to ship small quantities at premium rates. Often the
savings in freight alone is sufficient to offset the total public ware-
housing cost. On their part, the public warehouse makes a profit from
the charge for warehousing and consolidation services and, again, from
the revenue generated by warehouse-owned transportation vehicles.
5. Access to special features . Public warehouses can often provide a
number of specialized material handling, storage, and shipping services
more economically than a company-owned warehouse. The following
are examples of such special services:
Material handling equipment such as cranes, lift trucks, conveyor
systems, rail sidings, dedicated dock areas, docking facilities, and
manpower
Special storage requirements such as sterilized and ultraclean
rooms, barge and ship facilities, temperature controlled storage,
and special bulk storage
Broken-case order filling
Office space rental for depositor's sales, customer service, mar-
keting, accounting, and other business functional staffs
Repackaging of products for shipment
Bulk breaking
Freight consolidation
Invoicing for depositors
6. Computerization. Many companies do not have the capital or expertise
to respond to the computerized requirements of their customers. Many
public warehouses provide computerized tools such as EDI, Internet
access, bar coding, and business system interface that can expand a
firm's service functions without actually acquiring the equipment.
7. Overflow warehousing. Companies often need storage space to accom-
modate abnormally large product quantities. Such quantities can arise
from a number of sources, such as an opportunity purchase, an impen-
ding promotional sale, an unusual surge in customer sales, and season-
ality. Public warehousing is an appropriate alternative in such situ-
ations, especially when the cost to acquire additional facilities, man-
power, and equipment would be more 'than the cost of temporary stor-
age. It also eliminates the costly practice of personnel hiring and layoff
as the volume of business fluctuates.
8. Tax breaks. The use of public warehousing enables enterprises to
avoid local taxes arising from property ownership. In addition, certain
states do not charge taxes on inventories stored in public warehouses.
9. Inventory backup. Businesses will often use public warehouses to store
products against possible interruptions in supply caused by labor
strikes, weather, or international or marketplace conditions. To be
most effective, the backup inventory should be stored in a location far
from the main warehouse or stored in a manner that will neutralize the
threat to the main warehouse.
There are a number of disadvantages to public warehousing. To begin
with, lack of timely and accurate communication between the private and the
public warehouse may hinder information transfer and create excess inven-
tory and administrative costs. Second, the specialized services required by a
company may not always be available from a given public warehouse. This is
particularly true of distributors who require regional or national services.
Finally, firms may not always have access to public warehouse space and
services. Availability and limitations in capacities do periodically occur, ad-
versely affecting enterprise logistics and marketing strategies.
Contract warehousing is a form of public warehousing. The key difference
between the two types is the nature of the commitment made to the public
warehouse . For the most part, the public warehousing contract is executed
for a short-term period with renewal on a month-to-month basis. In contrast,
contract warehousing focuses on the creation of a long-term agreement that
ties both parties together for a period of time at least as long as is necessary
to amortize mutual investment. The goal of the contract is to establish a form
of guarantee on the part of the enterprise that the level of business will re-
main constant over the life of the contract, and on the part of the public ware-
house that the level of contracted services will be available throughout the
contracted period. In addition to the normal benefits, contract warehousing
provides both parties with the opportunity to explore new avenues for cost-
cutting and continuous improvement in communications and services. For
WAREHOUSING 547
example, contract warehousing provides a gateway for improvements in

warehouse planning, increased accuracy of receiving and shipping functions,
development of specialized material handling, storage and transportation
equipment, and the elimination of redundancies in transport, information, and
administrative services .
In addition to long-term contracts, there are also a number of variations.
Among these more limited contracts can be found the following:
Leased space. This contract option provides the distributor with some
of the benefits of both private and public warehousing . In this arrange-
ment, the public warehouse guarantees either dedicated storage space in
the facility isolated from other storage by fences or other types of
barriers , or a guarantee of general space, but not dedicated, except as is
specified by the lessee . The advantage to the lessee is that the contract
space should cost less than comparable private space or, by
guaranteeing a long-term contract, the expense of the lease would be
less than the cost of renting space. The public warehouse, on the other
hand, will benefit by being able to schedule space, equipment, and
manpower, thereby optimizing the full capacity of the warehouse .
Leased equip ment and manpower. Normally used in conjunction with
leased or dedicated space, businesses can also contract equipment and
manpower based on fixed rates per hour. Normally, the rate charges
will be higher, often three to five times higher, than comparable private
costs. The reason for this premium price is the high overhead and in-
direct costs that must be borne by the contract warehouse in having
these services ready and available . The best contract for equipment and
manpower is the one that provides mutual benefit to both parties.
Leased administrative services. Many public warehouses offer clerical
support for such activities as transaction recording, inventory manage-
ment, and customer service .
The final form of warehouse storage is storage in transit. This is a special
kind of warehousing in which products are stored in the mode of trans-
portation. For example, a company may elect to store product in the truck
trailer or railcar in which it was delivered. The firm will rent the storage con-
tainer from the shipper . Inventory will remain in this temporary warehouse
until it is finally unloaded and received into normal storage. Again, depen-
ding on transit times, businesses may select a mode that may substantially re-
duce the need to have space for stocked inventories by having them in transit.
This alternative is particularly attractive to distributors dealing with com-
modity products that must be shipped over long distances .
VARIOUS SPECIALIZED WAREHOUSE SERVICES
Cutting across the four forms of warehousing are various warehouse storage
types. For the most part, these types of storage are determined by product
characteristics. Selecting the most appropriate type of warehouse is the re-
sponsibility of a warehouse professional supported by planners from product
management, engineering, accounting, sales, production, and traffic manage-
ment. Among the possible types of warehouse can be found the following:
Cold Storage Warehouse. Often products must be kept at certain low
temperatures to preserve freshness or prevent spoilage. This is particu-
larly true of foodstuffs that must be refrigerated or kept frozen. Obvi-
ously, the cost of building, maintaining, and operating a cold storage
warehouse is substantially higher than other forms of storage. These
costs are a result of higher building material costs, equipment, energy,
premium pay for workers, insurance, and refrigerated transportation.
Temperature-Controlled Warehouse. There are some products, such as
fresh vegetables, fruit, liquids, and chemicals, that must be stored in
warehouses whose temperature is somewhere in between cold storage
and "dry" or ambient outside temperature. The temperature of such
facilities range from 50 to 68 degrees, and usually include some form
of humidity controls. Such warehouses regulate the temperature
through air conditioners, heaters, and humidity control equipment. As
the facility, equipment, overhead, and labor cost is usually less, this
type of warehousing is not as expensive as cold storage to operate.
Bonded Warehouse. Companies often will use a special type of ware-
house that will enable them to produce, transfer, and store products
without having to pay excise taxes and duties. The regulations deter-
mining a bonded warehouse have been defined by government agencies
such as the Public Utilities Commission, the Alcohol and Beverage
Control Commission, the Customs Services, and others. The most
well-known form of bonding is associated with wines and spirits. By
keeping these products in a bonded warehouse, a distributor may avoid
paying the tax until products are transferred out of bond. The term
"bonded" is often used loosely by public warehouses. Normally public
warehouses do not insure their customer's inventories. Companies
should insure inventories that are stored in public warehouses as if they
were stored in private facilities. The extent of legal protection should
always be stated by contract.
Records Warehouse. As the cost of office space spirals, firms are
increasingly using the more economical alternative of utilizing excess
or dedicated warehouse space and personnel for the pickup, filing,
WAREHOUSING 549
storing, retrieving, and delivery of company records. Some public

warehouses specialize in record storage, offering on-site pickup,
retrieval, and delivery of documents to and from their customers. The
requirements for effective record storage are environmental (absence of
dust, humidity, and excess heat), confidentiality and security, and the
availability of technical equipment such as computerized storage,
microfilming, reproduction, FAX, and Internet.
General Merchandise Warehouse. This type of warehouse accounts
for, by far, the largest percentage of all warehousing activities. For
lack of a better description, it can be defined as the storage of all goods
except specialized or commodity products. This type of warehouse can
be described as private or public, bonded or unbonded, and mayor may
not have customs and free-trade-zone privileges. In reality, merchan-
dise warehouses tend to specialize in certain classes of goods driven by
storage and material handing factors. An example would be grocery
warehouses that must employ certain types of transportation and stor-
age facilities.
Commodity Warehouse. This type of storage specializes in commodity
or bulk products such as wood, agricultural goods, cloth, building ma-
terials, cotton, and so on. Commodity warehouses can be either public
or private. Normally, commodity warehouses are located close to the
source of production or extraction or are at the distribution end of the
pipeline where they can be close to the consumer. The central ad-
vantage of a commodity warehouse is the availability of specialized
material handling equipment such as conveyors, heavy lift trucks, con-
tainerization, highly trained personnel, and other warehousing features
that enable them to achieve significant performance efficiencies. On
the other hand, a negative characteristic of commodity warehousing,
particularly in the agricultural industry, is their involvement with prod-
ucts dominated by seasonality which produces recurring cycles of
boom and bust.
Foreign Free-Trade-Zone Warehouse. This type of warehouse would
be used by enterprises engaged in international trade. These storage
facilities legally reside outside of U.S. customs territory where they are
exempt or have reduced customs duty liability. If the goods are re-
exported, no customs duties are owed. In addition, free-trade-zone
warehouses permit companies to buy and store goods in excess of
permissible import quotas for resale in the next period. Besides the
possible avoidance of duties altogether, this type of warehouse will im-
prove cash flow by delaying taxes and duties until the goods are
actually sold and shipped. Free-trade-zone warehouses can be either

private or public.
Miniwarehouse. This type of warehouse is usually characterized by
limitations in total space and the complete absence of warehousing
services. They are simply intended as extra storage space, ranging
from 20 to 200 square feet. They are normally administered by an on-
site caretaker, and they often have a limited assortment of material
handling equipment for rent. Besides their relative lack of expense, the
prime advantage of miniwarehouses is their close proximity and
convenience for renters. Distributors with overcapacity may get into
the business of turning their excess space into miniwarehouses.
DEVELOPING WAREHOUSE STRATEGIES
As the waves of change described above wash through the business environ-
ment of the 2000s, companies must develop comprehensive strategies that
will leverage and continually refocus the resources of their warehousing func-
tions to support the realization of both individual business and supply chain
objectives. Although most executive strategies are focused on marketing,
sales, and logistics, the sheer size of the asset and operational investment
necessary to run warehousing functions requires firms to closely define as
well the strategic role of warehousing in the organization. One warehousing
expert characterizes the warehousing function as "a business within a busi-
ness." Warehousing has its own distinct labor force, staff, accounting, man-
agement, and information system requirements that are unique from other
functional departments.
Normally, warehousing is structured as a service provider to sales and
production management and, in effect, "charges" the enterprise for the costs
incurred. Obviously, warehouse strategic planning involves more than just
building a warehouse, setting up storage racks, purchasing some material han-
dling equipment, and hiring staff. Nor, as has been pointed out, is it a static,
one-time activity. Instead, similar to other critical areas of the enterprise,
warehouse strategic planning and control is a continuous activity that must be
in alignment with overall organizational and customer service objectives.
STRATEGIC OVERVIEW
Before the warehouse planning process can begin, strategists must understand
the objectives of other enterprise functions. Planning decisions concerning
such elements as product, delivery, price, promotion, asset investment, and
costs made by marketing, sales, manufacturing, procurement, and finance will
WAREHOUSING 551
have a direct impact on the formulation of warehousing strategies. For

example, if a new marketing strategy is to offer customers a guaranteed 24-
hour order delivery cycle, warehouse management will need to explore the
capability of the warehousing function to respond to this goal. If enterprise
strategies are to be effectively executed, it is imperative that warehouse man-
agement be included as a full partner in the strategic planning process and
that the warehousing plan be closely integrated with the enterprise's other
functional business plans.
In addition to understanding their role in the company's strategic plan,
warehouse planners must also be apprised of the anticipated direction of the
marketplace and the supplier base. This function is directly the responsibility
of the marketing function that can deploy a variety of different techniques
from formal marketing surveys consisting of questionnaires , phone surveys,
to on-site interviews. Some of the questions posed to customer and suppliers
that will directly impact warehouse decisions are as follows:
What should be the strategy for using a combination of private, public,
and contract warehouses?
What should be the targeted warehouse utilizations?
How many warehouses should there be and what should be their type?
Should warehouse decisions be based on customer or product or both?
What new operational or marketing strategies have been formulated
that will require changes in current warehousing practices?
What new product lines are expected to be introduced and how will
they affect warehousing and delivery?
What changes to warehousing delivery and storage mechanisms, such
as equipment and information technologies , are being planned?
Are there any plans to open or close warehouses, and if so, in what
locations?
What plans are in place that will streamline the existing supply chain
warehousing configuration?
By conducting a comprehensive survey of those customers and suppliers that
account for the bulk of sales and procurement activities, warehouse planners
can develop a reasonably accurate profile of the directions being pursued gen-
erally by both groups. The patterns and objectives that emerge will signifi-
cantly assist in constructing warehousing strategies that aggressively address
marketplace trends while maintaining support for the overall objectives of the
enterprise [3].
Once a comprehensive understanding of the requirements arising from
marketing and supplier management is identified, a detailed strategy can be
defined describing the objectives of the three critical resource components of
the warehouse: storage space, material handling capacities, and personnel.

An effective storage space strategy consists of several facets. To begin with,
it entails calculating the resource capabilities of existing plant and highlights
possible requirements for leased or contracted space. Second, the storage
strategy must be based on a clear financial footing that details the cost of
maintaining and operating the storage space. Typically, warehouse carrying
cost can amount to anywhere from between $0.20 to $0.60 per cubic foot, and
can be even higher depending on location. A company not efficiently using
warehouse space could be incurring needless costs and decreasing overall
productivity.
Once warehouse storage resources have been defined, a strategy must also
be devised for the effective utilization or acquisition of material handling
equipment. Warehousing equipment can range anywhere from forklifts and
pickers, to automated conveyors and vehicles, dock facilities, and a variety of
computerized information workstations. When combined, these fixed assets
can account for a significant portion of the company's capital investment. In
addition to equipment, a comprehensive warehouse strategy cannot be com-
plete without planning for labor resources. Pickers, stockkeepers, packers,
shippers, management and other support personnel can amount to an
enormous current cost, accounting for over 50% of the company's entire
warehousing cost. Fashioning an effective labor strategy involves more than
just determining the necessary staffing levels: it also requires activating an
attitude of continuous operational improvement and total quality among the
warehouse staff targeted at the elimination of wastes found anywhere in
operations and the establishment of practices resulting in greater productivity,
mutually beneficial labor relations, and increased employee satisfaction.
Tompkins [4] succinctly summarizes the objectives pursued by a successful
warehouse strategy as follows:
Maximizing the effective use of space
Maximizing the efficient use of warehouse equipment
Maximizing the efficient use of labor
Maximizing the accessibility of all stock inventories
Maximizing the protection of all items from damage, spoilage, and
obsolescence.
DEVELOPING THE WAREHOUSE STRATEGIC PLAN
The warehouse strategic plan is directed at accomplishing two overall objec-

tives. The first is to align the resources of the warehouse with the enterprise's
long-term supply chain goals. A warehouse strategy cannot be developed in a
vacuum but can only have meaning in relation to and support of the strategies
WAREHOUSING 553
of the firm's other business functions . Examples of warehouse strategies

would be consolidating a national channel of satellite warehouses into a re-
gional distribution center, building new storage facilities or acquiring new
material handling equipment, and determining the percentage of warehousing
that should be owned and how much should be contracted from third parties.
Second, an effective strategy must forecast future company warehouse re-
quirements so that resources can be acquired in time to meet these require-
ments. Without such plans, the warehouse will be periodically subjected to
executing costly ad hoc solutions that are always detrimental to the overall
health of the enterpri se. A critical part of the strategy is the development of
realistic contingency plans. Contingency planning attempts to provide solu-
tions for possible circumstances beyond the control and estimates of strategic
planners. Without a comprehensive contingency plan, the warehouse strategy
risks being subjected to unanticipated problems for which there is no solution
and which will eventually render the warehouse strategy ineffectual.
Similar to other business areas, the warehouse strategy should be expressed
as a formal document detailing what goals are to be accomplished and how
they are to be attained over a given planning period. Each of the stated goals
should consist of: (1) statement of business requirements, (2) an inventory of
existing warehousing assets, (3) business justification for the acquisition of
any new warehousing equipment, (4) detailed description of new buildings,
material handling equipment, information technologies , and operations, in-
cluding diagrams or blue prints, (5) required support resources, (6) narrative
of organizational changes/impacts , (7) detailed implementation plan, and (8)
project capitalization and expected ROI. If possible, each goal should have a
detailed implementation plan. Besides establishing project timelines and
budgets, the plan should specify each activity, activity dependencies, and re-
sponsible roles. The plan should also include clear performance measure-
ments that can provide feedback to management indicating the relative suc-
cess or failure of the warehouse organization in attaining stated objectives.
Finally, an effective warehouse strategy should be bounded by a defined plan-
ning horizon. Most strategic plans are typically formulated in years, with a
minimum of a quarterly review . A strategic due date gives meaning to de-
tailed activities and provides the whole organization with a recognizable goal
to target their efforts.
Tompkins [5] feels that an effective methodology for developing a ware-
house strategy consists of the following seven steps:
1. Document existing warehouse operations. This step consists of two
separate elements. The first is concerned with documenting existing
warehouse facilities, cataloging warehouse equipment and capacities,
and establishing labor resources by department. The objective is to
confirm the nature of these resources and an accurate assessment of
their estimated capacities . The second part of this step involves perfor-
ming an operations diagnostic, first on each resource and then on the
general information and material flows in the entire warehouse. A
complete business diagnostics will reveal areas where actual practice
deviates from the established standard procedure.
2. Determine and document the warehouse storage and throughput re-
quirements over the specified planning horizon. This step requires
planners to forecast which products and in what volumes is anticipated
to be stocked in the warehouse over the planning horizon. In devel-
oping the estimate, planners must be specific as to the impact on
existing material handling equipment and available storage space.
Ideally, the product forecast should be in terms of unit weight and/or
cube to assist in warehouse analysis.
3. Identify and document deficiencies in existing warehouse operations.
One of the outputs from the operations diagnostics described in Step 1
is documentation of areas of waste and redundancy that inhibit produc -
tivity . Once these processes have been identified, a project can be.initi-
ated to eliminate them . However, operations diagnostics might also re-
veal that critical activities are being performed inefficiently due to a
lack of equipment or labor resources. Once documented, warehouse
management can use the findings as a basis for the acquisition of the
necessary capacity.
4. Identify and document alternative warehouseplans. Once deficiencies
in storage space, equipment, or labor have been identified in Step 3,
management must develop a plan that satisfies requirements by deter-
mining possible alternatives. One solution might be to expand capa-
cities by acquiring additional resources. Another might be to explore
the possibility of using rented equipment, temporary help, or public
storage facilities .
5. Evaluate alternative warehouse plans. Once alternative warehouse
plans have been formulated, each must undergo rigorous financial
analysis. Among the financial measurement used are capitalization,
cost/benefit justification, after-tax current asset evaluation, and return
on investment. In addition to an economic analysis, the proposed plans
must also be modeled against business, product, and marketplace ob-
jectives detailed in the business plan.
6. Select the recommended solution. Based on the results of the financial
and business evaluation, the desired plan will be selected. These plans
will, in tum, be mapped according to the five elements of the strategic
planning process described above. Plans will consist of detailed de-
scriptions of proposed warehouse storage, equipment, personnel, and
operating standards objectives for the forthcoming planning horizon .
WAREHOUSING 555
7. Update the warehouse strategic plan . Like all other corporate and
business function strategies, the warehouse strategy is not a static, but
rather a dynamic document that will change as the circumstances of the
marketplace and the competition change. Because it is founded on
aggregate forecasts of the future, the warehouse strategy will always
require updating as more accurate information about products, cus-
tomers, and competitors is revealed. As such, warehouse planners must
meet at least yearly, preferably quarterly, to review the viability of the
strategic plan and to weigh the impact of future requirements.
THE PRIVATE, PUBLIC, AND CONTRACT WAREHOUSE DECISION
One of the most critical components of the warehouse strategy is determining

what the mix should be between private, public, and contract warehousing.
In may ways this decision is reminiscent of the make-buy conundrum.
Should the company spend the capital resources to have its own warehousing
facilities and all the synergies and conveniences ownership provides, or
should the firm outsource the function to public and contract warehouses?
And again, how much control over such a critical logistics area do companies
want to surrender to third parties? Whether private or public, either decision
involves certain definite risks in handling a wide-range of issues from the
financial well-being to how customers grappling with the realities of
satisfying customer demand.
While there are some industry sectors, particularly in the e-business
environment, that are "virtual" companies and exclusively use public ware-
housing, most manufacturers and distributors maintain to some extent their
own warehouses . The objective of these facilities is to ensure that the com-
pany has the capacity to provide inventories for normal production and cus-
tomer demand. For the most part, full utilization of the typical private ware-
house throughout the year is a remote possibility. According to Bowersox
and Close [6], most warehouses will in fact be fully utilized only between 75
and 85 percent of the time. Thus 25 percent of the time or less, the capacities
of most private warehouses should be sufficient to handle inventory handling
requirements .
The problem occurs, however, when certain peak periods require ware-
housing functions that exceed available private warehouse capacities. Such
oc-casions could be driven by events such as product seasonality, new prod-
uct introduction, promotions, temporary regional demand requirements, or
planned plant shut-down . In solving this problem warehouse planners will
have to devise a strategy that seeks to utilize a combination of private, public,
and contract facilities . For example, it may be decided that temporary ware-
housing should be contracted to provide coverage during a peak season. Or

again, the strategy may be to utilize private warehouses as distribution hubs,
with public or contract warehouses used to service regional requirements. A
final example may find the use of private warehousing to be more cost
effective when the distribution volume is great enough, but will use public
and contract services in other markets if they are the least-cost option.
With the rise of the Internet economy and the dramatic shrinkages in prod-
uct and delivery life cycles, companies have over the past decade been turn-
ing to the use of public warehousing to provide a level of service value un-
reachable through the exclusive use of private warehousing. Two critical
warehousing attributes come to mind: flexibility and synergies . Require-
ments for the quick delivery of often short-cycle products have placed a pre-
mium on the flexibility of companies to bring goods to the marketplace as
quickly as possible. Outsourcing permits companies to quickly adjust the
number and location of channel warehouses to meet all forms of demand. In
addition, public facilities may offer rapid access to material handling or
information management tools required at short notice. Public warehousing
also provides companies with the opportunity to leverage synergy benefits.
By contracting with public facilities that service a wide industry, such as
grocery or consumer goods, companies can utilize their expertise to decrease
transportation and material handling costs while leveraging a high level of
flexibility and responsiveness.
COMPONENTS OF THE COMPLETED WAREHOUSE STRATEGY
The goal of the warehouse strategy is to communicate in clear and unequiv-

ocal terms the objectives to be pursued by the warehouse. Often the ware-
house function is treated as if it were an outside resource that can be opti-
mized to meet with a minimum of planning the ever-changing requirements of
supply chain sales and service. Such a viewpoint results in managers con-
sidering a company's warehousing capabilities as if they were a variable
resource that instantly expands or contracts to meet variances occurring as a
result of changes in the marketplace or product supply. In such an environ-
ment, warehouse managers, whose goals are not well defined, are condemned
to an endless and non-productive game of attempting to please everyone in
the enterprise with the result that they please no one.
An effective warehouse strategy needs to be accompanied by a warehouse
charter that has arisen out of the strategic planning process and defines in
detail the content of the often opposing poles of warehouse operating ef-
ficiency and customer service. The warehouse charter should contain the fol-
lowing elements:
WAREHOUSING 557
1. Clear statement of organizational and reporting structures

2. Performance metrics detailing targeted operating objectives
3. Authority to acquire capital equipment
4. Ability of management to hire, fire, and develop staff
5. Valid operating standards for all warehouse activities
6. Valid space utilization standards and performance measurements for
products and storage facilities
7. Clear service standards and performance measurements for all ware-
house functions
The warehouse charter is the document that ensures that warehouse objec-
tives are in alignment with both detailed strategies for marketing, sales, pro-
curement, traffic, and accounting and well as general supply chain objectives.
The warehousing function is a unique part of the company, charged with the
task of managing a complex set of inventory and delivery management activi-
ties all of which will determine the degree of success of the plans formulated
by upstream departments. The more the warehouse can be managed to the
targets established in the warehouse strategy, the more dependable and
efficient the warehouse will be. Conversely, as poor enterprise planning and
communication increase knee-jerk reactions on the part of the warehouse, the
less performance targets and efficiencies will be achieved [7].
THE WAREHOUSE MANAGEMENT PROCESS
The development of effective warehousing strategies enables supply chain

planners to successfully execute warehouse management activities. For most
companies, warehousing involves a number of functions ranging from prod-
uct receipt to order shipment. In responding to these activities, warehouse
managers must find answers to such questions as follows:
What size should the warehouse be to respond to desired customer
service levels?
How many warehouses should there be in the channel to handle ex-
pected demand?
What is the cost of running each warehouse in the channel?
How many employees are required to efficiently run each warehouse?
What capacities are required of equipment to handle expected demand
volumes?
What should stock receiving, put-away and picking rates be?
Are packing and docking capacities sufficient to achieve shipment
targets?
Are current information systems capable of providing each warehouse
with the necessary data on a timely and accurate basis?
What should be the performance measurements to ensure each ware-

house is achieving optimal efficiency and productivity?
Responding effectively to these and other questions is the objective of the
warehouse management process. As illustrated in Figure 11.3, this process
consists of four major activities that must be clearly defined if the warehouse
is to work effectively and efficiently.
(
l
Lo gistics Plan
I
... Processin g
tandards
1-+
Receivin g
lind
hipp ing
1-+
Order
Pick ing -
Perform an ce
Meas ure me nt
~
Busin ess Plan ]
FIGURE 11.3 Warehouse management process.
The first activity in the warehouse management process is determining the

process standards for labor, equipment, and storage performance. Operation-
al standards are the pillars of warehouse management and they enable the en-
terprise to chart in detail overall warehouse processing performance and pro-
ductivity. Historically, operations standards have been broken down into
three broad categories, the sum of which constitutes the statement of ware-
house capacity. Efficiency measures how well actual activities were perfor-
med against the standard times and costs assigned to perform them. For ex-
ample, a picking standard can be defined as the actual number of lines picked
in an hour's time against how many lines should have been picked (Figure
11.4). Utilization attempts to measure how much of a warehouse resource
was actually used to perform a task against the standard capacity that is avail-
able. Comparing the number of hours in a day a picking team actually has
available against the number of attendance hours provides an example (Figure
11.5). The standard capacity of an operation can be calculated by combining
the number of operators, number of shifts, standard available working hours,
the utilization and the efficiency (Figure 11.6).
WAREHOUSING 559
1. Standard Hours per Bin Picker (6 person crew)

Standard available hours = 6 Pickers x 7 hrs = 42 hrs per day
Standard lines p icked p er hour p er picker = 60 lines
Standard lines picked (per day) = 42 x 60 = 2,520.
II. Demonstrated Picking (per day)
2,520 Lines picked in 39 hours
III. Picking Efficiency Calculation (Picking Crew)
Std hrs per day 42

Eff = ------------------- ..- --- ----------
Demonstrated hrs 39
FIGURE 11.4 Efficiency calculation.
Warehouse standards can be defined using a number of methods. The first ,

histori cal standards, is a technique whereby a firm will calculate an average
time to perform activities by compiling actual time past work records for a
de signated period. The disadvantage of using this technique is that standards
I. Capacity Available for Picking Team

Capacity = # Pickers x Daily Hours Available
Capacity = 6 x 7 hrs/per picker = 42 hours
II. Demonstrated Daily Hours Used

Total Hours Used = 40 hours
III. Utilization Calculation
Demonstrated Hours 40
U = -------- --
Available Hours 42
FIGURE 11.5 Utilization calculation.
are compiled from actual times recorded to perform activities as opposed to

the time it should have taken. If the warehouse has poor work habits, these
subpar practices will become the standard. Another method is to use pre-
determined standards published by professional organizations like the U.S.
Department of Defense or WERe . These measurements suffer from the same
deficiencies as historical standards. A third method consists in a firm perfor-
ming its own time and work study analysis and determining standards based
on the results. By observing and recording the time and motion required to
perform tasks, a series of detailed performance standards can be determined.
The final method that can be used to develop warehouse standards is through
the use of multiple regression analysis. This technique seeks to calculate a
I. Data Elements (Picking Team of 6)

Shifts = 2
Picking Team = 6 pickers
Hours Available = 7 hrs
Efficiency = 108%
Utilization = 95%
II. Picking Team Calculation

Cap = 2 x 6 x 7 x 95% x 108% = 86 hrs available per day
FIGURE 11.6 Picking team capacity calculation.
work standard by combining actual work content with the associated values
impacting the activity. For example, the time required to pick a given quan-
tity of a given item is not a straight equation but one that utilizes a weighing
factor such as the item weight, number of cases, transport capacities and other
issues. A simple example is provided in Figure 11.7.
Standard = 60 lines in I hour
Ifweight is greater than 200 lbs x .10 hr
If cube is greater than 50 ft x .05 hr
Ifpicking area exceeds 250 ft x .25 hr
If material is manually picked x .15 hr
Utilization = 95%
FIGURE 11.7 Simple multiple regression technique .
Operational and resource capacity standards are necessary for the smooth
and efficient functioning of the warehouse. Effective standards enable the
warehouse to execute the following critical functions:
1. Resource availability. Warehouse standards provide managers with
metrics detailing the capacities of labor, equipment, and facilities.
These capacity standards form the basis for all subsequent warehouse
planning.
2. Scheduling. The ability to schedule warehouse resources is critical to
actualizing performance targets. Effective scheduling begins by estab-
lishing the standard capacity resource profiles of the various opera-
tional and storage elements in the warehouse. Next, the resource re-
quirements necessary to accomplish activities such as receiving, stock
put-away, picking, packing, and shipping need to be determined. Once
these elements are known, warehouse management can then develop an
everyday schedule designed to match resources with warehouse re-
quirements. For example, if an order filler can pick sixty lines an hour
and the projected load of lines to be picked for a seven hour day equals
4200, the production manager must schedule ten pickers to be avaiI-
WAREHOUSING 561
able. Schedules can also assist warehouse managers plan for work
backlog. By calculating the resources necessary to satisfy a backlog
condition , a plan can be formulated to increase capacities by scheduling
overtime, using part-time workers, or outsourcing alternatives. Com-
parable steps would be taken to handle capacity constraints caused by
seasonality.
3. Problem identifi cation. The availability of detailed standards can
significantly assist warehouse managers improve productivity.
Standards will pinpoint efficiency and utilization problems in the
warehouse and permit managers to redistribute resources to meet
requirements . The real focus of problem identification is to seek out
the source of why the problem is occurring in the first place, and then
to eliminate it.
4. Continuous improvement. Standards also form the basis for all quality
programs targeted at continuous improvement. The goal is to remove
all forms of waste in the process. Once standards have been defined,
management can decrease the standard by a given percentage and see
where the bottleneck develops. The object then is to solve the
bottleneck, revise the standard, and begin the process all over again.
Continuous improvement is the most effective way to reduce
warehouse costs while maintaining the same level of service.
5. Costing. The selling price of a product can be generally defined as cost
plus a percent margin over the cost. The cost, in tum, can be broken
down into the cost of product acquisition , direct labor associated with
material movement , and fixed and variable overheads associated with a
wide range of support operations and other burdened costs. When
deter-mining selling prices, it is absolutely necessary that the firm
know the exact content of operations cost. When the exact cost is
uncertain, companies run the risk of retaining less profit than planned
or missing opportunities to achieve price leadership opportunities in the
marketplace.
RECEIVING AND SHIPPING FUNCTIONS
The receipt and shipment of products define the input and output boundaries
of warehouse activities. Warehousing's accountability for product storage
and record accuracy begins when products are received; this accountability
ends when those products are shipped to the customer. Understanding each
of these functions can perhaps best be achieved by defining and examining
the operational activities of each. Receiving has been defined as
that activity concerned with the orderly receipt of all materials coming into the
warehouse, the necessary activities to ensure that the quantity and quality of
such materials are as ordered, and the disbursement of the materials to the
organizational functions requiring them.
The primary objectives of the receiving function can be described as follows:

Safe and efficient unloading of carriers
Prompt and accurate processing of receipts
Maintenance of accurate records detailing receiving activities
Timely disbursement of receipts to stocking locations in preparation for
picking and shipping [8].
In order to ensure receiving accuracy and the timely processing of neces-
sary documentation, it is imperative that the receiving process be formalized.
A conventional receiving flow is illustrated in Figure 11.8. Even before the
Delive ry
Plann ing
.-
Product
Delivery And

Unload ing
Count, Inspect,
Pr ocess

Documentation
Disp osition
.-
I
.
Return to
crap
Q To
.
upplicr Inspection tock
Material
Review
Board
FIGURE 11.8 Receiving flow.

shipment has left the supplier, it is receiving's responsibility, with pur-
chasing's assistance, to plan for the delivery by determining the arrival date
and time, the type and quantity of material to be received, the availability of
docking and material handling capacities, and preparation of staging areas.
WAREHOUSING 563
After the carrier arrives and is unloaded, receiving's next step is to unpack,
identify , sort, inspect , count, and verify receipts against purchase order and
receiving documentation. Following this step, receiving should then post the
receipt. For most companies, this is done through a computer terminal which
automatically marks the purchase order as completed, posts the inventory to
stock, records quality control inspection data and supplier performance statis-
tics, and provides , if necessary, for the scrap or return to supplier of the re-
ceipt. Often bar code reading equipment is utilized that significantly assists
in item and quantity identification. Included is the completion of docu-
mentation noting shortages, overages , and damaged goods. Finally, product
is then disbursed to the appropriate stocking or holding area.
In contrast to receiving, shipping can be defined as
those activities performed to ensure the accurate and damage free packaging,
marking, weighing and loading of finished goods, raw materials, and com-
ponents in response to customer order requirements in as cost effective and as
expeditious a manner as possible.
The primary objectives of shipping are as follows:

Efficient receipt and handling of picked orders
Prompt and accurate checking of order quantities and ship-to infor-
mation
Efficient packaging/packing of orders in a manner that will prevent
damage, reduce handling costs, and facilitate delivery
Selection of a carrier that will best deliver the order at the minimum
cost
Development of an effective schedule of docking and loading facilities
that eliminates outbound shipment bottlenecks and optimizes labor and
equipment availabilities
Maintenance of shipping documentation that expedites order delivery
and permits performance measurement
As illustrated in Figure 11.9, the first step is the selection and scheduling
of the common and private carriers to be used to transport products to the
customer. There are a multitude of types of carriers, ranging from couriers
and taxicabs to barges, the U.S. Postal Service, and United Parcel Service
(UPS). In selecting carriers, key attributes such as speed of delivery, schedu-
ling flexibility, service consistency, security, reliability, electronic tracing,
and cooperation should be considered. The second step is to design an ef-
ficient picked goods staging area. Such an area should facilitate the storage
of picked orders and promote the timely and accurate selection of orders for
packaging/packing. Once the order has been packed, another staging area is
needed to store orders for loading . Included in this step is the final quality
check of the order, processing of the shipment record, and the preparation of
the necessary packing lists, bills of lading, and documents specifying any
special marking (bar codes and hazardous materials labels), loading, and de-
livery information. The next step involves the physical loading of orders on
to the carrier, acknowledgment by the driver of accountability, and sometimes
the sealing of the storage vehicle. Finally, shipping documentation is dis-
bursed or entered into the computer for delivery follow-up and performance
measurement.
Carrier
election
...
Order Ord er
Picking f-+ Staging
...
Packaging!
Packing
...
Order Packing List
---+ Bill of Lading
Posting
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Documentation
Distribution
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FIGURE 11 .9 Shipping flow.
During the past several years, receiving and shipping functions have been
profoundly impacted by changes in equipment and management philosophies.
The first of these changes has occurred with the development of longer, wider
trailers. Due to changes in federal regulations, permissible trailer width
capacity has increased from 96 to l02 inches and length from 45 to 48 feet.
These new dimensions might require some warehouses to increase their
delivery areas and storage yards. The growing use of JIT and cross-docking
has also reoriented warehousing away from a traditional concern with picking
and storage and toward increased attention to facilitating receiving and
shipping activities to achieve maximum product flow through. A third area
can be found in the implementation of computers, bar code scanners, radio
frequency (RF), wireless technologies , and vehicle tracking networks. These
WAREHOUSING 565
technology tools have allowed for improvements in document preparation,

product identification, and work (labor and equipment) scheduling. The final
trend changing receiving and shipping is the application of new unloading
and loading equipment, such as dock levers, automatic unloading systems,
mobile warehouse equipment, and conveyor equipment. Equipment changes
have resulted in increasing the flexibility of receiving and shipping depart-
ments to handle a wide variety of transportation loads and improving safety,
product flow, and warehouse labor productivity.
ORDER PICKING
The third step in the warehouse management process is order picking and
management. The picking of inventory to fill customer and manufacturing
order requirements is perhaps the most important function of warehousing.
The enterprise stocks finished goods to be able to respond to marketplace
demand and components and raw materials to ensure manufacturing always
has the necessary inventory to build products. It is the responsibility of the
warehouse to fill customer and manufacturing orders within the smallest
cycle time possible with perfect accuracy. For the most part, order picking is
the most labor-intensive and expensive of all warehouse functions. Although
automation has greatly assisted in shrinking direct labor content, order
picking largely remains a manual activity, requiring significant planning,
supervising, quality review, computerized support tools, and management
direction. The failure to effectively pick orders can have a dramatic effect on
the whole enterprise. For example, it has been estimated that the cost of an
inaccurately filled customer order is $10 to $60 not to mention the potential
of losing customers due to poor service. In addition, order processing and
delivery that is not competitive places the firm at risk of losing business to
more efficiently organized rivals.
Actual order picking can be described as taking three forms. In the first,
manual picking, the picking operation is performed by teams that either walk
or operate from a vehicle and pick inventory as determined by paper picking
lists or computerized visual displays. The second type of picking, automated
picking, utilizes computer-controlled systems to retrieve inventory from each
picking location, in the quantity and at the time specified to meet order
demand. The third type of picking consists of a combination of manual and
automated picking driven by the nature of demand, the product, and the
availability of picking equipment. In addition, there are two order picking
routing patterns. The first, nonsequential, is characterized by the fact that
picking routes are completely random and determined by the random
arrangement of the order lines. This method is not recommended. The
second, sequential, is characterized by the use of several sequencing methods

that seek to increase picker productivity, reduce picking time, and reduce
picker fatigue by routing the picker level by level down a storage aisle,
improve picking location density, and ensure fast-moving products are up
front and close to shipping. Some sequential routing techniques are loop ,
horseshoe, Z, block, stitch, vertical or horizontal, and zone.
Regardless of the automation and the picking technique, most order-
picking operations are governed by the three methods detailed below.
Unit Load. In this method, the nature of the product permits the picker
to fill the order requirement by pulling a full pallet/container load from
stock. An example would be a refrigerator distributor who stocks each
product one-per-pallet. This method of picking lends itself best to auto-
mated forms of picking.
Case Lot. Often products are pulled to fill orders in full cases only.
Case-lot quantities can be stored on a shelf or on a pallet, depending on
the order point and replenishment quantities. Although this method can
be automated, for the most part it requires manual picking.
Broken Case. This method is used by companies that allow picking
quantities in less than full case-lot quantities. Again, this method of
picking can be done from a shelf, pallet, or other form of storage unit.
This method is very difficult to automate and is almost exclusively a
manual operation.
Due to the variances in packaging, product characteristics, required quan-
tities, space availability, and on-hand quantities, warehouses often use a hy-
brid of these methods.
In addition to the method, the way the picking order is controlled will have
an impact on warehouse operations. When discrete order picking is used,
pickers must fill all the open lines of an order before the next order is begun.
Often this means that the filler must pass through multiple storage zones to
complete the order. The advantage of discrete order picking is that it main-
tains order integrity throughout the picking process, works well when the
number of items to be picked is small, is simple to execute and easy to
control, eliminates excess handling, provides fast customer service, and
facilitates quality auditing and establishes direct fill responsibility.
Disadvantages include the time required for the picker to traverse the entirety
of the warehouse, increasing inefficiency as order size grows, and require-
ments for a large order filling staff. In contrast, when batch picking is used,
order requirements are aggregated by product, the summary quantity of the
product withdrawn, and the pick located at a consolidation area . In the final
step, the discrete identity of the order is reassembled in the consolidation area
and then shipped to the customer or moved to the production line . The
WAREHOUSING 567
advantages to batch picking are that it reduces travel and fill times to pick
individual products, permits volume picking from bulk storage, and improves
supervision by concentrating order completion at the consolidation point.
Disadvantages include double handling and sorting in the consolidation area,
the allocation of space and labor for the consolidation area, loss of order inte-
grity until consolidation occurs, and difficulty in tracing primary account-
ability for order line items picked.
A variation on the above methods is the use of zone picking. In this tech-
nique, picking is oriented around families of products inventoried in specific
storage zones. Basically, order pickers are printed at the zone where order
fillers pick the zone complete . Three possible zone configurations can be
utilized :
Serial Zones. In a fixed-zone picking route, order pickers must follow
a prescribed zone sequence. As an order is completed in one zone it is
conveyed to the successor zone by use of a cart or conveyor system.
Parallel Zones. In a variable-zone picking route, the filler picks from
independent zones, located, for example, on either side of the picking
aisle. The picker subsequently can choose to fill orders in a sequence
of zones. Finally, the a consolidation point can be used to reassemble
the order for shipment for movement to the manufacturing line.
Serial/Parallel Zones. This arrangement permits the existence of num-
ber of serial zones arranged in a parallel configuration.
The advantages of using zone picking techniques are that they establish good
work standards, increase picking accuracy and productivity, reduce damage
and errors, and increase shipping container utilization due to close picker
familiarity with zone specific products . Disadvantages are that the tech-
niques require high-volume picking, increase the requirement for manage-
ment control, and interzone queues slow down other pickers. Zone picking is
especially useful for distributors who normally pick products in family
groups. It is particularly applicable to storage areas utilizing flow racks.
Often post-order-picking activities involve picking location replenishment.
This function is used when products are stored in fixed forward locations
with floating reserves. Normally, each product in a forward location has
some form of minimum quantity that, once triggered, alerts the planning sys-
tem. Modem computer systems not only keep track of inventory levels but
also generate a picker that can be used by stock personnel to retrieve reserve
product and move it to the assigned forward location. Replenishment ac-
tivities include picking the required quantity of material from the reserve lo-
cation on schedule, transporting it to the proper forward location, and po-
sitioning it in the pick location.
In designing an effective picking system, warehouse management must

take into consideration a number of key factors. One of the most important is
how the stock location system has been defined. Is the warehouse arranged
by fixed location, random storage, fixed forward locations resupplied by a re-
serve stored in bulk locations, or a combination of methods? Another key
factor is fitting the picking system to meet customer-quoted lead times. Be-
sides these factors, another surrounds the acquisition of picking equipment.
New types of storage racks or bins, construction of mezzanines, picker ve-
hicles, carrousels , conveyors, computer-controlled stacker cranes, and a host
of other equipment can impact picking system design. Before embarking on a
new picking system, warehouse managers must thoroughly research its
impact on the organization, costs of equipment and labor, and a detailed
implementation program. In any case, a new picking system must always be
focused on cutting wastes in the process while improving picking accuracies.
The final step in the warehouse management process is establishing detailed

performance measurements. Warehouse performance metrics have three ob-
jectives:
1. They enable management to formulate a clear, quantitative statement of
the performance standards to be achieved by the warehouse. These
standards can then be used as a benchmark guiding daily activity ex-
ecution and continuous improvement.
2. They enable managers to chart how effectively warehouse activities are
being performed to standard. Because the rest of the organization
depends on the warehouse to execute receiving, storing, picking, and
shipping functions up to stated efficiency targets, performance mea-
sures demonstrate the degree to which the warehouse is responding to
enterprise operational needs.
3. They assist managers and associates in pinpointing problems that in-
hibit productivity so that constructive steps can be taken to eliminate
the problem from reoccurring.
Performance measurements provide companies with a means to plan and con-
trol the significant variances experienced by the warehouse. The randomness
of customer demand, customer service commitments, rush shipments, special
marking or packaging, equipment capacities, the environment, and a host of
other factors can disrupt normal throughput and require detailed planning and
control if the warehouse is to remain productive.
Performance measurement programs work best when designed as a closed-
loop system. Actual work is reported against the performance method, and
WAREHOUSING 569
the input and output is analyzed. The results can then be used to enable an
improvement initiative , which then communicates directly into work planning
and scheduling. Whether a change in the standard has occurred or not, this
standard needs to be communicated to warehouse employees as a guide to
subsequent work activity. For a performance measurements system to func-
tion properly , it must be valid, accurate, complete, cost-effective, and timely.
Without these components , the measurements system will generate mis-
leading data and cause managers to formulate false conclusions and execute
invalid corrective actions.
There are essentially five warehouse performance measurements. The
first, throughput, refers to the volume of product storage and retrieval trans-
actions that can be accomplished in a given unit of time. A particular perfor-
mance measurement might be the percentage of received pallets that can be
put away in a day's time. If the standard was set at 98%, then performance
metrics could be calculated by dividing the number of actual pallets put away
against the standard. Other possible throughput measurements are deliveries
unloaded, receipts checked in, orders picked, orders packed, and orders
loaded. The next two metrics, order filling and shipp ing accuracy are deter-
mined by calculating the ratio of actual work outputs to standards. Order fil-
ling can be based on a number of criteria such as lines filled without error, or-
ders filled without error, and orders filled on time. Shipping accuracy can be
determined by comparing lines packed accurately, total orders packed com-
pletely, orders packed and shipped on time, and incidence of packing damage.
As opposed to the previous measurements, the third critical warehouse
metric, inventory record accuracy, is more difficult to measure. Because of
the sheer number of products to control and the size of the warehouse, en-
suring inventory accuracy is a full-time role in many firms. The traditional
approach is to take a year-end physical inventory. Except for the compilation
of accounting measurements, however, this method has no value, and should
be replaced by cycle counting. As detailed in Chapter 5, cycle counting
methods not only are essential for maintaining record accuracy, but of more
importance, they provide managers with a means of isolating errors and de-
vising the appropriate action to be taken to eliminate the error from reoccur-
ring. In determining record accuracy, the following formula should be used:
Physical count - Record balance x 100.
Inventory accuracy =
Physical count
Another possible method would be to compile inventory accuracy based on a

predetermined accuracy target. The formula for this method would be
# of items at or exceeding target
Inventory accuracy = x 100.
Total number of items
The final warehouse performance area focuses on storage utilization.

Many companies neglect to analyze storage space, assuming that plant and
equipment are fixed assets and, therefore, the responsibility of accounting.
However, as Jenkins points out [9], the burdened cost of one warehouse em-
ployee is roughly equivalent to the cost of leasing 10,000 square feet of stor-
age. As such, metrics that assist managers to effectively utilize and evaluate
storage is a critical part of overall warehouse performance. The first step in
defining storage utilization is to define storage standards. This can be done
easily by noting the various types of storage in the warehouse, and then calcu-
lating the total capacity available by type and in total. A commonly used
measurement unit is cubic feet. As an example, one storage type consists of
shelf racks four feet high, four feet deep and eight feet long. The available
cube of this space would be 128 cubic feet (4x4x8). The next step would be
to determine the storage requirements of every product in the stockable in-
ventory by calculating the cubic space required for the stocking unit of mea-
sure multiplied by the total inventory storage requirement. By matching ag-
gregate storage requirements to capacities, planners can determine the per-
centage of warehouse utilization. In addition, storage metrics can assist man-
agers to review existing procedures, material handling, and storage types with
an eye toward optimizing the warehouse by developing new storage tech-
niques as well as rearranging current designs.
The success of warehouse performance measurements depends on the same
principles that characterize measurements in other enterprise functions.
Effective warehouse measurements include the following principles:
1. Simplicity. Because performance metrics are really targeted at ware-
house employees, they should be clear and easy to understand. Every-
one should know why the measurements exist, how the measurements
are calculated, what the results indicate, and what their role in
achieving performance targets is.
2. Goal oriented. Performance measurements should not only chart the
performance of each individual warehouse department and the ware-
house as a whole, but they should also clearly illustrate the goals and
progress toward goals. This principle provides visual evidence for
everyone in the warehouse on how well performance standards are
being met. Figure 11.10 provides an example of a graph illustrating on-
time delivery.
3. Standards consistency. Constant changes in measurements destroy
standards integrity and render performance goals meaningless. When
too many modifications are made, warehouse associates may feel they
are trying to hit a moving target that changes as the whims of manage-
ment change. Such distrust will negate the purpose for performance
measurement.
WAREHOUSING 571
Category Month (Apr.) Avg. 12MonthAvg. Year-to-Date

Orders Shipped 1,985 1,992 1,981
Avg. Lines perOrder 3 4 4
Total Items perOrder 5,955 7,968 7,924
Orders Shipped onTime 1,883 1,880 1,795
Performance 95% 94% 90.5%
______oil__
M thl!y__P~rf
__~r:.n:!C!'!c:.-:. _
- . Target 96%
95%
94%
93%
92%
Jan Feb Ma r Apr
FIGURE 11.10 Warehouse reporting.

4. Punishment. Performance measurements should never be used as a
basis to discipline employees. Effective measurements depend on em-
ployee cooperation. When measurements are used as a source of pun-
ishment, operators will always find ways to report data that portrays the
information as favorable when , in reality, the metrics are unfavorable.
5. Continuous improvement. The best performance measurements will
provide warehouse managers and associates with quantifiable infor-
mation to assist in the development of plant , procedures, processes, and
policies that will lead to continuous elimination of wastes and impede-
ments to productivity.
TRENDS IN MODERN WAREHOUSING
Similar to other aspects of manufacturing and distributing at the dawn of the

twenty-first century, the science and practice of warehousing has undergone
fundamental change. The ongoing economic recession, anti-terrorist legisla-
tion and fears about security, continued globalization, and the enabling power
of the Internet have blurred long-standing principles and changed the purpose
of the warehousing function. In the past, warehousing's prime role was to
serve as a buffer between supply and demand. Through intricate structures of
producers, wholesalers, and retailers, goods were stockpiled at various points
in the channel network to service customers and provide buffer supplies
against seasonality, promotions, lot-size production, transportation ef-
ficiencies, and variances in marketplace demand. The goal of the warehouse
channel structure was to have product available to the customer at the right
place and time, and at an appropriate trade-off cost to channel partners.
Today's challenges are now requiring fundamental revision of these long-

standing perceptions of the role and function of warehousing. In responding
to these new operational realities, a whole new set of questions must be an-
swered by logistics management:
Has the firm developed a comprehensive warehousing strategy?
Has this strategy been integrated with the goals of the supply chain sys-
tems and technologies in which they participate?
Should the number of warehouses in the channel be expanded or re-
duced?
What should be the mix of public and private warehouses?
How are supplier relations impacting warehouse requirements?
What opportunities are available for international warehousing?
What opportunities for customer service and cost reduction are being
offered by new information technologies like the Internet and automatic
identification?
How is the level of inventory in the pipeline to be continually de-
creased while customer service is continually increased?
Enterprises capable of finding answers to these questions and integrating
them with effective warehousing strategies will be those that will maintain
and expand competitive advantage. In order to better understand ware-
housing in the 2000s, it will perhaps be helpful to divide them into three
groups: nature of warehousing, technology applications, and channel al-
liances and partnerships.
NATURE OF MODERN WAREHOUSING
A preoccupation with operational and current asset costs is expected to re-

main as the critical focal point of warehousing in the twenty-first century.
During the mid-1990s it was projected that the implementation of Lean con-
cepts, the subsequent streamlining of operational procedures, and the appli-
cation of new technologies would result in a decrease in warehouse cost.
Overall, however, the changes brought about by technologies and manage-
ment practices designed to cut warehousing costs have been generally offset
by requirements of dealing with demand and supply in the Internet Age.
Warehouse costs have remained fairly constant over the past nine years and
reflect approximately the same percentage of total logistics costs. For ex-
ample, the total cost of warehousing in 1993 was set at $60 billion and
constituted about 9 percent of total logistics costs for that year. In 1996, the
figures stood at $67 billion and reflected an 8.4% of total logistics costs. In
2001, the figures stood at $78 billion and accounted for 8 percent of total
logistics costs [10].
WAREHOUSING 573
While it is true that companies of all types believe that large inventories
are not only unnecessary but are actually detrimental to the health of the en-
terprise, market and geopolictal forces have been requiring companies to
stock more inventory and not less. At the end of the 1990s managers, analy-
sts and consultant alike strove hard to pursue Lean inventory strategies and
consolidate distribution centers in an effort to cut costs and accelerate chan-
nel throughput. In reality, warehouse space stands at an all time high and, ac-
cording to the Colography Group "there's more square footage of warehouse
space than at any point in U.S history." This sentiment is corroborated by
public warehouse provider ProLogis that showed in a study that warehouse
space increased to 3.4 billion square feet in 2002, up from some 3.1 billion in
2000 [11].
Best Buy, the U.S. largest consumer Midwest. In addition, it operates

electronics retailer, has gone to great several other DCs dedicated to
lengths to minimize response time large-ticket items such as appliances
when a need is identified in a store. and big-screen TVs where deliveries
Although it is a national retailer, it are cross-docked, and sent to stores
relies heavily on a regional distri- or directly to the customer.
bution strategy. It has strategically
positioned six general merchandize To guarantee delivery, Best Buy
distribution centers around the uses a dedicated fleet through a
country, with a seventh to open in long-term agreement with a truck-
the first half of 2003, to provide load (TL) carrier that picks up
direct service to its chain of 538 product from suppliers and delivers
stores, as well as retail outlets Sam to stores on a twice-weekly basis. It
Goody, Suncoast, and Media Play. will also use contract carriers as
needed or to service a select market.
The company also distributes media
such as CDs and DVDs from a dedi- Source: Jedd, Marcia, "The regional
cated entertainment facility in the Difference," DC Velocity, I, 1,
(2003), pp. 62-65.
Several reasons can be shown for this slightly upward trend in warehouse
space and cost. One is the threat to inventory supplies caused by such factors
as the possibility of terrorist attacks on supply lines and the resulting signify-
cant increase in lead times due to the growing complexity of security, cus-
toms, and inspection requirements. Other events such as the U.S. West coast
dock strike in 2002 and the outbreaks of SARS have shown the fragility of
JIT/Lean practices. Both factors have forced logistics managers to replace a
strategy dependent on large consolidation warehouses with the deployment of

a greater number of much smaller regional distribution centers that are much
closer to the customer. Another factor is the growing popularity of distribu-
tion "pull" philosophies whereby stock replenishment is triggered by field de-
mand, rather than "pushed" from consolidation warehouses in response to
promotions . This view requires warehouses be much closer to the actual
point of sale. All in all, warehousing in the immediate future will be char-
acterized by a growing trend that seeks to optimize strategically located sup-
ply points supported by short-haul distribution.
TECHNOLOGY ApPLICATIONS
Whereas the type and location criteria of the warehouse of the future are
expected to change, so is the level of automation and use of information tech-
nologies . The reason for this projected growth is attributed to several factors,
the foremost of which are the following:'
Declining costs of warehouse automation
Increased cost of labor and associated overheads
Much closer demand for supply chain integration and collaboration
Value-added philosophies stressing continuous elimination of opera-
tional wastes and redundancies
Requirements for shorter purchasing and customer service cycle times.
The different forms of warehouse automation are illustrated in Figure
11.11. While each area is expressed equally, the biggest impact of technolo-
gy growth is expected not so much in the installation of material handling
equipment but in computerized tools that increase workstation capabilities or
automate material movement information. These results are in concert with
current thinking about the warehouse, emphasizing the prioritization of the
enterprise's knowledge base over material handling mechanization . Indeed,
the over-all goal of automation seems not so much to be on moving product in
the warehouse but rather in how to engineer sales, marketing, and supply
chain objectives so that the need for physical handling becomes obsolete and
storage gives way to direct delivery from producer to consumer.
One particular method that significantly facilitates the movement of goods
through the distribution pipeline is cross-docking. Cross-docking can be de-
fined as a method of moving products from the receiving dock to shipping
without putting it into storage. Typically, arriving merchandize is broken
down into case or pallet loads, then quickly moved across the warehouse to
the shipping dock where they are then loaded onto trucks bound for the next
level in the distribution pipeline . Technology tools such as computers, bar
codes, radio frequency (RF), and EDI have facilitated the case and pallet
WAREHOUSING 575
FIGURE 11.11 Forms of warehouse automation .
shuffling required to make cross-docking feasible. There are two funda-

mental goals driving distributors' interest in cross-docking. The first centers
on ways to eliminate handling, storage costs, shrinkage, damage, and product
obsolescence . The second is to reduce cycle time and get the product to the
end user as quickly as possible.
The goal of these changes in the nature of warehouse operations is to keep
warehouse size, equipment, personnel , and transportation in line with
enterprise demands. Tompkins [12] calls this the deployment of modular
distribution assets. When planning warehouse facilities, this means that
managers must have access to mechanisms that allow them to expand or
contract warehouse services to meet the targeted level of customer service.
To manage short-term problems, the expanded use of public warehousing
may be more viable, where possibly a more long-term approach would be the
expansion of company-owned facilities. The same could be said of trans-
portation : the use of public carriers, the purchase of equipment, leasing
equipment, and the viability of long-term contracts would have to be ex-
amined in light of short- and long-term fluctuations in traffic requirements.
CHANNEL PARTNERSHIPS
The tremendous pressures for the rapid deployment of inventories across the
supply chain can only expect to accelerate as the 2000s progress. Meeting
these challenges requires a strong foundation based on collaboration and part-
nership among all elements of the supply chain: customers, suppliers, distrib-
utors, third parties service providers, and transportation. Probably one the
most important trends in this area is the changing role of distributors as they
move from being stock keepers and order fillers to single point-of-contact
suppliers, providing both products and value-added services. With the
growth. of Internet fulfillment requirements and more integrated supply
chains, the warehouse of the twenty-first century must be able to execute
many of the functions traditionally performed in the past by predecessor
channel suppliers . In fact, today's customers are continually searching to out-
source upstream to their suppliers functions considered beyond their core
business competencies. These functions include such activities as consoli-
dating, kitting, and shipment of product to customers in a JIT mode, value-ad-
ded processing, direct management of customers' on-site inventories and pro-
duction floor stocks, ability to respond immediately to customers' and sup-
pliers' pick-up and delivery requirements, and inspection and quality control.
The availability of information technology tools and systems are also inte-
grating channel members into close alliances. Instead of a series of indepen-
dent warehouses and accompanying operational functions, technology is re-
moving the barriers of time and place by linking upstream and downstream
channel systems and processes in ways that enable the establishment of the
virtual supply chain. Internet tools provide direct entry of orders into cus-
tomer systems and permit, in some cases, visibility to the exact location and
status of shipments anywhere in the supply chain. Armed with accurate and
up-to-the-minute data, DC managers can monitor transactions and shipments,
respond to late or inaccurate shipments, and perform all the tasks normally
associated with real-time management of the supply chain. This growing in-
terdependence has even been extended to soliciting the input of channel part-
ners in warehouse design, organizational development, and selection of infor-
mation systems. Finally, many distributors will, in the future, seek to extend
the accumulated experience of employees through the implementation of ex-
pert systems. By making available through technology decision-making ex-
pertise related to operational functions, enterprise professionals can be freed
from administrative and expediting activities to devote their time to more val-
ue-added projects . Among the areas where expert systems can be applied are
inventory deployment, order processing, carrier management and selection,
and customer service cost trade-off analysis.
Another area requiring closer partnership is the growth of third-party ware-
housing, full-service logistics carriers, and freight forwarders. As distributors
look for ways to eliminate cost and improve throughput by outsourcing func-
tions traditionally performed in-house, third-party warehousing can free firms
from investing in plant and capacity outside their normal core competencies
or can provide resources, a local presence, or transportation economies that
WAREHOUSING 577
actually permit quicker and more reliable delivery at less cost than can be
performed through the use of enterprise-owned facilities. Other advantages
can be found in sharing the risks associated with delivery, higher control and
flexibility of operations , increased responsiveness to market demand, and
often at a lower operating cost. Perhaps the most radical development is the
growth of service providers who utilize the Internet to enlist third-party firms
that provide complete logistics services encompassing warehousing, order
processing, delivery, freight rating, and audit to meet a level of customer
specification unattainable by distributors acting on their own.
In summary, today's warehousing function is increasingly expected to be
more organizationally focused and more closely integrated into the supply
channel. As the twenty-first century progresses, distribution functions are
expected to divest themselves of unprofitable megalithic channels that are too
costly and unresponsive to the Internet-enabled, customer focused, and value-
added service driven requirements of tomorrow's global marketplace. In such
a climate, the traditional , static perception of the warehouse will be replaced
by alliances of customers and suppliers operating as a single supply chain
network, sharing the same competitive goals, functional activities, expertise,
and costs all linked through interoperable information systems.
DESIGNING THE WAREHOUSE NETWORK
Whether distribution is performed from a single warehouse or a channel net-

work of warehouses, warehouse location and size is a fundamental issue that
must be resolved. In determining the location of a warehouse or designing a
warehouse channel, planners must reconcile the firm's strategic objectives
with product and competitive strategies, network assets (facilities and equip-
ment), working capital, operating budgets, and marketplace strengths in de-
livery, price, information technology, value-added processing, and business
skills. An effective warehouse location or channel strategy must address such
questions as follows:
How many echelons should be in the distribution channel network?
Where should individual warehouses be located?
What is the total cost of operating the channel?
What level of customer service should be attained?
What are the mix, cost, and quantity of inventories at each facility nec-
essary to support targeted service levels?
What is the trade-off between customer service and inventory levels
throughout the logistic channel?
What is the trade-off between transportation and channel asset costs?
How much inventory should be in the pipeline?
What kind of information system(s) will be necessary to integrate the

distribution channel, and what will be the cost in personnel and equip-
ment?
These and other questions require logistics planners to develop answers as to
the size, number, and location of warehouses, and how each may be designed
to optimize efficiency and productivity . Ultimately, the mission, structure,
and operation of the distribution network is guided by the need to satisfy the
customer and to ensure an acceptable return on investment for the assets
expended in establishing and operating the distribution channel. Finally, each
warehouse in the logistics network must be viewed as an integrated node in a
single value-added customer supply chain.
OPENING ISSUES
The construction of a warehouse or a channel of warehouses is a critical de-

cision that will have an enormous impact on the enterprise and possibly on
the supply chains the business works within. The choice of a warehouse will
affect every aspect of a finn's financial well-being: fixed assets, costs of
labor, materials and services, size of the marketplace available, customer ser-
vice and pricing, transportation requirements, supply chain efficiencies, and
customers' perception of the company. Besides economic considerations, the
choice of a warehouse site may be influenced by other quality of life factors
such as climate, a desirable community or cultural life, access to schools, and
others that might contribute to employee satisfaction and the ability of the
company to attract and retain quality employees. In any event, the final
choice involves weighing a matrix of priorities, a determination of which ele-
ments are critical, and a process of elimination. Every location has benefits
and drawbacks; good decisions are based on intelligent choices that match
closely the needs of the enterprise.
Companies seek to establish warehouses for a number of reasons. The fol-
lowing are six common reasons:
Relocation . Often, shifts in product offerings, markets, population,
transportation access, industries, technologies, availability of raw mate-
rials and energies, growth of competitors, environmental or govern-
mental regulations, general operational expenses, and others will force
a company to consider relocating. These and other factors, for ex-
ample, can be found at the core of the shift of industry from its former
stronghold in the Northeast U.S. to the South and Southwest.
Flexibility and scalability. In today's environment, supply networks
have increasingly been subjected to an almost perpetual flux as they re-
spond to shifts in customer demand, product innovation, new forms of
WAREHOUSING 579
technology, and corporate mergers. The result is that supply chains

need to be just as flexible to be able to expand, contract, relocate, and
outsource to channel partners .
Expansion. There are two possible conditions driving expansion. In
the first, it has become apparent that existing facilities are insufficient
to serve current or potential customers. "Insufficient" can be defined as
limited plant capacity or the existence of obsolete warehouse tech-
nology. The second reason driving expansion is a desire to move closer
to new markets. Because of the growth in products and/or market
share, the firm may wish to expand its reach into new markets currently
on the peripheral of its warehouse channel system. Expansion could
also include the establishment of new state-of-the-art facilities not pos-
sible with the current plant.
Product diversification. When a company diversifies a product line, it
might prove advantageous to locate it in a new facility close to product
suppliers , raw materials, or markets. Diversification through product
acquisition often requires the firm to assume the plant, equipment, and
personnel of the former supplier. In any case, the objective is to pursue
the best alternatives that will optimize logistics expenses while estab-
lishing customer service leadership .
Rationalization . The quickest method to improve ROI and cash flow is
to reduce the amount of capital needed to operate large assets such as
plants and warehouses . By employing the latest optimization tools and
real estate expertise, companies can reduce channel costs by consoli-
dating assets and eliminating unnecessary facilities.
Decentralization. Often, a distributor will seek to establish additional
warehouses as a result of a decision to decentralize stocking of various
product lines. The reasons for such a decision could be optimization of
logistics costs, decline in labor availability , inadequacies in utilities ,
community zoning restrictions, government or environmental restrict-
tions, and greater specialization of activity, simplified administration,
lower overhead costs, and concentrated development of skills.
There can be little doubt that the demands of an increasing globalized,
Internet-enabled marketplace will place even more pressure on logistics
functions to provide the most efficient platform for supply-chain activities.
SIZE AND NUMBER OF WAREHOUSES
The process of determining the structure of a distribution channel network is

concerned with two fundamental issues: what should be the size and location
of each facility. As a norm, these two issues have an inverse relationship to
each other: that is, as the number of warehouses in the channel grows, the
size of each warehouse will decline, and vice versa. The reason is that as the
service market is segmented into spheres supplied from regional warehouses,
the inventory carried in each, and hence .the required size, will decline.
However, as the number of warehouses increase in the channel, so does the
total channel aggregate inventory level. This occurs not only because each
location needs to have sufficient inventory available to service customers, but
each must also carry reserve stock to prevent shortages due to variances in
interbranch resupply and excessive unplanned customer demand. Simply
stated, the more unpredictable the demand, the larger the warehouse nec-
essary to house cycle and reserve stocks.
There are a number of critical factors influencing warehouse size. Some of
these are influenced by marketplace consideration such as the desired cus-
tomer service level, size of the market(s) to be served, number of products to
be marketed, demand patterns, and strength of the competition. Other factors
focus on storage elements such the size of products, availability and type of
material handling systems, labor, stocking layout, and geographical access.
Finally, other factors are concerned with productivity metrics such as facility
throughput rate and exploitation of economies of scale. Normally, warehouse
planners will use not just one, but a matrix of these and other factors in ware-
house design. As a rule, larger warehouses are necessary when the size of the
product is large (refrigerators, washing machines, furniture, etc.), a large
number of SKUs are stocked, there is a high rate of warehouse throughput,
the material handling equipment is large or complex (forklifts, cranes, auto-
mated put-away and retrieval systems), and the building contains a large
office area.
Perhaps the key factor in determining warehouse size is understanding the
inventory and throughput requirements necessary to service the marketplace
in which the proposed warehouse is to be located. Arriving at warehouse size
is a complicated mathematical problem, involving knowledge of product re-
quirements, the space/cube of each product, sales trends, building storage
capacity, and costs. Simplistically, warehouse size is calculated by deter-
mining estimated sales by month, combining them, and then compiling space
requirements by converting units of inventory into required square feet of
floor space. Many firms will also plan the use of public warehousing into the
equation. When storage requirements fluctuate or cannot be known with pre-
cision, building a warehouse to meet maximum requirements usually results
in underutilization of the warehouse during nonpeak periods. The most cost-
effective plan would be to use a combination of private warehousing to re-
spond to normal demand and public warehousing or leased space during peak
periods. Finally, the warehouse sizing exercise cannot be complete without
figuring in the space requirements for receiving and shipping, dock require-
WAREHOUSING 581
ments, buffer and staging areas, and necessary vehicle maneuvering al-
lowances inside the stocking areas.
In determining the location of warehouses in the channel, planners must
seek to balance the fixed and current costs (plant and inventory) with the cost
of transportation and overall sales. If these three elements were portrayed
graphically, they would resemble the curves found in Figure 11.12. As the
" /
/
Total Cost
"- "- "- "- "
Cost
Transportation
... ... .Cost
...
...
. . _ .. .:::..r ...... _
Number of Warehouses
FIGURE 11.12 Determin ing the number of warehouses by cost.
number of warehouses grows, inventory and facilities costs increase while
relative transportation and sales costs would decline due to economies of
scale. However, as the number of channel supply points continues to in-
crease, eventually transportation and sales costs would also begin to slope up-
ward as the costs associated not only with interbranch transfer but also cus-
tomer delivery increase. Simply, as the number of warehouses grow, the
ability of the channel to ship on a full truckload (TL) basis declines, requiring
the firm to pay a higher transportation rate. Overall, the goal of the location
strategy is to maximize the perceived benefits arising from the optimal
positioning of each distribution point geographically in the channel.
In addition to calculating optimum transportation and assets cost trade-offs,
determining the number of warehouses in the channel must also be guided by
targeted customer service levels and, in particular, the speed with which prod-
uct can be delivered. In theory, the more centralized the pipeline inventories,
the greater the average distance between supply points and the customer, and
the longer the delivery lead time. This means that if customer service levels
are related to the speed of delivery, it is likely that sales will decline as in-
ventory is concentrated, and vice versa. When added to the curves in Figure
11.12, the sales revenue curve would appear to increase as the number of
stocking points increase. In a very crude sense, the distance between sales
revenue and total network costs is the measure of channel profitability. This
means that the optimum number of stocking points can be seen as that point
where the gap between the two curves is at its widest. This analysis, how-
ever, is based on two assumptions : reducing delivery times generates ad-
ditional sales and decentralizing channel inventories reduces delivery times.
Because neither of these assumptions are necessarily true, planners must be
careful to employ analysis methods (such as cost analysis, grid and graphic
techniques, and simulation and optimization modeling) that thoroughly ex-
plore long-term distribution patterns encompassing customer, plant, product
and transportation costs, and opportunities, and to develop effective strategies
for deploying goods to be held at various supply point levels in the channel.
DETERMINING WAREHOUSE LOCATION
One of the most heavily explored and a refined area in logistics management
is determining warehouse location. During the past 50 years, considerable ef-
fort has been expended into developing complex economic and channel
analysis techniques, supplemented by computerized simulation models. In
the late 1940s, Hoover [13] developed a macro approach that attempted to
leverage three types of location strategies: market positioned, product posi-
tioned, and intermediately positioned. In the first, warehouses are located
nearest to the end customer, the second in close proximity to the sources of
supply, and the last somewhere in between customer and supplier.
Schmenner [14], on the other hand, employed another macro approach where-
by warehouses are located either by a product strategy in which a single
product or product group is sold from a given warehouse, a marketing strate-
gy in which warehouses stocking all the firm's products are positioned in
specific market territories , or a general purpose strategy in which a full-ser-
vice warehouse serves a general market region. Greenhut [15] attempted to
determine warehouse location by calculating an optimum cost based on trans-
portation costs, proximity to suppliers and final customers, and profitability.
Finally, Harmon [16] felt that distributors can quickly determine where ware-
houses should be located by (1) establishing the geographic dispersion of cus-
tomers and/or sales volume, (2) locating warehouses near the largest produc-
tion plant to facilitate communications, (3) locating warehouses in order to
serve an established base of customers better or to penetrate a new market re-
gion, and (4) increasing stocking point exposure to protect existing market
share. An effective macro selection process should include a thorough analy-
sis of transportation costs, census information, local government and busi-
ness development agency positions, professional associations and other busi-
nesses in the area, labor availability and cost, and real estate issues.
In contrast to the macro approach, micro methods have been developed to
assist in location selection. Jenkins [17] identifies the following twelve criti-
WAREHOUSING 583
cal micro factors that must be considered during the warehouse selection
process :
1. Determine overall warehouse objectives. Defining the objectives to be
served by the warehouse or channel structure is a critical part of the
process of site selection. For instance, objectives, such as providing
higher levels of customer service or reducing delivery lead time, should
form the core elements guiding location selection.
2. Transportation costs. This factor is normally considered the most
important in warehouse location studies. Easy accessibility to trans-
portation involves the availability of trucking services and specialized
water, rail, and air carriers. The cost involved in supply chain re-
plenishment , transit times, possibility of damage and theft, service re-
liability, and other related factors require planners to search for trans-
portation optimizations that permit effective trade-offs while preserving
the overall objectives of the facility.
3. Personnel considerations. When either relocating or constructing a
new warehouse, consideration must be given to the effect such de-
cisions will have on existing employees, the availability of new labor,
and legal and social issues relating to equal opportunity employment.
4. Real estate considerations. Both the warehouse and the property it
rests on have a fixed asset value that transcends the purpose for which
they are to be acquired. When selecting sites planners have the option
of building in a nationally known distribution hub, such as Chicago,
New York, Los Angeles, Houston, Seattle, Dallas, and others, or opting
for a less expensive area. The choice must be guided by warehouse
objectives, real estate costs, and possibility of property appreciation .
5. Tax considerations. The taxes levied on property, inventory, and pay-
roll by local governments are an important determination in warehouse
selection . Depending on the state, these taxes can be minimal to high
to prohibitive. In addition, some locales may provide incentives to
build warehouses in their communities, whereas others might dis-
courage construction through exceptionally high tax assessments.
6. Communications. A critical element in site selection is the existence of
adequate telephone and other communication infrastructures. A ware-
house that has insufficient communications will soon become in-
operative or incur intolerably high costs.
7. Proximity to customers. A critical factor determining warehouse sel-
ection is the delivery time to customers. Aspects of this factor include
meeting the requirements specified in the warehouse objectives, the
availability and cost of transportation, travel distance to the customer,
and actual travel time for the customer.
8. Proximity to other warehouses. The distance between warehouses in

the channel network is a critical factor in measuring trade-off costs
between customer service and transportation, communications,
inventory carrying costs, and facilities. Normally, the more warehouses
in the channel, the better the customer service and the lower the freight
costs. On the other hand, proliferation of warehouses usually means an
increase in total inventory and operating costs.
9. Facility cost and value. The asset costs of the facility constitute a
prime factor in warehouse selection. Direct components of cost as-
sociated with the physical plant are the price of the land, facilities con-
struction, engineering, fees and permits, and financing. More variable
sources of cost include the cost of leasing facilities and/or properties,
the costs involved in the acquisition of equipment and hiring employ-
ees, and determination of the capitalized value of the facility.
10. Operating costs. These costs consist of those elements necessary to run
the facility such as heat, electricity, and fuel sources. Perhaps the
single most important element is the cost of labor and management.
11 . Company image. The impression the warehouse facilities make on
customers and the community can be very important to the business en-
terprise and deserves serious consideration. Companies seeking mar-
ketplace name recognition need to be located in areas that expose the
company's name and presence to the public at large.
12. Community resources. Community services, such as adequate police
and fire departments, community attitude, availability of schools and
professional education, lack of environmental dangers, public trans-
portation, and availability of affordable housing for employees, are also
critical factors in location selection.
To effectively utilize these factors, a location project methodology should
be employed. Schmenner [18] has developed an eight-phase methodology
that consists of the following steps:
1. Formally propose a project to search for a new warehouse location, and
solicit company feedback.
2. Form a project team, and divide tasks among the team associated with
land availability, labor requirements, finances, transportation, ware-
house and stocked inventory size, utilities, and governmental and en-
vironmental issues.
3. Constitute an engineering team responsible for external and internal
facility design, topology, and geology.
4. Develop essential criteria for the new warehouse. Included is align-
ment of business and functional area objectives and strategies.
5. Identify potential geographical regions and warehouse locations sup-
portive of enterprise goals.
WAREHOUSING 585
6. Select specific sites for evaluation.

7. Evaluate the benefits and disadvantages of each proposed location.
8. Select a specific location.
During the course of this or any similar methodology, project teams and
company executives must make the search a formal process and guide the
project along each step to ensure that critical decisions are not made without
the concurrence of the entire team. In some cases, planners can also utilize
several location strategy models to assist in determining warehouse location.
An easy to apply technique, the factor weighting method, attempts to utilize
location tangible costs, such as taxes, labor, and intangible costs, such as
community attitude or quality of life, to determine location. By assigning
weights and points to each factor, the method can provide a quantitative
means of site selection. An example of this technique appears in Table 11.1.
The advantages of this approach are that it provides an objective method of
identifying hard to evaluate costs related to each location and the ability to
compute qualitative factors into the analysis. Other techniques that could be
used to determine the optimal warehouse location include location break-
even methods, center of gravity method (a mathematical technique for deter-
mining the location of a warehouse servicing a number of satellites), and
transportation method (a linear programming method that attempts to deter-
mine the best pattern of shipments from several supply warehouses to several
receiving warehouses so as to minimize transportation costs) [19].
TABLE 11.1 Factor Weighting Method
Site Scores (100 points) Weighted Scores
Factor Weight Chicago Atlanta Chicago Atlanta
Labor costs 24% 55 65 .24x55 = 13.2 .24x65 = 15.6
Transportation
costs 7% 85 55 = 5.95 =3.85
Taxes 35% 50 65 = 17.5 = 22.75
Quality of life 11% 65 75 = 7.15 = 8.25
Utilities and
facilities cost 22% 75 60 = 16.5 = 13.2
Totals 60.3 63.65
WAREHOUSE LAYOUT AND EQUIPMENT
The design, layout, and selection of equipment for a warehouse is a complex

process requiring detailed knowledge of the requirements of customer
service, product stocking characteristics, material handling, receiving and

loading technologies, transportation capacities and capabilities, and the
availability of state-of-the-art storage and retrieval equipment. An effective
warehouse design and layout is one in which the physical facilities, equip-
ment, and labor can be optimized and are in alignment with overall corporate
strategies. If these elements could be ranked, warehouse designers should
first have a firm definition of warehouse strategic objectives; second, the
proper equipment should be selected and operational parameters established;
and, finally, the facility should be designed to satisfy operational goals while
acknowledging the physical constraints of the equipment.
Some of the critical physical characteristics of a proposed warehouse have
already been discussed in the previous section. Before construction of a new
warehouse can begin, architects and engineers must determine the overall
suitability of the land. This step includes knowledge of the terrain, the degree
of land preparation, and the cost of further site improvements, including
sewer, electricity, gas, water, and police and fire protection. The actual de-
sign of the building will depend on the nature of the storage environment.
When material handling and storage requirements are uncomplicated, the lev-
el of architectural and engineering design will be relatively simple and in-
expensive, stressing flexibility of storage areas and equipment. On the other
hand, if the warehouse contains products that require environmental control
such as cooling or dry storage, specialized material handling equipment for
bulk products or cross-docking, and other requirements, the architectural
design of the facility will reflect an increasing degree of complexity and cost.
VVAREHOUSELAYOUT
Once the general physical structure of the warehouse has been determined,
the next decision relates to the type and layout of storage equipment to be in-
stalled. In reality, the warehouse is nothing more than a materials handling
system whose purpose is to act as a repository facilitating the efficient and
cost effective movement of products through the channel network and out to
the customer. Analogous to the processing equipment necessary to run a
manufacturing company, material handling systems are a manifestation of the
objectives pursued by the distribution strategy, and their capabilities and
capacities determine the competitive boundaries available to the each supply
chain node. In general, the principles of effective warehouse design are as
follows:
1. The efficient and cost-effective use of warehouse space
2. The efficient and cost-effective utilization of material handling equip-
ment and labor
WAREHOUSING 587
3. Maximum warehouse flexibility in order to meet changing storage and

material handling requirements
4. Good housekeeping
5. Agility to respond to the changing, competitive needs of customer
service
The actual arrangement of a warehouse can take several forms depending
on the facility's products, service objectives, and physical characteristics . A
traditional model appears in Figure 11.13. This layout has been designed to
,~@w Receiving
---.
.
Inspection
Staging
EEEEE
e:::p
Office
"~
~torage and PiCki~
Manufacturing Packing
,,-~.;s.,.~ ' _ i Loading!
Shipping
FIGURE 11 .13 Basic warehouse layout.
simulate the movement of product from the point of receiving to the point of
shipment. On the other hand, the warehouse layout illustrated in Figure 11.14
attempts to employ an item ABC Classification methodology in warehouse
design. Here, receiving and shipping utilize the same docking facilities with
inventory storage location stratified by usage. The fast-selling products are
located closest to receiving and shipping, and slower-moving items progres-
sively to the rear of the building. Finally, Figure 11.15 portrays a schema of a
warehouse that contains multiple types of storage facilities. In this case, the
warehouse has been divided into receiving and shipping zones servicing small
parts, bulk parts, and automated stocking areas. In selecting the general de-
Slow Movers
Medium Movers
Fast Movers
Dock and Shipping Area
FIGURE 11.14 ABC storage technique
sign of the warehouse, planners must be careful to utilize storage techniques

that effectively leverage product and conveyance equipment and minimize
labor and investment costs while facilitating product throughput and service
targets.
Zone 1 Zone 2 Zone 3

Ship & Receive Ship & Receive Ship & Receive
Bins Semi-Automated Automated

Small Large
& Storage & Storage &
Racks Racks
Drawers Retrieval Retrieval
FIGURE 11.15 Mixed-storage mode.

Establishing an effective warehouse layout is a multistep approach re-
quiring detail knowledge of products, facilities capacities, and customer ser-
vice objectives. The actual storage area and the space necessary to perform
related activities constitutes, by far, the largest element in warehouse space
allocation. A poorly structured plan can result in a warehouse that is either
too large or too small for normal operations. Too much space will result in
excess cost arising from underutilized land, construction, equipment, and
energy. Too little space, on the other hand, can result in a host of operational
problems, such as excessive expediting, inaccessible products, damaged
WAREHOUSING 589
goods, poor housekeeping, and loss of productivity. In order to develop an

optimum warehouse layout, the following steps should be performed:
1. Establish a comprehensive warehouse planning process. Determining
an effective warehouse layout is a multitasked process that requires
detailed project management. A successful project is one that is gov-
erned by a task schedule outlining due dates, responsible roles, and
costs.
2. Define layout objectives. Although many managers may feel that the
objectives of the warehouse are intuitive, it is best that objectives be
precisely defined. Examples of such objectives might be as follows:
Provide minimum cost warehousing while maintaining established
customer service levels
Improve space utilization by 25 percent over last year's average
without reducing operating efficiency
Optimize space utilization in relation to the costs of equipment,
space, and labor
Make the warehouse a "showcase" of efficiency and good house-
keeping
3. Define warehouse profiles. In this step, planners should detail the re-
quirements of the following elements: (1) what products are to be
stored; (2) what is the storage size necessary to stock these products;
(3) exact dimensions of the warehouse; (4) capacities of the storage
area racks, pallets, bins, and so on; and, (5) capacities of planned mate-
rial handling equipment.
4. Generate a series of layout alternatives. In this step, planners must
"juggle" physical restrictions, such as the location of fixed objects like
pillars and walls, the placement of receiving and shipping functions,
storage areas and aisles necessary for equipment maneuverability, as-
signment of product storage requirements to stocking areas, stock put-
away and packing runs, and equipment storage areas. A critical part of
this process is determining layout constraints. Besides column spacing
and size, an effective plan must also consider bay size and direction,
the ceiling height, door and dock locations, building shape and land
conditions, geographic area (climate), and local building codes.
5. Layout evaluation. Several philosophies can be employed in deter-
mining the optimal warehouse layout. The use of ABC Analysis can
assist in pinpointing high-turnover items so that they can be located
close to receiving and shipping areas. Another philosophy states that
items commonly received and/or shipped together should be stored to-
gether. In a similar vein, another theory states that products with simi-
lar characteristics, such as chemicals, heavy and oddly shaped items,
items subject to shelf life, hazardous items, easily damaged items, and
high-value items should be stored together. Yet another suggests that
heavy, bulky, hard-to-handle products should be stored close to their
point of use in order to minimize costly material handling. Finally, the
space utilization principle asserts that the total cube of available ware-
house space should be accentuated while optimizing product ac-
cessibility and good housekeeping.
6. Layout implementation. Once the alternatives have been evaluated, a
specific layout must be chosen and implemented. At this point, project
activities should be structured around tasks, schedules, and costs neces-
sary for warehouse layout actualization [20].
TYPES OF STORAGE
The process of warehouse design requires detailed review and selection of the
necessary types of product storage equipment. Obviously, the selection pro-
cess depends on the nature of the products to be warehoused. Product charac-
teristics can be described as the number of units to be stocked, throughput tar-
gets, weight, cubic volume, width, depth, stacking limitations, association
with related products, packaging, dangerous and hazardous substances, tem-
perature control and shelf life. A useful way to view storage types is to di-
vide them into two classes: large-item or large-volume product storage and
small-item or small-volume storage. The use of either or both classes in a
given warehouse requires an expert knowledge of product and stocking bal-
ance requirements as well as the capacities and capabilities of available stor-
age types.
Large-item or large-volume product storage is used to handle products
whose unit size is significant or whose planned inventories quantities are
large. Examples of storage types in this class include the following:
Openfloor storage. This type of storage would be most applicable for
large products whose physical characteristics make it difficult for them
to be easily stored on pallets or placed on racks. Another application
would be the storage of products whose stocked quantity and volume
permit stockmen and order picking personnel to cost-effectively stack,
service, and fill items directly from open floor storage areas. "Cost-ef-
fectively" means that the trade-off for consuming open warehouse
space is justified by ease of product throughput.
Pallet racks. This type of storage structure has been designed to
facilitate the maximum storage and handling of a product by placing it
on pallets. Normally, both the pallet and the storage structure sizes are
standardized. When product is received, it is stacked to meet the maxi-
WAREHOUSING 591
mum pallet storage capacity. The pallet is then staged in the rack
through the use of material handling equipment such as a fork lift
(Figure 11.16) The advantages of this storage type is ease of material
FIGURE 11.16 Fork lift.
handling in put-away and the ability to pick case lots or whole pallets to
meet customer demand. The height of pallet structures is governed by
the height and load capacities of the lift vehicles possessed by the
warehouse . Figure 11.17 illustrates an example of a stacker vehicle
used to stage pallets in onen-oallet rack structures.
'DD
"'''::;' .
FIGURE 11.17 Stacker vehicle,

Drive-in/back-to-back pallet racks. Through the use of special storage
and lift truck equipment, pallet racks can be designed to store
Uprighl '
cob.Jmn
load /
rad
Back space'
FIGURE 11.19 Double deep pallet racks .

FIGURE 11.18 Drive-in racks .
FIGURE 11.20 Reach truck . FIGURE 11.21 Picker vehicle .

WAREHOUSING 593
two or more pallets deep as well as multiple pallets high. Drive-in

racks are designed so that forklifts or other equipment can "drive-in" to
the racks between structure uprights and pallet support rails (Figure
11 .18). Back-to-back pallet racks (Figure 11.19) require a special reach
lift truck that has the capability to position pallets two to three levels
deep (Figure 11.20). These types of storage provides maximum utili-
zation of warehouse space by eliminating wasted aisle and vehicle
maneuvering space.
Storage racks. Often product stocking quantities are too small to
warrant pallet storage but whose stock or physical size disqualifies
them for small parts storage. These items are best warehoused in
storage racks. These racks consist of structure uprights, cross rails,
shelving (usually wooden), and shelving cross rail supports. Normally,
the storage shelf is standardized into several heights to accommodate
product inventory requirements. The height of the rack is determined
by the capacity of manned picking vehicles (Figure 11.21).
Cantilever racks. This type of storage rack is named for the leverage
technique used to support the load-bearing arms (Figure 11 .22). Canti-
FIGURE 11.22 Cantilever rack.

lever racks normally consist of a row of single upright columns, spaced
several feet apart, with arms extending from one or both sides of the
upright to form supports for product storage. The columns rest on the
warehouse floor, preventing the structure from toppling backward or
forward, and horizontal and diagonal bracing between uprights prevents
the structure from collapsing inside or out. Because of their long, un-
obstructed support, these types of racks are best used to store metal
rods, tubes, pipes, bar stock, wood poles, and other products of com-
parable shapes.
Flow racks. The single characteristic of this storage type is the use of
conveyors positioned within a rack. By tilting up the back end of the
conveyor, gravity draws individual products or pallets serviced from
the rear forward so that they can be easily picked (Figure 12.23). Each
flow run is dedicated to a single product. The advantages of flow racks
over pallet and shelf racks are that they permit easy FIFO inventory
control, reduce the need for aisles, minimize handling by having one
input and discharge point, and reduce damage and pilferage. Disadvan-
tages are cost of structure materials, required quality of pallet, flexi-
bility, and downtime due to equipment failure .
FIGURE 11.23 Flow rack.
Specialized racks. Because of their shape characteristics, some

products require specialized storage racking . One example is the use of
tilted barrels staged in racks to store casters , metal ingots, and short
metal rods. Another is special racks constructed to hold "D" handled
shovels, rakes, and ladles [21].
Small-parts or small-volume storage is used to warehouse items whose
size and/or volume permit them to be warehoused in small-capacity storage
equipment. Small-parts storage systems can be generally classified into two
categories: static and dynamic [22]. The difference between the two is how
the storage systems permit access to parts . In static systems, stock keepers
and pickers must travel to stationary storage locations to service and retrieve
inventory. For the most part, stationary systems are relatively inexpensive as
compared to large-item or large-volume product storage or small-part dy-
namic systems. In fact, their lack of sophisticated automation and complexity
often render them the most efficient and economical type of storage when
handling a wide range of items subject to low to moderate throughput.
Examples of static storage systems are the following :
Shelving. Shelving is perhaps the most basic type of static storage
available. Normally, shelving structures are constructed of light-gauge
cold-rolled steel and consist of a number of different type of posts or
sides, shelving that is secured through bolts or special brackets, and
optional steel backings. Standard widths are generally 36, 42 and 48
inches, depths from 9 to 36 inches, and posts or sides up to 84 inches.
In order to provide for stocking integrity and the ability to position
WAREHOUSING 595
more than one item on a shelf, parts can be also be stored in stan-
dardized bin boxes or metal dividers located on the shelf. Because of
its flexibility , shelving can be used to store a wide range of types and
quantity of product. Other advantages are low equipment and mainten-
ance costs and ease of erection, modification, and removal. Drawbacks
center on space inefficiencies. Shelving makes poor use of vertical
space between the ceiling and the top of the shelf facing, as well as
wasted space on the shelf due to the size of the stored item. For ex-
ample, a product two foot in depth and width would waste significant
space on a standard shelf three foot in depth and width. Possible solu-
tions to more effectively utilizing vertical warehouse space are to create
mezzanines or high-rise shelving structures . Use of these techniques
must, however, be balanced against the cost of additional equipment.
Examples of storage shelves appear in Figure 11 .24.
_
--
....
\ OUAoon
FIGURE 11 .24 Small parts shelving.
Modular storage drawers. An alternative method to better utilize

shelving space is to use compartmentalized drawers mounted in storage
shelving or cabinets. As the size and quantity of items grows smaller,
the use of shelving becomes less and less an economical storage choice.
However, by dividing the drawer space into small compartments con-
sisting of a variety of sizes, product stocking requirements can be mat-
ched to the proper compartment, thereby increasing space utilization.
Similar to shelving, modular storage drawers can also be stacked or
mezzanined to utilize vertical warehouse space . The major disadvan-

tage of this type of stocking is its relatively high investment cost.
Wh ile static storage types have dominated the warehousing of small parts,
dynamic storage systems have been growing in popularity. Due to the de-
clining costs of computerized systems, the application of automated storage/
retrieval and dynamic systems have significantly increased their capabilities
and have provided dramatic savings in labor and reductions in inventory
levels. The following is a discussion of available dynamic storage systems.
Carousels . This type of storage can .be defined as a series of modular,
movable shelved or compartmentalized bin facings linked together by
means of a motorized oval track. The basic concept is that inventory is
brought to the stock person rather than the stock person moving to the
bin. Carousels consist of two types : vertical and horizontal. Vertical
carousels revolve on a vertical oval track and are either top-driven or
bottom-driven. The benefit of a vertical carousel is utilization of verti -
cal warehouse space. Drawbacks are limitations on widths , depths, and
weights, and they normally cost more than horizontal carrousels. ill
contrast, horizontal carousels revolve around a horizontal track. A mo-
tor, mounted in the center of the oval, moves the bins along the track.
Horizontal carousels can be configured into a much greater variety of
heights, widths, depths, and weight capacities than vertical types, and
they can be used for many different warehouse storage applications.
The most significant negative features are waste of vertical warehouse
space. Normally, an operator activates either type of carousel through
manual, microprocessor, or computer controls, bringing the desired bin
to the stocking and picking position. Benefits of using carousals are
greater labor utilization, increased throughput, improved control, space
utilization, simplified inventory control and replenishment, and
integration with other warehouse systems. An example of a horizontal
carousel appears in Figure 11.25.
FIGURE 11.25 Horizontal carousel.

WAREHOUSING 597
Moveable-aisle systems. This type of storage is characterized by shel-

ving cabinets or bins placed on movable carriages that either glide or
roll on stationary tracks. The major advantage of moveable-aisle sys-
tems is the elimination of aisle space between stocking rows. Basically
there are three types of movable-aisle systems determined by the type
and weight of products stored. Manual systems are characterized by
the ability of the operator to manually push rows when accessing the
necessary storage area. The number of rows in this systems are limited
and stocked products are light weight. Mechanically assisted systems
normally consist of gear systems that facilitate movement of the rows
and are used for systems approaching thirty feet in length and for prod-
ucts of medium weight. Finally, electric systems utilize electric motors
to move rows. This type is most useful for controlling large racking
systems and for heavy products.
Miniload ASIRS systems. Miniload systems can be defined as a fully
enclosed, automatic storage system that brings parts and materials to an
operator for picking, kitting, and so on, and automatically returns the
material into the system [23]. Similar to the much larger systems dis-
cussed in the next section, this type of small parts storage system de-
pends on an automatic storage container insertion and extraction
mechanism that traverses vertically and horizontally a stocking aisle.
Mini-load systems can be controlled from keyboards or integrated with
warehouse management systems. Benefits of this type of storage are
floor space reduction, stocking space cube utilization, increased
throughput, reduced labor costs, increased security, and increased
control of parts (Figure 11.26).
FIGURE 11.26 Miniload AS/RS system.

WAREHOUSE AUTOMATION
The demands of warehousing in the twenty-first century require companies to

have an optimal mix of manual and automated material handling systems. To
be effective, warehouse automation must be designed and implemented to
maximize the use of the enterprise's critical resources--space, labor, capital,
equipment, and inventory-while providing a high level of customer service.
The best choices are made when managers weigh critical ratios such as cash
liquidity, productivity, and profitability when deciding on warehouse auto-
mation systems. Generally, the prime reasons driving automation are a desire
to decrease labor and logistics costs, increase output rates, increase accuracy
of services, and accelerate the speed of customer order turnaround times.
Warehouse automation, however, is not without its disadvantages. Draw-
backs include high equipment and implementation costs, requirements for
modification, lack of flexibility, increased maintenance, and employee
training and acceptance.
....
Completed in 200 I. Saks, Inc.. the The goods are then passed to 126
parent company of Saks Fifth shipping doors where they marked
Avenue and other high-end retail for delivery to specific retail stores.
stores, decided to build a new $25
million, 180.000-square-foot state- The new DC can move a single
of-the-art flow-through distribution carton through the system in les than
center in Steele. Alabama. four minutes, with a shipping ac-
curacy of 99.9 percent. Altogether,
Thanks to the its robust capabilities, the new system has enabled Saks to
products can be processed through triple its throughput, from 15,000
the DC with little human inter- boxes per shift to around 43,000.
vention. Product is received on the
first floor of the facility through 20 Originally, Saks envisioned a DC
shipping doors. The cartons are un- where no merchandise would be
loaded onto conveyors and imme- stored. Today, 94% of merchandise
diately scanned for correct supplier is cross-docked, with the goal re-
identification. Correctly identified aching 100 percent in the near
material moves up the conveyors to future.
the second floor where Cartons are
sorted, scanned, marked, and pro- Source: Johnson, John R., "Speed
cessed to shipping by a completely Thrills," DC Velocity, I, 2, (2003),
automated operation. pp.32-36.
WAREHOUSING 599
The decision to automate warehouse functions requires thorough strategic

as well as operational planning. As with other enterprise projects, the
initiative involves weighing costs and potential benefits, as well as consid-
ering the risk of failure versus the anticipated productivity. Some of the
strategic questions that must be addressed are as follows :
To what degree will warehouse automation increase the company's
competitive advantage?
Are the plans for warehouse automation in alignment with the com-
pany's other strategic objectives?
What impact will warehouse automation have on the firm's marketing
objectives?
Can the proposed automation be transported to other parts of the supply
chain ?
What changes in products and markets could render the planned ware-
house automation obsolete or redundant?
Operational issues to be considered are as follows :
What is the increased percentage of space utilization to be expected
from warehouse automation implementation?
What is the increased percentage of productivity to be expected?
How will the proposed automation project eliminate work-flow bottle-
necks?
What impact will automation have on warehouse employees and skill
sets?
Can current equipment be applied to the automation project?
What will be the requirements and costs for equipment maintenance?
While automation can take many forms and can range from low-tech assets
such as acquiring a forklift to high-tech intelligent labels, for the most part
the three most important types of automation are the use of automatic identi-
fication systems, automated storage and retrieval systems (AS/AR) and intel-
ligent tags and voice recognition. Automatic identification systems attempt
to minimize or eliminate human operator involvement in the collection of in-
formation by using optical and radio technologies that input information
directly into warehousing systems . The importance of automatic identify-
cation systems in modem warehousing is twofold: (1) it minimizes or elimi-
nates the need for human activity in data collection and (2) it significantly in-
creases the accuracy and speed of data entry . Automatic identification sys-
tems generally fall into three main categories:
Radio Frequency. This technique utilizes vehicle attached or hand-held
devices that transmit information via radio frequency.
Magnetic Readers. This technique uses a magnetic film or strip on

which is encoded information. By passing a sensing head over the
strip, information is collected and passed back to the database.
Optical systems. Techniques in this category utilize light refracted from
a printed pattern. Normally, a wand emitting a light beam is passed
over the pattern, information encoded, and then passed to the database.
Of the optical system techniques, bar coding is perhaps the most popular.
Bar coding can be described as the use of electronically driven automatic
identification generated by moving a beam of light across a band consisting
of a set of alternating opaque bars and white spaces. A bar coding system
consists of three entities :
Bar Code Symbology. This element refers to the type of bar code
employed. Although a firm could develop its own codes, the goal is to
use universally accepted codes that apply to specific business functions.
The most common bar codes are UPC, Logmars Code 39, Code 2 of 5,
and Code 2 of 5 Interleaved.
Bar Code Printer. The reproduction of the bar code is of prime impor-
tance in bar code reading . Generally, the main concern is the repro-
duction of a code clear enough to be easily read by the scanning equip-
ment. In addition to this element are possible requirements for pack-
aging aesthetics . Bar codes can be printed in-house through the use of
several commercial printers, or by an outside professional printing
company.
Bar Code Readers. Readers or scanners come in a wide variety based
on warehouse need. The following are possible examples of commer-
cially available bar code readers : hand-held, moving beam readers,
fixed-location , fixed-beam readers, fixed-location, moving-beam read-
ers, and photodiode array (PDA) readers.
An effective bar coding system can be a significant assistance to warehouse
operations . The advantages of bar coding are accuracy, speed, cost, reli-
ability, simplicity, negligible space requirements, and ease of acceptance by
employees.
The use of automated storage/retrieval systems can be divided into two
groupings: miniload systems and unit-load systems. Miniload systems have
already been discussed relative to small-parts dynamic storage systems. In
contrast, unit-load systems can be defined as the automation of the stock
keeping and picking functions associated with pallet or standard container
loads. In designing unit-load ASIRS systems, the key is the size and storage
cube of the material. Characteristically, an ASIRS system consists of two
elements. The first is the rack structure that is to hold the pallets or contain-
ers. For the most part, free-standing or building-supported drive-through-type
WAREHOUSING 601
racks are employed. Normally, the aisles separating each row in the rack
cluster is wide enough only to permit the movement of the storage/retrieval
machine.
The second element of an AS/RS system is the storage/retrieval machine .
Whereas the rack system provides the storage environment, the stor-
age/retrieval machine provides the material handling function of the AS/RS
system. The machine must have the ability to perform vertical, horizontal,
and shuttle subcycle (extension, pickup, and retraction) activities. Normally,
the machine, called a "crane," resides on wheels and moves up and down
each row in the rack cluster. Cranes can be dedicated to just one row or ser-
vice a group of rows. For the most part, AS/RS cranes today are controlled
through the use of computer systems that stock keep and pick based on com-
puter databases that are integrated with sales order, receiving, and inventory
management systems. Finally, ASIRS systems are often accompanied by
other forms of warehouse automation. Conveyor systems are used to trans-
port product to and from storage clusters. Automated sizing and weighing
stations can also be employed to ensure storage loads conform to weight and
size requirements. In addition, automated guided vehicle (AGV) systems can
be used to convey material from and to stocking points and ARlRS pickup
stations. Benefits arising from ASIRS systems include enhancement of in-
ventory accuracy, reduction of labor costs, increased warehouse space uti-
lization, and reduced product damage.
The use of intelligent tags and voice recognition constitutes the third major
area of warehouse automation. These technologies are today on the cutting-
edge of warehousing automation. While still too expensive for general use,
several companies are beginning to deploy intelligent tags equipped with
RPID chips that have the ability to actually transmit signals to warehouse sys-
tems. These signals can be broadcast to tracking devices that will allow com-
panies to trace inventories as they move from manufacturing to storage, pick-
ing, palletizing and shipment. The goal is to not only use these intelligent
tags to control internal movements but also to persuade supply chain partners
to RPID-enable their receiving docks and distribution centers.
Even more radical is the view of Downes who, in an article entitled "The
Metamorphosis of Information" [24], details how Wal-Mart and its supply
and logistics partners are attempting to move the concept of RPID to its next
evolutionary step by installing a Electronic Product Code, similar to a bar
code but one that does not need to be scanned and contains its own power
source and antenna, to Bounty paper towels. The tag broadcasts by means of
radio frequencies to receivers in the warehouse and on store shelves the lo-
cation of pallets of individually labeled Bounty paper towels. The tracking
data is also transmitted up the supply chain to distributors and finally the
manufacturer. While the cost of these miniature computers today severely
limits their application to experiments only, if Moore's Law is true, perhaps

in the next few of years it will not be surprising to find that manufacturers
from Procter & Gamble to the Gap will be able to label all their products with
such information devices. "Imagine," concludes Downes, "a trillion new in-
telligent devices, each with its own Internet address , sending and receiving
data through their life spans, creating increasingly complete snapshots of
every transaction in every supply chain."
"'~.
ii(1~,'~
at1Gillette
. -'-
Until just recently RFID tags were five cents each.

reserved for use of big objects like
railcars. They were bulky and ex- Gillette believes the tag will make
pensive and the idea of tags small it possible to follow products
and cheap enough to use on indi- through their life cycle from
vidual items seemed futuristic. manufacturing through distribution
to the point of sale. It hopes the
Beginning in January of 2003, technology will help reduce losses
Gillette, will attach RFID tags to from theft or from stockouts, and
Mach 3 Turbo razor blades that ship will make its entire supply chain
to two Wal-Mart stores equipped more efficient by enabling the
with "smart shelves" capable of collection of real-time data on the
reading signals from the chips and status and location of its products,
tracking the merchandise's location. where ever they may be in the
The innovation is that these tags are supply chain.
small. measured in microns. Sus-
pended in a fluid, they look to the Source: Ewalt. David M., "Gillette
naked eye like the flakes in a snow Razors Get New Edge: RFI D Tags,"
globe. What is more, they tags are Information lVeek. (January 13,
produced in quantity for as little as 2003), p.22.
An extension of intelligent RFID tags is the application of a new technolo-

gy, voice recognition. Begun over a half century ago, software companies
have been working steadily to develop applications that can recognize and re-
produce the human voice. In 2000 the three main types of speech technology
(speech recognition, speaker verification, and text-to-speech) accounted for
$153 million in sales and is expected to exceed $1.5 billion by 2005 . The
first applications to warehouse management occurred in the early 1990s and
today are closely integrated with warehouse management systems . They
work by first synthesizing data (say, a sales order pick) into speech. This
data is then received by operators equipped with headsets to receive oral in-
struction from the computer. In tum, workers can use their microphones to
report task completion to the computer. Rather than pressing keys or scan-
WAREHOUSING 603
ning bar codes, the operator speaks into the headset to provide data such as
order numbers and quantities picked (25).
WAREHOUSE MANAGEMENT SYSTEMS
As the complexity and speed of warehouse operations accelerates in today's

business environment, many companies with distribution facilities are imple-
menting computerized warehouse management systems (WMS). In all too
many warehouse environments sophisticated business systems feed vital in-
formation to functions, such as receiving, stock put-away, picking, and trans-
portation, only to have control and feedback of these activities disappear into
manually performed tasks that are generally unconnected to each other and to
the business system. A WMS attempts to fill in this gap in information com-
munication and planning by providing computerized solutions that seek to
fully integrate the various functions of warehousing, ranging from inventory
control to yard management. These systems also can be easily linked with
the ERP business system as well as logistics transportation and supply chain
process management solutions to provide companies with a totally integrated
real-time fulfillment system.
Today's WMS offers a wide-range of applications. These solutions can be
grouped into seven general areas:
Receiving: In this area WMS toolsets consist of several functions as-
sociated with pre-receiving and receiving. Often these applications are
EDI or Web-enabled . Among pre-receiving functions can be found in-
bound product tracking , advanc ed shipping notice (ASN) planning, de-
livery appointment scheduling and cross-docking, and forward picking
planning . Receiving functions include PO verification, label printing,
repacking, unitization, inspection, returns, and supplier audit.
Warehousing: In this area can be found functions associated with ma-
terial handling such as cross docking, put-away, and location and stor-
age. Critical system functionality in this area includes palletizing, con-
tainerization, packaging, zone and random storage location selection,
off-site storage support, location capacity and utilization management,
bar-coding locator, serial and lot control, quarantine management, cycle
counting, yard management, and interbranch transfer. The goal of
these functions is to improve the accuracy of inventory storage.
Order management: WMS functions in this area are focused at in-
creasing customer service by automating picking and shipping func-
tions, shrinking processing times, and improving service accuracy.
Among the activities can be found order allocation , checking and
grouping/batching, auto-replenishment of picking locations, pick list
printing, FIFO, zone, and wave picking, product substitution, pallet

layering, assembly and kitting, and scanning.
Labeling and floor ready: Today's WMS must be able to handle com-
plex product labeling requirements such as UPC tagging, shipping con-
tainer marking, price mark tagging, custom label design/printing, inter-
national and customs documentation, and bar code and RFID tags.
Shipping and transportation: WHS systems integrate shipping and
transportation functions directly with the ERP backbone. Among
WMS functions offered are shipment and load planning, pallet scan-
ning, TL and LTL/parcel post carrier linkage, trailer management,
freight rating and shopping, traffic routing/scheduling, outbound ap-
pointment scheduling, transportation analysis, and in-transit inventory
tracking.
DC equipment support: A critical WMS enabler is the capability to
link warehouse equipment directly to the warehousing and business
systems . Among these toolsets can be found auto-sortation, conveyors,
RF units, speech recognition, picking/putaway equipment and robots,
and equipment/vehicle maintenance management.
Billing: WMS applications can also facilitate billing, time reporting,
and surcharges and chargebacks.
The benefits of an effective WMS system are obvious. By automating and
linking warehouse functions, companies can significantly increase warehouse
productivity, efficiency and accuracy. WMS applications can reduce the past
manual efforts expended on tracking locations and warehouse space
recording, tracking item storage and balance accuracies, reducing stock
keeping and picking personnel, and improving order management accuracy
and speed . In addition, a WMS helps in performance management through
effective cycle counting, automated data collection, accountability, and simu-
lation . Finally, WMS applications enable warehousing equipment to be truly
automated by integrating it with business system purchasing, receiving, order
management, and shipping and transportation databases.
SUMMARY
Like other functions in the modern supply chain-focused enterprise, the goals
and operating objectives of today's warehousing functions continue to under-
go significant change . In the past, warehousing's role in the organization was
purely operational and consisted of activities associated with receiving, stor-
age, order picking, product sorting, traffic management, production order
picking, and value-added processing. The warehouse was perceived merely
as a place where inventory was stockpiled, consolidated, assorted into kitted
WAREHOUSING 605
products , and shipped to the customer. In contrast to this view, it is evident

that today warehousing itself has begun to be viewed as a fundamental source
of competitiveness differentiation and marketplace leadership. Through the
use of such tools as the Internet, storage automation, and Lean philosophies
accentuating organizational integration, quality, and elimination of all forms
of waste and impediments to service leadership, the development of a com-
prehensive warehouse strategy has become an essential element of a suc-
cessful supply chain strategy.
There are several types of warehousing alternatives that can pursue. The
choice of warehouse type is governed by the ability of the decision to ef-
ficiently and effectively execute logistics functions while facilitating attain-
ment of customer service performance targets. The optimal warehouse
should permit the enterprise to leverage inventory levels, operations, and
transportation modes that effectively support marketing, sales, order pro-
cessing, and inventory planning in the quest for competitive advantage. In
addition , the warehouse system should promote the efficient management of
warehouse activities centering on the receipt, storage, picking, and shipping
of inventory.
Other critical decisions facing supply chain strategists are selecting the
optimal geographic location of warehouses , and effective storage and equip-
ment design. In determining the location or scope of the channel network,
planners must reconcile the firm's strategic objectives with product and com-
petitive strategies, channel assets, working capital, and operating budgets, and
marketplace strengths in delivery, price, information technology, value-added
processing, and business skills. When deciding on warehouse locations, plan-
ners have the choice of using several macro or micro approaches that
basically search to position facilities in locations that optimize transportation
costs, proximity to suppliers and customers , and profitability.
In determining the size of the warehouse, managers must understand in-
ventory and throughput requirements, balance the fixed and current costs as-
sociated with plant and equipment with transportation, and target the cus-
tomer service level to be provided. The design, layout, and selection of
equipment for a warehouse is a complex process requiring a detailed know-
ledge of the requirements of customer service, product stocking characteris-
tics, material handling, receiving and loading, transportation capacities and
capabilities, and the availability of automated storage and retrieval equip-
ment. The most effective warehouse layout is the one where the physical
facilities, equipment, and operational objectives are supportive of one
another. The general objectives of the warehouse layout are to maximize
warehouse space, labor, and equipment and to provide for good housekeeping
and the ability to respond competitively to the needs of the customer.
1. Discuss the three basic functions of the modem warehouse. Why do distributors
need to have warehouses?
2. How is warehousing integrated with the other major function of the enterprise?
3. Compare and contrast the advantages/disadvantages of using private or public
warehousing.
4. What are the different types of warehouse? Discuss what each would be used
for, and what kinds ofproducts would best be warehoused in each type.
5. During the first decade of the twenty-first century will distributors be adding or
eliminating warehouses in their supply channel structures? Discuss your
reasons.
6. Why must distributors develop effective warehouse plans? Detail the planning
process .
7. If productivity can be defined as the ratio of real output to real input, how could
a firm measure the productivity of its storage facilities?
8. Why is the development of detailed standards so important for effective ware-
housing?
9. Describe the various methods of performing warehouse picking.
10. Discuss the steps necessary when determining the geographical location and size
of a proposed warehouse.
11. Detail the steps required when designing a warehouse layout.
WAREHOUSING 607
REFERENCES
th
1. Delaney, Robert V., "Understanding Inventory - Stay Curious," 13 Annual
"State of logistics Report." Cass Information Systems, June 10, 2002 , Figure
#10 .
2. Foster, Thomas A., "The Logistics Factor," Global Logistics and Supply Chain
Strategies, 6, 12 (2002), pp. 46-49 .
3. See the discussion on developing warehouse strategies in Ackerman, Kenneth
B., Practical Handbook of Warehousing. New York: Van Nostrand Reinhold,
1990, pp. 205-209.
4. Tompkins, James A., "The Challenge of Warehousing," in The Warehouse
Management Handbook. New York: McGraw-Hill, 1988, p. 6.
5. Ibid., pp. 9-10.
6. Bowersox, Donald J. and Closs , David 1., Logistical Management: The
Integrated Supply Chain Process. New York: McGraw-Hill, 1996, p. 403.
7. Jenkins, Creed H., Complete Guide to Modern Warehousing. Englewood Cliffs,
NJ: Prentice-Hall, 1990, pp. 34-48 .
8. These definitions have been summarized from Appel, James M. and Ballard,
Randall M. , "Receiving Systems," in The Warehouse Management Handbook.
New York: McGraw-Hill, 1988, p. 561; Jenkins, pp. 184-197,379-384; and,
Ackerman, pp. 451-453 .
9. Jenkins , p. 320 .
10. These figures have been gathered from Robert V. Delaney's various "State of
Logistics Report" for the years cited.
II. These figures were cited by Jedd, Marcia, "The Regional Difference." DC
Velocity, I, 1,2003, pp.62-65 .
12. Tompkins, James A., "Distribution Today and Tomorrow." APICS: The Perfor-
mance Advantage, 4,4 (1994), pp. 22-28 .
13. Hoover, Edger M., The Location of Economic Activity. New York: McGraw-
Hill, 1948.
14. Schmenner, Roger W., Making Business Location Decisions . Englewood Cliffs,
N.J.: Prentice Hall , 1982.
15. Greenhut, Melvin L., Plant Location in Theory and in Practice. Chapel Hill:
University of North Carolina Press, 1956.
16. Harmon, Roy L., Reinventing the Warehouse. New York: The Free Press, 1993,
pp.66-69.
17. Jenkins, pp . 57-76. See also Gardner, R. William, "Distribution Facility Design
and Construction," in The Distribution Handbook. Robeson, James, F. and
House, Robert G., eds. New York : The Free Press, 1985, pp. 584-599 and
Foster, Thomas A., "Site Location Today," Global Logistics and Supply Chain
Strategies, 6, 12,2002, pp . 30-36.
18. Schmenner, pp. 16-21. See also Ackerman, Kenneth B., "Site Selection," in The
Warehouse Management Handbook. New York : McGraw-Hill, 1988, pp. 82-
90.
19. For more information on these techniques see Heizer, Jay and Render, Barry,
Production and Operations Management, 3rd ed. Boston: Allyn and Bacon,
1993, pp. 344-356.
20. For more information on warehouse layout see Jenkins, pp. 156-166; Smith,
Jerry D. and Peters, J. Eric, "Warehouse Space and Layout Planning," in The
Warehouse Management Handbook. New York: McGraw-Hill, 1988, pp. 101-
114; Smith, Jerry D. and Nixon, Kenneth L., "Warehouse Space and Layout
Planning," in The Distribution Management Handbook . Tompkins, James A.
and Harmelink, Dale A, eds. New York: McGraw-Hill, 1994, pp. 16.3-16.26;
Mulcahy, David E., Warehouse Distribution and Operations Handbook. New
York: McGraw-Hill, 1994, pp. 3.1-3.42; Coyle, John, L, Bardi, Edward J., and
Langley, C. John Jr., The Management of Business Logistics: A Supply Chain
Perspective. 7th ed., Mason, OH: South-Western, 2003, pp. 304-308; and
Bowersox and Close, pp. 407-416.
21. For more information on storage racks see Jenkins, pp. 253-278; Donnon, J.
Henry and Hammond, Ted, "Large-Parts Storage Systems," in The Warehouse
Management Handbook . New York: McGraw-Hill, 1988, pp. 237-262;
Nofsinger, John R , "Storage Equipment," in The Distribution Management
Handbook. Tompkins, James A. and Harmelink, Dale A., eds. New York:
McGraw-Hill, 1994, pp. 18.3-18.9; David R. Olson, "Material Handling
Equipment," in The Distribution Management Handbook . Tompkins, James A
and Harmelink, Dale A , eds. New York: McGraw-Hill, 1994, p. 19.11.
22. Weiss, Donald J. and Cramer, Michael A, "Small-Parts Storage Systems," in
The Warehouse Management Handbook. New York: McGraw-Hill, 1988, p.
263. See also Mulcahy, pp. 6.1-6.118.
23. Weiss and Cramer, p. 287.
24. Downes, Larry, "The Metamorphosis ofInformation," Optimize Magazine, June
2002, 37-43.
25. See Cooke, James A, "Vocal Minority," Logistics Management Magazine, 41,
10, 2002, pp. 45-48 and Douglas, Merrill, "Adding a Dash of SALT to
Logistics," Inbound Logistics, 22, 11,2002, pp. 80-82.
12
TRANSPORTATION
THE SCOPE OF TRANSPOR- Documentation Preparation and

TATION Payment
Principles of Transportation Performance Measurement
Relationship of Transportation to
Other Business Functions ISSUES CONFRONTING TRANS-
PORTATION
MODES OF TRANSPORTATION Transportation Infrastructure
Motor Transport Transportation Regulation
Railroad Transport Transportation Management
Air Transport Systems
Water Transport
Pipelines LOGISTICS SERVICE PRO-
Intermodal Transportation VIDERS
Origins and Growth of the LSP
TYPES OF TRANSPORTATION Industry
Legal Forms of Transportation Suite of LSP Services
Transportation Performance Internet-Driven LSPs
Characteristics Choosing an LSP Provider
Today's LSP Challenges
TRANSPORTATION MANAGE-
MENT PROCESS SUMMARY
Establishing Costs and Rates
Transportation Mode Selection APPENDIX
Scheduling and Routing
When asked to provide a functional definition of distribution, both the public

and professionals alike will most likely structure their response around two
general topics: warehousing and transportation . As was discussed in the pre-
vious chapter, warehousing is concerned with the storage and handling of in-
ventories. Warehousing provides value by satisfying marketplace time and
place utilities . Transportation, on the other hand, is normally associated with
the movement of product from one node in the supply channel network to
another. This ability to provide purposeful movement of goods in the supply
chain is fundamental in assisting companies achieve time and place utilities.
No matter how sophisticated the warehouse system, if a product is not avail-
able at the specific time and place it is wanted, the firm risks lost sales,
faltering customer satisfaction, and increased costs resulting from order ex-
pediting. Transportation attempts to solve this problem by ensuring that
product is moved as efficiently and cost-effectively as is possible from the
point of origin to the point of consumption. Basically, transportation creates
value by changing the location of inventory. In this sense, to conceive of a
"world-class" supply chain without an efficient transportation system to sup-
port it is clearly an impossibility. Transportation's ability to create place uti-
lity by ensuring that product will be available at the time the customer wants
it defines a fundamental pillar in the search for competitive advantage.
This chapter details the principles and functions of today's transportation
industry. The chapter begins with a discussion of the principles and statis-
tical scope of transportation as well as the interaction of transportation with
other enterprise functions. Following this discussion, the various legal forms,
performance characteristics, modes, and types of transportation are examined
in depth. The chapter then proceeds to outline the transportation management
process, beginning with the determination of internal transportation costs and
public carrier rate standards and concluding with a review of transportation
performance measurements. Following, the critical challenges confronting
the transportation industry are discussed. Included is a review of today's
physical transportation systems, regulation past and present, and a short
analysis of today's transportation management systems (TMS). The chapter
concludes with a detailed review of the role and activities of today' s logistics
service provider (LSP) in the management of the transportation function.
THE SCOPE OF TRANSPORTATION
The capacities and capabilities of the transportation system serving not only a
particular enterprise but also the entire supply chain determine the boundaries
of the market system in which both participate. The availability of inexpen-
sive, efficient, and easily accessed transportation services activates several
critical drivers of economic activity. To begin .with, transportation enables
companies to bridge the geographical gap between the place where products
are produced and inventoried from the point where they are consumed. It is
TRANSPORTATION 611
virtually impossible in modem economies for companies to function without

the ability of transportation to move products from point-to-point across the
supply chain. Second, transportation provides for the growth of competition.
The more mature the transportation system, the greater the ability of busi-
nesses to compete with other companies in distant markets on an equal
footing. Third, the wider the product distribution and the greater the demand,
the more producers can leverage economies of scale in production and chan-
nel transportation costs. Finally, the more efficient and the lower the cost of
transportation, the lower the selling price. Because transportation costs to the
producer are normally calculated into the price of products, as costs decline
and delivery capabilities rise, producers and distributors normally pass on the
savings to their customers in the form of lower prices, thereby increasing
marketplace advantage .
PRINCIPLES OF TRANSPORTATION
While the impact of transportation on the economic environment can be

clearly defined, a detailed understanding can perhaps best be attained by a re-
view of the principles constituting the transportation function. Overall, these
principles can be broken down into three fundamental components: economy
ofscale, economy ofdistance, and cost ofvelocity . The principle of economy
of scale states that as the volume and weight of the load increases the cost of
transport decreases . For example, the cost of full truckloads (TL) shipments
costs less per pound than less-than-truckload (LTL) shipments. The economy
exists because the fixed cost of the transportation asset can be spread over the
load 's weight. The principle of the economy of distance relates to the fact
that transportation cost per unit of weight decreases as distance increases.
Referred to as the tapering prin ciple, the longer in distance a load travels the
more the fixed expenses are spread over the distance, resulting in lower over-
all changes . Finally, the principle of cost of velocity states that as the speed
of the movement of the load increases the cost of the transportation increases.
Simply, as the velocity of the load increases, the cost of transportation ser-
vices, such as equipment and fuels, handling, tracking, and loss of scale
economies, dramatically increases [1].
In their analysis of transportation, Fair and Williams [2] have elaborated on
these three basic principles as such:
Continuous flow. One of transportation's prime objectives is to pro-
vide for the uninterrupted flow of products from the producer through
each node in the distribution network, concluding at the point of con-
sumption . In pursuing this objective, transportation must continually
seek ways to increase in-transit velocities by minimizing material han-
dling, use of modal equipment, and the transfer of product while re-
ducing costs of service.
Optimize unit of cargo. The proper use of transportation requires that
the cargo being transported effectively optimizes transportation vehicle
capacities. This principle seeks to ensure that transporters are utilizing
the best choice of vehicles, material handling equipment, and man-
power that provide the best service for the price.
Maximum vehicle unit. As the size of the shipping load grows larger,
the capacity of the transport vehicle utilized should grow accordingly.
Splitting a large load into smaller loads because of limitations in
vehicle capacity will result in increased costs and loss of efficiency.
This principle is based on two assumptions: (1) The operating costs of
the transportation vehicle do not increase in proportion to the size ; (2)
service costs, such as material handling, routing and dispatching, and
shipment documentation, remain unchanged regardless of the size.
Adaptation of vehicle unit to volume and nature of traffic. Shippers
must continually search for techniques to match vehicle transport char-
acteristics and capacities with the transit environment. This principle
requires that transportation vehicle size, weight, storage capacity, and
speed be optimized to permit as free as possible a flow through the traf-
fic medium. For example, the development of equipment such as two -
level rack carriers for automobiles pulled by trucks is targeted at
optimizing transport that minimizes costs and facilitates transit through
the highway system.
Standardization. Although specialized vehicles are often necessary to
meet the shipping requirements of certain goods, the existence of stan-
dardized truck trailers, railcars, cargo ships, and air containers offer
economical methods to transport products. Because of their general
availability, capacity to handle a wide variety of products, and ability to
be utilized for backhaul, standardized vehicles often can provide lowest
cost transport. This principle also applies to the standardization of
docking facilities, material handling equipment, and methods of
operation.
Compatibility of unit-load equipment. This principle emphasizes the
requirement that material handling equipment placed in transport
vehicles and containers should readily fit and maximize cube space. In
addition, equipment should be positioned so as to minimize damage to
cargo and reduce load shift during transport.
Minimization of deadweight to total weight. The cost of fuel when
transporting products is directly derived by combining the weight of the
load (payload) and the weight (deadweight) of the vehicle, containers,
TRANSPORTATION 613
and material handling equipment. Normally, the larger the transporta-

tion vehicle, the more favorable the ratio of payload to total weight.
The use of lightweight materials and vehicle design can assist trans-
porters decrease the deadweight of containers and transport vehicles.
Maximum utilization of capital, equipment, and personnel. Transport
vehicle design, routing and scheduling, and operational practices can
significantly impact the effective utilization of transport resources. Uti-
lization in transport refers to the percentage of time equipment and per-
sonnel are in use. The objective of transportation management is to re-
duce utilization imbalances caused by seasonality, the lack of
operational practices such as backhaul, and poor scheduling of vehicle
loading and unloading.
A thorough understanding of these principles is essential in developing trans-
portation strategies . The object is to establish transportation selection pro-
cesses that maximize on transportation economies while minimizing premium
carrier modes.
Transportation services. The role of transportation is to offer supply chains

participants a variety of critical services. In general, these services can be
grouped into two main areas: load transport and product storage. Load
transport services are concerned with the movement of product from an origin
location to a geographical receiving point. During this process, the goal is to
enhance the value of the product by positioning it in a more advantageous
marketing location while minimizing the cost of in-transit inventories, expen-
ditures for transportation and labor assets, and impact on environmental fac-
tors such as air pollution, energy consumption, and congestion. In general
transport services can be described as follows:
Freight servic es. The obvious function performed by transportation is
the movement of goods through the supply chain network. These ser-
vices can be performed internally or through the use of a third party
provider. Among the transport types can be found direct delivery from
origin to the customer, the use of air transport for next day delivery,
third party ground delivery within a certain shipment radius, delivery of
items requiring special storage such as refrigeration or perishability,
freight service for heavy and/or bulky items, LTLIparcel post delivery
of small/light items, and global package delivery by air or by freight.
Terminal Services. Whether performed in-house or by a third party car-
rier, transportation terminals provide several critical services. The
most obvious is the pickup and delivery of products from and to chan-
nel warehouses . Another critical service involves the performance of
value-added processing functions . Among these can be found consoli-
dation of many small shipments into full vehicle/container shipments

that will optimize transportation costs. Another service is bulkbreak
whereby large quantities to be shipped are broken down by customer
order into smaller deliveries. A third is shipment service where nor-
mally a third-party provides freight-handling services and performs
billing, routing, and other clerical functions. A final terminal service
performed by transportation is product and ownership interchange [3].
Loading and unloading. When transit is performed by a third party
carrier, responsibility for the loading and unloading of transport
vehicles varies by type of shipment. For example, when parcel post is
used the carrier normally performs the function. For TL shipments, the
shipper is required to load and the receiver is required to unload the
vehicle. Also, the carrier may perform these services for a charge. The
receiver is permitted a specified amount of time (normally one or two
days) to unload the vehicle. After that grace period, the carrier nor-
mally will charge a fee (termed demurrage in rail transport or detention
in motor transport) per storage vehicle for each day the equipment
remains at the receiving location.
Value-added services . Transportation also provides a number of value-
added services beyond material handling and transport. Among these
can be found electronic tracking of shipments from pickup to delivery,
availability of label imaging systems such as UPC or Bar Code, de-
livery confirmation, management and control of inbound customer
transportation charges, expediting of shipments to rush delivery, and
line-haul services that permit shippers to change a shipment's destin-
ation (reconsignment/diversion) or to perform some function that
physically changes product characteristics (transit privilege).
Documentation. Transportation is normally responsible for the pro-
cessing, control, and transmission of all shipping documentation. Doc-
umentation can consist of domestic documents, such as the bill of
lading, freight bills, F. G.B. terms ofsale, and claims, and international
documents, such as sales contracts, terms of sale, and export docu-
ments.
Transportation rates. In most organizations the transportation function
is responsible for establishing shipping rates when third party transport
carriers are contracted. Several factors are used in the determination of
transportation services rates. The process begins with the calculation
of the actual cost of the needed services. This cost will act as the basis
price to be used in carrier selection. Next, planners must factor in ad-
ditional prices due to the nature of the product to be transported. Based
on the principle of the value of service, as the value of products in-
TRANSPORTATION 615
creases, so do the transportation charges. Besides the value of the

product, the amount of distance to be transported needs to be con-
sidered when developing the price. Normally, the greater the distance
the product is moved, the greater the transportation rate. This increase
in cost due to distance , however, is not directly proportional. Because
of the tapering rate principle, the rate structure tapers due to the fact
that the greater the distance, the more carriers can spread costs, such as
handling and shipping monitoring, over a greater mileage base. Finally,
the calculation of the full price must consider the weight. For the most
part, the price of transport will decline as the weight and volume
mcreases.
The second major area of transportation services is product storage. While
the role of transportation is to move products from destination to delivery
point, often transporters must perform temporary in-transit storage functions.
The following types of storage can be found:
Transport mode. A common type of in-transit storage is to temporarily
store products in their mode of shipment, such as trailers, containers, or
tank cars. While the cost of this type of storage is high and is normally
used to span a very short period, it can be profitably deployed when the
cost is lower than the cost of unloading, warehousing, and reloading
transport vehicles .
In-transit storage . A variation of in-transit storage is to select a trans-
portation method that would take longer than a more direct or expen-
sive mode to reach its destination. The objective of this delaying op-
tion would be to use the transportation mode as a sort of rolling storage
facility to solve space shortage problems at the receiver's warehouse.
Diversion and reconsignm ent. Often companies will postpone ship-
ment receipt by changing the shipment's destination and/or consignee
while in transit. Diversion permits the shipper to divert a shipment
from its original destination to an alternative destination while en route.
Reconsignment provides a similar capability by allowing designation of
an alternative destination after it has reached its original destination,
but before it has been delivered to its original consignee .
The services transportation can render to the organization are a critical and
often overlooked component of competitive strategy. Effective transportation
requires a thorough understanding of such functions as pricing, use of third
party carriers for terminal services associated with loading and unloading,
consolidation, and bulkbreak, transportation regulations governing domestic
and international transport, and the selection of in-transit storage. An in-
depth knowledge of transportation services and principles is fundamental to
the effective cost management and optimization of the logistics system.
Transportation statistics. The importance of transportation in the

deployment of inventory in the manufacturing, wholesale, and retail sectors
of the economy can be best understood when the annual expenditure for
transportation is matched against the Gross National Product (GNP). Ac-
cording to Delaney [4], the cost of transportation and shipper related costs in
2002 totaled $577 billion, or 5.5 percent of GNP. When compared with fig-
ures since 1981, the transportation side of total physical distribution costs has
declined some 21 percent as deregulation enabled more efficient use of all
forms of transportation. 2002 saw a dramatic drop in transportation costs, but
this is attributable more to the poor economic conditions than to improvement
in cost management and will most likely be an anomaly. Since 1990, the
ratio between transportation cost and GNP has remained fairly stable and has
plateaued around 6 percent ofGDP (Table 12.1).
TABLE 12.1 Cost of Transportation in Relation to GNP (1981 - 2002)
GNP Transportation %of

Year $ Trillion Costs GNP
1981 3.13 $228 7.2
1985 4.21 274 6.5
1990 5.80 351 6.0
1995 7.40 441 5.9
1998 8.78 529 6.0
2000 9.87 590 5.9
2001 10.08 605 6.0
2002 10.47 577 5.5
As is illustrated in Figure 12.1, the cost-side of the transportation system

can be essentially broken up into five main areas. Of the five, two are
dominated by motor transportation. Without a doubt, it is the motor carrier
that drives the U.S. business logistics system. By referencing Figure 12.1 ,
highway transport in 2002 accounted for 80 percent of the total cost of
transportation. In terms of the sheer size of shipments in 2001, U.S. carriers
shipped 20.1 billion ton miles, with domestic carriers accounting for 7.5
billion and international carriers accounting for 12.6 billion [Table 12.2].
RELATIONSHIP OF TRANSPORTATION TO OTHER BUSINESS

FUNCTIONS
As was pointed out in Chapter 2, transportation is one of the key functions

constituting business logistics. Although some may argue that warehousing
is the pivotal logistics element, a warehouse cannot remain functional for
TRANSPORTATION 617
Transportation Costs $ Billions
Motor Carriers:
Truck - Intercity . 300
Truck - Local . . --lQL
Subtotal 462
Other Carriers:
Railroads . 37
Water. (InternationaI19, Domestic 9) . 27
Oil Pipelines . 9
Air. (International 7, Domestic 17) . 27
Forwarders . __
9_
Subtotal 109
Shipping Related Costs . 6
Total Transportation Costs 577
FIGURE 12.1 Total transportation costs - 2001
long without transportation. It is transportation's role to deliver products to

the warehouse from supply points in the distribution channel. It is also trans-
portation's responsibility to provide the services necessary to move product
from the warehouse to the customer in as efficient and cost-effective a man-
ner as possible. Whereas warehousing may rightfully be called the "heart" of
the supply chain function , transportation forms the veins and arteries through
which the heart pumps products and value-added services from one channel
member to another.
TABLE 12.2 Freight and Express Services
Figures in minions of ton miles
Date Domestic International Total

1991 4,946 5,279 10,225
1993 5,458 6,486 11,944
1995 6,397 8,181 14,578
1997 7,169 10,789 17,959
1999 7,289 12,028 19,317
2000 7,953 13,490 21,443
2001 7,452 12,657 20,109
Source: U.S. Department of Transpo rtatio n, 2002
The transportation and handling of inventories provides other business

functions with essential information concerning products, marketing place
and time utilities , and transit costs and capabilities necessary for effective
supply chain planning and operations execution. Some of these functions
interact directly with transportation; others are indirectly impacted. The re-
lationship between transportation and other business functions can be de-

scribed as follows:
Strategic planning. As enterprises design and improve on their product
and service value portfolios, the capabilities and costs associated with
the transportation network serve as key inputs to business decisions.
Whether it be expanding their geographical footprint or acquiring new
companies, strategists must consider how leveraging transportation can
optimize their proposed networks. Perhaps the most critical factor is
reducing their "cost to serve" by ensuring transportation enablers can
cost effectively link re-deployed manufacturing and distribution
channel nodes while increasing flexibility and service.
Traffic management. Many logistics functions have a traffic manage-
ment department that is responsible for monitoring the appropriate
transportation modes necessary to move products through the channel
pipeline . Figure 12.2 examines the different responsibilities of the
modem traffic manager. Over the past decade, warehouse and traffic
management have been working closely to reduce the cost of trans-
portation while improving delivery service. Most major freight traffic
movement in the United States is governed by master contracts
thoroughly negotiated with fine-tuned precision. If the firm possesses
its own transportation vehicles, traffic management needs to work
closely with warehousing in planning and selecting the optimal mix of
private, public, and transport services.
FIGURE 12.2 Administrative functions of the traffic manager.

TRANSPORTATION 619
Warehouse receiving and shipping. The effective scheduling of prod-

uct receiving and shipping is fundamental to the smooth flow of both
warehousing and transportation. For example, instead of planning with
carriers to have product delivery synchronized, vehicles haphazardly ar-
rive in bunches. The result is that vehicles have to wait their tum to be
loaded and unloaded, costing the company or the private carrier dearly
in lost productivity. In addition, inadequate scheduling forces the
warehouse to staff excess receivers and shippers than would be un-
necessary if the work flow was evened out. Poor scheduling also
causes daily periods of intense activity followed by periods of expen-
sive idleness . Finally, poor scheduling causes the warehouse to digest
uneven flows of material, requiring unnecessary material handling
equipment , and overflow staging areas.
Purchasing. Purchasing decisions have a direct impact on transporta-
tion. The physical attributes, quantity, and volume of purchased prod-
ucts require purchasers and transportation to work together to ensure
that the cost, availability, and adequacy of transport vehicles are suf-
ficient. In addition, purchasing can positively influence efficient sup-
plier delivery that can facilitate receiving activities. Areas of coopera-
tion include the following:
Working with suppliers in determining the most efficient
containerization methods for inbound products. Possible options
include selecting the best method to package, unitize, or palletize
purchased goods that will minimize damage, optimize carrier
capaciti es, and speed shipment and receiving.
Selecting the best transport equipment. This factor is particularly
important for firms that possess their own carrier services.
Determining the timing and location of supplier deliveries.
Customer service. Customer service delivery policy will have a sig-
nificant affect on outbound transportation. When customers place or-
ders, the price of the shipping and expected delivery can be as im-
portant as the product price. Service reps will need access to negoti-
ated shipping rates and lead times to not only provide key information,
but also to assist them in the selection of the appropriate service level
and cost that meets customers' requirements. Today's technology-en-
abled customer is also demanding the ability to leverage EDI and Inter-
net tools to increase in-transit inventory visibility as well as accurate
freight cost allocation for their orders.
Product pricing. The transportation decision has a direct bearing on
product pricing . Because transportation is a significant component of
total operations costs, transportation expense must be factored along
with purchasing, labor, and overhead costs when determining product

selling prices. Generally, the importance of transportation in price de-
termination grows as transportation's share of product costs increases.
Transportation costs can be as high as 50 percent or more of the selling
price of bulk commodities such as coal or wood and may be less that 1
percent for small-volume hard goods.
Supply channel locations. As was pointed out in Chapter 11, deciding
where to locate new channel warehouses is a complex affair, requiring
detailed analysis. Among the key factors in the planning process is de-
tennining the cost, availability, and adequacy of modes of trans-
portation. For example, if a distributor depends heavily on railroads for
product delivery, any decision concerning the location of a new ware-
house will be influenced by close proximity to rail transport.
Inventory planning. One of the areas of critical importance to
inventory planning is the comprehensive and timely maintenance of in-
transit inventory information, Whether statistical replenishment or
MRP/DRP techniques are employed, accurate information relating to
in-transit quantities and delivery dates is essential to effective inventory
planning and order promising .
MODES OF TRANSPORTATION
There are essentially five modes of transportation that may be used to move
goods through the supply channel and out to the customer. These five meth-
ods are as follows: motor, railroad, water, pipeline, and air transport. Each
provides the supply chain with certain advantages and each has its own par-
ticular limitation. In addition, certain combinations, or intermodal, variations
are possible. These include railroad-motor, motor-water, motor-air and rail-
water. Intermodal combinations of transport will be discussed at the end of
this section. Each of these transportation modes is described in detail below.
MOTOR TRANSPORT
As was mentioned above, highway motor transport is by far the most popular
mode of transportation today, accounting in 2001 for 80 percent of all trans-
portation revenues . The characteristic feature of this mode is that transit oc-
curs on the nation's highway network over which different types of carriers
operate a variety of motorized vehicles capable of carrying a wide range of
loads. Unlike the railroads, which must own and maintain tracks, line equip-
ment, and structures, the motor industry has the ability to move products free-
ly over 4 million miles of roads in the U.S. alone. It is estimated that the U.S.
TRANSPORTATION 621
interstate highway system carries more than one-fifth of the total motor trans-
port each year. As such, motor carrier capital investment is normally con-
fined to transport equipment, terminals, and related repair and storage
facilities .
The cost structure of the trucking industry is highly direct-cost intensive.
Although the fixed costs for trucks, trailer rigs, and material handling equip-
ment are significant, variable costs involved in labor, taxes and tolls for use
of public highways, terminal expenses, fuel, taxes, licenses, and insurance ac-
count for 80 percent to 90 percent of total motor transport costs. Of these
costs, labor accounts for about 60 percent of each cost dollar. Generally
speaking, about $0.97 cents of every operating dollar is consumed by opera-
ting expenses, with the balance going to cover interest costs and return to in-
vestors. As a result, the trucking industry cannot operate for very long with
rates below costs . In 2001, there were approximately 593,000 interstate
motor carriers registered with the U.S. Department of Transportation employ-
ing over 4.7 million drivers, deliverymen, and couriers. Less than full truck-
load (LTL) carrier leaders in 2002 were United Parcel Service with revenues
of $16 billion, Yellow Freight ($3.3 billion), Roadway Express ($2.8 billion),
North American Logistics ($2.2 billion), and Con-Way Transportation ($2.0
billion). Bulk transportation leaders were Schneider National with 2001 rev-
enues of $2.4 billion , J.B. Hunt ($2.2 billion), Swift Transportation ($1.3
billion) and Werner Enterprises (1.3 billion) [5].
Traditionally, motor transportation equipment has been divided into two
categories : intercity over-the-road equipment and specialized short-haul
equipment. The former category generates the majority of all motor transport
revenues . Equipment-wise, intercity freight carriers are usually characterized
by the familiar tractor-trailer rig, but it also can consist of special equipment
to haul products such as automobiles, liquids, tandem or double bottoms,
refrigerated , and large storage containers. Specialized short-haul equipment
is normally much smaller in volume capacity and more flexible in order to
handle a wider variety of products than intercity equipment. This category of
motor transport is used for pick-up and delivery of products over short
distances (up to a maximum of 20-30 miles). Automobiles, vans, trucks, and
short tractor-trailer rigs are examples of short-haul equipment.
The growth of motor transportation can be traced to several factors. To
begin with, the speed, flexibility, and relative cost of motor transport are
more in alignment with today's strategies aimed at high customer service and
Quick Response. These attributes have made motor transport over the past
half century the favored choice for manufacturers, distributors, and retailers
to haul high-value products over short distances. Unlike the other modes of
transportation, motor carriers can provide supply-point-to-supply-point ser-
vice. Furthermore, equipment versatility permits companies to ship almost
any weight or quantity easily and cost-effectively. Motor carriers also pro-
vide faster service than railroads and can successful compete with air trans-
port for short hauls. Finally, product loss and damage ratios for motor car-
riers are substantially less than for most rail shipments.
Still, despite its overwhelming benefits, motor transport will be facing sig-
nificant challenges in the twenty-first century. Perhaps the foremost is sur-
viving the difficult economic climate. Because of high terminal costs and
marketing expenses, LTL carriers in particular, are experiencing extensive
consolidation. The bankruptcy in 2002 of 73-year-old Consolidated Freight-
ways, who in 2001 controlled 14 percent of the LTL market, bears evidence
of the volatility of the industry. Furthermore, motor transport must assist
government and industry find solutions to such issues as shipment security,
congestion, pollution, fuel taxes, changes in the workforce and technology,
and the globalization of competition.
RAILROAD TRANSPORT
Historically, transportation in the U.S. was dominated by the railroad. From

the mid-nineteenth century to the conclusion of World War II, the continental
U.S. was linked by a network of rails that provided for the economic and spe-
edy transport of products and travel services. Today, while motor transport
accounts for the bulk of transportation revenues, railroads surpass all other
modes in terms of shipping tonnage, accounting for almost half of the freight
shipped in the United States. This leadership is due primarily to rail's ability
to transport large volumes of freight over long distances. In 2000, railroads
carried over 1.4 trillion ton-miles of freight (non-commuter) over a track
network totaling over 100,000 miles. In 2000, there were 8 major freight-car-
rying railroads in the United States, employing 168,000 people and operating
over 1 million freight cars [6]. For the most part, railroad usage had been
declining since the end of World War II, when rail accounted for about two-
thirds of the ton-mile traffic. The growth of motor transport has generally
absorbed a good deal of the small haulage while water and pipeline carriers
have been eroding away the shipment of bulk commodities.
All for-hire railroads in the U.S. are classified as common carriers. After
deregulation, railroads can legally offer their services to all shippers and are
not restricted as to cargo type. The railroad industry consists of a small
number of large firms. Altogether, there are about 360 railroads, of which
fewer than ten have revenues that exceed $250 million [7]. The reason for
the limited number of rail carriers is explained by the nature of the industry.
One of the most visible characteristic of rail transport is the enormous
physical plant consisting of track and accompanying rolling stock, terminals,
TRANSPORTATION 623
miscellaneous facilities, and administrative and management support. Unlike

motor transport that uses the public highway system, rail must maintain its
own facilities. Because of this very large fixed expense, the costs associated
with rights-of-way (tunnels and bridges), equipment maintenance, interest,
depreciation, taxation, and other costs must be absorbed by the carrier.
Unlike other modes of transportation whose life cycles are considerably
shorter, the cost of rail maintenance and physical plant remains fairly stable
over the life of the equipment and has a minimal impact on transport rates.
This means that railroads can take significant advantage of economies of
scale. The average freight train hauls a load of 2500 tons and pulls an aver-
age of 71.5 cars per freight train. Over the past 10 years, the trend has been
greater load per rail car, greater average daily car mileage, and faster trains
[8]. Simply stated, as the volume of freight increases, the total cost of trans-
port decreases on a per-unit basis.
Although the most significant advantage enjoyed by rail carriers is that
they can transport larger volumes of goods over great distances at a cost gen-
erally less than air and motor carriage, there are some distinct disadvantages.
To begin with, rail compares unfavorably to motor cartage when it comes to
transit time and frequency of service. Trains run on specific timetable
schedules dictating departure and arrival. In addition, rail provides terminal-
to-terminal service rather than stocking point-to-point service as does motor
transit. Unless the shipper has a railroad siding, product must be unloaded
and reloaded using other transit modes before it arrives at the stocking point.
Finally, rail carriers have not been able to guarantee the same general equip-
ment availability as motor carriers. Part of the problem is that the proper
storage car may not be physically present at' the shipment location when
needed. In order to overcome poor utilization or have rolling stock lost in the
cross-country rail network, the rail industry has been turning to a number of
advancements in car and information systems designs. Such developments as
computerized routing and scheduling, railcar identification systems, develop-
ment of specialized cars, upgrading of equipment, roadbeds, and terminals,
and nonstop shipments between metropolitan areas have enabled the rail
industry not only to hold its own but to enjoy the opportunity for growth in
the twenty-first century.
AIR TRANSPORT
Outside of pipelines, air carriers account for the smallest proportion of ton-
mile traffic. In 2001 air transport revenues amount to $24 billion and ac-
counted for only 4 percent of all transportation revenues. Although the In-
dustry grew during the late 1990s, the sagging economy, airline bankruptcies,
terrorist attacks , and war in the Persian Gulf during the first three years of the
new century dramatically hurt air transport. Revenues declines over 11 per-
cent as compared to the previous year ($27 billion). Overall ton miles de-
clined 9.2 percent in 2001 to 14.01 billion revenue ton miles; overall ship-
ments declined some 19 percent in 2002 to 2.58 billion from the peak of
nearly 3 billion in 2000. It has been estimated that altogether the industry has
lost from three to five years of growth. Returning to positive growth will re-
quire air cargo companies to successfully meet new security and safety pro-
visions, increased customer expectations, and internal pressures to be profit-
able and competitive.
For most airlines, providing freight transport is incidental to carrying pas-
sengers which is treated on a space-available basis. In 2002, of the 1.6 billion
tons of cargo shipped by air, 1.4 billion tons was carried by cargo airlines and
200.8 million tons was carried by passenger airlines . The air carrier industry,
furthermore, is highly concentrated into a small number of carriers that ac-
count for nearly 90 percent of the industry's revenues . While passenger air-
lines dominate, freight service companies, like UPS, Airborne, Federal Ex-
press, and Emery have their own fleets dedicated solely to transporting
freight . These carriers transport approximately 50 percent of all domestic air
transport freight.
Air transport equipment costs are associated with the aircraft and sup-
porting ground equipment and labor . For the most part, these variable costs
are high, accounting for over 80 percent of every airline expense dollar.
Support equipment is used mostly for transporting people, freight, baggage,
and fuels to and from the aircraft. Although the military does possess special
aircraft used exclusively for freight and troop transport, commercial aircraft ,
even those used only for freight, is designed around the passenger business.
In addition, the standard cargo bays in most aircraft are suitable only for
freight that is not subject to special requirements, such as refrigeration, gases
and flammable liquids, and dry-bulk storage .
The use of air transport provides shippers with some significant advan-
tages. The most obvious is the speed of service . Aircraft can deliver goods
in a fraction of the time required by the other four modes of transportation.
In addition, air carriers generally offer excellent frequency and reliability of
service, particularly to major metropolitan areas . Air carriers are most profit-
ably used under the following circumstances:
1. Speedy transportation of high-value, low-weight products that need to
traverse long distances
2. Emergency transport of critical repair parts
3. Emergency transport of products from stocking point to stocking point
in the supply channel to prevent loss of sales
TRANSPORTATION 625
4. Emergency shipments of components necessary to eliminate inter-

ruptions in product ion processes
5. Speedy transport of perishables and seasonal products such as exotic
flowers, foodstuffs , and fashion apparel
The foremost disadvantage to the use of air transport is the high cost of ser-
vice in comparison to the other four transport modes. In addition, the limited
cargo capacities of aircraft make it unsuitable for most classes of product.
Finally, like rail transport , air carriers function terminal-to-terminal rather
than stocking point to stocking point. This means that product must be un-
loaded from aircraft and then reloaded onto motor transport which then de-
livers the cargo to the receiving company. Another significant drawback is
weather. While modem day navigation equipment has enabled air carriers to
cut back on disruptions to service caused by minor weather problems, of the
five transport methods air transport is the most susceptible to weather
conditions.
WATER TRANSPORT
Historically, water transportation was the earliest form of mass transportation

in North America. Although during the colonial period there were a few
common carriers that transported goods by ferries, stagecoaches, and wagon
lines, the almost nonexistent state of the nation's roads made water transport
the only economical means of moving products from place to place until the
arrival of the railroad starting in the 1840s. The most important forms of
water transport were the trans-Atlanti c trade, rivers, lakes, and bays, and the
canal systems that were begun in the l820s and 1830s. Then as now, water
transport is particularl y suited to the movement of large, heavy, low-value-
per-unit goods that can be unloaded and loaded efficiently by mechanical
means. Water transport lends itself particularly well to commodity-type
products, such as iron ore, grains, building materials, and fuels, which do not
require quick delivery and are not particularly subject to shipping theft or
damage.
Today, with the explosion in global trade, water transport has grown into a
significant industry . In 2001 the U.S. water cargo industry showed revenues
of $19 billion for international and $9 billion for domestic trade, a growth of
over 6 and 12 percent respectively over 2000 totals. While in 2001 water
transportation accounted for only about 4.7 percent of all transportation
revenues, its importance is expanding. According to a report by the
Colography Group in April of 2003, global water transportation is expected
to outpace air transport in growth. Total international shipping is forecasted
to reach 10.98 trillion pounds with about 52 billion pounds moving by air. Of
the estimated $5.9 trillion in total international goods shipped in 2003, $2.3
trillion will move by air and $3.6 trillion will move by sea, a 4.3 percent in-
crease over 2002 levels.
Most texts on transportation divide water transportation into two major
categories: domestic and international. U.S. domestic water carriers opera-
tions can be broken down into three major areas. The first, internal water
transport, consists of the various inland rivers and canals crisscrossing the
nation. Excluding the Great Lakes and seacoasts, this category consists of
approximately 26,000 miles of waterway, the heaviest utilized being the
rivers and canals associated with the Mississippi Basin. About 55 percent of
the inland waterway traffic moves in this river system. The second water
transportation category, the Great Lakes System , comprises some 95,000
square miles of natural waterways, with a coastline of 8300 miles. About 10
percent of the total of the nation's inland waterway traffic in tons ($545 mil-
lion in 1999) navigates on the Great Lakes. In addition, continuing improve-
ments in Great Lakes facilities has provided access to the Atlantic Ocean and
connection with the Mississippi River system through canals. Coastal and
inter-costal transport is the third category of water transport. Comprised of
the many rivers, canals, bays, inlets, and channels that are connected to the
Atlantic and Pacific oceans and the Gulf of Mexico, coastal transport ac-
counts for the remaining 35 percent of domestic water transport. Companies
in this trade belong to one of four modes: private, contract, regulated, or
exempt.
On domestic waterways can be found large ships used on the Great Lakes
called lakers. Although they are similar to ocean vessels, their long, low pro-
files render them unseaworthy in the face of weather conditions characteristic
of ocean waters. In contrast, on the inland water systems, barges propelled by
towboats are the most common equipment. There are primarily three types of
barge. Open-hopper barges carry dry bulk cargoes such as coal, sand, gravel,
and limestone. Covered dry cargo barges primarily transport grains. Finally,
tank barges provide sealed storage environments for transporting petroleum,
liquids, or gases. Because of their shallow draft and ability to be linked to-
gether as a single unit or tow, barges are ideal for navigating the shallow
depths of rivers and canals.
The second major category is international water transportation. This
method is by far the most popular international shipping method and accounts
for over 70 percent of all u.s. international freight. U.S. companies can
utilize water to transport almost any product across the globe, but, for the
most part, this method is used primarily for low weight-to-value commodities
such as petroleum, minerals, dry bulk items, and commodities that are easily
containerized. The type of equipment used is governed by the commodity
carried and the category of waterway to be navigated. On the world's oceans,
TRANSPORTATION 627
large sea-going vessels are used. These ships normally are specifically de-
signed to transport various types of bulk cargos and can be described as bulk
carriers used for ores, grains, and metals; tankers used for petroleum and
natural gas; contain ers used for packaged commodities and food-stuffs; roll-
on-roll-off (RO-RO) used for automobiles and motor transport; and ocean-
going barges used to carry a wide-variety of products that are pulled by tugs
over short ocean voyages to places like Puerto Rico and the Hawaiian islands.
The major disadvantages to water transport are its relative slowness as
compared to other transport modes, dependence on water terminals and ports,
and low frequency of movement. Advantages possessed by water transport
are that of all the transport modes with the exception, perhaps, of pipelines, it
is the least expensive and is the most capable. Virtually anything can be
shipped by water, especially bulk-type products. For example, a single barge
tow comprised of 15 barges each with a capacity of 1500 tons, is the
equivalent of 2.25, lOO-car train units or 900 large semi truck rigs.
PIPELINES
Compared to the other modes, pipelines are one of the oldest forms of
transportation. Perhaps the most unique feature of pipelines is their physical
plant. Other than pipes, pumping stations, storage tanks, input and dispersal
facilities, and land, pipeline transport is not dependent on roads or facilities
and is barely visible to the public at large. As pipelines have no vehicles,
maintenance and investment are minimal and no backhaul problem exists. In
addition , the pipeline industry is highly automated. The movement of prod-
uct within the pipeline system can be controlled from pumping stations hun-
dreds of miles away, where computers are used to schedule and monitor op-
erations. Pipelines are very capital-intensive. In 1977, it was estimated that
$21 billion had been invested in the pipeline industry. In the late 1980s, it
was estimated that it would cost about $70 billion to replace the existing
pipeline system. That cost would be dramatically much higher today. The
pipeline industry operates (1999) over 177,000 miles of oil pipelines, and
(2000) over 1.4 million miles of gas pipelines . In 1990, approximately 22
percent of all domestic intercity ton-mile freight was transported using pipe-
lines [9]. In relationship to the other four transportation modes, pipelines re-
venues accounted for $9 billion in 2001, or about 1.5 of total u.s. trans-
portation.
The use of pipeline transport is governed by the types of products that can
be carried by this mode. There are three basic types of pipeline associated
with certain products : oil, natural gas, and slurry. In transporting these prod-
ucts, pipelines can be mounted above or buried beneath the ground. For the
most part, pipelines can only be used with commodities that are in liquid or
gaseous form. Petroleum products, crude oil, kerosene, water, chemicals, and
natural gas are excellent products for pipeline transport. In the oil industry
for example, pipelines are used to gather crude oil from the field, which flows
to the refinery. Product lines then distribute the finished goods from re-
fineries to consuming centers. Another important type of pipeline product is
slurry. Often, solid products can be ground and added to water for pipeline
transport. For instance, coal can be reduced to a powdered state, combined
with water, transported via pipeline, and converted back into a solid at the re-
ceiving point by removing the water component. By far, the predominant
users of pipelines are the oil and natural gas industries, with slurry products
constituting a very small percentage.
Advantages associated with the use of pipeline transport are significant for
liquefied types of products. Pipelines provide an extremely high level of ser-
vice dependability at a relatively low cost. Pipelines can move large volumes
of product, are not labor-intensive, can be easily monitored through auto-
mated computer control, are almost free of the chance of loss or damage to
product due to leaks or breaks, and are impervious to climatic conditions. On
the negative side, pipelines are extremely limited to the products they can
transport, have no geographical flexibility, are comparatively slow in speed,
and require the use of other transport modes as finished product moves closer
to ultimate consumers or retail outlets.
Each of the five transport modes has specific performance characteristic
strengths and weaknesses. As detailed above, when making transportation
decisions, managers must consider speed, completeness, dependability,
capability, frequency, and cost associated with the performance characteristic
of each transport mode. Table 12.3 ranks the performance characteristic of
each of the five modes of transportation according to these criteria.
INTERMODAL TRANSPORTATION
One of the most debated topics in the field of transportation is the proper al-
location of freight traffic among the five transport modes. The issue revolves
around the supposition that shippers do not always use the most appropriate
carrier mode to transport products and that too much or too little traffic is
being carrier by one mode, resulting in loss of efficiencies and possible in-
juries to the environment. One of the methods to combat possible inequal-
ities in transport mode use is the application of intermodal methods. The
basis of intermodal forms of transportation resides in the development of sys-
tems that integrate or combine together various elements of the five modes of
transportation. For the most part, intermodal transportation has focused
TRANSPORTATION 629
around variations in the following two methods: truck trailer on a rail jIatcar
(TOFC) and container on a rail flat car (COFC).
TABLE 12.3 Transportation Performance Characteristics
Transport
Mode Speed Completeness Dependability Capability Frequency Cost
Motor 2 1 3 3 1 2
Rail 3 3 4 4 3 3
Air 1 2 1 2 2 1
Water 5 5 5 5 5 5
Pipeline 4 4 2 1 4 4
Note: 1 = highest
TOFC. The basis of intermodalism in transport is how to facilitate the trans-

fer of unitized loads from one form of transport to another. TOFC, often cal-
led the piggyback system, is a method by which a truck trailer load is transfer-
red in-transit from the truck carrier to another transit mode without unloading
and reloading product. An example would be the use of a motor tractor and
trailer for local pick up. When the route is completed, the tractor-trailer
would then be loaded intact onto a rail flatbed, which would then execute a
long-distance haul. Upon arrival, the rig would be unloaded and would pro-
ceed to carry out delivery to the customer. In this TOFC example the low-
cost advantages of long-haul rail transport is combined with the flexibility
and convenience of the motor carrier. There are several possible forms of
TOFC systems. Piggyback methods can be used between motor carrier and
rail or between motor carrier and transoceanic vessels or barge (fishyback).
COFe. The transfer of containers from one mode of transport to another is a

key component of intermodal transportation. A container system is character-
ized by the storage of products in a box or similar form of container. Normal-
ly, the container size has been standardized to facilitate loading and un-
loading across several transportation modes. In addition to ease of move-
ment, containers also inhibit theft and decrease the possibility of damage.
Operationally, COFC methods function similarly to TOFC methods. Pro-
cedurally , the container(s) are first loaded onto motor flat bed trailers at the
shipping point. After what is usually a short haul, the containers are then un-
loaded onto flatbed railcars, waterway carriers, or even special air cargo
planes for delivery. Upon arrival, the containers are loaded back onto motor
carriers for customer delivery.
A variation on the intermodal forms of transport discussed above is the use
of an innovative intermodal vehicle called a railroader or a trailertrain. A
railroader is a special form of vehicle that combines motor and rail transport
in a single piece of equipment. The railroader resembles a conventional mo-
tor trailer that has been specially equipped with both road tires and railroad
track wheels that can be rotated as necessary. When the vehicle is used as a
railcar, the road tires are retracted and the vehicle rides directly on the steel
rail wheels. The advantage of a railroader is savings in time and handling
costs to mount conventional semi-truck systems onto railcars. The dis-
advantage is obviously the excess weight and added costs caused by hauling
the steel wheels when the trailer is on the highway.
The use of intermodal methods of transportation promises great benefits to
shippers. It can provide better and more flexible services as well as wider
area coverage at lower rates. Furthermore, by combining the optimum trans-
portation modes to fit the transportation task, it offers shippers the ability to
tailor a transportation package for each system that maximizes transport effi-
ciencies . Still, although intermodal methods offer significant cost advantages
and their use has grown over the last four decades, intermodal shares a very
small portion of total transportation revenues. According to Delaney [10],
intermodal transportation in 1992 accounted for only about $6-8 billion of the
$297 billion trucking and $30 billion railroad industries. Despite the fact that
the u.s. government has actually established an Intermodal Agency and pas-
sed legislation (the Intermodal Surface Transportation Efficiency Act of
1991) designed to promote intermodal transportation, it is evident that manu-
facturers and distributors prefer to focus their expenditures on trucking ser-
vices. Undoubtedly, the efficiency, reliability, and faster delivery service
provided by the trucking industry is perceived as enabling firms to hold less
inventory, hold it in fewer locations, and consolidate shipments from dif-
ferent origins into a single delivery.
TYPES OF TRANSPORTATION
There are several different legal modes of transportation that can be em-
ployed by traffic management. Choosing the appropriate type of transporta-
tion consists of a number of marketing, product, warehouse location, custom-
er service, and financial decisions. The goal is to develop operational meth-
ods that consistently provide for the selection of the best transport carrier sys-
tem that efficiently and effectively executes transportation requirements
while simultaneously facilitating the attainment of customer service perfor-
mance targets. Factors influencing transportation selection include the type
of distribution environment to be serviced, supply chain strategic goals, re-
quired delivery lead time, financial capacities, product characteristics such as
order quantity size, physical characteristics such as size, perishability,
TRANSPORTATION 631
seasonality, potential for obsolescence and theft, and intrinsic value, geo-
graphic size of the channel network, carrier-type availability, and strength of
the competition.
LEGAL FORMS OF TRANSPORTATION
Before transportation modes are discussed, it is necessary to review how the

various types of transportation are legally owned and organized. As a result
of the Interstate Commerce Commission (ICC) Termination Act of 1995, es-
sentially five basic types of carrier have emerged: common, regulated,
contract, exempt, and private. The first four types are owned more or less by
for-hire freight companies and are subject to various federal, state, and local
statutes and regulations. In contrast, the fifth type, private carrier, consists of
company-owned equipment that is used to transport company products and
supplies through proprietary channel networks. The following is a brief
review of the five legal types of transportation:
Common Carriers. A common carrier provides transport services to
the general public according to a published rates schedule. Although,
common carriers no longer have to file their rates with the Interstate
ICC, they are still, nevertheless, the most heavily regulated of the five
types of carrier. The purpose of this level of control is to protect the
shipping public and ensure cost effective service within reasonable
limits. In order to operate legally, common carriers must be granted
authority from the appropriate federal regulatory agency. Normally,
this authority also defines the type of product or commodity that can be
carried and the geographical area or terminal points to be served. As
part of their legal obligation, common carriers must service all comers,
provide rates, classifications, rules, or practices if requested by the
shipper, provide service to all points prescribed in their certificates of
authority, and deliver products within a reasonable time even if the
shipment is not profitable.
Regulated Carriers. This class of carrier provides basically the same
functions as a common carrier, but with a few exceptions. They have
the same responsibility to provide safe and adequate service, but with-
out the requirement to serve all comers. In addition, while regulated
carriers have basically the same immunity from government regulation
as other carrier types, they must provide rates to shippers on request
and they have the ability to collectively establish rates without antitrust
prosecution. A benefit of employing regulated carriers is that they can
be held liable for damages to transported goods. The extent of the
liability, however, can be limited through the use of tariff rules and
released value rates.
Contract Carriers. Similar to common carriers, contract carriers are
regulated by the federal government and are authorized to transport
certain types of products in certain geographical areas. Contract car-
riers are not required to offer their services to the general public, but,
instead, provide transport services for a negotiated price to selected
customers defined by contractual agreement. Normally, contract carrier
rates are less than common carrier rates for two reasons:
1. Contract carriers select customers that wish to transport products
that optimize the capacities and capabilities of their vehicle and
material handling equipment.
2. Because customers provide contract carriers with defined
contracts that specify products transit and delivery schedules,
they can plan better and budget for equipment resources.
Exempt Carriers. This type of for-hire carrier differs from common
and contract carriers in that it is not regulated with respect to routes,
areas served, and rates. The exempt status is determined by the type of
product transported and the nature of the operation. Examples include
a variety of land and water carriers that transport commodities such as
agricultural products, livestock, poultry, newspapers, and other
specialized products. Probably the most important class of carrier
belonging to this type is delivery and cartage firms that operate in a
local municipality or "commercial zone" surrounding a municipality.
Although exempt carriers charge lower rates than common or contract
carriers, limitations on the kinds of products that are exempt render
their use inappropriate for the transport of most industrial products.
Private Carriers. This final type of carrier is distinguished by the fact
that it is wholly owned or leased by the firm and is incidental to the
company's main line of business. Private carriers are not subject to fed-
eral government regulation regarding costs or scope of service. Private
carriers are not allowed to transport the goods of other companies and,
as determined by law, must be the sole owner of the cargo. After the
passage of the Motor Carrier Act in 1980, permission was granted to
companies with private fleets to transport products for wholly owned
subsidiaries or backhaul loads from nonaffiliated companies. The de-
cision to acquire a private transport fleet or use for-hire types of trans-
portation must be examined. Wholly-owned transport provides compa-
nies with a significant level of control and flexibility to respond direct-
ly to customer and internal channel requirements. On the other hand,
TRANSPORTATION 633
since deregulation, many for-hire carriers can offer services that are
more cost and operationally effective than private fleets.
In addition to these types of carriers, new forms of transport services have
grown dramatically since deregulation. These companies purchase transport
services from primary carriers, which they in tum retail to their customers by
providing services for handling small packages, consolidation and bulk
breaking, and local pickup and delivery. These transportation agencies can
be described as follows:
Freight Forwarders. A freight forwarder, as defined by law, provides
the general public with transportation services and, in the ordinary
course of business, assembles and consolidates, or provides for as-
sembly and consolidation of, shipments at origin and performs or pro-
vides for break bulk and distribution of shipments at the delivery des-
tination . In addition, freight forwarders must assume responsibility for
the transportation of a shipment, incur liability for loss or damage to
cargo, and must use, for any part of the cartage, a carrier subject to the
jurisdiction of the ICC. Finally, according to the Forwarder Deregu-
lation Act of 1986, this type of carrier can operate exempt from ICC
jurisdiction.
Parcel Post. Companies engaged in this type of transport focus on the
rapid shipment of small (weight and volume) goods and are designed
for general public use. Parcel post shippers use all types of air and sur-
face line-haul modes except for pipeline and can consist of bus, motor,
or air cartage. The U.S. Post Office, Federal Express, and United
Parcel Service are examples of companies in this group. The main ad-
vantage of using small-package carriers is speed ofdelivery, especially
for emergency situation. The high cost, however, generally prohibits
use of this mode for low-value, high-density commodities.
Shippers' Associations. This group is composed of nonprofit shippers'
cooperatives whose primary function is freight consolidation . These
associations will consolidate smaller shipments from members, search
for carriers , and execute low-rate shipment the savings from which can
be passed back to association members.
Shippers' Agents. This group is composed of transportation brokers
who provide ramp-to-ramp transit from railroads and motor vehicles at
origin and destination using truckers as needed under a single bill of
lading. They do not provide transport requiring consolidation or bulk-
breaking functions . Shippers' agents are exempt from government
regulation.
Brokers. The broker is a third-party agent who is neither a shipper nor
a carrier but rather an intermediary that arranges a match between the
shipper's transportation need and a specific carrier from a pool of car-

riers they represent. Brokers can be licensed by the Surface Trade
Board (STB) or unlicensed, but both work under a commission arrange-
ment. Since deregulation that use of brokers has dramatically in-
creased. In addition, brokers are generally not liable for cargo loss and
damage. Issues regarding brokers' assistance in pursuing damaged
goods claims, rate negotiation, billing, and tracing are normally deter-
mined during the contracting process.
When selecting from the above list of transportation carriers, the actual dis-
tinctions are slight. The real issues revolve around operating restrictions,
financial commitment, and operating flexibility. The dramatic changes
brought about by deregulation have lifted the heavy restrictions on the way
carriers operate and the way they can be used. Still, there are several critical
elements, such as service requirements, type of product, pricing, and level of
carrier commitment that must be reviewed during selection.
TRANSPORTATION PERFORMANCE CHARACTERISTICS
There are a number of performance characteristics that shippers must con-

sider when selecting the appropriate mode of transportation. These character-
istics must be matched with the type and quantity of product to be shipped,
the capacities and capabilities of the transportation mode, and relevant cost
issues. According to Bowersox et al. [11], there are six transport mode per-
formance characteristics (Figure 12.3) driving any transportation selection
decision.
D D ,---
I Speed
_--= - - -__ >
FIGURE 12.3 Performance characteristics of transportation.
1. Speed. The ability to transport products from one point in the supply
chain to another as quickly as possible is, by far, the fundamental per-
formance characteristic of transportation . Speed provides the mar-
keting utility of time and ensures place utility. In detail, transportation
speed can be defined as the time required to move products from the
production source to a terminal, load the products onto the transport
TRANSPORTATION 635
vehicle, traverse terminal points, and deliver the products to the re-
ceiving terminal.
2. Completeness. This performance characteristic refers to the ability of
the transport mode to move inventory from one location to another
without the use of other modes. This is critical because the less materi-
al has to be handled between the point of origin and the point of destin-
ation, the lower the transport cost and the short the delivery time. For
example, if material was shipped by rail and the company did not have
a rail siding, a second mode, most likely motor carrier, would have to
receive the load from the rail carrier, and then transport it to the com-
pany where it would have to be unloaded again for final receipt.
3. Dependability. The degree of transport dependability is measured by
the performance of a given mode in meeting anticipated on-time
delivery. Dependability is critical in ensuring that planned inventory
availability to meet place utility is realized to schedule. Poor de-
pendability adds cost in the form of excess inventories and poor
customer service.
4. Capability. Capability refers to the ability of a given transport mode to
accommodate a specific transport load. The driving factor is the nature
of the product. Characteristics such as product type (liquid, solid, bulk,
or package), load weight, and load dimensions will have an effect when
deciding on the necessary capabilities of material handling equipment
and mode of transport. For example, when moving liquids, tank cars
and pipelines would be the most appropriate methods of transport.
5. Frequency. This performance factor is a measure of the frequency a
given transport mode can pick up and deliver goods. Generally, the
shorter the transport interval the greater the flexibility of the mode to
respond to channel requirements . More frequent transport also de-
creases the required modal size and the magnitude of the inventory to
be transported.
6. Cost. Although marketing time and place utilities are critical elements
of transport mode selection, the cost the shipper must pay for the trans-
port service is equally important to the survival and competitiveness of
the supply channel. There are several costs in transportation. The most
obvious cost is the rate paid to the carrier for use of the mode itself.
Other indirect costs are labor and material handling to load and unload
the transport medium, occurrence of spoilage and damage, insurance to
protect against possible loss, and in-transit inventory carrying costs.
TRANSPORTATION MANAGEMENT PROCESS
The effective day-to-day management of transportation activities is absolutely

necessary for the smooth functioning of the supply chain. It is the responsi-
bility of the transportation function to perform such tasks as the selection of
proper carriers, monitoring and executing inbound and outbound logistics ac-
tivities, pricing, scheduling, and transport routing. The every-day functions
of transportation management are illustrated in Figure 12.4. In planning and
Pla nning Planning Invoicing and Reporting
pot Buy Invoice

C laims
Orders Receipt
Carrier
Assignment
Load

Freight
Bill

Se lf
.
Invoicing
Tenderingl Audit
Acce tance
Freight
Bill
Load
Prepare Payment
Planning
Shipping I
Documents
Performance
Reporting
Dispatch & -
Monitoring Financial
Operational
Serv ice
Order
Delivery
FIGURE 12.4 Transportation planning functions

executing these functions, transportation planners are concerned with such
questions as:
How will customer service objectives influence carrier selection and
cost?
If the firm possesses its own transportation equipment, what should be
the mix of shipping carried privately and contracted out to public
companies?
TRANSPORTATION 637
What is the cost in labor, equipment, and maintenance to run the pri-
vate carrier fleet, and is it cost-effective?
What transportation capacities are required to handle expected custom-
er demands?
How much will transportation cost to support current and projected lev-
els of inbound and outbound shipping cost?
Does transportation possess a formal process for public carrier se-
lection?
Are there formal procedures in place to ensure transportation is re-
ceiving the best freight rates possible?
Should the company use a freight rating service?
Can the transportation function benefit by the implementation of soft-
ware support tools?
What should be the performance measurements to ensure that trans-
portation is achieving optimal efficiency and productivity?
Whether it is the development of the enterprise's transportation strategy or
the daily requirement to service customers and purchase from suppliers, re-
sponses to the above questions revolve around an effective understanding of
transportation economics and carrier pricing. Surrounding all transportation
decisions are seven possible factors that must be used as the foundation
driving all transportation planning activities. Failure to understand the below
principles will result in excess costs and poor utilization of transportation
capabilities [12]:
Distance. The distance products travel from point of origin to the
destination will have a critical impact on the transportation decision.
Because of the tapering principle, the longer the distance the more the
fixed and variable costs of transport can be spread out over the total
trip. Since more distance can be covered with the same fuel and labor
and there are less stops, the cost will decrease.
Volume. Economies of scale can be gained in this factor from the fact
that transport cost per unit of weight decreases as volume increases.
Leveraging distance and weight factors will drive planners to seek to
gather full truck load shipments, especially as the distance grows
longer, during shipment planning.
Density. This factor attempts to utilize weight and space considerations
when planning for transportation. As a principle, as product weight in-
creases, the cost will generally decrease. The reason for this is that
higher density products will have a minimum impact on price because
variable costs are not greatly impacted and remain relatively unchanged
as weight increases . In contrast, once a transport vehicle's volume is
filled, it is completed regardless of the actual weight of the cargo.
Stowability. This factor relates to the actual volume cube of the

product to be shipped and how easily it can optimize standard transport
vehicle capacities. Simply, size and storage restrictions for some
products, such as heavy wheel products, steel rods, and trash cans, can
significantly increase transport cost due to use of specialized vehicles
or inability to optimize vehicle shipping volumes.
Handling. The loading, unloading, and storage of some products may
require shipping planners to utilize costly handling or equipment.
Liability. Many products will require shippers to plan for special
modes of transport because of product perishability or damage preven-
tion, the use of insurance to guard against damage or theft, or the use of
containers or special marking and handling to ensure transport safety.
These types of considerations will increase transportation costs.
Vehicle profitability. Perhaps one of the oldest problems in transporta-
tion management is vehicle return. Often when products are transpor-
ted to a destination, the return trip is made without any cargo, or dead-
head. This condition is purely a waste of assets and variable costs
which are simply added to the original price. Such a condition occurs
when there are imbalances in the direction of transport. The ideal is to
have a balanced transport environment where once a load is delivered
the transport vehicle can pick up another load, or back-haul, to the
point of origin.
ESTABLISHING COSTS AND RATES
Against the back-drop of the above seven transportation decision factors,

there are several critical management steps performed by transport planners.
As is illustrated in Figure 12.5, establishing costs and rates for shipments is
the first step in the transportation management process. In regard to termin-
ology, the price to move a specific product between two supply channel lo-
cations is defined as the rate. When this rate (normally expressed in terms of
value of service performed, weight, and distance) is listed on a price sheet, it
is known as a tariff. It is important at this point to separate the cost incurred
to operate a private fleet from the price (rate) public carriers charge for trans-
port. The cost for privately owned transport can be measured several ways.
Among the expenses to be considered are fixed costs, such a buying and
leasing equipment, maintenance, and terminal facilities. Other costs fall into
the category of variable expenses associated with fuel, labor, insurance,
license fees, supervision, and administration. There is also marginal cost
which is the cost associated with each product shipped. A private fleet must
achieve average revenue that must at least cover the average total cost. If a
TRANSPORTATION 639
private fleet does not generate enough revenue to meet costs, the firm might
seek to cut the fleet size or abandon it altogether in favor of public carriers.
I Logistics Plan
I 1
Esta blish Transport cheduling

.... Costs a nd r+ Mode r+ and I--
Rates election Routing
Document
Preparation
and Pa yment
~
Shipping Plan
J
FIGURE 12 .5 Transportation management process.
When using public carriers, critical issues revolve around negotiation and
calculation of rates. Before deregulation, the tariffs charged by public car-
riers were established by rate bureaus composed of carrier representatives.
Shippers could appear before these bureaus and petition for lower rates on
specific commodities or transit routes. Today, although rate bureaus still
exist, most rates are the result of direct negotiation between the shipper and
the carrier. Although each public carrier publishes transport rates, few ship-
pers pay them. Instead, through a series of negotiations, a discount off the
rate is agreed on which then serves as the actual price. Before rate analysis
can begin, however, transportation planners must perform two steps. The
first is to perform a classification of the products to be shipped. Basically
this activity requires grouping of shippable products by such criteria as
density, stowability, handling, liability and other value characteristics. Once
this step is performed, it would be possible to then progress to a determin-
ation of the rate. This activity is termed rate administration .
Rate negotiation is a four-step process [13]. To begin with, shippers must
assess the past, present, and expected shipping volumes. The goal is to
quantify the volume, and origin and destination regularity of shipments that
can be used during negotiations. The second step is to contact carriers, pre-
sent the relevant requirements, and solicit bids. In reviewing responses, some
of the possible criteria shippers could use include the following:
The carrier's financial stability
The carrier's reputation for reliable service

Billing accuracy of the carrier
The discount percent off the published rate proposed by the carrier
Whether the carrier charges for notifying consignee prior to delivery
The carrier's procedures for handling loss and damage claims
Availability of special equipment, such as material handling facilities,
refrigeration, containerization, intermodal equipment, and others
The location of the carrier's terminals
The carrier's level of customer service responsiveness
Copy of the carrier's insurance certificate.
The final selection of carriers is determined normally by a combination of the
price of the service and other quantifiable elements, as well as subjective
predilection.
The third step in the carrier negotiation process is the execution of any
final discussions between shipper and carrier, mostly relating to negotiating
for prices below the formal bid and award of the contract. At this point, a
legal contract is drafted, describing the extent of the criteria stated above,
plus other clauses relat ing to performance penalties and incentives. In ad-
dition, the contract should include the time limit of the contract, products, and
volumes to be shipped, assignment of liability, payment schedule, and the
rates to be charged. An example of a motor carrier contract appears in the ap-
pendix at the end of this chapter. The final step in the negotiation process is
the ongoing administration of the contract after it has been awarded. The re-
sults of the negotiation process should result in a contract that includes the
following:
1. A pricing system that is simple to understand and execute for all of the
shipper's/receiver's locations and commodities
2. Price stability for the shipper during the life of the contract
3. Shipping volume stability for the carrier during the life of the contract
4. A simple and understandable freight bill payment process
5. Capacity of the carrier to use computer technology such as EDI, rating,
and scheduling systems
6. Availability of data for auditing and performance measurement.
TRANSPORTATION MODE SELECTION
The choice of carrier shipping mode is the second step in the transportation
management process. The goal is to achieve the lowest possible transit cost
for the maximum service. In addition, in selecting a carrier, transportation
management must be able to address specific shipping issues relating to any
required special shipping needs, the rates and services offered by competing
TRANSPORTATION 641
carriers, and the probability of loss, damage, or delivery delay. Although the
everyday selection of carriers does not necessitate significant and time-
consuming analysis, the relative advantages and disadvantages of the various
modes and carriers normally employed must be constantly reviewed as con-
ditions change or exceptions arise.
Carrier selection follows five general principles. In the first, carrier re-
duction, transportation management must focus on reducing the carrier data-
base. Concentrating the number of carriers into a few select suppliers permits
shippers to develop a collaborative relationship that enhances mutual partner-
ship, increases negotiating power, reduces rates and increases service due to
increased volumes and revenues enjoyed by a dedicated carrier, and reduces
other logistics costs such as information technology, inventory, and ware-
housing.
Once carriers have been identified, traffic managers can progress to the
next step: comparing available alternatives. The goal of this step is to match
the shipment with the most appropriate mode of transport. This means, first
of all, selecting a carrier that offers the best rate for the service. Second, a
carrier should be selected with documented performance regarding speed and
reliability. Comparing possible carrier alternatives can be a difficult task:
Some transport modes have markedly different attributes not shared by other
modes, rendering them not easily substitutable. Studies have shown that most
selection is based on a number of criteria including rates, loss and damage
record, claims processing experience, transit-time reliability, past negoti-
ations experience, quality of on-time pick-up and delivery, and equipment
availability.
The third principle of carrier selection is for traffic management to con-
tinually review their carrier selection processes with an eye toward continu-
ous cost reduction and service improvement. For the most part, recent studies
have shown that firms have been reluctant to change their carriers in the short
run. In cases where the transportation fleet is privately owned, the firm is
naturally averse to using public carriers, preferring to search for every op-
portunity to optimize internal resources. In other cases, the carrier selection
process is the result of a strategic decision made at the time the supply chan-
nel network was being structured, and there is resistance to change. In any
case, traffic managers must continually search for ways to buy cost-effective
transportation. Some of the methods which can be employed are as follows:
Freight Bill audit. Freight bills must be continually audited to ensure
accuracy of the negotiated rate as well as the correct charges. Audits
will ensure that traffic management is aware of possible adverse rate
changes occurring over time.
Monitoring demurrage. Shippers need to be aware of demurrage

charges. Proper internal scheduling reduces the time railcars, trailers,
barges, and so on sit idle at the company site.
Packaging review. Changes in containerization or packaging can affect
the choice of carrier. Reusable, lighter, or more efficient packing
methods could result in easier to handle loads that might warrant a
change in carrier.
Carrier relations. Traffic management should always be working with
carriers to mutually discover methods of improving service and re-
ducing costs.
Outsourcing. One method to handle all or part of a firm's transporta-
tion needs is to outsource them to a third-party logistics services com-
pany. Some of the advantages are (1) keeping internal costs low by
outsourcing tasks , (2) more customized services, (3) transportation cost
reduction, and (4) acquisition of computerized capabilities, such as EDI
and Internet, without have to acquire them [14].
Developing selection criteria constitutes the fourth principle of carrier
selection. Selection criteria can be broadly divided into three areas: traffic
related, shipper related, and service related. These three areas have been
detailed in Table 12.4. In using this list of criteria, most traffic planners use a
TABLE 12.4 Factors Affecting Modal Choices
Traffic-Related Shipper-Related Service-Related

Lengthof haul Size of firm Speed(transit time)
Consignment of weight Investment priorities Reliability
Dimensions Marketing strategies Cost
Value Spatialstructureof Customer relations
Value density (weight production and Geographical coverage
and cube) distribution systems Accessibility
Urgency Availability of rail Availability of special
Regularityof shipment sidings vehicles/equipment
Fragility Stockholder policies Monitoring of goods
Toxicity Management structure Unitization
Perishability System of carrier Ancillary services (bulk
Packagingtype evaluation breaking, storage, etc.)
Specialhandling Computer capabilities/
characteristics compatibilities
Source: AdaptedfromRef 15.
weighting method. For the most part, size of shipment, length of haul, transit
time, and cost are the key factors employed. In making carrier selection
TRANSPORTATION 643
choices, planners usually trade off one factor against another, rather than con-
sider each separately in an ordered sequence.
The formulation of a rigorous selection procedure is the final principle of
carrier selection. Normally, it is feasible that a shipper could use one of sev-
eral modes of transport. Each mode will possess strengths and weaknesses
when matched against a particular shipment requirement. In practice, the
process for selecting the best mode and carrier must be one that meets the
company's shipping and cost objectives. This does not mean that any form
can be used just to meet or exceed service targets nor does it means that the
cheapest mode should be chosen to meet cost objectives. Similar to carrying
inventory, traffic planners must plot cost and quality of service and establish
the optimum trade-off. The criteria most likely to be used in any optimization
analysis are cost, speed, and reliability. As is exhibited in Figure 12.6, a
decision model can be constructed using costs and transit times, several dif-
ferent types of carrier marked A, B, C, and D, and their x and y coordinates
corresponding to particular combinations of cost and transit time. Shippers
would prefer carriers above the curve, and when two modes lay on or close to
the curve, other factors would then be applied. Another method would be the
use of a computeri zed transportation modeling application that would cal-
culate the optimum transportation mode based on user-defined and weighted
parameters.
c

I
\
.
Transportation " Mode
Cost " Indifference
"... Code
A ........ o
"

B
Transit Time
FIGURE 12.6 Plotting cost and transit time.
Traffic planners often find it advantageous to use more than one transpor-
tation mode to ship product. This can occur when the shipper uses inter-
modal methods, a given mode is regularly used for specific products, geo-
graphical locations, and types of customers, or emergency shipments or peak
transit periods require different modes. Developments facilitating the use of
multimode strategies include diversification of product ranges, growth in
market areas, reduced dependence on a single mode, inventory reduction
pressures, and innovations in intennodal systems. Such a strategy has shifted
transportation's concern from choosing the best mode, to an emphasis on

deciding on the optimum allocation of traffic among several modes [16].
SCHEDULING AND ROUTING
Scheduling and routing are two functions associated with shipping. Vehicle
scheduling can be defined as the selection of which customer orders are to be
delivered by a single vehicle. Vehicle routing, on the other hand, establishes
the sequence in which selected customer orders are to be delivered during the
route. Most shippers are more concerned with scheduling than with routing.
The selection of orders for the shipping schedule is normally the responsi-
bility of a load planner or dispatch clerk. After orders have been chosen,
scheduling is normally executed based on zones containing clusters of cus-
tomers, with the routing indicating the sequence of delivery within each zone.
In motor transport, the driver is usually empowered to select the routing with-
in each zone. When customers within a route are stretched across zones, the
usual practice is to treat groups of customers in different zones as nodes to be
serviced along the route. Once these nodes are reached by the vehicle, the
driver chooses the delivery sequence based on knowledge of local roads and
customer preferences.
The routing and scheduling of deliveries is a critical task. For small firms
with a limited number of products, shipment routing is a repetitive affair with
minimal variation. Larger firms, on the other hand, who ship a wide variety
and volume of products to a widely spaced geographical customer base, must
perform detailed routing analysis. For companies with their own fleets,
effective scheduling and routing of transportation has long been recognized
as pivotal in fully leveraging the significant capital investment in transporta-
tion equipment and facilities and operating expenses made by the firm neces-
sary to achieve service level and cost objectives. The key topics relating to
routing and scheduling are single versus multiple deliveries, value of load
consolidation, routing methods, and vehicle scheduling.
One of the fundamental elements of mode transport routing is the relation-
ship between the number of delivery loads per vehicle and the number of de-
livery points constituting the route. Basically, as the number of load deliv-
eries to be transported by a single vehicle declines, the complexity of the
routing correspondingly declines. For example, if the customer shipment fil-
led the total capacity of the vehicle, the routing would consist of only one
route and one delivery. On the other hand, as the number of load deliveries
per vehicle increases, the number of delivery locations normally increases,
and the more difficult it becomes to define a route that maximizes vehicle ca-
pacities and operating expense. Alongside the issue of routing complexity,
TRANSPORTATION 645
the number of loads per vehicle also has an impact on the distance the vehicle
will traverse en route to the customer. As a rule, as the number of deliveries
increase per route, the overall distance of the route declines. While the multi-
ple delivery routes may indeed be more complex, the round distance is nor-
mally shorter than a straight radial distance that also entails vehicle backhaul.
In the past, the relation of load size and the routing favored direct radial de-
liveries. The reason for this stemmed from two factors. The first related to
transportation cost per unit. Simply, the larger the load in relation to vehicle
capacity, the lower the transport cost. Full load delivery, although it did, in-
deed, require running empty return vehicles, was more efficient than multiple
delivery methods. The second reason can be found in the assumption that
customers preferred to have their inventory requirements met by shipping as
large a lot size as possible. In the past inventory planning systems focused on
ordering stock according to EOQs, max inventory levels, or other lot-sizing
rules. The result was that transit practices using small, more frequent stops
could deliver only a portion of customer demand, whereas a full truckload
could perhaps meet customer lot-size requirements in full. In addition, the
larger the lot size, the larger the vehicle. On routes subject to multiple de-
liveries, so much time is spent in repeating delivery activities that only a re-
latively small payload can be delivered in the time allotted. As the distance
between delivery sites decreases, payload can increase, but it cannot match
the economies achieved by singe delivery routes.
As the era of JIT arrived, the pendulum between single and multiple deliv-
eries began to swing dramatically in favor of multiple-delivery, LTL meth-
ods. Whereas unit-cost transport is still best served by as large a truckload as
is possible, customer requirements for smaller lot sizes and more frequent de-
liveries has caused a renewed interest in complex routing. Industrial cus-
tomers who use flow manufacturing in their plants are requiring a corres-
pondingflow of materials to the process floor. Automotive giants like Ford
and GM, for example, require multiple daily deliveries of products. One
transport technique, called a milk run, consists of the pick up and delivery of
empty containers and product beginning at the customer's plant, progressing
through the channel supply points, and ending up finally with delivery at the
customer plant daily or several times during the day. For deliveries which
must traverse long distances, milk runs can be combined with long-haul car-
riers to provide effective mixed-mode transportation [17].
Another method that can be utilized is to increase load volume and mini-
mize the number of delivery points through order consolidation. Shipment
consolidation can take place on the loading dock, externally through inter-
company collaboration, or through the use of a common carrier. Internally,
traffic planners can suspend delivery of orders to a customer until a suf-
ficiently large enough load has accumulated. The negative side of this
practice is that it lengthens lead times, increases cycle stocks, and requires
the customer to hold more safety stock to account for possible delivery vari-
ation. Externally, consolidation services can be used that will group orders
from multiple suppliers for shipment to a common customer. An example of
cost reduction using consolidation appears in Table 12.5. In the table, four
orders to be shipped each day starting on Monday have been delayed due to
consolidation. If the cost per hundred weight (CWT) was $2.00 for ship-
ments above 25,000 pounds, by consolidating the orders the shipper would
save $490.00 or 40% over the charges if each order had been shipped
separately. Besides carrier cost savings, multi-company consolidation also
assists in environmental issues such as declines in traffic congestion, fuel
consumption, and pollution.
TABLE 12.5 Consolidated Shipments
Order Ship Date Weight (lbs.) Rate (CWT) Cost

1 Monday 6,000 $4.00 $240.00
2 Tuesday 7,000 $4.00 $280.00
3 Wednesday 12,000 $3.00 $360.00
4 Thursday 11,000 $3.00 $330.00
Total 36,000 $1,210.00
Consolidated 36,000 $2.00 $720.00
Savings $490.00
When planning multiple delivery routes, transportation planners are faced

with the problem of maximizing two related but constrained elements: the
distance a vehicle can travel on a single route and the load capacity of the
vehicle. Obviously, if a vehicle had unlimited capacity to deliver all custom-
er orders on a single route, these constraints would not apply. Because this is
impossible, planners must then be able to determine specific routes that are to
serve specific customers as well as the order in which they are to be visited.
This conundrum has been termed the vehicle dispatching problem and is
defined as the process of establishing a route serving a number of customers
which minimizes delivery costs within vehicle payload and distance (or travel
time) constraints. A number of routing algorithms have been developed to
solve this problem that can essentially be divided into two classes. In the
first, simultaneous methods, solutions are determined by computing all
feasible routes to satisfy specific customer shipping requirements, and then
planners select the one that collectively yields the lowest cost. The problem
with this method is the complex mathematical calculation that must be per-
formed. As the number of delivery points increase, the solution is more dif-
ficult to compute. The second type of vehicle routing algorithms, sequential
approaches, attempts to overcome the problems associated with simultaneous
TRANSPORTATION 647
methods by either dividing delivery into smaller geographical regions of cus-

tomers that can be connected in a feasible route, or by constructing routes one
at a time, adding contiguous links to a single route until distance and vehicle
capacity constraints are reached. Many of the complexities of vehicle routing
have been facilitated by the introduction of warehouse management systems
(WMS) that contain applications for freight rating, rate shopping, traffic
routing/scheduling, outbound appointment scheduling, transportation analy-
sis, and in-transit inventory tracking. Computerization has assisted traffic
planners reduce costs, improve customer service, reduce clerical work, facili-
tate tracing of shipments, and collect data for performance measurement [18].
DOCUMENTATION PREPARATION AND PAYMENT
The final step in the transportation management process is the preparation of

all necessary shipping documentation and payment of carrier invoices.
Domestic transportation (international transport will be discussed in the
Chapter 13) utilizes several key documents to record, direct, and control
shipments. Perhaps the most important is the bill of lading. Normally, this
document is prepared in the shipper's traffic department and signed by the
carrier. The bill of lading is a legal document by which the carrier
acknowledges receipt of the shipment and provides evidence of title to the
goods. In addition, it also constitutes the basic contract of carriage between
shipper and carrier, setting forth the rights and responsibilities of each party.
The front side of the document is completed by the shipper or carrier. It con-
tains information such as the names and addresses of the consignor and
consignee, routing instructions, the shipping rate, a description of the goods
and the quantities to be shipped, payment method, and other information. On
the back of the document will be found the contract terms, degree of carrier's
liability, and other legal points. Railroads and truck carriers use standardized
bills similar to the standard bill of lading. Freight forwarders, on the other
hand, often use the bills of the mode of transport hauling the product. Both
ocean vessels and air freight shipments use special air bills and ocean bills.
Because of their uniqueness, pipelines use a tender of shipment form in lieu
of a bill of lading. Finally, all contract shipping is subject to the terms of the
individual carrier contract executed between shipper and carrier.
There are three classes of bills of lading: government, livestock, and com-
mercial. The first two are related to specific transactions; the third is used for
all other ordinary business or personal shipments. Commercial bills oflading
can be used either for domestic or for international shipping. Domestic com-
mercial bills of lading may be either an order or a straight bill. The former is
a negotiable instrument in which the title of goods can be endorsed over to
other parties. In contrast, a straight bill is non-negotiable. Receivers are

within their right to reject shipment of an improperly endorsed bill.
In addition to the bill of lading, there are a host of other pieces of shipping
documentation. Freight bills are tendered by the carrier to the shipper using
the bill of lading and indicate the price for the transport services performed
and data such as the carrier's credit payment terms. A prepaid shipment
means that the carrier presents the freight bill on the day of shipment. In
comparison, a collect shipment means that the bill is presented on the day of
delivery. Both must be paid according to the terms of the agreement.
Another document, the freight claim is used by the shipper to file a record of
reimbursable losses with the carrier for such events as loss, damage, loss due
to delay, and over-charging. The filing of claims is governed by law and the
terms specified on the original Bill of Lading. Transportation departments
must be routinely concerned with other documents such as arrival notices,
delivery receipts, inspection reports, claims reports, and others.
As critical as documentation preparation is the receipt and payment of car-
rier invoices after transport services have been completed. As is illustrated in
Figure 12.4, this process consists of the receipt of the carrier invoice, invoice
audit and possible adjustment, decision to pay, invoice payment, and, finally,
performance measurement reporting. In today's tight economic times, the
speedy performance of these steps has become of great importance to car-
riers. According a study by Ernst & Young (October 2002), it was found that
2 to 4 percent of the total carrier invoice was consumed in administrative and
financial costs. Administrative costs are composed of pure processing costs
of creating and delivering invoices, receiving payment, applying payment, re-
solving disputes with the shipper, and collections. Financial costs include
two components: day sales outstanding (DSO) carrying costs and bad debt
expenses [19].
Carriers have recently been looking to logistics partners and technology to
accelerate the payment process. A widely used technique is to employ the
services of third party payment providers (3PPs), which approach the prob-
lem from the shipper's AJP. These providers typically will assume manage-
ment of invoices and bill the shipper either a percent of the payment process-
sed or a per-invoice fee. For freight carriers, software applications providing
direct connectivity to shippers through technologies, such as EDI, that can
significantly automate the processing of BOLs and the generation of freight
invoices. The most advanced carriers have turned to the Internet and imple-
mented electronic bill presentment and payment (EBPP) extensions to their
web-enabled systems. The advantage of Internet-based tools is that they can
provide carriers with real-time communication as well as collaborative ap-
proaches to document management, payment processing, and exception
handling.
TRANSPORTATION 649
Transportation performance measurements provide traffic managers with

quantifiable data to track shipping metrics as well as illuminate regions for
increased productivity and competitive advantage. Improvement programs
require transportation planners to work closely with other business functions.
In fact, it is really customer service priorities and objectives, inventory
position , operational philosophies , and channel configurations, rather than
purely transportation activities themselves that contribute the most to overall
transportation performance. Once the enterprise is functioning as a unified
organization with a common set of objectives , transportation management can
formulate valid performance criteria and focus on continuous improvement
tools to reduce cost, improve flexibility, and increase productivity.
Designing effective performance measurements requires dividing trans-
portation into two separate entities: transportation services that are purchased
and transportation that is provided by internal (private) equipment. Although
both the cost and benefits of any performance measurement program will
vary by business, in general when transportation is purchased, performance is
determined by managing transport mix, quantity, and cost (price). In contrast,
in companies that possess their own transportation fleets, performance is
measured by managing input factors associated with fixed costs (vehicles,
maintenance facilities, terminals, computer systems, etc.) and variable costs
(labor, repair and service, fuel, administrative staff, etc.).
Performance measurements associated with purchased transportation focus
on two elements: purchase cost (price) and carrier delivery performance. Be-
cause the service is purchased, the shipper is unconcerned with operational
measurements associated with fixed and variable costs. On the other hand,
shippers can influence cost (price) through the following three inputs:
Price. Depending on the scope of the transportation requirement, ship-
pers can influence price either through competitive shopping or through
negotiation. Shipment destination, required date of delivery, shipment
size, mode of transport, nature and shape of the product, availability of
transport equipment , and other factors will have a direct impact on
price.
Quantity. Based on the size (volume) of the shipment, shippers can
work with carriers to arrive at advantageous prices. The larger the vol-
ume and regularity of the shipment, the greater the ability of the shipper
to control pricing.
Transport mix. The nature, size, and shipment quantity of the product
provide shippers with the ability to select modes of transportation
(truck, rail, air) that more economically match the shipment require-
ment.
The best single measurement in charting transportation performance is the
ton-mile . A ton-mile can be defined as the cost required to move 1 ton of
goods 1 mile . A ton-mile is calculated by multiplying the shipment weight by
the number of miles from point of origin to delivery, divided by 2000. If, for
example, a shipment weighed 2500 pounds and the delivery spanned 1500
miles, the ton-mile (TM) would be calculated as follows :
TM = 2500 x 1500/2000 = 1875.
From this figure, the price paid for the ton-mile can then be obtained by
dividing the price ($$P) paid to the carrier by the ton-mile (TM), or $$P/TM.
Shipment productivity can then be computed by inverting the factors,
TM/$$P. By comparing the ratio as a function of price charged by each car-
rier, it would then be possible to determine the best transportation produc-
tivity for the price. When a mix of transport-modes is used, the TM and $$P
would have to be calculated for each mode. Another variable to the ton-mile
ratio is produced by load scale factors . Prices can change depending on the
ratio of partial to full loads, average length of haul, and average weight of
partial loads [20].
Keeping transportation price and mix on target can be assisted by reporting
and adherence to shipping budgets. Through a system of thorough reporting
that collects information relating to ton-miles, cost per ton-mile , service mix,
product mix, and others, transportation managers can examine costs and
changes to costs. In addition, a shipping budget can be developed that will
provide shippers with price and mix targets (Table 12.6). In the final analy-
TABLE 12 .6 Simple Transportation Budget
Estimated Budgeted
Service Planned Ton Miles Cost Transportation
Type Mix % (Vol x Mix %) per TIM Cost
Truck 40 3,200,00 $0.11 $252,000
Rail 25 1,500,000 $0.12 $180,000
LTL 13 450,000 $0.45 $202,000
Piggyback 17 1,250,000 $0.15 $187,500
Air 0.05 65,000 $6.00 $390,000
sis, performance for purchased services is measured by controlling transport

mix and price. Mix is optimized by ensuring that shipment utilization is high
per mix and by avoiding premium-priced carriers. Price optimization is at-
tained through effective carrier negotiation. In both cases, pursuing the best
TRANSPORTATION 651
transportation for the dollar is really an entire company effort, requiring the
cooperation of sales, warehousing, and transportation departments.
When developing performance measurements for internal or private trans-
portation, three questions must be addressed :
1. Does owning and operating a fleet provide a more cost-effective advan-
tage than if the same service was contracted from a public carrier?
2. What should be the performance measurements used to examine inter-
nal fleet productivity and how should those metrics be collected?
3. Considering the multitude of changes due to costs and opportunities for
new equipment and technology alternatives, what are the appropriate
metrics to be employed for improving or at least maintaining the initial
cost level?
The first step in measurement identification is to detail the major compon-
ents and percent usage of transport cost. A possible breakdown appears in
Table 12.7. This breakdown should help traffic planners isolate areas where
TABLE 12 .7 Cost by Ma jor Activity
Activit y Percentage of Total Cost (%)

Linehaul 84 .6
Pick-up /Delivery 1.6
Platform 4 .0
Maintenance 2.4
Indirect , others 11.0
cost improvements can have the most significant impact. The next step
would be to associate with each major cost component, such as employee
compensation, vehicle costs (fixed as well as operating costs like depreciation
and fuel), support expenses (facilities and equipment), and other expenses
(cargo insurance, travel expense, general supplies and expenses) a produc-
tivity value. The value source would include such elements as miles per road
driver-hour worked, miles per gallon fuel, miles per trailer, weight handled
per platform-emp loyee hour, and fleet miles per maintenance employee-hour.
For example, when analyzing vehicle costs by using the activities expressed
in Table 12.7, value sources such as ton miles per road driver worked, cus-
tomer stops per local driver-hour, and shipments handled per platform-em-
ployee hour could be calculated by each activity. The goal of the process
would be to chart through time changes occurring in each expense value. Op-
portunity for improvements would focus on reversing an upward trend or de-
creasing a fairly stagnant cost. Possible examples for performance improve-
ment include the following: usage of vehicles on second and third shifts, re-
duce empty backhaul mileage, increase vehicle space utilization, alter routes
to reduce mileage and/or driving time, effectively mix private and public
transport to maximize on private fleet utilization, improve equipment utiliz-

ation, and others.
ISSUES CONFRONTING TRANSPORTATION
Transportation, like all business functions in the first decade of the 2000s, is
grappling with an accelerating rate of change and operational complexity. In
the past, transportation was a fairly straightforward process concerned with
rate and route calculations and carrier selection. Today, as the demands of
global competition, new paradigms of customer services, and growth of com-
puterization and Internet interoperability, architecting a successful logistics
strategy requires coming to grips with a number of critical issues. The first
relates to the physical transportation environment in the first decade of the
twenty-first century. The second concentrates on the issues surrounding
government regulation of transportation. Finally, the last issue is concerned
with the application of computer systems capable of automating all areas of
transportation management.
TRANSPORTATION INFRASTRUCTURE
While today's shippers and carriers have made enormous strides in improving
efficiency, reliability, and security of supply chain systems through the imple-
mentation of JIT/Lean operations philosophies and computerized technolo-
gies, some experts feels that the nation's infrastructure is not growing fast
enough to facilitate the output of the available logistics planning tools. Al-
though it is true that the existing infrastructure is providing an extremely
competitive and cost efficient foundation, as the decade of the 2000s proce-
eds there is worry in some quarters that the technologies by themselves will
increasingly become unable to overcome infrastructure shortcomings. With
funding for the reauthorization of the U.S. government's transportation infra-
structure funding mechanism, TEA-21 (the Transportation Equity Act for the
21sl Century), currently up for review, transportation functions are deeply
concerned. How Congress answers this issue will determine the nature of
transportation in the U.S. for years to come.
According to the data currently being assembled about the condition of
U.S. surface, air, and water systems, it is clear that major upgrades and new
development to increase capacity is warranted. According to the Texas
Transportation Institute's (TTl) Urban Mobility Study, traffic congestion
alone cost U.S. companies $67.4 billion in 2002, including the cost of 3.6 bil-
lion hours of extra travel time and 5.7 billion gallons of wasted fuel. What is
more, the level of "undesirable" congestion in urban areas rose to 56 per-cent,
TRANSPORTATION 653
up from 7 percent in 1982 and 29 percent in 1990. According to the U.S.

Department of Transportation's (USDOT) Bureau of Transportation Sta-
tistic s, on-time air travel fell to 77.4 percent in 2002, down from 82.1 percent
in 2001 even as air travel plummeted in the wake of terror ism and economic
slowdown. U.S. railroads and water transport infrastructures, historically
stuck on the short side of funding, are slowly falling each day farther behind
modern day requirements. One expert cites a study performed on a single
segment of the rail network on the 1-95 corridor between Richmond, Va. and
New York City identifying $6 billion of needed improvements over the next
twenty years to reduce bottlenecks. On the nation 's waterways, more than 53
percent of dams and locks are now older than their design life. As a result,
the locks are too short for modern vessels, causing excessive congestion and
loss of efficiency.
These problems are expected to spiral over the next twenty years. USDOT
estimates that by 2020 the nation's transportation system will transport cargo
valued at almost $30 trillion compared to $9 trillion in 2003. In addition, vol-
umes in tons will increase by nearly 70 percent over current levels of 15 bil-
lion tons. International transportation requirements are also expected to
double during this period. Finally, USDOT estimates that annual expen-
ditures of almost $76 billion will be required 2001-2020 just to maintain the
existing infrastructure at year 2000 capabilities and capacities [21].
While solutions to these problems are forthcoming, shippers and carriers
are gearing their strategies and transport assets to respond today. One key
area to performance enhancement is the growth and integration of technolo-
gies with transportation management processes and infrastructure. This mer-
ger of information and process should assist in the development of more ef-
fective transport strategies and practices that will enable system optimization.
Another area is the growth of intermodalism. Through the design of com-
patible vehicles and containers, intermodal transport will optimize mode utili-
zation and efficiency by providing for quick loading and unloading to ensure
that at the various points of delivery and shipment transport activities are per-
formed as cost-effectively and quickly as possible . In detail, carriers can as-
sist in removing transport bottlenecks by converting to equipment such as
smaller, faster, lower cost locomotives that speed up rail movement; en-
hancement of loading equipment and rolling stock that facilitates the "piggy-
backing" of motorized vehicles and containers ; the use of side-loading trailers
that permit quick loading and unloading; and the installation of docking bays
that facilitate tailer cargo handling, application of conveyor systems, and
cross-docking. These and other innovations will support the new view of
logistics as a continuou s flow pipeline rather than as a stagnant system of
warehouses connected by modes of transit.
TRANSPORTATION REGULATION
Government has long been involved in the regulation of transportation. Reg-

ulation has traditionally involved two key objectives: the promotion of trans-
portation and regulation to ensure safety and competition. During the early
history of the U.S., the country was more focused on developing adequate
transportation than imposing restrictions. During this promotional period,
although monopolistic excesses and other abuses took place, government was
more concerned with the building of an effective transportation system that
would support the economic growth of the young republic than imposing
legislation targeted at safety or the promotion of competition. It was not until
after the Civil War that government began to tum its attention to growing
abuses arising from monopolistic control, particularly the railroads.
. The first real government regulation, The Act to Regulate Commerce, oc-
curred in 1887. This legislation placed all railroad common carrier service
engaged in interstate and foreign transport under federal government regu-
lation. In addition, the act also established the Interstate Commerce Commis-
sion (ICC) which was invested with the administration of the act. The ICC
could hear complaints, issue cease-and-desist orders, determine awards for
damages, and recommend new legislation to Congress. In 1920, the act was
superseded by the Esch-Cummins Act (the Interstate Commerce Act). The
act marked a new era in regulatory control. Previous legislation had at-
tempted to enforce competition among transport companies; this act, on the
other hand, focused on guaranteeing a strong transportation industry through
positive regulatory controls on rates, service, carrier consolidations, securi-
ties, and labor. Other acts, such as the Hepburn Act (1906) and the Shipping
Act of 1916, focused on protecting the pipeline and ocean carrier industries
from monopoly.
Government regulation up to 1930 was targeted at one objective: preven-
tion of monopoly by increasing control over service routes, labor disputes,
consolidations and mergers, and issuance of securities. During this period,
regulation was focused on the emerging motor transport industry. One of the
results of the burst of activity focused on public works during the Great De-
pression was the growth of the nation's highway system. Although some
states did, indeed, exercise some control over motor transport safety, during
the late 1920s and early 1930s the ICC and other groups recommended the
federal regulation of motor carriers. It was not, however, until the passage of
the Motor Carrier Act of 1935 that the ICC gained control of the motor car-
riers and extended the same type of regulation to trucking that had been ap-
plied to the railroad industry. The main provisions of the act were to estab-
lish three classes of carrier (common, contract, and private), control carrier
TRANSPORTATION 655
entry by requiring an ICC certificate, institute strict rate control by the ICC,
oversee consolidation and merger regulations, and structure securities and ac-
counts provisions. The Civil Aeronautics Act of 1938 extended competition
protection to the newly emerging airline industry. Similarly, the Transporta-
tion Act of 1940 placed all domestic water carriers under ICC rate and service
regulation .
With the act of 1940, nearly all modes of the nation's transportation system
were now under government regulation. The act, however, also marked a
critical change of government policy away from a focus on preventing
monopoly and toward recognition of the place of competition in the
transportation industry. The critical concept embodied in the act was that a
healthy transportation system is based on a new idea that each mode of
transport is an integral part of an entire transportation system and that it is the
responsibility of government to preserve the competitive existence of each
mode. The essential accomplishment of the act was the recognition that the
fundamental problem facing transportation was no longer monopoly, but the
lack of intermodal competition.
Following the act of 1940, there were three additional pieces of govern-
ment regulation . The first, the Freight Forwarder Act of 1942, declared that
freight forwarders were now subject to the Interstate Commerce Act. The
Reed-Bulwinkle Act of 1948 amended the Interstate Commerce Act by auth-
orizing the use of rate bureaus. A rate bureau can be defined as a price-set-
ting body, governed by the ICC, consisting of carriers who decide among
themselves what rates are to be charged. The act did allow for the right of
independent action on the part of a carrier . This act was critical in that it still
left the ICC with control over rate-making, yet it did provide for recognition
of competition among carriers . Finally, the Transportation Act of 1958,
sought further clarification of the policy of competition. Perhaps the most
significant part of the act was an amendment to rate-making rules by adding
the phrase, "Rates of a carrier shall not be held up to a particular level to pro-
tect the traffic of any other mode." This meant that the federal government
was clearly at the same time protecting and calling for more intermodal
competition.
The era of deregulation began with President Kennedy's Transportation
Message in April, 1962. In the message, Kennedy talked about the deadening
effect regulation had had on transportation and ended by calling for "greater
reliance on the forces of competition and less reliance on the restraints of
regulation." Although no congressional action ensued, the initiative clearly
was pointing at responding to the problems that had been arising as a result of
regulation . As shifts in the population and industry from the Northeast to the
South and Southwest occurred in the 1960s and 1970s, regulated carriers
found it difficult to redeploy assets to meet more favorable markets. The
situation was further worsened by the growth of carriers exempt from regu-
lation, such as company-owned truck fleets, that quickly absorbed the busi-
ness of these new areas. In addition, the ICC literally prescribed the level of
competition, and some carriers found themselves caught in legal contra-
dictions permitting them to haul freight in one direction but not on the back-
haul, serving terminal points but not intermediate points, serving between
some cities only on a circuitous route, and being able to carry some goods but
not others . Finally, the cost of supporting carriers facing bankruptcy as well
as the whole regulatory structure was costing the u.s. anywhere from $6 bil-
lion to $12 billion annually.
The first salvo targeted at regulation was fired with the Railroad Revitali-
zation and Regulatory Reform Act of 1976. Serving as a prototype for de-
regulation legislation to follow, the act permitted railroads to charge dis-
cretionary rates within certain limits without ICC approval, rates were al-
lowed to at least cover variable costs, upper level of rates were unlimited un-
less the carrier possessed "market dominance," and speedier action was to be
taken by rate bureaus. The first real deregulation legislation was soon to fol-
low in 1977 with the passage of the Air Cargo Deregulation Act. The act es-
sentially permitted airlines to charge any rate they wished as long as it was
not discriminatory and removed restrictions on cargo aircraft size. In 1980,
the Motor Carrier Act and Staggers Rail Act extended regulatory reform to
the trucking and railroad industries, respectively. These acts gave both Indus-
tries substantial price-setting freedoms, established broader provisions for
geographic , route, and commodity authority for common and contract car-
riers, eliminated one-way provisions and other restrictions, significantly in-
creased opportunities for privately held carriage, permitted railroads to act as
contract carriers, and facilitated mergers and consolidations. Perhaps the
"final chapter" in the history of motor carrier deregulation occurred with the
signing of the Trucking Regulatory Reform Act of 1994. Effectively, the bill
eliminated the requirement that for-hire motor carriers file tariffs with the
ICC.
With the terrorist attacks of 9/11 and initiatives to provide for homeland
security, the U.S. transportation system has become subject to a new round of
regulation designed to make America 's boarders safer. For the most part,
these regulations are targeted at a much closer scrutiny of import/export op-
erations . Such legislation as the Customer-Trade partnership Against Ter-
rorism (C-TPAT) and the Container Security Initiative (CSI) are designed to
identify high-risk cargo and container shipments and mandate pre-approval of
shipments at foreign ports . Food imports are required to submit to FDA prior
notice of food importations; regulations for tightening security on inter-
national air cargo are pending. Domestically, the Department of Homeland
Security's Operation Liberty Shield is seeking new powers to ensure security
TRANSPORTATION 657
at U.S. boarders and protect transportation and vital infrastructure . Security

has been stepped up at rail facilities and key rail hubs; motor travel has been
subjected to more intense control over the shipment of hazardous materials,
the use of additional checklists , and checking employee identification. Such
legislative initiatives are sure to provoke fresh debate between the needs of
security and threats to the nation's competitiveness.
TRANSPORTATION MANAGEMENT SYSTEMS
Many traffic management functions are utilizing transportation management

systems (TMS) to assist in the transportation management process. Instead of
a mixture of a variety of manual and interfaced transportation applications,
the purpose of as TMS is to provide a single integrated solution that spans the
transportation management cycle from order selection and carrier bid to de-
livery and performance measurement. With the information provided by a
TMS, traffic planners can implement new transportation management
practices that integrate and streamline every aspect of the distribution system,
wringing costs from and adding value to every step of the distribution pro-
cess. What is more, as requirements for shipment accountability stemming
from legislation designed to ensure Homeland Security expand, the need for
systems capable of handling global logistics planning and documentation is
expected to expand concomitantly. According to AMR Research, TMS ap-
plications are expected grow at a five-year compound annual growth rate of
14 percent from 2002 to 2006, representing a jump from around $750 million
to $1.5 billion in sales.
Overall, a TMS will assist traffic planners to perform the following four
functions [22]:
Transportation procurement for automating and optimizing everything
from carrier and mode search and selection to rate quotation and final
negotiation .
Transportation planning for designing the transportation network, run-
ning simulation analysis, load building, fleet management, parcel man-
agement, structuring lanes, and identifying opportunities for improve-
ment.
Transportation execution for managing the entire in-transit life cycle,
from route planning to load tendering, the confirmation process, and
freight audit and payment.
Visibility and reporting for access to real time shipment status
information, track and trace, proactive exception-based alerting, cost
analysis, and post-shipment analysis processes.
As trading partners and logistics service providers become linked real-time

into the logistics network web, companies can freely retrieve shipping, ser-
vice, and contact information to identify carriers, transit times, and compli-
ance issues such as Certificate of Origin, customs invoice, global settlement
of freight payment and billing, allocating the true cost of transportation based
on .actual charges, and electronic notice of consignment and statements of
revised charges for change of destination of an in-transit shipment.
While these stand-alone applications provide significant benefits, the real
value of a TMS is found when it is combined with enterprise business and
supply chain management systems. By linking together a TMS and WMS,
demand management, and inventory systems, traffic planners have access to a
suite of supporting systems that can create a seamless flow of information up
and down the supply channel. For example, by linking a TMS system into a
WMS, planners can assign carriers as products are picked and moved to the
shipping point. Interfacing a TMS with a supply chain event management
system can provide order visibility from the point of shipment all the way to
customer receipt. An effective TMS is so critical to fulfillment that many ex-
perts consider a supply chain management system to be incomplete without it.
Finally, when the enabling power of the Internet is applied to a TMS, ship-
pers have the ability to share information across logistics e-marketplaces.
Among the new opportunities available for shippers and carriers is software
for consolidating, cost optimizing, and collaborating in real-time on load
planning. These applications can also optimize orders into loads for tender-
ing, matching loads across service providers, meeting hazardous materials re-
quirements, optimizing available assets, and more effectively managing and
measuring relationships and contracts. Finally, e-TMS assists carriers to
optimize fleet management through interactive tools providing for dynamic
routing, real-time dispatch, and wireless application integration.
LOGISTICS SERVICE PROVIDERS
Of the trends impacting today's management of transportation, the use of lo-

gistics service providers (LSPs) is perhaps the most dramatic. In today's fast
paced, complex business environment, companies are finding that they simply
can not provide effective supply chain end-to-end management. Increasingly,
logistics departments are struggling to cope with the task of responding to
continuously morphing supply channel networks characterized by frequent
new product introductions, the presence of Internet-based sales channels, the
impact of regulations surrounding home security, information technologies
that provide for real time information, transaction control, and delivery
visibility management, and an unquenchable thirst for speed in the movement
TRANSPORTATION 659
of goods and services through the supply chain. Effectively responding to

these challenges has driven many logistics planners to turn to a relatively new
channel partner facilitator, the LSP or, as it is often termed, the third-party
logisti cs (3PL) provider.
ORIGINS AND GROWTH OF THE LSP INDUSTRY
While companies providing logistics services have always existed , a water-

shed in their growth occurred with the deregulation of transportation. For ex-
ample , in 1980, Leaseway Transportation Corporation was the largest pro-
vider of contract services in the U.S. with revenues of $250 million. Through
its subsidiary, Signal Delivery Services, Inc., the company provided contract
trucking, home delivery, cross docking , and warehouse services for Sears
Roebuck & Co. and Whirlpool Corporation. As deregulation took hold, the
use of Leaseway and other budding LSPs mushroomed by providing custom-
ized services and offering an alternative to regulated carriers . Today, there
are more than 1000 LSPs offering services in North America alone, each
vying for survival through service innovation and intense competition.
Businesses in the twenty-first century are turning to LSPs to solve in-
creasingly sophisticated requirements for technology -based and strategic sup-
ply-chain services . In a survey conducted in mid-2002 [23], more than 75
percent of the respondents used outsourcing as part of their logistics strate-
gies. The top five areas outsourced were warehouse/DC management (77
percent), web-enabled communications (64 percent) , transportation manage-
ment (64 percent) shipment tracking/event management (62 percent) , and ex-
port/import /customs clearance (62 percent) . According to Delaney [24], the
revenues of the LSP industry in 2001 exceeded $60 billion [Table 12.8], up
Table 12.8: LSP Revenues (2001)
Figures in billions of dollars
ThirdParty Service Providers Gross Revenues Growth Rate (%)
Dedicated Contract Cartage 8.3 2.5
Domestic Transportation Mgmt. 17.5 3.6
Value-Added WarehouselDistribution 15.3 13.3
U.S. Based with International
Operations 15.7 7.5
3PL Software 4.0
Total Contract Logistics Mark et 60.8 7.4%
from $56.4 billion in 2000 . While the industry exhibited a slowing of growth
from the 24 percent recorded in 2000, to 7.4 percent in 200 1, the decline is
seen as temporary due to the economic slowdown of the period. All in all,
utilizing LSPs enable transportation planners to shrink dramatically physical
logistics assets, such as delivery and accounts payable systems and personnel.
Additionally, logistics outsourcing enables shippers to leverage LSP invest-
ments in information, material handling, and operating equipment. Finally,
the need to optimize the constantly shifting parameters of supply chain opera-
tions requires companies to possess a degree of agility that can only be found
in logistics organizations that are totally dedicated to logistics management.
While use of LSPs have been growing, there are, however, a number of
hurdles that transportation planners must solve before a more strategic ap-
proach to outsourcing can be pursued. To begin with, LSP relationships re-
quires a significant level of collaboration between two companies that often
possess separate objectives, information capabilities, financial targets, op-
erating philosophies, and work cultures. In addition, LSP partnerships, while
intended to be long-term, have a tendency to erode quickly as partners change
business priorities , levels of urgency, and strategic direction. In the survey
mentioned above, nearly half of respondents admitted to a fear of losing op-
erational control. Others cited cultural barriers, costs, risks of long-term de-
pendency on a LSP, and unreasonable expectations regarding return on in-
vestment. Finally, LSPs must find better ways to work with clients and
streamline processes . If a client spends as much time managing an out-
sourced process as they spent managing the process in-house, then that
defeats one of the main reasons for outsourcing. Responding to these hurdles
requires transportation planners to develop a comprehensive outsourcing
strategy complete with a project team assigned the task of identifying realistic
outsourcing service, operations, and financial objectives and determining how
the outsourcing relationship is to be managed.
SUITE OF LSP SERVICES
As the utilization of LSPs grows in the current decade, providers have begun
expanding their suite of services to encompass greater functionality in
finance, inventory, technology, and data management. In the past, businesses
often sought to utilize LSPs to outsource non-core functions that were com-
moditized and could realize quick cost savings. Today, logistic executives
utilize LSPs as part of their logistics strategies. The fact of the matter is that
the continuous squeeze on all elements of the supply cycle are simply pushed
executives to explore LSPs to realize added value. According to experts in
the field of outsourced logistics services, companies today are looking to
LSPs to provide four key sources of logistics value.
TRANSPORTATION 661
Trust. The goal of this value is to find a competent LSP partner that
can relieve the company from the task of managing the supply channel.
Information. The objective of this value is to leverage the technology
capabilities of LSPs to provide logistics information accuracy, quality,
and timeliness of the operations they deliver.
Capital utilization. The reduction of fixed assets in the form of
physical plant and equipment is a major source of LSP value. Less
fixed expense can expect to be returned in the form of better working
capital.
Expense control. The overall reduction of logistics channel costs is by
far the primary objective of using a LSP provider. Increase in customer
service combined with lower logistics costs is seen by savvy CEOs as a
critical path to survival [25].
LSP services can essentially be divided into the following five areas [26]:
Logistics. Services in this area are designed to provide shippers with
outsourced expertise in the management of a variety of tasks ranging
from the application of strategic management tools to on-going opera-
tional functions . Among the services can be found assistance with the
implementation and execution of JIT/Lean philosophies, global trade
services, management of inbound logistics functions, warehousing, per-
formance of payment audit and processing functions, inventory man-
agement, supplier management, and product life cycle management.
Transportation . The execution of carrier functions is at the core of all
LSP partnerships . The role of LSPs in this area is to absorb all of the
core functions associated with product transport including: small pack-
age delivery, air cargo management, all types of LTL and TL motor
cartage, intermodal transportation management, ocean, rail, and bulk
transport, track and trace, fleet acquisition consulting, and the leasing
of transport equipment and drivers.
Warehousing. While most businesses maintain their own warehousing
functions, often demand events, such as seasonality, requirements for
new geographic market penetration, the use of vendor managed inven-
tory (VMI) programs, and specialized delivery requirements, will
necessitate the use of an LSP. Among the warehousing services pro-
vided are pick/pack and assembly, cross-docking, DC management,
warehouse location services, and fulfillment.
Special services. As the marketplace grows, companies often find
themselves with the task of performing specialized services for their
supply chains. Among the services LSPs can perform in this area are
delivery direct to the retail environment, delivery direct to the con-
sumer's home, import/export/customs functions for international sales,
reverse logistics for the management of waste and damaged goods

returns, marketing and customer management, and logistics/transporta-
tion consulting.
Technology. In today's increasingly computerize environments, com-
panies may find themselves having to acquire technologies and tech-
nical personnel for which they are unable or reluctant to build in-house.
LSPs solve this dilemma by offering rented services and equipment to
manage applications such as EDl, satellite/wireless communications,
and enterprise web enablement.
According to a 2001 third-party logistics services study, the detail of the ser-
vices by percent contracted from LSPs can be seen in Table 12.9.
TABLE 12.9 Outsourced Logistics Services, 2001
Type of Service Percent Outsourced

Warehousing 73.7%
Outbound transportation 68.4
Freight bill auditing/payment 61.4
Inbound transportation 56.1
Freight consolidation/distribution 40.4
Cross-docking 38.6
Product marking/labeling/packaging 33.3
Selected manufacturing activities 29.8
Product returns and repair 22.8
Inventory management 21.0
Traffic management/fleet operations 19.3
Information technology 17.5
Product assembly/installation 17.5
Order fulfillment 15.8
Order entry/order processing 5.3
Customer service 3.5
Source: Langley, C. John Jr., Allen, Gary R. Allen, and Tyndall, Gene R. Tyndall,
Third-Party-Logistics Services: Viewsfrom the Customers. (Atlanta, GA: Georgia
Institute of Technology, Gap Gemini Ernst & Young and RyderSystem, Inc.,
2001).
Responding to these and other service needs have driven many LSPs to
architect strategies that are reshaping the nature of logistics outsourcing.
While the number of possible permutations is large, today's LSPs can be sep-
arated into two camps. On the one side can be found LSPs that are focused
on offering a limited selection of cost-driven, standardized services through
an owned network of transportation and warehouse functions. They provide
value to their customers by leveraging their logistics assets to cut supply
chain costs, manage non-asset cost factors, and drive process innovation. In
the other camp stands a much more aggressive type of LSP that seeks to man-
TRANSPORTATION 663
age their customers' logistics needs from end-to-end. Termedfourth party lo-
gistics (4PLs) or lead logistics providers (LLPs), LSPs in this category can be
defined as supply chain integrators whose strategy is to assemble and manage
dynamic organizations composed of a wide range of resources, capabilities,
and technologies either within the organization or in partnership with comple-
mentary LSPs to deliver a comprehensive, customized logistics solution to
the customer through a central point of contact. Most LSP arrangements fail
to deliver benefits beyond one-time operating cost reductions and asset trans-
fers: LLPs, on the other hand, are dedicated to long-term strategic logistics
partnership and continuous growth in revenues and reductions in operating
cost and fixed and working capital for the customer.
While providing a host of new and critical services, the use of an LLP for
strategic partnership is mostly on the horizon for most companies . While the
200 1 LSP services survey mentioned above indicated that over 93 percent of
the companies responding felt LSP services provided a "strategic, competitive
advantage ," few viewed their LSP relations as playing a dominant role. In the
multiple variable survey over 75 percent saw their LSP as purely an altern-
ative resource provider ; 68 percent saw them as "Problem solvers" and "Re-
source managers ." In contrast, only 13 percent felt their LSPs to be an "Or-
chestrator," 7 percent as a "Supply chain strategist," and 13 percent as a "Dis-
tribution strategist [27)."
INTERNET-DRIVEN LSPs
I' IT Solutions
W4uhouu' M....-wqemc:-nt
-: ""'_ f~ "'_ .,. . Ul" -'
FIGURE 12.8 APL Logistics web- site.

As the utilization of the Internet has expanded into the realm of logistics man-
agement, companies have increasingly turned to their LSP partners for access
to Web-based technologies. Many companies simply do not have the finan-
cial and people resources to hook-up to today's fast-paced Internet applica-
tions and are increasingly looking to their LSPs to provide the expertise to
collect and scrub data and drive it directly into their backbone systems, per-
form e-commerce functions, provide proactive exception management, and
enable participation in the Web-driven supply chain [Figure 12.8]. This
growth in Web-based LRM services caused several of logistics experts to dub
these LSPs .comLLPs [28]. The purpose of the description is to convey the
critical competitive advantage available to customers through LLPs who have
deep Internet capabilities.
, .~
';<'
l!ogisti~ and the Internet

~:.:..v
APL Logistics provides not only APL Logistics managed shipments.
core logistics services, but also
advanced technology capabilities to Pipeline View is a proprietary sys-
its customers. APL has an entire tem offering customers an integrated
division devoted to developing and view of their warehousing and dis-
integrating the latest in proprietary tribution "pipeline" in North Amer-
and industry-standard supply chain ica. Through an easy-to-use Web
technologies for product visibility. interface, customers can conduct
exception management, execution real-time inquiries about the status
systems optimizing shipping and of APL Logistics handled inventory
warehouse decisions. Web-based and shipments and get immediate
decision tools, and performance answers. 24 hours a day, seven days
reporting. Customers have the capa- a week.
bility to then turn-up or phase down
their use of these services depending APL's international services are
upon on-going needs and level of supported by a web-enabled oper-
internal expertise. ating system designed for real-time
shipment management and customer
For example, NetTrac XL is an end- service. Features include on-line
to-end supply chain visibility tool booking, tracking and tracing. and
for international shipments. It gives integration with APL Logistics' suite
logistics and procurement managers of visibility and data management
real-time, web-based visibility to tools.
Internet-driven LSP have the ability to provide the following information-

based services [Figure 12.9]:
Comprehensive solutions. Perhaps the critical advantage of a .comLLP
is to use technology to reverse the increased propensity for logistics
TRANSPORTATION 665
FIGURE 12.9 .comLSP functions .
fragmentation as products make their way through the supply channel.

.comLLPs possess the capability to offer customers a centralized, com-
prehensive logistics management point that can facilitate the merger of
a community of functional logistics providers with the enabling power
of a customized, client optimized, uniform technology strategy. Such a
technology-based solution has the capability of leveraging networking
tools like the Internet to drive the synchronization of real-time logistics
planning and execution across trading partners while increasing ever-
widening collaborative cooperation.
Improved information flows . The Internet provides LSPs with supply
chain event applications that enable real-time visibility to shipments
anywhere, at anytime in the supply chain. In addition, Web-based
workflow tools render the transfer of information, such as freight
tenders and bookings, a simple process. Also, by significantly acceler-
ating the flow of shipping information and providing electronic funds
transfer capabilities the payment cycle can be considerably shortened.
Enhanced fulfillment capabilities. Today's companies are being faced
with steep challenges when it comes to Internet-driven fulfillment. His-
torically , most companies have developed logistics practices and infra-
structure geared to handle the bulk storage and movement of products
through the supply network . Increasingly, companies are requiring
order picking and fulfillment in smaller, more frequently delivered lot
sizes and are turning to their LSPs for the answer. Responding to these
fulfillment needs will require nimble LSPs equipped with both the nec-
essary infrastructure and access to Web-based logistics communities
that can make delivery of any order size at anytime a reality.
Supply chain inventory management. Computerized supply chain ap-
plications provide .comLLPs with a range of inventory throughput tools
that seek to replace, when possible, inventories with information, en-
able nimble response to customer requirements, and reduce cycle times
everywhere in the supply channel. Among these computerized func-
tions can be found cross-docking, merge-in-transit, remote postpone-
ment, and delayed allocation of orders to the latest possible moment
before shipment, and the commingling of loads from multiple service
providers in order to maximize shipment, provide pricing advantages to
shippers, and remove waste from the fulfillment process [29].
CHOOSING AN LSP PROVIDER
Developing a logistics outsourcing partnership requires a comprehensive

strategy and a well conceived and executed implementation plan. Overall, an
LSP strategy is focused around attaining two major benefits : enabling the
businesses to shed costly transportation assets and activities that are normally
beyond the core competencies and traditional hard asset investments that are
at the heart of the company. Secondly, by outsourcing these functions to
third-party experts, firms can take advantage of world-class resources and
processes without developing them in house. When designing a logistics out-
sourcing strategy, it might be helpful to start by describing the array of pos-
sible LSP arrangements that are available. On the low end of the spectrum of
strategies can be found the traditional model where internal company func-
tions totally control logistics resources. When LSP activities do occur, these
would be for one-time spot buys to solve a temporary weakness in internal
capabilities. In the next model, classic LSP, logistics planners utilize LSPs to
service logistics functions that are on the periphery or are poorly performed
by the internal logistics group. An example would be using an LSP to handle
international distribution functions . For the most part, in both of these mod-
els control of strategic logistics functions and design and execution of supply
chain strategies is retained by the company.
In contrast to the first two strategies, which are focused strictly on opera-
tional objectives , a partial LLP model, is characterized by a partial surrender
of logistics control to the LSP. While the shipper still acts in the role of
logistics integrator and retains control of channel design, LLPs are given re-
sponsibility for managing entire portions of the supply chain. Normally, the
shipper plays an active part in assisting the LLP to assemble the team of LSP
TRANSPORTATION 667
service providers , is responsible for enforcing LSP adherence to the channel

strategy, and oversees operational logistics function execution . In the final
LSP model, a full LLP, the shipper selects a LLP who assumes full respon-
sibility for logistics management. While the shipper is still an active partner
in the architecting and maintenance of both the logistics strategy and the LSP
community of providers, full responsibility for the total logistics solution is
given to the LLP. The LLP assumes ownership for channel design, LSP part-
ner selection , and detail operations execution.
Whether committing to a full LLP or using a portfolio approach to LSP
services, transportation strategists need to consider the following factors in
their decisions :
LSP flexibility. The only thing known for sure about a logistics partner-
hip is that the circumstances driving its inception will change through
time. When structuring the LSP contract, logistics planners must be
careful to draft a document that provides for flexibility to respond to
service changes due to new technologies, remapping of the supply
channel , new products , new competitors, change of management, and
other issues . Open dialogue is critical in ensuring both parties have
commonly accepted definitions and terms, detailed performance mea-
surements , and a methodology to adjust logistics functions and ex-
pectations to meet current realities.
Defin ed cost of services. In spite of the best constructed contract,
rarely are all possible permutations of costs and scope of services fully
defined. Once actual services begin, timeliness , accuracy, thorough-
ness, and level of service detail can often vary widely from agreed upon
contracted standards. An effective method to cope with these issues is
to plan for high, medium, and low costs in the contract. Consistently
enforcing the low cost solution will unsettle even the best relationship .
Managing the human side of outsourcing. The introduction of a LSP
into the supply chain equation requires the effective education and con-
currence of the people side of an organization. Outsourcing what were
once internal functions to an outsider can cause friction and uneasiness
among affected employees . A plan that integrates managers, super-
visors, and staff into the process will ensure their feedback and support
are a critical factor in reaching the outsource decision .
Realistic exp ectations. False expectations about savings and effective-
ness of outsourced services can sink even the most finely tuned LSP re-
lationship . In reality, both parties must work closely together to estab-
lish realistic expectations and then structure a program to guide con-
tinuous improvement through time. From the beginning and throughout
the life of the relationship , both parties must be prepared to work
through practical examples, step-by-step, testing baseline and every

possible type of exception process to remove false expectations and un-
cover real measurable benefits.
Technology misunderstandings. All too often customers and LSPs
exaggerate their technologies capabilities as well as down-play what
technology expertise is required of each other. Solving this problem
requires both parties to come to the table with realistic technology
statements of their capabilities that can act as a baseline to initiate
technology improvements that enhance the partnership and drive new
benefits .
Partnership commitment. Similar to a corporate strategy, it is essential
to secure the firm commitment of top and middle management to the
proposed outsourced arrangement. The executive team must be ap-
prised of their role as leaders and supporters in the on-going manage-
ment of the relationship, both from a change management and an ex-
panding collaborative partnership perspective.
Retain core skills. Companies seeking outsourced logistics functions
must be vigilant to ensure that critical skills and processes are not con-
tracted away. A fine line must be preserved between outsourcing the
expense while retaining the skill set to be able to re-evaluate the ar-
rangement, recapture the outsourced function, or rethink the entire out-
sourced strategy.
Once these elements are incorporated into the LSP strategy, planners can then
begin the process of effectively identifying the services they really need from
an LSP, present and gain support for the project from management and staff,
search and locate LSPs possessed of the necessary competencies from fixed
assets to information technologies, execute a viable contract, and determine
the performance measurements to guide the on-going strengths and benefits
of the partnership .
TODAY'S LSP CHALLENGES
While the slowing of growth and continued consolidation in third party ser-
vices in 200 I indicates that the industry is still evolving in the current eco-
nomic environment, the real challenges confronting the development of the
LSP model revolve around a variety of issues, from strategic to technological.
One thing is certain: shippers are demanding that LSPs possess the capability
to support increasingly complex business processes and accelerate value-ad-
ded performance even as fragmentation of supply chains and resulting co-
ordination requirements escalates. These challenges can be organized into
the following points [30]:
TRANSPORTATION 669
Enhanced logistics fun ctions. The foundation of the LSP industry rests
on the ability to provide logistics functions that individual compa-nies
can not effectively perform with their own resources. LSPs must
continue to shape their service offerings around the dramatic changes
driven by growth in channel complexity, the need for ever smaller and
quicker LTL delivery, requirements for cross-docking or merge-in-tran-
sit operations, and the migration of supply chains from large super-DC
consolidators in favor of flexible, agile networks of regional DCs
characterized by an optimum mix of strategically located inventory and
short-haul distribution. LSP functions should facilitate the growing
use of "pull" replenishment systems, whereby demand is driven
through networks of regional DCs.
Partnership fun ctions. Beyond simple transaction-based functions,
LSPs are being asked to perform a host of specialized functions. For
example, LSPs are being asked to co-locate their activities at the ship-
per's location, serving as an extension of the shipper's processes and
performing activities normally belonging to the shipper. Alternatively,
LSPs may perform additional activities at their own or partner site
focused at reducing processing costs, reducing supply chain inventories
by postponing product final configuration , or facilitating customer
returns or product recycling. Then again, LSPs might be contracted to
perform order processing, procurement , and financial processes, such
as invoicing, credit management, and collections .
From transaction to process management. As logistics outsourcing
emerged during the period of deregulation, the use of LSPs has evolved
from a concern with simply performing transaction based services, like
warehousing and spot transport buys, to managing whole logistics pro-
cesses . Because of their core competencies, operational economies of
scale, and ability to leverage technologies tools, LSPs were easily able
to outperform the logistics departments of their customers. Regardless
of the nature of the outsourcing engagement, this has meant that LSPs
could take a systems approach to managing their client's logistics needs
and have an impact on process instead of simply providing one-time
solutions in isolation. LSPs can respond to this challenge by pursuing
either a basic focused strategy that limits capabilities to offering stan-
dardized services through an owned network of transportation and/or
warehousing assets, or a dynamic strategic solutions strategy that pro-
vides a more innovative and systemic approach to customer needs by
architecting customized, collaborative logistics channels composed of a
portfolio of multiple-focused service providers.
Technology facilitators. With the rise of Internet real-time connectiv-

ity, LSPs are increasingly being asked to shoulder the burden of pro-
viding advanced supply chain technologies. In the past, LSPs focused
on providing toolsets like ED! that provided transaction support. With
the advent of Internet networking, LSPs are now being required to pro-
vide a much broader set of information solutions that enable a supply
chain node to work directly with any other node in the channel net-
work. Major LSPs are now licensing their Internet systems with cus-
tomers and other partnered LSPs.
Increased globalization. A critical challenge before LSPs is respon-
ding to need for global logistics coverage in an age of increasing inter-
national outsourcing. As outsourced manufacturing makes its way
across the globe, supply chains have become extended and increasingly
complex. Shippers simply can not be hamstrung by unconnected log-
istics functions. Instead, LSPs are being asked to assist in the assembly
of resources to operate highly integrated logistics management systems
stretching across a global network.
Homeland security. A new and potentially fertile field for LSP support
is the area of logistics security. Since the attacks of September 11,
2001, the U.S. and other nations have begun the process of passing
legislation designed to eliminate the possibility of terrorist attacks. As
the opening salvos of this round of new regulation are applied to logis-
tics activities, global companies can expect to see increases in supply
chain transit times and increased documentation. The role of LSPs in
minimizing the impact of security legislation is destined to become of
the utmost importance as the decade of the 2000s unfolds.
SUMMARY
Although warehousing has often been called the "heart" of the distribution
channel function, transportation can justly be described as the veins and arte-
ries by which products are moved through the supply chain pipeline. By pro-
viding for the swift and uninterrupted flow of products, transportation pro-
vides companies with the ability to compete with other businesses in distant
markets on an equal footing. Transportation also permits wider and deeper
penetration of new markets far from the point of production. In addition, by
maximizing vehicle and materials handling capacities and cargo require-
ments, effective transportation permits enterprises to leverage economies of
scale by lowering the per-unit cost of transporting product. Efficient trans-
portation enables firms to reduce the seIling price by holding costs down,
thereby providing for more competitive product positioning. Finally, trans-
TRANSPORTATION 671
portation provides other business functions with essential information con-

cerning products, marketing place and time utilities, and transit costs and ca-
pabilities necessary for effective supply chain planning and operational
execution.
There are several legal forms and modes of transportation. Factors influ-
encing transportation selection include the type of distribution environment to
be serviced, enterprise strategic goals, financial capabilities, product order
volumes, required delivery lead time, physical characteristics such as size,
perishability, seasonality, potential for obsolescence and theft, and intrinsic
value, geographical size of the distribution channel, carrier type availability,
and strength of the competition. Shippers have the choice of using four pos-
sible legal types of transportation. The first three types, common carriers,
contract carriers, and exempt carriers, are operated by for-hire freight com-
panies and are subject to various federal, state, and local statutes and regu-
lations. In contrast, the fourth type, private carriers, are normally owned by
the company who uses their own equipment to transport products and sup-
plies through internal channel networks to the customer. There are essential-
ly five modes of transportation : motor carrier, railroad, water, pipeline, and
air transport. Selection of transportation mode is governed by performance
characteristics such as speed of delivery, minimization of changing modes
during transport, dependability, capacity, frequency, and cost.
The effective day-to-day management of transportation activities is abso-
lutely necessary for the smooth functioning of the business. The first step in
the management process is to establish the cost-effectiveness of private trans-
portation fleets and, as necessary, search for and select public carriers. The
goal is to ensure the highest level of customer service at the lowest possible
price. The selection of a carrier is normally based on a combination of fac-
tors including the price of the service, carrier financial stability, reliability,
mode availability, and subjective elements. The second step involves the on-
going choice of selected transport modes to meet daily shipment require-
ments. Modes should be chosen that will best perform the service for the
cost, satisfy any special shipping requirements, exceed the services offered by
competing carriers and minimize the likelihood of loss, damage, or delivery
delay. Once the mode and carrier have been selected, shippers must work
with their logistics service provider (LSP) to establish an effective schedule
and the proper vehicle routing to ensure timely customer delivery. The fourth
step of the process is the preparation and completion of the necessary ship-
ping documentation . Finally, mangers must be diligent in developing
transportation performance measurements that will provide them with
quantifiable data necessary for increased productivity and competitive
advantage. Metrics should be developed for both purchased and internal
transportation and should consist of price and carrier delivery performance.
The transportation industry in the twenty-first century is having to grapple

with a host of radically new domestic and international issues. These chal-
lenges can probably best be summarized into three areas. The first, challen-
ges posed by the need to renew the nation's aging transportation infra-
structure and problems in each transport mode, strikes at the very heart of
transport capabilities and efficiencies. The second area consists of managing
the challenges posed by regulation. While deregulation of the transport In-
dustry in the early 1980's dramatically freed transportation from outdated and
inefficient legislation, the threat of terrorism in the early part of the 2000s is
requiring transport managers and carriers to alter JIT/Lean assumptions about
the supply chain that had grown over a twenty year period. Finally, transpor-
tation functions are having to implement and utilize a number of new infor-
mation technologies. Today's Internet-enabled transportation management
systems (TMS) provide traffic managers with integrated applications for
transportation procurement, planning, and execution and tools enabling in-
transit visibility and reporting.
Finally, of the trends impacting today's management of transportation, the
use of logistics service providers (LSPs) is potentially the most revolutionary.
In today's complex, global logistics environments, companies are finding that
they simply do not have the capability to provide the full range of services to
effectively execute end-to-end supply chain management requirements. LSPs
fill this gap in non-core functions by providing the following critical services:
logistics services associated with strategic management of JIT/Lean initi-
atives, global trade, supplier management, payment and auditing, and product
life cycle management; transportation services including all forms of trans-
port from LTL and intermodal to fleet acquisition consulting and equipment
leasing; warehousing services focused on warehouse outsourcing and man-
agement, VMI programs, and fulfillment; special services required for such
activities as home delivery, international sales, reverse logistics, and
transportation consulting; and, technology services providing access to
computerized tools such as the Internet or EDI. Choosing an effective LSP
partner has become a critical strategy for most transportation departments
requiring a firm understanding of partnership objectives, depth of the
relationship, defined cost, benefits, and expectations, and flexibility of
services available.
TRANSPORTATION 673
APPENDIX: MOTOR CARRIER CONTRACT
This contract is entered into this th day of

19_, between
_ _ _, and ABC TRUCK LINES, INC ., having its place of

business at 500 West Madison St., Chicago, IL 60068, (hereinafter
called "Carrier").
Carrier is engaged in the business of transporting property by motor
vehicle as a contract carrier in interstate and foreign commerce, holding
authority issued to it by the Interstate Commerce Commission under Permit
No. 59367 (Sub No. 150).
Customer requires motor carrier transportation services designed to
meet Customer's distinct needs.
Customer desires to utilize the services of Carrier and Carrier is
willing to provide such services to Customer, as a contract carrier, in
accordance with all the terms and conditions set forth below.
NOW, THEREFORE, in consideration of the mutual covenants and
agreements contained herein, the parties hereto agree, as follows:
1. Term. The term of this Contract shall be one year beginning on the date set forth
above. The Contract shall renew automatically for additional periods of one year
each; provided, however, that either party may terminate this Contract by giving a
minimum of thirty days' advance written notice oftennination to the other party.
2. Minimum Shipping Requirement. Customer agrees to tender to Carrier a series
of shipments under this Contract, which shall include a minimum of three shipments
during the initial term and a minimum of three shipments during each renewal terms of
the Contract.
3. Carrier's Obligations. Carrier shall transport the minimum number of shipments
required to be tendered by Customer, and such additional shipments tendered by Cus-
tomer from time to time, subject to the capacity and availability of Carrier's equip-
ment. Nothing contained in this Contract shall require Customer to exclusively use
Carrier's service, or Carrier to exclusively serve Customer, and the failure of Carrier
to provide transportation service for any particular shipment, or the failure of Cus-
tomer to tender any particular shipment to Carrier, shall not be deemed to be a breach
of this Contract.
4. Relationship of Parties. Each party is an independent contractor and neither
party hereto is the agent of the other party. Employees or independent contractors uti-
lized by either party shall not be deemed to be employees or agents of the other party.
5. Customer's Distinct Needs. Customer represents and Carrier acknowledges that
Customer has distinct transportation needs which can be fulfilled by the contract car-
rier service to be performed by Carrier under this Contract.
6. Equipment and Costs. Carrier shall provide equipment in good condition and
repair which shall be suitable for the transportation of the commodities to be trans-
ported hereunder. Carrier shall assume and pay all costs and expenses incident to the
transportation of commodities tendered under this Contract, including, but not limited
to, all costs and expenses arising out of the maintenance, repair or operation of its
equipment, labor, supplies and insurance.
7. Rates and Charges. The rates, charges and specific terms of transportation cov-
ering all shipments moving under this Contract are set forth in Schedule A attached
hereto and incorporated herein by reference. The rates, charges and terms specified in
Schedule A may be amended from time to time, but only if such amendment is in
writing, signed by both parties, prior to the effective time of such amendment. Such
amendments containing copies of signatures of individuals repre senting both parties
shall be binding, without the necessity of producing original signatures.
8. Payment. The charges to be paid by Customer for services rendered under this
Contract shall be paid in the manner and at the times set forth in Schedule A. Cus-
tomer guarantees the payment of all freight charges lawfully charged by Carrier under
the terms of this Contract, regardless of whether such shipments are designated a pre-
paid or collect, and notwithstanding any notation to the contrary contained on the bill
of lading governing the shipments transported under this Contract by Carrier for Cus-
tomer.
9. Identification. Carrier shall indemnify and hold harmless Customer from and
against all loss, damage, fines, expense, actions, and claims for injury to persons (in-
cluding injury resulting in death) and damage to property wherein such loss, damage
or injury is proximately caused by acts or omissions of Carrier, its agents or employ-
ees, and arising out of or in connection with Carrier's discharge of duties and respon-
sibilities as specified in this Contract; provided, however, that such indemnification
and agreement to hold Customer harmless shall not extend to the amount of any loss,
damage or injury resulting from negligent or intentional acts or omissions of Cus-
tomer, its employees and agents.
10. Insurance. Carrier shall procure public liability and property damage insurance
with a combined single limit of not less than $1,000,000 per occurrence, and all-risk
cargo insurance with liability limits sufficient to cover shipments having a value of
$50,000.00 with a rider or other endorsement adequate to insure shipments having a
value not to exceed $100,000.00. Carrier shall immediately notify Customer in
writing if said insurance is canceled or modified in any material respect. Carrier shall ,
at the request of Customer, provide to Customer a certificate evidencing such in-
surance.
11. Freight Loss or Damage. Carrier shall be liable and responsible for loss, theft,
damage, or injury to shipments occurring while in the custody, possession or control
of Carrier under this Contract. The extent of Carrier's liability shall be governed by
Section 11707 of the Interstate Commerce Act, in the same manner that liability is
determined for common carriers. All claims for cargo loss or damage shall be
governed by the rules and regulations contained in Part 1005 of Title 49 of the Code
of Federal Regulations.
12. Allowance. It is mutually agreed that if Carrier's rates and charges set forth in
Schedule A provide for allowances (whether directly stated or not) to Customer for
services it provides, which services Carrier would ordinarily provide, such as loading
or unloading, such allowances are reasonably related to the actual costs of such ser-
vices.
TRANSPORTATION 675
13. Freight Bill Notations. If the rates and charges set forth in Schedule A are sub-
ject to any subsequent reduction , allowance or adjustment under any other provisions
contained in Schedule A, Carrier shall so indicate in its initial freight bill submitted to
Customer.
14. Successors and Assigns . This Contract shall be binding upon successors and
assigns of the parties hereto, provided, however, that no such assignment shall be ef-
fective without the written consent of the non-assigning party .
15. Entire Agreement. This Contract, including Schedule A and any written
amendments thereto, shall constitute the entire agreement between the parties, and no
oral representations , agreements, understandings or waivers shall be binding upon the
parties to this Contract.
16. Notices . All notices given under this Contract shall be in writing, signed by or
on behalf of the party giving the same and sent via mail or telefax to the other party;
provided, however, that requests for service and confirmation thereof may be com-
municated in person or by means of telephone or computer.
17. Applicable Law . The terms of this Contract shall be governed by the laws of
the State of xxxxxx.
18. Confidentiality. Except as required by law, the terms and conditions of this
Contract shall not be disclosed by either party to persons other than each party's own
affiliates, officers, directors , employees and agents; provided , however, that Customer
may disclose the contents of this Contract to its vendors and customers which might
be affected thereby.
IN WITNESS WHEREOF, this Contract has been signed by
authorized representatives of Carrier and Customer.
CARRIER: CUSTOMER:
ABC TRUCK LINES, INC.

500 West Madison
P.O. Box 915
Chicago, Illinois 60068
Telephone : (312)474-7350 Telephone: _
Telefax : (312)474-7300 Telefax : - - - - - -
By: Sam Smith By: - - - - - - - -

Title: Director of Operations Title: - - - - - - -
Date: July 7, 20xx Date: / /20
1. Describe the fundamentalprinciples of transportation.

2. Why must purchasing, warehousing, and transportation functions work closely
together?
3. What are the legal forms of transportation?
4. Detail the performance characteristics associated with transportation. How
would companies use these characteristics to plan for transportation
requirements?
5. Compare and contrast the five modes of transportation.
6. What is intennodal transportation? Point out some applications of intennodal
transport.
7. How have requirements for JIT and Quick Response deliveries changed the face
of transportation?
8. Why is transportation scheduling and routing so important to the efficient
running of the business?
9. In what ways has the U.S. government used regulation to control transportation?
10. Describe the nature of the logistics service provider (LSP) and why have they
become so important to logistics management?
TRANSPORTATION 677
REFERENCES
1. See the comments of Bowersox, Donald J. and Closs, David 1., Logistical Man-
agement: The Integrat ed Supply Chain Process. New York: McGraw-Hill,
1996 , p . 314 .
2. Fair, Marvin L. and Williams, Ernest W ., Transportation and Logistics. Plano,
Texas: Business Publications, 1981, pp. 90-100.
3. See the discussion in Coyle, John, J. , Bardi, Edward J. , and Langley, C. John Jr.,
The Management of Business Logistics: A Supply Chain Perspective. 7 th ed. ,
Mason,OH: South-Western, 2003, pp. 397 .
4. Delaney, Robert V. , Fourteenth Annual State Of Logistics Report. St. Louis,
MO : Cass Business Logistics, 2003, Figure #7 .
5. These figures were taken from Editor, "Trucking 2002," Inbound Logistics, 22,
9,2002, pp . 49-59.
6. Bureau of Transportation Statistics, U.S. Department of Transportation,
National Transportation Statistics, 2002. Washington D.C.: U.S. Government
Printing Office, 2002 .
7. Coyle, et ai, p. 346 .
8. Sampson, Roy J., Farris, Martin T., and Shrock, David L., Domestic
Transportation : Practice, Theory and Policy . Boston: Houghton Mifflin Com-
pany,1985 ,pp.62-63 .
9. Wood, Donald F. and Johnson, James c., Contemporary Logistics. New York:
Macmillan & Co ., 1993, p . 147 and U.S. Bureau of the Census, Statistical
Abstract of the United States: 1990, 110th ed . Washington, DC : U.S.
Government Printing Office, 1990 , p . 597 .
10. Delaney, Robert V. , Fourth Annual State of Logistics Report. St. Louis MO :
Cass Business Logistics, 1993, p . 4 .
11. Bowersox, Donald 1., Calabro, Pat J., and Wagenheim, George D., Introduction
to Transportat ion. New York: Macmillan Publishing Co ., 1981 , pp. 56-57.
12. These factors have been abstracted from Bowersox and Close, pp . 365 -367.
13. Cavinato, Joseph, "Tips for Negotiating Rates," Distribution 66-68 (February
1991); Patton, Edwin P ., "Carrier Rates and Tariffs," in The Distribution
Management Handbook. Tompkins, James and Harmelink, Dale A., eds . New
York: McGraw-Hill, 1994, pp . 12.11-12.18; Coyle et al, pp . 393-396; and ,
Bowersox and Close, pp . 370-378.
14. These fundamental methods have been abstracted from Dillion, Thomas F.,
"Outsourcing-More Than Another Buzzword." Purchasing World, (February
1989).
15. McKinnon, Alan C., Physical Distribution Systems. New York: Routledge,
1989 , p. 173.
16. See the comments in Ibid ., p. 178.
17. For the implications of JIT/Lean Manufacturing on traffic management see
Wantuck, Kenneth A. , Just-In Time For America. Milwaukee, WI : The Forum
Ltd ., 1989 , pp. 333-336.
18. For more information on these methods see McKinnon, pp 195-205.
19. Bass, Howard K., Garg, Ashish, and Iijima, T.J., "What is the 'Tru e' Cost of
Processing a Freight Bill?" Global Logistics and Supply Chain Management, 6,
10,2002, pp. 54-57.
20. For more information see Kreitner, John, "Managing Transportation
Productivity," in The Distribution Handbook. James F. Robeson and Robert G.
House, eds. New York: The Free Press, 1985, pp. 512-518.
21. These comments can be found in Panchak, Patricia, "Stuck in the Slow Lane,"
Industry Week, 252,5, (May 2003), pp. 47-50.
22. For information on TMSs see Bradley, Peter, "Tum on the Power," DC Velocity,
1, 3, 2003, 46-48; Gaines, Stephen, "Tips for Choosing the Right TMS
Package, " dot.com Distribution , 2, 2, 2001, pp. 3-8; and Ross, Introduction to e-
Supply Chain Management, pp. 295-296.
23. This survey was conducted jointly by Cap Gemini Ernst & Young, Georgia
Tech, and Ryder System and reported in Global Logistics and Supply Chain
Strategies. 6, 11,2002, p. 16.
24. Delaney, Robert V., Thirteenth Annual State Of Logistics Report. St. Louis,
MO: Cass Business Logistics, 2002, Figure #13.
25. Sutherland , Joel and Speh, Thomas W., "Using 3PL Service Providers to Create
and Deliver Significant Supply Chain Value," in Achieving Supply Chain
Excellence Through Technology , 4, Mulani, Narendra , ed., Montgomery
Research, San Francisco , CA, 2002, pp. 176-178.
26. See Kuglin, Fred A and Rosenbaum, Barbara A , The Supply Chain Network @
Internet Speed: Preparing Your Company for the E-Commerce Revolution,
AMACOM , New York, 2001, p. 129; Schryver, Rob, "The Trade Tsunami:
Traditional 3PLs Expand Roles," Inbound Logistics, 21, 9, 2001, 71-76; and,
Editors, "Top 100 3PLs," Inbound Logistics, 22, 7, 2002, pp. 65-75.
27. Langley, C. John Jr., Allen, Gary R. Allen, and Tyndall, Gene R. Tyndall, Third-
Party-Logistics Services: Views from the Customers. (Atlanta, GA: Georgia
Institute of Technology, Gap Gemini Ernst & Young and Ryder System, Inc.,
2001).
28. See Kuglin and Rosenbaum, p. 138.
29. This section is abstracted from Ross, David F., Introduction to e-Supply Chain
Management : Engaging Technology to Build Market-Winning Business Part-
nerships. Boca Raton, FL: St. Lucie Press, 2003, p. 301.
30. See the comments in Kopczak, Laura Rock, "Trends in Third Party Logistics,"
in Achieving Supply Chain Excellence Through Technology, I, Anderson,
David, ed., Montgomery Research, San Francisco, CA, 1999, 268-272 ; and
Truncik , Perry A., "4 Logistics Trends Driving and Driven by 3PLSs," Chief
Logistics Officer, 10,2002, pp. 7-11.
UNIT 5
INTERNATIONAL DISTRIBUTION AND
DISTRIBUTION INFORMATION TECHNOLOGY
CHAPTERS:
13. International Distribution

14. Information Technology and Supply Chain Management
Unit 4 focused on the distribution operations execution processes. Planning

and control activities in this area centered on the short- to immediate-range
activities associated with servicing the customer, acquiring and warehousing
inventory in the supply channel network, and transportation and delivery. The
goal of the execution processes discussed was to ensure that the entire supply
chain possesses sufficient inventories and warehousing and delivery capabil-
ities to achieve total customer service at the lowest possible cost. Unit 4 con-
cluded the enterprise management planning process that had begin in Unit 2.
Unit 5 is concerned with a discussion of two areas that are integral elements
of today's supply chain environment. The first focuses on the management of
international trade. The growth of global trade is the result of a number of
marketplace trends. Some relate to the convergence of several information
process technologies, particularly the Internet, and their ability to network
companies from across the globe in a common community. Other factors fo-
cus on the maturing of the economies of today's industrialized nations and
their need to explore foreign markets as a source of both competitive advan-
tage as well as of basic materials, cost-effective components, and low labor
costs.
The rise of international competition and global trading blocks has also oc-
curred because of fundamental changes in the marketplace. Of prime impor-
tance is the end of the long-standing international predominance of U.S. man-
ufacturing and distribution. The rise of Japan, China, and the Pacific Rim and
the solidification of European Union have altered the balance of trade and
680 INTERNATIONAL AND DISTRIBUTION SYSTEMS
necessitated the establishment of new global partnerships and logistics tech-

niques. Finally, the growth in incomes worldwide, the development of lo-
gistics infrastructures, and the speed of communications have created new
marketplace opportunities. To respond to these changes, companies have had
to alter fundamentally their inventory and delivery systems. The goal of to-
day's international company is to attain the best cost and customer service
possible while welding enterprise and worldwide partner logistics resources
together with global markets, capital, and manufacturing to maximize com-
petitive advantage.
The final chapter in the text is concerned with the second critical area
facing today's supply chain manager: the implementation of information
technology. As it has had in all elements oftoday's business environment, the
availability of computerized tools that not only facilitate and accelerate the
speed of information processing but also provide the framework for the inte-
gration and interoperability of companies regardless of time and geography
has had an enormous impact on supply network management. In harnessing
the power of today's software applications, open-system architectures, and
Internet networking capabilities, companies must be prepared to conduct an
effective computerized application solution search and then possess the neces-
sary project management skills to successfully implement the software. Such
a task requires implementers to have a full grasp of the strategic and tactical
objectives to be attained by the software, the impact system changes will have
on the organization and its capabilities, the costs, manpower, and time it will
take to implement the software, and the expected improvements in
productivity and competitive advantage resulting from the implementation.
Finally, effectively leveraging information technology requires supply chain
professionals on all levels to develop performance measurements targeted at
continuous improvement in information technology tools and organizational
capabilities.
13
INTERNATIONAL DISTRIBUTION
FORCES DRIVING GLOBAL- Opening Issues

IZATION Intermodal Transport Options
Trends Accelerating Globalization Ocean Transport
Barriers to Globalization International Air Transport
Surface Transport
DEVELOPING GLOBAL STRAT- International Warehousing
EGIES
Global Strategy Development INTERNATIONAL PURCHASING
Strategy Development Summary Overview
Advantages of International
CHANN EL STRATEGIES Sourcing
Exporting Countertrade Purchasing
Licensing International Purchasing Manage-
J oint Ventures ment Process
Direct Ownership
TODA Y'S GLOBAL TRADE
MANAGING GLOBAL DISTRI- ENVIRONMENT
BUTION NETWORKS North America
Managing the Global Distribution European Community
Channel Asia and the Pacific Rim
Global Marketing Considerations
International Financial Issues SUMMARY
Documentation
INTERNATIONAL TRANSPOR-
TATION AND WAREHOUSING
When business historians look back at the period of the last 25 years of the
20th century and the opening of the new millennium, one of the most salient
developments will be the emergence of the global economy. For several
decades after the Second World War most manufacturing and distribution
companies remained within their own national boundaries. Although some of
the world's largest corporations, such as Coca-Cola, Ford Motor, and Procter
& Gamble, had historically engaged in a significant international trade, gov-
ernments were fearful of exporting technology and wealth that might drain
national resources in the face of the Cold War. In many cases, whole markets,
such as Eastern Europe and China, were closed to U.S. and European compa-
nies. Today, the end of the Cold War, the connective capabilities of informa-
tion technologies like the Internet, and the deployment of global outsourcing
strategies has accelerated the growth of the international marketplace and the
integration of the world's economic activities. The old Soviet Union and the
emerging nations of Eastern Europe are now openly soliciting political al-
liances, economic assistance, trading status, and investment from the West.
The European Union has a common currency and is moving closer to full
elimination of trade barriers. Perhaps the most fertile area of economic
growth, the Pacific Rim, is seeking favorable trading status and the import of
foreign goods.
Fundamental to sustaining this growth is efficient and cost-effective global
supply chain management strategies and processes. Beyond the manufac-
turing, financial, and marketing aspects of international trade, distribution
channel issues relating to global materials and product sourcing, cost-ef-
fective storage, fulfillment management, and speedy transportation have be-
come the foremost frontiers of competition. As the world's industrialized
nations intensify .their search for new markets and new sources of products
and services abroad, the state of logistics functions have become increasingly
pivotal for success. Nations that have substandard systems of roads, water-
ways, and rail, poorly trained labor pools, inadequate distribution support
systems, and protectionist governments will be more costly to penetrate and
by-passed by global strategists. As internationalization expands, it will be the
responsibility of supply chain planners to design the logistics networks of the
future, determine cost versus benefit, and engineer the sourcing, manu-
facturing, inventory control, warehousing, and transportation functions that
will propel the global economy into the 21st century.
Understanding global distribution is the focus of this chapter. After con-
sidering the economic, competitive, and supply chain trends fueling globali-
zation at the dawn of the twenty-first century, the chapter proceeds to a dis-
cussion of the major features of an effective international distribution strate-
gy. Next, the chapter explores the options available to international firms in
the search to effectively penetrate global markets and position products.
Critical to the success of a channel strategy is the development of an inter-
national distribution network. Topics discussed in this section are managing
the service and cost of the distribution network, structuring the global chan-
INTERNATI ONAL DISTRIBUTION 683
nel, international marketing considerations such as price, promotion and sales

terms, international financial issues, and export documentation. The chapter
then proceeds to discuss in detail the transportation and warehousing require-
ments of global channel management. An analysis of international pur-
chasing and product importing forms the basis of the next section. Topics
discussed are advantages of international sourcing, countertrade purchasing,
and the international purchasing management process. The chapter concludes
with a short review of the nature of today's international environment.
FORCES DRIVING GLOBALIZATION
Over the past 30 years, the growth of global trade has been dramatic. In 1970
the U.S. exported over $56.6 billion and imported over $54.3 billion. In
1990, exports reached $535 billion and imports $616 billion. By 1995
exports stood at $794 billion and imports at 890 billion. Finally, in 2002
exports reached $97 1 billion ($682 billion in goods and $289 billion in
services) and imports stood at $1.4 trillion ($1.16 trillion in goods and $240
billion in services). By the year 2005, the World Trade Organization (WTO)
estimates the totally of International trade to grow to over $9 trillion (1).
Although the U.S. trade deficit amounted to $435.6 billion in 2002, global
trade, according to the U.S. Department of Transportation, supports over 11
million jobs and has accounted for one-third of economic growth since 1993.
This explosion in foreign trade and increasing inter-dependence of global
markets is the result of a number of trends, such as continued world economic
growth and the connective power of technology that are expected to acceler-
ate the growth of globalization in the twenty-first century. This growing eco-
nomic internationalism, however, is not assured nor universally accepted as
evidenced by the recent violent protests accompanying the meetings of inter-
national bodies like the International Monetary Fund and the WTO. Among
the barriers are to be found political and economic regulations, financial bar-
riers, and poor logistics infrastructures
TRENDS ACCELERATING GLOBALIZATION
There are a variety of forces driving today 's growth in international trade.
Among the key factors are the following: maturing of the U.S. economy,
growing foreign competition, acceleration in global deregulation , growth of
strategic alliances, and closer integration of domestic and international distri-
bution systems. Each of these topics is discussed below.
Maturing of the U.S. Economy. The maturing of the U.S. economy has
fundamentally altered traditional thinking about global trade. For over a
decade before the new millennium, it had become clearly evident that the era
of high growth was over as business consolidations, shrinking margins, de-
clining profitability, and overcapacity indicated that many sectors of the
economy had slipped from growth to maturity. While it is true that the U.S.
occupies a position of unsurpassed global economic hegemony, it had become
clear that continued economic growth can only take place in the context of
increased dependence on international partnerships. Today, some of the
largest global corporations , such as Daimler/Chrysler, are combinations of
once solely owned U.S. companies and foreign companies.
As markets at home have stagnated, U.S. enterprises have turned to the
newly opening markets of the Pacific Rim, Central and South America, and
Eastern Europe . The decline in global tensions, the explosion in communi-
cations technologies, the movement of former communist countries toward
market economies, and the easing of protectionist attitudes have made foreign
trade of critical importance in sustaining competitive advantage. In addition,
the U.S. can no longer avoid the fact that continued economic success is pre-
dicated on international trade. Many products, such as oil and other basic
raw materials, must be imported; often cost-effective components assembled
in foreign countries are critical for the production of domestic finished goods.
Finally, there can be no denying that certain imported products are here to
stay. China's growing capacities in the production of high-labor, low cost
commodities and textiles can only expect to expand; Japanese leadership in
television sets and low-priced microelectronics and parity in the automobile
market are testimony of the impact of foreign products on American
purchasing habits.
Growing Foreign Competition. Over the past decade, the expanding inter-
nationalization of foreign companies, as well as the coalescence of trading
blocks in Europe and Asia, have dramatically impacted U.S. manufacturing
and distribution and altered the balance of trade. This globalization of com-
petition has accelerated sharply in just the past few years. The market value
of U.S. direct investment abroad rose 35 percent, to $776 billion, from 1987
to 1992 while the value of direct foreign investment in the U.S. more than
doubled to $692 billion. Similar to the growing maturation of domestic mar-
kets in the United States, the advanced industrialized nations in Western Eur-
ope, China, and Japan have long looked to the U.S. import marketplace to
sustain their growing economies and to gain trade parity. In addition, many
second-tier countries, such as Brazil, Mexico, and South Korea, who enjoy
lower operating costs, are also seeking to catapult their economies to "world-
class" status by supporting domestic companies with leadership in textiles,
INTERNATIONAL DISTRIBUTION 685
apparel, and electronics. The U.S. has countered by refocusing its efforts at
increasing exports, not only with the major industrialized nations, but also
with developing countries on a bi-lateral basis. The result has been a clear-
cut requirement for American businesses to decrease production and distri-
bution costs to remain competitive.
In addition, many nations have come to realize that deregulation and open-
ing avenues of foreign trade, reducing tariffs, and fostering free trade are nec-
essary to their continued expansion. The growth in incomes worldwide, the
development of distribution channel infrastructures, and the speed of com-
munications have increased global demand for new products and market op-
portunities. The initiatives targeted at dividing the industrialized world into
three massive trading blocs in Europe, Asia, and North America can also have
an enormous impact on U.S. trade and logistics. The surprisingly easy suc-
cesses enjoyed by the European Union to effect continental economic unifi-
cation and a common currency (2002) are providing Europe with the potential
to assemble a powerful economic engine.
A critical development has been the emergence of the Pacific Rim
countries. Despite over a decade of recession, Japan still possesses the
world's second largest economy. As a single nation, China is expected to be
the third largest economy before long and, if the current rate of growth is sus-
tained, will be the world's largest economy in 20 years. Despite many origin-
al misgivings, Beijing, Hong Kong, and Taiwan are becoming one China
from the standpoint of trade. In 1993, the United States, Canada, and Mexico
took the first step in signing the North American Free Trade Agreement
(NAFTA) as a counterbalance to the emergence of the trading blocks in Eur-
ope and Asia. While much of the early fears of massive loss of jobs and
industries to Mexico have proven baseless as the agreement completes its
first decade, NAFTA has helped to expedite trade between the U.S.'s largest
(Canada) and second largest (Mexico) trading partners.
In order to manage the new era of global competition, the efficient
operation of logistics functions is fundamental. As companies seek to export
products not only to major trading partners but also to markets dispersed
throughout the world, logistics costs involved in international warehousing
and transportation will become critical in holding down prices and assuring
tolerable margins. In addition, as many U.S. companies seek to source com-
ponents or even to relocate their operations overseas, corporate planners are
having to formulate logistics strategies that will guarantee the smooth and
efficient flow of materials and products through the domestic and inter-
national distribution pipeline. In summary, the goal of these movements
toward regional trading blocks is to reduce tariffs and customs requirements,
develop common shipping documentation, and establish compatible trans-
portation and material handling systems that enable countries belonging to a

regional trade union to act as if they were a single commercial entity.
Deregulation. A fundamental condition for the growth of global trade is the

lessening and/or elimination of legal barriers to international trade. There are
two major areas driving this trend : financial and logistics deregulation [2].
The massive changes brought about by such events as the creation of the u.s.
Export-Import Bank and the International Monetary Market (IMM), have en-
abled establishment of global financial standards, the extension and guarantee
of long-term import/export credits beyond individual bank capabilities, and
the mechanism to exchange currencies and trade futures at market rates. The
decision of the U.S. to drop the gold standard in the early 1970s has assisted
in removing previous restrictions on the setting of monetary rates. In ad-
dition, the adoption of the Euro in 2002 has greatly facilitated the flow of
global trade by providing yet another source of stable mediums for exchange.
In fact, one commentator recently felt that the use of the Euro would
eventually surpass the dollar as the global standard of exchange.
The second area of global trade deregulation is occurring in transportation.
The decision of the U.S. in the early 1980s to deregulate transportation has
been slowly but steadily expanding across the globe. Historically, govern-
ments rather than market forces determined the scope and price of transpor-
tation . Many nations did not allow foreign-owned carriers to operate within
their boarders. Many transport modes, such as the current rail system in
Mexico, were state owned or, as in Germany, subsidized by the government.
Today, removal of these barriers to free-market drivers in most industrialized
nations have followed U.S. example. UPS, for example, currently operates
via any combination of rail, motor, air, or water in over 190 countries in a
seamless manner via ownership, joint marketing, and operating agreements.
Beyond operating privileges and privatization, changes in cabotage (require-
ments that goods and passengers between two domestic ports must use only
domestic carriers) have been gradually relaxed, especially between countries
in the European Union and the partners to NAPTA.
Strategic Alliances. The fourth major trend driving globalization is the con-
tinued expansion of strategic alliances and joint ventures. In the past, most
companies pursued a strategy of vertical integration . The argument ran that
if the enterprise owned not only the production and distribution processes but
also the source of raw materials, then corporate control over material fabri-
cation, product design and marketing, and supply sources, market share and
profits would be assured. By removing dependence on other companies, the
enterprise would be self-sustaining and free of disruptions to the flow of ma-
terial , labor, and transportation. Today, the vertically integrated company has
become a strategic objective of the past. No one firm can possibly hope to be
the leader in all aspects of their industries . With the growth of competitors,
both domestic and foreign, focused on price parity and value-added features
such as quality and service, vertical organizations could not hope to sustain
their previous market dominance . One by one, leadership in steel, auto, com-
puter, and other markets was lost to more streamlined foreign enterprises that
focused on core competencies .
This refocusing of the strategies and detail operations of the enterprise on
core competencies has also been accelerated by the needs of today's products
and markets. Global competition, high product and service quality expecta-
tions, short product life cycles, and rapidly shifting markets have motivated
firms to seek partnerships and alliances both domestically and internationally.
Partnerships provide the benefits of vertical integration without the risks.
Joint ventures permit all participating companies to leverage the compe-
tencies of other partners to increase the speed of product design, and process,
quality and service flexibility. In addition, other partner ing advantages in-
clude access to capital, communications, and markets that businesses acting
on their own could not attain or which are closed by foreign governments or
restricted by trade barriers .
One of the best examples of global partnering can be found in the auto
industry. Auto dealers both in the U.S. and abroad often buy vehicles from
other countries to satisfy customer requirements for imports. Many a U.S.
Ford or GM dealer that formerly sold only domestic models often today have
foreign import divisions for sales and services. Recent trends among global
auto makers have indicated a flourish of joint ventures. The merger of Ger-
man automaker Daimler with Chrysler, GM partnerships with Saab, Toyota in
Australia, Isuzu in Japan, and Daewoo in Korea are examples. In addition,
GM has foreign-owned subsidiaries in Europe (Opel), the United Kingdom
(Lotus and Vauxhall) , and South America (GM do Brasil). As the world
moves closer to three trading blocks in North America, Europe, and Asia,
U.S. firms that do not have either foreign subsidiaries or joint ventures might
find themselves excluded from free trade with the European and Asian
blocks.
Integration of Global Distribution Systems. The final area driving globali-

zation is the use of international logistics service providers, transportation
functions, and information technologies to link companies spanning several
continents . The objective of end-to-end service with real time order visibility
and order tracking has become the mantra of today's LSPs as they search to
expand their international footprint. These global LSPs provide continuity
and visibility to the logistics needs of customers across the entire supply
chain, rather than dependence on individual players who perform narrow loc-
al transactions and then pass shipments on to the next channel partner. The
goal is to provide customers with technology tools to control the global sup-
ply chain by enabling them to change both the velocity and delivery points of
goods as they move across global networks. Such a capability is critical for
companies utilizing forms of intermodalism that utilize combinations of
ocean-land bridge (ocean, rail or motor, and ocean), all water, or oceanlmini-
land bridge (ocean and rail or motor) transport.
The key driver of global logistics integration is today's information tech-
nology tools, particularly the Internet. Through Internet Marketing sites cus-
tomers can search the globe for competitive suppliers who can provide as
well as stimulate interest in products and services without regard for time or
geographical limitations. e-Business Web sites also provide anyone, any-
where on the earth the ability to buy products and participate in trading ex-
changes. Such tools enable companies to open real-time communication with
global suppliers as well as eliminate cumbersome paper documentation
relating to contracts, orders, delivery requirements, and customs forms.
Finally, these systems are providing planners with real-time visibility to a
range of critical functions from forecasting requirements to on-line track-and-
trace of products in-transit and electronic bill payment.
BARRIERS TO GLOBALIZATION
While the above factors are enabling companies world-wide to expand their
international trade strategies, there remain significant barriers that threaten
growth. Among these barriers can be found tariffs and trade practices, cul-
tural issues, financial restrictions, security, and logistics infrastructure weak-
nesses. Each of these barriers to globalization is detailed below.
Tariffs and Trade Practices. As companies draft a globalization strategy,

they are soon confronted with a critical barrier: international taxes, tariffs,
and duties. Originally these charges were designed by governments to protect
domestic industries by making imported goods more expensive. As such,
they must be considered primarily as political instruments devised for the
purpose of governing the practice of foreign trade within national boarders.
These costs not only can greatly fluctuate by country and region, they are
often difficult to ascertain, complex, and continuously changing. While such
data is compiled by every country's department of commerce, it is published
in widely different formats, taxonomies, and languages. As one expert put it
Traditionally, the only accurate way to access this information is through customs
brokers , who must often research the intended shipment before they can estimate
the cost. This process is painful, slow, manual, error-prone , and often outdated
by the time it's completed. It does not lend itself to rapid iteration, let alone
optimization [3].
What is more, as the world grows smaller, countries and trading communities
can utilize threats of increased tariffs, duties, or other restrictions as a power-
ful diplomatic tool. Retaliation is often swift, with talk of looming trade
wars. For example, President George W. Bush's decision in 2002 to increase
protective tariffs on U.S. steel brought a storm of protest from the European
Union who in tum appealed to the WTO for punitive action.
Beyond the use of tariffs and restrictions to control trade, countries often
promote national practices that give domestic industries an unfair advantage.
Sometimes these practices are administrative and consist of unnecessary tech-
nicalities or regulatory requirements that simply add cost and retard trade.
Many countries require that a portion of the material composition of the
product and the labor force originate from the home country. More serious
are license requirements and import quotas that limit trade and protect local
immature industries . Perhaps the biggest barrier is global competitors that
are supported by local governments. For example, even giant UPS cannot
compete with global shipping concern Deutsche Post that draws financial
support from the German government.
Cultural Barriers. Building a successful global trade strategy requires

bridging cultural complexities that can add new dimensions to the challenges
of international channel management. While trade laws, exchange rates,
tariffs and restrictions, coping with managing transit distance, global finance,
and political risk are difficult enough for the international planner, cultural
differences pose a serious threat to success. A failure to understand local
customs or an unintentional violation of social taboos can create a veiled
resistance on the part of nationals to do business with offending outside
traders . While many practices and the use of logistics assets are uniform
across the world, global companies must be able to manage the following
cultural issues [4].
Trade relationships. The personal elements necessary to develop trade
relationships can vary widely by nation . For example, in the U.S. busi-
ness can be conducted over the phone or bye-mail. In Asia, face-to-
face contact is a requirement.
Use ofLSPs. The use of outside service providers is perceived in some
countries as a negative factor, indicating that a trading partner does not
possess sufficient competencies .
Contracts. Many cultures have different views regarding the binding
power of contracts. In the U.S., contracts are perceived as legal and
moral documents that posses the force of law and personal commit-
ment. In some countries a contract is understood as a statement of in-

tent, and if the environment in which the contract was originally drafted
changes drastically, parties are justified in abandoning their commit-
ment to the contract.
Working styles . The work ethic and considerations of holidays and pay
may differ greatly in many countries. In Europe, for example, many
nationals expect lengthy vacation and holiday seasons. The best way to
manage local workers is to have local or regional managers guiding
employee decisions. The golden rule is to strategize globally, but ex-
ecute regionally using the local language and culture.
Speed. In many cultures the signing of contracts or commitment to
strategic decisions can be a lengthy affair. While u.s. strategists are
accustomed to quick deals and rapid decision deployment, many cul-
tures often wish to deliberate over alternatives before making a de-
cision.
Differences in national management, work ethics, and decision styles can
cause considerable friction and frustration when developing international
strategies. Besides possessing the skill to execute the proper number
crunching and legal deliberations, effective global planning teams must also
possess a deep familiarity with the cultural and linguistic sensibilities of pro-
posed local partners.
Financial Restrictions [5]. Financial barriers to global trade consist of two

critical areas: generating effective financial forecasts and charting the
capabilities of institutional and monetary infrastructures. The ability to fore-
cast financial positioning is critical to effective business management. It is
the responsibility of financial managers to forecast company investment
(earnings, growth, and ROI), profits (revenues, margins, and profits), assets
(cash, receivables, and plant), and capital (debt) in order to chart business
strategy. Domestically, creating forecasts for these elements is a challenge in
itself. When combined with a global perspective, computing in additional
factors such as exchange rates, customs and tariffs, inflation, and local gov-
ernment policies render the tasks of financial forecasting even more complex.
Financial infrastructure barriers arise out of the practices found in every
country governing how facilitating institutions, such as banks, insurance, law
courts and the legal practice, and transportation carriers, operate. Often,
many of the financial and legal services found in the highly industrialized na-
tions are in their infancy or simply not available in many parts of the world.
For example, Hewlet-Packard found out early that legal and operating ex-
pectations with LSPs varied greatly by region. HP has solved the problem by
having each LSP sign a base agreement, but then tacks-on addendums that
contain regional specifics. Through this approach, HP is able to standardize
its processes on a global basis as much as possible, while structuring the busi-
ness to accommodate local and regional differences. The lack of financial
and institutional structure can add a significant degree of uncertainty and
pose critical challenges to the development of competitive global trading
strategies.
Security. While historically a complex process, international trade has be-

come exponentially more difficult as nations grapple with the growing prob-
lem of security and international terrorism . In fact, since the terrorist attack
of 11 September 200 1, governments have been erecting compliance and sec-
urity restrictions on passengers and cargo that have the potential to seriously
impede global trade. Global transportation costs are rising as carriers add
security surcharges and delays elongate transit times. For example, Con-Way
Transportation Services began charging an $8 per shipment Homeland Secur-
ity tax on January 1,2003 . The extra fee is used to pay the cost of U.S. gov-
ernment-mandated changes regarding registration of equipment, drivers, cus-
toms documentation, and security inspections at the u.S ./Canadian boarder.
Several U.S. government initiatives have been passed that impact im-
port/export operations directly. The Customs-Trade Partnership Against Ter-
rorism (C-TPAT) and the Container Security Initiative (CSI), both passed in
the first half of 2002, are designed to protect the security of cargo entering
the U.S. Other security measures are aimed at protecting the nation's sea-
ports (Operation Safe Commerce - OSC) by making it mandatory for carriers
to file electronic manifests information in advance of arrival. Such regula-
tions are also to be enacted on international air cargo movements by October
of 2003. U.S. customs will require that all carriers, deconsolidators, freight
forwarders , and some consignment couriers use the Automated Manifest Sys-
tem (AAMS) to provide advance electronic cargo declaration information to
U.S. customs.
The impact of these and other measures on global trade is potentially far-
reaching . Already companies have begun to revisit their JIT strategies and
alter assumptions about inventory as lead times and delays elongate. Rules
requiring transmission of shipment-level detail could add 24 to 72 hours to
inventory cycles, threatening to reverse decades of logistics productivity
improvement overnight. These security measures have also generated a great
deal more documentation which is often slower than the speed of the goods
shipped, causing deliveries to languish while freight clears an increasingly
entangled customs system. What is worse, as the outbreak of Severe Acute
Respiratory Syndrome (SARS) in China during the first half of 2003 bares
witness, security measures have to grapple with non-terrorist attacks on the
general health, food supplies, and well-being of trading nations.
Infrastructure Weaknesses. Besides government policy, legal, cultural, and

financial barriers, the lack of physical distribution infrastructure is perhaps
the most critical impediment to global trade. Part of the problem resides in
the lack of standardized transportation, material-handling equipment, contain-
erization, warehousing, port facilities, and communications and technology
that renders inter-country movement of goods difficult. Such barriers require
products to be loaded and unloaded, sometimes by hand, from vehi-
cles/containers as they cross national boundaries. What is worse, many de-
veloping nations do not have sufficient logistics infrastructures. Often basic
transportation infrastructure, such as roads, rail lines, fuel depots, and cus-
toms agencies are rudimentary or, in some cases, non-existent. When it is
considered that an average of 17 to 20 parties touch a typical international
shipment in one way or another as it moves between carriers, brokers, for-
warders, across boarders, and through customs and financial institutions, even
minor problems in the global supply chain can cause major shipment delays.
Summary. Companies are faced with many opportunities as well as chal-

lenges in the pursuit of global trade. Each year, an increasing number of
products from steel to toys and jewelry are imported, whereas at the same
time, more U.S. goods are finding their way to new foreign markets. Few
businesses today can feel immune from the threat of foreign competition.
Bender [6] has succinctly described the conditions propelling globalization as
composed of three interconnected areas. The first consists of strategic
reasons such as the following:
Attempting to leveraging shrinking product and process life cycles and
recovering development costs by selling products on a global basis.
Denying marketplace sanctuaries to competitors. Companies can sell at
a high profit margin to captive markets, making it affordable to sell at a
lower margin to more markets.
Avoiding government-directed protectionism as found in many devel-
oping countries.
Balancing production and investment with the differing economic
growth patterns and economic cycles occurring across the globe.
Profiting from global financial systems, communications and media,
and market demand homogenization.
Establishing early presence in emerging markets.
Maximizing opportunities arising from symbiotic relations between
suppliers and customers based on long-term commitments and close re-
lationships .
The second area fostering business globalization is associated with the fol-
lowing tactical issues:
Capitalizing on foreign trade to increase profits. Companies participa-

ting in international trade are likely to grow faster and be more profit-
able than companies focusing on national or regional markets.
Participating in countertrade agreements . About one-third of all inter-
national trade involves countertrade (bartering), rather than cash trans-
actions.
Achieving stabilization by matching product and investment with glo-
bal business cycles.
Obtaining economies of scope by maximizing marketing, production,
and logistics advantages through international trade.
Reducing costs by transferring products across national boundaries that
reduces taxes.
The final area focuses on operational issues and is concerned with the
following:
Reallocating manufacturing and distribution capacities to match global
market demand.
Reassigning production, purchasing, processing, sales, and financing to
take advantage of different rates of international exchange.
Accelerating the learning effect. As a company learns more about the
global marketplace, costs associated with manufacturing and distri-
bution processes decrease .
Exploiting automation's declining breakeven point. As the volume of
product and processes increase, technology costs are recovered much
quicker.
DEVELOPING GLOBAL STRATEGIES
Although it is critical for today's enterprise to explore international trade al-

ternatives if they are to maintain and expand competitive advantage, there are
a number of questions that must be addressed before engaging in international
operations. Among those questions are the following:
What is the scope and objective of the current international trade
initiatives?
What should be the firm's strategies in pursuing foreign trade, given the
available logistics alternatives and assessment of opportunity, risk, and
enterprise capability?
What are the competitive pressures currently being experienced from
foreign imports?
What foreign markets are to be targeted, and what global strategies
should be formulated to penetrate those markets?
What are the finn's logistics strengths and weaknesses relative to

proposed foreign markets?
Who should make domestic and international trade decisions?
How are domestic and international logistics functions to be structured
and integrated to ensure optimization of objectives, costs, skills, and
resources?
What customer service, inventory, warehousing, and transportation op-
erational strategies are to be established for each target market?
How are global logistics strategies and operations to be measured to en-
sure the supply channel is achieving optimal performance?
Without a thorough evaluation of these and other strategic questions, firms
searching for definition of their involvement in foreign markets cannot pos-
sibly hope to succeed.
GLOBAL STRATEGY DEVELOPMENT
When embarking on an international trade initiative companies normally will

pursue one of three possible strategies [7]. The first, and most common,
strategy is concerned with the simple export and import of products and ser-
vices as part of a general effort to penetrate the global market. Normally,
companies pursuing this strategy will tum over the entire effort to a broker,
freight forwarder, or LSP rather than establish an internal international or-
ganization to perform these activities. In this model the global initiative is
more concentrated on transaction management than building a comprehensive
strategy. In the second strategy, companies are pursuing a limited form of
international business. While they may be working through distributors or
subsidiaries, the finn will actually be conducting some form of regional pro-
duction and sourcing as a separate function within the company. In the final,
and most advanced strategy, companies are truly conducting international
trade and possess international brands. They possess global, centralized plan-
ning functions that are responsible for conducting international sourcing and
distribution functions. Companies pursuing such a strategy think globally
and are really integrated networks where channel distribution and manufac-
turing nodes pursue local objectives built around standardized processes.
Regardless of the approach taken, an effective strategy must identify the
nature and scope of the international trade initiative, define the appropriate
marketing and logistics strategies, design operational objectives and struc-
tures, and, finally, develop the appropriate performance metrics to measure
success and uncover regions for improvement. According to Keegan [8], an
effective international trade strategy is composed of the following five ele-
ments: (1) environmental analysis, (2) global strategic planning, (3) organiza-
tional infrastructure, (4) implementation, and (5) performance measurement

[Figure 13.1]. The goal of the exercise is to develop "world-class" inter-
national trade operations that provide global companies with the mechanics to
optimize and align the distribution system with each international target
market.
1. External environment
Environ mental 2. Organizational strengths and weakness
Analysis 3. Stakeholder expectations

Global
Strategic
1. Marketing objectives and goals
2. Marketplace selection

Planning
Organizational 1. Centralized
Infrastructure 2. Decentralized

Implementation 1. Organizational commitment

Performance 1. Feedback
Ieasurements 2. Metrics
FIGURE 13.1 . Global Strategy Development

Environmental Analysis. The first step in global strategy development is de-
fining the strategic dimensions of the enterprise. There are essentially three
areas to consider. The first is concerned with detailing the external business
environment. This environmental analysis should be divided into macro eco-
nomic, sociocultural, political, and technical factors, and then into micro fac-
tors such as markets, costs, competitors, and governments. An effective
analysis should cover the whole world, ensuring that no relevant market,
competitor, or trend is overlooked. The second strategic dimension involves
assessing the strengths and weaknesses ofsupporting infrastructure . A firm
understanding of this strategic area is essential in dealing with identified op-
portunities, threats, and global trends. In addition, the firm should identify its
own particular area of distinctive competence. This means that planners
should know the products to be offered and the markets served, technological,
sales, distribution and resource capabilities, and growth and profitability
targets .
The final strategic dimension is coming to tenus with and matching stake-
holder values with perceived enterprise objectives. Stockholders, managers ,
employees, customers, and others often have conflicting values and interests
regarding enterprise size and growth, profitability and return on investment
(ROn, sense of social responsibility, and ethics. Before a global strategy can
be constructed, planners formulating the direction of the company must be
sure that objectives are in alignment with the realities of the external environ-
ment, the capabilities of the organization, and the desires and assumptions of
the stakeholders.
Global Strategic Planning. Once the strategic environmental dimensions

have been identified, planners can proceed to detail the nature and scope of
the overall global channel strategy and define in detail the unique characteris-
tics of each national market. Normally, a company begins to explore the pos-
sibility of entering foreign markets either because it feels it must in order to
sustain competitive advantage or it is solicited by an importer or a foreign
government. Before detailed market analysis can begin, however, it is impor-
tant that the finn defines its international marketing objectives and policies.
This process normally consists of three parts. To begin with, planners must
determine the desired proportion of foreign sales to total sales. This ratio de-
pends on product, competition, logistics channel requirements, and market-
place aspirations. Second, planners must choose between marketing and dis-
tributing to a few countries or to many countries. Generally, it makes sense
to begin first by selecting a few countries in which a strong commitment and
significant product penetration can occur. Finally, the finn must decide on
the types of countries with which they would like to do business with. Issues
relating to political stability, product fit, income, transportation substructure,
geography, and others are possible elements to consider.
Once the global strategy has been determined, marketing and logistics
planners must turn their attention to pinpointing which national markets are
to be selected. Kotler [9] feels that candidate countries should be rated on
three major criteria: market attractiveness, competitive advantage, and risk.
Market attractiveness consists of such factors as language, laws, geographical
proximity, stability, cultural similarity, and other micro factors. Competitive
advantage focuses on overall marketplace strategies, presence of competitors,
product life cycles, and such. Risk is divided into two types: asset pro-
tection/investment recovery risk, which is concerned with the possibility of
foreign government nationalization or limits to the transfer of invested re-
sources, and operational profitability/cash flow risk, which arises from local
economic depression, currency devaluation, strikes and other factors. Once
these criteria have been reviewed, choices must be made based on estimated
return on investment. This step includes estimating market potential and pos-
sible risk, forecasting sales potential, estimating costs and profits, and, final-
ly, determining the rate of return on investment.
Organizational Infrastructure. In the past, global logistics has often suffered

from poor organization, a lack of training, and the absence of interorganza-
tional power and influence. Physical distribution is normally considered as
playing a supporting role and not regarded as a key element in the enterprise's
global marketing strategy. What is more, often the responsibilities of both
domestic and global logistics are divided between competing business depart-
ments. Such infrastructures have resulted in limited opportunities for integra-
ting the two functions and pursuing simultaneously improvements in cost, ef-
ficiency, and productivity. Without effective global logistics organizations,
the enterprise cannot hope to optimize on global opportunities and deter pos-
sible competitive threats.
The architecture of an effective global logistics organization can vary. For
firms whose global effort is focused on a single country or homogeneous re-
gion, a centralized organization can be particularly effective. When, how-
ever, the scope of the logistics effort traverses many countries and diverse
regions, the best form of organization is one in which the planning and
control functions are centralized and integrated with other enterprise depart-
ments but the actual operations functions are decentralized. Simply, as the
variety of differences in culture , governmental regulations, and knowledge of
trends in local economic conditions expands, centralized global organizations
become increasingly ineffective. In such environments, personal familiarity
with the countries composing the international marketplace becomes in-
valuable.
Implementation . Once the global strategy has been completely structured, it

must be implemented. This step entails obtaining and committing current re-
sources to executing regional market, market cluster, and product life cycle
plans . The key element in implementation is the presence of effective organi-
zational infrastructures for ongoing logistics resource management.
Performance Measurement. Once the global strategy has been put in place,
strategists must be careful to have a comprehensive program of performance
measurements in place. In this step, actual results are constantly compared
with expected output. To the extent that the results of the strategy are consis-
tent with original goals and assumptions, it can remain unaltered. If, how-
ever, wide performance variances occur, planners must adjust the strategy by
isolating specific areas for improvement. In addition, performance measure-
ment must provide information that enables continuous strategic alignment
with the external environment and organizational and value assessment as-
sumptions established at the beginning of the strategy formulation process.
STRATEGY DEVELOPMENT SUMMARY
As the requirements for globalization increase in the twenty-first century,

strategists must change fundamental methods of planning and operating the
logistics functions of their companies. Firms with minimal involvement in
foreign trade can defer logistics complexities to intermediaries who will
handle the problems associated with shipping, insurance, pricing, trade re-
strictions and licensing, warehouse storage, and transport mode selection.
For multinational corporations, however, a unified global strategy is neces-
sary to ensure the smooth flow of product through the international pipeline.
In responding to global strategies, Gopal and Cypress [10] feel that com-
panies must find solutions to the following issues:
1. Ability to balance company resources (capital and inventories) and
organizational structure with the needs of the global marketplace.
2. Monitoring and managing the constant changes occurring in global
trade. Trends include shifting attitudes toward tariffs, administrative
procedures, restrictions on intercountry transportation modes, and
warehouse storage, as well as managing the pace of rapidly changing
marketing and logistics strategies, new product introduction, and in-
creased information linkages. By responding effectively to change,
multinational firms can increase the speed and reliability of global de-
livery, reduce overall transportation costs, and reduce the size
(quantity) of shipments.
3. Extending and tailoring the supply chain to meet the distribution struc-
ture of each foreign nation or geographical region. Distribution chan-
nels in Europe, for example, are very mature and require local distribu-
tion centers, local management of transportation owing to the number
of transit countries, knowledge of local customs, and all regulations
dealing with the European Union. Trade with Japan requires short de-
livery cycles and local inventory to meet planned and random demand
patterns. Distribution in the Pacific Rim, on the other hand, requires
using local freight forwarders and lead time planning to counter delays
due to the lack of a fully developed logistics infrastructure and pro-
tected local industries.
4. Ability to execute distribution for simultaneous multicountry, multi-
product introductions.
5. Ability to work with value-added taxing found in many foreign
countries and transfer price regulations both domestic and foreign.
6. Implementation of information systems that provide for worldwide in-
ventory planning and stock availability and customer order status.
7. Benchmarking global channel performance with that of international
competitors.
Effectively managing these and other global trade issues is more oper-
ational than strategic. The companies that will succeed in the highly com-
petitive international marketplace of the twenty-first century will be those
that can leverage information and decision support technology tools to solve
global differences in market preferences, logistics structures, perceptions of
quality and service, and performance measurement.
CHANNEL STRATEGIES
In defining the strategic approach to the global marketplace, firms have four
possible alternatives available. A company may choose to follow one or
combine several together to match particular objectives or marketplace con-
ditions. The four strategies are exporting, licensing, joint venture, and direct
foreign investment (ownership). Of the four, exporting is the easiest to ex-
ecute. The remaining three strategies, licensing, joint venture, and owner-
ship, are in order increasingly more complex because they involve the estab-
lishment of manufacturing or warehousing facilities within foreign countries
and the integration of company-owned domestic and foreign distribution
channels (Figure 13.2).
Distribution Channels
Between Nations
Distribution Channels
Within a Na tion
Global
Enterprise
FIGURE 13.2 Alternative international strategies.
EXPORTING
The most common form of global trade is the export of products into foreign
markets from domestic facilities. Exporting requires the least involvement
because the actual marketing and logistics activities are carried out by some
form of international trading house or intermediary. Exporting can be pur-
sued as either a passive or an active strategy. In a passive strategy, com-
panies might engage in exporting products to foreign markets from time to

time, or in response to an unsolicited order from a foreign customer. Active
exporting, on the other hand, occurs as part of a strategic decision to expand
sales into foreign markets. Regardless of the policy, exporting as a method of
approaching foreign markets involves the least change in product lines, distri-
bution channels, internal organization, investment, and enterprise mission.
Exporting can take two forms, depending on how involved the firm wants
to become in the export process. Exporting can be executed indirectly
through a variety of specialized brokers or directly through foreign merchants
or wholesalers.
Indirect Exporting. Indirect exporting involves the least amount of effort and
is the method normally recommended to firms that are taking their first steps
toward developing international trade . This type of exporting is indirect be-
cause the company deals with some form of intermediary that is located in the
same domestic market. The major advantage of indirect exporting is that the
business can engage in foreign trade without having to deal with the com-
plexities of global logistics, tariffs and taxes, international marketing con-
tacts, and accompanying paperwork and legal issues. In addition, it requires
little risk or investment, the bulk of the work for transaction management fal-
ling upon the intermediary. Finally, indirect exporting renders the firm im-
mune to possible foreign political and economic upheavals, as well as permits
easy exit from a foreign market that fails over time to realize sales or profit
targets . Negatives surround the company's loss of control over the ultimate
cost and delivery of its products. The various types of indirect export inter-
mediaries are described below.
International Trading Company. This type of intermediary performs
many functions. Among them are the purchasing and selling of goods,
arrangement for the transportation and warehousing of goods from the
export company to the foreign customer, financing currency conversion
and absorbing .rate fluctuations, assisting with consulting advice, and
other logistics issues.
Export Merchants . Export merchants act as a form of international
wholesaler. Similar to domestic wholesalers, they purchase goods from
domestic manufacturers and distributors and then pack and ship them to
foreign markets. Although some export merchants may have facilities
located in foreign countries close to the target market, they mostly deal
with foreign intermediaries in the country of destination.
Resident Buyers. Foreign firms and governments will often locate buy-
ers directly in the export country. Their responsibility is to locate, pur-
chase, and ship goods to their home countries. Sears, for example,
maintains buyers in foreign countries who buy direct from manu-

facturers for resale in the United States.
Export Commission House. This type of intermediary performs the
same functions as a resident buyer except that the buyer is not an
employee but rather of an agent empowered to negotiate, buy, and ship
from firms in the exporting country. In return, the commission house is
normally paid a commission by the foreign buyer.
Allied Manufacturer. Exporting through a business partner is an easy,
cost-effective way of shipping overseas. In the arrangement, a compa-
ny with well-established foreign trade activities negotiates to "piggy-
back" the products of other domestic firms with shipments of their own
products to foreign countries. The advantage is mutual. For the ship-
ping company, carrying other products can assist in presenting foreign
markets with extended product lines or achieving a higher utilization of
transportation and warehousing capacities. For the exporting firm, the
arrangement provides them a good deal of the benefits of a mature
foreign trade system without the investment.
Export Management Company. An export management company is a
product line or foreign market specialist who works that export for one
or a group of noncompeting manufacturers. Although most act as sel-
ling agents directly for their manufacturers , some of the larger firms do
purchase products for resale.
Direct Exporting. Despite the advantages offered by indirect marketing,

some firms choose to export directly to intermediaries located in foreign
nations. The choice of this strategy requires the establishment of an export
department whose responsibility it is to establish the necessary distribution
channels appropriate to each trading nation; find, maintain, and motivate
intermediaries in targeted foreign countries; plan and execute all international
shipping requirements; and, execute all export documentation. The major
advantage of direct exporting is increased control over products sent to
foreign markets. Disadvantages are found in the extra costs and overheads
that arise from shipping directly to a foreign nation. The various types of
direct export intermediary are described below.
Domestic-Based Export Department or Division. Many companies
have an export department or division in their organizations manned by
an export manager and staff. This group executes actual selling and, in
some instances, will perform other tasks associated with shipping,
establishing logistics channels , and export documentation.
Foreign Sales Branch/Subsidiary. Companies with a significant pres-
ence in certain foreign countries might elect to locate a sales branch or
subsidiary in each country. Overseas branches permit the exporter a

much greater control over marketing decisions and product positioning
and can provide on-site skills and services necessary for effective sales
or marketing activities. In addition, branches may handle warehousing
issues and promotions.
Traveling Export Sales Representatives. Export firms may send sales
representatives directly to foreign nations to solicit and execute export
arrangements and sales.
Foreign Wholesale Agents and Merchants . There are several types of
intermediaries in this class. A foreign sales agent is an independent
contract sales representative that promotes and sells for an export com-
pany. The agent is generally compensated through commissions. The
actual sale is shipped and paid for by the exporter and the foreign
buyer. On the other hand,foreign merchant distributors buy the goods
directly from the exporter and establish their own pricing, promotions,
and other marketing strategies except where prohibited by contract.
Direct Sales. This is the least used form of direct export. In this tech-
nique, exporters seek to sell products directly to foreign retailers or
even end customers. Normally, this type of exporting is used only for
high-ticket and specialty items sold to foreign governments, businesses,
or institutions.
LICENSING
Similar to exporting, licensing manufacturing processes and distribution of

products is a relatively simple, cost-effective method of entering global mar-
kets. Licensing can be defined as a contractual arrangement by which a finn
(the licensor) in one country agrees to permit a company in another country
(the licensee) the right to use a manufacturing process, trademark, patent,
technical assistance, trade secret, merchandising knowledge, or other skills.
In exchange for these rights, the licensor will receive a fee or royalty. The
objectives of a licensing agreement are straightforward: The licensor is able
to gain access to a foreign market with a minimum of risk and capital ex-
pense; in tum, the licensee receives the right to distribute brand name prod-
ucts or access to proprietary processes either to found a business or to add to
existing product lines. The best known examples of licensing are Coca-Cola
and McDonald's. Both firms penetrate foreign markets by licensing (fran-
chising) product name, processes, and products to bottlers and food service
companies across the globe.
There are several advantages licensing has over exporting. To begin with,
licensing provides the licensor with a greater degree of control over how the
product is marketed and distributed. Also, licensing normally does not re-
quire a great deal of capital investment. Like exporting strategies, licensing
provides licensors with a less risky method of gaining access to foreign mar-
kets than direct ownership, while providing sufficient flexibility to cancel un-
profitable arrangements . On the negative side, the licensor has less control
over the licensee than if the firm had established a directly owned business.
If the licensee does not live up to the terms of the contract, all the licensor
can do is threaten to end the agreement. Finally, if the licensor decides to
cancel the contract, they might find that they have not only lost control but
have created a competitor with a strong market position in a foreign country
where the licensor might subsequently find it difficult to penetrate on their
own.
There are several forms of licensing in foreign markets. One is to execute
a management contract in which a licensor sells management services for a
fee to a foreign company to assist in managing a factory, distribution center,
hospital, or other organizations. Management contracts are low-risk methods
of gaining entrance to a foreign market, especially if the contracting firm
provides an option to purchase a portion of the business. Another method is
contract manufacturing. In this method a firm licenses and agrees to assist a
foreign company produce or distribute its products. Although licensing has
the drawback of potential loss of control over processes, it does provide the
firm with the opportunity of partnership or acquisition if the market matures.
JOINT VENTURES
Unlike the first two strategies, the decision to execute a joint venture with a
foreign company directly involves a company in the management of a foreign
enterprise. Normally, a joint venture occurs when a firm decides to join with
a foreign company for the purpose of exercising joint ownership and control
over a business. Joint ventures may occur when a firm invests in the manu-
facturing and distribution operations of an existing foreign company, or the
two parties may join together to found an entirely new company.
Companies decide to enter into joint ventures for several reasons. The
most obvious is to significantly increase local control over the product, distri-
bution, and marketing strategies of the foreign company due to its financial
partnership. A firm may also enter into a joint venture to utilize the
specialized skills or gain access to the physical distribution system possessed
by a foreign partner. Companies are sometimes prohibited by foreign govern-
ments from entering alone into a local marketplace. Such restrictions often
occur in less developed countries where government is actively promoting the
growth of home industries. A partnership with a local firm may provide an
avenue around this difficulty. Finally, a firm may lack the capital, manager-
ial, and personnel capabilities to enter a foreign market on its own without the
assistance of an established foreign company.
There are a number of drawbacks associated with joint ventures. The most
obvious is the significant degree of risk involved. Outside firms normally
invest capital in foreign ventures that they wish to convert to profits that can
be returned to the home country. Disagreements with the partner or even
government restrictions may inhibit return on investment expectations. In
addition, disagreements might also arise over product, marketing, and distri-
bution channel strategies. Settling these differences might be a difficult affair
requiring some compromise on the part of both parties. Finally, joint ven-
tures might even impede a multinational company from executing specific
marketing and distribution strategies on a worldwide basis.
DIRECT OWNERSHIP
The direct ownership of manufacturing and distribution companies in a

foreign country represents the highest level of control and involvement an
enterprise can have in the pursuit of foreign trade. Instead of working
through an intermediary or a venture partner, the firm assumes all the respon-
sibilities for facilities, personnel, marketing, and product distribution. Own-
ership can occur through two methods. In the first, a company may seek to
build a new facility. This method is the more difficult of the two. The com-
pany must establish marketing contacts and distribution channels, select the
site, hire personnel, acquire equipment, and provide for capital funding
among other things. A far more cost-effective method is to acquire an estab-
lished foreign firm. All the company has to do is to buy into the preexisting
structure, making alterations as required to meet changes in product and mar-
ketplace emphasis.
There are some significant advantages to direct ownership. As the compa-
ny now controls the foreign venture, it can determine the marketing, product
positioning, and distribution strategies to be pursued in the local market with-
out interference. This point is critical for multinational enterprises seeking to
develop long-term, unified strategies throughout the globe. Second, direct
ownership provides the ability to compete more effectively on price. Because
the cost, in some cases, of transportation of the product from the home
country is eliminated along with import taxes and customs duties, the foreign
subsidiary can become more price competitive. Third, the new venture might
be able to achieve cost economies in the form of cheaper labor or raw mate-
rials, foreign government incentives, or process improvements. Fourth, the
company's image may improve in the foreign country due to its commitment
to the local economy. Finally, as the company's knowledge of the foreign

country grows, it might be able to improve on its marketing techniques and
product offerings to match the ongoing needs of the local community.
Although the benefits of direct ownership are substantial, so are the draw-
backs. The most obvious negative is the enormous risk a company takes in
investing in a wholly-owned foreign venture. Some of the concerns are cur-
rency devaluation, political unrest, declining markets, and nationalization. In
addition, the investor company can find its flexibility to respond to home or
other foreign markets circumstances curtailed because of the financial com-
mitment involved. In addition, if the company decides to discontinue the op-
eration, it may involve not only forfeiting the cost of the plant, equipment,
and personnel but also the company's reputation in that region. Finally, re-
orienting the product and the sales environment in response to overall
changes in the company's internal objectives might be more difficult to imple-
ment due to governmental and regional regulations.
MANAGING GLOBAL DISTRIBUTION NETWORKS
The establishment and maintenance of a global distribution network is a com-

plex affair involving most of the functions of domestic distribution, plus ad-
ditional requirements associated with global market channels, terms of sale,
pricing, transportation , and warehousing. What is more, whereas the func-
tions of distribution are universal, the structure and performance criteria of
channels of distribution vary throughout the world. It used to be assumed
that the level of distribution channel structure development found in one
country paralleled the structures of other countries that had attained the same
degree of economic and technological development. As Bowersox and
Cooper [11] have pointed out, however, actual global distribution structures
are "so closely intertwined with a country's social, cultural, economic, tech-
nological, and political conditions and development that it is impossible to
generalize about one specific form or structure throughout the world." As a
result, firms aspiring to participate in global trade must constantly seek to
understand and adjust to the marketing and logistics channel structures of
their trading partners if effective global strategies are to be realized.
In general, structuring a global distribution channel requires making many
of the same decisions concerning cost, product positioning, sales and profit-
ability, channel control, and flexibility that are made when defining the ob-
jectives for domestic channels. There are, however, a number of issues that
are specific only to global channels. These refer to sales, marketing, pricing,
investment and payment, and documentation. Managing these issues will be
the subject of the sections below.
MANAGING THE GLOBAL DISTRIBUTION CHANNEL
Establishing and maintaining a global distribution channel requires working

with marketing functions to design an effective distribution network, monitor
costs and benefits, and tirelessly search for avenues of constant improvement
in customer services. The following points explore these topics.
Service/Cost Elements. In the creation of any marketing channel, the enter-

prise must chart out the desired product and service targets and the cost of
meeting those objectives. This is particularly true when it comes to struc-
turing a global distribution channel. Because of the increased number ofvari-
ables and constraints, however, clearly understanding service and cost ratios
can be a difficult exercise. The flow of communications can be easily inter-
rupted by distance and differences in language, culture, and legal factors.
Documentation is more extensive, often resulting in long delays. Financial
flows are full of roadblocks in the form of cash and payment transaction con-
versions, pricing, credit management, insurance, and liability. Furthermore,
the presence of legal and regulatory restrictions, duties and taxes, export and
import restrictions, and local laws and customs make measurement difficult.
Finally, the number of channel levels in the pipeline, the use of intermodal
freight carriers over long distances, and packaging and labeling can make it
difficult to create precise metrics to weigh the cost versus the level of service.
In effectively mapping service versus cost elements, Bender [12] feels that
four service criteria (response time, order completeness, shipping accuracy,
and shipment condition) are critical in making any evaluation. Response time
refers to the time elapsed from receipt of a customer order until goods are re-
ceived by the customer. When it comes to global distribution, the market is
less sensitive to long lead times. Owing to the size and complexity of the
channel, most foreign customers normally will increase lead times and in-
ventories to compensate for slower service. Still, a global distributor must
constantly search for methods of increasing delivery service while main-
taining or lowering costs. Developing alternate distribution systems, stream-
lining paperwork flows and operations, the use of computerized supply chain
management applications, and others are possible avenues for improvement.
Due to the length of the channel and the time required for order delivery,
the last three service elements are of much greater importance. Probably the
most critical of these elements is order completeness. Order completeness
can be defined as the percentage of how close the actual shipment satisfies
the product and quantity requirements of the original order. As the percent-
age of order completeness grows, logistics costs decline correspondingly.
Simply, the less a company has to handle backorders and expediting, the less
the cost for order completion processing and shipping. Shipping accuracy is
the ratio between the number of deliveries that have the correct products,
quantities, and so forth, and the total number of deliveries for a specific time
period. The level of accuracy depends normally on the level of control, and
the higher the level of control the higher the expense. The cost of poor ac-
curacy in global distribution is excessive, including paying for and processing
returns, reshipping orders, canceling orders, and loss of customer goodwill.
The final service/cost element is ship ment condition. This measurement can
be defined as the ratio between the number of orders delivered in good con-
dition and the total number of orders shipped. Unlike domestic shipments,
international orders are often handled many times as they move through the
pipeline. At each occasion, the order is exposed to the possibility of damage.
Considering the cost of backorders, packaging, and time spent in order re-
placement, undamaged orders are a significant service/cost element. Similar
to response time improvement, global distributors must constantly search for
ways to improve these service elements while reducing costs.
The Distribution Channel. Whether domestic or global distribution, the goal

is identical: how to transport product from supplier to customer as quickly
and cost-effectively as possible. Beyond this goal, however, domestic and
global distribution differ significantly as to channel structure and techniques.
Perhaps the most obvious distinction is the explosion of the number of levels
in a typical global channel. On a high level, a global channel can be broken
up into four distinct sections: the domestic channel, channels between
nations, channels within nations, and the buyer (Figure 13.3). The domestic
Buyer
FIGURE 13.3 Overview of international channels.
portion of the channel is fairly homogeneous. Once, however, the shipment

begins its transit through foreign ports to the customer, it can pass through
several iterations of unloading and reloading, transport consolidation, and
warehousing occurring in different foreign countries. These distribution
nodes can represent an intermediary, government customs and tariffs check
point, or stocking location. In addition, because of the relative size of the dis-
tribution channel, there are a significant number of options available to sup-
pliers and customers. For example, orders can be filled from several lo-
cations in the channel. Because of the size and flexibility of the global net-
work, it is of critical importance that planners structure a channel that opti-
mizes cost and service objectives and is in alignment with marketing, prod-
uct, and financial strategies.
mizes cost and service objectives and is in alignment with marketing, prod-
uct, and financial strategies.
In a classic article, Picard [13] segmented global channels into four sys-
tems. These systems cut across the four channel strategies described above.
In the first system, as illustrated in Figure 13.4, products are shipped directly
Foreign Markets
FIGURE 13.4 Direct system of global trade.

from the home country to intermediaries or customers in a single foreign mar-
ket. The advantages of this system are that there is no need for foreign ware-
housing or consolidation and there is less product in the distribution channel.
A serious drawback of this system is the accompanying long lead times for
customer delivery. In addition, the length of the supply line renders the ship-
ment subject to possible disruption and delay. Finally, the packaging and
documentation costs associated with this system are normally higher than for
the other three systems. The second channel system (Figure 13.5) attempts to
Country Boundary
Markets
-~ ..- Markets
Markets
FIGURE 13.5 Consolidation strategy.
solve some of the problems of the direct system by interposing a consoli-

dation center in between the domestic warehouse and the customer. The pur-
pose of the consolidation center is to decrease the overall cost of transport.
Product can be shipped from the home country in bulk and then converted
(bulk break) into individual customer orders and stocking units and distrib-
uted within the foreign market.
The last two global channel systems are distinguished from the first two
by the fact that they both require the creation of a stocking warehouse in the
foreign market. In the third system (Figure 13.6), inventory is shipped from
the home country to a stocking warehouse located within the foreign market.
The benefits of this arrangement are obvious. Delivery to the foreign ware-
house can be done in bulk and with slower transportation modes, thereby de-
creasing shipping costs; order lead times are shorter that in the first two sys-
tems; customers have greater flexibility in product and quantity selection;
and, because the shipment is really an intracompany transfer, the costs as-
sociated with tariffs and documentation are reduced. Negatives to the system
are the cost associated with maintaining a foreign facility and higher levels of
pipeline inventory.
Markets
Markets
Markets
FIGURE 13 .6 Consolidation strategy within a country.
The final global channel system (Figure 13.7) expands on the concept of
foreign warehousing by enabling product sales to multiple foreign markets
from a single strategically positioned warehouse. 1 he most significant ad-
vantage of this system is reduction in facilities and inventory stocking costs
while preserving shorter lead times and customer flexibility. Benefits, how-
ever, might be compromised by transport and administrative costs as ship-
ments are sent to other foreign countries. Multicountry warehouses should
ideally be located in a free-trade zone, thereby eliminating costs arising from
local tariffs and taxes .
FIGURE 13.7 Consolidation strategy for multiple countries.

In deciding which channel system or combination of systems to implement,
channel planners must carefully review a number of key factors relating to the
nature of the product, market, export requirements, and foreign environment.
Product-related issues focus on such attributes as value density, product line
variability, perishability, obsolescence, position in the product life cycle, and

expected turnover rate. Market-related issues refer to the number and size of
the foreign customer base , level of expected service, sales volume, quality of
foreign intermediary or company-owned distribution channels, fitness of
product, and prospects for growth. Export-related factors center around ex-
port marketing strategy, sophistication of intermediaries, and firm size. For-
eign environment issues focus on sophistication of global channel infrastruc-
ture , political and economic stability, degree of government regulation and
customs constraints, and the presence of strong, cost-effective foreign part-
ners and transit contractors. By using these key factors, planners have the
abil ity to develop several different global channel systems. For instance, a
direct channel system could be used to supply bulk shipments to large foreign
customers, whereas a multicountry approach could be employed simultane-
ously to penetrate several different countries supplied from a central foreign
warehouse [14].
Distribution Operations Costs. Effective management of a global distribu-

tion network also requires close supervision of channel operations costs .
Some of these costs are the same whether they are associated with domestic
or foreign distribution channels. Among these are costs for administrative
facilities and warehouses, transportation rates and fleet maintenance, pur-
chasing, value-added processing, inventory, and information processing. In
addition, foreign distribution channels can have other significant costs. The
expense of developing new marketing channels, maintaining an internal inter-
national department, carrying in-transit inventory, insurance, product pack-
aging, customs duties, and taxes fall within this category. As a result , areas
for cost controls and potential improvement will grow significantly as the size
and scope of the global channel expands.
GLOBAL MARKETING CONSIDERATIONS
Although there are great similarities among domestic and global channel
costs, network design, and management systems, there are also a number of
differences regarding terms of sale, pricing, and marketing that are unique to
international transactions. These features are described below .
Marketing Issues. An effective global distribution system requires several

decisions regarding the marketing approach to be taken by the firm in regard
to product positioning, promotions, and organization. The marketing ap-
proach pursued can take one of two approaches. In one option strategists
might choose to follow a standardized approach by offering the same prod-
ucts, prices, advertising, promotions, distribution channels, and value-added

services to all foreign market segments. This option is the less costly, as little
or no modification is made to the marketing offering. On the other hand,
strategists might pursue a customized approach in which the marketing
offering is tailored to meet the needs of each target market. Many companies
develop a strategy somewhere in between these two extremes, searching for
ways to optimize sales and profits while reducing costs.
Among the marketing decisions, probably the most important relates to
product. When offering a product to a global buyer, the seller must deter-
mine how closely existing product characteristics fit local marketplace re-
quirements. Keegan [15] has identified five possible options. In the first,
straight extension , the product is offered to the marketplace without modifi-
cation to local needs. This is the least expensive of the options and can be
successfully used for most durable goods such as appliances, cameras, con-
sumer electronics , tools, and machinery. Still, whatever the level of success,
marketers must be constantly searching for new ways to market the product in
foreign countries. The second product option is product extension-communi-
cations adaptation. In this strategy, the product is offered to the marketplace
essentially unchanged; the only adjustment required is in marketing com-
munications. Bicycles and motor scooters are examples of products that fit
this approach. The third product management approach is product adapta-
tion. This strategy requires changing the existing product in some way to
meet the standards or tastes of local customers. This option is particularly
important for food distributors who must change seasonings, textures, and
colors to meet local preferences . Durable goods, such as automobiles,
sometimes must be modified to fit the safety requirements of foreign
countries. The fourth strategy involves both product and communications
adaptation. The final option, product invention , occurs when a firm decides
to reintroduce an obsolete product into a less developed foreign market or
create a new product just for the target market. This option is a costly strat-
egy, the benefits of which must be closely analyzed.
Advertising and promoting products in foreign lands is a critical activity
that requires an intimate knowledge of the cultures, languages, and histories
of each target market. Even small things such as name, color, and nuance can
have an enormous impact on foreign market acceptance. One alternative is to
promote products using the same messages as those used in the domestic mar-
ket. The familiar sight of the Coca-Cola logo and MacDonald's "Golden
Arches" are good examples. However, sometimes product names, advertising
media, and labeling need to be changed because of local customs and lan-
guage. For example, the color purple is associated with death in most of
Latin America, and white in Japan with mourning. Finally, the utility of ad-
vertising media throughout the world varies. Television is a critical medium
in the U.S. but limited by country in Europe and almost nonexistent in poor
countries. The same variance in global audience can occur for ads placed on
the radio, in newspapers or magazines, or available through the Internet.
The final global marketing decision that must be made refers to the type of
marketing channel organization used by the firm. Often large multinational
companies may pursue several types based on their global channel strategies.
The least complicated type of organization is the domestically based export
department. Such a department can consist of an export clerk, a sales man-
ager, and a few assistants, or a complex business unit with expanded roles
and service offerings. Exporting departments can be indirect, contracting
with domestic or foreign wholesalers or distributors, or direct, shipping prod-
uct directly to foreign buyers. If a company is involved in licensing, joint
ventures, or direct ownership, normally these affairs are conducted by an in-
ternational division. This function could be organized around geographical
or regional managers and sales representatives, product groups, and global
subsidiaries and branch sales offices. Finally, some organizations have be-
come so big that they consider themselves more as global marketers rather
than national marketers. Companies like IDM, Black and Decker, Xerox,
Warner Lambert, and others are involved in the planning and execution of
global distribution channels, manufacturing, marketing strategies, and finan-
cial systems.
Terms of Sale. Beyond issues associated with advertising, promotions, and

channel organization, global marketing must consider issues associated with
the following range of fees, duties, and terms of sales:
Harmonized system (HS) codes. These codes, which vary by country
and number in the hundreds of thousands, detail the fees and restric-
tions associated with the transport of goods across national borders.
These codes must be defined and harmonized for all goods crossing a
border.
Incoterms. When selling goods across international boundaries it is
critical to determine when and where the physical transfer, payment,
and legal transfer of the goods, and responsibility for such things as in-
surance, payment for transportation, and controlling (preserving) the
goods occurs between seller and international buyer. The below terms
define the roles and responsibilities associated with any given cross-
border transaction.
1. At the seller's dock (or "ex works"). The sale is executed at the
price quoted at the domestic warehouse or factory.
2. Free carrier (at a named point). In this method, the sale is com-
pleted with the delivery of the goods to a carrier at a specific ware-
house or consolidation point. This method is common used when

intermodal carriers are employed.
3. Free on rail. Sale occurs usually when the goods are loaded aboard
rail cars near the shipper's dock.
4. FOB (free on board) airport. Transfer occurs with delivery to the
airport of export.
5. FOB a vessel. The shipper is responsible for obtaining export
clearance and for loading the ship.
6. FAS (free alongside ship) at port of export. The buyer is respon-
sible for clearing the goods for export and loading them aboard a
vessel.
7. FRC (free carrier). This term applies to overland movements
between adjoining states. The shipper has responsibility for trans-
port until the goods are transferred to the buyer at the international
boundary.
8. C & F (cost and freight). The shipper pays costs and freight to a
specified destination, making the buyer responsible once goods
have been loaded.
9. CIF (cost, insurance, freight). This method is similar to C & F,
except that the seller is also responsible for insurance.
10. Freight and carriage paid to a specific point. Responsibility in this
method is placed on the buyer at the point where the goods are
tendered to the first carrier.
11 . Freight or carriage and insurance paid to a specific point. This is
the same as the previous method, except that the shipper also in-
sures the goods during shipment.
12. Ex ship. The shipper transfers the goods to the buyer aboard the
ship at the port of import.
13. Ex quay. The shipper transfers the goods to the buyer alongside
the ship at the port of import.
14. Delivered at frontier. The shipper transports the goods up to the
location of the buyer's national customs.
15. Delivered, with duty paid. The shipper delivers the goods to the
buyer's facility.
Collectively, these various terms are referred to as incoterms. In ad-
dition, sellers and buyers might agree on variations in these terms to ac-
commodate the many special services and charges associated with the
movement of goods.
Preferential fees, duties, and taxes. Import tariffs are normally com-
prised of general and preferential duty rates, in additional to other fees
and charges. Preferentially duties are influenced by such elements as
most favored nation 's (MFN) status and duty rates based on specific
certain countries to offset unfair pricing of the imported product. Final-

ly, marketing must be aware of taxes, such as valued-added tax (VAT),
general services tax (GST), and merchandise processingfee (MPF) and
a host of fees collected for other government agencies (OGA), inclu-
ding excise taxes, harbor fees, trade promotion fees, control taxes, and
others, that can impact a global trade initiative.
Pricing. Closely aligned with terms of sale is global pricing. Similar to the
process of determining domestic prices, global prices must be set in accor-
dance with price-setting behavior of competitors, customer's ability to buy in
various national markets, strategic cost and profit goals, place of product in
the product life cycle, and local legal and pricing regulatory environments.
Firms have three options in fashioning global pricing policies. A company
may, first of all, establish a uniform price for all markets. When pursuing this
policy, all nations, whether rich or poor, would pay the same price. A second
method would be to set a market-based price in each trading country. In this
strategy, the firm would charge what each country could bear. Finally, a firm
may pursue a cost-based price in each country. Selling price would be cost
plus a standard markup. In any case, prices for products sold in foreign coun-
tries are likely to be higher than in domestic markets. Much of the reason re-
sides in the fact that shippers must add the cost of administrative overheads,
transportation, tariffs, intermediary, wholesaler, and retailer margins to the
factory price.
Once a pricing policy has been determined, actual pricing is governed by
the terms of sale. The pricing set by the terms of sale differs in the way trans-
portation, insurance, tariffs, and other costs are incorporated into the total
price. Prices charged at the point of origin are normally the domestic selling
price minus any export discounts. Beyond Ex (point of origin) pricing,
pricing schemes normally fall somewhere in between two basic methods: ex
works, where the foreign customer must bear the freight and insurance costs,
and delivered pricing. When using delivered pricing, the shipper's price in-
cludes not only the price of the goods but the cost of all transport, customs,
tariffs, insurance, documentation, and other expenses. Delivered price pro-
vides certain advantages. To begin with, the seller gains control over the dis-
tribution process, thereby ensuring customer service and pricing competitive-
ness. Second, the seller may be able to obtain bulk discounts, which ulti-
mately allows price reduction. Finally, delivered pricing has the effect of in-
creasing the nation's balance of trade and utilization of domestic logistics
services.
There are several forms of FOB pricing depending on the type of carrier.
The price is basically a composite of the transportation costs associated with
packing, marking, loading, and transit freight costs. To this price is added
There are several forms of FOB pricing depending on the type of carrier.
The price is basically a composite of the transportation costs associated with
packing, marking, loading, and transit freight costs. To this price is added
other charges for unloading/loading, material handling, and transit duties. C
& F pricing includes the FOB cost plus the ocean freight charge, export
license, and export duties and taxes. ClF pricing consists of C & F cost plus
marine insurance. Ex ship and ex quay pricing consists of Clf costs plus ex-
penses for consular invoices, certificate of origin, unloading, import licenses,
tariffs and taxes, customs clearance, and additional marine and war risk
insurance coverage.
INTERNATIONAL FINANCIAL ISSUES
An enterprise involved in global trade is faced with a number of financial is-

sues that are not present in the domestic market. These issues are concerned
with such factors as cash flow and currency conversion, inventory cost, the
role of government, and methods of payment. Without a doubt, cash flow is
of prime importance. Typically, global companies need a great deal of work-
ing capital to pay for plant and equipment, transportation services, inven-
tories, and credit. Much of the reason lies in the great distances goods have
to travel and the nonnal administrative delays encountered in foreign trade.
Even when the transactions are relatively simple, customs clearance, the
transfer of international payment documents, government restrictions, and
shipment disputes can hold up payment. In addition, variations in the rate of
currency exchange can severely impact capital planning. This is particularly
true when it is considered that the value of the currency upon which the price
was based could devalue between the time of shipment and the time of de-
livery. Besides cash flow issues, currency variation will have an effect on
local costs associated with warehousing, labor, transportation, information
processing, and other costs. Finally, there are also potential collection issues
arising from inadequate credit reports on customers, problems of currency ex-
change controls, distance, different legal systems, and the cost and difficulty
of collecting delinquent accounts.
The management of inventories is also a critical aspect of international fi-
nance. Because of the size and variability of global distribution channels, the
flow of inventory is subject to delays and unexpected stoppages. In general,
these variances in inventory availability require global firms to carry high
levels of safety stock in each foreign market. A significant risk is the poten-
tial for high carrying costs due to monetary fluctuations due to inflation. In
such environments, LIFO (last-in-first-out) methods of inventory valuation
are preferred in order to keep inventory value as close as possible to the cur-
rent market cost of replacement. Although modern computer systems can sig-
nificantly assist firms to monitor the value of their inventories and the costs
associated with duties and tariffs, international inventory managers must be
ever vigilant in controlling global inventories.
The flow of cash can also be impacted by the wide variety of methods of
payment common in international trade. In the U.S. order value is normally
first reviewed against the customer's credit, with actual billing occurring on
shipment. Although this method is commonly employed in international
transactions as well, letters of credit and drafts are also used. A letter of
credit is a document issued by foreign banks on behalf of a company in that
country assuring the seller that the company possesses sufficient capital to ef-
fect payment for products received. There are three types of letters of credit:
Irrevocable . This form of credit can be opened at either the domestic
or foreign company's bank at the request of a foreign correspondent in
favor of the exporter. This type of letter of credit cannot be canceled
without the consent of the exporter.
Confirmed irrevocable. In this situation, a foreign bank opens the letter
of credit and it is guaranteed by a U.S. bank in favor of the shipper.
Revocable . Normally, this letter of credit is really a pro forma docu-
ment to be used as a basis when preparing irrevocable letters of credit.
Besides letters of credit, international payments can occur through the use of
drafts. One type, a sight draft, permits the foreign buyer to defer payment
until the actual draft is presented at the time goods are delivered. Actual
ownership is not transferred until after the draft is paid. The second type, a
time draft, permits the foreign buyer to assume ownership of a shipment upon
receipt of the draft but may defer payment for 30,60, or 90 days.
DOCUMENTATION
Another aspect differentiating international from domestic distribution is the

number of additional pieces of documentation necessary to execute the trans-
action. Global documentation is determined by the product being shipped, its
origin, and its destination. The major types of documentation surrounding
product export are the following:
Bill of Lading. This document is executed upon acceptance of a ship-
ment by a carrier. As such, it is both a receipt for the shipment and a
contract detailing the agreed upon transportation services. There are
several types of global Bills of Lading. An Order Bill of Lading is a
unique type that may be used as a negotiable instrument of ownership
and can be sold, bought, or traded while the goods are in transit. A
Clean Bill ofLading is issued when the shipment is received complete
and in good condition. An On Board Bill of Lading certifies that the

cargo has been placed aboard the named vessel and is signed by the
master of the vessel. On letter-of-credit transactions , an On Board Bill
of Lading is usually necessary for the shipper to obtain payment from
the bank. An Inland Bill of Lading, also known as a Waybill for rail or
a Pro Forma Bill of Lading in trucking, is used to document the trans-
portation of the goods between the port and the point of origin or
destination.
Dock receipt. This document is used to transfer responsibility for the
cargo between the domestic shipper and the carrier at the terminal
where the transaction occurs. The dock receipt is prepared by the
shipper and is signed by the carrier acknowledging receipt of the cargo.
Delivery instructions. This document provides specific information to
the inland carrier concerning the arrangement made by the shipper to
deliver the merchandise to a particular pier or steamship line.
Export declaration. Required by the U.S. Department of Commerce,
this document controls exports, in compliance with export licensing,
and acts as a source document for export statistics. It includes com-
plete particulars on the shipment.
Letter of credit. A financial document issued by a bank at the request
of the consignee guaranteeing payment to the shipper for the cargo if
certain terms and conditions are fulfilled. It normally contains a brief
description of the goods, documents required, a shipping date, and an
expiration date after which payment will no longer be made.
Consular invoice. Required by some countries, this document is used
to control and identify goods shipped into their country. It usually must
be prepared on special forms and may require legalization by the
purchasing nation's diplomatic consul.
Commercial invoice. A bill for the shipment from the seller to the buy-
er. It is often used by governments to determine the true value of goods
for the assessment of customs duties and consular documentation.
Certificate of origin. This document is affirms for the buyer the coun-
try of origin where the shipped goods were produced . The certification
is usually performed by a recognized chamber of commerce.
Insurance certificate. This document assures the consignee that insur-
ance is provided to cover loss or damage to the cargo while in transit.
Transmittal letter. This document provides a list of the particulars of
the shipment and a record of the documents being transmitted together
with instructions for disposition of documents. It also includes any
special instructions [16].
Over the last couple of decades, the paperwork associated with inter-
national trade has been significantly simplified. As Bender points out [17],
this movement
was prompted by the complexity and cost that was involved in preparing the
necessary forms to support international logistics operations. By the early
1970s, the situation had reached a point where common international shipments
might involve up to 28 different parties, originating more than 120 different
documents to move the cargo. Documentation costs amounted to as much as
10% of the dollar value of the trade itself - enough to eliminate a substantial
part of the profits.
Since that time, a number of developments have occurred targeted at reducing

the volume of paperwork. One of those developments has been the creation
of several national and international bodies , such as the U.S. National Com-
mittee on International Trade Documentation (NCITD), the Canadian Organi-
zation for the Simplification of Trade Procedures (COSTPRO), and the
United Nations Economic Commission for Europe (ECE), to eliminate and
simplify trade documentation. Another has been the development of Internet
and EDI systems for international transportation. In the United States the
Transportation Data Coordinating Committee (TDCC) and the ECE have de-
veloped extensive sets of electronic transmission standards to cover both do-
mestic and international transportation. Finally, a number of specialized
firms have grown that handle the requirements of international trade docu-
mentation. For example, international freight forwarders assume complete
responsibility for documenting all of a customer's export shipments.
INTERNATIONAL TRANSPORTATION AND

WAREHOUSING
The scope of an enterprise's global supply channel dictates the structure and
defines the boundaries of its international trade strategy. The execution of
the global channel process is the function of transportation and warehousing.
As is the case with other elements of the supply chain, international transpor-
tation and warehousing have a number of distinguishing factors that require
them to perform different functions than their domestic counterparts. The
most obvious differences stem from the long distances goods are transported,
heavy reliance on intermodal transport methods , and interaction with foreign
governments. More subtle differences can be found in political issues re-
volving around "balance of payments," the right of nations to use their own
carriers for all domestic trade (known as cabotage), and arrangements made
by nations to facilitate and make international transportation more affordable.
OPENING ISSUES
All nations engaging in global trade are concerned about their balance-of-
payments position. When it is considered that in 2000 transport buyers paid
$1.5 trillion for international transportation , controlling costs is critical. A
favorable balance of payments occurs when more goods are exported than im-
ported into a country. The objective is to ensure that more "hard" cash is
entering the country than leaving it. Beyond fiscal concerns about product,
pivotal to this strategy is the possession of viable transportation modes that
span boarders. Nations possessing international transportation capabilities
can significantly assist in reducing their out-going cash flow. To this end,
governments will subsidize the growth of local carriers to ensure that as large
a portion as possible of exports and imports are carried in domestic transport
modes. Also, nations will sometimes have cargo preference laws requiring
that certain types of goods can only be carried by domestic carriers. For ex-
ample, all military supplies and cargoes arising from U.S. government appro-
priations, such as charitable foodstuffs being sent to foreign lands, must be
carried in U.S. vessels.
Transportat ion services may even themselves be considered an export
product that is offered to the global community. For nations wishing to en-
gage in cross-trading, the possession of a diverse transportation fleet is a re-
quirement. Cross-trading occurs when a country's maritime vessels or aircraft
is engaged to transport products of other nations. Some nations have at-
tempted to control cross-trading by a pooling agreement. Such agreements
require that all or part of the products moving between the agreeing countries
must be transported by their own international carriers.
INTERMODAl TRANSPORT OPTIONS
Companies wishing to either export or import products have a wide range of

transportation mode options available. Trade flowing from the U.S. to Cana-
da and Mexico might use just one mode, such as a motor carrier, to move
goods. Most international shipments, however, must traverse large distances
and overcome oceans and other natural obstacles. In such cases, the shipment
will require the use of more than one of the following carrier modes.
1. Ocean and air transport as the international/intercontinental medium
2. Motor, rail, and canal networks for inland feeder services
3. Numerous systems of intermodal transfer
The selection of the most efficient and cost-effective intermodal combination
is a complex affair requiring an expert knowledge of intercontinental trans-
port mediums and the internal transport systems of foreign nations. Many ex-
porters will use the services of a freight forwarder in structuring the proper
mix of transportation modes for foreign shipments.
A critical part of intermodal selection is the ability of the transport type to
handle unitized loads. Although the transfer of products in bulk, such as pet-
roleum and grains , comprises an enormous portion of the world's internation-
al trade, specialized vessels and equipment are usually employed. Nonbulk
products, on the other hand, are best handled through unitization. Whether
packed in a container, rigid boxes, shrink wrapped pallets, or other packing
forms, unitization is significantly more efficient than handling loose indi-
vidual products. It facilitates loading, marking , and shipment identification
as well as intermodal product transfer. Furthermore, it removes the need for
enclosed storage space at ports, consolidation points, and freight terminals.
Finally, it also reduces the chance of damage or theft while in transit.
The two most popular forms of unitization are standard containers and trac-
tor trailers. Containers come in a variety of sizes and can be used for all
types of transport from aircraft to ocean vessel. Containers have been de-
signed to realize two goals: (1) maximization of the cubic capacity within the
container and (2) maximization of the cubic capacity within the transport
equipment. The great advantage of containers is that they can be used practi-
cally with any transportation mode. In addition, they can easily be loaded
and unloaded and stored in freight terminals. Finally, containerization re-
duces the risk of damage and theft and facilitates documentation flows.
Drawbacks to using containers include their relatively high handling cost,
limited storage capacity because of their cubic dimensions, and reduction of
maximum payload due to tare weight.
Tractor trailers are, in essence, a form of self-mobile or partially mobile
container. When used in an intermodal fashion, trailers can be accompanied
by a tractor or shipped alone. In the latter case, the trailer is usually loaded
aboard a rail car or canal or ocean vessel and sent "piggyback" to the next ter-
minal, where it can then be transferred to another form of transportation.
Besides advantages associated with handling, trailers are relatively easy to
pass through customs, thereby reducing lead times and speeding overall trail-
er utilization. Disadvantages to utilizing trailers are found in the cost for trac-
tors and having to pay for drivers during transport along with the goods . Un-
accompanied trailers normally take longer to move from terminal point to
terminal point and require a high level of organizational control.
OCEAN TRANSPORT
Ocean transport varies from domestic water transportation in the variety and
sizes of the vessels used and in the required services provided. In 1994 total
revenues for ocean transport was approximately $960 billion. Domestic

water carriage, except Great Lakes carriage, is normally performed by barge.
Although barges do differ, they are wholly different than the types of
oceangoing vessels used in international transportation. According to
Sampson et al. [18], there are at least five different types of ocean vessel,
which can be further divided into several subtypes based on size, intended
use, and specialization. The five types are described as follows:
Break-bulk freighters. These vessels primarily transport individually
packaged or crated cargoes, each of which is loaded one piece at a time.
Often these vessels can carry cargoes for dozens even hundreds of
individual shippers at a time. Sometimes these vessels may specialize
in carrying products that require refrigeration or other services.
Container vessels. These vessels primarily transport products stored in
containers. The containers are brought to the seaport by other modes of
carriage, loaded aboard ship, and distributed at destination seaports by
other modes of carriage. Container ships normally stow all types of
containers. Containers moving between the Far East and Europe often
make use of the landbridge route across the United States. In this pro-
cess, containers are unloaded in western ports, then moved by railroad
across the country to the east cost, and then reloaded aboard vessels for
the voyage across the Atlantic. Landbridges have the advantage of dra-
matically reducing transit time by avoiding much slower and often cir-
cuitous water routes, and increasing the utilization of containerships. A
variation of container vessels are Lighter Aboard Ship (LASH) and
Roll-on/Roll-OjJ (RO/RO) vessels. LASH vessels handle floating con-
tainers and can be used most advantageously in areas where the central
port is connected to inland areas by shallow waterways. RO/RO
vessels are designed to transport trucks, tractor trailers, and other self-
propelled vehicles that roll on and off when loading or unloading.
Bulk vessels. These vessels are designed for transporting nonpackaged
dry goods commodities such as grain, coal, and ores. They rarely carry
more than one type of product at a time and usually service only one
shipper, or a few shippers, on one voyage.
Tankers. These vessels have been designed to transport liquified prod-
ucts. Among these products can be found crude and refined petroleum,
liquified gases, chemicals, wine, molasses, and other goods. Much of
the world's total shipping tonnage is the transportation of petroleum.
Seagoing barges. These types of vessels are carriers involved with
small cargoes, short hauls, or routes with narrow or shallow channels.
These vessels are much larger and built sturdier than river barges.
Normally seagoing barges can handle bulk, bulk break, containerized,

and liquid cargoes.
Usage of these types of oceangoing vessels varies. The unit of capacity mea-
surement for ocean vessels is deadweight tonnage. According to figures
gathered in 1991, 39% of the total ocean going tonnage was transported by
oil tankers, 30% by ore and dry goods carriers, 6% by vessels carrying either
liquid or dry bulk cargo, 16% by break bulk general cargo, and 4% by
containerships.
There are three basic types of service provided by ocean vessels: liner,
tramp, and industrial carriage. These services roughly correspond to com-
mon, contract, and private carriage in land transportation. Liner service pro-
vides scheduled for-hire carriage for general goods between ports based on
published freight rates. Ocean general cargo (or break-bulk liner) rates are
set by shipping conferences. A conference is an organization consisting of all
vessel owners operating in certain regions who agree to offer regular service
and lower rates to shippers who agree to use the service exclusively. Tramp
services are offered by vessels that literally "tramp" from port to port looking
for freight. Tramp vessels do not follow established schedules or routes, and
rates are established by individual charters with shippers. This type of ser-
vice is used by most of the world's bulk freighters, tankers, and seagoing
barges. The final type of service is industrial carriage. Here the shipper
uses its own, or a leased vessel, to transport its own goods [19].
INTERNATIONAL AIR TRANSPORT
Whereas air transportation accounts for only a small fraction of the total in-
ternational freight, it has become, nevertheless, the fastest growing mode of
transportation. Revenues for international air transportation in 1994 totaled
approximately $40 billion. Nations big and small have the ability to open
lanes of international trade simply by buying aircraft and opening an airport.
In many nations, the air transport industry is either wholly- or partially-owned
by the country. Also, air transport and facilities normally used for passenger
service can easily be used to carry and handle freight as well.
The main advantage of air transport lies in the speed by which goods can
traverse the globe in comparison to other carrier modes. Although even the
largest cargo aircraft has a tonnage-carrying capacity of about I percent of a
fairly small break-bulk ocean vessel, it can make a delivery within a few
hours or a few days that would take an ocean vessel several weeks. Inter-
national air carriers are normally used to transporting small shipments of
products, characterized by high value, extreme seasonality, perishability, and
sensitivity to fashion, over long distances. Often, such products would never
be able to find their way into foreign markets without air transportation. The
negative side to air transport is obviously the cost for aircraft, maintenance
and repair, and airport facilities. In addition, the limited storage capacity of
aircraft and the inability to carry many types of products limit its use to all
but emergency-type deliveries.
International air transportation consists of two types: chartered and
scheduled. Companies can charter an aircraft from a variety of private and
commercial services. Although chartering an aircraft is expensive, it could be
justified for the shipment of a product whose nature or demand requires
extreme reduction in transit time over other forms of carriage. Regularly
scheduled flights by major commercial airlines offer companies who wish to
ship by air a cheaper alternative. Shippers have the benefit of planning
delivery almost anywhere in the world by consulting the published routes of
commercial airlines. Rates are established by the International Air Transport
Association (lATA), a cartel consisting of almost all of the world's airlines.
SURFACE TRANSPORT
When nations are not divided by oceans, inhospitable terrain, and political
conditions, they may be able to use rail and motor carriers to transport goods
across international boundaries. In North America, for example, trade be-
tween Canada, the United States and Mexico is unimpeded by natural bar-
riers. In fact, the equipment of the three nations has been designed to be
interchangeable. Railroads and highways interconnect at various border
points. The railroad gauge is the same for all three countries and they all use
similar rolling stock. The same can be said about highway structures and
tractor and trailer equipment. Actually, the only barriers inhibiting the free
flow of goods in North America are associated with motor transport and con-
sist of customs requirements, operating rights, and other restrictions. The
passage in 1994 of NAFTA should remove the last impediments to free trans-
portation throughout North America. The trading blocks in Europe and Asia
are focusing on the same liberalization of transportation within their own
trading communities.
When using foreign surface transportation, global companies must be
thoroughly apprised of conditions within individual nations. With the ex-
ception of the U.S., the railroad systems throughout the world are owned or
controlled by the state for the common good of the nation. Rates are not pub-
lished but rather are negotiable. Finally, although railroads are critical for
intermodal transportation, the rail systems of many poorer nations do not pos-
sess the equipment to effectively work with containerization or "piggyback"
operations . Effective motor transport is also critical for intermodalism. In
North America and Western Europe, the road systems and availability of mo-
tor transport is excellent. In most Eastern Bloc countries, motor transport is
run by the state. In the rest of the world, road transit is carried on with small
companies or individual operators on a contract basis.
INTERNATIONAL WAREHOUSING
International warehousing can be divided into two basic categories. The first
consists of a variety of different types of consolidation warehouse. These
facilities can be privately owned by the exporting firm or offered for public
use by local transit companies and can be found at seaports, airports, and in
most large cities. The basic purpose of consolidation warehousing is to re-
ceive foreign shipments and prepare them for the next leg through the distri-
bution channel as they move toward the end customer. The functions of in-
ternational consolidation centers are similar to those performed by domestic
counterparts . Operations may consist of such activities as bulk breaking, con-
version of the shipment to other modal means of transport, repacking, label-
ing, and marking. Among this type of warehouse can be found the following:
Transit Sheds . This is perhaps the most basic form of international
warehousing. Transit sheds are normally enclosed facilities at piers
used to temporarily store shipments. The shed provides sufficient pro-
tection against weather conditions and assists in organizing the ship-
ment for the next carrier. Transit sheds usually contain cargo, such as
containers and trailers that have been unloaded from an ocean vessel
and are waiting to be loaded onto a rail or motor carrier.
In-Transit Storage . Often, international shippers need to temporarily
store inventory while performing consolidation activities and negoti-
ating rates with local carriers. In-transit storage warehousing provides
this service. These warehouses are normally provided by the nation's
railroad system and are located at seaports and airports.
Hold-on-Dock Storage . This type of storage is offered by ocean car-
riers who permit shippers to warehouse cargoes in their facilities,
usually at no charge, until the next scheduled sailing. Often shippers
take advantage of the free storage to warehouse goods and to perform
consolidation activities.
Public Warehousing. When shipments are delayed or are held by the
customer or government regulation, shippers may have to contract with
a public warehouse to store the cargoes. Practically all international
ports offer public warehousing to foreign shippers.
Shared Warehousing. It is not uncommon for foreign shippers to pool
their resources and contract as a co-operative for public warehousing.
This practice enables companies to retain public warehouse storage at

lower costs.
Bonded Warehouse . This type of warehouse is operated under govern-
ment customs supervision for the express purpose of storing imported
goods. Bonded warehouses can be owned directly by the government,
by private companies for their imported goods only , or by public ware-
housing LSPs . All shipments to and from bonded warehouses must be
handled by government-licensed bonded carriers. While they are stored
in a bonded warehouse, goods cannot be further processed or manufac-
tured
Foreign Trade Zones. This is a special type of warehousing in which
imported goods can be stored duty free until they are sold in the foreign
market. In add ition, goods marked for reexport do not pay any duties
as long as they remain in the free-trade-zone location. While in stor-
age, goods can be further processed or manufactured. Shippers must be
thoroughly familiar with the regulations affecting both bonded and
free-trade-zone warehouses [20].
The second category of international warehousing is concerned with
privately owned warehousing. The decision criteria for building and main-
taining a foreign warehouse is fairly close to that for domestic warehousing.
Criteria can be broken up into two sets of elements: macro and micro. Macro
elements can be divided into five major factors.
Transportation. One of the most critical factors when making a de-
cision to locate a warehouse in a foreign country is the availability of
transportation. The site should provide easy access to foreign termin-
als, such as sea docks and airports. Also, the state of local land trans-
portation is critical. Quality and accessibility of the road system, avail-
ability of local carriers, and ability to use a private fleet must be deter-
mined before site selection.
Labor . Once a warehouse has been built, it will need to be staffed.
Issues to be considered are the level of education and skill possessed by
the local work force, requirements for training, ability to recruit local
management, attitudes and customs of the local populace, and govern-
ment restrictions and labor laws.
Land. The property occupied by the warehouse must be thoroughly
investigated. Key issues are the existence of public services such as
sewers, water, roads, refuse pick-up, police and fire protection, govern-
mental construction requirements, terrain, and possibility for ex-
pansion,
Energy and utilities . A constant and uninterrupted source of power is
crucial for effective warehouse operations. In regions were utilities are
inadequate, companies may have to construct and operate their own

power plants.
Taxes and incentives. When looking for an off-shore warehouse site,
companies often can get local governments to assist in construction and
operation, as well as to give special tax breaks. The reverse can just as
easily be the case, with some nations placing high taxes and restrictions
on foreign operations in an endeavor to protect local businesses .
Once these macro factors have been addressed, the firm must consider a
host of micro concerns. Some of these issues relate to the following:
Currency exchange rates
Government and social stability
Currency stability
Ability to take profits out of the country and availability of barter agre-
ements
Popular attitude of the locale toward the company
Government attitude toward the company
Depth and complexity of import and export regulations
Availability of required materials handling equipment
Free trade or most-favored nation status
Culture and customs of the host country
INTERNATIONAL PURCHASING
As was discussed in Chapter 10, purchasing has become of a critical strategic

function in the quest for competitive advantage in the twenty-first century.
Increasingly, global purchasing decisions are having an enormous impact on
product quality, delivery reliability, increased flexibility, and cost competi-
tiveness as companies intensify their implementation of JIT/Lean and Internet
approaches to suppliers, internal operations, and customer service. This
search for continuous improvement in products and services has led pur-
chasing functions in increasing numbers from both domestic and international
firms to search for new sources of supply outside the domestic market. The
effective management of this movement toward international sourcing is
pivotal to the acquisition of the best products to meet ever-accelerating levels
of customer service.
OVERVIEW
Historically, U.S. firms first embarked on a serious concern with importing

products and raw materials as far back as the 1960s. At that time, the motive
was purely to reduce the cost of labor. By the 1980s, this central concern
with cost reduction , a somewhat negative approach to foreign sourcing, began

to be replaced by the realization that a number of dramatic changes in the
global economy had altered the traditional view of international sourcing.
According to Carter [21], there have been several changes in the basic busi-
ness mechanics of nations that have facilitated the emergence of international
purchasing as a strategic weapon.
To begin with, the growing competitive intensity and interdependence of
the global marketplace, complicated by pressures to reverse the trade deficit,
has "internationalized" the purchasing function. Second, the pressure to re-
duce costs while simultaneously increasing quality and customer satisfaction
in mature markets with little product differentiation has pushed purchasers to
look for the best sources of supply, either domestic or foreign. Third, pur-
chasers have looked at importing foreign components as a way to increase
marketplace flexibility . Capital invested in new products and process equip-
ment is expensive and restricts the firm's ability to respond to the market. Im-
porting components permits them to sustain "world-class" leadership by pur-
chasing demonstrated foreign engineering, technological, and process capa-
bilities. These capabilities provide reduced cycle times for new product de-
velopment and increased quality. Finally, importing provides purchasers with
the ability to leverage the technology of other nations for products such as
industrial machinery and consumer electronics. Instead of being merely a
market for cheap labor, overseas suppliers are now viewed as prime sources
of new technology for manufacturing and global distribution .
ADVANTAGES OF INTERNATIONAL SOURCING
There are many valid reasons for today's purchasing function to explore inter-
national sources of supply. Among these reasons can be found the following:
Availability. Due to the growth of foreign competition, many products
that were once made domestically are now available only through inter-
national sources. Among such products can be found many electronic
components, machine tools, capital equipment, specialty metals and
alloys, and electromechanical goods.
Quality. Many buyers have had to look to global sources for products
that will meet the levels of quality demanded by the marketplace. Al-
though the quality and JIT/Lean movements in U.S. manufacturing
have enabled many domestic producers to quickly close the "quality
gap," the lead in quality seized by some foreign companies provides
buyers with little alternative but to purchase from them.
Timeliness. As JIT/Lean techniques continue to decrease inventories,
the need for reliability in meeting schedule requirements correspond-
ingly has grown in proportion. Many purchasers have had to import

products from global companies who have developed philosophies and
techniques focusing on 100 percent customer satisfaction.
Continuity of supply. Increased demand and competition for goods
worldwide has made purchasers sharply aware of possible shortages in
raw materials and finished components due to strikes, economic
downturns, or even political unrest. Today's purchasers must be aware
of and cultivate alternative sources of supply to ensure continuity of
product.
Cost/price. Generally, foreign companies have been able to offer inter-
national buyers lower prices on goods because of lower material, labor,
and overhead costs. This is particularly true of products, such as tex-
tiles, apparel, shoes, molds and dies, assembled components, and auto-
mobiles. Coupled with this advantage, some foreign producers also
may possess specialized skills, technologies, or patent rights that pro-
vide them with a overwhelming competitive advantage. In exploring
cost advantages, buyers must be careful to calculate the total landed
cost, including transportation, communication, import duties, source in-
vestigation and so forth, when executing foreign purchasing.
Technology. Many foreign nations historically have prided themselves
on the high level of craftsmanship and quality that characterizes their
products. Today, there are many foreign nations, particularly Japan and
Germany, which now possess technologies in some industries far in
advance of comparable U.S. companies who often are charging a higher
price. Buyers who do not take advantage of this technological leader-
ship to acquire superior products might find themselves losing to com-
petitors who do. In addition, the superior technology of some foreign
companies may permit other firms to "acquire" the technology without
investing in the development of the process itself. Importing the
products of these technologies permits companies to remain focused on
core competencies while leveraging imported components to offer to
the market a wide variety of highly competitive products.
Market entry. Some nations require foreign exporters to also buy from
their country, or have a certain percentage of the export product be
manufactured from materials or components originating from the home
country. International purchasing also requires buyers to know the
overall sources of products if they are to effectively procure com-
ponents or finished goods in support of marketing, manufacturing, and
sales plans.
COUNTERTRADE PURCHASING
Countertrade is a generic term used to describe any transaction in which pay-

ment is made partially or fully with goods instead of money. Countertrade
links together two normally independent functions: the export of sold goods
to a specific country and the import of purchased goods from the same coun-
try. Countertrade can occur for a number of reasons. For example, the im-
porting country has balance-of-payments, currency exchange, or political re-
strictions preventing cash purchase. Sometimes it is imposed by governments
in an effort to promote local products or to gain imports while also keeping
currencies inconvertible. Countertrade provides certain advantages such as
facilitating sales, expanding competition, improving profit potential, opening
responsive markets, developing new capabilities, and retarding inflation.
There are, however, drawbacks. It complicates purchasing, adds adminis-
trative costs, extends transportation time and cost, incurs duties and taxes,
drains home technology resources, and imposes unfamiliar requirements to be
performed.
There are five types of countertrade. These types, in tum, are driven by
four variables: (1) the nature of the goods, (2) the percent of payment made
in goods, (3) length of time before full payment is to be made, and (4) the
number of parties involved [22]. The five major types of countertrade are as
follows:
Barter. This is probably the oldest form of transaction. Barter is the
direct exchange of goods or services or both between two parties with-
out the exchange of cash. Problems with this type of countertrade are
the normal lag in time before goods are fully received, the possibility
that one party may receive goods they cannot use, or one party receives
goods that are less than the expected value.
Counterpurchase. Many times two companies will agree upon recipro-
cal buying arrangements. Both companies agree to buy the products of
each, pay for the majority of their purchases in cash, and fulfill their
mutual sales obligations within a specified time period.
Offset . This type of countertrade is similar to counterpurchase. The
difference is that some or lOO% of the counterpurchase obligation can
be offset by buying from any company in the foreign country. Offset
countertrade agreements are normally executed with countries that have
centrally planned economies. As an example, McDonnell Douglas
agreed to buy aircraft components from Canada in exchange for a $2.4
billion commitment by Canada to buy aircraft over a 15 year span [23J.
Compensation or Buy-Back. In this type of countertrade a company
agrees to build a plant or supply technology, equipment, and/or
technical advise to a foreign country, and takes a percentage of the

output from the facility as payment. Occidental Petroleum, for ex-
ample, negotiated a $20 million deal with Russia to build several plants
there and receive ammonia over a 20-year period as partial payment.
Normally, the host country receives ownership when the terms of the
agreement have been completed.
Switch-Trading. This countertrade method utilizes a third-party trading
house that buys the selling company's counterpurchase goods, services,
or trade credits, and sells them to another company that requires them.
In a survey conducted by Carter offset was practiced by 73 percent of the
businesses engaged in countertrade . This type was followed by counter-
purchase at 60 percent, buy-back at 22 percent, barter at 19 percent, and
switch trading at 3 percent [24].
The purchasing function plays a key role in countertrade. On the strategic
side, a successful global countertrade system requires effective global pur-
chasing planning. It is purchasing's role to develop the long-term relation-
ships with foreign suppliers necessary for the effective execution and transfer
of products, skills, and technologies across the globe in support of enterprise
manufacturing and distribution competitive advantage. In detail, it is pur-
chasing's responsibility, along with marketing, to pursue, negotiate, and
schedule those products whose value will assist in competitive sourcing.
Also, its is purchasing's role to monitor and control the costs involved in
countertrade transactions. These costs are comprised of the cost of fees paid
to trading agents and companies and the discount from the perceived or fair-
market value of the goods versus the value actually received.
INTERNATIONAL PURCHASING MANAGEMENT PROCESS
Perhaps the best way to look at the process of international purchasing is to

divide it into several critical activities. As illustrated in Figure 13.8, the first
step in the process is to identify that a foreign source is necessary or econom-
ically feasible for the procurement of raw materials, a component, or family
of components. This step could be undertaken for a variety of reasons: prod-
uct unavailability in the domestic market, requirements for a higher level of
quality than can be found from domestic suppliers, search for alternate sup-
pliers other than domestic sources, and search for lower-cost alternatives. In
addition, more detailed criteria, such as the length of the supply line, desire
for supplier partnership and involvement, stability of product design, com-
pleteness of engineering documentation, length of the product life cycle,
superiority of manufacturing methods, necessary materials and tooling, and
terms and conditions of contracts, are also critical criteria that must be
determined ahead of any outsourcing negotiation.
r In entory Plan
l 1
4 Id entify
Requ ir em ents
... Id entify
o u rce
r+ upplicr
ego tia t ions
f--
Procurem ent
Te r ms
!
Procurement Documentation ]
FIGURE 13.8 Intern ational procurement process.
As planners begin to map out the first leg of the process, it is critical that
they also detail the drawbacks as well as the advantages of international sour-
cing. In most cases, purchasing from foreign sources is a good deal more dif-
ficult than buying from domestic sources, requiring the ability to solve not
only the same kind of problems encountered in domestic procurement but
also problems accentuated by language, culture, currency, transportation, and
government regulations. The contrast between domestic and global pur-
chasing are illustrated in Table 13.1. In managing these and other dif-
ferences, global purchasers must continually review foreign sourcing to en-
sure that anticipated advantages associated with lower prices, better service,
exceptional quality, and technological innovation do not evaporate over time.
Once the determination to use a foreign source has been made, the next
step is to begin the search for a global partner. This step can be as easy as
making a phone call or as complex as a small project. Information con-
cerning prospective suppliers can be gathered from trade journals and news-
papers, directories of manufacturers and distributors, government trade lists
and surveys conducted by the U.S. Department of Commerce, professional
purchasing associations, and word of mouth. A critical part of the process is
deciding whether the goods are to be purchased directly from a foreign sup-
plier or indirectly through a trading intermediary. If the latter is chosen, pur-
chasing will have the choice of working with import merchants, commission
houses, manufacturer's/distributor's agents, import brokers, or trading com-
panies. Some of these intermediaries assume financial risk and carry inven-
tory; brokers and agents, on the other hand, do not.
TABLE 13.1 Comparison Between Global and Domestic Purchasing

Domestic Purchasing Global Purchasing
Culture
Single nation and culture Multinational/multilingual factors
Communications
Single language; short lines of Multilingual; long, complex lines of
communication communications
Currency exchange
Single currency Currencies differing in stability and value
Customs regulations
Relative freedom Complex customs and tariff requirements
Lead times and inventories
Stable/decreasing lead times and Long lead times and large safety stocks;
inventories need for repackaging and relabeling
Payment
Cash and credit transactions Letters of credit, electronic payment, and
countertrade
Quality
Common quality standards and Different standards of quality
specifications
Government involvement
Minimal interference Direct involvement in national economic
plans
Economic stability
Uniform economic environment Variety of financial climates ranging from
over conservative to wildly inflationary
Operational coordination
Easy access to plant visits and Long-distance coordination with local
technical assistance managers
Finns that choose to buy direct must perform the services normally ex-
ecuted by intermediaries, Besides administrative functions, the most impor-
tant of these services is qualifying the prospective supplier. Intermediaries,
through long experience, know the international market and can make ar-
rangements with the best foreign companies. When buying direct, the impor-
ting company must verify the supplier on its own. Among the criteria that
should be used are (1) evaluation of the supplier's experience and manage-
ment expertise, (2) financial strength and capability to meet requirements for
new equipment and inventories, (3) availability of excellent communications
for speedy decision-making on markets, equipment, and inventory control, (4)
ability to maintain levels of inventory necessary to meet longer lead times and
faster delivery, and (5) willingness of the supplier to enter into a long-term
partnership . Sometimes firms with strong global purchasing functions will
establish foreign offices to assist in supplier relations. Such offices normally

cost less than intermediary fees, provide purchasing with better controls over
price, quality, and delivery, provide more current information, and encourage
better understanding with the supplier [25].
With the selection of prospective suppliers, the next step in the purchasing
process is request for quotation (RFQ). The purpose of this step is to detail
the purchase requirements and evaluate the total cost of the proposed pur-
chase. The former consists of such elements as submission of necessary
specifications and drawings, statement of quality requirements, special pack-
aging needs, likely lead times, and estimated annual volume and quantities.
Calculating the total cost also requires extensive analysis. Closely monitored
costs will ensure that price advantages are not lost over time due to cost
changes. Among the cost elements to be considered are standard elements
such as transportation , customs, duties, and taxes, insurance and broker costs,
inventory carrying costs, risk of damage or spoilage, fees for documentation,
terminal and port costs, letters of credit, and others.
Of particular importance in price negotiation is currency valuation manage-
ment. One of the realities in international purchasing is that no matter what
currency is used for the base price, fluctuation in exchange rates will ulti-
mately shift currency values. Currency fluctuation is influenced by such fac-
tors as domestic interest rates, inflation or deflation, and relative balance of
trade. There are several strategies purchasers can use to counter currency
fluctuations. The most radical approach is to insist that negotiation and pay-
ment be executed in the home currency. Another alternative is for buyer and
seller to split fluctuations in value either fifty/fifty or by some other agreed
upon formula. Many buyers will negotiate a price along with a variance, say
of plus or minus 5%. If the price exceeds the variance threshold, buyer and
seller would equally share in the variance. Finally, some companies can
hedge currency fluctuations by purchasing fixed rates via currency futures or
forward contracts [26].
Negotiations with prospective foreign suppliers, once price and product is-
sues have been resolved, require purchasers to acquire a good deal of under-
standing and insight about the supplier's country and customs. Although the
normal planning activities associated with a negotiation, such as team mem-
bership, establishment of objectives, and issues up for compromise, are
critical, purchasers must be prepared to tailor the process to meet the often
very different practices and perceptions of foreign negotiators.
One of the most critical decisions that must be resolved during negotiations
revolves around shipping terms and method of payment. Most of the terms
reviewed earlier in this chapter relating to exports also apply to product im-
ports. Among the most common are FOB, Ex Works, FAS, C&F, CIF and
Delivered Duty Paid. Traditionally, a number of payment methods are used

when transacting international trade including the following:
Cash in Advance. Often when buyers do not have a good credit rating
or are unknown, or when the buyer's country is politically or econom-
ically unstable, sellers will require them to pay for purchased material
in advance.
Open Account. Although this is the preferred method of payment for
domestic business in the U.S., it is not often used in international
purchasing. The reason stems mostly from the uncertainties in cur-
rencies and international political conditions.
Drafts . This is currently the most widely used of the payment methods.
A draft is a negotiable instrument that contains an order to pay. When
a sale takes place, the seller forwards the transfer documentation and
draft through its bank to the buyer's bank for payment. A sight draft is
executed when the buyer pays the draft. A time draft requires that the
buyer pay the draft on a specific due date. In a clean draft, the seller
presents its draft to the buyer for collection and the transaction
documents are delivered directly to the buyer.
Letters of Credit. In this method, letters of credit are arranged by the
buyer with a bank, and the supplier can draw payment against the credit
with the submittal of the appropriate transaction documents. Letters of
credit can be irrevocable, meaning that they cannot be changed without
the prior agreement of all parties, or revocable, meaning that they can
be changed without the seller's consent.
The final area relating to pricing and terms is the payment of tariffs or
duties on imported goods. Tariffs can be used as a method for revenue gener-
ation, as a devise to protect domestic industries and/or to discourage the im-
portation of certain products. There are three major types of tariffs: Ad val-
orem, specific, and compound. Ad valorem, the type of tariff most applied, is
calculated as a percentage of the appraised value of the goods received. A
specific tariff is defined as a specified amount per unit weight or other unit of
measurement. For example, $0.20 per gross. Finally, a compound tariff is
calculated as a combination of both an ad valorem and a specific rate. The
payment of tariffs can be delayed by warehousing goods in a free-trade zone.
Tariffs are not paid on the goods until they are removed from the free-trade
zone and sold. Another method used by firms that reexport products is a duty
drawback. The drawback provides for a 99 percent refund of ordinary cus-
toms duties paid when the goods were originally received [27].
The last step in the international purchasing process is the completion of
the trade documentation. Whether handled by an international freight for-
warder, customshouse broker, or the company's own agents, the proper ex-
ecution of documentation is critical. The following represents the key import

documents :
Arrival Notice. This document is sent by the carrier and informs the
buyer of the estimated arrival date of the transport mode, identifies the
shipment with details such as number of packages and weight, and in-
dicates when "free time" will expire. The notice is often used as a
freight bill.
Customs Entries. There are several different types of forms used when
entering imported goods into the U.S. The first type, consumption
entry, is required of all entering goods by U.S. Customs. The form con-
tains information as to the origin of the cargo, a description of the mer-
chandise, and estimated duties applicable to the particular commodity.
Estimated duties must be paid when the entry is filed. The second type
of entry form, an immediate delivery entry, is used to expedite the de-
livery of cargo . It allows up to 10 days for the payment of estimated
duty and processing of the consumption entry. In addition, it permits
delivery of the cargo prior to payment of the estimated duty and then al-
lows subsequent filing of the consumption entry and duty. It is also
known as "LD. entry." The third type of customs entry, immediate
transportation entry, allows the cargo to be moved from the pier to an
inland destination via a bonded carrier without the payment of duties or
finalization of the entry at the port of arrival. It is also known as an
"LT. entry." The final type of customs entry, transportation and ex-
portation entry, permits goods coming from or going to a third country
to enter the U.S. for the purpose of transshipment. It is also known as
"T&E entry."
Carrier's Certificate and Release Order. This document is used to ad-
vise U.S. Customs of shipment details, ownership, port of lading, and
other information. By means of this document, the carrier certifies that
the company or individual named in the certificate is the owner or con-
signee of the cargo. It is commonly known as the "Carrier Certificate."
Delivery Order. This document is issued by the consignee or author-
ized customs broker to the ocean carrier providing authority to release
the cargo to the inland carrier. It includes all data necessary for the pier
delivery clerk to determine that the cargo can be released to the
domestic carrier. This document is also known as a "Pier Release."
Freight Release . This document provides evidence that the freight
charges for the cargo have been paid. If in writing, it may be presented
at the pier to obtain release of the cargo. (Normally, once the freight is
paid, releases are usually arranged without additional documentation.)
It is also known as a "Freight Bill Receipt."
Special Customs Invoice . This is an official form usually required by

U.S. Customs where the rate of duty is based on value and the shipment
value exceeds $500. The document is usually prepared by the foreign
exporter or authorized forwarder and is used by Customs in deter-
mining the value of the shipment. The exporter or designated agent
must attest to the authenticity of the data furnished [28].
The execution of the international purchasing process is significantly dif-
ferent than domestic purchasing and must be effectively managed if it is to be
successful. As illustrated in Figure 13.9, the first step is the development of a
Formal
Stra tcgic
.
Plan
Functional
.
Organization
Interdepartmental
.
Intcgration
Program
Evaluation
FIGURE 13.9 Managing the global procurement process
formal global purchasing plan. This exercise should detail international

sourcing requirements, the methods to be followed for achieving these re-
quirements, and how the strategy is to be aligned with and supportive of over-
all enterprise goals. The second step is the organization of an international
purchasing function whose role it is to gather information and evaluate oppor-
tunities, as well as execute the activities associated with managing global
channel inventories, foreign negotiations, pricing, and delivery issues. This
department can be organized several ways, including the use of a resident for-
eign purchasing office, import broker, merchant or international trading com-
pany, or formal structure within the corporate purchasing function. Third, the
international purchasing organization needs to be closely integrated with
other company and channel functions. This will assure that individual depart-
mental objectives as well as the supply chain strategy are effectively sup-
ported. Finally, the purchasing planners must devise detailed procedures that
can assist in international sourcing program evaluation. Among the key ele-
ments are review of cost-reduction strategies, pursuance of targeted value-ad-

ded services, maintenance of quality levels, and others.
TODAY'S GLOBAL TRADE ENVIRONMENT
As the last years of the twentieth century drew to a close, the global economy
appeared to be steaming forward to new heights. The fall of communism and
the end of the Cold War, the rise of an independent Eastern Europe, the ex-
plosion of commerce in the Pacific Rim, and the apparent movement of con-
trolled economies toward the market system and free trade seemed to portend
a golden age of global wealth. As the new century dawned, however, global
events have dampened what was once an unbridled enthusiasm. To begin
with, a stubborn recessionary period was ushered in with the new century,
drying up global capital investment and forcing companies to approach the
marketplace with extreme caution. The terrorist attacks of 9/11, continued
unrest in the Middle East, the second Gulf War, and sporadic attacks by glo-
bal terrorists like al-Qaida have ushered in a new era of restrictions on trade,
increased vigilance, and a general wariness of foreign trade. If economic and
political traumas were not enough, the outbreak of Severe Acute Respiratory
Syndrome (SARS) in China and Mad Cow disease in Canada in early 2003
threaten to curtail global trade from yet another direction. In the 1990's the
concern was that they newly emerging world economy would be stymied by
protectionist trading blocks. As the new century proceeds, that fear has
switched from protectionism to security from terrorism and fears regarding
the spread of potentially lethal diseases.
Although what specific avenues global trade will take in the 2000s is still
uncertain , there are, nevertheless, three main themes governing overall devel-
opment. The first is the growing importance of supply chain management as
a global competitive weapon. There are two critical components: one tactical
(associated with the operational acceleration of the velocity of products and
information through the global pipeline) and the other strategic (associated
with the architecting of collaborative partnerships designed to make global
enterprises more flexible and agile to capitalize on new vistas of competitive
advantage). The second theme points to the fact that although barriers to
trade are falling globally, the international market will still be fragmented.
This is particularly true in the case of emerging nations with strong cultural,
socioeconomic, and political differences . International companies who wish
to exceed will not only have to develop a clear understanding of national dif-
ferences but also be able to leverage them if competitive advantage is to be
gained. The final theme is developing effective global security systems that
can protect individual countries and infrastructures from armed and bio-
terrorism while providing for the progressive expansion of trade among all
the nations of the earth.
NORTH AMERICA
With the activation of the North American Free Trade Act (NAFTA) on Janu-
ary 1, 1994 between the U.S., Canada, and Mexico, the globe's richest
trading was established. Altogether, the North American bloc contains a pop-
ulation exceeding 365 million people and accounts for a Gross Domestic
Product (GDP) of over $6.5 trillion and a total merchandise trade of $250 bil-
lion . NAFTA will phase out tariffs between the three nations on more than
10,000 commodities over the next fifteen-year period and will create a free
trade zone that stretches from Alaska to the borders of Central America. For
example, in 1993, U.S. goods faced an average tariff barrier at the Mexican
border of about 10 percent, five times the 2.07 percent rate that the U.S. im-
posed on Mexican goods. With NAFTA, Mexico's average tariff has already
fallen to about 2 percent. Import licensing and other non-tariff barriers have
been eliminated and more than two-thirds of U.S. exports now enter duty-
free.
The purpose of NAFTA was to create the opportunity for the countries of
North America to create an environment conducive to mutual trade and eco-
nomic development as well as pose as an alternative to the trade blocks for-
ming in Europe and Asia. Essentially, the goals of the alliance are to facil-
itate cross-border investment and trade ; reduce or eliminate tariffs, admini-
strative costs, infrastructure incompatibilities and other barriers; and, finally,
to foster between the three nations an attitude of economic creativity, innova-
tion, and development. In 2002 the trade statistics between the partners
demonstrates the potential of NAFTA. U.S. exports in industrial and agri-
cultural products and services to Canada in 2002 stood at $16 billion and
Mexico at $9.7 billion. Imports from Canada were posted at $21 billion and
Mexico at $13.4 billion (29).
The challenges to NAFTA in regard to implementing the kinds of logistics,
legal, and commercial environment necessary for a truly borderless trade
community are uneven. Since 1989 the U.S. and Canada already had in effect
a Free Trade Agreement that eliminated protective tariffs and government re-
strictions. Also, the political and economic environment in Canada is highly
advanced and very receptive to trade partnership. The same issues with
Mexico are quire different. After decades of controlled economies, Mexico
has only recently undergone dramatic change in the direction of currency sta-
bilization, social accord among workers, employers, and the government,
trade liberalization," growth of privatization, and government deregulation.
Mexican law still strictly enforces its cabotage laws and prohibits U.S. and
Canadian motor carriers from operating domestically. There is only one rail-
road, which is owned and operated by the Mexican government. Finally,
Mexico has no LTL trucking companies, and air cargo transport is limited to
just a few airports.
While there are still many barriers inhibiting truly free trade between the
NAFTA countries, they will diminish with time as infrastructure improve-
ments, political change, and the implementation of new systems facilitate
documentation, procedures, transportation, and the identification of new mar-
kets and trading intermediaries. One thing is clear: the challenges of Euro-
pean and Asian trading blocks will only intensify. Already Mexican
maquiladoras, manufacturing and distribution plants located along the U.S.-
Mexican border that pay no duty on imported semi-finished goods and only a
value-added export duty, are reeling from competition from China. As a
community, supply chain strategists from all three countries must continue to
refine their efforts to create a highly competitive borderless trade network
capable of competing globally.
EUROPEAN COMMUNITY
The European marketplace is a densely populated region of 320 million con-

sumers packed into a relatively small and compact geographical area, with
mature economies and logistics systems. It is also the gateway to Eastern
Europe and the old Soviet Union. At the dawn of the twenty-first century this
community of nations (Austria, Belgium, Denmark, Finland, France, Ger-
many, Greece, Ireland, Italy, Luxembourg, the Netherlands , Portugal, Spain,
Sweden, and the United Kingdom) has been welded together into an inte-
grated economic entity (with the faint glimmerings of political overtones
looking towards a "United States of Europe") called the European Economic
Community (EEC), popularly known as the European Union (EU). The goals
of the EU are straightforward and call for the eventual removal of all trade
barriers associated with
Political barriers, such as restrictions due to border checks, goods
inspection, customs controls, national brands and markets, cabotage,
and documentation
Governmental barriers, such as focused around welfare, pensions,
health, safety, and labor migration
Fiscal barriers , such as customs duties, taxes, excise duties, and cur-
rency fluctuations .
As political and economic conditions continue, the EU is likely to emerge
as a tightly knit trade network. A significant step towards European econom-
ic and political integration was achieved with the acceptance in 2002 by most
EU countries of the Euro as the common currency for all EU transactions.
Politically, the acceptance of most of the former Soviet block into NATO,
including Russia, which recently became a "junior" member, has also eased
the concern of so many countries, their economies anything but equal in size
and influence. The impact of a united Europe is sure to have both an eco-
nomic and, as witnessed during the Second Gulf War (2003), political impli-
cation. For example, trade between the U.S. and the EU in 2002 was dra-
matic. The U.S. exported $14.3 billion in goods and services while importing
$22.6 billion .
Despite all of the positive signs, there have been some persistent troubles.
Some nations, notably the UK, Sweden, and Denmark, elected not to adopt
the Euro as their currencies, preferring to hold on to national fiscal decisions.
The continued threat of terrorism has distracted many European governments
from seeking even closer business ties. The continuing recession of 2000 has
exposed problems caused by the inequality of national economies. The EU
desperately needs to reduce interest rates to stimulate the economies of the
wealthier nations, such as Germany (the flagship of the EU) which has shown
stagnant growth for years and is saddled with an unemployment rate that ex-
ceeds 10 percent unemployment, but cannot do so without EU concurrence.
Finally, many differences, ranging from tax policies to transport access
remain to be resolved.
ASIA AND THE PACIFIC RIM
Although the most disorganized of the major global trading blocks, Asia and
the Pacific Rim has been described as potentially the world's largest market.
For many decades Japan has been the key player in the region with the
world 's second largest national economy. Other countries, notably Hong
Kong, South Korea, Singapore, Taiwan, and most importantly, China, ac-
count for significant portions of global trade. During the mid-1990's the re-
gion was considered the hot-bed of future economic development. By the
late-I 990s reality had set in. Talk of the Asian miracle and of Japanese banks
dominating global finance has been silenced in the near collapse of hyper-ex-
tended economies and a prolonged Japanese recession. Instead of unlimited
development, the problems of the region, huge foreign debt, unstable govern-
ments, non-standard commercial practices, a still-emerging middle-class, and
woefully inadequate logistics infrastructures, have become all too evident.
U.S. trade with the region has been growing unevenly. In 1999, Japan was
the largest exporter of goods to the U.S., accounting for over $130.8 billion,
with $57.4 billion in imports. By 2002, U.S. trade with Japan had slipped to
$121.4 in imports and $51.4 in exports. Much the same results were evident
with trade with the U.S.'s two other large regional trading partners, Taiwan,
which has experienced a 9 and 4 percent decline respectively in exports and
imports, and South Korea, which during the same period saw exports to the
U.S. grow from $31.1 to $35.5 billion, with imports from the U.S. remaining
flat. The big exception has been China which has emerged as a legitimate
economic player with a $4.5 trillion economy, the world's sixth largest. In
1999 the U.S. imported $81.7 billion while exporting $13.1 billion in trade
with China. In 2002, those figures had increased dramatically to $125.1 bil-
lion in imports with exports reaching $22 billion [30].
'l'lH..:.
China SyJdromc
.. !'~~~-
An executive from a large U.. re- the Institute of Logistics and Trans-
tailer sourcing in China was mysti- portation, China's logistics System
fied: Why were all the goods in can be described as backward, even
ocean containers arriving depal- chaotic. As example, the report stat-
letized? The goods had left the fact- ed that most warehousing facilities
ories in China on pallets. A visit to are fairly rudimentary and make
the port revealed the answer. Ware- little use of information technology.
house equipment is expensive and The survey also identified other
labor is cheap. It was simply more serious impediments to Chinese
cost effective to load the containers logistics development. Both foreign
by hand than make use of a fork and domestic logistics providers say
truck. that the shortage of logistics pro-
fessionals is a critical concern.
This example bears witness to the Domestic companies also worry
fact that while China economy is ex- whether sufficient resources are
ploding and the country has invested available for future development.
heavily on supporting infrastructure, Foreign companies cite policy re-
logistics is still in its infancy. strictions and regulation in China as
their biggest challenge.
According to a survey conducted by
The Logistics Institute-Asia Pacific, Source: Bradley, Peter, "T he China
a joint venture between Georgia Syndrome: Logistics is Hot, Perfor-
Tech's Logistics Institute, the Nati- mance is Not," DC Velocity, April,
onal University of Singapore. and 2003, p. 43.
Logistically , the Pacific Rim contains a block of highly developed infra-

structures located in Japan, South Korea, Hong Kong, and a few other indus-
trialized areas. Although languages and cultures are different , international
companies have found sophisticated transportation systems, a variety of ware-
housing options, high use of automated material handling systems, and
familiar standards of customer service. In less developed nations, on the

other hand, logistics systems are woefully inadequate and slow to develop, re-
quiring a great deal of capital investment and management skill. In addition,
in countries such as China, the government is responsible for executing logis-
tics activities. In fact, many analysts feel that China's slowness to respond to
necessary changes in the transportation infrastructure is holding back pro-
gress. The country's GDP has grown approximately 8 percent over the past
ten years, but the growth rate for railway and highway construction has never
reach 5 percent a year and total demand for transportation exceeds the current
capacity of road, railway, and water systems. The World Bank estimates that
China will not be able to meet its logistics requirements until at least 2020.
Chinese planners, however, have been concerned with expansion that is too
rapid and misdirected, resulting in transportation imbalances and over-
capacity . In any case, global firms can only be expected to accelerate their
investment in China and other Pacific Rim countries . Already these countries
have become the preferred sources for raw materials and manufactured com-
ponents . With their almost unlimited reservoirs of cheap labor (China's man-
ufacturing labor cost averages just 5 percent of the average U.S. manufac-
turing wage) and reputation for quality, these countries are expected to ex-
pand their capacities as global suppliers of commodity goods such as apparel,
furniture, consumer electronics, and automobiles.
SUMMARY
At the dawn of the twenty-first century, the globalization of the marketplace

has become one of the most critical components shaping today's business
climate. This explosion in international trade is the result of the maturing of
the economies of the highly industrialized nations, growing global competi-
tion, the establishment of strategic alliances and joint ventures with foreign
companies, and the development of a single logistics system focused on at-
taining the best cost and service possible while welding enterprise and partner
logistics resources with global markets, capital, and manufacturing to maxi-
mize competitive advantage. While global trade offers many advantages,
companies need to be aware of the many barriers that render an international
trade initiative difficult. Global strategists must be prepared to find solutions
to such barriers as tariffs and trade practices , cultural issues, financial
restrictions , security requirements , and logistics infrastructure weaknesses.
An effective global initiative requires the development of a comprehensive
global business strategy to effectivelyguide the effort. The construction of
such a strategy is composed of five steps. In the first, planners must identify
the three strategic dimensions of the internal and external business environ-
ment. The goal of this step is to isolate the macro economic, political, and
governmental environments as well as the micro factors of markets, costs, and
customers, and determine how well the organization is posed to handle identi-
fied opportunities, threats, and trends. In the second step, planners must
select those markets that match enterprise aspirations and capacities. The
third step consists of defining the structure of the organization to optimize ob-
jectives given existing skills and resources. The fourth step is implementing
the product, marketing, communications, and logistics channels detailed in
the third step. The final step is concerned with the measurement and moni-
toring of the success of the strategy.
In defining the strategic approach to the global marketplace, firms have
four possible alternatives. One strategy is to export products into foreign
markets from domestic sources passively through the use of a domestic inter-
mediary, or actively by seeking out intermediaries in foreign countries.
Another strategy, joint venture, differs from exporting in that the finn invests
and is directly involved in the management of a foreign enterprise. The final
strategy is direct ownership of a company located in a foreign country. Once
the international channel strategy has been defined, it must be effectively
managed. Maintenance of a global channel is a complex affair involving
most of the decisions required to run domestic functions, plus new require-
ments associated with the realities of international trade. Of critical impor-
tance is the execution of the functions of transportation and warehousing.
Transportation is essential in delivering the product through the distribution
channel to foreign destinations and warehousing with consolidating and
storing it on its way to the customer.
Enterprises have also turned to global purchasing as a critical source of
competitive advantage. Historically, foreign sourcing has been used for dec-
ades as a method of acquiring products at prices cheaper than what could be
purchasing in the U.S. domestic market. Today, importing products from
international sources is considered as a means to increase marketplace
flexibility by acquiring the products manufactured by advanced engineering,
technological, and production processes without investing in those resources.
Fundamental to effective global sourcing is the execution of the international
purchasing management process. The first step in the process is to identify
the feasibility of using a foreign source for the procurement of a component
or finished good. Once the decision to outsource has been made appropriate
suppliers have been identifies, the second step is request for quotation. The
purpose of this step is to detail the purchase requirements and evaluate the
total cost of the proposed purchase. After the list of perspective suppliers has
been finalized, purchasers must then negotiate for prices, delivery schedules,
and contracts detailing the scope and length of the proposed partnership. The
final step in the process is the completion of the importing documentation.
1. List some of the key trends in today's business environment accelerating the
growth of international trade.
2. What are some of the reasons why a domestic-based manufacturer or wholesaler
would seek to engage in foreign trade?
3. Why is an international distribution strategy so important to an enterprise
seeking to enter global markets?
4. Compare and contrast the four possible alternatives a firm would implement to
enter foreign markets.
5. It used to be assumed that the level of distribution channel structure
development found in a country paralleled the structures of other countries that
had attained the same degree of economic and technological development. Why
is this assumption incorrect in today's marketplace?
6. Describe the performance tools companies can use to measure the cost/service
trade-offs of their international marketing effort.
7. Describe the four basic marketing channel structures . What are the factors
influencing a company to choose a given strategy?
8. What are some of the product marketing decisions that an international company
must make?
9. List some of the reasons why international marketing and logistics is so much
more complex than performing the same functions domestically .
10. Discuss the impact of international trade on the development of an effective
transportation policy.
II . Describe the advantages companies can gain by engaging in global purchasing.
12. What is countertrade purchasing, and why is it so important?
REFERENCES
1. These trade figures are from the U.S. Census Bureau, Foreign Trade Bureau.
2. These points have been summarized from Bowersox, Donald J. and Closs,
David J., Logistical Management : The Integrated Supply Chain Process. New
York: The McGraw-Hill Companies, Inc., 1996, pp. 133-135 .
3. Home, David J., "Global Sourcing Scenario," APICS: The Performance
Advantage, 13,5,2003, pp. 21-24.
4. See the discussion in Harps, Leslie Hansen, "Bridging the Cultural Divide ,"
Inbound Logistics , 23 , 3, 2003 , pp. 34-40 .
5. For more information see Bowersox and Closs , pp. 138.
6. Paul S. Bender, "Int ernational Logistics," in The Distribution Management
Handbook, Tompkins, James A. and Harmelink, Dale A. eds. New York:
McGraw-Hill, 1994, pp . 8.2-8.4 .
7. For a more detailed discussion see Tyndall, Gene, Gopal, Christopher, and
Partsch, Wolfgang, Supercharging Supply Chains. New York: John Wiley and
Sons, 1998.
8. Keegan, Warren J., Global Marketing Management, 4th ed. Englewood Cliffs,
NJ: Prentice-Hall, 1989, pp . 41-49.
9. Kotler, Philip , Marketing Management, 6th ed. Englewood Cliffs, NJ : Prentice-
Hall, 1988, pp . 388-389.
10. Gopal, Christopher and Cypress, Harold, Integrated Distribution Management.
II . Bowersox, Donald J. and Cooper, M. Bixby, Strategic Marketing Channel
Management . New York: McGraw-Hill, 1992, p. 415 .
12. Bender, Paul S., "The International Dimensions of Physical Distribution
Management," in The Distribution Handbook, Robeson, James F., and House ,
Robert G., eds. New York: The Free Press, 1985, pp. 784-786 .
13. Picard, J., "Topology of Physical Distribution Systems in Multi-National
Corporations." International Journal of Physical Distribution and Materials
Management, 12, (6), 26-39 (1982) .
14. For more discussion see McKinnon, Alan C., Physical Distribution Systems.
New York: Routledge, 1989, p. 220 .
15. Keegan, Warren J., Global Marketing Management, 4th ed. Englewood Cliffs,
NJ: Prentice-Hall, 1989, pp. 378-382.
16. For more information on these documents see Johnson, James C. and Wood,
Donald F., Contemporary Transportation, 3rd ed. New York: Macmillan, 1993,
p.472.
17. Paul S. Bender, "The International Dimensions of Physical Distribution Man-
agement," p. 808 .
18. Sampson, Roy J., Farris, Martin T., and Shrock, David L., Domestic
Transportation: Practice, Theory, and Policy. Boston: Houghton Mifflin Co.,
1985, pp . 99-102 .
19. See the discussion in Sampson, et al., pp. 100-101; and, Paul S. Bender, "The
International Dimensions of Physical Distribution Management," p. 793 .
20. See the discussion in Bender, "The International Dimensions of Physical

Distribution Management," pp. 799-802.
21. Carter, Joseph R., Purchasing: Continued Improvement Through Integration.
22. See the discussion in Norquist, Warren E., Lees, Robert H., Morton, James E.,
and Tahmoush, Frank, "Global Purchasing," in The Purchasing Handbook,
Fearon, Harold E., Dobler, Donald W., and Killen, Kenneth H., eds. New York:
McGraw-Hill, 1993, p. 194.
23. Carter, p. 134.
24. Ibid, p. 136.
25. See the discussion in Ibid, pp. 121-122.
26. For more information on currency issues see Heinritz, Stuart, Farrell, Paul V.,
Giunipero, Larry C., and Kolchin, Michael G., Purchasing: Principles and
Applications, 8th ed. Englewood Cliffs, NJ: Prentice-Hall, 1991, pp. 196-198.
27. For additional information see Heinritz, et al., pp. 201-202; and, Cateora, Philip,
International Marketing, 8th ed. Homewood, IL: Irwin, 1993, pp. 41-44.
28. For a full treatment of these documents see Johnson and Wood, p. 47.
14
INFORMATION TECHNOLOGY AND
SUPPLY CHAIN MANAGEMENT
FOUNDATIONS OF ENTERPRIS E Identifying Information System

INFORMATION TECHNOLOGIES Solutions
Basics of Supply Chain Information Evaluating Information Tech-
Processing nology Solutions
Information System Basics - Inte- Making Technology Choices
gration and Networking
IMPLEMENTATION ISSUES
CONFIGURING THE EIS Part l : Aligning Information
SOLUTION Technology and Company
Enterprise Information Systems Strategies
EIS Architecture for Distribution Part 2: Selecting Technology
Industries Solutions
EIS Connectivity Tools in the Part 3: Software Implementation
Age of e-Business Part 4: Continuous Improvement
INFORMATION TECHNOLOGY SUMMARY

SOLUTIONS
As it has in all areas of today's business environment, the application of infor-

mation technology has caused a revolution in the concept and practice of Sup-
ply Chain Management (SCM). As the complexity of managing today's glo-
bal enterprise expands and the speed by which information concerning prod-
ucts, customers, and processes accelerates, companies can have little hope of
responding effectively without applying computerized information systems .
Many areas impacted by the computer have already been discussed in previ-
ous chapters: the integration of the operating functions of the enterprise, solu-
tions accelerating ordering processes and shrinking delivery times to custom-

ers, Internet and electronic data interchange (EDI) applications providing
connectivity between companies, planning systems that facilitate channel in-
ventory management, simulation programs eliminating the guesswork invol-
ved in transportation routing and scheduling, and many others. The use and
complexity of such computerized tools can only be expected to grow,
changing the way companies have traditionally serviced their customers and
how they communicate with supply channel partners.
Exploring the impact of information technology on supply chain manage-
ment is the subject of this chapter. Discussion begins by exploring how com-
puter technologies have reshaped the way companies utilize information to
plan and control internal functions and create interactive, collaborative re-
lationships with their customers and trading partners out in the supply chan-
nel network. Among the topics defined are the principles of information pro-
cessing, integration, and networking. Following, the chapter focuses on an
in-depth exploration of the basic architectural elements of today's enterprise
information system (EIS). Included is a review of how the EIS architecture
can be adapted to respond to the needs of the distribution industry. Next, the
various forms of connectivity made available by the Internet are examined.
Topics detailed are Web-based marketing, e-commerce, e-business, and e-col-
laboration. The chapter concludes with a discussion of the processes neces-
sary to properly identify and evaluate today's range of information technol-
ogy solutions, making technology choices, and implementation and continu-
ous improvement issues.
FOUNDATIONS OF ENTERPRISE INFORMATION

TECHNOLOGIES
As the importance of timely, accurate, and complete information increases in

the supply channel environment, information technologies have progressively
become the key enabler integrating the supply network environment. What
this means is that today's marketplace leaders must view computerized tech-
nologies not only as a tool to accelerate the speed and productivity of busi-
ness functions through automation, but also as a key driver that enhances the
opportunity for supply chains to continually activate new relationships and
operating structures that change the way they compete in the marketplace.
Internally, information technologies enable companies to develop databases
and implement applications that provide for the efficient management of
transactions and the timely collection, analysis, and generation of information
about customers, processes, products, services, and markets necessary for ef-
fective decision making. Building a real-time knowledge repository can
INFORMATION TECHNOLOGY AND SCM 749
create the pathway necessary to seamlessly synchronize the capabilities of

individual companies with their customers and trading partners. Externally,
information technologies enable supply chain strategists to architect channel
networks that are collaborative, agile, scalable, fast flow, and Web-enabled.
The goal is to present customers anywhere in the supply chain a single, inte-
grated response to their wants and needs by creating a unique network of val-
ue-creating relationships . Connectivity and synchronization at this level re-
quire the elimination of channel information silos and the construction of col-
laborative, channel-wide communication and information enablers directed at
a single point: total customer satisfaction.
There can be little doubt that while it can be said that the supply chain
management is perhaps the single most important driving force in today's
global business environment, at the heart of SCM can be found the integrative
power of information technologies. Employing this power, however, requires
both planners and technologists to rethink their use of the computer. Actual-
izing the potential of today's information systems will require companies to
move beyond traditional paradigms that utilize computerization purely as a
means to plan and control internal business processes. In fact, connectivity
enablers, like the Internet, now permit companies to escape from the narrow
boundaries of their own information environments to network with a universe
of geographically dispersed channel trading partners and create real-time
strategies, operations, and planning systems previously thought unattainable.
Today 's boundary-spanning technology tools enable companies to harness the
explosion of data that continuously emanates from every plane in the supply
chain galaxy, integrate it with internal business systems, perform sophis-
ticated analysis of the information, make visible an accurate picture of in-
dividual enterprise and supply chain partner performance, and architect rev-
olutionary capabilities and competencies for the generation of new sources of
products and services, whole new businesses and marketplaces, and radically
new forms of competitive advantage.
BASICS OF SUPPLY CHAIN INFORMATION PROCESSING
It can be stated that the operational and strategic functions of any supply
chain consist of two major flows: the flow of material from the source of sup-
ply to the customer and the flow of information from the customer back
through each channel node to the origins of supply. As the velocity of the
flow of materials is limited in time by the capabilities of channel handling,
storage, and transportation, so too is the availability and usefulness of infor-
mation limited by existing information technologies. Definition of these
limits directly defines the physical capabilities of the supply chain and the
ability to create, collect, assimilate, access, and transfer information neces-

sary for effective action and decision-making. Historically, the ability of sup-
ply chains to not only control physical events, but also to leverage data to
achieve operational optimization and exploit the internal and external link-
ages between activities was inhibited by limitations in information process-
sing. Data could be collected, assimilated, and passed on to other business
functions only as fast as human efforts, assisted by crude forms of auto-
mation, could process it.
With the advent of the computer, capable of handling information in vol-
umes and at speeds previously thought unimaginable, the heavy information
processing constraints of the past were lifted, revealing new horizons of
information and obsoleting many of the older methods and organizational
processes and structures. Availability of information provided channel man-
agers with a variety of previously unavailable tools to solve critical supply
chain problems. To begin with, computers enabled companies to integrate
their internal business functions so that strategies and plans could be broad-
cast to each department. Second, computers provided for the accurate and
timely entry and maintenance of business transactions. This data in tum
could be used to control processes as well as verify performance. Third, the
computer provided customer service with the means to confirm inventory
availability, order and delivery status, and payment information. And finally,
the computer enabled planners to reduce channel inventories and resource re-
quirements by substituting information about supply and demand in place of
redundant physical assets as a means to react to supply chain uncertainties.
Effectively utilizing the computer requires a full understanding of the archi-
tectural functions and nature of computerized information.
INFORMATION SYSTEM BASICS -INTEGRATION AND NETWORKING
At the core of today's enterprise information system (EIS) can be found two
fundamental principles . The first is the availability of a technical infrastruc-
ture that links computer systems and people. The word commonly used for
this process is integration . One of the problems with this dimension is under-
standing exactly what it means. As Savage has pointed out [IJ, there has
been a great deal of confusion concerning the definition of the word inte-
gration . It is often erroneously used synonymously with connectivity and in-
terfacing. Connectivity means connecting processes together, such as when a
telephone system connects customers and order processing functions. Inter-
facing means bringing information from one system and presenting it for in-
put to another, such as occurs in an ED! transaction. Although both assemble
and transmit information to the enterprise, neither connectivity nor inter-
facing change the way the organization works. If the organization is really
nothing more than a collection of independent functions, each performing
separate activities according to their own strategies and performance mea-
surements, then neither connectivity nor interfacing will have much impact
on transforming the organization.
In contrast, integration calls for the elimination of the ideological, strate-
gic, and performance barriers that separate functions within an organization.
Integration means to come in touch, or to be in touch with itself. Organiza-
tionally, integration means leveraging information tools that bring business
functions together by facilitating ever closer coordination in the execution of
joint business processes . Integration focuses on activating the creative
thinking within and between enterprises. Integration attempts to bring into
alignment the challenges and opportunities offered by information tech-
nologies and the cultures and capabilities of the modem organization.
The second technology dimension at the core of today's EIS is networking.
In the past, computer system architecture permitted only hierarchical com-
munication. As each processor completed its tasks, the output was then avail-
able for the next processing task, which, in tum, passed its output to the next
downstream processor. With the advent of client/server architectures and In-
ternet browsers, the process of communicating information has shifted from
processing hierarchies to connecting different computers and their databases
together in a network. The growing availability of open-system softwares
and intranet and extranet networks is targeted at solving the problem of the
dissimilarity of hardware operating systems. The advantage of networked
systems is that people can now communicate information directly to other
people in the network. This peer-to-peer networking enables companies to
leverage the capabilities, skills, and experience of people by integrating and
directing their talents around focused tasks. What is more, the establishment
of focused teams can occur not only inside the enterprise but also can be
extended to suppliers, customers, and trading partners constituting the entire
value chain [Figure 14.1].
Integration is the process of linking business functions together; net-
working, on the other hand, is the activation of those links by enabling and
empowering people to cut across functional barriers and interweave common
and specialized knowledge to solve enterprise problems. Integration and net-
working are complimentary activities that can be combined and defined as the
integrative process. According to Savage, this process
puts us in touch with the whole, with one another, with customers, and with
suppliers in ever-changing patterns of relationships. It also puts us in touch with
our own wills, emotions and knowledge. The integrative process is a process of
human networking: networking our visions and knowledge so we can take

decisive action in concert with other efforts [2].
FIGURE 14.1 Basic business universe.
This integrative process is the driving force in the acquisition of compu-

terized technology and is, in tum , governing the development of its topology.
Basic Enterprise System Architectural Functions. While the modem enter-

prise information system has evolved dramatically over the past decades, to-
day's business system architectures are essentially based on a common set of
functions. As portrayed in Figure 14.2, there are five critical functions found
in every business system:
Enterprise database. The foundation data necessary to operate the
business is located in the system database. These records are, for the
most part, composed of two types of data. The first, static data, con-
sists of core information elements, such as customer and supplier
masters, item masters, product structures, product costing, warehouse
geography, bills of material (BOMs) and process routings, manufac-
turing equipment, and channel structures that do not change during the
performance of transactions. The second type, variable data, consists
of databases, such as open order, transaction balance, and accounting
that are impacted through transaction management. Today's computing
technologies enable companies to have a single database (relational
database) that all departments can use jointly. Furthermore, the advent
of connectivity tools, like the Internet, provide the capability for data-
base networking, where key database files such as forecasts, channel
inventories, and open order status, can be viewed by users both external
as well as internal to the company.
FIGURE 14.2 Enterprise system architecture.
Transaction management. The transaction functions form the founda-

tion applications of every EIS and consist of such activities as order
entry, inventory balance maintenance, order selection, allocation and
shipment, payables and receivables, and various data displays. Func-
tions in this area served several purposes. They provide for the ac-
curate and timely entry and collection of transaction data; they auto-
mate difficult and time-consuming record-keeping; they enforce rules
governing transaction data entry and maintenance; and, they enable
companies to collect large volumes of data that can in tum be used for
business analysis, management control, and strategic planning. The
overall goal of transaction management functions is to ensure an ac-
curate record of the finn's day-to-day operations.
Management control. The entry of transactions and the compilation of
databases are meaningless without defined performance measurements
to guide decision-making. Applications residing in this function focus
on toolsets that permit analysts to "mine" enterprise databases in an ef-
fort to uncover and detail operational and financial measurements re-
lating to such issues as cost, asset management, customer service, pro-
ductivities, and quality. Management control has the following goals:
provide the feedback necessary for the timely reformulation of oper-
ations plans and activities, on-going measurement of the competitive

capability of the enterprise, and development of plans providing for
continuous improvement.
Decision analysis/simulation. A critical function of today's EIS is the
ability of planners to utilize a variety of modeling tools to assist in
managing simple to increasingly complex processes during decision-
making. Some of these applications, such as MRP and capacity man-
agement, provide mature and easy-to-use tools to simulate the impact of
demand on inventories and productive capacities. Other computerized
applications assist in the identification, evaluation, and comparison be-
tween alternative courses of action, such vehicle routing and schedu-
ling. Finally, this area also can consist of powerful advanced planning
systems (APS) and supply chain management (SCM) systems driven by
complex mathematical algorithms used to design supply chains,
determine plant locations, and aggregate demand and supply data
across channel networks. The goal of these functions is to provide
planners with the capability to identify and evaluate the best choices
from a range of competing alternatives.
Strategic planning. The role of strategic planning functions is to pro-
vide managers with the capability to construct long-term plans and
forecasts used to determine enterprise financial goals, explore strategic
business partner alliances, design marketing approaches, and define and
develop productive capacities necessary to support product and ser-vice
requirements . The plans developed in this function provide the basis
for management control, decision analysis, and performance, and are
used to drive the operations plans executed by transaction func-tions.
The overall goal of strategic planning functions is to provide the
enterprise with competitive advantage.
While the exact structure of the applications used by today's EIS varies by in-
dustry, they must all provide the business with a common database, a suite of
relevant transaction programs, some form of simulation, and data and func-
tionality for on-going operations management and control as well as long-
range planning.
Principles of System Management. Whether it be in the capture of his-

torical data for forecasting or the utilization of inventory transaction balance
records, an effective EIS requires databases of the highest integrity and pro-
cesses easily understood by the user. The following seven principles of sys-
tem management are fundamental to an effective EIS [3]:
Accountability. While computers provide the functions for the entry
and maintenance of data, the quality and integrity of that data resides
squarely with the people who use the system and must ultimately be
held responsible. Furthermore, while the system generates production
schedules and order picking priorities, it is the planner who must be
held accountable for approving the schedule. Without accountability,
an EIS will quickly spin out of control and lose its ability to provide
meaningful information for planning and decision making.
Transparen cy. One of the fundamental keys to effective EIS archi-
tecture is that the logic of how the system works be simple, understand-
able, and apparent to the user. To the user, the complexity and sophis-
tication of the technical architecture of the system is irrelevant. The is-
sue is simply one of understanding. If the logic of a particular appli-
cation is easy to work with and conforms to best practices, the system
will be intelligently and competently used. Transparency means that
the system provides the user with answers as to why and how the sys-
tem requires a particular activity to be performed.
Accessibility. One of fundamental problems of paper-based systems is
that data is not readily accessible for decision-making. Effective com-
puter systems remove the difficulties surrounding data retrieval by con-
taining programs that provide for quick access and update of critical in-
formation, such as order status, that span company departments, geo-
graphical dispersion , or even databases belonging to trading partners .
Data integrity. The usefulness of an EIS is directly dependent upon the
accuracy and timeliness of its databases . Accuracy can be defined as
the degree to which actual physical data matches up against the same
data recorded in the system. As a metric, most data in an EIS should be
at 99 percent. As the gap between the physical and the system data
widens, companies are normally forced to increase inventory levels or
safety stocks as a buffer against variance. Timeliness can be defined as
the spatial delay between the moment a transaction occurs and the point
in which it is recorded in the system. The speed of data update is criti-
cal in providing managers with current information to guide them in
taking corrective action. Similar to accuracy, high levels of timeliness
enable companies to remove uncertainties and increase the accuracy of
decisions.
Valid simulation. If an EIS is to provide useful information, the trans-
actional and maintenance programs in the system must work the way
the business actually works. In effect, a business application is in
actuality a representation, a simulation of the actual physical action
performed during process execution . For example, if the act of physi-
cally receiving a product to a location is not mirrored by the transaction
entered in the application , data integrity is diminished and the ability of
users to keep data records accurately decreases exponentially as invalid

data cascade through the system.
Flexibility. An effective EIS must provide the users with the capability
to perform transactions or manipulate data to meet the needs of both the
business and customers and suppliers out in the supply chain. For ex-
ample, inventory allocation and shipping functions should permit cus-
tomer and interbranch transfer orders to be created restricting delivery
to a single receiving location or allowing multiple delivery points on a
single order. In addition, the software itself should permit easy upgrade
capabilities without causing the company undo cost or implementation
time.
Control versus planning. A fundamental benefit of an EIS is the ability
to control business processes through management by exception. EIS
applications provide managers with reporting and exception messaging
designed to alert them as early as possible to actual or pending out of
control processes. For example, a forecasting method should be able to
recognize changes in basic patterns or relationships at an early stage
and provide forecasters with warning alarms to take preemptive action.
Such functionality is critical for effective planning, which assumes that
existing patterns will continue into the future.
The basic architecture and principles of effective system management are
fundamental to the establishment of an effective EIS. The basic architecture
should contain programs for database management, transaction management,
management control, decision analysis/simulation, and strategic planning.
Actual operation of the EIS should encompass the seven critical principles of
accountability, transparency, accessibility, data integrity, valid simulation,
flexibility, and control versus planning.
CONFIGURING THE EIS SOLUTION
Effectively managing today's multi-faceted supply chain requires architecting

enterprise solutions that facilitate the management of the linkages existing
within the supply chain. The goal of the process is not to create a monolithic,
rigid system, but rather to configure scalable, highly flexible information en-
ablers that provide the business with the capability to respond with cus-
tomized customer value solutions and collaborative relationships at all points
in the supply channel network. The software solution that emerges should be
able to effectively respond to the various levels of information management
to be found within the supply chain. As will be discussed, there are three
possible dimensions today's enterprise system must encompass. The first is
concerned with solutions that integrate internal data and processes. The
second is concerned with linking external parts ofthe company together. The
third, and final, dimension examines technology tools that link external cus-
tomers and suppliers to enterprise demand and supply planning functions.
ENTERPRISE INFORMATION SYSTEMS
The fundamental objective of an EIS is to extend the structure and benefits of

computer integration and networking to encompass the entire enterprise. In
practical terms, this means that not just a portion but all business functions,
from purchasing and inventory control to forecasting and general ledger, are
integrated together. The goal is to place all internal enterprise processing,
decision -making, and performance measurement in a common database sys-
tem capable of being maintained and referenced in real-time by all company
users. The EIS itself is composed of two elements: the hardware, consisting
of the computer, input/output devices, and data storage/warehousing, and the
software, the application programs used for processing transactions , dis-
playing the database, printing reports, management control, and operational
and strategic planning.
Basic Architectural Issues. A fully integrated EIS enables companies to

manage the business from two sets of interrelated activities . As illustrated in
Figure 14.3 these activities can be described as strategic planning and opera-
Planning Region
Financial ~ Ia lc riltl Manu faclu rin g Ca pacity Logi lies

Pl an Plan Plan Plan Plan
Accounlinw Deman d
Procuremen t
o ling ;\1. nage mcnl
FIGURE 14.3 Regions of basic EIS activities.

tions execution. The strategic planning area provides company management

with the tools to translate strategic objectives into the functional level plans
necessary to develop marketing and sales campaigns, construct the fulfillment
channel, schedule production and materials acquisition, and identify financial
and capacity constraints. The goal of the process is to integrate and synchro-
nize information and plans within each business function and between the en-
tirety of the enterprise. An EIS seeks to link not only homogeneous business
areas, such as financials, but also heterogeneous business areas, such as sales,
inventory, logistics, purchasing, and manufacturing into a common planning
process. Finally, integrated strategic plans enable the effective execution,
control, and performance measurement of detail operations activities and
databases .
The operations execution functions found in an EIS are broadly grouped
around the performance of the transactional activities necessary to generate
orders, plan for finished goods acquisition, schedule production, ship product
through the supply chain, purchase materials and components, manage costs,
and post payables and receivables. There are several objectives pursued in
this region. To begin with, it is the role of the EIS to provide for the integra-
tion and coordination of business activities driven by enterprise plans by pro-
viding process-specific application functionality that enable users to easily
and consistently enter, maintain, and view system data. These tools should in
tum reduce delays, errors, process redundancies, and bottlenecks and ensure
operational flexibility and agility to respond to any circumstance. In addition,
the functionality offered by the software provides each business area with
new opportunities to engineer process optimization and to promote best
practices internally across supply channels and externally with suppliers and
customers . Finally, by creating a common community of users, each inter-
dependent on the participation, knowledge, and information inputs found in
the system, the enterprise as a whole can move to a higher level of co-
ordination, service, and performance measurement.
The Standard EIS Architecture. As was mentioned at the beginning of this

section, today's EIS must be capable of being configured to meet the infor-
mation solution requirements of various types of players in the typical supply
chain. In this section the most common EIS type found in every firm popu-
lating the typical supply chain - applications to manage the internal functions
of the firm - is explored. A common software that has been applied by firms
over several decades to manage their internal supply chain is enterprise re-
source planning (ERP). An illustration of the functions of the typical ERP
system can be found in Figure 14.4. Depending on the nature of the business,
an enterprise may utilize some or all of the applications. For example, the
business system solution for a manufacturing company with distribution func-
tions will utilize all of the applications. A wholesaler, on the other hand, will
exclude the manufacturing related functions. Regardless of the business
environment, every company will at least have to install marketing and sales
planning, order management, financial, and asset applications. These core
functions would be difficult to outsource without loosing corporate integrity.
- - - - - - - - - - - - - - - - - - - - - - ~ Region 1
Business
PllInning
Material, Component
Requirements
Deta il Capacit y
Requireme nt s
Load Scheduling
Product Qualit y
Quality, Pricing.
Receiving, Suppliers
Transpar t at ion,
Rates, Ware housing
Fixed and Human
Resources,Pay roll
FIGURE 14.4 Basic ERP functions diagram .
The architecture of an EIS system attempts to integrate all of the informa-

tion processes of the enterprise and use the resulting synergy of planning and
control enabled by this integration to continuously improve performance to
the customer as well as establish uniform policies and practices across the
internal supply chain. An EIS system can be best understood by dividing Fig-
ure 14.4 into three regions. In region 1 can be found applications used for the
development and disaggregation of top management plans governing the
overall direction of the enterprise, products and market programs, sales and
promotions campaigns, and aggregate product family priority and resource
capacity planning. Region 2 is composed of applications for demand man-

agement encompassing forecasting finished goods, order management, order
promising, and managing inter-company channel demand and inventory
replenishment priority and capacity planning. In region 3 can be found ap-
plications focused on operations execution activities such as purchasing, pro-
duction activity control, transportation and shipping, fixed asset and human
resource management, and financial accounting. A short description of these
critical applications is as follows [4]:
Strategic planning. Applications in this area provide corporate strate-
gists with tools to develop the overall goals and objectives to be pur-
sued by the enterprise. The output of these applications is focused on
determining how the business is going to compete - product lines,
financial investment and return, markets, research and development - in
the future. Planning in this area begins with the utilization of detail
transactional databases from marketing, finance, production, and distri-
bution that in tum are used as the basis for long-range forecasting and
decision making. The strategic business plan developed from the pro-
cess is then used as a framework that determines the goals and objec-
tives for marketing and sales, finance, engineering, production, and lo-
gistics departments. Each department translates the plan into their own
set of performance objectives necessary to meet the corporate objec-
tives. Finally, the ERP system provides the planning and control tools
to ensure the performance of activities in support of departmental
goals.
Sales and Operations Plann ing (S&OP). The goal of application func-
tions in this area is to build consensus teams in sales, operations,
finance, and product development that enable the continuous revision
of the business strategy and realignment of departmental plans. The
process begins with marketing and sales, which are responsible for
using the business system database to review the success of the sales
plan, assess market potential, and forecast future demand. Plan
revisions are then communicated to manufacturing, engineering, and
finance who in tum must re-align their operations plans to meet the
demands of the new marketing and sales plan.
Customer management. The primary role of these applications is to
enable quick and accurate order entry, order promising, and open order
status maintenance. Order entry and on-going service maintenance is
the gateway to the sales and marketing database. Second, this module
should provide the data necessary to perform real-time profitability
analysis to assist in calculating costs, revenues, and sales volumes
necessary for effective quotation, on-going customer maintenance, and
accounts receivable . Third, these applications should provide mar-

keters with tools to design sophisticated pricing schemes and discount
models. In addition, the software should permit the performance of
miscellaneous functions such as order configuration, bonus and com-
missions, customer delivery schedules, global tax management, custom-
er returns, and service and rental. Finally, the customer database
should be robust enough to permit the generation of sales budgets for
forecast management and the generation of statistical reporting illus-
trating everything from profitability to contributing margins analysis.
Inventory planning processes. At the heart of the modem day EIS can
be found the oldest applications of the system: the finished goods, com-
ponent and raw materials, and distribution channel inventories planning
tools. These modules contain functionality to enable the generation
and maintenance of inventory database records and parameters, the ef-
ficient and timely replenishment of inventories, and inventory planning
simulation. The Master Produ ction Schedule (MPS) receives demand
on finished goods from the production plan, forecasts, actual customer
orders, and interbranch demand (DRP) and calculates the replenishment
quantities necessary to maintain customer service levels. Once com-
pleted, this application sends finished goods requirements down to the
Material Requirements Planning (MRP) by exploding product bills of
materials (BOMs) where component and raw materials are then calcu-
lated to provide the company's plan for materials and product re-
plenishment.
Capacity management. Once EIS applications have generated the in-
ventory priority plan, it must be reviewed in relation to the available ca-
pacities within the firm and outside in the supply channel to manage re-
plenishment proposals . Capacity constraints can arise from a variety of
sources including manufacturing capabilities , warehousing, transporta-
tion, and labor, and material handling equipment. The goal of the pro-
cess is to identify process bottlenecks that could constrain the efficient
production, storage, and movement of goods. Today's EIS provides
planners with the capability to view plant and channel capacities that
match aggregate, finished goods, and detail inventory priority plans. If
priority and capacity plans are not found to be in balance at any
planning level, planners must resolve the imbalance by resource
acquisition, outsourcing, or postponement of production or delivery.
Manufacturing/Valu e-Added Processing. Functions in this application
comprise the activities determining manufacturing order release, daily
order scheduling and synchronization, overall shop floor control, forms
of value-added processing such as labeling and bulk breaking, and cost
762 INTERNATIONAL ANDDISTRIBUTION SYSTEMS
reporting. Included in these modules is functionality for activities such

as inspection, project management, capacity/resource management, and
the compilation of production statistics . Finally, advances in technol-
ogy have enabled the enhancement of these applications with "bolt-on"
data collection devices and advanced shop floor planning and opti-
mizing software.
Procurement. Once the materials plan has been authorized, it is the re-
sponsibility of purchasing applications to begin the task of acquiring all
purchased components and raw materials. Basic management of pro-
curement requires a close integration with internal MRP and main-
tenance, repair, and operations supplies (MRO) systems. Today's EIS
contains robust functionality to facilitate purchase order processing, de-
livery scheduling, open order tracking, receiving, inspection, and sup-
plier statistics and performance reporting. In addition, detailed request
for quotation (RFQ) must be available that ties back to customer
demands and extends out to supplier management, negotiation, and
pricing capabilities. Finally, the system architecture must include ele-
ctronic data interchange (ED!) and Internet-enabled capabilities.
Logistics. The logistics applications in an BIS are concerned with co-
ordinating transportation, warehousing, labor, and material handling
equipment with the place and time requirements of sales, manufac-
turing, and inventory management. Today's EIS must provide the
mechanism to run the internal supply chain of the business as well as
provide the necessary connectivity to external trading partners located
on the rim of the supply network. Perhaps the most critical goal of log-
istics applications is to ensure that overall supply chain requirements
are integrated with both capacity constraints at the origins of the chan-
nel and with manufacturing, inventory, and delivery capabilities at the
ends of the supply network. Critical tools in the module center on dis-
tribution channel configuration, warehouse activity management, chan-
nel replenishment planning and distribution order management, and the
generation of distribution, asset, and profitability reporting. Also, of
growing importance is the integration of EIS functions with "bolt-on"
warehouse (WMS) and transportation management systems (TMS), as
well as applications supporting Web-based customer and supply chain
management systems.
Product data. At the core of manufacturing and distribution informa-
tion systems reside the databases describing the products that they build
and distribute. Often considered highly proprietary, these databases
contain information ranging from engineering descriptions to details
concerning cost, suppliers, planning data, and product structure details.
Beyond their use for inventory and manufacturing planning and shop
floor management, these databases are critical for product life cycle
management analysis and costing, engineering product introduction,
and financial reporting and analysis. As the speed of new product time-
to-market and ever-shortening product life cycles accelerates, progres-
sive companies have been looking to channel partners to implement
collaborative technologies through the Internet that can network-in real-
time comp uter-aided design (CAD) and design documentation in an
effort to compress product development and introduction time, and
facilitate the phase-out of obsolete products and services.
Finance. Perhaps the most highly developed applications within an
EIS are the suite of financial modules dealing with management ac-
counting. In fact, one of the criticisms leveled at an EIS is that it is
really an accounting system requiring everyone in the business to report
in real-time each transaction performed with 100 percent accuracy. To-
day's financial applications provide for the reporting of all transaction
information originating from inventory movement, accounts receivable,
accounts payable, taxes, foreign currency, cost accounting, and journal
entries occurring within the enterprise . The more timely and accurate
the posting of data, the more effective are the output reports and bud-
gets that can be used for financial analysis and decision-making at all
levels in the business.
Assets. Effective control of an enterprise's fixed assets is essential to
ensuring the success of the continuous planning of the supply chain
productive resources. EIS applications center on the establishment of
equipment profiles, diagnostics and preventive maintenance activities,
and financial tracking.
Human resources: Finally, a modem EIS contains applications for the
management of an enterprise's people resources. Functions in this area
can be broken down into two main areas. The first is concerned with
the performance of transaction activities, such as time and attendance
reporting, payroll administration, compensation, reimbursable expen-
ses, and recruitment. The second is focused on the creation of data-
bases necessary to support employee profiles, skills and career plan-
ning, and employee evaluations and productivity statistics.
EIS Benefits. The applications and management processes constituting an

EIS are universal for any type of manufacturer or distributor and truly can be
said to be the "backbone" oftoday's business system. As a planning and con-
trol mechanism, an EIS enables whole enterprises to organize, codify, and
standardize business processes and data. Achieving such objectives in tum
permits strategists and planners to optimize the business's internal value

chain by integrating all aspects of the business, from purchasing and inven-
tory management to sales and financial accounting. In addition, by providing
a common database and the capability to integrate transaction management
processes, data is made instantaneously available across business functions,
enabling the visibility necessary for effective planning and decision making,
while simultaneously eliminating redundant or alternative information man-
agement systems and reducing non-value-added tasks.
; J 1 ........ -
Behr:Z<jimate Systems Inc.

I~~ .:
When Behr Climate Systems, lnc., a sing, parts availability. and fulfill-
supplier of automotive parts started ment. All these functions, in turn,
their technology search by looking sent real-time data to the financi al
at a partial solution to integrate cust- applications.
omer service. forecasting, and DRP.
It quickly became apparent that to The real advantage of the EIS, how-
attain the level of performance ever, was Behr' s ability to signi-
desired. what was needs was an EIS ficantly increase the entire flow of
approach that also encompassed fi- business as it passed through the
nancial, distribution, and ware- company. Altogether the EIS is
housing into a single comprehensive enabling Behr to accomplish the ori-
system. ginal goals of increase customer
service and improved ROI while
The implementation of a major EIS providing new avenues to total
solution enabled Behr to realize im- quality management and superior
mediate results due to automation. marketplace advantage.
Table-driven put-away and picking
rules significantly assisted ware- Source: Brooks, Harold, "Computer
house control. In customer service. Overhaul Improves the Warehouse
the system streamlined order promi- System," APlCS-The Performance
Advantage. 4,4, 1994, pp. 29-30.
An EIS provides other benefits. As companies grapple with managing con-

tinuous change to products, processes, and infrastructure, strategists are
looking to the suite of "best practice" process designs embedded in today's
EBS business functional work flows to assist in the removal of ill-defined or
obsolete processes and the structuring of "best in class" processes by building
them around the capabilities of EIS applications. Finally, as enterprises
evolve to meet new challenges, companies with standardized processes driven
by an EIS are more adaptable to change. A single, logically structured, and
common information system platform is far easier to adapt to changing cir-
cumstances than a hodge-podge of systems with complex interfaces linking

them together.
EIS ARCHITECTURE FOR DISTRIBUTION INDUSTRIES
One of the most crucial aspects of an EIS is its ability to adapt to different
supply chain environments. The applications and processes detailed in the
previous section can aptly be described as constituting an ERP system pri-
marily used to run the internal functions of manufacturing companies. In this
section the architecture of an EIS for running an enterprise with external
functions will be examined. Termed Distribution Resource Planning (DRP
II) [5], such as system is defined as a
computer assisted management philosophy for planning the utilization of the

totality of a distribution enterprise's resources, while providing for the execution
and performance measurement of material procurement, supply chain distribution,
and financial accounting to fulfill strategic business requirements for customer
service and marketplace leadership.
The DRP II system function flow is illustrated in Figure 14.5.

This model illustrates the integrative, interactive, and closed-loop nature of
the typical activities occurring within a distribution enterprise. Similar to the
general ERP model detailed in the previous section, DRP II presents a sys-
temic approach. The flow of information begins with business planning func-
tions and proceeds through operations and financial execution and concludes
with performance measurement. Besides providing a systems approach to
directing and measuring the entire enterprise, from internal functions to the
management of supply channels, DRP II provides a solution to the following
problems plaguing the distributor:
1. DRP II permits the creation of business plans addressing the strategic
decisions defining enterprise mission, market demand, and the al-
location of financial, physical assets, and human resources, and then
provides the mechanism to disaggregate those plans through logistics
resource planning (supply chain capacity) and inventory planning (dis-
tribution requirem ents planning - DRP). The goal is the generation of
time-phased plans where the demands of the entire supply chain are
balanced against inventory, value-added processing, logistics, and pur-
chasing capabilities.
2. DRP II provides distributors with the capability to be agile and flexible
enough to respond to the many changes occurring in the business en-
vironment by providing visibility to customer demand and real-time sta-
tus of the supply chain. Change in market demand, supplier delivery
problems, excess inventories, inventory imbalances within the channel

network, marketing promotions, and a host of other events are made
visible along with the mechanism to adjust and reallocate critical
resources.
I Ent erprise Functions Enterprise Objectives
Forccas linw r------I.---~I Products, Aharkets ,

l' rod llcll' la nning f - - - - 1 .... Price, Campaigns
i:::::::
Supply Chain Structure
.-----1.--- -1 VVarehouse,Labor,
Transportation,
Inventory Capacities
.-----1.--- 1
Customer Service
.----_--1._----, -1 DRP, ROP, Storage

Costs, Channel
Distribut ion
.----_----1_----, 1
Transportation,
r------I.---~ l
Rates, VVarehousing
Kitting, Labe ling, Bulk

Break ing, Processing
.------'------.1 Costs
J
Qua lity , Pricing,
Rece iving, Suppliers
I- ; - - - - - - ...... _ _ _ _ _ Human Resources,

Payro ll
FIGURE 14.5 Distribution enterprise system diagram.
3. By applying the time-phased logic of MRP and the ability to structure

an integrated channel planning mechanism through the bill ofdistribu-
tion (BOD), DRP II provides planners with a detailed workbench to
keep channel inventories low and evenly distributed to meet the de-
mands placed on each channel node, while providing the tools to resup-
ply the supply chain as efficiently and cost effectively as possible.
DRP II also enables the design of performance measurement programs
that look beyond local agendas to how well each channel segment is
supporting the overall business plan.
4. Finally, when integrated with today's newest supply chain event man-
agement and collaborative forecasting and planning toolsets, DRP II
provides a catalyst for the application of Internet-based technologies
and Lean/JIT principles targeted at removing barriers to time and space
as well as to quality and excellence.
DRP II offers wholesalers and distributors a fresh approach to running the
supply chain that is fully compatible with today's newest Web-based technol-
ogies. Both as a management philosophy and as a suite of integrated business
applications, DRP II permits distribution companies to synchronize demand
and supply up and down the channel network and link their planning systems
with the EIS functions of customers, suppliers, manufacturers, and retailers.
Such approaches enable entire supply chains to compete as if they were a
single, seamless entity focused on cost reduction and superior customer
service.
EIS CONNECTIVITY TOOLS IN THE AGE OF e-BUSINESS
While the various forms of today's EIS provide manufacturers and distribu-
tors with effective technology tools for the management of the internal and
external functions within the enterprise, the third dimension of information
technology, the application of connectivity technologies, is providing
companies with the ability to link in real-time demand and supply functions
directly with customers and suppliers. In the past, even the most technology
savvy company was constrained by the inability of computerized applications
to connect and synchronize the vital information passing between customer
and suppliers out in the business network. Even simple data components, like
inventory balances or forecasts, were communicated with great difficulty to
sister warehouses or divisions, let alone to trading partners whose databases
resided beyond the barriers of their own information systems.
Electronic Data Interchange (EDI). The first major technology breakthrough

was the use of EDI to enable the company-to-company transmission of data.
EDI constitutes today's most widely used method of supply chain connec-
tivity. EDI provides for the electronic transmission of such critical supply
chain transactions as planning information, customer orders, invoices, ship-
ping notices, and payment. Architecturally, EDI is an extranet application
consisting of a computer-to-computer linkage whereby information driven by
a mutually agreed upon set of data transfer standards is transmitted between
trading partners via private value-added networks (VANs). A critical ad-
vantage of EDI is that the technology permits electronic data transfer between
transacting companies that are using EISs running on different software sys-
tems and hardware. The EDI standards function like a "translator" the enable
disparate systems to "talk to each other."
The importance of the use of EDI as a technology that enables companies
to escape from the barriers of their internal IS solution can be seen in its
various benefits [6]:
Increased communications and networking. By enabling channel part-
ners to transmit and receive up-to-date information regarding network
business processes electronically, the entire supply chain can begin to
leverage the productivities to be found in information networking.
Streamlining business transactions. By eliminating paperwork and
maintenance redundancies, EDI can significantly shrink cycle times in
a wide spectrum oftransaction processing activities.
Increased accuracy. Because transactions are transferred directly from
computer-to-computer, the errors that normally occur as data is
manually transferred from business to business are virtually eliminated.
Reduction in channel information processing. EDI provides for the
removal of duplication of effort and acceleration of information flows
that can significantly reduce time and cost between supply channel
partners.
Increased response. EDI enables channel members to shrink process-
sing times for customer and supplier orders and provide for timely
information that can be used to update planning schedules throughout
the channel.
Increased competitive advantage. EDI enables the entire supply net-
work to shrink pipeline inventories, reduce capital expenditure, im-
prove on return on investment, and actualize continuous improvements
in customer service.
While providing obvious benefits, there are, however, some serious draw-
backs to ED!. To begin with, the technology is expensive and time-con-
suming to implement. Companies must agree upon the use of a transmission
standard, often in itself a daunting task. Next, companies will have to
shoulder the cost for hardware and software, and then they must begin the
process of data-mapping and architecture design. Once in place, companies
must then be prepared to pay for recurring costs associated with on-going
modifications and upgrades to hardware and software. In addition to the
costs, there are serious deficiencies in the capability of EDI to support real-
time information processing. EDI works by transmitting whole packages of
information, versus a continuous data stream, that may often take several
days for transmission, translation, and receipt from one trading partner to
another. While it enables partners to improve on transactional elements, its

high costs and proprietary nature render it a poor channel planning tool.
Rise of Internet Connectivity. By the late 1990's a new technology tool, the
Internet, had begun to fully emerge with the potential to achieve the level of
information connectivity necessary to link supply chains anywhere, at any
time on the globe. Fueled by the explosion in personal computer (PC) owner-
ship, advancements in communications technologies, and the declining cost
of computer hardware and software, companies quickly became aware of a
new information integration medium that would sweep away the previous
limitations governing the flow of supply chain products and data. The rise of
modem information system connectivity is portrayed in Figure 14.6 and is
briefly described below [7].
Global
knowledge/compet-
encies exchanges ,
interoperative value
-- -~b~~~ --- -1- _
B2B model,
CRM,ERP
I!! integration,
~ ~al~e_cE~~ __ y -_ _
Ifi Transactions,
customer
~ interaction,
~ _ _~~.?~~l~~t~o~_
If Marke ting, product
~ catalogs - sta tic
;; content
U
'1: _
Orders, invoices,
ASNs . billing,
documentation
ED! Internet e-Commerce e-Business e-Collaboration

Mar keting
Connectivit y Technology
FIGURE 14.6 Phases of Web-enabled e-business ,
Phas e 1: ED!. The application of the Internet to EDI has enabled a re-
surrection of traditional EDI, extending its capabilities through the ap-
plication of Web-based technologies that increase automation and ef-
ficiency while augmenting its benefits and overcoming its short-
comings. Simply, Web-based EDI can be defined as using the Internet
instead of VANs to send transactions accessed by the receiver using a
PC and browser. There are several advantages. First, using the Internet
is a much cheaper technology alterative to implement and maintain.
Second, the use of extensible markup language (XML) cuts transaction
costs by enabling parties to connect directly without VANs, which re-
quire both parties to pay for each communication. Third, since tools
like Java enable Internet applications to be reusable, Web-based EDI
possesses virtually unlimited scalability. Fourth, Web-based EDI is
more flexible and easily adapted to different business models and sys-
tem infrastructures . Fifth, the Web enables the structuring of a central-
ized many-to-many point of contact that facilitates supply chain col-
laboration and provides the basis for the creation of new forms of chan-
nel models, such as vertical marketplaces and trade networks. While
the immaturity of XML standards at this point in time guarantee the use
of EDI for the immediate future, it is destined to die as new Internet
technologies evolve that yield capabilities and levels of efficiencies
beyond their current scope [8].
Phase 2: Internet Marketing. The first pure use of the Internet for busi-
ness purposes occurred in the early to mid-l990s and took the form of
using the Web as a source for marketing products, services, and com-
pany stories. In the past, businesses were forced to utilize expensive
advertising, printed matter such as catalogs and brochures, trade shows,
industry registers, promotions, and direct sales that represented a
physical and passive approach to marketing. The application of the
Internet revolutionized this concept of marketing. Internet marketing
enables marketers to place information about their companies on the
Web where they can be easily searched for and accessed actively by
prospects anywhere, at anytime around the world utilizing relatively
simple Internet-based multimedia browsing functions. Today it would
be hard to find a company, both large and small, that does not have an
Internet marketing site.
Phase 3: e-Commerce. While Internet marketing sites provide informa-
tion about company products and marketing strategies, they were never
designed to allow browsers to actually order products and services
through the Web site. During the mid- to late-1990s, a new type of In-
ternet site began to emerge - the pure-play Internet storefront or (B2C) -
designed specifically to sell and service customers on-line. By the end
of the decade, on-line e-tailers like Amazon.com, eBay, and Price-
line.com were offering Web sites that combined Internet marketing, on-
line catalogs, and advertising with order management functions, such as
site personalization, self-service, interactive shopping carts, and credit
card payment, that provided actual on-line shopping. While the rise
and fall of the dot-com mania severely injured the budding industry and
exposed its weaknesses , the pure B2C trading exchange has provided a
virtual revolution in customer-supplier connectivity by combining ease
of shopping via personal PC with an immediacy, capability for self-ser-
vice, access to a potentially limitless repository of goods and services,
and information far beyond the capacities of traditional business
models.
Phase 4: e-Business. By the year 2000, a new Internet approach that
sought to utilize the interactive and integrative power of the Web to
connect companies began to emerge. The differences between e-com-
merce and e-business are pointed. To begin with e-business is focused
on using the Web to construct e-marketplaces for transactions between
businesses (B2B). Second, the business relationship established is dif-
ferent. Instead of a focus on the consumer and creating brand (Internet
site) loyalty, B2B resembles traditional purchasing in that the goal is to
use the Web to generate long-term, symbiotic, collaborative relations
between businesses through the deployment of real-time connectivity.
B2B relationships can be divided into three types: independent trading
exchanges (ITX) composed of buyers and sellers networked through an
independent intermediary focused on spot purchasing; private trading
exchanges (PTX) defined as a single trading community hosted by a
single company that requires collaborative membership as a condition
of doing business ; and consortia trading exchanges (CTX) whereby a
few powerful companies organized into a consortium establish a
trading group consisting of the collective supplier base.
Phase 5: e-Collaboration. For the most part, the e-business solutions
that have arisen around the tum of the twenty-first century have been
primarily focused on facilitating the flow of information and trans-
actions across the supply chain. In contrast, e-collaboration attempts to
extend the capabilities of the Internet to closely network customers,
information, core competencies, and people, process, and inventory re-
sources. In place of the traditional linear supply chain, e-collaboration
calls for the generation of value webs described as any-to-any con-
nections that can drive procurement webs, manufacturing webs, and
even linked business strategies. The goal is the architecting of real-
time, integrated Web-based connectivity that permits supply chain
members to share their planning systems and core competencies
directly wherever they are located on the globe.
While the bursting of the dot-com bubble has tempered the once unbridled
enthusiasm for e-business, beneath the hype and misunderstandings there are
a lot of benefits companies can take directly to the bottom line. The range of
benefits can be detailed as
Increased choices for customers, larger markets, and better prices

Increased order processing, purchasing, and selling efficiencies
New forms of customer service customization
Radically new concepts of market segmentation that seek to match
product and service value to specific customers
Increased collaboration among buyers and suppliers integrating product
design, forecasting and planning, marketing campaigns, and product
life-cycle management programs
Generation of synchronized supply chains where total channel demand
and supply information can be driven simultaneously across the entire
value chain resulting in increased inventory turnover, faster product
introduction, lower channel WIP, and lower total channel costs.
While the capabilities of e-collaboration are limited by the scope of today's
technologies, there can be little doubt that future e-businesses will possesses
tools to effect closer integration and synchronization of value producing
resources.
INFORMATION TECHNOLOGY SOLUTIONS
The deployment of JIT/Lean, quick response (QR), and Internet-enabled ap-

plications to manage supply chains, coupled with the explosion in compu-
terized tools, have provided companies with an array of organizational and in-
formation technology choices targeted at increasing supply channel produc-
tivity and serviceability while reducing total costs. The ability to properly
align information technology and new performance objectives requires
strategists to closely match channel management goals with the capabilities
of the technologies available. In weighing the decision to acquire new
technology, strategists must find answers to such questions as the following:
What is the nature of the internal and external information require-
ments of the enterprise necessitating a change in the manner by which
information is currently processed?
Is the decision to expand information capacities governed by a desire to
automate or to activate and empower the whole enterprise?
Of the many business areas, where should technologies be applied first,
and which areas will provide the largest competitive boost for the
expense?
What impact will the implementation of new information technology
have on the customer service, logistics, and financial functions of the
current organization?
What will the implementation of new technology cost in terms of
resources and operational trauma to the existing organization?
How is new technology to be integrated with legacy systems?

What new resources will be required to operate the new technology?
What new opportunities for competitive advantage will be available to
the enterprise?
In responding to these and other questions, strategists must first thoroughly
understand the scope and nature of the possible technical solutions available
before deciding on the proper solution.
.....~~
UES iGoes Wire-Free

.. !in;'
United Parcel Service Inc. plans to Inc. that use Bluetooth wireless
invest in wireless technology for its technology. Smaller hubs will get
1,700 hubs worldwide, including its the devices first, UPS manager
new S I billion Worldport air trans- Donna Barrett says. so UPS can
portation hub at Louisville Inter- work out any kinks before deploying
national Airport in Kentucky, where the technology at Worldport. The
304.000 packages are sorted per current technology is cumbersome
hour. In June 2003 , UPS will start a and the wires often break , the carrier
$20 million project to rep lace wired says, adding that wireless tech-
scanners. used to record package- nology is now mature enough to
tracking data. withy 55.000 devices handle UPS's huge workload .
from Symbol Technologies
IDENTIFYING INFORMATION SYSTEM SOLUTIONS
Enterprises seek to acquire information technology to solve a broad range of

opportunities for improvement. Most problems experienced by companies
are universal and can be found at the core of productivity and performance
deficiencies in just about any business system. The requirements are
familiar :
Faster customer order turnaround time
Continuous reduction in inventories and carrying costs
Increased information accuracy
Better equipment utilization and reduced labor costs
Reduction in transportation costs
Closer integration of business functions
Reduction in capital investment
Closer integration with supply chain partners
Doubtlessly this list could be expanded to cover the myriad of other problems
that contribute to rising customer complaints, shrinking profit margins, and
loss of business to competitors.
While the implementation of information systems can assist companies

solve a host of operational impediments to productivity, it also holds out op-
portunities for strategic advantage. Several key enablers come to mind.
1. Lowering cost and improving productivity. As stated above, informa-
tion technologies can lower costs and improve productivities in any
part of the value chain. Historically, technology has always been ap-
plied to reduce the cost of activities subject to repetitive information
processing. The advent of networking technologies, however, has em-
powered technologists to not only search for cost and productivity dri-
vers through activity automation, but also to expand the information
content of the activities themselves. In this sense, information systems
cannot only help a company function more effectively, it can also ex-
ploit advantages in competitive scope.
This dynamic can perhaps best be seen by contrasting operations in a
manual or batch-oriented warehouse and the opportunities offered by a
real-time integrated processing system. In a batch environment, cus-
tomer order processing generates orders which are passed to the ware-
house for picking and shipping. Normally, orders arrive with little lo-
gic as to how they are to be picked or consolidated. In addition, be-
cause receiving and order promising are not integrated, stock could be
temporarily located on the dock or in staging areas waiting put-away
and is unavailable for order fulfillment. In contrast to this chaos, a
warehouse possessed of an integrated, real-time system would have
portable terminals that communicate with the central computer via
radio frequency. Orders would be released to warehouse pickers based
on such criteria as the shipping departure time of the carrier trans-
porting the product to the customer, classification by order quantity or
dollar size, and the availability of picking and packing resources. Pro-
ductivity can be astounding. One company that possesses four distribu-
tion centers and processes between 1800 and 2700 orders daily has re-
ported that real-time warehouse tools permit the company to ship 96%
of its orders by noon, and every rush order by 3 P.M. Shipping ac-
curacy has approached zero-percent defects, while receiving to put-
away time has been reduced by 12 hours [9].
2. Enhancing strategic differentiation. Information technology has the
power to leverage cost, differentiation, and focus strategies focused on
a company's products. By shortening the order processing and delivery
cycle and providing customers the ability to customize their product re-
quirements while reducing lead times and increasing the speed of infor-
mation transfer through EDI or Web functions, companies can improve
product positioning. For example, a Fortune 500 manufacturer needed
to get inventory to meet customer requirements from its domestic and
foreign warehouses when and where it was needed. The implementa-

tion of a logistics system enabled the company to achieve a single de-
livery solution through an in-transit merge program. Information on the
sales order is sent electronically to the system, which, in turn, allocates
specified products from different locations as they are ready, "merging"
the sales order for delivery at the point closest to the final delivery
destination [10]. Technologies can also enhance the performance of
value-added services such as inside delivery, installation, kitting, and
crating that increase marketplace differentiation.
3. Broadening competitive scope. The effective implementation of en-
abling technologies can also provide the enterprise with an opportunity
to broaden the competitive scope of operations and, by extension, alter
the reach of competitive advantage. Besides increasing the ability to
coordinate activities on a global scope, technologies can assist a
company to penetrate new markets and offer value-added services
beyond former capabilities. Consider Dell Computer's distribution
strategy. By selling to customers directly, building to order rather than
to inventory, and integrating its logistics functions with its suppliers,
Dell has been able to revolutionize the way pes are made, marketed,
and financed. Dell's competitive advantage rests on an organizational
culture that optimizes and streamlines operations and management
systems driven by integration, reliability, and high-speed transactions.
EVALUATING INFORMATION TeCHNOLOGY SOLUTIONS
While technology can provide the enterprise with the ability to achieve order-
of-magnitude breakthroughs in productivity and competitiveness, strategists
must be careful to match technology solutions and business scope. Perhaps
the first action to be undertaken is identifying clearly the scope of the busi-
ness problems to be solved. This step will significantly narrow the range of
possible solutions. An effective requirements definition will greatly assist
companies to avoid critical errors, such as buying technology that is overkill,
does not address the critical issues, or narrows future technology options be-
cause of hardware or software enhancement limitations. In addition, the re-
quirements definition will determine whether the company wishes to merely
automate activities that are currently being done manually or open net-
working capabilities to a group of business functions or to the whole enter-
prise. This determination is critical. The cost and impact on the organization
to automate activities is significantly less than it is to integrate business
functions. The following five steps can assist enterprises in leveraging the
range of technology solutions for competitive advantage [11].
1. Assess information intensity. Before a solution can be effectively

chosen, companies must evaluate the existing and potential information
intensity of its products and operations processes. The objective is to
determine the breadth of the information required both to run the sup-
ply chain and manage product and service processes. The former inclu-
des the number of customers and suppliers in the channel, scope of
marketing and selling information, number of product variations and
depth of product variety, and length of cycle times. The latter includes
product related issues such as complexity, requirements for buyer
knowledge and training, and the ability of the product to service alter-
native uses. Technology solutions should enable the enterprise to lev-
erage product and process information content to achieve marketplace
leadership.
2. Industry impact. Companies must closely examine the impact of the
introduction of new technologies on marketplace competitive forces.
Technology can dramatically alter a firm's bargaining power with sup-
pliers, ability to offer new products and substitute products, and capa-
bility to fight off new as well as existing competitors. Effective tech-
nology strategies can enable a company to seize marketplace leadership
and force competitors to follow. Costco, the chain of warehouse club
stores, uses its information systems to track product movement to
ensure that new products are integrated with successful existing lines to
provide customers with the assortments they want. These data also
drive stocking decisions that optimize floor space usage.
3. Search for ways technology can increase competitive advantage. By
targeting activities that represent a large proportion of supply chain
costs, are critical to marketplace differentiation, or compose critical
links internally and externally within the supply channel, technology
can assist companies to identify new avenues for sustainable com-
petitive advantage. In addition, technology provides the opportunity
for strategists to explore changes in competitive scope. Does the solu-
tion permit the enterprise to enter new market segments or invade the
preserve of strong niche players? Will the solution enable the com-
pany to compete globally or to exploit interrelationships with other
industries?
4 . Investigate how technologies can spawn new industries. Information
tools can spawn new businesses by diversifying existing organizations.
Can a company's technologies provide sources of information or pro-
cessing capabilities that can be sold? Does the solution enable the
development of ancillary products that complement existing product
lines? Take, for example, North American Van Lines who has created
an information services and logistics software business that is compli-

mentary to their traditional product and services strategy.
5. Develop a long-term plan that seeks to continuously leverage new
information technologies. Strategists must be diligent in instituting a
formal methodology for the on-going review of new technologies, the
strategic alignment of business opportunities and new technology tool-
sets, the investments necessary to implement new hardware and soft-
ware, and the impact technologies will have on supply chain linkages.
Successfully enhancing competitive positioning can no longer occur
simply by entrusting the exploration of new information technologies to
the firm's chief informati on officer (CIa). Tomorrow's successful com-
panies will require the participation of all functional levels both within
the organization and outside in the partner channel if business technol-
ogies tools are to be effectively utilized.
A possible method that can be used to match business information needs
and available technologies is to chart out the critical relationships between
the level of business functionality and the scope of planning and control in-
formation desired. Such a chart can be found in Figure 14.7. Along the verti-
Integration.
Synchronization
Supp ly Cftain
Supply Chain
Plan '
Annual . fSS
BUSln '
Plcln
Monthly S&OP I
I
DRP, Itftentory
Weekly Capacity Plan peployment
.. .. .. .... .. .. .. .. .. .. . .. ... .. ... . .. .. .. .. .. .. .. .. .. .. .. .. .. . ........ .. .. .. .. .. ... .. .. .. .. .. ....... .. .. .. .. ... .. .. . .. . .. . .. .. .. .. .. p ..
Automation
, ,,"
Order Purchasing, Performapee Customer
Daily Activities Management, AP/AR, ,, Service,
'"
Shipping/Receiving VAP
..... '" ... '" Performance
Data
Collection _ _ ...-
...... ... ... ...
Minutes
-- --
Daily Functional Enterpri se Integrated
Activities Area Value Chain
FIGURE 14.7 Charting busine ss and technology solution requirement s. [Adapted
from Ref. 12]
cal axis can be found the type of information processing required. On the
lower end of the scale can be found information that is transaction based,
such as order entry or accounts receivable, and occurs in the immediate time
frame. As the vertical axis is ascended, information requirements move more
into the realm of planning and control, concluding with strategic channel
planning. Correspondingly, the information time frame moves from the short
term to the long term. The horizontal axis details the level of business func-
tion, beginning with technologies seeking to automate and accelerate the pro-
cessing of daily activities and progressing through functional area, enterprise,
and integrated supply chain information management needs. The curve in the
diagram represents the relative cost and time required to implement targeted
technologies .
MAKING TECHNOLOGY CHOICES
In this section, three possible technology solution choices will be examined.

The first examines the application of technology to automate business activi-
ties targeted at increasing speed and accuracy. The second examines the ap-
plication of technology to integrate a group of homogeneous business areas.
Finally, the third examines the requirements and ramifications of integrating
the entire enterprise with the implementation of a full EIS.
Automation. The idea of applying tools that ease or facilitate work has been
in existence since ancient times. Aristotle in his Politics dreamed of a world
where work could be performed by the object itself on command or in intel-
ligent anticipation. However, the removal of physical drudgery is not the
only reason for automation. When human skills are applied to highly repeti-
tive tasks or activities that require a great deal of precision, variation in out-
put quality is inevitable. Automation attempts to solve this problem by sub-
stituting technology for humans to perform the work. Machines never tire,
are unimpeded by personal concerns, and will faithfully execute their tasks
according to their designs. Although it is true that machines suffer from a
lack of flexibility and cannot exceed the boundaries of their capabilities,
work flows can be redesigned that optimize their functionality. Overall, the
decision to implement computer software targeted at automation represents a
tactical move to either gain additional productivity and quality or to cut the
cost of an operation in a workflow process.
An example of the application of the principle of automation can be found
in the decision of the Burnham Corporation, a leading manufacturer and sup-
plier of hot water and steam boilers, to install a PC-based item and order
verification system. Because of the length of the sales cycle involved, price
of the product, and cost of transportation, the company needed a way to
reduce or eliminate misshipments and incomplete orders. The company nor-
mally processes over 2500 orders yearly, ranging from orders as large as 200
boilers to small replacement parts. In the past, orders had to be pulled,
staged, and serial numbers painstakingly recorded before loading. Today,
customer orders are downloaded from the company business system into the
PC verification system. The PC system, in tum, generates picking lists and
bar codes. Picker teams, equipped with handheld radio-frequency (RF) scan-
ners, then scan their own bar-coded badges and the bar-coded order number
on the pick list. As each product is picked, it is scanned and loaded. When
the loading is complete, the system closes out the order file on the PC and
signals the shipping clerk that a final bill of lading can be printed for the
freight carrier [13J.
The implementation of information technology to automate an activity or
group of activities is a fairly straightforward process. The objectives, bene-
fits, and payback period of the project are relatively easy to calculate; so are
costs, such as equipment, training, maintenance, and supplies. What was re-
quired at Burnham was expenditure for the PC and RF equipment, program-
ming to interface the company's business system and PCs, and a little
training. In addition, the impact on business operations was localized in the
company's picking and shipping departments.
Partial System Integration . The application of the next level of information

technology involves integrating a homogenous group of business functions.
This level of information technology is significantly more complex than
simply automating activities and is designed to propel a targeted group of
contiguous business functions and operations onto a new plane of perfor-
mance. In this sense the application of technology focused on a partial busi-
ness functional integration is both a tactical decision intended to increase op-
erational productivity and a strategic decision centered on the search for com-
petitive advantage. The functionality of the software will not only increase
productivity and/or eliminate the cost of an operation, but it also will provide
the business areas affected with the opportunity to change and improve the
entire process. By integrating functions, the software will provide users with
the ability to link information together to provide new levels of performance
and productivity.
Several points need to be discussed at this juncture. Although accelerating
the performance of an operation, automation will not significantly impact the
performance of a business process as a whole. For example, whereas EDI
will enable customers to transmit order information faster, unless the entire
organization can respond at the same speed, the customer will most likely not
experience any significant decrease in delivery time. Although it is true a tar-
geted business function will enjoy varying levels of increased productivity as
a result of automation, the real objective of implementing an integrative tech-
nology is to provide a mechanism whereby functions along an information
chain can perform not only one particular operation of an activity better but
the entirety of the activity better, as well as other activities that intersect it.
This integration of activities enhances connectivity and synchronization,

whereby the level of performance of one activity drives information automa-
tically into and increases the level of performance of other activities. Auto-
mation provides a business function with the ability to leverage technology to
achieve incremental improvements to operations; integration, on the other
hand, enables order-of-magnitude breakthroughs in the processes by which
the company does business.
An excellent example of partial systems integration is the implementation
of applications targeted at computerizing a finn's financial functions . As il-
lustrated in Figure 14.8, the functions to be implemented are general ledger,
Ge neral
Ledger
System
t
_ _J
Bounda ry
I I I
Accounts Accoun ts
Payroll
Payable Receiva ble
------lr---------- ------f ----------------t-------

Purchasing/Receiving Shipping/Invoicing Employee Reporting
Interface Interface Interface
FIGURE 14.8 Financial system implementation.
accounts receivable, accounts payable, and payroll. Architecturally, the four

modules are linked together by interactive programs and a common database.
Receivables, payables, and payroll information outputs, for instance, are
driven directly into the general ledger module . Inputs into receivables, pay-
ables, and payroll come from activities occurring in their respective down-
stream functions . The difference between the information that flows into the
general ledger and the information that flows into receivables, payables, and
payroll is that the former is integrated, whereas the latter is interfaced. For
example, by running a processor summary account information from
receivables will automatically update account values in the general ledger. In
contrast, purchasing/receiving information will have to be manually keyed or
loaded through a programmed interface into payables.
The benefits of a partially integrated system occur on two levels. In the
first, business functions can leverage computer functionality to automate ac-
tivities. For example , payables personnel can automatically generate checks
for supplier payment, review the current payables aging report, check on open
account statuses, perform check reconciliation, and execute other functions.
The degree of the benefit of the automation depends on the level of a business
function's dependence on manual processes. The real value of the system,
however, can be found in the ability of the organization to integrate infonna-

tion both within the function (i.e. payables, receivables, etc.), and among the
business areas constituting the information system. Instead of a fragmented
set of business functions, each bounded by the constraints under which each
operates, an integrated system brings individuals and functions together by
putting each in touch cross-functionally, by activating and linking together
creative thinking within and between people and functions to respond to
whole challenges and opportunities . A partially integrated computer solution
will provide those business functions involved with the capability to act and
make decisions, not as separate entities but as a networked group with a com-
mon set of goals and measurements, drawn together by common data and re-
quirements for interactive participation.
The selection and implementation of a partial systems integration project is
significantly more difficult that an automation project. To begin with, the
benefit and payback period are more difficult to calculate . Because the real
benefits arising from the technology are to be achieved from the integration
of information and functions, performance metrics are more difficult to estab-
lish and measure . Second, because the technology will in some cases drama-
tically change the way employees have traditionally performed their jobs, the
costs associated with conceptual as well as functional training, current opera-
tions diagnostics, database loading, systems testing, and policy and proced-
ural development will be high, as much as 50-100 percent or more of the
original hardware and software purchase cost. In addition, a high level of dis-
ruption in operational productivity and performance is likely to occur during
the implementation life cycle. Finally, because a number of the inputs neces-
sary to feed the system will come from areas outside of the system, signify-
cant attention must be paid to interfacing outside manual or automated busi-
ness functions .
Business System Integration. The most complex application of information

technology is to extend the structure and benefits of business system technol-
ogy to encompass the entire enterprise. In practical terms, this means that not
just a portion but all of the functions of the business, from purchasing and in-
ventory control to forecasting and general ledger, are integrated into a single
E1S. The goal is to place enterprise processing and decision-making in a
common database that is shared by all users. As such, implementation of an
E1S represents a strategic decision on the part of management to provide the
enterprise with the potential to catapult the entire organization onto new
planes of competitive advantage made possible by a fundamental change in
the speed and accuracy by which information in the organization is as-
sembled, processed, and disseminated . A possible schematic of an EIS can
be seen in Figure 14.4.
Similar to a partial system implementation, the benefits of a fully integra-

ted EIS occur on two levels. The functionality offered by the software pro-
vides each business area with new opportunities to streamline workloads and
eliminate wastes and redundancies in information processing through automa-
tion. However, the real benefit of the system is found in the utilization of in-
tegrated information both within each function and between the entirety of
the enterprise. An EIS seeks to link not only homogeneous business areas to-
gether, such as financials, but also heterogeneous business areas, such as in-
ventory, sales order, purchasing, and value-added processing. Finally, by
creating a common community of users, each interdependent on the participa-
tion, knowledge, and information inputs found in the system, the enterprise as
a whole can move to a higher level of coordination, service, and performance
measurement.
By extending the information system to the whole organization, the selec-
tion and implementation of the software becomes exponentially more difficult
and contains enormous risks as compared to a partially integrated solution.
Besides the cost of the hardware, software, and equipment, the demands
placed on the user community during a full business system implementation
can be overwhelming. In a partial implementation, normally a horizontally
organized group of business functions, such as the financials, are involved.
The operating principles and user skills and knowledge represent a fairly fo-
cused and homogeneous group that can be readily retrained and quickly
oriented to the new system. A full business system implementation, on the
other hand, requires training and integrating functions that run vertically
through the organization. Problems arise when conflicting business area ob-
jectives, levels of education and training, and variances in the current level of
functional automation must be elevated to a common plane so that the soft-
ware can link the actions and goals of each area cross-functionally. In ad-
dition, the length of most implementations, extending normally a year or
longer, can significantly drain the enthusiasm of the user community, divert
critical resources, and disrupt the pursuit of other corporate strategic
objectives.
IMPLEMENTATION ISSUES
The decision to undertake the implementation of information technology is a

critical one for the organization. Whether it is automation, partial system, or
full EIS, success depends on thorough planning, design, and commitment
from all enterprise professionals from the president to the loading docks.
According to Walton [14], there are three fundamental processes essential to
the success of any information technology project:
Alignment. This process is concerned with the ongoing alignment of

enterprise business, organizational, and technology strategies during the
course of the implementation. As the implementation moves succes-
sively through each part of the implementation life cycle, the alignment
process must focus on developing and sustaining a management context
where technology , business , organizational, and operational strategies
are kept in alignment.
User commitment and ownership. This process has two closely inter-
woven themes. The first is establishing and developing a strong sense
of commitment on the part of users and management to the system.
The second is nurturing a sense of system ownership. Without the
existence of these two conditions, an implementation will never
achieve the expected improvements nor will it provide the stimulant for
the organizational change necessary to engineer fundamental improve-
ment in operational processes.
User compe tence and mastery. Implementation objectives are met
when users utilize the system to create higher levels of operational
competencies that permit the broadening and deepening of enterprise
capabilities. An acceleration of information flows requires manage-
ment to continuously reinvestigate and realign original business, opera-
tional, and technology strategies that more closely mirror competitive
advantages.
Lack of development in anyone of the three processes is fatal to the realiza-
tion of information system potential. Without proper alignment efforts
focused on commitment and system mastery, the new system will be mis-
directed and still-born. Without a sense of full enterprise commitment, sys-
tem mastery will always lag behind strategic objectives. Finally, without sys-
tem mastery users will never realize full system potential.
PART 1: ALIGNING INFORMATION TECHNOLOGY AND COMPANY

STRATEGIES
The starting point for any information technology project is to, in effect, un-
fold a broad vision of the goals to be pursued and how the integration of tech-
nology and organizational strategies will assist in the pursuit of those goals.
It is critical, therefore , that before a technology solution search begins, top
management clearly articulates a comprehensive strategy to align the enter-
prise business vision, organizational goals and values, and information sys-
tems. The objective is to activate thinking among the management team con-
cerning the development and communication of a coherent strategy detailing
the expectations and anticipated opportunities. This strategy should include
such elements as a clear definition of enterprise strategic priorities, organi-

zational structure and values, operational implications, and appropriateness of
the proposed system to the culture and objectives of the firm.
Perhaps the most difficult task at this juncture is defining business objec-
tives to be achieved by the implementation. Normally, firms begin a software
search in response to problems occurring at two levels :
1. Strategic objectives. On this level , companies are searching for sys-
tems to provide solutions to broad enterprise problems regarding com-
petitive positioning, sales and marketing objectives, products and ser-
vices, financial capacities, and marketplace realities. These strategic
problems influence the performance of the enterprise on the macro
level and cut across all bus iness functional areas. An example of a
strategic objective would be increasing enterprise profitability by
decreasing total logistics costs and increasing sales.
2. Tactical objectives. Solutions on this level are focused on increasing
functional or business area performance and productivity. These
objectives can be attained either through automating activities or inte-
grating members in a business area or group of business areas . Exam-
ples of tactical objectives would be decreasing transportation costs , re-
ducing warehousing storage costs, increasing the speed of customer de-
liveries, and reducing purchasing costs.
As can be seen from the above objectives, in many cases managers can de-
fine goals that in reality have conflicting strategic and tactical objectives. No
one would disagree that a business strategy whose objective it would be to in-
crease profit while reducing costs constitutes a sound corporate mission.
However, on the tactical level, pursuing such a strategy often results in
counterpoising tactical objectives. For example, achieving higher sales while
reducing costs means that, while sales and service are increasing, the cost of
logistics is decreasing. Conflicts can arise as each business function employs
the system to realize tactical objectives. Sales and service fear that as inven-
tory, warehouse, and transportation costs decline, so will their ability to re-
spond to customer requirements. On the other hand, logistics assumes that as
sales and service pursue higher levels of sales and delivery, they will be
forced to increase their operational costs. Resolving these dichotomies be-
tween strategic and tactical objectives is critical to a successful system imple-
mentation. The goal for implementers is to ensure that enterprise strategic
and tactical goals are in alignment with and supportive of one another. If sys-
tem strategies are directed narrowly on improving the performance only of
tactical functions or on too broad of an enterprisewide perspective, the ex-
pected value of the technology solution will never be realized.
PART 2: SELECTING TECHNOLOGY SOLUTIONS
Once an effective technology strategy has been designed, the next task will be
to find the appropriate system solution. In selecting an information system
solution, implementers have two basic alternatives. The first method is to de-
velop the system in-house using internal management information and opera-
tional staffs. Whether the solution consists of an automation project or the
implementation of a full EIS, there are a number of pros and cons to this ap-
proach. To begin with, developing solutions in-house involves a great deal of
time. Developing and executing a fully integrated EIS, for example, is a
multiyear project that involves a tremendous commitment of organizational
resources . In the end, the cost of development and implementation may far
exceed the cost of purchasing and implementing a packaged system. Second,
a significant danger encountered in in-house development projects is
spending enormous resources on functionality that currently can be found in
commercial packages. Although in-house development will result in a system
that has been custom-fitted to the needs of the organization, design teams may
find themselves rediscovering all the mistakes that software suppliers had
made and solved years ago. Third, even the best run systems development
project may not succeed in realizing the original business objectives. One of
the benefits of a commercial package is that it can be seen in operation in
existing customer sites. Finally, applications developed in-house reflect the
needs of the organization as it exists today. As time and the needs of the
enterprise move forward, however, software that once answered business
information requirements can become obsolete. In addition, home-grown
software must be able to change to meet the rapidly developing technology
environments of tomorrow.
The second method of acquiring technology systems is to purchase them
from a software supplier. In today's current marketplace there are literally
hundreds of technology companies marketing products designed to service
every industry. They range from very small PC software companies offering
low-cost products targeted at specific business needs, such as EDI and freight
rating systems, to full-blown integrated manufacturing and distribution
resource planning systems that also possess the ability to network with other
systems. In today's technology environment, most of these suppliers offer
applications that are based on open systems principles and are designed to
work through Internet technologies without dependencies on proprietary
hardware .
The advantages of using commercial software are the immediate avail-
ability of applications that are compliant with today's state-of-the-art technol-
ogies, portability of most packages to migrate across hardware platforms and
database management systems, and availability of maintenance, support, en-

hancements, and documentation. The disadvantages are the need to modify
applications to fit internal processes or development of whole new functions
not supported by the package, high cost of training and implementation due to
the number of applications and complexity of functionality, and, finally, the
trauma often experienced by internal technology groups who must often learn
new programming languages, networking, and system administration func-
tions.
The final activities in software selection revolve around live demon-
strations of the software. Some consulting firms recommend the use of
sophisticated checklists to compare suppliers' applications with the firm's per-
ceived functionality and technology requirements. A more important part of
the search process is gaining insight into the software and the supplier
through a series of well-constructed demonstrations. Effective demos consist
of both application as well as technical demonstrations. Application demos
will reveal such system attributes as easy of navigation, maintenance, entry,
inquiry, and reporting. Technical demos should be targeted to reveal system
architecture and programming standards. Perhaps the most critical aspect of
the demo process is positioning the firm's user base at the forefront of the
process. Their acceptance and buy-in are the foundations of implementation
success, and it should be their concerns and recommendations that are the
determining factors in the final selection.
PART 3: SOFTWARE IMPLEMENTATION
Once the technology solution has been chosen, the organization must turn its
attention to the task of system implementation. Many a top executive has as-
sumed that most of the hard work in implementing a system has been com-
pleted with the software selection and hardware installation. In reality, im-
plementing a system, and an EIS in particular, is one of the greatest chal-
lenges an enterprise can undertake. An implementation project requires a
great deal of time, effort, and expense on the part of the company and all of
its employees. Many times an implementation project is misperceived as
purely a computer system and properly the responsibility of the MIS depart-
ment. In reality, the implementation of business software presents the enter-
prise with the opportunity to streamline business processes and activate new
levels of competitiveness. To be successful, the implementation should be
considered as a formal management process consisting of the following pro-
ject elements:
Obtaining top management's commitment to the new system
Developing a strategic plan detailing project scope and objectives
Establishing a detailed and achievable project plan and budget

Executing a full education plan and conference room pilot test of the
software
Defining and performing necessary modifications
Conducting effective ongoing system performance measurements
The implementation process consists of four interwoven elements: people
resources; project control; hardware, software and data; and enterprise struc-
ture, policies, and procedures. The central requirement of a successful pro-
ject is to keep these four elements on track as the organization moves toward
successful implementation. ill managing this process of alignment, project
teams can utilize a number of management tools and techniques . Perhaps the
most critical of these is the structuring and publishing of a detailed project
schedule. The project schedule should consist of all the phases, steps, and
activities necessary to complete the implementation on time and within
budget. The project schedule should also time-sequence all implementation
tasks, specifying start and completion dates, responsible roles for task ex-
ecution, and all project budgets.
The second essential project management component is the establishment
of an effective project organization (Figure 14.9). Overall, it is the responsi-
Steering

Committee
Project Industry
~

Leader Consultant
Project

Team
I Project Resources I
FIGURE 14.9 Implementation project organization.
bility of the project organization to define the strategic objectives of the sys-
tem, provide funding and enterprise resources, execute the project schedule,
and review performance measurements. The project organization defines all
project roles and organizational structures necessary to execute successfully
the project schedule. The third component of successful project management
is the placement of project milestones at key junctures in the project's life cy-
cle. The purpose of the project milestone is to provide the project organiza-
tion with a measuring stick detailing implementation progress. Each mile-
stone contains a set of activities, beginning and completion dates, and project
roles. As each milestone is reached, the project organization should review
the costs, time, problems, and opportunities that have occurred. After review,
a plan detailing the steps necessary to achieve the next milestone should be
defined. The final component of project management is developing effective
project management skills and techniques that will assist in assigning, execu-
ting, and evaluating the success of project resources in performing project ac-
tivities and accomplishing tasks on time and within budget. Types of project
management techniques include project tracking, interviewing, analysis, con-
ceptual and technical design, development, and quality assurance.
PART 4: CONTINUOUS IMPROVEMENT
After completion of Part 3 of the implementation framework, the event must

be understood more as gateway than as an end point in exploring the use of
technology and the opportunities it provides to the enterprise. The avail-
ability of a business system does not automatically guarantee that the opera-
tional constituents will use it properly nor that it will activate an on-going
pro-cess of improvement and competitive advantage. In order to realize the
full value of any technology system, implementers need to constantly
reexamine and reorient the elements of the implementation management
processes stated above.
Alignment. Although a particular technology solution was chosen to respond

to particular strategic business and tactical needs, implementers can be as-
sured that the original objectives will shift over time. Change can come from
either the firm's strategic or operational sectors. A redirection of the enter-
prise's business mission, expansion in the distribution channel, or entry into
international trade, may require an overall restructuring of the original busi-
ness system. Just as important, shifting operational requirements may also re-
quire system modification. Such things as Internet technologies, interface
with third-party applications, and the automation of activities previously per-
formed manually will alter not only the way the system is currently being
used but also the level of user mastery and the way the system is applied to
enhance user performance.
Finally, the need for realignment may emerge out of the technology en-
vironment itself. This need for realignment can be the result of continuous
incremental changes or breakthroughs that permit the system to move to new
technological planes. For example, incremental functional enhancements to
the system may provide constituents with new opportunities to eliminate
costs and improve information throughput. On the other hand, advancements
in technology, such as the integration of intelligent workstations into a

client/server network, may provide new information technology vistas or
even obsolete current systems.
User Commitment and Ownership. Ideally, the commitment to and owner-

ship of the system on the part of the user constituency should have been
gained during Part 2 of the implementation framework and strengthened
during Part 3 with the final design and implementation of a solution that ful-
fills the needs of users and other stakeholders. In Part 4 of the implement-
tation framework, management must seek to confirm and extend this com-
mitment and ownership.
IT system implementations are always characterized by a spectrum of user
support. In most projects support for the solution proceeds essentially
through two stages. In the first, found during the execution of Part 3, the user
constituency can be divided into three groups: those who are committed to
the new system, the mass of the users who are uncommitted with a "wait and
see" attitude, and a small percentage of nay-sayers who feel the initiative will
be a failure. By the time Part 4 of the implementation framework is reached
this original division should be dramatically altered. The majority of users
should be fully committed and prepared to take ownership of the system.
Naysayers should have completely disappeared. The ability of management
to continually expand system commitment and ownership becomes especially
important as incremental and technological advancements change original
system objectives and the social contract between the user constituency and
the enterprise.
User Competency and Mastery. Earlier in this chapter it was stated that as
the functionality of the business system becomes more robust, the knowledge
and flexibility required of the user constituency to effectively utilize it grows
exponentially. With this fact in mind, the critical question then becomes,
"How can system users develop and expand system competency so that it is
operationally aligned, progressively owned, and increasing mastered?" Dur-
ing Part 3 of the implementation framework, users should have been closely
involved in system definition, exploration of system capabilities, and asses-
sment of potential system results, as well as determining regions for user
learning and self-management. In Part 4 of the implementation framework,
managers must be careful to develop metrics illustrating the skill gap be-
tween the user constituency and the operational requirements and po-
tentialities of the new system. The goal is to close this gap by illuminating
the alignment between the system and the business vision, ongoing training
and education, performance measurement systems, encouragement of user in-
novation, and participation in system functional evolution. This develop-

mental process is detailed in Figure 14.10.
C u r re nt

kills ct - Self-Lea r ning
Emcrging System Formal

~-

Competency Ed uca tion
IT Systcm
Development
User Syste m Formal

Mat urat ion Education
Continuously
Expanding User
Knowledge lind
Innovation
FIGURE 14.10 Developing system mastery and competen ce.
Regardless of the complexity of a given technology solution, implementers

must continually realign technology and the enterprise's strategic and opera-
tional objectives . Walton [15] has proposed an iterative process for ensuring
the alignment of IT and business requirements. As illustrated in Figure
14.11, the process consists of three elements. In the first, design/redesign ,
~ Evaluate!Reevaluate
New -jEvaluate
Business Needs & Expectations Introduc e!Operat e! Business
Vision Institutionalize V..
ISlOn
& ' Syst em Implementation &
Design/Redesign
Capabilities
Capabilities
Needs & Expectat ions Redes ign
implementers must seek to design systems that are in alignment with business
realities and enterprise strategic and operational goals. Once designed, the IT
system enters the introduce/op erate/institutionalize phase, in which the solu-
tion is applied to the business environment. Because no system design can be
considered as definitive , current design must continually be under a process
of evaluation/reevaluation . This process occurs because of changes to tech-
nology, enhancement to system functionality, or even rising user expectations
concerning system capabilit ies. Figure 14.11 is meant to illustrate both the
iterative nature of Part 4 of the implementation framework, as well as the

objective of attaining ever-expanding business system results.
SUMMARY
The application of computer technologies has caused a virtual revolution in

the concept and practice of modem supply chain management. In today's
business climate, the importance of timely, accurate, and complete infor-
mation has increasingly become the key enabler for marketplace advantage.
Internally, information technologies enable companies to develop databases
and implement applications that provide for the efficient management of
transactions and the timely collection, analysis, and generation of information
about customers, processes, products, and markets necessary for effective de-
cision making. Externally, information technologies enable strategists to
architect channel networks that are collaborative, agile, scalable, fast flow,
and Web-enabled. Actualizing the potential of today's technologies will re-
quire companies to move beyond viewing computers as purely a tool for
automating business functions. Increasingly, the real value of information
technology will be found in its ability to enable integration and networking
between channel trading partners that will provide for revolutionary capa-
bilities and competencies for the generation of new products and services,
whole new businesses and marketplaces, and radically new forms of com-
petitive advantage.
The ability to leverage the power of today's information technologies re-
quires a detailed knowledge of basic system architecture features as well as a
thorough grounding in the principles of modem system management. To-
day's system architectures consist of five basic elements: the database (the
static and transactional data captured during system processing); transaction
management (the performance and recording of daily operations); manage-
ment control (the performance feedback necessary for purposeful planning);
decision analysis/simulation (the use of modeling tools to manage complex
processes); and strategic planning (the development of long-term forecasts,
market approaches, and business partner alliances). Effectively utilizing
these general system features requires a firm grasp of the seven principles of
system management. Regardless of the scope of the technologies used or
their ultimate objectives, the effective operation of today's business appli-
cations requires accountability for the entry, maintenance, quality, and integ-
rity of data, transparency as to how the system works and can be applied to
the solution of practical business problems, accessibility to data and retrieval
utilities for reporting, a valid simulation of the way the business actually
works, flexibility to perform transactions or manipulate data, and the capa-
bility to use system exception messaging for the planning and control of busi-
ness management processes.
A critical characteristic of today' s enterprise business software is its ability
to be configured to meet any particular industry or specific business require-
ment. The goal of the system architecture is to facilitate, either through
existing application suites or through software partners, the creation of scal-
able, highly flexible information enablers that provide the business with the
capability to respond with customized customer value solutions and col-
laborative relationships at all points in the supply channel network. The con-
figured product must be capable of encompassing three possible solutions.
The first is concerned with solutions that integrate the internal data and pro-
cesses of an enterprise. The second is concerned with the availability of con-
nectivity tools necessary to link external parts of the enterprise together.
Finally, the technology solution must link the business with the customers
and suppliers constituting the supply chain network.
When exploring the application of technology solutions, implementers
must ask several critical questions focused on determining the optimal align-
ment of information tools and expected increases in enterprise productivity
and serviceability. Perhaps the most critical decision to be made at the begin-
ning of the technology search is clearly defining the scope of the business
problems to be solved. Successfully completing this step will narrow the
range of possible technology solutions and ensure the effort is focused on
core business issues. Equally as important is charting the effect the tech-
nology will have on the organization and its capabilities. In fact, the more
encompassing the implementation, the more robust are the requirements for
learning and change management necessary to utilize the solution.
This alignment of the organization with the proposed system impacts the
enterprise in three ways. To begin with, the integrative capabilities oftoday's
enterprise systems require implementers to restructure the culture and capa-
bilities of their organizations to promote values fostering continuous im-
provement and teamwork. Second, enterprise systems enable the organi-
zation not only to rethink traditional enterprise information flows but also to
leverage new information tools such as graphics, workstation technologies,
and Internet-driven network-to-network computer integration. Finally, the
effective application of new information technologies requires a redefinition
of the goals and skills of the enterprise's people resources.
Besides orchestrating changes to organizational structure and cultural
fabrics, implementers must also focus on a detailed framework designed to
guide them successfully through the entire technology solution search and in-
stallation project. Such a framework should consist of four broad phases. In
the first, enterprise management defines the intensity of the automation and
process integration objectives to be achieved. The second phase of the frame-
work encompasses the technology search process, culminating in the sel-

ection of the optimal solution. There are two possible avenues that can be
pursued : legacy software can be enhanced to meet new enterprise information
requirements, or a totally new software system is purchased. In phase three,
the new information system is introduced, users trained, the software tested,
modifications performed, and the final product implemented. In the final
phase of the framework, a program targeted at continuous improvement in
organizational capabilities and identifying new technology tools is initiated.
By far, of the four phases of the implementation framework, the greatest chal-
lenges to the organization will be found in planning and controlling the
implementation processes found in phase three. Successful technology pro-
jects occur when implementers create a functional project organization and
run the project according to a detailed project plan and budget.
1. It has been said that the velocity of a firm's ability to process information defines
the boundaries of its business activities. Explain.
2. What is the objective of information technology targeted at automation?
3. Explain why IT focused on integrating business functions is a more difficult task
than automating functions.
4. The implementation of integrative IT systems requires changing the organization
and its capabilities . Explain.
S. What are the three fundamental management processes essential to
implementation success, and why are they so important?
6. Why is obtaining top management's support for the IT project so important?
7. Outline the structure and discuss the responsibilities of an effective IT
implementation team.
8. The use of the Internet can drastically alter the competitive field. Why is this the
case?
9. Discuss the five stages ofInternet connectivity.
10. How can the implementation of information technologies impact strategic
advantage?
REFERENCES
1. Savage, Charles M., Fifth Generation Management. Burlington, MA: Digital

Press, 1990, p. 70.
2. Ibid, p. 71.
3. There are many descriptions of what constitutes an effective system. One of the
most important is Wight, Oliver W., Manufacturing Resource Planning: MRPII
- Unlocking America's Productivity Potential. Essex Junction, VT: Oliver
Wight Limited Publications, Inc., 1982, pp. 100-106. See also Bowersox,
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4. For a full treatment of these applications see Ross, David F., Introduction to e-
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6. These points have been abstracted from Ross, Introduction to e-Supply Chain
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INDEX
Abbo tt Laboratories 249, 369 Balanced Scorecard 29, 124-128
ABC analysis 283-287,333-335, 349 Barter 729
Accumulating 81 Behr Climate 764
Ace Hardware 62 Best Buy 62, 108, 226, 573
Activity-Based Costing (ABC) 29, Bic Pens 184

269
Bloom indales' s 65
Adaptive SCM. See e-SCM
Boyd Company 537
Advanced Planning Systems (APS)
30, 393, 402-409 Brokers 69-70, 633-6 34
Agents 69-70 Bull Whip Effect 33, 43
Airborn e 624 Bulk break 76-77 , 221-222,539-540
Allocation 81 Burgen Brunswig 62
Amazon .com 6, 74,420 Burnham Corporation 778-779
APL Logistics 664 Busines s Plannin g

assetplan 112,119-121 ,128
Aristotle 778 balance sheet 114-115
Balanced Scorecard 124-128
Armani 186 benefits of 113
boundaries of 106-110
Assembly 222-223 business forecast 112, 118-119
business unit 108-109, 112-113
Asset planning 119-121 capacit y estimating 394-395
capital utilization plan 123-124
Assortments 76, 81 cash management 128
corporate 106-107
Automation 778-779 critical questions I 10-111
defined 105
Balanc e sheet I 14-115 defining goals 111-112
Economic Value Added (EVA) 117
804 INDEX
formulating 104-110 Circuit City 74

functional areas 109-110
global channels 699-705 Cisco 28
global trade 699-705
goals 103-104 Coca Cola 81,184,682,702,711
income statement 114
information systems 760 Collaboration
inventory management 128,211- defining 35-36
212,213,215,263-264,290-292 e-SCM 24
link to DO&CP 176-178
mission statement 104 Collaborative Planning, Forecasting,
plan disaggregation 112-113 and Replenishment (CPFR) 28,
planning process 110-113 404,434-436, 490
Return on Investment (RIO) 116-
117 Colography Group 573, 625
role of 102
technology implementation 791 Competitive advantage
strategy fonnu1ation 104-110 types of 108
supply channel planning 121-128,
223-236 Continental Freezers of Illinois 78
types of competitive advantage 108
warehousing strategy 550-557 Continuous Replenishment Planning
(CPR) 434
Business Process Reengineering
(BRP) 9 Cost management
carrying costs 247
Business-to-Business (B2B) 30, 490- channel management 236
492,528-529, 771 customer service trade-off 457-459
global channel management 706-
Business-to-Customer (B2C) 770-771 707, 710
importance of 9
Cabotage 718 inventory 256-258, 265, 266-275
logistics capacity 394-395
Cardinal Glass 410 purchasing costs 503-504
transportation 635
Carrying costs
calculating 273 Customer management
capital 271 challenges to 421-422
function of 247,268,270-271 components of 427-427
risk 272 customer service management 437,
service 271 447-465
stockout 273-275 demand management 429-437
storage 272-273 definition of 421-427
e-infonnation 28, 31-32
Causal forecast types 156-160 e-marketing 468-469
fulfillment management 43,445-
China 6,684 447
INDEX 805
importance of 419-420 order management 437, 440-441

information systems order performance 441
Internet technologies 465 -470 performance gaps 455-457
order management 437 -447 service/cost trade-offs 457-459
organizational issues 427-429 service elements 448-450
power of the customer 5-6,422 technologies 459-463
Partner Relationship Management
(PRM) 469 -470 Cycle Counting 287-288
partnership requirements 423
principles of 423 -425 Daimler/Chrysler 684
relation to SCM 18-19
relation to technologies 429 Dell Computer 32, 775
sales force automation 467-468
today's dynamics 422-423 Demand management
values of 427-429 Collaborative Planning, Forecasting
and Replenishment (CPFR) 28,
Customer Order Management 404, 434-436
convenience in 438-439,444 components of 430
customer service management 437, customer collaboration (CC) 433-
440-441 434
cycle time management 437-438 demand smoothing (DS) 433
data base management 440 forecasting demand 432-436
dimension of 437 -439 importance of 429-430
importance of 437 strategies 4 :~0-432
order management cycle 441-445 supply chain engineering (SCE)
order picking 565-568 433
performance 439 ,441 techniques for 433-436
planning process 439-441
shipping 563-565 Demand, Operations and Channel
Planning (DO&CP)
Customer Relationship Management basics of 176-178
(CRM). See Customer components of 178-179
Management definition of 177-178
goal of 177-178
Customer Service Management inputs and outputs 179-181
(CSM) information systems 760
Customer Interaction Center (CIC) link to business strategy 176-178
447 logistics planning 210-223
definition of 447-450 marketing planning 181-195
elements of effective service 451- plan integration 236-238
455 production planning 202-210
importance of 447 sales planning 195-202
lIT Techniques 437-438 supply channel planning 223-236
managing strategies 450-451, 460 - volume/mix planning 177
463
measuring performance 453-455, Delphi Method 142
463-465
806 INDEX
Deutsche Post 689 calculation of 377-383

capacity planning 393-40 I
Distribution management compared to order point 360-366,
capacity planning 393-401 381-384
challenges 90-91 Distribution Resource Planning
characteristics of 65-67 (DRP II) 765-767
components of 60-61 forecasting in 376-377
definition of 60-64, 75-79 gross requirements calculation 371-
e-business types 73-75 372
environmental concerns 7 historical view of 366-370
global management of 705-718 information management systems
global strategies 693-699 401-402
globalization of 6-7 introduction to 359-360
history of 3-4, II inventory cost planning 394-395
importance of 3-4, 5-6 lumpy demand 364
information systems 765-767 manufacturing system interface
labor and equipment planning 399 400-401
level of channel exposure 231 order policies 374-376
Logistics Service Providers (LSPs) perpetual inventory control 367
658-675 planning horizon 377
magnitude of 64 planning process 389-393
manufacturing 61 processing 374-377
materials management flow 86-89 replenishment timing 367-369
need for 80-82 safety stock in 377
outsourcing 8-9 supply chain planning 383-389,
physical distribution flow 86-89 387-389
retailers 61-62
strategies 91-92 Distribution Resource Planning (DRP
supply channel planning 121-128, II)
223-236 definition 765
transaction functions 82-86 functional diagram 766
transportation planning 395-397 importance of 765-766
types of 67-75
types of international channels 707- eBay 770
710
value-added processing 77,83, e-businesses
219-223 types 73-75
warehouse space planning 216-219,
398-399 e-Collaboration 771
warehousing strategy 550-557
wholesalers 61-62 e-SCM
collaboration 24, 35-36
Distribution Requirements Planning components of26-36
(DRP) CRM 31-32
basics of 370-374 definition of 23-26
Bill of Distribution (BOD) 385,400 e-information 27-30
"bucketless" view importance of 21-23
INDEX 807
interoperability 24-25 strategic planning 754

synchronization 32-35 transaction management 753
Economic Order Quantity (EOQ) Enterprise Resource Planning (ERP)

329-333 9,18,25,247,429
Economic Value Added (EVA) 117 Environmental concerns 7
Electronic Data Interchange (EDI) Exponential Smoothing 149-153

24,25 ,30,35,434,489,762,
767-769, 769-770 Exporting 72-73, 699-702
Efficient Customer Response (ECR) Extrinsic forecasting. See Causal

434 forecast types
Electronic bill presentment and Federal Express 28,624,633

payment (EBPP) 648
First-In-First-Out (FIFO) 277-278
Emery 624
Focus Forecasting 154-156
Enterprise Information Systems (ElS)
architectural issues 757-763 Ford Motor Company 61,645,682
benefits of 763-765
business applications 760-763 Forecast tracking signals 165-167
components of 757-765
concept of 750 Forecasting
configuring 756-757 adaptive exponential smoothing
connectivity tools 767-772 151-153
database 752 averages 147-148 .
decision analysis 754 Causal forecast types 156-160
distribution systems 765-767 characteristics of 136-138
Distribution Resource Planning database 137,168
(DRP II) 765-767 definition of 134-138
DRP II functional diagram 766 Delphi Method 142
Electronic Data Interface (EDI) development of 160-165
24,25 ,30,35 ,434,489,762, Exponential Smoothing 149-151
767-769, 769-770 family level 179-180, 196-197,
Internet connectivity 769-772 198-200
solutions implementation 781-782 forecasting demand 432-436
value-added networks 767, 769- Focus Forecasting 154-156
770 forecast error 165-167
general characteristics 135-136
ERP 758 importance of 133-134, 135
functional diagram 759 levelofdetail 137
management control 753-754 management control 138, 160-165,
principles of 754-756 169
simulation 754
808 INDEX
Mean Absolute Deviation (MAD) supply channels 225-226

166-167 tariffs 688-689 , 734
outliers 146, 165 trends 683-688,692-693
pyramid forecasting 199-200 trading blocks 6
qualitative techniques 141-1
quantitative techniques 143- Grupo Eroski 436
sales forecast tracking 201-2
seasonality 145-146 ,153-15 Henkel KGA 436
simple models 146-147
time horizons 136-137 Hewlett Packard 499
time series analysis 144-146
tracking signals 165-167 Home Depot 62, 108
trends 145-146
types of 140-160 Homeland Security 656-657,670
weighted averages 148-149
why forecasts fail 167-169 IBM 32
Freight-on-board (FOB) 511-512, Importing

713, 733 basics of 72-73
Fulfillment Income statement 114

changes to 446-447
importance of 445-446 Incoterms 712-713
relation to SCM 18,43
Information technology
Gap 602 Advanced Planning Systems (APS)
30, 393,402-409
Gateway 32,61 ,66 automation 778-779
CRM 465-470
configuring 756-772
General Motors 645 connectivity 750-752 ,767-772
Gillette 602 customer service 459-463
design collaboration software
Globalization (DCS) 30
barriers to 688-693 DRP 303,400-401
cultural barriers 689-690 DRP II 765-767
deregulation 686 e-information 27-30
factors of 683-693 e-SCM 19-36
financial restrictions 690-691 EDI 24,25,30,35,434,762,767-
growing competition 684-685 769,769-770
importance of 6-7, 683 Electronic bill presentment and
infrastructures 692 payment (EBPP) 648
Internet impact 688 Enterprise Information Systems
logistics systems 687-688 (EIS) 750, 752-767,
NAFTA 685 Enterprise Resource Planning
security 691 (ERP) 9,18,25,30
strategic alliances 686-687 implementation of 782-791
INDEX 809
importance of 10,747-750 automation 778-779

information flows 748-749 choosing 778-782, 785-786
integration concept 750-752, 780 Enterprise Information Systems
foundations of 748-756 (EIS) 781-782
logistics 43-44 evaluating 775-778
Manufacturing Execution Systems identifying 773-775
(MES) 30 importance of 772-773
MRP 30,254,300,303,312,360, implementation 782-791
761 integrated 780
MRP II 30 partial integration 779-781
Networking concept 750-752
principles of 754-756 Intel 6,8
purchasing management 509-510 ,
523-524 International channel strategies
solutions strategies 772-782 direct ownership 704-705
Supplier Relationship Management documentation 716-718,734-737
(SRM) 489-492, 510, 522-529 duties 713-714
Supply Chain Event Management exporting 699-702
(SCEM) systems 409-412 finance 715-716
Supply Chain Management incoterms 712-713
applications 29,304-305,401- joint ventures 703-704
412,762,748-749 licensing 702-703
Supply Chain Planning (SCP) marketing issues 710-715
systems 304-305 ,402-409,429 pricing 714-715
Transportation Management System service/cost 706-707
(TMS) 657-658 terms of sale 712-714
Warehouse Management System transportation in 712
(WMS) 603-604 ,647,762 types of distribution demand 707-
Warehousing 574-575, 603-604 , 710
762
International distribution
Information technology air transport 722-723
implementation al-Qaida 737
components of 782-783 barriers to 688-693
Part 1: Aligning Information Brazil 684
Technology and Company cabotage 718
Strategies 783-784, 788-789 Canada 685, 723, 729, 737, 738,
Part 2: Selecting Technology 739
Solutions 785-786 Central America 684
Part 3: Software Implementation channel development 699-718
786-788 China 684, 740-742
Part 4: Continuous Improvement Denmark 740
788-791 deregulation 686
project management 787-788 documentation 716-718, 734-737
duties 713-714
Information technology solutions Eastern Europe 682,737
strategies environment of 737-742
810 INDEX
Euro 790 JIT/Lean 726,727

European Union (EU) 685, 689, management process 730-737
698, 739-740 payment methods 734
exporting 699-702 planning process 736-737
financing in 715-716 RFQ 733
forces driving 683-693 sourcing 731-733
Germany 686, 740 tariffs 734
Gulf War II 737, 740 terms 733-734
historical dynamics 681-682
Hong Kong 740-742 Internet
incoterms 712-713 Business-to-Business (B2B) 30,
intermodal 719-720 490-492,528-529, 771
Japan 684,698,740-742 Business-to-Customer (B2C) 770-
management of 705-718 771
Mad Cow Disease 737 e-Collaboration 771
Mexico 684,685,723,738-739 e-commerce 770-771
Middle East 737 e-information 27-30
~A.FTA. 685, 723, 738-739 ED! phase 769-770
North America 738-739 Extensible Markup Language
ocean transport 720-722 (XML) 770
Pacific Rim 682, 684, 685, 698, CRM 420,465-470
737,740-742 globalization 6, 688
purchasing 726-737 importance of 10, 769
Russia 682, 730 Logistics Service Providers (LSPs)
Severe Acute Respiratory 663-666
Syndrome (SAAS) 737 marketing 770
South America 684 phases of 769-772
South Korea 684 purchasing 490-492
strategies 693-699 team-based organization 49-51
surface transport 723-724 trading exchanges 490-492, 528-
Sweden 740 529, 771
transportation in 718-724
United kingdom 740 Inventory control
warehousing in 724-726 A.BC analysis 283-287
Western Europe 684,724,739-740 accuracy 264-265, 341-342
customer service performance 288-
International purchasing 290
advantage of 727 cycle counting 287-288
barter 729 distribution by value report 284-
contrast with domestic purchasing 287
732 importance of 281-283
cosUprice 728, 733 inventory investment 211-212,
countertrade 729-730 247-248,263-264,290-292
documentation 716-718, 734-737 performance measurement 288-292
growth of 727-728 shrinkage 281-282
import documents 735-736 surplus and obsolete 286-287
importance of 726-727 turnover ratios 128,290-292
INDEX 811
transaction point control 281-283 managing uncertainty 261-262

magnitude of 250
Inventory costs manufacturing 249
absorption 276 nature of 251
Activity Based Costing (ABC) 29, performance measurements 128,
269 265,288-292
carrying cost 247,268,270-275 perpetual control 276,367
decision 269-275 physical distribution 249
direct 268-269,276 postponement 212,219-223
elements of 266-268 principles of 255-262
estimating 394-395 product classification 184-185,
fixed 269 187-188
importance of 266 "pull" systems 258-261, 344-347
incremental 275 purchasing classification 495-496
indirect 269 purchasing strategy 494-496
operational 268-269 purpose of 246-248, 255
procurement 270 "push" systems 255,344, 347-349
stockout 268, 273-275 quality 257
sunk 268 role of information 258-261
transportation 270 safety stock 252,305-306,311,
315-322 , 342, 362
Inventory management service elements 256-258
ABC analysis 283-287 strategy 263-264, 211-212
accuracy 264-265,341-342 supplier managed inventory (SMI)
anticipation inventory 252-253 259-260
carrying costs 247,268,270-275 surplus and obsolete 286-287
channel flow 248-250 , 264 transportation costs 248, 253-254
channel planning 211-212,213-215 transportation strategies 620
control 281-292 tum ratios 128,290-292
cost management 256-258 , 265, valuation 275-280
266-275,394-395 value-added processing 219-223
cycle (lot size) 252 vendor managed inventories (VMI)
cycle counting 287-288 259-260
defining 248-250 Warehouse Management Systems
functions of 252-255 (WMS) 603-604,647,762
hedge 254 work-in-process (WIP) 254
importance of 245-246
independent demand 252 Inventory planning
information systems 761 accuracy 341-342
investment planning 211-212, 214- adjusting channel imbalances 351-
215,247-248,263-264,290-292 352
Just-In-Time (JIT) 261,254,255 Bills of Material (BOMs) 300,343
lumpy demand 364 DRP basics 370-374
Maintenance, Repair and Operating DRP calculation 377-383
(MRO) 185,478,482,494-496, DRP concepts 303
505 DRP processing 374-377
management process 262-265 EOQ 328-335
812 INDEX
"Fair Shares" 352-353 Inventory valuation

importance of 298-299 absorption costing 276
JIT 304, 335-340 accounting systems 275-276
lead time 314-315,342 actual 279-280
MAD 317-319 average 279
MRP 300,303 ,312 direct costs 268-269,276
multiechelon warehouses 349-353 first-in-first-out (FIFO) 277-278
optimization techniques 304-305 last-in-first-out (LIFO) 278-279
order point 303,362 periodic system 275
order point methods 322-328 perpetual system 276, 367
order quantity techniques 328-335 standard cost 277
order techniques 300-305
periodic review 303 Iraq 340
"Pull" systems 258-261,344-347
purchasing classification 495-496 J.F. Braun & Sons 257
purchasing strategy 494-496
"Push" systems 255,344,347-349 Japan 6,684,698
replenishment techniques 305-310
safety stock 252, 305-306, 311., Jewel Foods 78
315-322,342,362
statistical replenishment process Just-In-Time (JIT)
341-343 concepts 16,35,62,107,254,255,
Time Phased Order Point (TPOP) 261,304
303-304,305 future of 340
transportation strategies 620 information technologies 772
two bin system 301-303 international trade 727
types of demand 299-300 mechanics of 337-340
visual review 301 replenishment flow 339
SCM use 336-337
Inventory replenishment techniques philosophy of 335
compared to DRP 381-384 transportation 652
concept of 305-307
continuous review 308-309 Kitting 222
cycle stock 305-306
Kardex 308, 367 Korea 340
methods 322-328
order point techniques 306-307, Labeling 222
310-328,362
order quantity techniques 328-335 Last-In-First-Out (LIFO) 278-279,
periodic review 309-310 715
planning process 341-343
principles of 307 Lean Manufacturing. See JIT.
problems with 360-366
replenishment review interval 308- Leaseway Transportation Corporation
310 659
safety stock 252, 305-306, 311,
315-322,342,362
INDEX 813
Logistics Logistics planning

Bull whip effect 33,43 capacity plan 212,393-401
centralized 46 inventory plan 211-212,213-215
competitive weapon 9,16-17 link to DO&CP 179
decentralized 12-14,46 planning process 211-213
definition of 37-39 postponement 212,219-223
e-information 29 purpose of 210-211
fleet management 41 shipping plan 212
freight 41 transportation 215-216
history of 10-23 warehouse capacity 216-219
importance of 9 value-added processing 212,219-
inbound 38, 109 223
information technology 43
integrated 15-17
international transportation 718- Logistics Service Providers (LSPs)
724 challenges to 668-670
international warehousing 724-726 choosing a LSP 666-668
load planning 41 .comLLP 664-666
Logistics Service Providers (LSPs) fourth party logistics (4PLs) 663
42-43, 658-670 growth of 659-660
magnitude of 39 importance of 42-43, 658-659
materials management 38, 109 Internet-driven 663-666
matrix organizations 48 Lead Logistics Providers (LLPs)
network design 40-41 663,666-667
operation of39-46 problems with 660
order management 41 revenues of 659-660
organ ization of 46 suite of services 660-666
outbound 39, 109 value offered 660-661
performance measurement 44-46
physical distribution 39, 109 Lucent Technologies 410
planning 210-223
procurement 41 Manufacturing
production 37-39 channel-based organization 63
relation to SCM 17-19 information systems 761-762
reverse logistics 45-46 inventory flow 249
team-based 49-51 Lean 62,78,254,255
total cost management 14-15 process-based organization 62
transportation 41 product-based organization 62
warehouse management 41 production planning 202-210
supply channel position 61
Logistics capacity planning WIP inventories 254
financial estimating 394-395 wholesale offices 70-71
importance of 393
labor and equipment planning 349 Marketing
transportation estimating 395-397 channel operations 183-184, 223-
warehouse space planning 398-399 236
channels 601-61
814 INDEX
e-CRM 468-469 North American Free Trade

global issues 710-715 Agreement (NAFTA) 685,723,
Internet-driven 770 738-739
link to DO&CP 178-179
market development 192-195 Occidental Petroleum 750
operating profit calculation 194-
195 Order Point
planning process 182-184 accuracy of 342
pricing 183,714-715 adjusting 312-314
product classification 184-185 basics of 305-307,311-322
product decisions 186-187 combining techniques 327-328
product families 184-185,187-188 compared to DRP 381-384
product life cycle 183, 188-191 formula 311
product management 184-187 item usage 311-314
promotions 183 joint replenishment 324-326
purpose of 181-182 lead time 314-315,342
services management 184-187, MAD 317-318
191-192 methods 322-328
terms of sale 511-512,712-714 min/max 323-324
periodic review 326-327
Master Production Scheduling (MPS) problems with 362
400-401,761 safety stock 252, 305-306, 311,
315-322,342,362
Materials Management statistical order point 322-323
flows 86-89 terms 310-311
fundamentals of 38 trends 312-314
Maytag 104 Order quantity techniques

basics of 328-329
McDonalds 66, 711 EOQ 329-333
EOQ assumptions 332-333
McDonnell Douglas 729 EOQ problems 343
item class replenishment 333-335
McKesson 62 problems with 362-363
quantity discounts 331-332
Mean Absolute Deviation (MAD)
166-167,317-318 Outsourcing 491
Mercedes 186 Packaging 222
Merchandizing 79 Pareto Principle 283
Merchant Wholesalers 67-69 Partner Relationship Management

(PRM) 469-470
Nordstrom's 66
Performance Measurements
Activity-Based Costing (ABC) 29
INDEX 815
asset management 128 resource profiles 204, 208-209

Balanced Scorecard 29
cash management 128 Purchase Order Management
inventory management 128 blanket PO 509
Logistics 44-46 costs 503-504
manufacturing 204, 209-210 database accuracy 502-504
purchasing 480, 500-50 I, 515, 522 direct ship 509
sales 439,441 ,453-455 ,463-465 importance of 501-502
Total Quality Management (TQM) processing cycle 504-508
9, 16,35,45 MRO 505
transportation 649-652 negotiating 506-509
warehousing 568-571 P-card 527
performance measurement 515-522
Physical Distribution receiving 512-514,538,561-565
flows 86-89, 249 Request for Quotation (RFQ) 503,
fundamentals of 39 524,526
status reporting 514-515
Postponement 212, 219-223 terms of sale 511-512
transportation 510-512
Priceline.com 770 types of PO 508-510
Procter & Gamble 602, 682 Purchasing Management

buyer 's role 481-482,507-508
Procurement centralized/decentralized 483
e-business 30 contracting 480
contrast with international
Product life cycle 183, 188-191 purchasing 732
countertrade 729-730
Product management defining 477-478
basics of 184-187 e-procurement 490-492 , 522-529
consumer goods 185-186 importance of 475-476
convenience goods 185 information systems 762
global issues 711 international 726-737
industrial goods 185 international planning 736-737
MRO 185,478,482,494-496,505 inventory strategy 494-496
product classification 184-185, item classification 495-496
187-188 MRO 185,478,482,495-496,505,
shopping goods 185 762
negotiating 506-507
Production Planning objectives of 483
aggregate capacity 204, 208-209 order management process 501-515
developing 204-209 organization 480-483 ,493,518-
link to DO&CP 179 522
performance 204,209-210 outsourcing 491
planning process 202-204 payment methods 734
production rate 203,204-207 performance 480, 500-50 I, 515-
purpose of 202 522
816 INDEX
planner's role 507-508 planning process 196-198

receiving 512-514 ,538,561-565 purpose of 195-196
responsibilities 479-480 pyramid forecasting 199-200
Request for Quote (RFQ) 503, 524, strategy development 197
526, 762 tracking of forecast 201-202
sourcing 479,488-489,524-525,
730-733 Sam's Wholesale Club 64
strategy development 492-501
Supplier Relationship Management SAP 104
(SRM) 486-492, 496-498
technology applications 489-492, Sears, Roebuck & Co. 62,249,659
498-500,510
types of products purchased 478 Seasonality 145-146,153-154
value-added services 527-528
value analysis 479 Sequencing 78
Quick Response (QR) 772 Severe Acute Respiratory Syndrome

(SARS) 737
Regression Analysis 157-160
Retailers Sony 61
organization of 61-62
organizational objectives 63 Specialization 80-82
wholesale offices 70-71
Sorting 81,221,538
Return on Investment (RIO) 116-117
Strategic planning. See Business
Reverse logistics 45-46, planning
Rolls Royce 193 Sun Micro Systems 32
Safety stock 252, 311, 315-322, 342, Supplier Relationship Management

362,377 (SRM)
components of 487-492
Sales and Operations Planning e-SRM 490-492
(S&OP) . See Demand, growth of 486-487
Operations and Channel Planning outsourcing 491
(DO&CP) performance 516-518
strategic sourcing 488-489,524-
Sales force automation (SFA) 467- 525
468 trading exchanges 490-492, 528-
529
Sales Planning technology applications 489-492,
forecast of sales 197,198-200 510, 522-529
link to DO&CP 179 value-added services 527-528
managing resources 197 versus traditional purchasing 486-
performance 198 487
INDEX 817
Supplier Relationship Management strategic planning 121-128

technologies strategy of 17-18
applications 523-524 synchronization 32-35
auctions 527 transition to e-SCM 22-23
e-procurement 525-527 value-networks 10, 17
e-sourcing 525-526 warehouse strategy 550-557
growth of 522-524
trading exchanges 490-492, 525- Supply chain event management
529 (SCEM) systems 409-412
value-added services 527-528
Supply chain planning (SCM) systems
Supply Chain Operations Reference 304-305,402-409
Model (SCOR) 29, 34
Supply Channel Planning
Supply Chain Management (SCM) basics of 226-227
bull whip effect 33,43 capacity management 393-401
.comLLPs 664-666 cost management 236
channel structure 7-9,226-227, defining channel mission 227-330
230-233 ,249 inventory 248-250, 343-353
channel planning 223-236 link to DO&CP 179
collaboration 24, 35-36 operations management 233-236
Collaborative Planning , performance 235-236
Forecasting , and Replenishment planning process 224-226
(CPFR) 28,404,434-436,490 purpose of 223-224
components of 17-19 service outputs 230-231
e-SCM 19-36 structures 226-227,230-233,249
fulfillment 18-19 supply
global strategies 693-699 use ofDRP 383-389
history of 10-23
importance of 4-5 SYSCO 62
information systems 748-750, 765-
767 Terms of sale 511-512, 733-734
interoperability 24-25
inventory 248-250, 343-353 Theory of Constraints (TOC) 393,
JIT 336-337 403-409
Logistics Service Providers (LSPs)
658-678 Third Party Logistics (3PL). See
operations management 233-236 Logistics Service Providers
outsourcing 8-9 (LSPs)
problems with 19-21
production 18 Timex 193
relation to logistics II, 12,36-37
SCM software 29,401-412 Total Quality Management (TQM) 9,
sourcing and procurement 18 16,35,45
stages of 10-23
strategic performance Trading exchanges 490-492, 528-529
measurements 123-128
818 INDEX
Transportation strategic planning 618

air transport 623-625,722-723 tapering principle 611,637
brokers 633-634 tariff 638
common carriers 631 terms of sale 511-512,712-714
container on a rail flatcar (COFC) traffic management 542,618
629-630 transportation profiles 216
contract carriers 632 truck trailer on a rail flatcar (TOFC)
costs 270, 635 629
deadhead 638 types of 630-634
defining 610-620 water transport 625-627, 720-722
demurrage 614
detention 614 Transportation issues
documentation 647-648 Homeland Security 656-657,670
freight forwarders 633 infrastructure of 652-653
importance of 609-611, 616-617 innovations 653
inbound 510-512 intermodalism 628-630,653, 719-
intermodal 628-630,653,719-720 720
international 718-724 JIT/Lean 652
intransit storage 615 regulation 653-657
issues facing 652-658 Transportation Management
Logistics Service Providers (LSBs) Systems (TMS) 657-658
658-670
management process 636-638 Transportation planning
modes of 620-630 documentation 647-648
motor carrier contract 673-675 elements of 638-639
motor transport 620-622, 723-724 milkrun 645
parcel post 633 payment 648
payment 648 performance 649-652
performance 649-652 rates 639-640
performance characteristics 634- scheduling and routing 644-647
635 transport mode selection 640-644
pipelines 627-628 Transportation Management
planning 215-216,395-397,637- Systems (TMS) 657-658
652 Warehouse Management Systems
principles of 611-613 (WMS) 647
private carriers 632-633
railroad transport 622-623, 723- lIPS 104,624,633,773
724
rates 614-615,639-640 U.S. Post Office 633
reconsignment/diversion 614,615
regulated carriers 631-632 Value-added processing
regulation 654-657 advantage of 220
relation to other business functions assembly 222-223
616-620 bulk break 76-77,221-222
service agencies 633-634 contrast with manufacturing 223
services 613-615 elements of 220-223, 538
statistics 616 information systems 761-762
INDEX 819
kitting 222 cross-docking 540,574-575

labeling 222 definition of 537
packaging 222 free-trade 549
purpose of 77,83,219,538 functions of 538-542
sorting 81,221,538 importance of 535-536
international 724-726
Value networks 10, 17 intransit storage 615
layout 586-590
Vendor managed inventory (VMI) management process 557-571
259-260,434,661 material handling 538
nature of 572-574
Venezuela 340 network design 577-585
order management 541-542
W. W. Granger 6 order picking 565-568
partnerships 575-577
Wal-Mart 6,8,60,62,65,67,104, performance measurement 568-571
108,249,537,601 planning 216-219,398-399
private 543-544,555-556
Warehouse design public 544-546, 555-556
AS/RS systems 597, 600-601 receiving 512-514,538,561-563
automation 574-575, 598-603 shipping 542, 563-565
bar codes 600 sorting 81,221,538
cantilever racks 593 special services 548-550
carousels 596 standards for 558-561
cost analysis 581-582 storage 538-541
decision issues 578-579 strategy development 550-557
flow racks 593 technology applications 574-575,
importance of 577-578 603-604
layout and equipment 585-604 traffic management 542
locating 582-585 trends in 571-577
micro-location factors 582-584 types of 543-547
radio frequency 599 types of storage 590-597
reasons for 578-579 warehouse management 41
size and number of 579-582 Warehouse Management Systems
small parts storage 594-597 (WMS) 603-604 ,647,762
types of storage 590-597
Warehouse Management Systems Whirlpool 659
(WMS) 603-604,647
Wholesalers
Warehousing brokers and agents 69-70
automation 574-575, 598-603 challenges to 90-91
bonded 548 definition 66-67
bulkbreak 76-77,221-222,539- distributors' offices 70-71
540 durable/nondurable goods 73
capacity 216-219 e-businesses 73-75
cold storage 548 exporting 72-73
contract 546-547 ,555-556 functions of 75-79
820 INDEX
importing 72-73
manufacturers' offices 70-71
materials management flow 86-89
merchant 67-69
need for 80-82
organization of 61-62
physical distribution flow 86-89
strategies 91-92
transaction functions 82-86
types of 67-75
value-added processing 77, 83
Yamaha 8
Zenith 226

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Distribution

Planning and Control

Managing In The Era Of Supply

David Frederick Ross

A C L P . Catalogue record for this book is available

Distribution: Planning and Control

by David Frederick Ross

Copyright 2004 by Springer Science+Business Media New York

A l l rights reserved. No part of this work may be reproduced, stored in a retrieval

Permission for books published in FAirope: [email protected]

Printed on acid-free paper.

UNIT 1. DEFINING THE SUPPLY CHAIN MANAGEMENT

1. The Rise Of Supply Chain Management I 3

2. Components Of Distribution Management I 59

UNIT 2. TOP MANAGEMENT PLANNING I 97

3. Business And Strategic Planning I 101

4. Forecasting In The Supply Chain Environment I 133

Forecasting Types / 140

5. Demand, Operations, And Channel Planning I 175

UNIT 3. DISTRIBUTION OPERATIONS PLANNING / 243

6. Managing Supply Chain Inventories I 245

7 . Replenishment Inventory Planning I 297

8. Distribution Requirements Planning I 359

UNIT 4 . DISTRIBUTION OPERATIONS EXECUTION I 417

9. Customer Relationship Management I 419

10. Supplier Relationship Management I 475

11. Warehousing / 535

12. Transportation / 609

UNIT 5. INTERNATIONAL DISTRIBUTION AND DISTRIBUTION

13. International Distribution / 679

14. Information Technology and Supply Chain Management

Implementation Issues / 782

curement is also the establishment of collaborative relationships with sup-

how enterprise distribution management can search and implement informa-

An instructor's manual is available for the text containing chapter outlines,

ABOUT THE AUTHOR

A distinguished educator and consultant, David Frederick Ross, Ph.D.,

1. The Rise of Supply Chain Management

organization. The chapter concludes with a full definition of logistics man-

ADVENT OF SUPPLY CHAIN e-SCM Definition

ADVENT OF SUPPLY CHAIN MANAGEMENT

lODAY'S BUSINESS ENVIRONMENT

will increasingly depend on the creation of closely integrated supply chains to

Globalization. The growth of business and industry throughout the globe at

Supply Chain Structure. The requirement that today's businesses be agile as

Over the past several decades, energy consumption by 15% in 200 I

current assets and capital expenditure. Second, by eliminating non-core func-

Logistics as a Competitive Weapon . In the past, logistics was seen pri-

Information Technology. Finally, the development of radically new infor-

EVOLUTION OF SUPPLY CHAIN MANAGEMENT [3]

While the concept of supply chain management (SCM) is little more

and distributors to overcome the barriers of space and time to deliver

STAGES OF SUPPLY CHAIN DEVELOPMENT

STAGE 1: DECENTRALIZED FUNCTIONS

and Cost Logistics Chain Chain ~

mental performance measurements actually pitted logistics functions against

STAGE 2: TOTAL COST MANAGEMENT

cision of companies to centralize logistics functions into a single depart-

STAGE 3: INTEGRATED FUNCTIONS