Supply Chain Management:

 Supply chain management is the management of network of interconnected businesses

involved in the ultimate provision of goods and services required by the end customer.
 Supply chain management spans all movement and storage of raw materials, work-in-
process inventory and finished goods from point-of-origin to point-of-consumption.

 6 R’s in SCM:
 Supply Chain Management – In a nutshell is SCM is all about effective integration of…
1) Right Product
2) At Right Place
3) Right Quantity
4) At Right Time
5) Right Quality
6) At Right Value

 Essential Features of supply chain management:

1) Mutually sharing information- For effective SCM mutually sharing information among
channel members is required, especially for planning and monitoring processes.

2) Mutually sharing channel risk and Rewards- Effective SCM also requires mutually sharing
channel risks and rewards that yield a competitive advantage. Risk and reward sharing
should happen over the long term focus and cooperation among the supply chain members.

3) Co-operation- Co-operation among channel members is required for effective SCM. Co-
operation refers to similar or complimentary co-ordianted activities performed by firm in a
business relationship to produce superior mutual outcomes or singular outcomes that are
mutually expected over time.
4)Focus on serving customers – Supply chain succeeds if all the members of supply chain
have the same goal and the same focus serving customers. Establishing the same goal and
same focus among Supply chain members is a form of policy integration.

5) Integration of Processes – The implementation of SCM needs the integration of processes

from sourcing to manufacturing and to distribution across the supply chain. The integration
can be accomplished through cross functional terms, in plant supplier personnel and third
party service provide.

6) Partners to Build and Maintain Long Term Relationship – Successful relationships aim to
integrates channel policy to avoid redundancy and overlap while seeking a level of co-
operation that allow participants to be more effective at lower cost levels. Policy integration
is possible if there are compatible cultures and management techniques among the chain
members.
 Objectives of Supply chain management:
1) Service Orientation – (i.e services to customers) the very basis of supply chains has been
to provide superior customer service. Service is all about the value that the customer gets,
which in turn depends upon his own perception about what constitutes value. The design,
the alignment, the integration of the companies on the supply chain and the co-ordination
between them are all for the customer- the ultimate customer, and these are performed as
such.
2) System Orientation- system orientation is at the existence of any supply chain. Synergy
due to co- operation and coordination is the main gain of a supply chain. This entails that
while getting optimal results for the chain as a whole, results for the partners on the chain
may not necessarily be optimal, these could be less than optimal.
3) Competitiveness and Efficiency – Supply chain is a business organization. It provides value
to the customers while being competitive. Competitiveness is essential for it to healthy
sustain itself in order to be able to provide increasing value to its customer. Efficiency is an
important element of competitiveness.
4) Minimizing the time – efficient supply chain is an organization reduces the time required
for converting orders into cash. So there is minimal time lag and increase in productivity of
the organization. Minimizing Work in Progress- supply chain minimizes total work in process
in supply chain.
5) Improving Pipeline Visibility – efficient supply chain improve the visibility of each one of
the activities of the supply chain by each one of the partner.
6) Improving visibility Demand- Efficient supply chain improves visibility of demand by each
one of the partners.
7) Improving Quality- Efficient supply chain management helps in improving the quality of
operation of the organization. TQM has become a major commitment throughout all facet
of industry. Overall commitment to TQM is one of the major commitment throughout all
facets of industry.

 Supply-Chain Principles Methodology and Solutions

If supply-chain management has become top management's new "religion," then it needs a
doctrine,

- "Seven Principles" of supply-chain management

1. Segment customers based on service needs: Companies traditionally have grouped

customers by industry, product, or trade channel and then provided the same level of
service to everyone within a segment. Effective supply-chain management, by contrast,
groups customers by distinct service needs--regardless of industry--and then tailors
services to those particular segments.
2. Customize the Supply Chain Management network: In designing their Supply Chain
Management network, companies need to focus intensely on the service, requirements
and profitability of the customer segments identified. The conventional approach of
creating a "monolithic" Supply Chain Management network runs counter to successful
supply-chain management.
3. Listen to signals of market demand and plan accordingly: Sales and operations planning
must span the entire chain to detect early warning signals of changing demand in
 ordering patterns, customer promotions, and so forth. This demand-intensive approach
leads to more consistent forecasts and optimal resource allocation.
4. Differentiate product closer to the customer: Companies today no longer can afford to
stockpile inventory to compensate for possible forecasting errors. Instead, they need to
postpone product differentiation in the manufacturing process closer to actual
consumer demand.
5. Strategically manage the sources of supply: By working closely with their key suppliers
to reduce the overall costs of owning materials and services, supply-chain management
leaders enhance margins both for themselves and their suppliers. Beating multiple
suppliers over the head for the lowest price is out.
6. Develop a supply-chain-wide technology strategy: As one of the cornerstones of
successful supply-chain management, information technology must support multiple
levels of decision making. It also should afford a clear view of the flow of products,
services, and information.
7. Adopt channel-spanning performance measures: Excellent supply-chain measurement
systems do more than just monitor internal functions. They adopt measures that apply
to every link in the supply chain. Importantly, these measurement systems embrace
both service and financial metrics, such as each account's true profitability.

Logistics Management:

 LOGISTICS MANAGEMENT

A distribution channel usually comprises two complementary networks: the commercial network
and the logistical network. The commercial network takes care of the resources required for the
efficient and effective operation of the logistical network. The logistical network is involved in the
actual transportation of the goods and services from the place of manufacture to the place of
consumption. The logistical function, since it is concerned with the physical movement of goods, is
also called the physical distribution function. Logistics management is conventionally defined as the
process that has the responsibility to ensure the delivery of the right product at the right place at
the right time in right quantities.
Normally, when logistics management is talked about, the entire supply chain is considered, from
the raw material procurement stage to the delivery of finished goods to the customers. The Council
of Logistics Management defines logistics in the following manner: Logistics is the process of
planning, implementing, and controlling the efficient, cost-effective flow and storage of raw
materials, in-process inventory, finished goods and related information from the point of origin to
the point of consumption for the purpose of conforming to customer requirements. However,
since we are limiting our focus to the logistical activities concerned with the distribution channels,
we will only be concentrating on the second part of the chain viz. the delivery of the finished goods
and services to the customers from the manufacturers' end. This part of the logistical activities of a
firm is called the outbound logistics of the company. The outbound logistics is a critical activity in
any firm as it directly links the company to its consumer and comprises a set of activities that
complements the marketing function of the firm.

 Objectives of Logistics

The logistics strategy is a key component of the distribution strategy of the firm which in turn
forms part of the marketing strategy. Usually, the logistics strategy brings together the
components of the manufacturing and marketing strategies of the firm. This is because the
concerns of the logistics and the manufacturing function of the firm overlap.
 The logistics strategy comprises three objectives

i. Cost reduction,
ii. Capital reduction, and
iii. Service improvement.

The cost reduction strategy is aimed at reducing the variable cost related to the movement and
storage of goods. The cost reduction is usually achieved by such tactics like altering the number
and location of warehouses, altering the mode of transport, route optimization for the transport
function, optimizing the quantum of inventory; etc. Technology can also be used to reduce the
variable cost of logistics.
Capital reduction is a strategy devoted towards minimizing the level of investment in the logistical
system. The main aim is to maximize the return on investment. A substantial amount of money is
spent on creating capital assets for undertaking the logistical function. These assets include
warehouses, trucks, material handling equipment, software for order processing, etc. With increased
outlay on these accounts, the total cost of logistical operations becomes very substantial. The
objective of the logistics strategy, therefore, is to reduce the outlay for capital assets such that only
the most critical assets are acquired. Also, substantial capital reduction can be achieved by leasing
and renting facilities without affecting the service output to the customers.

Service improvements involve giving better service across the dimension of service without
substantially increasing the cost of logistics. Although the costs increase rapidly with greater service
levels, service improvements can also be achieved in the context of greater anticipation of revenue
by attracting more customers. The increase in logistics costs can thus be offset by the increase in
revenue.

 Logistics Planning

The logistics planning activity is a continuation of the logistics strategy in the sense that the
strategy developed is given a more detailed and practical meaning in the planning phase. Logistics
planning, as in the case of any other planning process, can be considered as arranging the flow of
activities.
Logistics planning tackles four major problem areas:
i. Customer service levels
ii. Facility planning
iii. Inventory management, and
iv. Transportation decisions.

The customer service demand is however very critical for the logistics planning process since it is
instrumental in providing the central objective for the logistical planning function. The entire plan
revolves around this aspect. Thus, the logistics planning process is often considered as a triangle of
logistics decision- making. As the figure illustrates, the three major components of the logistical
plan in effect attempts to fulfil the objective set under the customer service goals. This is because
the level of logistical activity and consequently, the cost of providing the logistical support are
totally dependent on the level of customer service envisaged in the strategic plan of the firm. The
level of service provided also affect the design of the logistical system. If a higher level of customer
service is planned to be provided the system would require more facilities like warehouses,
transportation, etc. Conversely, as the cost of logistics is reduced, the ability of a firm to provide
greater service levels is also reduced
The triangle of logistical decision

 Facilities Decisions
A logistical system would normally require some permanent facilities for storing and supplying
the products to the end consumers. Warehouses are locations where the inventory is received,
stored, and shipped out according to the demand. Warehouses are usually secure well-protected
buildings with special facilities to prevent any damage to the stored goods.
Modern warehouses are equipped with sophisticated material-handling equipment that enable
easier handling of inventory. Since the primary purpose of a warehouse is to handle inventory,
the need for a warehouse would exist whenever a system has some amount of inventory. While it
is difficult to eliminate warehouses or storage locations altogether from the logistical systems,
certain types of logistical systems do operate without warehouses. Three generic types of
outbound logistics strategies are possible:

1. Direct shipment
2. Warehousing
3. Cross-docking

In direct shipment strategies, goods once manufactured are directly shipped to the point of sale
without being stocked anywhere. While this strategy is practicable and increasingly being adopted
by companies the world over, it is an extremely difficult strategy to implement especially when there
is need for an extensive distribution network so as give maximum spatial convenience to the
customers.
In the warehousing strategy, however, goods once manufactured are stored in warehouses waiting
for orders from the retail outlets or other points of sale. This is the classic strategy where the
logistics system consists of a network of warehouses which adjusts the differences in the pattern of
production and the pattern of demand. Given the huge difference in these patterns both in terms
of the size of orders, the timing of the orders, and the time interval permissible between the
customer's order and delivery, warehouses which adjusts these discrepancies are considered to be
a must.
In cross-docking, while warehouses do exist, the storage time is reduced to a minimum. In this
strategy, items are distributed continuously from suppliers through warehouses to suppliers with
the items lying in the warehouses for just a few hours. Such a strategy also requires a high level of
coordination between production and sales department.

Being an extremely difficult activity, cross-docking is possible only when certain conditions are
satisfied. Some of the important conditions are: (i) the inventory destination is known when stocks
are received, (ii) customer is ready to receive inventory immediately, (iii) the number of locations
to ship inventories are not high (less than 200), (iv) it is possible to pre-label the inventory, and (v)
inventory arrives at a state where it is immediately conveyable The warehousing decisions thus
assume great importance if the latter two types of outbound logistics strategies are adopted.

 Why need Warehouses at all?

The main function of a warehouse is to store inventory or perform the critical functions of
accumulation, storage, and allocation. Goods from the locations of production are accumulated in
the warehouses. This function assumes great importance when the variety of products stored is
very high. If the number of items or stock keeping units (SKUs) is large and originates from
different plants, the warehouse serves the function of bringing together these supplies from
multiple points. In the absence of a warehouse, tracking the inventory position for thousands of
SKUs being sourced from several plants becomes a difficult task. Warehouses also serve as points
of allocation. It is at the warehouse that the products usually received in bulk quantities are
broken down into smaller quantities as per the order received from the retailers or the next
entity in the chain. When the number of retail outlets is high, the allocation function becomes
complex and requires a highly equipped warehouse where the orders received are picked and
packed to be sent to the respective retail outlets. In terms of transportation, warehouses help in
achieving greater economies of scale as it becomes possible to transport goods in large
quantities.

 Main Functions of Warehousing Operations

The warehousing function performs several specific activities as part of integrated logistics system
so as to enable the system to function perfectly with the maximum level of efficiency. These
activities can be basically classified into three main types: movement, storage, and information
transfer.
The movement function itself consists of several activities such as (i) receiving (ii) transferring (iii)
order picking/ selection, and (iv) shipping. The receiving activity involves all the activities that are
required when product shipments are received from the sender. The main activities at this stage
involve the unloading of the goods, updating of the inventory records, inspection of damage, and
verification of the merchandise count against the orders and shipping records. The transfer
activity involves transferring the shipment received to locations within the warehouse specifically
meant for the storage of that category of inventory to enable easy access whenever required. The
order picking or selection activity takes place whenever the warehouse gets an order from the
downstream recipient for the goods stored. Once the order is received, the order is picked and
packed to be shipped after selecting the mode of transport, after adjusting the inventory records.
The storage function may be performed on a temporary or a semi-permanent basis. Goods can be
stored in a warehouse temporarily awaiting an order from the downstream intermediary or else,
mainly in the case of seasonal products, goods can be stored for a reasonably long period either
to offset the seasonal demand or on the basis of speculation or forward buying.
The information transfer function of warehousing occurs simultaneously with the movement and
storage functions. Information on inventory levels, throughout levels (i.e., the amount of product
moving through the warehouse), stock keeping locations, inbound and outbound shipments,
facility space utilization, order fulfilment data, etc. are the type of information that a firm expects
a warehouse to provide. Information technology is increasingly being used to make it easier to
capture these kinds of data and transfer it online to decision makers.

 Main Decisions in Warehousing

The two main decisions with regard to the warehousing function in a firm are:
 The number of warehouses and
 The location of the warehouse.
Number of warehouses Four factors are considered in deciding about the number of warehouses
 Cost of lost sales,
 Inventory costs,
 Warehousing costs, and
  Transportation costs.

Cost of lost sales: The cost of lost sales is the stockout cost when a customer's order is not
fulfilled due to lack of availability of stock within the permissible waiting time allowed by the
customers. It is estimated that when the number of warehouses increases, the possibility of
stockout reduces and consequently the cost of lost sales comes down. However, with greater
information dissemination and better transportation facilities now available it is quite possible to
avoid stockouts with fewer numbers of warehouses.

Inventory costs: The inventory costs are the costs incurred in procuring and holding the inventory
for the entire system. Since every warehouse will have a specified safety stock for all the items
stocked, the inventory costs are estimated to go up with the number of warehouses.

Transportation costs: Transportation costs of the system includes the costs incurred in
transportation for the entire system consisting of the transportation from the production points
to the warehouses as well as the warehouses to the points of sale. Transportation costs initially
decline with the increase in the number of warehouses since it becomes possible to increase the
proportion of full truckload shipments in the overall shipments from the production plant.
However, when the number of warehouses increases beyond a point, the transportation costs are
seen to increase owing to the combination of the inbound and outbound transportation costs.

Warehousing costs: The warehousing costs consist of the cost of renting, leasing, or owning the
warehouse as well as the maintenance of the warehouse. Warehousing costs will naturally
increase in direct proportion with the number of warehouses. The fluctuation in the costs of
logistics with regard to the number of warehouses is shown in the following figure.

Relationship between logistics cost and the number of warehouses

Warehousing locations: Being supply points for the entire market, it is very important that the
warehouses are properly located. Proper location will lead to greater customer need fulfillment at
a lesser cost. Hence, the objectives of location decisions must be to ensure the required level of
customer service with regard to the service output levels with the minimum costs. The location or
site selection decision can be approached from macro and micro perspectives.
Macro perspectives on warehouse locations: Most of the macro approaches on warehouse
location try to give a more general solution to the problem. According to Lambert (1998), the
macro perspective examines the issue of locating a warehouse within a broad geographical area
and concerns issues like whether the warehouse should be located near the production plant, the
market, or midway between the both.
Micro perspectives on warehouse locations: The micro perspective takes a more precise
approach and attempts to pinpoint locations using optimization techniques. Most of the micro
perspectives on warehouse locations tend to give specific solutions to problems concerning
facilities locations.
Centre of gravity method: The centre of gravity method tries to minimize the cost of logistics by
selecting an appropriate site for locating the warehouse when the transportation cost as well as
the volume to be shipped to various markets is known. It is a very simple model which uses
straightforward minimization principles. However, when we try to bring in more information, the
computations can be quite complex and would require powerful computer programs.

While the centre of gravity method is quite simple and easy to understand, it makes certain
assumptions that may not always be the case in practice.
 i. For instance, in this method the location decision is made after considering only the
variable as cost the fixed cost of setting up the warehouse could vary from one location to
another based on the terrain, access to roads, etc. and that is why it is not considered.
ii. The method tries to come out with the most optimized location by considering the straight-
line distances between points. This may not work out perfectly every time. The presence of
a river or some other geographical obstruction like mountains etc. could make the use
of radial distances as approximations of actual distances impractical.
iii. The market is considered as a single point while in reality it is not so. It is always very
dispersed. While this disparity can be explained in terms of using the centre of gravity of
the market as the point to be considered, it might not always work out properly.
iv. The transportation cost is assumed to increase in proportion to the distance, but in reality,
the transportation cost will normally have a fixed component and a variable component.

Cost- Volume-Profit analysis This is another method used for warehouse location decision. It is
a simple method which uses the break-even analysis to select from a set of locations. In this
method we decide about a few alternative locations and then select from this set of alternative
locations. We also estimate the fixed and variable costs for each of the locations. This method
assumes the following:
1. Fixed costs are constant for the range of probable output.
2. Variable costs are linear (i.e., variable costs per unit are constant) for the range of probable
output.
3. The required level of output can be closely estimated.
4. Only one product is involved

 INVENTORY MANAGEMENT DECISIONS

Managing the inventory in the distribution system is probably the most critical activity in the
logistics management process. Inventory levels directly influence the profitability of a company
since building up inventories lead to greater costs. Strategic orientation is therefore needed to
maintain the most optimum level of inventory so that the customer service standards are met
with the minimum level of inventory. Modern approaches like JIT (just-in-time) and ECR (efficient
customer response) thus try to find out this optimum level of inventory and programme the
system in order to achieve it.

Just-in-Time inventory
The just-in-time or JIT inventory system pioneered by Japanese auto manufacturers like Toyota
basically aims to reduce the raw material inventory to virtually zero levels so that the raw material
reaches the production site just when it is required for use. The just-in-time system thus reduces
costs by focusing on identification and elimination of waste found in the manufacturing system.
This requires extensive planning and coordination among the vendors and the production plant.
The method involves accurate forecasting of the requirements on a day to day or even on an
hourly basis as well as synchronizing the ordering and delivery of products with extremely high
levels of precision. JIT practices require a 'pull' system of manufacturing where the production
takes place entirely on the basis of demand generated. Under JIT, close and frequent
communication between buyers and sellers is required. The suppliers are given deep insights into
the buyer's production schedule. From a distribution point of view, ability to deliver products on a
JIT basis can be used as a major differentiator by companies, as the Jindal Vijayanagar steel plant
does. It offers all its customers inventory delivered only when they exactly want it. To facilitate
this, the company has employed a fleet of Volvo trucks with a capacity of 60 tons that are routed
in a highly optimized travelling pattern so that travel time is reduced to the minimum.
Efficient Customer Response
Efficient customer response refers to a movement for enhancing the value proposition for the end
customers by increasing the efficiency of the supply chain. This movement was first stated by the
grocery industry in the US in the early 1990s. The movement primarily is concerned with the fast
moving consumer goods, mostly the grocery items. In practice, the movement tries to cut cost
wherever possible in the distribution chain. It also involves maintaining high levels of merchandise
availability. Often, competing manufacturers come together to ensure that the distribution
logistics functions in the most efficient manner. A case in point is the unique arrangement
between Nestle and Johnson and Johnson for delivering their finished goods. The 'backhaul'
arrangement consists of a shared transporter, Transport Corporation of India, which delivers
goods for Nestle as well as J&J from the manufacturing locations to warehouses. Most of Nestle's
production locations are centred around Delhi while J&J's is around Mumbai. Since both these
locations are big markets for both the companies, TCI optimizes the transportation costs between
these two locations. The benefits are faster turnaround times at lower costs and quicker supply of
stocks. For the ECR movement to succeed, the menu- factures, wholesalers, retailers, and the
supply chain providers will have to come together to reduce costs and work efficiently. The
efficient customer response movement requires a widespread use of electronic data interchange.
This implies a continuous capturing of point-of-sales information, which helps in analysing the
rate at which each SKU is getting sold from the shop shelves. This POS information also has -to be
shared with the retailers, wholesalers, and manufacturers in a regular manner so as to enable
continuous replenishment of inventory and flow through distribution.

 Why do we Need Inventories?

Several reasons are responsible for the existence of inventories in a distribution channel. Some of
the most important ones are:
Improves Customer Service: Production facilities, which have to be programmed in advance for
producing at specific capacities, cannot respond to fluctuating demands instantaneously. However,
demand is normally very stochastic in the short term. This means that the exact level of demand
cannot be accurately predicted in the short term. Hence, inventory is required to service the
possible increase in demand that might occur defying the forecasts.
Smoothens the Operations of the Logistics System: Much of the inventory is actually carried out as
a buffer to service unpredictable demand during the lead time after passing the order for
replenishment to the production facility. Any logistics system will have a lead time between the
order transmission and the order receipt.
Reduces Costs: While inventory pile up usually leads to higher costs, some cost-saving is also
affected due to inventory management. For instance, the capability to carry inventory in the
system enables a production facility to avail of quantity discounts from its raw material suppliers.

 Objectives of Inventory Management

Inventory management aims to achieve the perfect balance between achieving customer service
targets and reducing inventory costs. The customer service demands are expressed in terms of
product availability. The term used to express the service level is fill rate (FR). Fill Rate is defined
as the ratio of the number of orders completely serviced to the total number of orders received
during a particular time period.

Fill Rate Expression

The expression fill rate is actually used to express two different perspectives to indicate the
service level of the logistics system. These two measures are line fill rate (LFR) and order fill rate
(OFR). Both the measures are used to denote the extent to which the warehouse or the inventory
management system has been able to fulfil the orders placed in the expected lead time. It is in
reality an indication of the system's ability to anticipate the demand from

As can be seen from the above example, the OFR is a more exacting measure of inventory
management service levels. It is possible to have a high line fill rate with abysmal order fill rate.
When the logistics system is planned, a specific fill rate figure is always kept in mind as a target.
Further, different systems can be compared on the basis of the fill rates and the corresponding
inventory level that is used to achieve those fill rates. If an inventory is high, the fill rate will
consequently be high. However, the efficiency of a system is to achieve the same fill rate figure
with fewer inventories.

Costs Associated with Inventory

The costs associated with inventory can broadly be classified into three: (i) inventory procurement
costs, (ii) inventory carrying costs, and (iii) stockout costs. If the inventory carrying cost is reduced
by ordering lesser quantities of inventory each time, both the procurement and the stock-out
costs will increase.

Inventory Procurement Cost

The inventory procurement costs are normally considered as the ordering costs for the inventory.
These are fixed costs which have to be incurred in setting up the machinery, procurement of
related materials, transportation, order processing, etc. Hence, when the order quantity is large,
the procurement costs will come down.

Inventory Carrying Cost

Inventory carrying costs can be classified into four basic categories.
 Capital costs
 Inventory service costs
 Storage space costs
 Inventory risk costs

 Components of the inventory carrying costs

Capital Costs
To build up inventory sufficient capital has to be tied up for a considerable length of time. The
capital cost of inventory is the cost of the capital tied up in the inventory. It is estimated that
on an average this constitutes about 80% of the entire inventory carrying costs.
Inventory Service Costs
Inventory service costs mostly consist of insurance and taxes.
Storage Space Costs
These costs relate to the charges for the warehouse including the rent, maintenance charges,
etc.
Inventory Risk Costs
Often inventory stored for a longer period of time might lose its value because of shrinkage,
obsolescence, deterioration, etc. In the case of perishable items, the time period involved is
very short. It is often necessary that someone bears this cost. Often the owner of the
inventory bears this cost. However, the manufacturer takes responsibility for the expired stock
from the retailers.
 Out of Stock Costs
Out of stock costs are incurred when an order is placed but cannot be filled from the inventory
to which the order is normally assigned. The two types of out-of-stock costs are
(i) cost of lost sales and (ii) back-order costs. The cost of lost sales occurs when the customer
withdraws the purchase order in case the product is not supplied within the tolerable waiting
time. Back-order costs occur when the purchase is delayed and not lost. Back orders create
additional burden on the system with greater clerical time and associated costs in order
processing and delivery.

Inventory Level Decisions

"While it is possible to estimate the costs associated with inventory, the most important thing
concerning inventory management is the decision about the quantum of inventory to be carried
during a specific period. Since this decision directly affects the inventory carrying costs to a
significant extent, the entire logistics cost of a company is based to a great extent on the policy
decisions that are taken about the levels at which inventory is to be managed in a system. These
decisions involve decisions about 'push or pull' inventory strategy and inventory replenishment
points.

 Push vs Pull Inventory Control

The push and pull systems are distinguished by the way a company's production systems are
managed. In push strategy, the inventory management is centralized and decisions about the
inventory levels are forecast at the central level.
The push method is considered to be appropriate where the production quantities exceed the
short-term requirements of the inventories. On the other hand, the pull system of inventory
planning is a typical bottom up approach where the inventory levels are decided in a
decentralized manner with the warehouses and the other storage points calculating their
inventory requirements on a periodic basis and receiving them from the production facility.
A pull system, if implemented properly, can significantly reduce the inventory in the total
logistical system, as the production is demand driven so that it is coordinated with actual
customer demand rather than a forecast. However, to implement a pull-based system effectively,
a highly reliable information system is required that can transfer information about customer
demand to the production facility.

Risk Pooling
One of the major reasons for greater inventory investments is to store up the safety stocks at
various storage points. As the number of storage points increases, the safety stock component
also increases proportionately. An alternative to this is to reduce the number of storage points.
When the storage points are reduced, it has been observed that the total variability in demand is
reduced considerably. This phenomenon is called risk pooling. Risk pooling happens because of
the possibility of higher than average demand from one point being offset by the lower than
average demand from another point, assuming that the demand occurs randomly at different
points at short periods. The total average demand at the centralized warehouse will thus witness
less variation leading to a lesser provision of safety stock. This phenomenon therefore supports
the argument for a centralized system rather than a decentralized system. The benefit of risk
pooling is possible only when there is insignificant positive correlation in the demand between
customer points. This means that the demand from two points should not generally increase or
decrease together.
Echelon Inventory
A distribution system will consist of tens of large warehouses, hundreds of small warehouses,
and thousands of retailers. Hence, it is often impossible to manage inventory by looking at
individual points one at a time as we were trying in the earlier examples. The echelon inventory
concept is a viable solution to this. In a distribution system, each stage or level is called an
echelon and the echelon inventory is the inventory at the echelon and the entire inventory in the
downstream echelons. Hence, a distribution system consists of stockists in every state supplying
to the retail network in those state. The echelon inventory at the stockist level can be defined as
the inventory at the warehouse of the stockist plus the entire inventory in transit or on stock at
the retailers' end. When the inventory is managed in this way, typically the echelon inventory
reorder point is calculated at the stockist level, which takes into consideration the entire
echelon inventory comprising the inventory at the stockist's and at the retailer's level. The idea
is to maintain sufficient inventory below each level in the distribution system.

 TRANSPORTATION DECISIONS
The transportation activity moves products to markets that are geographically disparate and
provides added value to the customers when the products arrive on time, undamaged, and in
quantities required. The utility provided by the transportation function is called place utility, while
time utility is created by the storage function. However, without transportation function, the
delivery of time utility will not be complete since transportation function decides how fast and
how consistently a product moves from one point to another.
Transportation is thus a critical logistics activity. It has been found that apart from the cost
of goods sold, which is reflected in the inventory carrying costs, the transportation cost is the
largest component of the logistical costs.
The major decision areas in transportation include (i) mode selection, (ii) vehicle routing and
scheduling, and (iii) shipment consolidation.

Mode selection
Generally, five modes of transportation are used in moving goods from one point to the other,
viz., air, rail, road, water, and through pipeline. In reality, however, intermodal combinations are
always resorted to.

Vehicle Routing and Scheduling

While one of the major objectives of logistics is to reduce the inventory storage time, the
transportation efficiency also plays a major part in achieving this objective. The vehicle routing
problem is related to this aspect. It tries to find out the best path a vehicle should travel through
a network of roads, rail lines, shipping lines, etc. so that the time and distance traveled is
minimized to the maximum. The methods of routing a vehicle through a network has been
solved by methods designed specifically for it. Most of these methods are highly analytical in
nature and require powerful computers to solve practical problems. Some of these methods are
the shortest route method, which tries to work out the best route from a single origin through
an iterative solution methodology, the transportation method where problems with multiple
origin and destination points are solved, etc. Vehicle scheduling problems are extensions of
vehicle routing problems. In vehicle scheduling more realistic restrictions are included like
restrictions on the number of stops on the route where goods have to be picked up/or delivered,
the use of multiple vehicles with different capacity limitations of both weight and volume,
restrictions on maximum driving time, etc.

Freight Consolidation
Freight consolidation activity is mainly intended to reduce the cost of transportation through
bringing together smaller quantities of inventory in order to create a bigger quantity for
 transportation. This principle ensures the optimum sharing of fIxed costs of transportation.
Consolidation is achieved by: (i) consolidating the inventories which involves grouping different
items together so that these items are transported together and not one or a few items
together, (ii) vehicle consolidation where vehicles with less than truckload inventory are not
allowed and consolidation of inventory into full truckload is preferred, (ill) warehouse
consolidation where warehouses are located in such a way that large quantities of inventory are
transported through large distances and smaller quantities are transported through smaller
distances, or (iv) temporal consolidation where orders from the downstream are held so that
larger orders are accumulated for transportation.

 Factors affecting Transportation costs

Transportation costs are affected by a variety of factors. These factors can be divided into product-
related factors and market-related factors.
The product related factors include: (i) the density of the product, (ii) stow ability, (iii) the ease or
difficulty in handling, and (iv) liability.
The weight to volume ratio or density has a major part to play in deciding the transportation
costs. Products which are heavy will usually require costlier transportation alternatives. The stow
ability refers to the extent to which a product can fill in the available area. For instance, liquids
like petroleum or food grains can completely fill the volume of the area available while machinery
or automobiles will not fill the area to that extent. Products with greater stow ability will thus
require relatively less transportation space. Ease or difficulty in handling is also associated with
stow ability. Products that are uniform in their physical characteristics or that can be manipulated
with material handling equipment require fewer handling expenses and are therefore less costly
to transport. Often, products which have high value to weight, like electronic gadgets, crockery,
etc. are easily damaged and cost more for transport.
Some of the market-related factors that affect transportation costs are: degree of intermode or
intramode competition, location of the markets, balance or imbalance of infreight traffic in and
out of the market, season ability of the product movements, etc. If the degree of competition
between two types of transportation modes or between operators of the same mode is higher, it
is possible to get transportation services at a lesser price. Location of the market will greatly affect
transportation costs, as far-flung locations will usually incur greater transportation costs. In any
geographical location there will be some freight being transported in and some freight being
transported out. The freight being transported in is used for consumption while the freight
transported out is for sale outside the geographical region. If the freight is transported in is more
than that transported out, trucks or other transport vehicles will have to return back empty,
which is inherently inefficient and will affect the transportation cost. Instead, if the vehicles can go
back fully loaded, the costs of transportation will come down. If there is high seasonal variation in
the demand and the consequent product movement, the transportation cost will be reduced
since the bulk of the demand will be transported in fewer trips.

 Why logistics is important in today’s economy

Logistics plays a huge role within today’s economy. Just imagine a world where nothing was
delivered or transported between places. Not only is logistics vitally important to the distribution
industry, it has made distribution prompt and efficient. In this very competitive market, it is
extremely useful that companies no longer have to wait for what they need.
Many companies rely on transport and logistics to keep their business strong.

Today, companies have good infrastructure and record keeping, which continues to improve through
advancements in technology. As time has progressed, so has the importance of logistics, in fact this
rise has brought factors such as warehousing and other facilities closer to large towns and cities.
Logistics is affecting businesses within towns and cities, bringing more jobs into these locations.

 Logistics is an important part of the supply chain.

It controls the effective forward and reverse flow of goods and services origin to recipient. This
means that logistics has an impact on the shipment of goods and how quickly they can get to the
consumer, again adding a competitive edge to other businesses.

 The trend of third-party logistics is on the rise.

Globally, the logistics industry has seen an immense growth over the past decade, with 40% of
organisations now using third party logistics and the industry being said to be worth $750 billion
globally, and $174 billion in Europe. This shows an increase in jobs for transporters, warehouse
facility owners, and brokers in freight-related jobs.

 Technology is making logistics more efficient.

A huge part of the economy that is benefiting from an increase in logistics is technology. A good
logistics company will integrate all of the supply chain functions into a digital strategy. They will track
orders and vehicles to gain greater visibility and improve their methods.
This better visibility helps companies to optimise their flow of goods, reduce wait times and manage
their costs. Technology is an essential part of logistics and its use is benefiting today’s economy.

 The Role of Logistics in the International Economy

The growing wealth of trade has led to rising national and international markets for goods and
services. Thousands of new goods and services have been introduced in the past and are
presently sold and circulated to consumers in every area of the world. To gather the challenges
of extended markets and the increase of new products and services, business have increased in
volume. Multiple-plant operations have replaced single plants. The distribution of products from
point-of-origin to point-of-consumption has become an enormously important component of
the Gross Domestic Product (GDP) of developed nations. Considering its utilization of land,
labor, and capital, and its impact on the standard of living, logistics is clearly big business.

 Logistics as a Significant Component in National and International Economy

As a significant component, logistics affects the rate of inflation, interest, productivity, energy costs
and availability, and other aspects of the economy. Improvements in a nation’s productivity have
positive effects on the prices paid for goods and services, the balance of national payments, currency
valuation, the ability to compete effectively in global markets, industry profits (higher productivity
implies lower costs of operation to produce and distribute an equivalent amount of product), the
availability of investment capital, and economic growth leading to a higher level of employment.
Perhaps the best way to illustrate the role of logistics in economy is to compare logistical
expenditures with other shared activities. The amount spent on logistics is higher than what have
been spent on advertising, twice that spent on national defence and equal to that spent on medical
care.
Logistics also supports the movement and flow of many economic transactions; it is an important
activity in facilitating the sale of virtually all goods and services. To understand this role from a
systems perspective, consider that if goods do not arrive on time, customers cannot buy them. If
goods do not arrive in the proper place, or in the proper condition, no sale can be made and thus all
economic activity throughout the supply chain will suffer.

 Logistics’ Role in the Organization

In recent years, effective logistics management has been recognized as a key element in improving
both the profitability and the competitive performance of firms. In the late 1980s and early 1990s,
customer service took center stage in many organizations. Even organizations that had previously
adhered to the “marketing concept” were reexamining what it meant to be customer driven. The
trend toward a strong customer focus continues today. Coupled with operational efficiencies and
effectiveness, a marketing orientation provides organizations with opportunities to gain competitive
advantage.

 Logistics Leads to Competitive Advantage

The marketing concept is a “marketing management philosophy that holds that achieving
organizational goals depends on determining the needs and wants of target markets and delivering
the desired satisfactions more effectively and efficiently than competitors. In other words, the
marketing concept holds that a business exists to meet customer needs. The three critical elements
of the marketing concept are “customer satisfaction”, “integrated effort” and “company profit”.
Logistics plays a key in order for a firm to be successful, any marketing effort must integrate the
ideas of having the right product, at the right price, combined with the right promotion, and
available in the right place—these are the four Ps of the marketing merge. Logistics plays a critical
role, particularly in support of getting the product to the right place. As we will note with regard to
utility creation, a product or service provides customer satisfaction only if it is available to the
customer when and where it is needed. Achieving customer satisfaction requires an integrated effort
both internally and externally (with suppliers and ultimate customers).

 Product.
Product refers to the set of utilities or characteristics a customer receives as a result of a purchase.
In an effort to lower price, management may decide to reduce product quality, eliminate product
features, reduce the breadth of product offerings, reduce customer service or warranty support, or
increase the time between model changes. However, any of these actions may reduce the attraction
of the product for consumers, creating a loss of customers and thereby a reduction in long-term
profits. To avoid making poor decisions, management needs to understand the trade-offs and
interrelationships between logistics and other marketing activities.

 Pricing Considerations
The amount of money a customer pays for a product or service is typically referred to as its price.
Price factors include discounts for buying in quantities or for role in each of these elements in
several ways belonging to a certain class of customers, discounts for prompt payment, rebates,
consignment arrangements, and delivery costs.
A supplier may attempt to increase sales by reducing the price of its product or by changing the
terms or service offering. Unless demand for the item in question is very elastic (that is, sales change
dramatically due to changes in price), such a strategy may create higher unit sales but not
necessarily higher profit—the sales may not increase enough to offset the lower price. This is
particularly true in mature industries, where customer demand is relatively fixed and the
competition may follow the price decrease. In such cases the sales and the profitability of the entire
industry may suffer.

 Promotion.
Promotion of a product or service encompasses both personal selling and advertising. Whereas
increasing advertising expenditures or the size of the direct sales force can have a positive impact on
sales, there is a point of diminishing returns. At this point, the extra money being spent does not
yield high enough increases in sales and/or profits to justify the added expense. It is important for
organizations to understand when they reach this point so that they can avoid misallocating funds. A
prudent idea may be to reallocate extra advertising funds to, perhaps, employee training.

 Selling Value-Added to Customers

The sales force, for example, could be trained to provide more value-added services to the customer
or to make the customer more aware of the value-added the firm currently provides through
superior logistics.

 Place
Customer Service is an Output of the Logistics System Expenditures in the place component of the
marketing mix support the levels of customer service provided by the organization. This includes on-
time delivery, high order-fill rates, and consistent transit times. Customer service is an output of the
logistics system and represents the firm’s expenditure for logistics. On the other hand, when the
organization performs well on all the elements of the marketing mix, customer satisfaction occurs.
For many organizations, customer service may be a key to gaining competitive advantage. By
adjusting customer service levels to meet what the customer desires and is willing to pay for, the
organization may simultaneously improve service levels and reduce costs. All of the logistics trade-
offs must be considered in terms of their impact on customer service. In order to accomplish this
analysis, the total cost concept must be used.
Additionally, when combined with operational efficiencies and effectiveness from the adoption and
implementation of technology and various management strategies such as supply chain
management (SCM), total quality management (TQM), just-in time (JIT), and quick response (QR),
organizations can develop competitive advantage. Technology and management strategies will be
discussed later in this chapter and throughout this text.

 Logistics Adds Time and Place Utility

Manufactured products possess some value or utility because an assembled item is worth more than
its unassembled components or raw materials. A completed automobile, for example, is much more
valuable to a consumer than its unassembled parts would be. The value, or utility, of making
materials available in a completed state is called form utility. To the customer, however, the product
not only must have form utility but also must be in the right place, at the right time, and be available
to purchase. The value added to products beyond that added by manufacturing (form utility) may be
called place, time, or possession utility. The logistics activity provides place and time utility, while
other marketing activities provide possession utility.
Management is quite concerned with the value added by logistics, because improvements in place
and time utility are ultimately reflected in the firm’s profits. Both cost savings in logistics and a
stronger marketing position due to an improved logistics system can cause improved bottom-line
performance. The more logistics contributes to the value of a product, the more important logistics
management is. Place Utility is the value created or added to a product by making it available for
purchase or consumption in the right place. Logistics is directly responsible for adding place utility to
products as it efficiently moves raw materials, in-process inventory, and

 Time Utility is the finished goods from point-of-origin to point-of-consumption.

Time utility is the value created by making something available at the right time. Products are not as
valuable to customers if they are not available precisely when they are needed. For example, a food-
processing company must have raw materials (food items), packaging materials, and other items
available before the production process begins or, if already begun, before existing supplies run out.
Failure to receive these items at the proper time can cause costly production shutdowns and place
the firm at a competitive disadvantage. As the remaining chapters of this book will show, logistics
activities combine to add place and time utility to products.

 Possession Utility
Possession utility is the value added to a product by allowing the customer to take ownership of the
item. Possession utility is a result not of logistics but of the offering of credit, quantity discounts, and
delayed payments that enable the customer to assume possession of the product. The logistics and
marketing processes culminate in possession utility.
Logistics Allows Efficient Movement to the Customer

 Five Rights of a Logistics System

“Five rights” of a logistics system are supplying the right product at the right place at the right time
in the right condition for the right cost those customers consuming the product.

 The term right cost deserves consideration.

The first four rights are analogous to form, time, place, and possession utilities created by
manufacturing and marketing, the addition of the cost component is immensely important to the
logistics process.
Improvements in marketing efficiency and reductions in marketing costs still lie in the future,
representing a major frontier for cost economies. There is room for substantial improvement,
particularly in the performance of the physical distribution functions of marketing which constitute a
major part of the total marketing costs.

 Logistics is a Proprietary Asset

An efficient and economical logistics system is similar to a tangible asset on a corporation’s books.
Logistics competency cannot be readily duplicated by the firm’s competitors. If a company can
provide its customers with products quickly and at low cost, it can gain market share advantages
over its competitors. It might be able either to sell its product at a lower cost as a result of logistics
efficiencies or to provide a higher level of customer service, thereby creating goodwill. Although no
organizations presently identify this “asset” on their balance sheets, it theoretically could be shown
as an intangible asset, a category that includes such items as patents, copyrights, and trademarks.

 Technology
Computer technology and distribution software are two other factors that have caused businesses to
become more interested in logistics management. The development of computer technology,
particularly the microcomputer, has allowed executives to implement logistics management much
more effectively and efficiently than ever before. Firms can improve their cost efficiency because of
the speed and accuracy of the computer; they can use sophisticated techniques to manage and
control activities such as production scheduling, inventory control, and order processing. In fact,
such advances, and the resulting impact on the firm’s marketing, production, and financial activities,
have been instrumental in creating top management awareness of logistics.

 Factors Underlying the Development of Interest in Logistics Management

A number of factors underlie the recognition of the importance of logistics management: advances
in computer technology and quantitative techniques; development of the systems approach and
total cost analysis concept; recognition of logistics’ role in the firm’s customer service program;
erosion of many firms’ profits because of their failure to examine functional areas where cost
savings might be realized profit leverage resulting from increased logistics efficiency general
economic conditions and recognition that logistics can help create a competitive advantage in the
marketplace.