OPERATİONS & LOGİSTİCS MANAGEMENT İN AİR TRANSPORTATİON

PROFESSOR DAVİD GİLLEN (UNİVERSİTY OF BRİTİSH COLUMBİA ) &

PROFESSOR BENNY MANTİN (UNİVERSİTY OF WATERLOO)
Istanbul Technical University Air Transportation Systems and Infrastructure
Air Transportation Management Strategic Planning
M.Sc. Program Module 11-12 : 14 June 2014
 LOGİSTİCS
Learning Objectives
– Key components of logistics
• Order Processing, Inventory, Transportation, Sourcing,
Warehousing, Materials Handling, and Packaging, integrated
through a network of facilities (warehouses and distribution
centers)
– Logistics is integral to a firm’s strategy
– Keys to managing logistics costs
• Inventory management
• Transportation management
– Supply Chain Flexibility and Synchronization
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 WHAT İS LOGİSTİCS?
• Logistics is the design and administration of systems
to control movement and spatial positioning of factor
inputs (raw materials, labor, capital, energy) work-
in-process, and finished inventories at the lowest
total cost.

• Our focus will be on inventory management and transportation

management
THE FİVE FUNCTİONS OF LOGİSTİCAL WORK ARE
İNTERRELATED
 WHAT DO WE KNOW ABOUT TURKEY
• 81 provinces
• Bordering countries: Armenia, Azerbaijan, Bulgaria, Georgia, Greece, Iran, Iraq,
Syria
• Population (January 2013) 74.6 million (18th largest in the world)
• Urbanization: about 72 %
• Age structure: 0–14 years (26.0%); 15–64 years: (67.9%); 65 and above (6.1%)
• Nominal GDP (2012) US$790.5b
• GDP per capita (US$ current prices) (2012) - US$10,595.2
• GDP Composition: Agriculture (9.1%); Industry (27.9%); Services (63.0%)
• Public debt: 40.4 % of GDP
• Labor force (2012): 26.5 million

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GEOGRAPHİC
STRENGTH

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INTERNATİONAL FREİGHT-MODAL SPLİT

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GROWTH İN LOGİSTİCS ACTİVİTİES

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CARE İN COMPARİNG LOGİSTİCS COSTS

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 U.S. LOGİSTİCS COST,
1980-2010 İN FİVE YEAR İNTERVALS ($B)
Year Nominal Inventory Transportation Administrative Total Logistics
GDP ($T) Cost Cost Cost Logistics % of GDP
Cost

1980 2.80 220 214 17 451 16.1

1985 4.22 227 274 20 521 12.3
1990 5.80 283 351 25 659 11.4
1995 7.40 302 441 30 773 10.4
2000 9.82 374 594 39 1007 10.3
2005 12.43 395 739 46 1180 9.5
2010 14.60 396 769 47 1212 8.3
THE COST OF LOGİSTİCS
LOGİSTİCS COSTS CANADA-U.S. COMPARİSON

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LOGİSTİCS WİLL CONTİNUE İTS RENAİSSANCE İN THE FUTURE

• Information technologies will automate many of the

traditionally manual logistical functions:
– Automated port and rail operations
– RFID tagging of materials
– Advanced technologies for warehousing and inventory
operations
• Removal of trade barriers will continue to expand global trade
and logistics
• Outsourcing versus near-shoring
– Implications for airlines?
 LOGİSTİCAL VALUE PROPOSİTİON-MANUFACTURİNG &
SERVİCE INDUSTRİES

• Logistical value proposition consists of a commitment to

key customer expectations and requirements at a minimum
cost
• The two elements of this value proposition are Service and
Cost Minimization
– Firms must make appropriate tradeoffs between service and cost
for each of their key customers
 SERVİCE BENEFİTS ARE CREATED BY LOGİSTİCAL
PERFORMANCE İN 3 AREAS

• Availability involves having inventory to consistently meet

customer material or product requirements

• Operational performance deals with the time required to

deliver a customer’s order
– Key metrics for this area involve delivery speed and consistency

• Service reliability involves the quality attributes of logistics

– Key to quality is accurate measurement of availability and operational
performance over time
 COST MİNİMİZATİON USİNG THE
TOTAL COST LOGİSTİCS MODEL
Traditional Cost Logistics Model Total Cost Logistics Model

• Focused on achieving the lowest • Focused on achieving the lowest

possible cost for each individual total cost across each function of
function of logistics logistics
– For example, Transport the • A cost decision in one function
material the cheapest way should consider impact to costs of
possible all other logistics functions
• Expected lowest cost based on – For example, Transporting
decisions that were cheapest for material the cheapest way is
individual functions slower than other choices. This
• Ignored the impact of cost requires an increase in storage
cost to hold the material longer
decisions across logistics
functions – Would it still be a lower cost to
use the cheapest mode of
transport?
 DİFFERENT PERSPECTİVES ON COST MİNİMİZATİON
Traditional Cost Logistics Model Total Cost Logistics Model
Minimize order processing cost Minimize (order processing +
+ inventory + transportation +
Minimize inventory cost warehousing, materials handling
+ and packaging + facility) cost
Minimize transportation cost _________________________
+ Lowest total logistics cost
Minimize warehousing, materials
handling and packaging cost
+
Minimize facility cost
__________________________
Lowest logistics cost
FRAMEWORK: TOTAL LOGİSTİCS COST FUNCTİON

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 COMPONENTS OF TLC
TLC (Q, r: T, ST) = RDi + (UCTDi/365) + (SDi/Q) + (QCI/2) + rIC + K(Di/Q) N(Z)S1

where:
TLC = total logistics cost
R = Transportation Rate per Unit between Origin and Destination
D = Annual Demand for some good ‘i’
U = Carrying Cost of In-transit Inventory
C = Value per Unit
T = Transit Time of Transportation Alternative
S = Fixed Ordering Cost per Order
Q = Order Quantity
I = Carrying Cost of Warehoused Inventory
r = Safety Stock
K = Stockout Cost per Unit
N(Z) = Unit Loss Integral
S1 = Standard Deviation of Demand During Transit Time
ST = Standard Deviation of Demand During Lead Time 20
HOW THESE COSTS ARE DİSTRİBUTED

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Cost Conflicts: Speed versus Service Reliability

Total cost
Cost, in dollars

Cost of
Inventory cost transportation
(includes service
storage and
intransit

Rail Truck Air

Transportation service
(greater speed and dependability)

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 OTHER COST CONFLİCTS/TRADEOFFS
Revenue

Total costs Total costs

Revenue
Cost
Cost

Transportation,
order processing,
and inventory Inventory
costs costs
Lost sales cost Transportation costs 0
0
0 100% 0 Increasing number of stocking points
Improved customer service

(a) Setting the customer service level (b) Determining the number of warehouses in a logistics
system

Total costs Total costs

Cost

Cost

Inventory Inventory
carrying carryng cost
costs
Lost sales cost Production costs
0 0
0 Average inventory level Product run length and product sequencing
altenatives

(c) Setting safety stock levels (d) Setting the sequence of production runs for
multiple products

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 TRANSPORTATİON
• Transportation is the operational area that geographically
moves and positions inventory
• There are three basic ways to satisfy transportation requirements
– Operate a private fleet of equipment
– Contract with dedicated transport specialists
– Engage carriers that provide different transportation services as
needed on a per shipment basis
 MEASURİNG COSTS
Cost Structure Accounting Costs
• Variable costs
• Costs vary with factor prices, – Material
productivity & output – Manufacturing/production
• Scale economies – shipping
• Scope economies • Fixed costs
• Utilization economies – Contracts
– Capital
• Density economies
– Manufacturing/production
• Agglomeration economies
• Ownership
• Value of time/reliability – Purchase
– Acquisition
– Usage
– salvage
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• Opportunity cost-forgone sales
 PRİCİNG
• Concept to ‘Willingness to Pay’
• Unit cost or average cost pricing
• Cost plus pricing
• Incremental cost pricing
• Differential Pricing (special case of Ramsey pricing)
• Non-linear pricing and two-part tariffs
• Bundling and unbundling

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THE SCOPE OF İNTEGRATED LOGİSTİCAL OPERATİONS
LOGİSTİCAL İNTEGRATİON REQUİRES ACHİEVİNG SİX
OBJECTİVES SİMULTANEOUSLY

 Responsiveness
 Variance reduction
 Inventory reduction
 Shipment consolidation
 Quality
 Life cycle support
 EXAMPLE SİTUATİONS FOR FLEXİBLE LOGİSTİCS
STRUCTURE

• The customer-specified delivery facility might be near a

point of equal logistics cost or equal delivery time from
two different logistics facilities
• The size of a customer’s order creates improved logistical
efficiency if serviced through an alternative channel
arrangement
• Decision to use a selective inventory stocking strategy
• Agreements between firms to move selected shipments
outside the established echeloned or direct arrangements
SUPPLY CHAİN SYNCHRONİZATİON
• Supply chain
synchronization is the
operational integration of
multiple firms across a
supply chain
– Seeks to coordinate the flow
of materials, products and
information between supply
chain partners to reduce
duplication of effort
– Seeks to reengineer internal
operations of individual firms
to leverage overall supply
chain capability
THE LOGİSTİCS PERFORMANCE CYCLE İS THE BASİC UNİT
OF SUPPLY CHAİN DESİGN AND OPERATİONAL CONTROL
• The performance cycle represents elements of work
necessary to complete the logistics related to customer
accommodation, manufacturing or procurement
• A performance cycle consists of the following elements
– Nodes
– Links
– Inventory
• Base stock
• Safety stock
– Input and output requirements
 PERFORMANCE CYCLE UNCERTAİNTY
• Major objective of logistics in all areas is to reduce
performance cycle uncertainty
• Operational variance is randomly introduced during the cycle
through
– The structure of the performance cycle itself
– Operating conditions
– The quality of logistical operations
TOTAL TİME TO COMPLETE THE CUSTOMER DELİVERY CYCLE İS
BASED ON EACH TASK WİTHİN THE CYCLE

Figure 2.8 Performance Cycle Uncertainty

 INVENTORY MANAGEMENT
THE ECONOMİC ORDER QUANTİTY MODEL

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Knowing what you've got,
Knowing what you need,
Knowing what you can live without –
That’s inventory control.

Frank Wheeler, Revolutionary

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 INVENTORY
• Definition: The stock of any item or resource used in an
organization

Raw Materials &

Component Parts

Goods in transit to
Replacement parts,
Work-In-Process warehouses or
tools & supplies
customers

Finished Products

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IMPORTANCE OF INVENTORY:2005 FİSCAL YEAR
Wall Mart Boeing General Dell
(Billion $) (Billion $) Motors (Billion $)
(Billion $)
Cash & Short-
Term 6.4 5.9 50.4 9.0
Investments
Account
2.6 5.2 180.7 5.4
Receivable
Inventories 32.2 73.5% 7.7 35% 30.1 9.6% 0.57 3.3%
Other Current
2.5 2.8 51.7 2.6
Assets
Total Current
43.8 100% 22 100% 312.9 100% 17.7 100%
Assets
Other Assets 94.3 38.1 163.1 5.4

Total Assets 138.2 60 476.1 34.1

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 IMPORTANCE OF INVENTORY MANAGEMENT
• ... by 1990 Wal-Mart was already winning an important
technological war that other discounters did not seem to
know was on. “Wal-Mart has the most advanced inventory
technology in the business and they have invested billions
in it”. (New York Times, Nov. 95)

• Kmart increased its inventories to $8.3 billions in the third

quarter of 2001 with an expectation of more shoppers.
“But higher sales never materialized, leading to a
disastrous holiday selling season.” Kmart filed for
bankruptcy on Jan. 22. (Business Week, Mar. 02)

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 IMPORTANCE OF INVENTORY MANAGEMENT
MORE RECENT NEWS
• SanDisk suspends production as inventories pile up for
makers of computers, cell phones, and TVs … (Business Week, Dec. 08)
• Natural-gas futures soared 15% Thursday after U.S. inventory
data slightly eased concerns about the possibility of a storage
glut (Wall Street Journal, Sept. 11, 09)
• Fruit growers were blessed with excellent weather this year.
But that hasn’t translated into a great year for the province’s
cherry and blueberry growers, as a bumper crop has flooded
the market and pushed down prices. (The Vancouver Sun, Aug. 09)
• The Ford assembly plant in Oakville and 3,000 workers will
remain idle this week because of a parts shortage from a
supplier in India. (Toronto Star, Oct. 27, 09) 39
WHY SHOULD YOU HOLD İNVENTORY?
Predictable Variability Seasonal Inventories

What are some of the inventories

Unpredictable Variability Safety Stock
that you have?
Economies of Scale Cycle Stock

Whytimes
Transportation do /you
Flowhave these
Pipeline Inventories
times
inventories?
Other: Strategic /
Speculative / etc.
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 WHY SHOULD YOU NOT HOLD İNVENTORY?
• Inventory increases certain costs such as
– Carrying cost
– Cost of customer responsiveness
– Cost of diluted return on investment
– Large-lot quality cost
– Cost of production problems, etc.

• The Sea of Inventory

Inventory hides problems …

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 REDUCİNG WASTE
THE SEA OF INVENTORY

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 HOW MUCH İNVENTORY SHOULD YOU HOLD?
• Trade-off #1
Inventory ordering costs
(Economies of scale)

Inventory holding costs

• Trade-off #2
Cost of running out

Cost of having excess

inventory
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 INVENTORY COSTS
Ordering/Setup
Costs • Fixed transportation Cost
• Order Processing Cost
(Fixed Costs)

Holding Cost • Costs for storage, handling, insurance,

(Carrying Cost) working capital tied-up, etc

Shortage Cost
• Lost sales, etc
(Opportunity Cost)

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 INVENTORY CLASSİFİCATİON
A classification to help manage inventories better
Type A Items
• Small group of high volume items
• Accounts for 15% by the number of parts, and 70-80% of
the total sales of all parts
Type B Items
• Accounts for 35% of the number of parts, and 10-15% of
the total value
Type C Items
• Accounts for 50% of the total number of parts, and for 5-10% of the
total value
(The above percentages are approximate)
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 MOTİVATİON: ATM
• How much cash do you take out from ATM?
• Why not more or less?

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 ECONOMİC ORDER QUANTİTY (EOQ)
• The Economic Order Quantity (EOQ) balances

Inventory ordering costs

(Economies of scale)

Inventory holding costs

• Assumptions
– Known annual demand, constant demand rate
– No uncertainty

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 NOTATİON
D Annual Demand Rate
Q Lot or batch size
S Set-up cost per lot/batch, or average cost of
processing/placing an order
C Unit cost
H Annual holding and storage cost per unit of
average inventory
i Percent carrying cost (e.g., “interest” rate)

Usually, H = iC.

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 CYCLE STOCKS: TRADEOFF BETWEEN FİXED COSTS
AND HOLDİNG COSTS
Profile of Inventory Level over Time

Q Demand
rate

Quantity
on hand

Time
Receive Receive Receive
order order order
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 Example: “The South Face”
• Some facts about The South Face retail shop
Warehouse
D Annual Demand Rate 1200 jackets/year
S Set-up cost per lot/batch, or $2,000
average cost of
processing/placing an order
Retailer
C Unit cost $200 per jacket
i Percent carrying cost (e.g., 25%
interest rate)
Customers
Thus, H = iC = (0.25)*($200) = $50 per unit-year
• What order size (Q) would you recommend for
The South Face?
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 THE SOUTH FACEInventory Profile:
Inventory
D Annual Demand # of jackets in
Q Lot or batch size inventory over time.

(Number of jackets per

replenishment order) Q

S Order or setup cost D = Demand rate

Annual Holding cost

Q/2
H

Time t

Number of orders per year D/Q

???
Average inventory ???
Q/2
Annual Setup Cost (D/Q) * S
Annual Holding Cost (Q/2) * H
Annual Total Cost Annual Setup Cost + Holding Cost 51
 THE SOUTH FACE: COST
Per Order/Batch Batches per Year Annual Annual Annual
Q D/Q Setup Cost Holding Cost Total Cost
EOQ Model: Cost
50
30000 24.0 48000 1250 49250
100 12.0 24000 2500 26500
150 8.0 16000 3750 19750
25000
200 6.0 12000 5000 17000
250 4.8 9600 6250 15850
260 4.6 9231 6500 15731
20000
270 4.4 8889 6750 15639
280 4.3 8571 7000 15571
290
15000 4.1 8276 7250 15526
300 4.0 8000 7500 15500
310 3.9 7742 7750 15492
10000
320 3.8 7500 8000 15500
330 3.6 7273 8250 15523
340
5000 3.5 7059 8500 15559
350 3.4 6857 8750 15607
400 3.0 6000 10000 16000
0
500 2.4 4800 12500 17300
170

310

450
110
130
150

190
210
230
250
270
290

330
350
370
390
410
430

470
490
510
530
550
570
590
610
630
650
670
690
710
730
750
770
790
810
830
850
870
890
910
930
950
970
990
600 2.0 4000 15000 19000
Setup Cost Holding Cost Total Cost
700 1.7 3429 17500 20929
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Annual Cost COST MİNİMİZATİON GOAL

Total Cost
Q D
TC  H  S Q
2 Q H
2
Lowest Inventory holding
Annual cost
Cost
D
Ordering Costs S
Q
QO (optimal order quantity) Order Quantity (Q)

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 ECONOMİC ORDER QUANTİTY
Q D D Annual Demand Rate
TotalCost TC (Q)  H  S
2 Q S Order or Setup Cost
H Annual Holding Cost

2SD
QOPT 
H

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 ECONOMİC ORDER QUANTİTY:THE SOUTH FACE
D 1200 jackets/year
2SD
QOPT  S $2,000
H
H $50 per unit-year
• What is the optimal order quantity?
2SD 2(2000 )(1200 )
QOPT    309 .8
H 50
• How many times would you place orders per year, i.e.,
frequency of ordering? D 1200
  3.8
QOPT 309 .8
• What is the time duration between successive orders (this is
also called the cycle time or reorder interval)?
QOPT 309 .8
  0.258
D 1200 55
 EOQ AND SENSİTİVİTY ANALYSİS
• What happens to the cost and optimal
quantity as the parameters change? 2SD
QOPT 
H

As …. “Cost” EOQ Frequency

S↑ ↑ ↑ ↓
H↑ ↑ ↓ ↑
D↑ ↑ ↑ ↑

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 MANAGERİAL IMPLİCATİONS OF EOQ
EOQ Model: Cost
• Cost curve is almost “flat” near the optimal point
30000

– Use the EOQ formula, but do not worry about making minor
25000
adjustment to get a number that is “more realistic” for your
organization
• The flatness of the cost curve implies that the EOQ figure is
20000

“robust”
15000
– Estimating holding cost is usually difficult
– The EOQ formula guarantees that the “optimal” order quantity is not
10000

very sensitive to errors in estimation

5000

0
170

310

450
110
130
150

190
210
230
250
270
290

330
350
370
390
410
430

470
490
510
530
550
570
590
610
630
650
670
690
710
730
750
770
790
810
830
850
870
890
910
930
950
970
990
Setup Cost Holding Cost Total Cost

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 MANAGERİAL CHALLENGES
HOW TO ESTİMATE COSTS?
Ordering/Setup Costs (Fixed Costs): S
• Estimate costs incurred during the start of each new order
• Do not count “sunk” costs and fixed overhead

Unit Cost: C
• Estimate variable cost incurred in the production of each additional unit

Holding or Carrying Costs (as % of unit cost): i

• Estimate opportunity cost of working capital
• Estimate cost of storage, handling, etc

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 MANAGERİAL CHALLENGES
HOW TO REDUCE THE EOQ İNVENTORY?
• Reduce the set-up cost
2SD
• Re-evaluate sources of fixed costs, and QOPT 
find ways to reduce, spread-out, or H
eliminate these costs

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APPENDİX MATERİAL

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 CONTENTS
I. INTEGRATED LOGISTICS MANAGEMENT
Ia. The Growth of Logistics and Its Role in the Economy
A. What is Logistics?
B. History of Logistics
C. Role of Logistics in the Economy
D. Why Logistics is gaining in importance
Ib. The Integrated Logistics Management Concept
A. Definition
B. Logistics is concerned with questions about inventories
D. Strategic profit analysis
Ic. Logistics As An Element of Corporate Strategy
A. A Few Logistics Facts
B. Corporate Leverage From Logisitics
C. Product Strategy: Innovation Phase
D. Product Strategy: Cost Leadership Phase
E. Product Line (Customer Service) Strategies
 CONTENTS
Id. Distribution Channels
A. Channels: Definition, Types, Functions
B. Integrated Channel Concept
C. Some Logistical Implications
Ie. Customer Service
A. Defining Customer Service
B. Measuring Customer Service
C. Relationship of Customer Service to Marketing
D. Optimizing Customer Service
E. Stockouts
F. Stockout Costs
G. ABC Analysis
If. International Logistics
A. Importance of International Logistics
B. International Strategies
C. Some Additional Considerations
 CONTENTS
II. LOGISTICS SYSTEM ELEMENTS
IIa. Inventory Management - Introduction
A. Financial Impact
B. Reasons for Holding Inventory
C. Types of Inventory
D. Example of Financial Impact
IIb. Inventory - Carrying Costs
A. General
B. Capital Costs
C. Other Costs
D. Annual Inventory Costs
E. Valuing Inventory (i.e. Value on Balance Sheet)
F. Why Inventory Costs are Often Misstated
IIc. Inventory - Management Under Certainty (EOQ)
A. Basic Inventory Cycle
B. Ordering Costs
C. Effect of Decrease in Cycle Time
D. Total Costs
E. Optimum Quantity to Order
F. Quantity Discounts
G. Other Cases
 CONTENTS
IId. Inventory - Uncertainty
A. Calculating Safety Stocks
B. Example of Safety Stock Calculations
C. The Flip Side: Reducing Cycle Variability for Your Customers
D. Appendix Derivation of Formula for σc
IIe. Inventory - Control
A. Stock Control Methods
B. Inventory System Design
C. Fixed Order Point
D. Fixed Order Interval
E. Transport Choice Case
F. Items covered in readings, not in lectures
G. Postscript: Inventory, Production, Marketing, Finance
IIf. International Shipping
A. Importance
B. Technology
C. Demand - Shippers (Two main market segments)
D. Supply - Shipping Carriers/Owners
E. Freight Rates
 CONTENTS
IIg. Transport - Modes and Service Characteristics
A. Mode Characteristics
B. Costs
C. Rate-Service Tradeoff
IIh. Transportation: Consolidation
A. Types of Consolidators
B. Reasons for Consolidation
C. Types of Consolidation
D. Typical LTL Routing
E. Containers
IIi. Transportation: Traffic Management
A. Traffic Management Functions
B. Deregulation
C. Negotiations
D. Private Versus Public Carriage
 CONTENTS
IIj. Warehousing
A. Functions of Warehousing
B. Types of Warehouses
C. Optimal Number of Warehouses
D. Optimal Size of Warehouse
E. Stock Location Methods
F. Order Picking Design
G. Public versus Private Warehouse Choice
H. A Note on Warehouse Costs
IIk. Facility Location
A. Two Types of Locational Decisions
B. Transport Cost Models
C. Other Locational Decisions
D. Tactical Location Considerations
 CONTENTS
IIl. Packaging
A. The Two Functions of Packaging
B. Unitization
C. Packaging Materials
D. Some Packaging Problems/Solutions
E. Where/When Should Packaging Be Added?
IIm. Purchasing
A. Introduction
B. Forward Buying
C. Other Aspects of Purchasing
IIn. Materials Management
A. Introduction
B. Materials Requirement Planning (MRP)
C. Manufacturing Resource Planning (MRP II)
 CONTENTS
IIo. Total Quality Management
A. Introduction
B. TQM versus Traditional Approach
C. Employee motivation
D. Examples
IIp. Just-in-Time Systems
A. Just-In-Time-System
B. Manufacturing Resource Productivity (MRP III)
IIq. Production Systems
IIr. Distribution Requirements Planning
A. Distribution Requirements Planning (DRP)
IIs. Order Processing
A. The Order Cycle
B. The Order Processing System
C. Impact on Logistics
D. Implications of Advanced Order Processing Systems
INVENTORY TURNS 2007
CANADA

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