Chapter 2: Role of Logistics in Supply Chains

Learning Objectives
After reading this chapter, you should be able to do the following:
 Understand the role and importance of logistics in private and public
organizations.

 Discuss the impact of logistics on the economy and how effective

logistics management contributes to the vitality of the economy.

 Understand the value-added roles of logistics on both a macro and

micro level.

 Explain logistics systems from several perspectives.

Learning Objectives (cont.)

After reading this chapter, you should be able to do the following:

 Understand the relationship between logistics and other important

functional areas in an organization, including manufacturing,
marketing, and finance.
 Discuss the importance of management activities in the logistics
function.
 Analyze logistics systems from several different perspectives to
meet different objectives.
 Determine the total costs and understand the cost tradeoffs in a
logistics system
Source: Center for Supply Chain Research, Penn State University (2008).
SCM was defined using a pipeline analogy with the start of the pipeline
representing the initial supplier and the end of the pipeline representing
the ultimate customer. It was an extended set of enterprises from
supplier's supplier to the customer’s customer.
 Logistics professionals realize that in spite of all types of
the internet, successful organizations must manage
order fulfillment to their customers effectively and
efficiently, deploy appropriate levels of inventory, and
manage any returns to build and sustain competitive
advantage and profitability.

 If an organization cannot get its products to customers, it

will not stay in business very long.

 The challenge is to manage the entire logistics system in

such way that order fulfillment and exceeds customer
expectations through controlling transportation, inventory
and other logistics costs.
 What is Logistics?
 Logistics management
 Business logistics management
 Integrated logistics management
 Materials management
 Physical distribution management
 Marketing logistics
 Industrial logistics
 Distribution
 Logistics Definitions
 Inventory:
 Management of materials in motion and at rest

 Customer:
 Getting the right product, to the right customer, in the right quantity, in
the right condition, at the right place, at the right time, and at the right
cost (called the dictionary “seven Rs of logistics”) +right financial
accounts

 International Society of Logistics:

 The branch of military science having to do with procuring, maintaining,
utility/ value and transporting material, personnel, and facilities
 Council of Supply Chain Management
 The art and science of management, engineering, and technical
activities concerned with requirements, design, and supplying and
maintaining resources to support objectives, plans, and operations.
 Logistics Definitions
 Component support:
 Providing time and place utility/value of materials and products in
support of Functional management organization objectives
 Common culture:
 That part of the supply chain process that plans, implements, and
controls the efficient, effective flow and storage of goods, services, and
related information from point of origin to point of consumption in order
to meet customer requirements
 Supply management for the plant (inbound logistics) and distribution
 Management for the firm’s customers materials requirements,
purchasing, transportation, inventory management, warehousing,
materials handling, industrial packaging, facility location analysis,
distribution, return goods handling, information management, customer
service, and all other activities concerned with supporting the internal
customer (manufacturing) with materials and the external customer
(retail stores) with product
 Four Subdivisions of Logistics
 Business logistics:
 That part of the supply chain process that plans, implements, and
controls the efficient, effective flow and storage of goods, service, and
related information from point of use or consumption in order to meet
customer requirements.
 Military logistics:
 The design and integration of all aspects of support for the operational
capability of the military forces (deployed or in garrison) and their
equipment to ensure readiness, reliability, and efficiency.
 Event logistics:
 The network of activities, facilities, and personnel required to organize,
schedule, and deploy the resources for an event to take place and to
efficiently withdraw after the event.
 Service logistics:
 The acquisition, scheduling, and management of the facilities/assets,
personnel, and materials to support and sustain a service operation or
business.
 Value-Added Roles of Logistics

 The five principal types of economic utility which add value to a product or
service are:
 Form (production)
 Time (logistics)
 Place (logistics)
 Quantity (logistics)
 Possession (marketing)
Source: Center for Supply Chain Research, Penn State University (2008).
Fig. 2-2 illustrates five principal types of economic utility add vale to a
product or service.
 Form utility

 Form utility describes the value added to goods through manufacturing or

assembly process.

 Form utility results when raw materials or components are combined in

some predetermined manner to make a finished good.

 Process of manufacturing or assembly changes the product’s form, thereby

adding value to it

 Certain logistics activities can also create form utility, such as breaking bulk,
mixing products for smaller shipments.
 Example: Dell Computers combining components.
 Place utility

 Logistics provides place utility by moving goods from production sites to

points of demand, creating markets distant from the manufacturing facility

 Place utility primarily created through transportation

 Market boundary extension increases competition, leading to lower prices

and more product availability
 Time utility

 Not only must goods and services be available Where customers need them
but also at the point When customers demand them.

 Time utility describes the economic value added to a product by having it at

a place when there is demand for it.

 Logistics creates time utility through proper inventory maintenance, the

strategic location of goods and services, and transportation.

 This can be done by having the right products in inventory, having them
stored close to the point of demand or using a premium (faster) mode of
transportation.

 Time utility is very important today because of the goal to reduce inventory
levels.
 Quantity utility

 Today’s business environment demands that products not only be delivered

on time to the correct destination but also be delivered in the proper
quantities. So, the utilities of When and Where must be combined by how
much.

 Quantity utility describes products delivered in the right quantities, according

to demand levels.

 Logistics creates quantity utility through production forecasting, production

scheduling, and inventory control.
 Possession utility

 Possession utility is created through marketing activities related to the

promotion of products and services.

 Promotion is the effort, through direct and indirect contact with the customer,
to increase the desire to possess a good or benefit from a service.

 Marketing depends on logistics, because possession utility cannot be

offered unless time, place and quantity utilities are provided.
Logistics Activities

 Transportation
 Warehousing and storage
 Industrial packaging
 Materials handling
 Inventory control
 Order fulfillment
 Demand forecasting
 Production planning/scheduling
 Procurement
 Customer service
 Facility location
 Return goods handling
 Parts and service support
 Salvage and scrap disposal
 Transportation

 Transportation, a very important activity in the logistics system, is often the

largest variable cost.

 A major focus in logistics is on the physical movement or flow of goods and

on the network that moves the product.

 The network consists of transportation organizations providing services for

the shipping firm.

 The logistics manager is responsible for selecting the mode or modes and
carriers used in moving raw materials, components, and finished goods, or
for developing private transportation.
 Storage

 Storage involves inventory management and warehousing.

 Direct relationship between transportation and the level of inventory and the
number of warehouses required.

 Using a slow mode of transportation causes higher inventory levels, more

warehousing space for inventory.

 Using a fast mode of transportation causes lower inventory levels, less

warehousing space required.
 Packaging

 Industrial/ exterior packaging protects the product during transportation and

storage and includes materials such as corrugated (cardboard boxes),
stretch wrap, banding, bags, and so on.

 Type of transportation mode selected affects packaging requirements, e.g.

high packaging costs for ocean and rail transport, low packaging costs for
airfreight.

 For ocean transportation, additional packaging might be needed to prevent

moisture from invading the product.
 Materials Handling

 Materials handling describes the processes of moving goods into the

warehouse, the placement of goods into a warehouse, and the movement of
goods from storage to order-picking areas and to dock areas for
transportation out of the warehouse.

 Materials handling concerned with mechanical equipment used for short-

distance movement, including equipment such as conveyors, forklift trucks,
overhead cranes, automated storage and retrieval systems (ASRS).

 Materials handling designs required to be coordinated with the types of

equipment used and the storage devices moved.
 Inventory Control

 Inventory found in both warehouses and manufacturing facilities.

 Two dimensions of inventory control:

- Assurance of adequate inventory levels (inventory in line with demand).
- Assurance of inventory accuracy (correct inventory shown in the information
system).
 Order Fulfillment

 Order fulfillment describes the set of activities required for filling and
shipping customer orders.

 Order lead time is the time from when a customer places an order until the
customer receives its satisfactory fulfillment, it’s very important to logistics.

 Order fulfillment consists of order transmittal, order processing, order

preparation, and order shipment.
 Forecasting

 Accurate forecasting of inventory requirements and materials and

components is essential to inventory control, manufacturing efficiency, and
customer satisfaction.

 Inventory in need of being developed with marketing forecasts of demand to

assure proper inventory levels.
 Production Planning

 Production planning/ scheduling closely related to forecasting regarding

effective inventory control.

 Manufacturing requires to determine the inventory on hand properly, and to

forecast demand.
 Procurement

 Procurement of raw materials and components for manufacturing is a major

aspect of inbound logistics.

 Transportation costs affected by the distance of raw materials and

components needed for manufacturing.

 Quantities purchased affect inventory levels and total logistics costs.

 Customer Service

 Two dimensions of customer service:

- The process of interacting directly with the customer to influence or take the
order.
- The levels of service an organization offers to its customers.

 Logistics affects inventory levels in the proper locations required to meet the
customer’s order requirements.

 Logistics is concerned with being able to promise the customer, at the time
the order is placed, when it will be delivered.
 Facility Location

 Planning of manufacturing plant and warehouse locations an important area

to logistics.

 Facility locations affect transportation costs and service, customer service,

and inventory requirements.
 Other areas

 Other areas also a part of logistics:

- Parts and service support

- Return goods handling

- Salvage and scrap disposal

Logistics in the Economy
 Absolute cost of logistics on a macro basis increase the growth in
the economy

 If more goods and services are produced, logistics costs will

increase

 To determine the efficiency of the logistics system, total logistics

costs need to be measured in relationship to gross domestic product
(GDP)
 Figure 2-3 Logistics Costs as a Percentage of GDP
12.3
13
12
11
10
9
8
7
6
5
4
3
2
1
0

Year

Source: 17th Annual State of Logistics Report, 2006

 Logistics cost as a percentage of GDP

 Declining costs of logistics as a percentage of GDP

 Reasons:
- Improvement of the overall logistics systems of organizations operating in
the economy
- Deregulation of transportation and more competition in this sector
- Improved management of inventory levels
 Reduction in relative costs allows organizations to be more competitive,
directly impacting the cost of producing goods
 Major logistics cost elements:
- Warehousing and inventory costs
- Transportation costs
- Other costs
 Inventory costs

 Inventory costs on a macro perspective include:

- Carrying costs include interest expense (the opportunity cost associated

with the investment in inventory)

- Risk-related costs (obsolescence, depreciation)

- Service-related costs (insurance, taxes)

 Transportation costs

 Transportation costs on a macro perspective are the total national

expenditures for the movement of freight in a certain country
 Large share of expenses on motor carriers in the total transportation costs
within a country

Other costs

 Administrative and shipper-related costs associated with managing logistics

activities and personnel
Source: 18th Annual State of Logistics Report, 2007
 Logistics in the Firm: The Micro Dimension
 Another dimension of logistics is the micro
perspective which examines the relationships
between logistics and other functional areas
in an organization
 Marketing
 manufacturing/operations

 Finance

 Accounting

 Others
 Logistics Interfaces with Marketing

 Price:
Adjustment of quantity prices to conform to shipment sizes appropriate for
transportation organizations important
Discount prices offered by organization for large quantities of products
ordered recommended to be in line with transportation rate discount
schedules
Examples:
Motor carriers publish minimum weight requirements for truckload lots, offer
discounts, the larger the shipment size the lower rate charged
Organization sells products including delivery costs, with its price schedule
matching the shipping requirements on a weight basis
 Better equipment utilization of carriers in case of larger shipments, lower
prices per weight unit for the buyer
 Logistics Interfaces with Marketing

 Product:
Physical attributes of products (weight, length, width, height) and their
packaging affecting their storage, handling and transportation

 Promotion:
Promotional practices used to improve sales influence inventory levels
Difficult: Prediction of demand levels, and response to it
Two basic types of promotional strategies:
Push and Pull

 Place:
Decisions whether manufacturers should supply retailers directly, or through
wholesalers and other intermediaries, impact on quantities ordered
 Logistics Interfaces with Manufacturing

 Relationship between logistics and manufacturing mostly focused on the

length or production runs and the related inventory levels

 Longer production runs result in lower production costs per unit but more
inventory held

 Shorter production runs result in higher production costs per unit but less
inventory held

 Overall trend towards shorter production runs for the reduction of inventory
levels, and for the ability to quickly change the product produced according
to the demand

 Procurement relevant for production, components and raw materials need to

be available when needed
The impact that logistics can have upon return on assets
(ROA) or return on investment (ROI) is very significant

 ROA is defined as follows:

 ROA = Revenue - Expenses/Assets Or
 ROA = Gross Profit/Assets
 Logistics in the Firm: Factors affecting the
Cost and Importance of Logistics
 Competitive Relationships:
 Price and Service competition important

 Relationships:
 Order Cycle
 Substitutability
 Inventory Effect
 Transportation Effect
 Order Cycle

 Order cycle length affects inventory levels, with the shorter order cycle the
less inventory required to be held
 Order cycle: Time from placement of an order until its receipt

Substitutability

 Substitutability affects the importance of customer service, with competitive

and similar products likely to be bought by a customer in case of a product’s
stockout
 Customer service more important for highly substitutable products than for
products that customers would be more likely to reorder
 Effects of substitutability can be avoided by higher inventory levels or faster
transportation
 Inventory effect

 Increasing inventory levels and costs reduce the cost of lost sales
 Inventories should only be increased to the point at which marginal savings
from reducing lost sales cost equal the marginal cost of carrying additional
inventory

Transportation effect

 Decreasing transit times through increasing transportation costs reduce the

cost of lost sales
 Transportation costs should only be increased to the point at which marginal
savings from reducing lost sales cost equal the marginal increment
associated with increased transportation cost
Figure 2-7 The General Relationship of the Cost of Lost Sales to
Inventory Cost

Flow
TC = Total cost
INV = Inventory cost
COLS = Cost of lost sales
Figure 2-8 The General Relationship of the Cost of Lost Sales to Transportation Cost

Improved transportation service

Flow -----------------------------------------------------
TC = Total cost
Tr = Transportation cost COLS = Cost of
lost sales
 Logistics in the Firm: Factors affecting the
Cost and Importance of Logistics
 Product relationships:
 Dollar value
 Density
 Susceptibility to Damage
 Special Handling Requirements
 Dollar value

 Product’s dollar value, or value in the currency sold, affects warehousing

costs, inventory costs, transportation costs, packaging costs, materials-
handling costs.

Density

 Weight/ space ratio (density) of a product affects logistics cost

 Increasing product density decreases product’s transportation and
warehousing costs.
Fig 2 -10 The General Relationship of Product Weight Density to Logistics Costs

Weight density of product

Flow ----------------------------------------------------------
Tr = Transportation cost
Inv = Inventory cost (including
storage) Whse = Warehousing
cost
 Susceptibility to Damage

 The greater the risk of damage to a product, the higher the transportation
and warehousing cost.

 High degree of risk and liability associated with fragile goods, high prices
charged by both transportation and warehousing providers.

Special Handling Requirements

 Products that require special handling, such as specifically designed

equipment, refrigeration, heating, etc.
 Special requirements increase warehousing, transportation, and packaging
costs.
Figure 2-11 The General Relationship of Product Susceptibility to Loss and
Damage to Logistics Cost

Susceptibility to loss and damage

Flow ------------------------------------------------------------------
Pkg = Packaging cost
Tr = Transportation cost
Whse = Warehousing cost
 Spatial Relationships:
 Spatial Relationships are extremely significant to logistics. spatial
relationship is the location of fixed points in the logistics system with
respect to demand and supply points. Spatial relationships are very
important to transportation costs, since these costs tend to increase
with distance.
 The distance factor or spatial relationships might affect logistics
costs in ways other than transportation costs. For example, a firm
located far from one or more of its markets might need to use a
market-oriented warehouse to make customer deliveries in
satisfactory time period. Therefore, distance can add to
warehousing and inventory carrying costs.
Figure 2-12 Logistics and Spatial Relations
Techniques of Logistics System Analysis
Short-Run/Static Analysis

Long-Run/Dynamic Analysis
 Short-run/ Static Analysis

 Short-run analysis considers a specific point in time or level of output in

order to select the system with the lowest overall cost after comparison of
various alternatives.

Long-run/ Dynamic Analysis

 Dynamic analysis analyses a logistics system over a long time period and a
range of output.
 Dynamic Analysis

 Total Cost = Fixed Cost + Variable Cost / Unit * x Number of Units

 Comparison of total costs between alternative systems, considering the

number of units to be produced, for the optimal solution.
 Approaches to Analyzing Logistics Systems

 Materials management versus physical distribution

 Cost centers

 Nodes versus links

 Logistics channels
 Materials management versus physical distribution

 Classification of inbound and outbound flows.

 Different transportation and storage requirements for inbound and outbound

movements.

 Coordination between inbound and outbound flows necessary.

 Materials management versus physical distribution

 Balanced systems:

 Logistics systems with similarities between inbound and outbound flows.

 Suppliers with raw materials and components, and customers of finished

goods located in different places.

 Use of similar modes of transport for inbound and outbound flows.

 Consumer product companies, e.g. Kraft and Unilever, characterized by

balanced logistics systems.
 Materials management versus physical distribution

 Heavy inbound:

 Very sophisticated inbound and very simple outbound flows.

 Use of thousands of parts and components for the assembly of a finished

product.

 Use of multiple modes of transportation for inbound flows, use of one or few
modes of transportation for outbound flows.

 Aircraft and car manufacturers characterized by heavy inbound logistics.

 Materials management versus physical distribution

 Heavy outbound:

 Simple inbound and complex outbound flows

 Sourcing from a limited number of supply points, with movements frequently

involving short distances

 Wide variety of outbound flows, with different storage, transportation,

packaging requirements

 Chemical companies characterized by heavy outbound flows

 Materials management versus physical distribution

 Reverse systems:

 Reverse flows on the outbound side, resulting from durable goods that
customers might return for trade-in, repairs, salvage and disposal.

 Electronic consumer goods manufacturers and organizations using

returnable containers typical of reverse systems.
 Cost Centers

 Breaking down various cost centers into various costs, including

transportation, warehousing, inventory, material handling, and industrial
packaging.

 Analysis of tradeoffs between the cost centers to determine the overall

lowest cost or highest service of a logistics system.
 Nodes versus Links

 Nodes
 The nodes are fixed spatial points where goods stop
for storage or processing.

 Links
The links represent the transportation network and
connect the nodes in the logistics system.
 Logistics Channels

 Logistics channels include both logistics and transaction flows.

 Logistics channels point out the control of the various aspects of the flow.
 Logistics and Systems Analysis

 Systems:
 Set of interacting elements, variables, parts, or objects functionally related
to one another to form a coherent group.

 Cost Perspective:
 In case of efficiency being measured in cost, an individual part of a system
not operating at its lowest cost might still lead to the systems overall
efficiency.
 Logistics and Systems Analysis

 Levels of optimality

 Optimality level 1: Optimizing the organization.

 Optimality level 2: Optimizing the supply chain, including other organizations.

 Optimality level 3: Optimizing under the consideration of external aspects,

such as social, political and economic
influences.
Chapter 2 Summary
 Logistics has developed as an important area or function of business since
World War II. It has gone through several phases of development in
achieving its present status.
 Logistics is a critical part of supply chain management. The coordination
and, perhaps, integration of the logistics systems of all the organizations in
a supply chain are necessary requirements for successful management of
the supply chain.
 Logistics has a number of different definitions because of the broad-based
interest in its activities and the recognition of its importance. The definition
developed by the Council of Supply Chain Management Professionals is the
primary definition used in this text.
 Logistics is an area of management that has four subdisciplines: business,
military, service, and event.
Chapter 2 Summary (cont.)
 On a macro basis, logistics-related costs have been decreasing on
a relative basis, which has helped the U.S. economy regain its
competitive position on a global basis.
 Logistics adds place, time, and quantity utilities to products and
enhances the form and possession utilities added by manufacturing
and marketing.
 Logistics has an important relationship to manufacturing, marketing,
finance, and other areas of the organization.
 Logistics managers are responsible for a number of important
activities, including transportation, inventory, warehousing, materials
handling, industrial packaging, customer service, forecasting, and
others.
Chapter 2 Summary (cont.)

 Logistics systems can be viewed or approached in several different

ways for analysis purposes, including materials management versus
physical distribution, cost centers, nodes versus links, and
channels. All four approaches are viable for different purposes.
 Logistics systems are frequently analyzed from a systems
approach, which emphasizes total cost and tradeoffs when changes
are proposed. Either a short- or long-run perspective can be used.
 The cost of logistics systems can be affected by a number of major
factors, including competition in the market, the spatial relationship
of nodes, and product characteristics.