LOGSTICS & SCM

1 The Framework of Logistics

1st & 2nd Lectures
WHY?
• All organizations need to move materials, goods and things to and from each
other.
• Logistics is the function that is responsible for this movement. It is
responsible for the transport and storage of materials on their voyage
between suppliers and customers.
• All economies rely on logistics to collect materials from suppliers and
deliver them to customers.
• Millions of people are involved in this effort, and it costs billions of dollars a
year to keep everything moving.

Definition Of Logistics
 Supporting operations
o Every organization delivers products to its customers. (product
spectrum FIG. 1)
Fig 1: Product spectrum

o At the heart of an organization are the operations that create and

deliver the products. These operations take a variety of inputs and
convert them into desired outputs (operation spectrum FIG. 2)

Fig 2: Operation spectrum

 o The products created by an organization are passed to its customers,
giving the cycle shown in Figure 3 customers generating demands,
with operations using resources to make products that satisfy them.
Logistics moves materials around this cycle. The operations are
usually divided into several related parts, So logistics also moves
materials through the different parts of an organization, collecting
from internal suppliers and delivering to internal customers
(Figure 4).

Fig 3: Cycle of demand and supply

o This leads to our basic definition:

Logistics is the function responsible for the flow of materials from suppliers into
an organization, through operations within the organization, and then out to
customers.

Fig 4: The role of logistics

Notes:
• Moving materials into the organization from suppliers is called Inbound or
inward logistics.
• Moving materials out to customers is Outbound or outward logistics;
• Moving materials within the organization is Materials management.

Materials
what we mean by materials?
• Tangible goods clearly must be moved, and you can easily see the role of
logistics. Even organizations providing the most intangible services move
some goods around – perhaps paperwork or consumables – so they still need
logistics.
• We can take a broader view and say that logistics also moves less tangible
things, such as information and messages.
• In different circumstances, logistics is responsible for moving raw materials,
components, finished products, people, information, paperwork, messages,
knowledge, consumables, energy, money, and anything else needed by
operations.
• To simplify things, we describe all of these as materials.

Materials are all the things that an organization does to create its products. These
materials can be both tangible (such as raw materials) and intangible (such as
information)

The Supply Chain

A Supply Chain consists of the series of activities and organizations that materials
move through on their passage from initial suppliers to final customers.

Fig. 5: Outline of the supply chain for paper

 • Every product has its own unique supply chain.
• Materials may move through raw materials suppliers, manufacturers,
finishing operations, logistics centers, warehouses, third party operators,
transport companies, wholesalers, retailers, and a whole range of other
operations. Sometimes, the supply chain goes beyond the final customer to
add recycling and re-use of materials.

Structure of the supply chain

The simplest view of a supply chain has a single product moving through a series
of organizations, each of which somehow adds value to the product.
• Downstream:
o moving materials outwards – are called downstream to the customers.
o Customers divided into tiers:
− first tier customer: One that gets a product directly from the
operations is a first-tier customer.
− second tier customer: one that gets a product from a first-tier
customer is a second-tier customer.
− third tier customer: one that gets a product from a second-tier
customer is a third-tier customer, and so on to final customers.
• Upstream:
o moving materials inwards – are called upstream.
 o upstream activities are divided into tiers of suppliers:
− first tier supplier:
o supplier that sends materials directly to the operations is
a first-tier supplier.
− send materials.
o one that send materials to a first-tier supplier is a second-
tier supplier.
− third tier supplier
o one that sends materials to a second-tier supplier is a
third-tier supplier, and so on back to the original sources.
• In Figure 6:
o most organizations get materials from many different suppliers and
sell products to many different customers.
o Then the supply chain:
• converges as raw materials move in, through the tiers of
suppliers, and
• diverges as products move out, through tiers of customers.

Figure 6: Activities in a supply chain

 A manufacturer might see:

 up-assembly providers as first tier.
 suppliers, component makers as second tier suppliers,
 materials suppliers as third tier suppliers, and so on.
 It might see:
 wholesalers as first tier customers,
 retailers as second tier customers, and
 end users as third tier customers (as Figure 7 shows).
• Each product has its own supply chain, and there is a huge number of
different configurations.
o Some are very short and simple – such as a cook buying potatoes
directly from a farmer.
o Others are surprisingly long and complicated.
o An everyday product like a shirt has a long journey from the farm
growing cotton through to the final customer. It also has several
chains merging as buttons, polyester, dyes, and other materials joins
the main process.
o In the same way, when you buy a computer, many strands of the
supply chain merge as Intel provide the processor, Matshita the DVD
drive, Agfa the scanner, Hewlett-Packard the printer, Microsoft the
operating system, and so on.
o Supply chains diverge to meet demand from different types of
customers. Manufacturers of car components, for example, sell some
products to car assembly plants, some to wholesalers for garages
doing repairs, some to retail shops for individual customers, and some
directly to customers through websites.
• Then the supply chain divides into separate features with the same
product following alternative routes.
Benefits of logistics
• Logistics exist to overcome the gaps created when suppliers are some
distance away from customers.
• They allow for operations that are best done at locations that are distant
from customers or sources of materials.
• Logistics can also make movements a lot simpler.
• The following list of benefits:
o Producers locate operations in the best locations, regardless of the
locations of their customers.
o Concentrating operations in large facilities to get economies of scale.
o keep large stocks of finished goods nearer to customers.
o Wholesalers place large orders, and producers pass on lower unit
costs.
o Wholesalers keep stocks from many suppliers, giving retailers a
choice of goods.
o Wholesalers are near to retailers and have short lead times.
 o Retailers carry less stock as wholesalers provide reliable deliveries.
o Retailers can have small operations.
o Transport is simpler, with fewer, larger deliveries reducing costs.
o Organizations can develop expertise in specific types of operation.

Logistics must:
• organize 32 different delivery routes but,
• if the factories use a central wholesaler, the number of routes is cut to 12.
Figure 8: Using intermediaries to simplify the supply chain.

Logistics Activities
Separate activities
Logistics is responsible for the movement and storage of materials as they move
through the supply chain. But what activities does this include?
o Procurement or purchasing.
o Inward transport or traffic
o Receiving
o Warehousing or stores
o Stock control.
o Order picking.
o Materials handling
o Outward transport Physical distribution management
o Recycling returns and waste disposal.
 o Location. Some of the logistics activities can be done in different
locations.
o Communication
o Other activities can be included: sales forecasting, production
scheduling, customer service management, overseas liaison, third
party operations, and so on.

The Council of Logistics Management also highlights the combination of materials

and information flow in their definition:

“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 point of origin to point of consumption for the
purpose of conforming to customer requirements.”

Organizing logistics
• The activities can be arranged in many ways within an organization, and
there is certainly no single ‘best’ arrangement.
o A small organization might have one person looking after everything.
o A medium sized organization might have one department with
different sections for purchasing, transport, stock control, distribution,
and so on.
o A large organization might have a logistics division employing
thousands of people and running huge transport fleets.
o Sometimes all the activities are organized in a single department
reporting to a logistics director.
• sometimes they are part of a larger department such as
marketing or production; sometimes they are spread out in
small pockets throughout the organization.
• sometimes they are contracted out to third-party suppliers.
o The current trend is towards an organization where logistics is a single
integrated function, with a logistics director – or equivalent – at its
head.
o This follows a traditional functional structure, with the logistics
director working with directors in production, finance, sales, human
resources, and so on (as shown in Figure 9a). There are many
variations on this, with a common one found in companies organized
around products or projects.
 o Then some logistics might exist in each division, with a matrix
structure allowing co-ordination of the overall function (shown in
Figure 9b).

Fig. 9: (a) Conventional functional structure (b) Matrix type of structure

Aims Of Logistics
• Logistics is responsible for the flow of materials through a supply chain.
• This function is also called supply chain management.
• LOGISTICS is the time-related positioning of resources, or the strategic
management of the total supply-chain.
• The SUPPLY-CHAIN is a sequence of events intended to satisfy a customer.
• logistics managers have two main aims.
o The first is to move materials into, though, and out of their own
organization as efficiently as possible.
o The second aim is to contribute to an efficient flow through the whole
supply chain. Traditionally, managers concentrate on the first of these,
focusing on those parts of the supply chain that they directly control.
• But! What do we mean by ‘efficient’?
• There are several answers to meaning of ‘efficient, including:
o fast deliveries,
o low costs,
o little wastage,
 o quick response,
o high productivity,
o low stocks,
o no damage,
o few mistakes,
o high staff morale, and so on.
• A realistic aim for logistics balances the service given to customers with the
cost of achieving it.
• So, the overall Aim Of Logistics is to achieve high customer satisfaction. It
must provide a high-quality service with low – or acceptable – costs.
• We can phrase this balance in terms of perceived customer value.
• Logistics adds value.

The 7 Rights of logistics: to add value.

‘The right materials,

to the right place,
at the right time,
To the right customer
from the right source,
with the right quality,
at the right price’.

Importance Of Logistics
• Essential:
o ‘Logistics has always been a central and essential feature of all
economic activity.’
o Without logistics, no materials move, no operations can be done, no
products are delivered, and no customers are served.
• Not only essential, but also expensive:
o The cost of logistics varies widely between different industries.
o Logistics costs are 15–20 per cent of turnover.
 o Improvements in logistics are more than compensating for price rises,
and the overall cost is falling.
o By improving methods and replacing outdated practices, logistics
costs continue to fall as a proportion of product value.

Effects on financial performance

• the effects on the return on assets (ROA).

• summarize the importance of logistics by saying that it:

o Is essential, as all organizations rely on the movement of materials.
o Is expensive, with costs forming a surprisingly high proportion of
turnover.
o Directly affects profits and other measures of organizational
performance.
o Has strategic importance with decisions affecting performance.
o Forms links with suppliers, developing mutually beneficial, long-term
trading relationships.
o Forms links with customers, contributing to customer satisfaction and
added value.
o Has a major effect on lead time, reliability, and other measures of
customer service.
o Determines the best size and location of facilities.
o Gives public exposure with visible locations, advertising on trucks,
‘and so on
o Can be risky, because of safety, health, and environmental concerns.
 o Prohibits some operations, such as moving excessive loads or
dangerous goods.
o Can encourage the growth of other organizations – such as suppliers
and intermediaries offering specialized services.
Example:
• Company Xl currently has sales of LE10 million a year, with a stock level of
25% of sales. The annual holding cost for the stock is 20% of value.
Operating costs (excluding the cost of stocks) are LE7.5 million a year and
other assets are valued at LE20 million. What is the current return on assets?
How does this change if stock levels are reduced to 20% of sales?
Solution
• Taking costs over a year, the current position is:
o Cost of stock = amount of stock × holding cost
= 10 million × 0.25 × 0.2 = LE 0.5 million a year
o Total costs = operating cost + cost of stock
= 7.5 million + 0.5 million = LE8 million a year
o Profit = sales − total costs
= 10 million − 8 million = LE2 million a year
o Total assets = other assets + stock
= 20 million + (10 million × 0.25) = LE22.5 million
o Return on assets = profit / total assets
= 2 million / 22.5 million = 0.089 or 8.9%
o The new position with stock reduced to 20% of sales has:
o Cost of stocks = 10 million × 0.2 × 0.2 = LE0.4 million year
o Total costs = 7.5 million + 0.4 million LE7.9 million a year
o Profit = 10 million − 7.9 million = LE2.1 million a year
o Total assets = LE 20 million + (LE10 million × 0.20) = LE22 million
o Return on assets = 2.1 million / 22 million = 0.095 or 9.5%
• Reducing stocks gives lower operating costs, higher profit and a significant
increase in ROA.

LOGSTICS & SCM

2 Integrating the Supply Chain
3rd & 4th Lectures

How Can We Achieve Integration of Logistics Activities Within With And Across
Sc?
Topics
• Progress in logistics
• Current trends in logistics
• Integrating logistics within an organization
• Integration along the supply chain
• Achieving integration

Logistics has developed over time and is now responding to pressures for change,
with the benefits of creating a single, integrated logistics function.
But, how to achieve internal integration and what are the benefits of further
integration along the supply chain. Are there different approaches to this
integration?

1. Progress in logistics
 Early views
o logistics has been identified as a high-cost function, and one where
organizations can make significant savings.
 Pressures to improve logistics.
o As well as potential savings, many other factors are encouraging
organizations to improve the management of their supply chains.
o The following list suggests some of these pressures:
− Customers are more knowledgeable, and demand higher
quality, lower costs, and better service.
− Competition is getting fiercer.
− Changing power in the supply chain. Very large retail chains
demand customized logistics from their suppliers.
− Growth of 24-hour opening, home deliveries, out-of-town
malls, and on-line shopping.
− International trade continues to grow.
− New types of operation, such as just-in-time, lean operations,
fragmentation, time compression, flexible manufacturing, mass
customization, virtual operations, ...
− Turning from a product focus (concentrate on the end products)
to a process focus (concentrate on the way products are made).
− improvements in communication
− outsourcing
− increasing co-operation through alliances, partnerships, …
− Managers are recognizing the strategic importance of the
supply chain.
 − Revolution in the transport industry.

2. CURRENT TRENDS IN LOGISTICS

Improving communications
• Logistics are changing faster now than at any time in the past.
• The most obvious change is the increasing use of technology:
o directly in the movement of goods – such as electronic identification
of packages, satellite tracking of lorries and automatic guidance
systems
o The greatest impact has come with communications.
• By the 1990s the obvious next step had arrived with electronic data
interchange (EDI).
• Purchasing, which has developed into e-purchasing or e-procurement.
• New types of transactions have emerged due to ICT: B2B, B2C, …

Improving customer service

• Organizations must maintain their service levels.
• Improved logistics means giving the service that customers want at the
lowest possible cost.
• A problem is finding the features that customers really want and the level of
service they are willing to pay for:
o Suppliers want to keep customers happy with fast service, and with no
products hanging around and jam the supply chain.
o Ideally, the lead time should be as close to zero as possible, and one
approach to this uses synchronized material movement. This makes
information available to all parts of the supply chain at the same time,
so that organizations can coordinate material movements, rather than
wait for messages to move up and down the chain.
o Another key factor for customer satisfaction is personalized products.
Instead of buying a standard one,
• Mass customization.
o Combines the benefits of mass production with the flexibility of
customized products.
o It uses B2C to give direct communications between a final customer
and a manufacturer, and
o It needs supply chains that are flexible, that move materials very
quickly, and respond to varying conditions.

Other significant trends

 • Globalization:
o Physical distances are becoming less significant.
o Organizations can become global in outlook.
• Reduced number of suppliers:
o Develop long-term relationships with the best.
o Working closely with a small number
• Concentration of ownership:
o Large companies can get economies of scale, and they have come to
dominate many supply chains. concentration of ownership seen in
many logistics sectors ranging from food wholesalers to shipping lines
• Outsourcing:
o ‘Outsourcing has been one of the dominant business trends of the
1980s and 1990s.
o Surveys suggest that around 30 per cent of logistics expenditure is
outsourced in the EU.
• Postponement:
o Moves almost-finished products into the distribution system, and
o Delays final modifications or customization until the last possible
moment.

Benefits of supply chains

• Supply chains exist to overcome the gaps created when suppliers are some
distance away from customers.
• They allow for operations that are best done at locations that are distant from
customers or sources of materials.
• Supply chains can also make movements a lot simpler.
• The following list of benefits:
o Producers locate operations in the best locations, regardless of the
locations of their customers.
o Concentrating operations in large facilities to get economies of scale.
o keep large stocks of finished goods nearer to customers.
o Wholesalers place large orders, and producers pass on lower unit
costs.
o Wholesalers keep stocks from many suppliers, giving retailers a
choice of goods.
o Wholesalers are near to retailers and have short lead times.
o Retailers carry less stock as wholesalers provide reliable deliveries.
o Retailers can have small operations.
 o Transport is simpler, with fewer, larger deliveries reducing costs.
o Organizations can develop expertise in specific types of operation.
• Cross-docking:
o Co-ordinates the supply and delivery, so that goods arrive at the
receiving area and are transferred straight away to a loading area,
where they are put onto delivery vehicles. This dramatically reduces
stock levels and associated administration.
o One form: packages are moved directly from arriving vehicles and
onto departing ones. Or
o Second form: materials arrive in larger packages which are opened,
broken into smaller quantities, sorted, consolidated into deliveries for
different customers and transferred to vehicles.
• Direct delivery
o Means that logistics must move small deliveries quickly to final
customers.
• Other stock reduction methods
o Just-in-time operations
o Vendor managed inventory.
• Increasing environmental concerns
o Logistics is moving towards ‘greener’ practices.
• More collaboration along the supply chain
o Competitors are not other organizations within the same supply chain
but are organizations in other supply chains.

3. Integrating Logistics Within An Organisation

Three important themes for logistics consider:
• Leanness,
• Agility and
• Integration.
Perfectly, logistics should aim for all three of these.

Problems with fragmented logistics

• Fig. 1 summarizes a series of related logistics activities within an
organization, it add value to the final product.

Fig. 1:
 • These activities have traditionally been managed separately, so that an
organization might have a distinct purchasing department, transport
department, warehouse, distribution fleet, and so on.
• Unfortunately, dividing up logistics in this way creates a few problems.

Disadvantages of Fragment ED logistics:

● giving different, conflicting objectives within an organization
● duplicating effort and reducing productivity
● giving worse communications
● reducing co-ordination between the parts – leading to lower efficiency,
higher costs and worse customer service
● increasing uncertainty and delays
● making planning more difficult
● introducing unnecessary buffers between the parts,
● distorting important information
● giving logistics a low status within an organization.

Bringing activities together

o Integrating logistics within an organization so that all the related activities
working together as a single function.
o This is responsible for all storage and movement of materials throughout the
organization.
o It tackles problems from the viewpoint of the whole organization and looks for
the greatest overall benefit.

In practice, it is difficult to integrate all the logistics within an organization.

 o The supply chain consists of many different activities, with different types of
operation, using different systems and geographically dispersed.
o The usual approach has the integration developing over time.
• One department might slowly take over all aspects of ordering and
receiving raw materials.
• Another department might slowly take over all aspects of delivering
finished products to customers.
o Some organizations are tempted to stop when they reach this stage, and they
work with two functions:
• Materials management, aligned with production and looking after the
inwards flow of raw materials and their movement through operations;
and
• Physical distribution, aligned with marketing and looking at the outward
flow of finished goods.
• However, this still leaves an artificial break in what is essentially a continuous
function.
• The obvious step is to:
o Combine the two into a single function responsible for all material movement
into, through and out of the organization.
o This completes the internal integration of an organization’s logistics.
• Despite the obvious benefits of integrated logistics, there can still be practical
difficulties.
o This needs a senior manager who has the necessary power to start the changes.
o New practices and relationships come from individuals working together,
developing a culture that is based on teamwork and co-operation rather than
self-interest and conflict.
• Another factor that encourages internal integration is the analysis of total logistics
cost:
o Total logistics cost = transport cost + warehouse cost + stock holding cost +
packaging cost + information processing cost + other logistics overheads
o The traditional view considered each of these separate costs as independent, so
reducing, say, the transport cost automatically lowered the total cost.
• One other important factor for integration is the availability of integrated
information and control systems.
o An information system might show that stocks are running low, and
o Control system uses this information to place an order with suppliers.
• logistics has moved from being fragmented function, to a strategic, integrated one.
through the 7 stages in previous layout.
Stages in integration
Stage Separate logistics activities not given much attention or considered important.
1

Stage 2 Separate activities of logistics are important for the success of the organisation.

Stage 3 Making improvements in the separate functions, making it efficient one.

Internal integration – recognising the benefits of internal co-operation and combining the
Stage 4 separate functions into one.

Stage 5 Developing a logistics strategy, to set the long-term direction of logistics.

Benchmarking – comparing logistics’ performance with other organisations, learning from

Stage 6 their experiences, identifying areas of improvement and finding ways of achieving this.

Stage 7 Continuous improvement.

• By Stage 4:
o An organization has integrated logistics, and the last three stages show
how the function can be improved.
o Stage 5 emphasizes the need for a strategic view,
o Stage 6 looks at other organizations for comparisons and lessons, and
o Stage 7 recognizes that logistics must continually evolve. However,
this is not the end of the story.
• Once an organization has efficient, integrated and strategic logistics, it can
start looking at integration along more of the supply chain.

4. Integration Along The Supply Chain

 Problems with fragmented supply chains
Benefits of integrating logistics along more of the supply chain.
o External integration removes boundaries between them to improve the
whole chain.
o Most opportunities for cost reduction and/or value enhancement lie at
the interface between supply chain partners.
o This effectively gives three levels of integration:
− The first has logistics as separate activities within an
organization.
− The second has internal integration to bring them together into
a single function.
 − The third has external integration, where organizations look
beyond their own operations and integrate more of the supply
chain (as in Fig. 2).
− Organizations within the same SC should CO-OPERATE to get
final customer satisfaction.
− They should not compete, but with organizations in other SC.

Fig. 2: Three levels of logistics integration

Benefits of integration
Benefits from external integration are:
• Genuine co-operation between all parts of the supply chain, with shared
information and resources
• Lower costs – due to balanced operations, lower stocks, less expediting,
economies of scale, elimination of activities that waste time or do not add
value, and so on
• Improved performance – due to more accurate forecasts, better planning,
higher productivity of resources, rational priorities, and so on
• Improved material flow, with co-ordination giving faster and more reliable.
• Better customer service, with shorter lead times, faster deliveries, and more
customization
• More flexibility, with organizations reacting faster to changing conditions.
• Standardized procedures, becoming routine and well-practiced with less
duplication of effort, information, planning, and so on
 • Reliable quality and fewer inspections, with integrated quality management
programs. Vements.

5. Achieving Integration
 Co-operation and conflict

 Different types of co-operation

• Do business together. If an organization has a good experience with a
supplier, it will continue to use them and over some period will develop a
valuable working relationship.
• Sometimes the cooperation is more positive, such as small companies
making:
o Joint purchases to get the same quantity discounts as larger
companies.
o Edi links to share information.
o Combining loads to reduce transport costs.
o Agreed package sizes to ease material handling,
o Lists of preferred suppliers, and so on.
• Japanese companies take this approach further forming Keiretsu – which are
groups of organizations that work together without forming partnerships.
• An informal arrangement has the advantage of being flexible and non-
binding.
• On the other hand, it has the disadvantage that either party can end the co-
operation without warning, and at any time that suits them.
• This is why many organizations prefer a more formal arrangement, with a
written contract setting out the obligations of each party.
• These are common when organizations see themselves as working together
for some time.
Strategic alliances
• The basis of a strategic alliance or partnership shown in Fig. 4.

Fig..4: Spectrum of relationships

Adversarial Informal Contractual Formal Minority Vertical
cooperation alliance investment integration
Relationship Arm’s Unspecified Medium Long term cont.
length term cont.
Information little More FULL
sharing
Trade with Much Less Little
competitors
Culture Different Coming Share
together

• Supplier Partnering is ‘an ongoing relationship between firms, which

involves a commitment over an extended time period, and a mutual sharing
of information and the risks and rewards of the relationship.’
• The following list gives the main features of alliances:
o Organizations working closely together at all levels.
o Senior managers and everyone in the organizations supporting the
alliance.
o Shared business culture, goals, and objectives
o Openness and mutual trust
o Long-term commitment
o Shared information, expertise, planning and systems.
o flexibility and willingness to solve shared problems.
o Continuous improvements in all aspects of operations
o Joint development of products and processes
o Guaranteed reliable and high-quality goods and services.
o Agreement on costs and profits to give fair and competitive pricing.
o Increasing business between partners.

Factors that contribute to a successful partnership include:

• Drivers, which are the compelling reasons for forming partnerships, such as
cost reduction, better customer service, or security.
 • Facilitators, which are the supportive corporate factors that encourage
partnerships, such as compatibility of operations, similar management styles,
common aims, and so on
• Components, which are the joint activities and operations used to build and
sustain the relationship, such as communication channels, joint planning,
shared risk and rewards, investment, and so on.

Vertical integration
• The most common arrangement is one organization simply buying other
organizations in the supply chain. This increases its level of vertical
integration.
• Vertical Integration describes the amount of a supply chain that is owned by
one organization.
• Fig. 5 show different levels of vertical integration:
o Little
o Backward
o Forward
o High
Fig. 5: different levels of vertical integration

• What do you think are the main factors that encourage logistics to change?
• How is it responding to these pressures? What changes do you think there
will be in the next decade?
• When logistics is divided into separate functions, each is likely to have its
own objectives. Is this necessarily a bad thing, or can there be positive
benefits?
• An integrated supply chain is a convenient notion, but it does not reflect real
operations. An organization is only really concerned with its own customers
 and suppliers and does not have time to consider other organizations further
along the chain. Do you think that this is true?
• When we say that ‘supply chains compete, not companies’ what exactly does
we mean?
• integration in the supply chain can be at the level of: Physical movement,
Shared information, Integrated control, Integrated infrastructure. What this
mean?

3rd Party logistics (3PL)

• The use of an outsider logistics company to perform all part of a company's
material management or product distribution function.
• It is the integration of:
o Information,
o Inventory,
o Warehousing, and
o Transportation services,

Fourth Party Logistics (4PL)

• A 4PL provider is a supply chain integrator that assembles and manages the:
o Resources,
o Capabilities, and
o Technology of its own business
 • with those of complementary services providers to deliver comprehensive
supply chain solution.

What is Lean Logistics?

• lean logistics:
o Is the application of lean management ideas to supply chain
performance.
o It analyzes and removes non-value-added operations to enhance the
flow of materials and goods and reduce costs.
• The goals of lean logistics:
o Waste elimination,
o Quality enhancement.
o Increasing the flexibility of logistics systems and supply processes.
• The foundation of lean logistics
o Any process can be more effective by eliminating unnecessary steps.
o To become a lean organization, the logistical procedures must be
improved.
o While logistics costs in industry range from 5 to 15% of turnover, they
can potentially approach 15 to even 25% of turnover in retail.

Five effective ways to adopt lean logistics.

• Focus on the lean principles of a lean organization
• Identify customer benefits
• Eliminate waste through lean logistics
• Reduce inventory
• Performance measurement

1. Focus on the lean principles of a lean organization

The principles of lean manufacturing, administration, and logistics management:
 Customer-centricity:
o Understanding the logistics value stream.
 Process Orientation:
o Identifying and enhancing the steps in the process that increase the
value stream.
 Flow orientation:
o Pull methods to decrease lead and waiting buffers,
o Discover and continually eliminate waste,
o Minimize inventory, and
 o Utilization of technology.
 supply chain improvement through:
o Creating a continuous improvement process
o Monitoring performance.

2.Identify customer benefits:

• Value stream analysis for supply chain management.
• Value stream mapping of the movement of materials and information
through them.
• Develop targeted value stream, and
• Implement it with the help of an action plan.

3. Eliminate waste through lean logistics

• Waste must be found in the current logistical operations to be eliminated.
• For instance, there are various ways that resources might be wasted in
logistics, such as:
 Longer wait times due to excess inventory (inventory/overstock)
 Poor planning and unnecessary transportation
 Rejects or defects.
 Overproduction (e.g. packaging: packaging that does not effectively
protect against damage or too much packing material)
 Long lead times and wait times.
 Movement and travel times

4. Reduce inventory:
• pull principle of lean management.
o Inventory reduction throughout the supply chain is one of the most
prominent lean logistics approaches.
o As a result, it is demand oriented. Only when a consumer places an
order does the production and logistics procedures start. This reduces
the consumption of resources.

5. Performance measurement.
• The goal of the Lean Logistics Manager is to continuously enhance the
efficiency of the company’s supply chain and logistics.
• Direct process improvement at the site of work is the aim of lean
management.
 LOGSTICS & SCM
Business Logistics
5th & 6th Lectures

Main Topics:
1. Trends and Strategies in Business Logistics
2. Strategic Supply Chain and Inventory Positioning
3. Supply Chain Network Design
4. Best Practices in Supply Chain Management
5. Resource Planning and Optimization
6. Forecasting and Just-in-Time (JIT)

1 . Trends and Strategies in Business Logistics

Understand the importance on business logistics and its impact on the supply
chain:
• Define business logistics
• Know the key activities in logistics management
• Understand the importance of logistics/supply chain
• The value added role of logistics

1. 1 Defining Business Logistics

Logistics is the part of the supply chain process that:
• Plans, implements and controls
o The efficient, effective flows and storage of
 Goods, services and related information
 From the point of origin to the point of consumption
o In order to meet customers’ requirements.

The 3 key points to note are:

• Product flows are to be managed from the point where they exist as raw
materials to the point where they are finally discarded.
• Logistics is also concerned with the flow of services as well as physical
goods, an area of growing opportunity for improvement.
• Logistics is a process that includes all the activities that have an impact on
making goods and services available to customers as and when they wish to
acquire them.

1.2 Key Activities of Logistics Management

• Alliance between Customer Service and Marketing
 • Transportation
• Inventory Management
• Information flows and order processing

Alliance between Customer Service and Marketing TO:

• 1. determine customer needs and wants for logistics services
• 2. set customer service levels
• 3. determine customer responses to service

Transportation:

• Select
• Mode and transport service
• Equipment
• Carrier
• routing
• Vehicle scheduling
• Freight consolidation
• Financial
• Claims processing
• Rate auditing

Inventory Management:
• Stocking Policies
• Raw materials and finished goods
• Short-term sales forecasting
• Stocking Points
• Product mix
• Number, size and location
• Strategies
• Just-in-time,
• push and pull

Information flows and order processing:

• Sales order-inventory interface procedures
• Order information transmittal methods
• Order rules (e.g. EOQ, Lot for Lot etc)

1.3 The Importance of Logistics/Supply Chain

1. The importance has changed over time:
  (1980s and 1990s)
o Improving customer service in supply chain management was important
because:
 Customer service contributed directly to revenue increase and market
share
 Business logistics management was considered to be equally
important with sales and marketing to produce development

The emphasis of logistics in organizations has changed over time:

o Therefore, firms was in a continued need for reducing supply chain costs
and assets as well as improve customer service for long term growth
o Now
 The emerging view is that SCM can both drive and enable the
business strategy of many firms.
 Aligning supply chain strategy with business strategy will enable
value enhancement all over the firm.
 Example: Dell
 Dell Computer’s “Retail Direct” involves processing orders direct
from their customers, building the system to the customer’s order and
delivering then within 5 days.
 To support this logistical approach, Dell requires its suppliers to
maintain inventories within 15 minutes of its manufacturing plants.
 By unleashing the strategic power of the supply chain, Dell Computer
easily outperformed its competitors in terms of shareholder value
growth by over 3000 percent (taken from Stern Stewart EVA 1000
database)

2. Value
o According to studies conducted for the US economy, logistics costs rank
second only to the cost of goods sold.
o Value is added by minimizing these costs and passing the benefits to the
customer and the firm’s shareholders.
3. Impact on cash earnings
o Shareholder Value is represented by Profitability (which is a relation of
Revenue and Cost) and Invested Capital (represented by Working Capital
and Fixed Capital). ..
o Revenue – Greater customer service
…Greater product availability
 o Cost – Lower cost of goods sold, transportation, warehousing, material
handling, and distribution management costs
o Working Capital – Lower raw materials and finished goods inventory
o Shorter ‘order to cash’ cycles
o Fixed Capital – Fewer physical assets (e.g. trucks, warehouses, material
handling equipment)
5. Key Capabilities
o 4 key supply chain capabilities that contribute directly to financial
performance: They are:
 1. Delivery speed
 2. Reliability
 3. Responsiveness to target markets
 4. Low cost total distribution
1.4 Value-Added Role of Logistics
o There are 4 principal types of economic utility that add value to a product
or service, i.e.
 form utility,
 possession utility,
 place utility and
 time utility

Product Marketing
Form Possession
Utility U.

Logistics
Place U.
Time U.

Economic utilities : What, Where, When and Why

o What – Form Utility
  Refers to the value added to goods through a manufacturing ,
production or assembly process.
 For example, breaking bulk and product mixing changes a product’s
form by changing its shipment size packaging characteristics
o Where – Place Utility
 Logistics extends the physical boundaries of the market area, thus
adding economic value to the goods.
 This addition is known as place utility
o When – Time Utility
 Goods and services must be available when customers demand them.
 By having goods and services available when it is needed creates time
utility
o Why – Possession Utility
 is primarily created by the marketing activities related to the
promotion of goods and services.
 It increases the desire in a customer to possess a good or to benefit
from a service

LOGSTICS & SCM

logistics Services & Marketing Mix in Logistics Services

7th & 8th Lectures

Logistics as a Service
• Logistics holds all five characteristic which proving that logistics is a service
as well.
• Those five characteristic are in the next slides
 Intangibil
ity

Lack of
ownership / Inseparability
Inability to
Own

Heterogeneity
Perishability /
/ Inventory Inconsistency

Five Characteristic Are:

1. Intangibility
o You cannot hold or touch a service unlike a product.
o Thus, customers obtain their experience from the service has an impact
on how they will perceive it.
2. Inseparability
o Services cannot be separated from the service providers.
o A product when produced can be taken away from the producer.
o However, a service is produced at or near the point of purchase.
o Buying the courier services to transfer the articles from the origin to the
destination, the services have been produced by the service providers
from when the articles is picked up till it is delivered.
3. Heterogeneity / Inconsistency
o It is very difficult to make each service skill identical.
o Unlike the commodities, the service quality is varying from one checking
to the other.
o This quality varying is result from the expectation of the client and the
service provided to them.
o If the client expects 100% and we fail to meet that requirement, the
quality will be low.
o However, if they expect 100% and we provide them 120% service, so
that service quality is good.
4. Perishability / Inventory
 o Services last a specific time and cannot be stored like a product for later
use.
o If the vessel’s space is not fully booked to transport the goods, the vessel
owner cannot keep this as inventory to sell it later at all. If we cannot sell
the space now, it means the space is useless and gone.
5. Lack of ownership / Inability to Own
o You cannot own and store a service like you can a product.
o Services are used or hired for a period of time.
o For example, we lease the vessels not own the vessels.

In sum:
o We can see clearly that logistic is a service business.
o To understand the characteristics of the service industry is very much
important because the customer cannot touch and own what they buy.
o Hence, the service provider must make sure that the buyers/customer can
have physical proof of satisfaction.
o Also, the service quality assurance is also very important, so it is very
ideal that we can give them a kind of feedback available from the
previous clients.

STP Concept in Logistics

o The STP process is an important concept in the study and application of

marketing.
o The letters STP stand for segmentation, targeting, and positioning.
o The STP process demonstrates the links between an overall market and
how a company chooses to compete in that market.
o It is sometimes referred to as a process, with segmentation being
conducted first, then the selection of one or more target markets and then
finally the implementation of positioning.
 o The goal of the STP process is to guide the organization to the
development and implementation of an appropriate marketing mix, as
highlighted in the following diagram.

The STP Process

• Market segmentation can be defined as the process of splitting a market
into smaller groups with similar service needs or identifiable characteristics,
for the purpose of selecting appropriate target markets.
• Targeting refers to an organization’s proactive selection of a suitable market
segment (or segments) to focusing the firm’s marketing offers and activities
towards this segment.
• Positioning is the target market’s perception of the product’s key benefits
and features, relative to the offerings of competitive products.

In sum:
o It is very important to target the market segment of the client.
o By knowing this target we can start to position ourselves in the market in
order to offer the most competitive business strategy in the competitions.
o By choosing right products or services the company going to operate.

Marketing Mixes
Marketing Mix
o Successful marketing depends upon addressing a number of key issues.
These include:
• what a company going to provide;
• how much it is going to charge;
• how it is going to deliver its services to the customers.
o Traditionally, these considerations were known as the 4Ps – Products,
Price, Place and Promotion.
o These first 4 Ps are known as marketing principle.
o As marketing become more sophisticated discipline, a fifth ‘P’ was added
– People.
o And recently, two further ‘P’s were added, mainly for service industries
• Process, and
• Physical evidence.
o However, for the logistic service we added one more ‘P’ namely
• Partnership.

1. Product:
 o The perfect product must provide value for the customer. This value is in
the eye of the beholder – we must give our customer what they want, not
what we think they want.
o A product does not have to be tangible – an insurance policy can be a
product.
o Ask yourself whether you have a system in place to regularly check what
your customers think of your product, your supporting service, etc. what
their needs and now and whether they see them changing.
o Beware going too far with product quality. Don’t try to sell a Rolls-Royce
when the customer really wants a Nissan Micra.
2. Place:
o The place where customers buy a product, and the means of distributing
your product to that place, must be appropriate and convenient for the
customer.
o The product must be available in the right place, at the right time and in
the right quantity, while keeping storage, inventory and distribution cost
to an acceptable level.
o Customer surveys have shown that delivery performance is one of the
most important criteria when choosing a supplier.
o Place also means ways of displaying your product to customer groups.
This could be in be in a shop window, but it could also be via the internet.
3. Price:
o A product as well as a service is only worth what customers are prepared
to pay for it.
o The price also needs to be competitive, but not means the cheapest. The
small operators like us could add more value to our service to get more
income.
o Thinking of price as ‘cost’ to the customer helps to underscore why it is
so important.
o Price positions you in the market – the more you charge, the more value
or quality your customers will expect from their money.
o Existing customers are generally less sensitive about price than new
customers – a good reason for looking after them well.
4. Promotion: - Promotion is the way a company communicate what it does and
what it can offer customers.
o It includes activities such as branding, advertising, PR, corporate identity,
sale management, special offers and exhibition.
o Good promotion is not one-way communication – it paves the way for a
dialogue with customers.
 o Promotion should communicate the benefits that a customer obtains from
a product or service.
o The promotion material should be easy to read and enable the customer
to identify why they should buy your service/ product customers.
5. People:
o Anyone who comes into contact with your customers will make an
impression, and that can be a profound effect – positive or negative – on
customer satisfaction.
o The reputation of your brand rests in your people’s hands. They must be
appropriately trained, well-motivated and have the right attitude.
o The level of after sales support and advice provided by a business is one
way of adding value to what you offer, and can give an important edge
over your competitors. This will probably become more important than
price for many customers once they start to use you.

For Service Industries

6. Process:
o The process of giving a service and the behavior of those who deliver are
crucial to customer satisfaction.
o Issue such as waiting times, the information given to customers and
helpfulness of staff are all vital to keep customers happy.
o Customers are not interested in the detail of how your business runs.
What matters to them is that the system works.
o Do customers have to wait? Are they kept informed? Are your helpful? Is
your service efficiently carried out? Do your people interact in a manner
appropriate to your service?
o Process is often overlooked. For example, when the customers call in, we
let them wait for long time, and this phone system of process
8. Physical Evidence
o A service cannot be experienced before it is delivered. This means that
choosing to use a service can be perceived as a risky business because
you are buying something intangible.
o This uncertainty can be reduced by helping potential customers to ‘see’
what they are buying. Facilities such as a clean, tidy and well-decorated
reception area can also help to reassure. If your premises aren’t up to
scratch, why would the customer think your service is?
o Although the customer cannot experience the service before purchase, he
or she can talk to other people with experience of the service. This is
credible.
9. Partnership
o Without the good partnership with all the suppliers in the logistics
procedure, the logistics job cannot be going smooth as promise to the
client at all.
o So we have to strengthen the partnership between partners in order make
the best out of them.

In Sum:
o Different type of business will need different kind of marketing mix as
well.
o If we are working on the product industry, we will use the 4Ps, and if we
are in the service industry, we may use the 7Ps.
o Logistics is also the service industry, and we will use the 7Ps as well.
o However, since this service very much relevant to the networking and
trust between each other, it is also giving a big weigh on the partnership
as well, so it become 8Ps for the logistics.

BCG Models
o The growth–share matrix which also known as BCG-matrix, is a chart
that was created by Bruce D. Henderson for the Boston Consulting Group
in 1970 to help corporations to analyze their business units.
o This helps the company allocate resources and is used as an analytical
tool in brand marketing, service management, strategic management,
and portfolio analysis.
 • “Cash Cows”
o It is the strategy where a company has high market share in a slow-
growing industry.
o These companies generate cash in excess of the amount of cash needed to
maintain the business.
• “Dogs”
o “Dogs” is more charitably called pets, are units with low market share in
a mature, slow-growing industry. These units typically "break even",
generating barely enough cash to maintain the business's market share.
• “Question Marks”
o It is also known as problem child. This strategy is used when business
operating in a high market growth but having a low market share.
Question marks have a potential to gain market share and become stars,
and eventually cash cows when market growth slows.
• “Stars”
o are units with a high market share in a fast-growing industry. They are
graduated question marks with a market or niche leading trajectory

Conclusion:
The BCG model is the matrix of the combination of the level of the growth of the
business’ market together with the growth of the market share. It is providing the
considerate strategies which the businesspeople may need to carry out in order to
response to the situation of the company.

SWOT Analysis
o SWOT (which stands for Strengths, Weaknesses, Opportunities, and
Threats)
o It is a way to analyze and evaluate your current situation and
environment.
o While it's used for strategic planning in business settings, it can also be
used in goal setting to help business identify goals and get the most
benefit.
o It is a way of matching your internal capabilities, resources and liabilities
with the external factors you are facing.

Strength
o Characteristics of the business or a team that give it an advantage over
others in the industry.
o Positive tangible and intangible attributes, internal to an organization.
o Beneficial aspects of the organization or the capabilities of an
organization, which includes human competencies, process capabilities,
financial resources, products and services, customer goodwill and brand
loyalty.
o Examples:
• Abundant financial resources,
• Well-known brand name,
• Economies of scale,
• Lower costs [raw materials or processes],
 • Superior management talent,
• Better marketing skills, Good distribution skills,
• Committed employees.
Weakness
o Characteristics that place the firm at a disadvantage relative to others.
o Hinder the organization from its ability to attain the core goal and
influence its growth.
o Weaknesses are the factors which do not meet the standards we feel they
should meet.
o However, weaknesses are controllable. They must be minimized and
eliminated.
o Examples
• Limited financial resources,
• Weak spending on R & D,
• Very narrow service line,
• Limited distribution,
• Higher costs,
• Out-of-date technology,
• Weak market image,
• Poor marketing skills,
• Limited management skills,
• Under-trained employees.

Opportunity
o Chances to make greater profits in the environment - External attractive
factors that represent the reason for an organization to exist & develop.
o Arise when an organization can take benefit of conditions in its
environment to plan and execute strategies that enable it to become more
profitable.
o Organization should be careful and recognize the opportunities and hold
them whenever they arise.
o Opportunities may arise from market, competition, industry/government
and technology.
o Examples
• Rapid market growth,
• Rival firms are self-satisfied,
• changing customer needs,
• new uses for service provided,
• Economic boom,
 • Government deregulation,
• Sales decline for a substitute service.
Threats
o External elements in the environment that could cause trouble for the
business - External factors, beyond an organization’s control, which
could place the organization’s mission or operation at risk.
o Arise when conditions in external environment jeopardize the reliability
and profitability of the organization’s business. Compound the
vulnerability when they relate to the weaknesses.
o Threats are uncontrollable. When a threat comes, the stability and
survival can be at stake.
o Examples
• Entry of foreign competitors,
• Introduction of new substitute service,
• Service life cycle in decline,
• Changing customer needs,
• Rival firms adopt new strategies,
• Increased government regulation,
• Economic downturn.
TOWS Analysis:
o Out form this SWOT analysis, the TOWS Analysis can be created as
following

o A. SO Situation: Strategies that enable competitive advantage, external

opportunities match well with internal strengths, allows for competitive
advantage to be built and maintained.
 o B. WO Situation: In this situation company has the more vulnerability -
weaknesses, but its environment gives more opportunities. The strategy
should include the use of these opportunities while reducing or correcting
weaknesses within the organization.
o C. ST Situation: The source of development difficulties for the company
is unfavorable external conditions (prevalence of threats). The company
may use large internal strengths in attempt to overcome threats from
environment.
o D. WT Situation: The Company in this case is devoid of any
development opportunities. It operates in hostile environments, and its
potential for change is small. It does not have significant strengths, which
could withstand threats.
Conclusion:
It is very important to understand the weakness and strength of the company. Once
we know the weakness, we can make the correction of the weaknesses. And for the
strength we can make the advantages out of them.
Also, we will need to know clearly the opportunity and the threats in the market as
well in order that we can match to our weakness and strength.

Case Study – TNT Express

o Founded in Australia after the Second World War, TNT went Dutch in
1992 following rapid international expansion. Our history is noteworthy
for decisive acquisitions and a drive for excellence.
o Today, TNT Express is a global company, operating in 200 countries
around the world.
o But the company actually started from very modest beginnings, in
Australia back in the 1940s, when Ken Thomas set up his own transport
business with just a single truck.
o Business boomed in the 1950s as Ken’s company began offering road and
rail freight services across Australia including, for the first time, new
overnight services.
o In 1958, the company became known as Thomas Nationwide Transport
or TNT for short and, by 1961, TNT had become so successful that it was
listed on the Australian stock exchange.
Situation - Going Up Against the Big Guys
o TNT Express Worldwide was a multi-billion dollar overnight courier
service, headquartered in Australia.
o They were a major presence in the Australia and European business
markets with a comparatively small business in the U.S.
 o Competing against the giants in the industry, Fedex, UPS, DHL, etc.,
they needed to develop a growth strategy against these much larger, and
better funded companies.
o Having a very small share of the market, and being outspent 20-30:1 in
marketing, TNT needed to determine the best direction for their business
growth moving forward.
o Previously, like their competitors, TNT had a horizontal approach to their
sales and marketing programs, i.e. their sales people called on prospects
in every industry, and their marketing effort tried to appeal to everyone.

Solutions – Finding the Best ProspectsTNT.docx

o A segmentation strategy was developed to concentrate on the vertical
markets where TNT was most competitive.
o Their unique products for these verticals formed the foundation of the
marketing programs for each vertical.
• These unique products afforded them the opportunity to be added
to the list of overnight couriers for prospects instead of the need to
replace an existing vendor.
• This niche strategy avoided head on sales and marketing clashes
with Fedex, UPS, DHL, etc.
o A good sales commission program rewarded the sales team for new
clients in the selected industries, encouraging the sales team to focus on
these new target verticals.
o By concentrating all their marketing dollars against the verticals that the
sales team was now calling on, TNT was able to create a presence for
itself against its highly targeted audiences.
Results
After a Year of This New Marketing Strategy,
o Sales Are Up 25%
o Revenue increased 25%.
o Margins were retained on all product offerings.
o Marketing spending was maintained at the previous levels.
Plan Your Own Marketing Plan
From the case study above, you may wish to start writing your own marketing
strategy to compete with your respective competitor. Use the following tool to help
you to map your marketing plan and strategy.

Conclusion
No matter how small your company is; with the right marketing plan and
strategies, you will be able to knock down some big players in the market with
your uniqueness and your right focus.

LOGSTICS & SCM

Business Logistics
9th Lectures

1. Trends and Strategies in Business Logistics

2. Strategic Supply Chain and Inventory Positioning
3. Supply Chain Network Design
4. Best Practices in Supply Chain Management
5. Resource Planning and Optimization
6. Forecasting and Just-in-Time (JIT)

2 . Strategic Supply Chain and Inventory Positioning

Understand the key concepts in supply chain inventory modeling and its
components
o Understand the Economic Order Quantity (EOQ)
o Know how to determine the Reorder Point (ROP)
o Explain the use of the Newsboy Model in inventory replenishment
o Understand Pipeline Inventory and its components

2.1 Economic Order Quantity EOQ

o EOQ is a set point designed to help companies minimize the cost of
ordering and holding inventory.
 The cost of ordering an inventory falls with the increase in ordering
volume due to purchasing on economies of scale.
 However, as the size of inventory grows, the cost of holding the
inventory rises.
 EOQ is the exact point that minimizes both these inversely related costs.
o EOQ is an accounting formula that determines the point at which the
combination of order costs and inventory carrying costs are at least.
 The result is the most cost effective quantity to order.
o The (EOQ) model is used by calculating the number of units a company
should add to its inventory with each batch (lot) order to reduce the total
costs of its inventory. The costs of its inventory include:
holding Cost + Order Cost
The EOQ model seeks to:
o ensure that the right amount of inventory is ordered per batch so a company
does not have to make orders too frequently, and
o there is not an excess of inventory sitting on hand.
o It assumes that
 there is a trade-off between inventory holding costs and inventory order
costs, and
 total inventory costs are minimized when both order costs and holding
costs are minimized.

Assumptions used for Economic Order Quantity:

o Demand occurs at a known and reasonably constant rate
o The item has a sufficiently long shelf life
o The item is monitored under a continuous review system
o All the cost parameters remain constant forever (over an infinite time
horizon
o A complete order is received in one batch

Components of the EOQ Formula:

o D: Annual Quantity Demanded
o Q: Volume per Order
o S: Ordering Cost (Fixed Cost)
o C: Unit Cost (Variable Cost)
o H: Holding Cost (Variable Cost)
o i: Carrying Cost (Interest Rate)

Ordering Cost
o The number of orders that occur annually can be found by dividing the
annual demand by the volume per order. The formula can be expressed as:

o For each order with a fixed cost that is independent of the number of units,
S, the annual ordering cost is found by multiplying the number of orders by
this fixed cost. It is expressed as:
Holding Cost
o Holding inventory often comes with its own costs. This cost can be in the
form of direct costs incurred by financing the storage of said inventory or
the opportunity cost of holding inventory instead of investing the money tied
up in inventory elsewhere. As such, the holding cost per unit is often
expressed as the cost per unit multiplied by the interest rate, expressed as
follows:
H = iC
o As such, the holding cost of the inventory is calculated by finding the sum
product of the inventory at any instant and the holding cost per unit. It is
expressed as follows:

With the assumption that demand is constant, the quantity of stock can be seen to
be depleting at a constant rate over time.

When inventory reaches zero, an order is placed and replenishes inventory as

shown:

Total Cost and the Economic Order Quantity

 o Summing the two costs together gives the annual total cost of orders TC =
annual ordering cost + annual holding cost

o To find the optimal quantity that minimizes this cost, the annual total cost is
differentiated with respect to Q.
o It is shown as follows:

Example
a company faces an annual demand of 2,000 units. It costs the company $1,000 for
every order placed and $250 per unit of the product. It faces a carrying cost of 10%
of a unit cost. What is the economic order quantity?

The variables can be arranged as follows:

The cost for each value of Q is shown as:

Volume Batches Annual Annual Annual
per per year order holding total cost
order Q Q/2*H costing Cost TC (5)
() (2) D/Q*S Q/2*H
(3) (4)
50 40 40000 625 40625
100 20 70000 1250 21250
150 11.32 13333 1875 15208
200 10 10000 2500 12500
250 8 8000 3125 11125
300 6.67 6666 3750 10416
350 5.71 5714 4375 10089
 400 5 5000 5000 10000
450 4.44 4444 5625 10059
500 4 4000 6250 10250

A Graphical Representation

3) Cycle Time (T)

o The cycle time, T, represents the time that elapses between the placement of
orders.
T = Q/D
4) Number of Orders per Year (N)
o To find the number of orders per years take the reciprocal of the cycle time
N = D/Q
Examples:
XXY COMPANY wholesales small appliances.
o XXY currently orders 600 units of the Toshiba brand food processor each
time inventory drops to 205 units.
o Management wishes to determine an optimal ordering policy for the product.

o Available Data
 Co = $12 [($8 for placing an order) + (20 min. to check)($12 per hr) ]
 Ch = $1.40 [HC = (14%)($10)]
− C = $10.
− H = 14% (10% ann. interest rate) + (4% miscellaneous)
 D = demand information of the last 10 weeks was collected:
− The constant demand rate seems to be a good assumption.
− Annual demand = (120/week) x (52weeks) = 6240 food
processor.
o Calculate the EOQ and Total Variable Cost.
 o Solution:
 EOQ and Total Variable Cost:
− Current ordering policy calls for Q = 600 food processor.
− TV ( 600) = (600/ 2)($1.40) + (6240 / 600)($12) = $544.80
− The EOQ policy calls for orders of size
Q* = 327.065 = 327 TV(327) = (327 / 2)($1.40) + (6240 / 327) ( $12) =
$457.89
 Under the current ordering policy XXY holds 13 units safety stock. XXY
is open 5 day a week. – The average daily demand = 120/week)/5 = 24
food processors. – Lead time is 8 days. Lead time demand is (8)(24) =
192 food processors. – Reorder point without Safety stock = LD = 192. –
Current policy: R = 205. – Safety stock = 205 – 192 = 13.
 For safety stock of 13 food processor the total cost is
 TC(327) = $457.89 + 6240($10) + (13)($1.40) = $62,876.09

o Sensitivity of the EOQ Results:

 Changing the order size
− Suppose juicers must be ordered in increments of 100 (order
300 or 400)
− AAC will order Q = 300 juicers in each order.
− There will be a total variable cost increase of $1.71.
− This is less than 0.5% increase in variable costs.
 Changes in input parameters
− Suppose there is a 20% increase in demand. D=7500 juicers.
− The new optimal order quantity is Q* = 359.
− The new variable total cost = TV(359) = $502
− If AAC still orders Q = 327, its total variable costs becomes
$504
Cycle Time
o For an order size of 327 juicers we have: T = (327/ 6240) = 0.0524 year. =
0.0524(52)(5) = 14 days.
o This is useful information because: – Shelf life may be a problem. –
Coordinating orders with other items might be desirable.

2.2 Determining the Reorder Point (ROP)

o The following scenarios will be modeled:
 Continuous Review :
− Constant Demand and constant Lead Time
− Variable Demand and constant Lead Time
  Fixed Period Review

Continuous Review – Constant Demand and constant Lead Time

o In reality lead time (LT) always exists, and must be accounted for when
deciding at which point in time to place an order
o The reorder point, ROP, is the inventory position when placing an order
o The formula to calculate the Reorder point when there is a Constant daily
demand (D) and lead-time (LT) is: ROP = LT x D
o Note: LT and D must be expressed in the same time unit (e.g. per month)
o The formula to calculate the Reorder point when there is a Variable daily
demand with mean đ and standard deviation sd and lead-time (LT) is:

đ = Mean of daily usage = variance in demand

z= represents the service level.
o It is assumed that the variability in Lead Time follows a Normal
Distribution.
o The second term on the right represents the Safety Stock. Safety Stock acts
as a buffer to handle higher than average lead time demand and longer than
expected lead times.
Fixed Period Review
o Definition of Order up-to-level point (Imax) Imax = Expected demand
during (OI + LT) + safety stock

o The Order Quantity is simply the difference between Imax and the quantity
on hand during the review
i.e. Order Quantity = Imax – Quantity on Hand
o Example:
1. Continuous Review (Constant Demand, Constant Lead Time)
Reorder Point R = D x LT
2. Continuous Review (Variable Demand, Constant Lead Time)
Reorder Point

3. Periodic Review (Order up to level or Imax)

 Imax is defined as expected demand during order interval (OI) , lead time
(LT) and safety stock
i.e.

 Order Quantity = Imax – Quantity on Hand

1) Continuous Review (Constant Demand, Constant Lead Time)

o A Carpet manufacturer has the following: Daily usage D = 30 yards/day
Lead Time LT = 10 days
o Reorder Point R = D x LT
o = 30 x 10 = 300 yards
2) Continuous Review (Variable Demand, Constant Lead Time)
o Additionally, the following is known:
o Mean of daily usage đ = 30 yards/day
o Variance in demand = 5 yards/day Service Level of reordering,
o z = 95% (corresponding to normal variate of 1.65)
o Reorder Point

o = 30 x 10 + 1.65 x 5 x Ö10 = 326.1 yards

3) Periodic Review (Order up to level or Imax)
o Using the following information:
 Lead Time LT = 10 days Mean of daily usage đ = 30 yards/day
 Variance in demand = 5 yards/day
 Service Level of reordering, z = 95%
 Fixed time between orders OI = 60 days
o First compute Imax (defined as expected demand during order interval (OI) ,
lead time (LT) and safety stock)

i.e. Imax = đ x (OI + LT) + z x x

o = 30 x (60 + 10) + 1.65 x 5 x √(60+10) = 2169 yards
o Based on that value of Imax, and at the point of placing the order, the
quantity to be ordered will be the difference of Imax and the quantity on
hand i.e. If Quantity on hand = 450 units,
o Order Quantity = Imax – Quantity on Hand
o = 2169 – 450 = 1719 yards
2.3 Newsboy Model
o The Newsboy Model copiers a person who buys newspapers. at the
beginning of the day, sells a random amount and junks any leftovers.
o 2 main issues are:
 Single Refill
 The need to determine the appropriate order quantity in the face of
uncertain demand
o Insights to the Newsboy Model
 In an environment of uncertain demand, the appropriate production/order
quantity depends on both the distribution of demand and the relative
costs of overproducing versus under producing.
 In general, increasing the variability (i.e. standard deviation) of demand
will increase the production/order quantity and will therefore increase the
likelihood that the actual demand is far from what is produced/ordered.
 This implies that mean and variance of total cost will increase with
variability of demand.

Consider the following:

o A manufacturer of Christmas lights faces a problem each year.
o Demand is somewhat unpredictable and occurs in such a short burst just
prior to Christmas that if the inventory is not on the shelves, the demand will
be lost.
o Therefore the decision of how many sets of lights to produce must be made
prior to the holiday season. Additionally, the cost of collecting unsold
inventory and holding it until next year is too high to make year-to-year
storage an attractive option. Instead, any unsold sets of lights are sold after
Christmas at a steep discount.
o Suppose that a set of lights costs $1 to make and distribute and is selling for
$2. Any sets not sold by Christmas will be discounted to $0.50. Suppose
 further that demand has been forecast to be 10,000 units with a standard
deviation of 1,000 units and that the normal distribution is a reasonable
representation of demand.
o How many sets should the manufacturer produce?

Preliminary Analysis:
o A set of lights costs $1 to make and distribute and is selling for $2. Any sets
not sold by Christmas will be discounted to $0.50.
o In terms of the above modeling notation, this means that the unit overage
cost is the amount lost per excess set or Co = $(1 - 0.50) = $0.50. The unit
shortage cost is the lost profit from a sale or Cs = $(2 - 1) = $1.00
o The firm could choose to produce 10,000 sets of lights. But, the symmetry
(i.e., bell shape) of the normal distribution implies that it is equally likely for
demand to be above or below 10,000 units.
o If demand is below 10,000 units, the firm will lose Co = $0.5 per unit of
overproduction.
o If demand is above 10,000 units, the firm will lose Cs = $1 per unit of
underproduction.
o Clearly, shortages are worse than overages.
o This suggests that perhaps the firm should produce more than 10,000 units.
But, how much more?
o Original Selling Price, OP = $2.00 Cost of Production, C = $1.00
Discounted Selling Price, DP = $0.50
o Assuming the firm could choose to produce 10,000 sets of lights,
o The unit overage cost is the amount lost per excess set or Co = $(1.00 - 0.50)
= $0.50 This means that if demand is below 10,000 units, the firm will lose
$0.5 per unit of overproduction
o The unit shortage cost is the lost profit from a sale or Cs = $(2.00 – 1.00) =
$1.00 This implies that if demand is above 10,000 units, the firm will lose
$1.00 per unit of underproduction. Clearly, shortages are worse than
overages
o Solving for the Probability function, we have:
 o As its demand is normally distributed,

o Where Φ represents the cumulative distribution function of the standard

normal distribution. From a standard normal table, we find that Φ(0.44) =
0.67. Hence, we have:

o Note: The Newsboy analysis is only applicable when the goods are time-
perishable i.e. OP > C > DP
o In which of the following situations, can the Newsboy Model be used?
 Scenario 1: Croissants are sold at $1.60 each. Cost of production is
$1.20 each Unsold unit are discounted to $0.80 each
 Scenario 2: Newspapers are sold at $0.80 each. Cost of production is
$0.40 each Unsold unit are discarded i.e. $0 value
 Scenario 3: Cookies are sold at $2.80 per packet. Cost of production is
$1.20 Unsold units are discounted to $2.20

2.4 Pipeline Inventory

o The formula below describes the formula to calculate the average demand
during the lead time.
ĎL = đ x LT
Where ĎL is the average demand during the lead time
o Example:
đ = 20 units per week , LT = 3 weeks
ĎL = 20 x 3 = 60 units in the pipeline