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M&DC Purchasing & Supply Chain: Material Management

 

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Physical Distribution

 

Contents

  • Chapter 1 introduced the supply chain concept. It was pointed out that a supply chain is composed of a series of suppliers and customers linked together by a physical distribution system. Usually the supply chain consists of several companies linked in this way. This chapter will discuss the physical distribution aspect of supply chains.

  • Physical distribution is the movement of materials from the producer to the consumer. It is the responsibility of the distribution department, which is part of an integrated materials management or logistics system. Figure 13.1 shows the relationship of the various functions in this type of system.

  • In Figure 13.1, the movement of materials is divided into two functions: physical Supply and physical distribution. Physical supply is the movement and storage of goods from suppliers to manufacturing. Depending on the conditions of sale, the cost may be paid by either the supplier or the customer, but it is ultimately passed on to the customer. Physical distribution, on the other hand, is the movement and storage of finished goods from the end of production to the customer. The particular path iii which the goods move—through distribution centers, wholesalers, and retailers—is called the channel of distribution.

Figure 13.1 Supply chain (logistics system).

Channels of Distribution

  • A channel of distribution is one or more companies or individuals who participate in the flow of goods and/or services from the producer to the final user or consumer. Sometimes a company delivers directly to its customers, but often it uses other companies or individuals to distribute some or all of its products to the final consumer. These companies or individuals are called intermediaries. Examples of intermediaries are wholesalers, agents, transportation companies, and warehouses.

  • There are really two related channels involved. The transaction channel is concerned with the transfer of ownership. Its function is to negotiate, sell, and contract. The distribution channel is concerned with the transfer or delivery of the goods or services. The same intermediary may perform both functions, but not necessarily.

  • Figure 13.2 shows an example of the separation of distribution and transaction channels. The example might be for a company distributing a major appliance such as a refrigerator or stove. In such a system the retailer usually carries only display models. When the customer orders an appliance, delivery is made from either the regional warehouse or the public warehouse.

  • In this text we are concerned with the distribution channel.

  • Although it can be argued that one firm’s physical supply is another firm’s physical distribution, frequently there are important differences, particularly as they relate to the bulk and physical condition of raw materials and finished goods. The logistics problems that occur in moving and storing iron ore are quite different from those that occur in moving sheet steel. These differences influence the design of a logistics system and are important in deciding the location of distribution centers and factories. This text refers to both physical distribution and physical supply as physical distribution, but the differences for any particular company should be remembered.

Figure 13.2 Separation of distribution and transaction channels.

  • Physical distribution is vital in our lives. Usually, manufacturers, customers, and potential customers are widely dispersed geographically. If manufacturers serve only their local market, they restrict their potential for growth and profit. By extending its market, a firm can gain economies of scale in manufacturing, reduce the cost of purchases by volume discounts, and improve its profitability. However, to extend markets requires a well-run distribution system. Manufacturing adds form value to a product by taking the raw materials and creating something more useful. Bread is made from grain and is far more useful to humans than the grain itself. Distribution adds place value and time value by placing goods in markets where they are available to the consumer at the time the consumer wants them.

    The specific way in which materials move depends upon many factors. For example:

    • The channels of distribution that the firm is using. For example, producer tc wholesaler to retailer to consumer.

    • The types of markets served. Market characteristics such as the geographic dispersion of the market, the number of customers, and the size of orders.

    • The characteristics of the product. For example, weight, density, fragility, and perishability.

    • The type of transportation available to move the material. For example, trains ships, planes, and trucks.

  • All are closely related. For instance, florists selling a perishable product to a local market will sell directly and probably use their own trucks. However, a national canning company selling a nonperishable product to a national market through a distribution channel composed of wholesalers and retailers may use trucks and rail transport.

 

  • Physical distribution is responsible for delivering to the customer what is wanted on time and at minimum cost. The objective of distribution management is to design and operate a distribution system that attains the required level of customer service and does so at least cost. To reach this objective, all activities involved in the movement and storage of goods must be organized into an integrated system.

Activities in the Physical Distribution System

  • A system is a set of components or activities that interact with each other. A car engine is a system; if any part malfunctions, the performance of the whole engine suffers. In a distribution system, six interrelated activities affect customer service and the cost of providing it:

    1. Transportation. Transportation involves the various methods of moving goods
      outside the firm’s buildings. For most firms, transportation is the single highest cost in distribution, usually accounting for 30% to 60% of distribution costs. Transportation adds place value to the product.

    2. Distribution inventory. Distribution inventory includes all finished goods inventory at any point in the distribution system. In cost terms, it is the second most important item in distribution, accounting for about 25% to 30% of the cost of distribution. Inventories create time value by placing the product close to the customer.

    3. Warehouses (distribution centers). Warehouses are used to store inventory. The management of warehouses makes decisions on site selection, number of distribution centers in the system, layout, and methods of receiving, storing, and retrieving goods.

    4. Materials handling. Materials handling is the movement and storage of goods inside the distribution center. The type of materials handling equipment used affects the efficiency and cost of operating the distribution center. Materials handling represents a capital cost, and a tradeoff exists between this capital cost and the operating costs of the distribution center.

    5. Protective packaging. Goods moving in a distribution system must be contained, protected, and identified. In addition, goods are moved and stored in packages and must fit into the dimension of the storage spaces and the transportation vehicles.

    6. Order processing and communication. Order processing includes all activities needed to fill customer orders. Order processing represents a time element in delivery and is an important part of customer service. Many intermediaries are involved in the movement of goods, and good communication is essential to a successful distribution system.

Total-Cost Concept

  • The objective of distribution management is to provide the required level of customer service at the least total system cost. This does not mean that transportation costs or inventory costs or any one activity cost should be a minimum, but that the total of all costs should be a minimum. What happens to one activity has an effect on other activities, total system cost, and the service level. Management must treat the system as a whole and understand the relationships among the activities.

Example Problem

  • A company normally ships a product by rail. Transport by rail costs $200, and the transit time is 10 days. However, the goods can be moved by air at a cost of $1000 and will take one day to deliver. The cost of inventory in transit for a particular shipment is $100 per day. What are the costs involved in their decision?

Answer

                                                                                               Rail              Air

                                                          Transportation Cost        $ 200        $1000

                                       In-Transit Inventory-Carrying Cost         1000            100

                                                                                Total       $1200         $1100

 

  • There are two related principles illustrated here:

    1. Cost tradeoff. The cost of transportation increased with the use of air transport, but the cost of carrying inventory decreased. There was a cost tradeoff between the two.

    2. Total cost. By considering all of the costs and not just any one cost, the total system cost is reduced. Note also that even though no cost is attributed to it, customer service is improved by reducing the transit time. The total cost should also reflect the effect of the decision on other departments, such as production and marketing.

  • The preceding example does not mean that using faster transport always result~ in savings. For example, if the goods being moved are of low value and inventory

  • By taking the goods produced by manufacturing and delivering them to the customer, physical distribution provides a bridge between marketing and production. As such, there are several important interfaces among physical distribution and production and marketing.

Marketing

  • Although physical distribution interacts with all departments in a business, its closest relationship is probably with marketing. Indeed, physical distribution is often thought of as a marketing subject, not as part of materials management or logistics.

  • The “marketing mix” is made up of product, promotion, price, and place, and the latter is created by physical distribution. Marketing is responsible for transferring ownership. This is accomplished by such methods as personal selling, advertising, sales promotion, merchandising, and pricing. Physical distribution is responsible for giving the customer possession of the goods and does so by operating distribution centers, transportation systems, inventories, and order processing systems. It has the responsibility of meeting the customer service levels established by marketing and the senior management of the firm.

  • Physical distribution contributes to creating demand. Prompt delivery, product availability, and accurate order filling are important competitive tools in promoting a firm’s products. The distribution system is a cost, so its efficiency and effectiveness influence the company’s ability to price competitively. All of these affect company profits.

Production

  • Physical supply establishes the flow of material into the production process. The service level must usually be very high because the cost of interrupted production schedules caused by raw material shortage is usually enormous.

  • There are many factors involved in selecting a site for a factory, but an important one is the cost and availability of transportation for raw materials to the factory and the movement of finished goods to the marketplace. Sometimes, the location of factories is decided largely by the sources and transportation links of raw materials.

  • This is particularly true where the raw materials are bulky and of relatively low value compared to the finished product. The location of steel mills on the Great Lakes is a good example. The basic raw material, iron ore, is bulky, heavy, and of low unit value. Transportation costs must be kept low to make a steel mill profitable. Iron ore from mines in either northern Quebec or Minnesota is transported to the mills by boat, the least costly mode of transportation. In other cases, the availability of low-cost transportation makes it possible to locate in areas remote from markets, but where labor is inexpensive.

  • Unless a firm is delivering finished goods directly to a customer, demand on the factory is created by the distribution center orders and not directly by the final customer. As noted in Chapter 11, this can have severe implications on the demand pattern at the factory. Although the demand from customers may be relatively uniform, the factory reacts to the demand from the distribution centers for replenishment stock. If the distribution centers are using an order point system, the demand on the factory will not be uniform and will be dependent rather than independent. The distribution system is the factory’s customer, and the way that the distribution system interfaces with the factory will influence the efficiency of factory operations.

 

  • Transportation is an essential ingredient in the economic development of any area. It brings together raw materials for production of marketable commodities and distributes the products of industry to the marketplace. As such, it is a major contributor to the economic and social fabric of a society and aids economic development of regional areas.

    1. Rail.

    2. Road, including trucks, buses, and automobiles.

    3. Air.

    4. Water, including ocean-going, inland, and coastal ships.

    5. Pipeline.

    Each mode has different cost and service characteristics. These determine which method is appropriate for the types of goods to be moved. Certain types of traffic are simply more logically moved within one mode than they are in another. For example trucks are best suited to moving small quantities to widely dispersed markets, bu trains are best suited to moving large quantities of bulky cargo such as grain.

Costs of Carriage

  • To provide transportation service, any carrier, whatever mode, must have certain basic physical elements. These elements are ways, terminals, and vehicles. Each results in a cost to the carrier and, depending on the mode and the carrier, may be either capital
    (fixed) or operating (variable) costs. Fixed costs are costs that do not change with the volume of goods carried. The purchase cost of a truck owned by the carrier is a fixed cost. No matter how much it is used, the cost of the vehicle does not change. However,
    many costs of operation, such as fuel, maintenance, and driver’s wages, depend on the use made of the truck. These are variable costs.

  • Ways are the paths over which the carrier operates. They include the right of way (land area being used), plus any roadbed, tracks, or other physical facilities needed on the right of way. The nature of the way and how it is paid for vary with the mode. They may be owned and operated by the government or by the carrier or provided by nature.

  • Terminals are places where carriers load and unload goods to and from vehicles and make connections between local pickup and delivery service and line-haul service. Other functions performed at terminals are weighing; connections with other routes and carriers; vehicle routing, dispatching, and maintenance; and administration and paperwork. The nature, size, and complexity of the terminal varies with the mode and size of the firm and the types of goods carried. Terminals are generally owned and operated by the carrier but, in some special circumstances, may be publicly owned and operated.

  • Vehicles of various types are used in all modes except pipelines. They serve as carrying and power units to move the goods over the ways. The carrier usually owns or leases the vehicles, although sometimes the shipper owns or leases them.
    Besides ways, terminals, and vehicles, a carrier will have other costs such as maintenance, labor, fuel, and administration. These are generally part of operating costs and may be fixed or variable.

Rail

  • Railways provide their own ways, terminals, and vehicles, all of which represent a large capital investment. This means that most of the total cost of operating a railway is fixed. Thus, railways must have a high volume of traffic to absorb the fixed costs. They will not want to install and operate rail lines unless there is a large enough volume of traffic. Trains move goods by train loads composed of perhaps a hundred cars each with a carrying capacity in the order of 160,000 pounds.

  • Therefore, railways are best able to move large volumes of bulky goods over long distances. Their frequency of departure will be less than trucks, which can move when one truck is loaded. Rail speed is good over long distances, the service is generally reliable, and trains are flexible about the goods they can carry. Train service is cheaper than road for large quantities of bulky commodities such as coal, grain, potash, and containers moved over long distances.

Road

  • Trucks do not provide their own ways (roads and highways) but pay a fee to the government as license, gasoline, and other taxes and tolls for the use of roads. Terminal are usually owned and operated by the carrier but may be either privately owned or owned by the government. Vehicles are owned, or leased, and operated by the carrier. If owned, they are a major capital expense. However, in comparison to other modes, the cost of a vehicle is small. This means that for road carriers most of their costs are operating (variable) in nature.

  • Trucks can provide door-to-door service as long as there is a suitable surface on which to drive. In the United States and Canada, the road network is superb. The unit of movement is a truckload, which can be up to about 100,000 pounds. These two factors—the excellent road system and the relatively small unit of movement—mean that trucks can provide fast flexible service almost anywhere in North America. Trucks are particularly suited to distribution of relatively small-volume goods to a dispersed market.

Air

  • Air transport does not have ways in the sense of fixed physical roadbeds, but it does require an airway system that includes air traffic control and navigation systems. These systems are usually provided by the government. Carriers pay a user charge that is a variable cost to them. Terminals include all of the airport facilities, most of which are provided by the government. However, carriers are usually responsible for providing their own cargo terminals and maintenance facilities, either by owning or renting the space. The carrier provides the aircraft either through ownership or leasing. The aircraft are expensive and are the single most important cost element for the airline. Since operating costs are high, airlines’ costs are mainly variable.

  • The main advantage of air transport is speed of service, especially over long distances. Most cargo travels in passenger aircraft, and thus many delivery schedules are tied to those of passenger service. The service is flexible about destination provided there is a suitable landing strip. Transportation cost for air cargo is higher than for other modes. For these reasons, air transport is most often suitable for high-value, low-weight cargo or for emergency items.

Water

  • Waterways are provided by nature or by nature with the assistance of the government. The St. Lawrence Seaway system is an example of this. The carrier thus has no capital cost in providing the ways but may have to pay a fee for using the waterway.

  • Terminals may be provided by the government but are increasingly privately owned. In either case, the carrier will pay a fee to use them. Thus, terminals are mainly a variable cost. Vehicles (ships) are either owned or leased by the carrier and represent the major capital or fixed cost to the carrier.

  • The main advantage of water transport is cost. Operating costs are low, and since the ships have a relatively large capacity, the fixed costs can be absorbed over large volumes. Ships are slow and are door to door only if the shipper and the consignee are on a waterway. Therefore, water transportation is most useful for moving low-value, bulky cargo over relatively long distances where waterways are available.

Pipelines

  • Pipelines are unique among the modes of transportation in that they move only gas, oil, and refined products on a widespread basis. As such, they are of little interest to most users of transportation. Capital costs for ways and pipelines are high and are borne by the carrier, but operating costs are very low.

 

  • Carriers are legally classified as public (for hire) or private (not for hire). In the latter, individuals or firms own or lease their vehicles and use them to move their own goods. Public transport, on the other hand, is in the business of hauling for others for pay. All modes of transport have public and for-hire carriers.

  • For-hire carriers are subject to economic regulation by federal, state, or municipal governments. Depending on the jurisdiction, economic regulation may be more or less severe, and in recent years, there has been a strong move by government to reduce regulations. Economic regulation has centered on three areas:

    1. Regulation of rates.

    2. Control of routes and service levels.

    3. Control of market entry and exit.

    Private carriers are not subject to economic regulation but, like public carriers, are regulated in such matters as public safety, license fees, and taxes.

For Hire

  • A for-hire carrier may carry goods for the public as a common carrier or under contract to a specified shipper.

  • Common carriers make a standing offer to serve the public This means that whatever products they offer to carry will be carried for anyone wanting their service. With some minor exceptions, they can carry only those commodities they are licensed to carry. For instance, a household mover cannot carry gravel or fresh vegetables. Common carriers provide the following:

    • Service available to the public.

    • Service to designated points or in designated areas.

    • Scheduled service.

    • Service of a given class of movement or commodity.

  • Contract carriers haul only for those with whom they have a specific formal contract of service, not the general public. Contract carriers offer a service according to a contractual agreement signed with a specific shipper. The contract specifies the character of the service, performance, and charges.

Private

  • Private carriers own or lease their equipment and operate it themselves. This means investment in equipment, insurance, and maintenance expense. A company normally only considers operating its own fleet if the volume of transport is high enough to justify the capital expense.

Service Capability

  • Service capability depends on the availability of transportation service, which in turn depends on the control that the shipper has over the transportation agency. The shipper must go to the marketplace to hire a common carrier and is subject to the schedules and regulations of that carrier. Least control is exercised over common carriers. Shippers can exercise most control over their own vehicles and have the highest service capability with private carriage.

Other Transportation Agencies

  • There are several transportation agencies that use the various modes or combinations of the modes. Some of these are the post office, freight forwarders, couriers, and shippers. They all provide a transportation service, usually as a common carrier. They may own the vehicles, or they may contract with carriers to move their goods. Usually, they consolidate small shipments into large shipments to make economic loads.

 

  • There are four basic cost elements in transportation. Knowledge of these costs enables a shipper to get a better price by selecting the right shipping mode. The four basic costs are as follows:

    1. Line haul.

    2. Pickup and delivery.

    3. Terminal handling.

    4. Billing and collecting.

  • We will use motor transport as an example, but the principles are the same for all modes.
    Goods move either directly from the shipper to the consignee or through a terminal. In the latter, they are picked up in some vehicle suitable for short-haul local travel. They are then delivered to a terminal where they are sorted according to destination and loaded onto highway vehicles for travel to a destination terminal. There, they are again sorted, loaded on local delivery trucks, and taken to the consignee. Figure 13.3 shows this pattern schematically.

Figure 13.3 Shipping patterns.

Line-Haul Costs

  • When goods are shipped, they are sent in a moving container that has a weight and volume capacity. The carrier, private or for hire, has basic costs to move this container, which exist whether the container is full or not. For a truck, these include such items as gasoline, the driver’s wages, and depreciation due to usage. These costs vary with the distance traveled, not the weight carried. The carrier has essentially the same basic costs whether the truck moves full or empty. If it is half full, the basic costs must be spread over only those goods in the truck.

  • Therefore, total line-haul costs vary directly with the distance shipped, not on the weight shipped. For example, if for a given commodity, the line-haul cost is $3 per mile and the distance is 100 miles, the total line-haul cost is $300. If the shipper sends 50,000 pounds, the total line-haul cost is the same as if 10,000 pounds is sent. However, the line-haul costs (LHC) per hundred weight (cwt.) is different.

                    300

LHC/cwt =        .

                     500

      = $0.60 per cwt. [for 50,000 lb. (500 cwt.)

                    300

LHC/cwt =        .

                     500

      = $3 per cwt. [for 10,000 lb. (100 cwt.)

  • Thus, the total line-haul cost varies with (a) the cost per mile and (b) the distance moved. However, the line-haul cost per hundred weight varies with (a) the cost per mile, (b) the distance moved, and (c) the weight moved.

Example Problem

  • For a particular commodity, the line-haul cost is $2.50 per mile. For a trip of 500 miles and a shipment of 600 cwt., what is the cost of shipping per cwt.? If the shipment is increased to 1000 cwt., what is the saving in cost per cwt.?

Answer

Total line-haul cost = $2.5 X 500 = $1250

Cost per cwt. = $1250 ÷ 600 = $2.083

If 1000 cwt. is shipped:

Cost per cwt. = $1250 ± 1000 = $1.25

Saving per cwt. = $2.08 — $1.25 = $0.83

  • The carrier has two limitations or capacity restrictions on how much can be moved on any one trip: the weight limitation and the cubic volume limitation of the vehicle. With some commodities, their density is such that the volume limitation is reached before the weight limitation. If the shipper wants to ship more, a method of increasing the density of the goods must be found. This is one reason that some lightweight products are made so they nest (for example, disposable cups) and bicycles and wheelbarrows are shipped in an unassembled state. This is not to frustrate us poor mortals who try to assemble them but to increase the density of the product so more weight can be shipped in a given vehicle. The same principle applies to goods stored in distribution centers. The more compact they are, the more can be stored in a given space. Therefore, if shippers want to reduce transportation cost, they should (a) increase the weight shipped and (b) maximize density.

Example Problem

  • A company ships barbecues fully assembled. The average line-haul cost per shipment is $12.50 per mile, and the truck carries 100 assembled barbecues. The company de cides to ship the barbecues unassembled and figures they can ship 500 barbecues in truck. Calculate the line-haul cost per barbecue assembled and unassembled. If the average trip is 300 miles, calculate the saving per barbecue.

Answer

Line-haul cost assembled = $12.50 ± 100 = $0.125 per barbecue per mile

Line-haul cost unassembled = $12.50 ± 500 = $0.025 per barbecue per mile

Saving per mile = $0.125 0.025 = $0.10

Trip saving = 300 x $0.10 = $30.00 per barbecue

Pickup and Delivery Costs

  • Pickup and delivery costs are similar to line-haul costs except that the cost depends more on the time spent than on the distance traveled. The carrier will charge for each pickup and the weight picked up. If a shipper is making several shipments, it will be less expensive if they are consolidated and picked up on one trip.

Terminal Handling

  • Terminal-handling costs depend on the number of times a shipment must be loaded, handled, and unloaded. If full truckloads are shipped, the goods do not need to be handled in the terminal but can go directly to the consignee. If part loads are shipped, they must be taken to the terminal, unloaded, sorted, and loaded onto a highway vehicle. At the destination, the goods must be unloaded, sorted, and loaded onto a local delivery vehicle.

  • Each individual parcel must be handled. A shipper who has many customers, each ordering small quantities, will expect the terminal-handling costs to be high because there will be a handling charge for each package.

  • The basic rule for reducing terminal-handling costs is to reduce handling effort by consolidating shipments into fewer parcels.

Billing and Collecting

  • Every time a shipment is made, paperwork must be done and an invoice made out. Billing and collecting costs can be reduced by consolidating shipments and reducing the pickup frequency.

Total Transportation Costs

  • The total cost of transportation consists of line-haul, pickup and delivery, terminal-handling, and billing and collecting costs. To reduce shipping costs, the shipper needs to do the following:

    • Decrease line-haul costs by increasing the weight shipped.

    • Decrease pickup and delivery cost by reducing the number of pickups. This car be done by consolidating and increasing the weight per pickup.

    • Decrease terminal-handling costs by decreasing the number of parcels by consolidating shipments.

    • Decrease billing and collecting costs by consolidating shipments.

  • For any given shipment, the line-haul costs vary with the distance shipped However, the pickup and delivery, terminal-handling, and billing costs are fixed. The total cost for any given shipment thus has a fixed cost and a variable cost associated with it. This relationship is shown in Figure 13.4. The carrier will consider this relationship and either charge a fixed cost plus so much per mile or offer a tapered rate. In the latter, the cost per mile for short distances far exceeds that for longer distances.

Figure 13.4 Distance versus cost of carriage.

  • The rate charged by a carrier will also vary with the commodity shipped and will depend upon the following:

    • Value. A carrier’s liability for damage will be greater the more valuable the item.

    • Density The more dense the item, the greater the weight that can be carried in a given vehicle.

    • Perishability. Perishable goods often require special equipment and methods of handling.

    • Packaging. The method of packaging influences the risk of damage and breakage.

  • In addition, carriers have two rate structures, one based on full loads called truckload (TL) or carload (CL) and one based on less than truckload (LTL) and less than carload (LCL). For any given commodity, the LTL rates can be up to 100% higher than the TL rates. The basic reason for this differential lies in the extra pickup and delivery, terminal-handling and billing, and collection costs. Truckers, airlines, and water carriers accept less than full loads, but usually the railways do not accept LCL shipments.

 

  • The last chapter discussed the management of warehouses. This section is concerned with the role of warehouses in a physical distribution system.

  • Warehouses include plant warehouses, regional warehouses, and local ware houses. They may be owned and operated by the supplier or intermediaries such as wholesalers, or may be public warehouses. The latter offer a general service to their public that includes providing storage space and warehouse services. Some warehouse specialize in the kinds of services they offer and the goods they store. A freezer storage is an example. The service functions warehouses perform can be classified into two kinds:

    1. 1. The general warehouse where goods are stored for long periods and where the prime purpose is to protect goods until they are needed. There is minimal handling, movement, and relationship to transportation. Furniture storage or a depository for documents are examples of this type of storage. It is also the type used for inventories accumulated in anticipation of seasonal sales.

    2. The distribution warehouse has a dynamic purpose of movement and mixing. Goods are received in large-volume uniform lots, stored briefly, and then broken down into small individual orders of different items required by the customer in the marketplace. The emphasis is on movement and handling rather than on storage. This type of warehouse is widely used in distribution systems. The size of the warehouse is not so much its physical size as it is the throughput, or volume of traffic handled.

  • As discussed in the last chapter, warehouses, or distribution centers, are places where raw materials, semi-finished, or finished goods are stored. They represent an interruption in the flow of material and thus add cost to the system. Items should be warehoused only if there is an offsetting benefit gained from storing them.

Role of Warehouses

  • Warehouses serve three important roles: transportation consolidation, product mixing, and service.

Transportation consolidation

  • As shown in the last section, transportation costs can be reduced by using warehouses. This is accomplished by consolidating small (LTL) shipments into large (TL) shipments.

  • Consolidation can occur in both the supply and distribution systems. In physical supply, LTL shipments from several suppliers can be consolidated at a warehouse before being shipped TL to the factory. In physical distribution, TL shipments can be made to a distant warehouse and LTL shipments made to local users. Figure 13.5 shows the two situations graphically. Transportation consolidation in physical distribution is sometimes called break-bulk, which means the bulk (TL) shipments from factories to distribution centers are broken down into small shipments going to local markets.

Product mixing

  • While transportation consolidation is concerned with reduction of transportation costs, product mixing deals with the grouping of different items into an order and the economies that warehouses can provide in doing this. When customers place orders, they often want a mix of products that are produced in different locations.

  • Without a distribution center, customers would have to order from each source and pay for LTL transport from each source. Using a distribution center, orders can be placed and delivered from a central location. Figure 13.6 illustrates the concept.

Figure 13.5 Transportation consolidation.

Figure 13.6 Product mixing.

Service

  • Distribution centers improve customer service by providing place utility. Goods are positioned close to markets so the markets can be served more quickly.

Warehousing and Transportation Costs

  • Any distribution system should try to provide the highest service level (the number of orders delivered in a specified time) at the lowest possible cost. The particular shipping pattern will depend largely upon the following:

    • Number of customers.

    • Geographic distribution of the customers.

    • Customer order size.

    • Number and location of plants and distribution centers.

  • Suppliers have little or no control over the first three but do have some control over the last. They can establish local distribution centers in their markets. With respect to transportation, it then becomes a question of the cost of serving customers direct from the central distribution center or from the regional distribution center. If truckload shipments are made, the cost is less from the central distribution center, but if LTL shipments are made, it may be cheaper to serve the customer from the local distribution center.

Example Problem

  • Suppose a company with a plant located in Toronto is serving a market in the northeastern United States with many customers located in Boston. If they ship direct to customers from the Toronto plant, most shipments will be less than truckload. However, if they locate a distribution center in Boston, they can ship truckload (TL) to Boston and distribute by local cartage (LTL) to customers in that area. Whether this is economical or not depends on the total cost of shipping direct compared with shipping via the distribution center. Assume the following figures represent the av¬erage shipments to the Boston area:

    Plant to customer LTL: $100/cwt.

    Plant to distribution center TL: $50/cwt.

    Inventory-carrying cost (distribution center): $1 O/cwt.

    Distribution center to customer LTL: $20/cwt.

  • Is it more economical to establish the distribution center in Boston? If the annual shipped volume is 10,000 cwt., what will be the annual saving?

Answer

Costs if a distribution center is used:

TL Toronto to Boston = $50 per cwt.

Distribution center costs = $10 per cwt.

LTL in Boston area = $20 per cwt.

             Total cost = $80 per cwt.

Saving per cwt. = $100 — $80 = $20

Annual saving = $20 x 10,000 = $200,000

Market Boundaries

  • supply customers in other locations directly from the factory in Toronto or through the distribution center in Boston. The question is to decide which locations should be supplied from each source. The answer, of course, is the source that can service the location at least cost.

  • Laid-down cost (LDC) is the delivered cost of a product to a particular geographic point. The delivered cost includes all costs of moving the goods from A to B. In the previous example problem, the laid-down cost of delivering from Toronto would be the transportation cost per mile x the miles to a particular destination. The LDC from Boston would include all costs of getting the goods to Boston, inventory costs in the Boston distribution center, and the transportation costs in getting to a particular destination.

LDC=P+ TX

Where

P = product costs

T = transportation costs per mile

X = distance

  • The product cost includes all costs in getting the product to the supply location and storing it there. Tn the previous example, the product cost at Boston includes the TL cost of delivery to Boston and the inventory cost at Boston.

Example Problem

  • Syracuse is 300 miles from Toronto. The product cost for an item is $10 per cwt., and the transportation cost per mile per cwt. is $0.20. What is the laid-down cost per cwt.?

Answer

LDC = Product cost + (transportation cost per mile) (distance)

       = $10 + ($0.20 X 300) = $70 per cwt.

 

Market boundary

  • The market boundary is the line between two or more supply sources where the laid-down cost is the same. Consider Figure 13.7. There are two sources of supply: A and B. The market boundary occurs at Y where the LDC from A is the same as B.

  • In the example shown in Figure 13.7, the distance between A and B is 100 miles. If we let the distance from A to Y be X miles, then the distance from B to Y is (100 — X) miles. Assume supply A is the factory and supply B is a distribution center. Assume the product cost at A is $100 and product cost from B is $100 plus TL transportation from A to B and inventory costs at B. For this example, assume the TL transportation and inventory carrying costs are $10 per unit so the product cost from B is $110. Transportation costs from either A or B are $0.40 per unit per mile.

    Point Y occurs where:

    LDCA = LDCB

    100 + 0.40X= 110 + 0.40(100 —X)

    X=62.5

  • Thus a point Y, 62.5 miles from A, marks the market boundary between A and B.

Example Problem

  • The distance between Toronto and Boston is about 500 miles. Given the cost structure in the previous example problems and an LTL transportation cost of $0.20 per cwt., calculate the location of the market boundary between Toronto and Boston. Assume the product cost at Toronto is $10 per cwt.

Answer

  • The product cost at Boston is the sum of the product cost at Toronto, plus the cost of TL shipment from Toronto to Boston, plus the handling costs at Boston.

  • Product cost at Boston = product cost at A + TL transportation + handling costs

                                  = $10 + $50 + $10

                                  = $ 70

The market boundary occurs where

                         LDCT = LDCB

              $10 + $0.20X = $70 + $0.20(500 — X)

                           0.4X = 160

                               X = 400

The market boundary is 400 miles from Toronto or 100 miles from Boston.

Effect on Transportation Costs of Adding More Warehouses

  • We have seen from the previous example that establishing a distribution center in Boston reduces total transportation costs. Similarly, if a second distribution center is established, perhaps in Cleveland, we expect total transportation costs to be reduced further.

  • Generally, as more distribution centers are added to the system, we can expect the following:

  • The cost of truckload (and carload) shipments to the distribution centers to increase.

  • The cost of LTL shipments to customers to decrease.

  • The total cost of transportation to decrease.

  • As expected, the major savings is from the addition of the first few distribution centers. Eventually, as more distribution centers are added, the savings decrease. The first distribution center added to the system is located to serve the largest market; the second distribution center, the second largest market, and so on. The number of customers served by additional distribution centers decreases, and the volume that can be shipped TL to the additional distribution centers is less than to the first distribution centers. Figure 13.8 shows the relationship that exists between transportation costs and the number of distribution centers in a system.

Figure 13.8 Transportation cost versus number of warehouses.

Packaging

  • The basic role of packaging in any industrial organization is to carry the goods safely through a distribution system to the customer. The package must do the following:

    • Identify the product.

    • Contain and protect the product.

    • Contribute to physical distribution efficiency.

  • For consumer products, the package may also be an important part of the marketing program.

  • Physical distribution must not only move and store products but also identify them. The package serves as a means of identifying the product in a way not possible from its outward appearance. When shoes are offered in ten sizes, the package becomes an important identifier.

  • Packaging must contain and protect the product, often against a wide range of hazards such as shock, compression, vibration, moisture, heat, solar radiation, oxidation, and infestation by animals, insects, birds, mold, or bacteria. Packages are subject to distribution hazards in loading and off-loading, in movement, in transportation, and in warehousing and storage. The package must be robust enough to protect and contain the product through all phases of distribution.

  • Packaging is a pure cost that must be offset by the increased physical distribution efficiency that the package can provide.

  • There are usually at least three levels of packaging required in a distribution system. First is a primary package that holds the product—the box of cornflakes. Next, for small packages, a shipping container such as a corrugated box is needed. Finally, there is a third level of packaging where several primary or secondary packages are assembled into a unit load.

Unitization

  • Unitization is the consolidation of several units into large units, called unit loads, so there is less handling. A unit load is a load made up of a number of items, or bulky material, arranged or constrained so the mass can be picked up or moved as a single unit too large for manual handling. Material handling costs decrease as the size of the unit load increases. It is more economical to move the product by cartons rather than individually and still more economical to move several cartons in one unit load.

  • This principle is used when we go shopping and put a number of articles into bags and then put the bags into the trunk of the car. In industry, unit loads are used instead of shopping bags.

  • There are a number of unit-load devices such as sheets, racks, or containers. One of the most common is the pallet.

  • The pallet is a platform usually measuring 48” x 40” x 4” and designed so that it can be lifted and moved by a forklift industrial truck. Packages are arranged on it so that several packages may be moved at one time. Loaded with packages, it forms a cube that is a unit load.

Figure 13.9 Stable and unstable pallet loads.

  • Unitization can be successive. Shippers place their products into primary packages, the packages into shipping cartons, the cartons onto pallets, and the pallets into warehouses, trucks, or other vehicles.

  • To use the capacity of pallets, trucks (or other vehicles), and warehouses, there should be some relationship between the dimensions of the product, the primary package, the shipping cartons, the pallet, the truck, and the warehouse space. The packages should be designed so space on the pallet is fully utilized and so the cartons interlock to form a stable load. Figure 13.9 shows two unit loads each using the total space of the pallet. However, load B does not interlock and is not stable.

  • Pallets fit into trucks and railway cars. The dimensions mentioned earlier were selected so pallets would fit into nominal 50’ railway cars and 40’ truck trailers with a minimum of lost space. Figure 13.10 shows the layout in railcars and trailers.

  • Thus to get the highest cube utilization, consideration must be given to the dimensions of the product, the carton, the pallet, the vehicle, and the warehouse.

 

  • Materials handling is the short-distance movement that takes place in or around a building such as a plant or distribution center. For a distribution center, this means the unloading and loading of transport vehicles and the dispatch and recall of goods to and from storage. In addition, the racking systems used in distribution centers are usually considered as part of materials handling.
    Some objectives of materials handling are as follows:

    1. To increase cube utilization by using the height of the building and by reducing the need for aisle space as much as possible.

    2. To improve operating efficiency by reducing handling. Increasing the load per move will result in fewer moves.

    3. To improve the service level by increasing the speed of response to customer needs.

Figure 13.10 Railcar and trailer pallet position plan.

  • There are many types of materials handling equipment. For convenience, the) can be grouped into three categories: conveyors, industrial trucks, and cranes and hoists.

  • Conveyors are devices that move material (or people) horizontally or vertically between two fixed points. They are expensive, create a fixed route, and occupy space continuously. As a result, they are used only where there is sufficient throughput between fixed points to justify their cost.

  • Industrial trucks are vehicles powered by hand, electricity, or propane. Diesel and gasoline are not used indoors because they are noxious and lethal. Industrial trucks are more flexible than conveyors in that they can move anywhere there is a suitable surface and no obstructions. They do not occupy space continuously. For these reasons, they are the most often-used form of materials handling in distribution centers and in manufacturing.

  • Cranes and hoists can move materials vertically and horizontally to any point within their area of operation. They use overhead space and are used to move heav3 or large items. Within their area of operation, they are very flexible.

  • This section will look at the result of adding more distribution centers to the system. As might be expected, there is an effect on the cost of warehousing, materials handling, inventories, packaging, and transportation. Our purpose will be to look at how all of these costs and the total system cost behave. We also want to know what happens to the service level as more distribution centers are added to the system. To make valid comparisons, we must freeze the sales volume. We can then compare costs as we add distribution centers to the system.

Transportation Costs

  • In the section on transportation, we saw that if shipments to customers are in less-than-full vehicle lots, the total transportation cost is reduced by establishing a distribution center in a market area. This is because more weight can be shipped for greater distances by truck or carload and the LTL shipments can be made over relatively short distances. Generally, then, as more distribution centers are added to a system, we expect the following:

    • The cost of TL shipments increases.

    • The cost of LTL shipments decreases.

    • The total cost of transportation decreases.

  • The major savings are made with the addition of the first distribution centers. Eventually, as more distribution centers are added, the marginal savings decrease.

Inventory-Carrying Cost

  • The average inventory carried depends on the order quantity and the safety stock. The average order quantity inventory in the system should remain the same since it depends on demand, the cost of ordering, and the cost of carrying inventory.

  • The total safety stock will be affected by the number of warehouses in the system. Safety stock is carried to protect against fluctuations in demand during the lead lime and depends, in part, on the number of units sold. In Chapter 11, it was shown that the standard deviation varies as the square root of the ratio of the forecast and lead-time intervals. Similarly, for the same SKU, the standard deviation varies approximately as the square root of the ratio of the different annual demands. Suppose that the average demand is 1000 units and, for a service level of 90%, the safety stock is 100 units. If the 1000 units is divided between two distribution centers each having a demand of 500 units, the safety stock in each is:

  • With two distribution centers and the same total sales, the total safety stock in creases to 142 from 100. Thus, with a constant sales volume, as the number of distribution centers increases, the demand on each decreases. This causes an increase in the total safety stock in all distribution centers.

Warehousing Costs

  • The fixed costs associated with distribution centers are space and materials handling. The space needed depends on the amount of inventory carried. As we have seen, as more distribution centers are added to the system, more inventory has to be carried, which requires more space.

  • In addition, there will be some duplication of nonstorage space such as wash-rooms and offices. So as the number of distribution centers increases, there will be a gradual increase in distribution center space costs.

  • Operating costs also increase as the number of distribution centers increases. Operating costs depend largely on the number of units handled. Since there is no increase in sales, the total number of units handled remains the same, as does the cost of handling. However, the nondirect supervision and clerical costs increase.

Materials Handling Costs

  • Materials handling costs depend upon the number of units handled. Since the sales volume remains constant, the number of units handled should also remain constant. There will be little change in materials handling costs as long as the firm can ship unit loads to the distribution center. However, if the number of distribution centers increases to the point that some nonunitized loads are shipped, materials handling costs increase.

Packaging Costs

  • Per-unit packaging costs will remain the same, but since there will be more inventory, total packaging costs will rise with inventory.

Packaging Costs

  • Per-unit packaging costs will remain the same, but since there will be more inventory, total packaging costs will rise with inventory.

Total System Cost

  • We have assumed that total system sales remain the same. Figure 13.11 shows graphically how the costs of transportation, warehousing, materials handling inventory, and packaging behave as distribution centers are added to the system. Up to a point, total costs decrease and then start to increase. It is the objective of logistics to determine this least-cost point.

System Service Capability

  • The service capability of the system must also be evaluated. One way of assessing this is by estimating the percentage of the market served within a given period. Figure 13.12 represents such an estimate.

  • As expected, the service level increases as the number of distribution centers increases. It increases rapidly from one to two distribution centers and much less rapidly as the number is further increased. The first distribution center is built to serve the best market, the next to serve the second best market, and so on. Let us assume that a study has been made of a system of one to ten distribution centers and the costs an as shown in Figure 13.13.

Figure 13.11 Total system cost.

 

Number of Warehouses

Percentage of Reached in I Day

1

2

3

10

30

70

87

95

Figure 13.12 Estimate of market reached versus number of warehouses.

 

Cost ($1000)

Number of Locations

1

2

3

10

Transportation

$8,000

$6,000

$5,000

$4,500

Warehousing

500

600

700

900

Materials Handling

1000

1000

1100

1400

Inventory

400

425

460

700

Packaging

100

100

100

100

Total Cost

$10,000

$8,125

$7,360

$7,600

Figure 13.13 Cost versus number of warehouses.

  • A three-distribution center system would provide the least total cost. Figure 1 shows that by moving from three to ten distribution centers, the one-day service 1 increases by 8%. Management must decide which system to select. The decision ri be based on adequate analysis of the choices available and a comparison of th crease in costs and service level.