Managing Inventories in

Supply Chain
Chapter 11

Aggregating Multiple Products

in a Single Order
To reduce lot size is the reduction of fixed cost incurred
per lot. One major source of fixed cost is the fixed
transportation cost. In several companies, the array of
product sold is divided into groups, with each group
managed independently by a separate product manager.
This results in separate orders and deliveries for each
product thus increasing overall cycle inventory.
Aggregating orders and deliveries across product is an
effective mechanism to lower cycle inventories. This
allows fixed cost to be spread across multiple suppliers
(single delivery coming from multiple suppliers) or fixed
cost spread across multiple retailers (single truck
delivering to multiple retailers)

Aggregating Multiple Products in a

Single Order
To reduce lot size reduce fixed costs
(fixed transport cost)

Two options
Single delivery coming from multiple sources
Single truck delivering to multiple retailers

Lot Sizing With Multiple Products or

Customers
1. No aggregation: Each product manager orders
his model independently
2. Complete Aggregation: The product manager
jointly orders every product in each lot
3. Tailored Aggregation: The product managers
order jointly but not every order contains every
product; i.e., each lot contains a selected
subset of the products

Lots are Ordered and Delivered

Independently for Each Product (EOQ)
Annual demand = D
Number of orders per year = D/Q
Annual material cost = CD
Annual order cost = (D/Q)S
Annual holding cost = (Q/2)H = (Q/2)hC
Total annual cost = TC = CD + (D/Q)S + (Q/2)hC

Lots are Ordered and Delivered

Independently for Each Product (EOQ)
D: Annual demand
S: Setup or Order Cost
C: Cost per unit
h: Holding cost per year as a
fraction of product cost
H: Holding cost per unit per
year
Q: Lot Size
T: Reorder interval
Material cost is constant and
therefore is not considered
in this model

H hC
2 DS
Q*
H
n*

2S
DH

Aggregating Multiple Products in a

Single Order
Key Point
Aggregating replenishment across products,
retailers, or suppliers in a single order allows
for a reduction in lot size for individual
products because fixed ordering costs are
now spread across multiple products,
retailers, or suppliers.

Multiple Products Ordered and

Delivered Independently

Demand
DL = 12,000/yr, DM = 1,200/yr, DH = 120/yr
Common order cost
S = $4,000
Product-specific order cost
sL = $1,000, sM = $1,000, sH = $1,000

Holding cost
h = 0.2
Unit cost
CL = $500, CM = $500, CH = $500

Multiple Products Ordered and Delivered

Independently

Litepro

Medpro

Heavypro

Demand per year

12,000

1,200

120

Fixed cost/order

$5,000

$5,000

$5,000

1,095

346

110

548

173

55

$54,772

$17,321

$5,477

11.0/year

3.5/year

1.1/year

$54,772

$17,321

$5,477

2.4 weeks

7.5 weeks

23.7 weeks

$109,544

$34,642

$10,954

Optimal order size

Cycle inventory
Annual holding cost
Order frequency
Annual ordering cost
Average flow time
Annual cost

Total annual cost = $155,140

Lots Ordered and Delivered Jointly

S* = S + sL + sM + sH

Annual order cost = S * n

DL hC L DM hCM DH hC H
Annual holding cost =
+
+
2n
2n
2n
DL hC L DM hCM DH hC H
Total annual cost =
+
+
+S*n
2n
2n
2n
n* =

DL hC L + DM hCM + DH hC H
2S *

n* =

k
i=1

Di hCi

2S *

Products Ordered and Delivered Jointly

S* = S + sA + sB + sC = $7,000 per order

12,000 100 +1,200 100 +120 100
n* =
= 9.75
2 7,000
Annual order cost = 9.75 x 7,000 = $68,250
Annual ordering
and holding cost

= $61,512 + $6,151 + $615 + $68,250

= $136,528
A decrease of 12%

Products Ordered and Delivered Jointly

Litepro

Medpro

Heavypro

Demand per year (D)

12,000

1,200

120

Order frequency (n)

9.75/year

9.75/year

9.75/year

1,230

123

12.3

615

61.5

6.15

$61,512

$6,151

$615

2.67 weeks

2.67 weeks

2.67 weeks

Optimal order size (D/n)

Cycle inventory
Annual holding cost
Average flow time

Key Learning
A key to reducing cycle inventory is reducing lot
size. A key to reducing lot size without
increasing cost is to reduce fixed costs. This
may be achieved by reducing fixed costs itself or
by aggregating lots across multiple products,
customers, and suppliers. The fixed ordering
and fixed transportation costs are now spread
over multiple products, retailers, or suppliers.

Lessons from Aggregation

Aggregation allows firm to lower lot size
without increasing cost
Complete aggregation is effective if product
specific fixed cost is a small fraction of joint
fixed cost
Tailored aggregation is effective if product
specific fixed cost is a large fraction of joint
fixed cost

Lots are Ordered and Delivered Jointly for

Select Subset of the Products
Tailored aggregation
Higher demand products ordered more
frequently and lower demand products
ordered less frequently
Appropriate when product-specific ordered
costs are high

(Lessons from Aggregation)

Scenarios

Total Cost

% Decrease

Independent Ordering
(no aggregation)

$155,140

Lots ordered and

delivered jointly
(complete
aggregation)

$136,528

12%

Ordered and delivered

jointly for select
subset (tailored
aggregation)

$130,767

4.2%

Key Learning
A key to reducing cycle inventory is reduction of
lot size. A key to reducing lot size without
increasing costs is to reduce the fixed costs
associated with each lot
Reducing fixed costs involves
Reducing fixed costs itself
Aggregating lots across multiple products, customers,
or suppliers
Tailored aggregation is best is product-specific order
costs are large

Managing Uncertainty in
Supply Chain: Safety
Inventory
Chapter 12

Safety Inventory
Safety inventory is carried to satisfy
demand that exceeds the amount
forecasted for a given period
It is the average inventory remaining when
the replenishment lot arrives

The Role of Safety Inventory

Safety Inventory
Raising the safety inventory increases
product availability, but also increases
inventory holding costs
The issue is particularly significant in
industries in which product life cycles are
short and demand volatile.
Inventory on hand in such situation becomes
worthless

Factors Affecting Level of

Safety Inventory
The level of safety inventory is determined by
two factors
The uncertainty of demand and supply
Higher uncertainty in demand leads to higher
safety inventory
Milk: Low uncertainty low safety inventory
Spices: High uncertainty high safety
inventory
Higher uncertainty in supply leads to higher safety
inventory
If LT decreases by k, the required safety
inventory decreases by a factor k.

Factors Affecting Level of

Safety Inventory
The desired level of product availability
Ability to fill a customer order out of available
inventory
Product fill rate fraction of product demand that
is satisfied from product in inventory
Order fill rate fraction of orders that are filled
from available inventory
Cycle service level fraction of replenishment
cycles that end with all the customer demand being
met
As the desired product availability goes up, the required
safety inventory increases

Learning
Key to success of any supply chain is to
find ways to decrease the level of safety
inventory carried without hurting the level
of product availability

Impact of Aggregation on
Safety Inventory

How does aggregation affect forecast accuracy and safety

inventories
Di: Mean weekly demand in region i, i = 1,, k

si: Standard deviation of weekly demand in region i, i = 1,, k

rij: Correlation
1ijk

of

weekly

demand

for

regions

i,

j,

Impact of Aggregation on
Safety Inventory
Total safety inventory in
decentralized option

DC = Di ;
k

i=1

z LT s i
i 1

( )

var DC = s i2 + 2 rijs is j ;
i=1

( )

i> j

s DC = var DC

If all k regions have demand that is independent (ij =0), and identically
distributed, with mean D and standard deviation D, then above equation becomes

DC = kD

s DC = k s D

Impact of Aggregation on
Safety Inventory

z L s DC

Require safety inventory on

aggregation

i 1

Holding-cost savings on aggregation per unit sold

FS1(CSL) L H
DC

C
s i s D
i=1

Impact of Aggregation on
Safety Inventory

The safety inventory savings on aggregation increase with the

desired cycle service level CSL

The safety inventory savings on aggregation increase with the

replenishment lead time L

The safety inventory savings on aggregation increase with the

holding cost H

The safety inventory savings on aggregation increase with the

coefficient of variation of demand

The safety inventory savings on aggregation decrease as the

correlation coefficients increase

Inventory at Multiple Locations

(The Square Root Law)
The square root law states that total safety stock
inventories in a future number of facilities can be
approximated by multiplying the total amount of
inventory at existing facilities by the square root of the
number of future facilities divided by the number of
existing facilities

X2 = X1(n2/n1)
Where n1 = # of existing facilities
n2 = # of future facilities
X1 = Total inventory in existing facilities
X2 = Total inventory in future facilities

Problem
(Square Root Law)
A company operated 16 regional
warehouses. Each warehouse carried
$165,000 inventory on average. If all
stocks are to be consolidated into one
location, how much inventory can be
expected?

Square Root Law

Solution
X2 = X1(n2/n1)
X2 = 16500016(1/16) = $660,000

Question: If consolidated in two locations that

equally divide the stock, how much inventory
can be expected in each warehouse?
X2 = $16500016(2/16) = $933381
Reduction in inventory: $2640000-$933381
=$1,706,619

Square Root Law

If the number of independent stocking
locations decreases by a factor n, the
average safety inventory is expected to
decrease by a factor of n

Benefits of Aggregating Safety

Inventories
Information centralization
Gap and Walmart can use information system
to inform customers of the closest store with
the product in inventory

Specialization
If reduction in safety inv. high Central
location
If reduction in safety inv. low Multiple
decentralized locations

Safety Inventory and Demands

Coefficient of Variation
For a product with a low coefficient of
variation, disaggregate demand can be
forecast with accuracy
Benefit of aggregation is minimal

High coefficient of variation of demand,

disaggregate demand is difficult to
forecast
Benefit of aggregation is substantial

Impact of Item movement on

Safety Inventory
Fast moving items decentralized locations
Slow moving items centralized locations

Component Commonality and

Inventories
When a supply chain is producing a large
variety of products, components can easily
become very large. The use of common
components in a variety of products is an
effective supply chain strategy to exploit
aggregation and reduce component
inventories.

Two Major Disadvantages of Aggregating

Inventories in One Location
Increase in response time
Increase in transportation cost to customer

Both disadvantages result because of the average distance between

inventory and the customer increases with aggregation

Postponement
Postponement is the ability to delay
product differentiation or customization
until closer to the time the product is sold.

Transportation and Logistics

Management

Logistics Management
Part of supply chain management that plans,
implements, and controls the efficient, effective
forward and reverse flow and storage of goods,
services, and related information between the
point of origin and the point of consumption in
order to meet customers requirements.
Logistics and SCM are intimately related, with
logistics perhaps being the nuts and bolts on
which SCM framework rests

Logistics Estimates - INDIA

Logistics spent: USD 110 Billion (2014)
Expected to reach 200 Billion by 2020
Share of GDP: Around 13% (estimated)
Share of logistics cost (% of total)
Transportation..63%
Warehousing29%
Others 8%
Improvement in transport and warehousing can
improve Indian logistics sector

What is Transportation?
Transportation refers to movement of a
product from one location to another as it
moves from beginning of a supply chain to
the customer
57% of goods transported by volume are
transported by road
Road - least efficient among
Inland water, rail, and road

Transportation
Single largest element of logistics cost (63%)
Selecting mode(s) and carrier to move raw
materials, components, and finished goods
Designing the most effective way of reaching
products to geographically dispersed markets
from plants in a cost-effective manner

Parties the Influence the

Effectiveness of Transportation
Shipper - Party that requires movement of

the product between two points in the

supply chain
Carrier - Party that moves or transports the
product
Owners and operators of transportation
infrastructure such as roads, ports, canals, and
airports
Bodies that set transportation policy worldwide.

Infrastructural Issues that Hamper

Supply Chain in India
1. Scarcity of express highways
2. Pot-holed and clogged roads reduce speed to
1/3rd of developed countries
3. Inability of ports to handle goods quickly
4. Lack of modern technology in warehouses
5. Varying tax rates across states prevent warehouse
to be located optimally from SCM perspective
6. Poor telecommunication network (poor IT
infrastructure)
7. Dwell-times for air cargo at Indian airports are
substantially higher than other countries
8. Multiple checkpoints for inspection and tolls and
taxes

Modes of Transportation in SC

Air
Package Carriers
Truck
Rail
Water
Pipeline
Intermodal

Trucks
Dominant mode of transport in India
Highly fragmented industry
85% of total fleet controlled by unorganized sector
75% of the vehicles are owned by entrepreneurs who
own less than 5 trucks*
11% operate with more than 20 trucks
Door-to-door shipment, shorter delivery time
Less capable of handling all types of freight than rail
mainly due to highway safety restrictions that limit the
dimension and weight of shipments
Most shipments must be smaller than 40 to 53 trailer
and less than 8 wide and 8 tall to ensure road clearance
Offers reasonably fast and dependable delivery
*Note: Few logistics firms in India with a fleet size larger than 100 trucks.

Overview of Indian Infrastructure

for Transportation

Roads
Total 3,319,644 kms
12% are four lanes
56% are double lanes
32% are single lane
Road conditions
Narrow, pot-holed poor surface quality
Congested
average truck speed is only 30-40 km/h
The Golden Quadrilateral
5952 kms connecting Delhi-Kolkata-Chennai-Mumbai via National
Highways

Note: Shipments by road that can be completed in three days in the U.S.,
for example, could take as long as nine days in India.

Truckload (TL)
Shorter delivery time
Low fixed and medium variable costs
Suited for transport between manufacturing
facilities and warehouses or between suppliers
and manufacturers
Transhipments
Types of freight
Lumber, steel coils, machines, fabricated items,
consumer durables, cars, two wheelers, stone chips,
sand, containers, cement etc.

Less Than Truckload (LTL)

Suited for shipments in small lots
(< TL) as TL is cheaper for larger
shipments
Low capacity utilization or will have to
aggregate a number of small shipments in
one trip
Higher delivery time than TL shipments
because of other loads to picked and
dropped

Truck Costs
Truck costs are typically grouped into three
categories
Fixed costs
Insurance, interest charges on money tied up in vehicles,
licensing fees, equipment amortization, expenses related to
housing vehicles, tax

Operator costs (related to time rather than distance

travelled)
Wages, health and pension plan, expenses while on road
(meal, hotel, telephone)

Vehicle operating costs (incurred in keeping the

vehicle on road)
Fuel, tyres, maintenance, spares, lubricants

Rail
Ideally suited for large, heavy or high density products
over long distances. 95% of the freight carried is bulk
goods
Example: coal, steel coils, metal ores, cement, containers
Coal accounts for more than 50% of the traffic

Ideal for heavy, low-value ship shipments

Not ideal for small, time-sensitive, short distance
shipments
Major issues
Vehicle and staff scheduling
Track and terminal delays
Poor on-time performance

Rail
Indian Railways account for 22% of the
freight movement in India
High fixed costs in terms of rail, locomotives,
terminals, load/unload, billing
High wages, fuel and oil, and maintenance
costs
Traditionally, variable costs = -1/3 rd of
total costs
High idle time
Government monopoly

Overview of Indian Infrastructure

for Transportation
Indian Railways Fourth largest rail network in the world

Total length: 63,465 km

Transports 667 million tons of cargo/year
Freight segment accounts for 2/3rd of revenue
IR runs about 16,021 trains everyday
Railway budget (2006-07) approved Rs 220 billion construction
of dedicated multi-modal high axle load freight corridor
Factories

Rail Coach Factory: Kapurthala

Diesel Loc: Varanasi
Integral Coach Factory: Chennai
Wheel and Axle Plant: Bangalore

Rail
Rail has not been so popular in India
because of last mile delivery issues,
infrequent movement of trains, and lack of
flexibility

Air
Key issues:
Fast and most expensive mode
Appropriate for small, time-sensitive, high
value products
Accounts for very small % of freight
High fixed costs in infrastructure
Large labour and fuel costs

Major International Cargo Air

Carriers

Airborne Express
British Airways
BAX Global
DHL Worldwide Express
Federal Express
United Parcel Service (UPS)

Package Carriers
Companies like FedEx, UPS, USPS, Gati,
Bluedart that carry small packages ranging from
letters to shipments of about 150 pounds
Expensive
Rapid and reliable delivery
Small and time-sensitive shipments
Provide other value added services
Track status of product in transit

Pick package from source and deliver to

destination site

Air Cargo vs. Package Carriers

Air Cargo
Large Shipments
Example: Dell uses air
cargo to bring
components from Asia

Package Carriers
Small, time-sensitive
Example: Dell uses
package carriers to
ship PCs to customers

Water

Limited to certain geographic areas

Used extensively for international cargo
Ocean, inland waterway system, coastal waters
Very large loads at very low cost
Slowest among all modes of transport
Significant delays occur at ports and terminals
Turnaround time for a ship is at least 4 days in India which is
higher than in most countries
Cheapest mode of transport
Dominant in global trade (autos, grain, apparel, etc.)
Though India has a coast line of 7517 km, none of the ports figure
in the top 10 ports of the world
Largest post Jawaharlal Nehru Port Trust, carries 37 million tons
of cargo against 4000 million tons by Shanghai airport
Ships can wait up to five days to dock at an Indian port, compared to little
or no wait time in Europe.

Water
Water transportation is used for low value
to weight ratio items like
Timber, iron ore, coal, chemicals, grains,
petroleum, and cements
For India, in 2010-2011, Iron ore constituted
(18%) of cargo traffic, coal constituted (15%)
of cargo traffic

Commodities which are bulky but low

value where the items are not required in a
hurry are most suitable for water transport
Source: Business India, July 24, 2011

Overview of Indian Infrastructure

for Transportation
Waterways
12 major ports
Managed by GOI
High investments and high trade volume

200 minor ports

Managed by state governments
Low investments and low volume

Cargo Traffic in Minor Ports of India

(2010-2011)

Commodity-wise Traffic Population

Source: Business India, Aug 2011

Traffic Handled at Major Indian

Ports (2010-2011)

Source: Business India, Aug 2011

Coastal Shipping
Coastal shipping of goods is gaining momentum in India
For example, cars are being transported from one
part of India to other part through sea
Advantages
Cost effective, environment-friendly, helps reduce
road traffic congestion
Mitigating risk of road transport
Dis-advantages
Increased shipping duration compared to road
Non-availability of return cargo

International Commerce Terms

(Incoterms)
Free on Board (FOB) Port of Departure
FOB Paradip, India
Exporter is responsible for the goods until they are
placed on the ship. The importer is responsible for
them after that.

Cost, Insurance, and Freight (CIF) Port of

Destination
CIF Kobe, Japan
The exporter is responsible for minimum insurance
and freight (shipping costs) to the port of destination.
It is also responsible for clearing goods for export.

Top Ocean Carriers

Ocean Carrier

Rank by Capacity

A. P. Moller, Maersk - Denmark

3 Million TEU, Ranked 1

Mediterrain Shipping Co - Italy

2.6 Million TEU, Ranked 2

CMA CGM - France

1.8 Million TEU, Ranked 3

Hapag-Lloyd - Germany

0.94 Million TEU, Ranked 4

Evergreen Marine - Taiwan

0.93 Million TEU, Ranked 5

COSCO - China

0.85 Million TEU, Ranked 6

China Shipping - Sanghai

0.7 Million TEU, Ranked 7

Hamburg Sud - Germany

0.65 Million TEU, Ranked 8

Hanjin Shipping, Korea

0.63 Million TEU, Ranked 9

TEU = 20 feet equivalent unit. Used to measure ships cargo capacity.

1 TEU = 20 feet long, 8 feet tall

Pipeline
High fixed cost, low variable costs
Primarily for liquid, gases, semi-solid materials
crude petroleum, refined petroleum products,
natural gas, slurry (coal, iron ore, limestone,
copper)
Best for large and predictable demand
Would be used for getting crude oil to a port or
refinery, but not for getting refined gasoline to a
gasoline station
Low cost compared with other modes
Product movement by pipeline is very slow (oil
moves 1-6 metres / second)
Product moves 24 / 7

Overview of Indian Infrastructure

for Transportation
Pipeline
Gas, 5798 km
Liquid Petroleum Gas: 1,195 km
Oil: 5,613 km
Refined products: 5,567 km
Example: 1,469 kms long Hazira-Bijapur-Jagdishpur
(HBJ) pipeline network is the most noteworthy
pipeline in India that carries natural gas from Gujrat to
Central India
Other examples are Gauhati-Barauni, AnkleswarBaroda, Mathura Viramgam pipelines

Inter-modal Transport
Use of two or more carriers of different modes to move a
shipment to its destination
Birdyback
Airline + Truck
Fishyback
Ship + Truck
Piggyback (most widely used)
Rail + Truck
Container on Flatcar (transporting container on
railroad flat cars: COFC)

Containerization
Large container box into which a firm places
commodities to be shipped.
After initial loading, the commodities are not handled
until they are unloaded at their final destination
Reduced cost of packaging
Faster turnaround for ships (faster loading and
unloading)
Ease of cargo transfer across multiple modes
Reduced material handling, theft, damage

Inter-modal Transportation
Most common example: rail/truck
Also water/rail/truck or water/truck
Grown considerably with increased use of
containers
Increased global trade has also increased use of
inter-modal transportation
More convenient for shippers (one entity
provides the complete service)
Key issue involves the exchange of information
to facilitate transfer between different transport
modes

Problems in Intermodal
Carriers are reluctant to participate
When one carrier can transport the
commodity the entire distance over its own
lines, the carrier is hesitant to coordinate with
others
Transfer of freight from one mode to another
Creates time delay and adds to transportation cost

ICDs and CFS

Inland Container Depots (ICDs) and Container Freight
Stations (CFSs) are inland locations and designated as
dry ports for the sake of custom formalities related to
export import cargo to be handled in these locations
For example, exporters in Delhi can complete their
custom formalities while handling over export cargo at
ICD, Tughlakabad without having to go through the
process at the seaport through which their cargo is
routed
ICDs are located away from seaports, the CFSs are
adjacent to the port. CFS is a facility where containerized
cargo can be loaded or unloaded

Inland Container Depot (ICD)

Container Freight Station(CFS)

ICDs and CFSs

Functionally no difference between the two
ICDs are located outside the port towns
CFS is an off-dock facility (extension of
port)

Relative Ranking of Transportation

Mode by Performance Measures

Ranking of Transportation Mode

in terms of SCM Performance
Mode

Cycle Inv. Safety Inv.

In-Transit
Cost

Transportation Transportation
Cost
Time

Rail

Road - TL

Road - LTL

Package

Air

Water

Read Vertically, 1 = Best, 6 = Worst

Key Point
When selecting a mode of transportation,
managers must account for cycle, safety,
and in-transit inventory (or pipe line
inventory) costs that result from using
each mode. Modes with high
transportation costs can be justified if they
result in significantly lower inventory costs.

Total Cost Approach to

Performance Measures
Total cost = Transport cost + Cycle stock
inventory carrying cost + Pipeline
inventory carrying cost + Safety stock
inventory costs + Cost of losses and
damages

Average Pipeline Inventory

Shipping time (St) is 30 days,

The order cycle (OC) is 5 days,
A shipment is 100 units
What is the average pipeline inventory?
A shipment begins on days, 0, 5, 10, 15, 20, 25 & 30, . .
They arrive on days 30, 35, 40,
Formula to calculate # SHIPMENTS = St / OC
# shipments in transit = 30 / 5 = 6
100 units per shipment = 600 units of transit inventory at
$3,000 per item = $1,800,000

Design Options for a

Transportation Network
Direct Shipment Network
Direct Shipping with Milk Runs
All shipments via Central DC
Cross Docking

Shipping via DC using Milk Runs

Tailored network

Most effective when large quantities are moved

Cross-Docking

Cross Docking

Tailored Network
Combination of previous options to reduce
cost and improve responsiveness
Combination of cross-docking, milk runs, TL
and LTL carriers, along with package carriers
in some case
Goal is to use appropriate option in each
situation

Mixing

Trade-offs in Transportation
Design
Transportation and inventory cost trade-off
Choice of transportation mode
Inventory aggregation
Transportation cost and responsiveness trade-off
Mode of transportation that results in lowest transportation
cost does not mean lowest costs for a supply chain
Cheaper mode of transport typically have longer lead times
and larger minimum shipment quantities, both of which
result in higher levels of inventory in the supply chain and
so higher inventory costs
Faster modes of transportation allows shipment in small
quantities so lower inventory costs but higher transport cost

Trade-offs in Transportation Design

High value-to-weight products --faster
modes of transportation
Small value-to-weight products cheaper
modes of transportation

Trade-off Between Transportation Cost

and Customer Responsiveness
Small outbound shipments high
responsiveness and high transport cost
Aggregated shipments over time
(Temporal aggregation) low
responsiveness and low transport cost

Third Party Logistics (3PL)

Outsourcing logistics function to third party
These companies allow economies of scale that
were not feasible in single-customer relationship
They operate by consolidating loads from
multiple suppliers located near each other,
realizing full truck load economies without the
batches coming from the same supplier.
There are additional handling and administrative
costs for such consolidations or multiple pickups,
but the savings often outweigh the costs

3 PL
External supplier that performs all or part of companys logistics
function such as transportation, warehousing, distribution, financial
services and so on.
3PL providers
UPS Supply chain solutions
Fed-ex supply chain solutions
DHL-Exel
Ryder
Menlo Logistics
Schneider Logistics
IBM Supply Chain Management Services (IBM)
Caterpillar Logistics Services (Catterpillar)
Intral Corporation (Gillette)

Outsourced Logistics Services

Transportation
Warehousing
Customs Clearance
Freight Forwarding
Shipment consolidation
Cross docking
Reverse logistics
Product labelling, packaging, assembly, kitting
Fleet management

Logistics Companies - India

Warehousing Companies in India
Indo Arya House, SMG Spacers Private
Limited

Transport companies India

Associated Road Carriers (ARC), Patel
Roadways, Safex, TCI, Gati

Freight Forwarders
A-Z Logistics, APT Logistics, Cargo Channels
(P) Limited

3 PL
Logistics activities most outsourced based
on 2006 survey worldwide
Most frequently outsourced: Transportation
(90%)
Warehousing (74%)
Customs clearance (70%)
Forwarding (54%)

Source: 2006 Eleventh Annual 3PL study, Georgia Tech

Third Party logistics players in

India
Market is highly fragmented with large number of small players
Rail is state run while truckers are often family-run
Complex business environment, eg. tax rates differ between
provinces, cultural differences
Poor warehousing and transportation infrastructure
Foreign logistics competitors are DHL, Fedex, Blue Dart, Exel,
Danzas, Bax, Global, TNT, Panalpina main revenue from freight
forwarding
Indian:Yusen Logistics, Rhenus logistics, Jamtrans logistics, Gati
Logistics, Menlo logistics, DTDC logistics, TCI
Logistics market is expected to grow by more than 20% over the
next 3 years as against the present rate of 12-15%
EVOLVING
Source : Scope, Indian Logistics Industry, January 2002

3PL Market

Source: Business India, July 22, 2012

4PL
4PL first defined by Anderson Consulting (Accenture)
3PL manages a function, a 4PL targets management of
the entire process
4PL manages the entire supply chain process, i.e.,
manages 3PLs, truckers, forwarders, custom brokers
and others essentially taking responsibility of a complete
process for the customer
Single interface between client and logistics provider
Still at its infancy
Example: Menlo Logistics, Kuehne and Nagel AG
Menlo Logistics designs the supply chain, information systems,
integrates transportation, warehousing, home delivery, product
set up and reverse logistics for Homelife, a national home
furnishing retail chain

Fourth-party Logistics
A firm that assembles and manages
resources, capabilities, and technology of
its own organization with those of
complementary service providers to
deliver a comprehensive supply chain
solution
In one sense, a 4PL is to manage and
direct activities of multiple 3PLs, and the
IT providers

3 PL and 4 PL

Reverse Logistics
Backward flow of goods returned to supply
chain from their final destination. Goods
may be returned because they are
defectives, unsold, or simply customer
changed their minds
Two elements
Gatekeeping
Avoidance

Measuring Logistics Performance

Delivered on time
Shipped complete
Invoiced correctly
Undamaged in transit

Risk Management in
Transportation

Three main risks to be considered in transportation are:

1. Risk that the shipment is delayed due to congestion
2. Risk of not reaching destination due to disruptions by
external forces (weather or man made)
3. Risk of hazardous material

Risk Management in
Transportation

Risk Mitigation Strategies

1. Delays due to congestion

Use alternative lanes or alternative modes of transport

Building buffer into the lead time
Owning transport fleet or enter into long-term agreement
with third party
Having inventories closer to customers

2. Disruptions by natural events or terrorism

Use alternative routings

3. Risk of hazardous materials

Use of modified containers, low-risk transportation modes,

modification of physical and chemical properties of material
to make it less dangerous

VEHICLE ROUTING

Vehicle Routing
Transport costs typically range between
50%-60% of the total logistics costs
To reduce transport and delivery costs and
to improve customer service, finding the
best paths that a vehicle can follow
through a network of roads, rail lines,
shipping lanes is a frequent decision
problem

Objectives of Routing and

Scheduling
Decrease total distance traveled by a
vehicle
Decrease total travel time of vehicles
Eliminating service failures
In sum: decrease transport and delivery
cost and improve responsiveness

Vehicle Routing and Scheduling in

Transportation

Savings Matrix Method

1.
2.
3.
4.

Identify the distance matrix

Identify the savings matrix
Assign customers to vehicles or routes
Sequence customers within routes

Note: Steps 1- 3 are used for assigning

customers and step 4 is used for
sequencing customers

Vehicle Routing and Scheduling

1. Identify Distance Matrix

Distance Matrix for Peapod

Deliveries

2. Identify Savings Matrix

S (x,y) = Dist (DC, x) + Dist (DC, y) Dist (x , y)

3. Assign Customers to Vehicles or

Routes

Vehicle capacity = 200 units

3. Assign Customers to Vehicles or

Routes

3. Assign Customers to Vehicles or

Routes

Four Routes
Groups
(6,7,11), Weight 163 < 200, vehicle capacity
(1,2,4), Weight 183 < 200, vehicle capacity
(5,10,12,13), Weight 197 < 200, vehicle cap
(2,8,9), Weight 123 < 200, vehicle capacity

4. Sequence Customers Within

Route
Consider the truck that has been delivered to
customers 5, 10, 12 and 13
If the deliveries are in sequence 5, 10, 12, 13,
the total distance travelled by truck from DC to
back is 15+9+9+8+15 = 56
In contrast, if deliveries are made in the
sequence of 12, 5, 13, and 10 from DC and
back, the distance travelled is
11+14+22+16+16 = 79
Clearly, 1st option is better

Vehicle Sequencing (Sweep

Method)

Vehicle Sequencing
(Sweep Method)
1. Locate all stops including the depot on a map or grid
2. Extend a straight line from the depot in any direction.
Rotate the line clockwise or anticlockwise. Ask the
question: If the inserted stop is included in the route, will
the vehicle capacity be exceeded? If the answer is no,
proceed with the line rotation until the next stop is
intersected. As the question: Will the cumulative volume
exceed the vehicle capacity? Use the largest vehicle
first. If the answer is yes, exclude the last point and
define the route. Continuing with the last sweep, begin a
new route with the last point that was excluded from the
previous route. Continue with the sweep until all points
have been assigned to routes.

Vehicle Sequencing
(Sweep Method)
3. Within each route sequence stops to
minimize distance. The sequence may
be accomplished using the tear-drop
method or by using any algorithm that
solves travelling salesman problem

Advantages of Sweep Method

Simple to calculate
Average error rate is approx 10%
Provides very good solutions when each
stop volume is a small fraction of the
vehicle capacity
All vehicles are of same size
No time restrictions

Guiding Principles of Good Routing

1.

2.
3.
4.

5.
6.
7.

Load Trucks with stop volumes that are in closest proximity to

each other
Stops on different days should be arranged to produce tight
clusters
Build routes beginning with farthest stop from the depot
The sequence of stops on a truck route should follow teardrop
pattern
The most efficient routes are built using the largest vehicles
Pickups should be mixed into delivery routes rather than assigned
to the end of routes
A stop that is greatly removed from a route cluster is a good
candidate for an alternate means of delivery

Note: These guiding principles produce satisfactory, although not necessarily optimal
Solutions to realistic routing and scheduling problems

Poor and Good Stop Sequencing

Clustering for Assigning Stop

Volumes to Vehicles

Clustering Stops By Day of Week

Route Sequencing

Route Sequencing to Minimize

Number of Trucks

Article
Insights into INDIA, Supply Chain
Management Review, July/August 2012

Sourcing in Supply Chain

Chapter 15

What is Sourcing?
Sourcing is a set of business processes
required to purchase goods and services
Selection of suppliers
Design of supply contracts
Product design collaboration (80% of the cost
of the product is determined during design)
Procurement of material
Evaluation of supplier performance

Contract
Text on business law define a contract
as:

A contract is an agreement between

competent parties, for consideration, to
accomplish some lawful purpose with
terms clearly set forth
1.

Agreement: Parties involved must have a meeting of minds

2.

Between competent parties: People that make the

agreement must be competent to make the agreement
Consideration: Something must be given for something
else. If there is no exchange there is no contract

3.
4.

Accomplish some lawful purpose: No contract can be legally

written that violates the law

What is procurement?
Purchasing, also called procurement, is
the process by which companies acquire
raw materials, semi-finished goods,
finished goods, capital equipment,
services etc. from suppliers to execute
their operations

Outsourcing
Outsourcing results in supply chain
function being performed by a third party.
For example, since 2007 retailing function of
Dell is performed by Walmart (third party)
Britannia outsourcing to other contract
manufacturers

Importance of Outsourcing
Businesses have realized that efforts required to
increase profits through increasing sales were far greater
than those involved in generating equivalent returns
through reduction in procurement prices

Today 70%-80% of the spending at a manufacturer is

through procurement compared to only 20% several
decades back
Organizations procure
components, products, and even product design

In-house or Outsource
The most significant decision is whether to
perform in-house or outsource
Outsource results in the supply chain
function being performed by a third party
Outsourcing makes sense only if it
increases supply chain surplus
Capacity aggregation, transportation
aggregation, warehousing aggregation,
procurement aggregation (GPO in hospitals)

Importance of Outsourcing
Tata Motors going for almost 80% auto component
outsourcing for its cars
Procures through E-sourcing
Conducts 400 reverse auctions every year
Sources direct materials (tyres, bearings, castings,
forgings), indirect materials (lubricants, MRO),
machine tools, material handling equipment, services
(food, housekeepng)
Maruti and Ashok Leyland have similar outsourcing
practices
Cisco has major suppliers across the world
Apple has more than 70% of components outsourced

Make-or Buy Decision

Make or buy decision is based on the
basis of
Cost
Outsource if the cost is less if procured from third
party

Core vs. non-core activities

Focus on core activity and outsource non-core

Fine and Whitney Framework for

Outsourcing of Components
Reasons for outsourcing
Dependency on capacity
Firm has knowledge and skills required to produce
the components but for various reasons (time,
money, space, or managements attention)
decides to outsource

Dependency on knowledge
The firm does not have the people, skills, and
knowledge required to produce the components
and out sources in order to have access to these
capabilities
Fine and Whitney, 1996

Illustration of Framework:
Outsourcing at Toyota
The company designs and makes 30% of its car
components
Engines: Toyota has both the knowledge and
the capacity to produce engines and 100% of
the engines are produced internally
Transmissions: Has knowledge but lacks
capacity 70% of components outsourced
Vehicle electronic systems: Designed and
produced by Toyotas suppliers lacks both
capacity and knowledge
Fine and Whitney, 1996

Key Learning from Toyota

Toyota seems to vary its outsourcing practice
depending on the strategic role of the
components and subsystems
The more strategically important the component
is, the smaller the dependency on knowledge or
capacity

Fine and Whitney, 1996

Toyota Sourcing
Toyota
Sourcing and
Strategic
Choices
Independent
for capacity
Dependent for
capacity

Independent
for knowledge

Dependent for
knowledge

ENGINES

Rare Case

Transmissions

Electronics

Benefits of Using Third Parties

Capacity aggregation
Transportation aggregation
Warehousing aggregation
Procurement aggregation
Receivables aggregation

Major Risks of Using Third Party

The process is broken

Quality is compromised
Underestimation of the cost of coordination
Reduced customer/supplier contact
Loss of internal capability and growth of third-party hard-to-replicate
expertise
Leakage of sensitive data and information with firms competitors
Conflicting objectives
Buyer looking for flexibility to match supply and demand. In
contrast, supplier looking for economies of scale
Vendors may produce parts that suit their schedule and
capabilities and not necessarily what is required by a specific
buyer, thus delaying the delivery of goods

Multiple and Single Sourcing

Approaches to Supply Management
Multiple Sources
Deal with several suppliers for
every item procured
Set-up competitive position
among suppliers
Engage in price negotiation
every time an item is procured
Withhold information, obtain
better price
Suppliers face uncertainty
about future business,
uncertainty weakens supplier
position
Customers benefit from
suppliers weaknesses,
confusions, and fears

Single Source
Deal with one supplier
Avoid engaging in any
conflicts
Engage in joint cost reduction
to obtain low cost inputs,
quality improvement efforts
Engage in product
development exercises
Exchange relevant business
information
Suppliers informed of future
business prospects, capacity,
technology investments
Benefit from mutual
cooperation and mutual trust

Supplier-Partnering Hierarchy
(Toyota and Honda)
Six steps:
Understand how suppliers work
Conduct joint improvement exercises
Share information intensively but selectively
Develop suppliers technical capabilities
Supervise suppliers
Turn supplier rivalry into opportunity

Source: Building deep supplier relationships, HBR, Dec 2004

Sourcing Process

Kraljics Framework
Kraljic argues that firms supply strategy
should depend on two dimensions
Profit impact
Supply risk

Procurement Strategies:
Kraljics Supply Matrix

Long term contracts

Spark plugs, brake linings

Nuts, bolts, oil seals

Supply contracts
Engines, transmissions

Car seats, tyres

Kraljics Supply Matrix

Top right quadrant:
Strategic items where supply risk and impact on profit
are high
Highest impact on customer experience
Price is a large portion of the system cost
Typically have a single supplier
Focus on long-term partnerships with suppliers

Bottom right quadrant

Items with high impact on profit

Low supply risk (leverage items)
Many suppliers
Small percentage of cost savings will have a large
impact on bottom line
Focus on cost reduction by competition between
suppliers

Kraljics Supply Matrix

Top left quadrant:

High supply risk but low profit impact items.

Bottleneck components
Do not contribute a large portion of the product cost
Suppliers have power position
Ensure continuous supply, even possibly at a
premium cost
Focus on long-term contracts or by carrying stock
(or both)

Bottom left quadrant:

Non-critical items
Simplify and automate the procurement process as
much as possible
Use a decentralized procurement policy with no
formal requisition and approval process

Sourcing Process
Need Identification
Receive purchase request
Estimate order size
Finalize specification

Payment, Vendor Rating

Payment authorization
Performance Rating
Vendor-record updating

Vendor Selection
Search vendors
RFQ
Negotiations

Order Acceptance
Inward goods inspection
Acceptance / rejection
Updating stocks

Order Placement
Price fixing
Dely and payment terms
PO generation

Order Receipt
Follow-up with vendor
Receipt of material as
per specification

Sourcing Process
Simplest purchasing procedure
Off-the-self buying
Oral orders over phone
Placing repeat orders with an existing supplier
Sourcing in public-sector and government agencies
Technical bids
Screened and short listed
Commercial bids
L1 (lowest), L2, L3 suppliers
Supplier selection should be based on total cost of using a supplier
and not just the purchase price

E-PROCUREMENT

E-Procurement
E-procurement means procurement of goods
and services online using internet
The intention is to automate the entire
procurement process, along with tender bid
submission and payment by suppliers, in an
online web based real time environment
E-procurement can resolve many of the
constraints and delays of traditional procurement

Modes of E-Procurement
Electronic procurement activities could be
effected using one of the several ways or
modes given below, or a combination of
these could also be used as per need:1. e-Tendering
2. e-Auctioning: Reverse Auction
3. e-Catalogue based buying/e-Ordering
Procurement by individuals

What is an Auction?
The two major types of auction
Forward auction in which several buyers
bid for one seller's good(s)
Reverse auction in which several sellers
bid for one buyer's order. An auction is
complete (and a binding contract is
created) when a bid is accepted by the
seller or the buyer (as the case may be).

Modes of E-Procurement
In common parlance, a basic Eprocurement application consists of
E-Tendering and E-Auctioning system

It could also encompass E-Catalogue

based buying also

Benefits of E-Procurement

Reduces cycle time of procurement

Reduce cost of procurement
Remove cartelization by supplier group
Removes clandestine dealing between suppliers
and a section of officials from buyer side (pact)
Increases transparency of the procurement
process
Almost complete elimination of paper work for
speedy and efficient functioning

Contents of a Tender
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.

Notice inviting Tenders

Instructions to the bidders
Form of submission
Documents required to be submitted along with the bid
Draft of the Agreement proposed to be signed between the two
Parties
General Conditions of Contract
Special Conditions of Contract
Trade Specifications including that for Material & Workmanship
Bill of Quantities (BOQ)
List of Materials proposed to be issued by the Owner
Tender drawings and sketches

Reverse Auction
The traditional auction is a Forward Auction. It normally
involves a seller offering an item for sale, while potential
buyers compete with each other for purchase. Thus price
is driven up, until no buyer is willing to go up further.

In a Reverse Auction, multiple sellers vie for the

business of a single buyer. Therefore the price is driven
down.
There are 3-4 types of reverse auction, called as:
English Auction, Dutch Auction, Sealed Bid Auction etc.

How Does Reverse Auction

Work?
Pre-screening/Pre Qualification of
suppliers is essential to have technically
qualified vendors
Complete requirement specification are
pre-known/agreed and frozen for all before
auction
Usually online auction service provider is
engaged

How Does Reverse Auction

Work?
Suppliers are required to be pre-registered
with the auction service provider and have
received training before participation
All the vendors are notified in advance
about the start and closing time of auction
Bidders submit their price bids by remotely
logging-in from their offices

How Does Reverse Auction

Work?
Bidders identities are masked but they can
see in real time the competing prices and
could revise their bids as desired
There is no communication or negotiation
with bidders during the auction
Buyer also watches the progress of
bidding from his office

How Does Reverse Auction

Work?
In reverse auction, competition is high,
bidders get tempted to bid lower and lower
to clinch the deal, until they are unwilling
to go any further
At the conclusion, the lowest bidder
emerges as the winner of the auction

Auctions in the Supply Chain

Auctions:

Sealed-bid first-price auction

English auctions
Dutch auctions
Second-price (Vickrey) auctions

Links to auctions
http://www.ariba.com/
http://www.freemarkets.com.

Indian companies portal

http://www.indiamarkets.com/imo/
//etender.ongc.co.in
Eproc.karnataka.gov.in

Benefits of Online Reverse

Auctions to Buyers
Helps achieve significant reductions in
procurement costs on account of Dynamic
Bidding process

Access to a large number of vendors.

A tool for efficient price discovery
complementing the direct negotiation process.
Source:indiamarkets.com

Benefits of Online Auctions to

Vendors
Ensures savings in marketing costs /
distributor margins
Allows vendors to access hitherto
inaccessible buyers
Increased transparency
Facilitates flexibility in pricing decision

Source: Indiamarkets.com

Total Cost of Ownership

Comparing suppliers based on total cost of
ownership (TCO)
TCO includes all supply chain costs of
sourcing a good or service from a
particular supplier and can be considered
in three buckets
Acquisition costs
Ownership costs
Post-ownership costs

Auctions in Supply Chain

Auctions:

Sealed-bid first-price auction

English auctions
Dutch auctions
Second-price (Vickery) auctions

Links to auctions
http://www.ariba.com/
http://www.freemarkets.com.

Indian companies portal

http://www.indiamarkets.com/imo/
//etender.ongc.co.in
Eproc.karnataka.gov.in

Benefits of Online Reverse

Auctions to Buyers
Transparency in the procurement process
Helps achieve significant reductions in
procurement costs on account of dynamic
bidding.
Access to a large number of vendors.
A tool for efficient price discovery
complementing the direct negotiation process.
Source:indiamarkets.com

Supplier Development
Supplier certification
Assesses the financial and equipment
capabilities, the cost structure, the contract
performance, the quality assurance system,
and the value analysis effort of the supplier
under consideration

Vendor rating
Systematic method to evaluate suppliers
performance using data from the delivery of
items in response to purchase orders placed

Supplier Certification Programme

Value Analysis
Effort

Quality
Assurance

Financial
Capability

Single Source
Certification
Program
Equipment
Capability

Cost
Structure

Contract
Performance

VENDOR RATING SYSTEM

(Yardstick for Measuring Performance)
Criterion

Weights

Excellent5

Very
Good - 3
Good - 4

Average 2

Below
Average 1

Quality

28

<1000 ppm

10015000
ppm

500110,000
ppm

10,00150,000

>50,001
ppm

Delivery
reliability

24

100%
schedule
adherence

1 day
after due
date

2-4 days
after due
date

5-7 days
after due
date

> 7 days
after due
date

Price

21

Base price

Upto 1%
above
base
price

2-3%
4-5%
>5%
above
above
above
base price base price base price

Delivery
Terms

14

Free
delivery

FOB

Only
collection
free

Chargeabl Ex works
e basis

Payment
Terms

13

60 days

45 days

30 days

10-15
days

Total

100

Immediat
e

VENDOR RATING SYSTEM

Criterion

Weights

Vendor 1
Performance

Rating

Vendor 2

Factor scores

Performance

Rating

Factor
Scores

Quality

28

792 ppm

140

5400 ppm

84

Delivery
Reliability

24

1 day after
due date

96

2-4 days
after due
date

72

Price

21

2-3% above
base price

63

Up to 1%
Above base
price

84

Delivery
Terms

14

FOB

56

FOB

56

Payment
Terms

13

45 days

52

60 days

65

Total

100

Vendor
Rating

407

361

81%

72%

For example: (4/5)*8=6.4, similarly, (5/5)*7 = 7

Sourcing/Purchasing Design Matrix

Sourcing Related Metrics

Days payable outstanding

Average purchase price
Range of purchase price
Average purchase quantity
Fraction of on-time delivery
Supply quality
Supply lead time
Supplier reliability

Risk Management in Supply

Chains

SUPPLY CHAIN RISKS AND THEIR DRIVERS

IMPACT OF VARIOUS MITIGATION STRATEGIES