26/02/19

Customer Service and Logistics

DR.  NINIET  I.  ARVITRIDA DEPARTMENT  OF  INDUSTRIAL  
ENGINEERING  – ITS
INDONESIA

Outline
§ Customer  service  defined
§ Customer  service  elements  and  importance  of  service  elements
§ Order  cycle  time
§ Service  effects  on  sales  and  cusytomer  patronage  
§ Modelling  the  sales-­‐service  relationship

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Reference
Text  books
◦ Ballou,  Ronald.  H.  (2004)    Business  Logistics  Management,  Prentice  Hall  International,  Inc.,  USA  –
Chapter  4

“Logistics  is  no  longer  the  ‘last  frontier  of  cost  

reduction,’  it’s  the  new  frontier  of  demand  
generation.”

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Customer  Service in  Planning  Triangle

Inventory  Strategy
• Forecasting Transport  Strategy
• Inventory  decisions • Transport  fundamentals
• Purchasing  and  supply   • Transport  decisions
scheduling  decisions Customer  
• Storage  fundamentals service  goals

ORGANIZING

CONTROLLING
• The  product

PLANNING
• Storage  decisions
Logistics  sservice
• Logistics   ervice
• Ord .  proc.  &  info.  sys.

Location  Strategy
• Location  decisions
• The  network  planning  process

Customer  Service  Defined

• Customer  service  is  generally  presumed  to  be  a  means by  which
companies  attempt  to  differentiate  their  product,  keep  customers
loyal,  increase  sales,  and  improve  profits.

• Its  elements  are:

- Price
- Product  quality
- Service

• It  is  an  integral  part  of  the  marketing  mix  of:

- Price
- Product Customer  service  
here
- Promotion
- Physical  Distribution

• Relative  importance  of  service  elements

- Physical  distribution  variables  dominate price,  product,  and
promotional  considerations  as  customer  service  considerations
- Product  availability and   order  cycle  time are  dominant  physical
distribution  variables

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Customer  Service  Elements

Customer  
service

Pretransaction Transaction Posttransaction

elements elements elements
• Written  statement   •Stockout level   • Installation,  warranty  
of  policy •Ability  to  back   alterations,  repairs,  
• Statement  in  hands   order parts
of  customer • Elements  of  order   • Product  tracking
• Organizational   cycle • Customer  claims,  
structure • Time complaints
• System  flexibility • System  accuracy • Product  packaging
• Technical  services •Product  substitution • Temporary  
replacement  of  
product  during  repairs

Common  Customer  Service  Complaints

31%
Product  or  quality
mistakes

12%  Damaged
goods
7%
Other

6%
Frequently  cut
items

44%  
Late  delivery

4-­‐8

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Penalties  for  Customer  Service  Failures

29%  
Reduced  the  
2%  
volume  of  
Refused  to  
business
support  
promotion

16%  
Discontinued  
items

18%  
Stopped  all  
purchases  
with  supplier

9%   26%  
Refused  to   Called  in  
purchase  new   salesman  or  
items manager
CR  (2004)  Prentice  Hall,  Inc.

Most  Important  Customer  

Service  Elements

•On-­‐time  delivery
•Order  fill  rate
•Product  condition
•Accurate  documentation

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Order  Cycle  Time

•! Order%cycle%time!contains!the!basic!elements!of!customer!service!
where!logistics!customer!service!is!defined!as:!
!
!!the$time$elapsed$between$when$a$customer$order,$purchase$order,$or$
service$request$is$placed$by$a$customer$and$when$it$is$received$by$
that$customer.$
$
•! Order%cycle%elements%
! ! 6!Transport!time!
! ! 6!Order!transmittal!time!
! ! 6!Order!processing!and!assembly!time!
! ! 6!Production!time!
! ! 6!Stock!availability!
!

•! Constraints!on!order!cycle!time!
! ! 6!Order!processing!priorities!
! ! 6!Order!condition!standards!(e.g.,!damage!and!filling!accuracy)!
! ! 6!Order!constraints!(e.g.,!size!minimum!and!placement!schedule)!

Components  of  a  Customer  Order  Cycle

WAREHOUSE
Order  processing  
Customer   and  assembly
order  
transmittal Transmittal  of  
backorder  items
CUSTOMER
Retail  outlet Order  
delivery

FACTORY
Express   Order  processing,  
order   assembly  from  stock,  or  
delivery production  if  no  stock

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Importance  of  Logistics  Customer  Service

• Service  affects  sales  
    -­  From  a  GTE/Sylvania  study:  
 
      ...distribution,  when  it  provides  the  proper  
levels  of  service  to  meet  customer  needs,  can  
lead  directly  to  increased  sales,  increased  
market  share,  and  ultimately  to  increased  profit  
contribution  and  growth.  
 
    -­  Service  differences  have  been  shown  to  
account  for  5  to  6%  variation  in  supplier  sales  
 
• Service  affects  customer  patronage  
    -­  Service  plays  a  critical  role  in  maintaining  the  
customer  base:  
 
           On  the  average  it  is  approximately  6  times  
more  expensive  to  develop  a  new  customer  
than  it  is  to  keep  a  current  one.  
 

Service  Observations

• The  dominant  customer  service  elements  

are  logistical  in  nature
• Late  delivery  is  the  most  common  service  
complaint  and  speed  of  delivery  is  the  most  
important  service  element
• The  penalty  for  service  failure  is  primarily  
reduced  patronage,  i.e.,  lost  sales
• The  logistics  customer  service  effect  on  
sales  is  difficult  to  determine

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Modeling  a  Sales-­‐Service  Relationship

•   A  mathematical  expression  of  the  level  of  service  

provided  and  the  revenue  generated  
 
•   It  is  needed  to  find  the  optimal  service  level  
 
•   A  theoretical  basis  for  the  relationship  
 
•   Methods  for  determining  the  curve  in  practice  
    -­  Two-­points  method  
    -­  Before-­after  experiments  
    -­  Game  playing  
    -­  Buyer  surveys  

Sales-­‐Service  Relationship  by  the  Two-­‐

Points  Method
Approximation  by
two-­points  method
Sales

0
0 Logistics  customer  service  level

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Determining  Optimum  Service  Levels

• Cost  vs.  service
• Theory
-Optimum  profit  is  the  point  where  profit      
contribution  equals  marginal  cost
• Practice
-For  a  constant  rate,
D P =  trading  margin  ´ sales  response  rate  ´
annual  sales
D C  =  annual  carrying  cost ´ standard  product  
cost  ´ demand  standard  deviation  
over  replenishment  lead-­time  ´ D z
Set  D P =  D C  and  find  D z  corresponding  to  a  
specific  service  level

Generalized  Cost-­‐Revenue  Tradeoffs

Revenue

Profit  
maximization
Costs  or  sales

Logistics  costs

0
0 Improved  logistics  customer  service

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Determining  Optimum  Service  Levels

(Cont’d)
•   Example  
    -­  Given  the  following  data  for  a  particular  product  
 
  Sales  response  rate  =  0.15%  change  in  revenue    
                                                             for  a  1%  change  in  the  
                                                                 service  level  (fill  rate)  
      Trading  margin  =  $0.75  per  case  
      Carrying  cost  =  25%  per  year  
      Annual  sales  through  the  warehouse  =  80,000  cases  
      Standard  product  cost  =  $10.00  
      Demand  standard  deviation  =  500  cases  over  LT  
      Lead  time  =  1  week  

Determining  Optimum  Service  Levels

(Cont’d)
Find  D P
D P =  0.75  ´ 0.0015  ´ 80,000
=  $90.00  per  year
Find  D C
D C =  0.25  ´ 10.00  ´ 500  ´ D z
=  1250  D z

Set  D P  =  D C and  solve  for  D z,  i.e.,  90.00/1250  =  D z
D z  =  0.072
For  the  change  in  z found  in  a  normal  distribution  table,  
the  optimal  in-­stock  probability  during  the  lead  time  
(SL*)  is  about  92%.

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DSL Levels  in  %  for  Various  Dz Values

DSL (%) zU – zL              = D z
U L
87-86 1.125-1.08 = 0.045
88-87 1.17 -1.125 = 0.045
89-88 1.23 -1.17 = 0.05
90-89 1.28 -1.23 = 0.05
91-90 1.34 -1.28 = 0.06
92-91 1.41 -1.34 = 0.07 Ü
93-92 1.48 -1.41 = 0.07 Ü
94-93 1.55 -1.48 = 0.07 Ü
95-94 1.65 -1.55 = 0.10
96-95 1.75 -1.65 = 0.10
97-96 1.88 -1.75 = 0.13
98-97 2.05 -1.88 = 0.17
99-98 2.33 -2.05 = 0.28
*Developed  from  entries  in  a  normal  distribution  table

Graphically  Setting  the  Service  Level

350

300 Change  in

safety
stock  cost,  DC
250
$/year

200

150
Change  in  gross  profit,  DP  
100

50

0
87-­‐86 88-­‐87 89-­‐88 90-­‐89 91-­‐90 92-­‐91 93-­‐92 94-­‐93 95-­‐94 96-­‐95 97-­‐96 98-­‐97 99-­‐98

Probability  of  being  in  stock  during  replenishment  lead  time,  %

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Optimizing  on  Service  Performance  Variability

Setting  service  variability  according  to  Taguchi

• A  loss  function  of  the  form  L = k (y - m)2

L =  loss  in  $
k =  a  constant  to  be  determined
y =  value  of  the  service  variable
m =  the  target  value  of  the  service  variable
Service  penalty  only  if  outside  this  
Cost  penalty,  L

range¾Traditional

Missing  target  causes  

increasing  penalty  ¾
Taguchi
Target y
Service  variable,  m

Optimizing  on  Service  Performance  

Variability (Cont’d)
•Setting  the  allowable  deviation  from  the  target  service  level  m is  
to  optimize  the  sum  of  penalty  cost  for  not  meeting  the  service  
target  and  the  cost  of  producing  the  service.
TC =  service  penalty  cost  +  service  delivery  cost  
If  the  service  delivery  cost  is  of  the  general  form  DC  =  A  - B(y-­m),
then  find  the  optimum  allowed  deviation  from  the  service  target.
2
TC = k ( y - m ) + A - B( y - m )
dTC
= 2k ( y - m ) + 0 - B = 0
d ( y - m )
B Marginal  delivery  cost  =  
y - m = marginal  penalty  cost
2k
If  m is  set  to  0,  y is  the  optimal  deviation  allowed  from  target

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Service  Variability  Example

Example Pizzas  are  to  be  delivered  in  30  minutes  (target.)    Pizzas  delivered  more  than  10  minutes  
late  incur  a  penalty  of  $3  off  the  pizza  bill.    Delivery  costs  are  estimated  at  $2,  but  decline at  the  
rate  of  $0.15  for  each  minute  deviation  from  target.    How  much  variation  should  be  allowed  in  the  
delivery  service?
Convert  fixed  penalty  to
Find  k Taguchi-­‐style  loss  curve

Cost  penalty,  $
L = k ( y - m)2 3
3 = k( 10 - 0 ) 2

3
k = 2 = 0.03
10 40
30
and  y  if  m  is  taken  as  0 Delivery  service,  min
0.15
y - 0 = = 2.5  minutes
2(0.03)

No  more  than  2.5  minutes  should  be  allowed  from  the  30-­‐minute  delivery  target  to  minimize  cost.

Service  Variability  Exercise

Another  fast  food  company  sets  the  time  target  of  its  delivery  service  to  30  
minutes  (target.)    Food  delivered  more  than  15  minutes  late  incur  a  penalty  of  $5  
off  the  bill.    Delivery  costs  are  estimated  at  $2,  but  decline at  the  rate  of  $0.18  for  
each  minute  deviation  from  target.    How  much  variation  should  be  allowed  in  the  
delivery  service?

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Setting  Service  Levels

•Service  treated  as  a  constraint  on  design
•Planning  for  service  contingencies

Measuring  Service  Performance

•Percent  of  sales  on  backorder
•No.  of  stockouts
•Percent  of  on-­time  deliveries
•No.  of  inaccurate  orders
•Order  cycle  time Most  comprehensive

•Fill  rate-­-­%  of  demand  met,  %  of  orders  

filled  complete,  etc.

Service  Contingencies
System  Breakdown  Actions
•Insure  the  risk
•Plan  for  alternate  supply  sources
•Arrange  alternate  transportation
•Shift  demand
•Build  quick  response  to  demand  shifts
•Set  inventories  for  disruptions

Product  Recall  Actions

•Establish  a  task  force  committee  
•Trace  the  product
•Design  a  reverse  logistics  channel

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