I was recently asked by a large food manufacturer to help them develop a formal logistics organization. At the kickoff meeting the participants spent the first two hours arguing with one another about who should be represented in the new organization. As utter frustration was setting in and the first meeting was about to adjourn by default, it finally dawned on me why we were not able to make any progress. Each person in the room came to logistics without a formal degree in logistics and from a different professional discipline. One came from marketing, another from sales, another from material management, another from manufacturing, another from warehousing, another from transportation, and another was the nephew of the chairman of the board. As a result each had his or her own different definition of logistics. It is impossible to develop anything, let alone an organization, for a process that is not even defined, and where each of the major players speaks a different language.
Remember what God did to humble the people who were trying to build a monument to themselves reaching all the way to Heaven. He gave them all a different language, so that the people could not communicate with each other. As a result, they could not complete the construction of the tower. We are the same way in logistics; if we can’t speak the same language, we can’t start, let alone finish a project.
There are many definitions of logistics circulating in the world of supply chain management – almost as many as there are supply chains. We developed a simple definition over 20 years ago. Logistics is the flow of material, information and money between consumers and suppliers.
Much can be learned from the three parts of that simple sentence. First, logistics is “flow”. Flow is a good thing! What happens to water when it stops flowing? Stagnation, scum, insects, and possibly death. What happens to blood when it stops flowing? The nerds in the group always say, “coagulation”. The non-nerds usually just say, “somebody dies.” The point is, when material, information, and money stop flowing, some elements of the business and supply chain become unhealthy and potentially die. Even the highest performing professionals may lose their jobs when those flows stop. Customers and shareholders become disgruntled when those flows stop. Flow is a good thing!
Second, material, information, and money should flow simultaneously, in real-time and without paper.
Lastly, logistics flow should be viewed, considered, and modeled bi-directionally, “between consumers and suppliers”. Otherwise, its design will be sub-optimal.
We can also learn about “logistics” from its root, “logic”. According to Webster, “logic” means “reason or sound judgment”. Unfortunately reason and sound judgment are missing from many logistics and inventory decisions. Wisdom and sound judgment often fall prey to the tyranny of self-imposed deadlines and/or prevailing fads and philosophies. Ironically, “logic” has gone missing from a lot of logistics.
On the left (in green) is the ratio of the standard deviation of the mean to the average of the mean. The higher that percentage, the more variable is the demand. The other indicator that you see is the number of days in the year that the item had activity. If you look at the very first item, it had 330 days in the year with activity, and the standard deviation of demand over the average demand is 100 percent which means it is one. Based on what you see in that graph, what is the relationship between the popularity of the item and the demand variability? It sounds like a good quiz question. All right, fill in the blank. Items that are very popular have a higher or lower demand variability than items that are hardly ever ordered? Lower demand variability and usually a higher forecast accuracy because you get to see the demand more often, so you have a better chance to predict it. Suppose you are a basketball team and you are in a conference. For example, in the ACC Georgia Tech may play Carolina three, sometimes four times in the year. They play them at home, they play them away, they may play them in the ACC tournament, and they may play them in the NCAA tournament. How well do you think Georgia Tech can forecast what Carolina is going to do in a game by the time they get to the NCAA tournament? They know exactly what they are going to do. They can call the play for the other team.
The third set of RightChain™ decisions work in the area of supply. Supply is the process of producing or acquiring inventory sufficient to meet the targets established in inventory planning. The objective of supply management is to maximize the financial performance of production and/or acquisition while meeting the availability, response time, and quality requirements stipulated in the customer service policy and the inventory strategy. Since we have to make up gaps between supplier service and customer service with excess inventory and/or excess transportation costs, we need high performance suppliers who have the same (or greater) passion for customer service that we do.
Optimizing supply (RightBuys™) includes supplier valuation (RightCard™), supplier optimization (RightCore™), supplier service policy (RightTerms™), sourcing (RightSource™), and supplier integration (RightLinks™). Those activities and their related decisions have a major impact on inventory requirements. Inefficient and unreliable suppliers with unpredictable leadtimes require us to carry excess inventory to cover their unreliability. Efficient and reliable suppliers supplying fast moving items with predictable demand allow us to take advantage of inventory reduction strategies such as cross docking and non-stop putaway.
Of all the supply-based decisions, sourcing, the allocation of business to suppliers and the related choice of purchasing terms, has the greatest impact on inventory. Unfortunately, of all the groups working in supply chain management, the sourcing and procurement organization is the least likely to be trained in inventory and supply chain management. To help make the connection in one client engagement, I recommended that sourcing and procurement move from their posh offices at headquarters to a set of cubicles in the warehouse overlooking the receiving dock. It was highly unpopular but highly effective. The people making the decisions could literally see (and sometimes hear and feel) the impact of their decisions.
Just as suppliers need visibility into our inventory levels to execute vendor managed inventory programs, we need visibility into our supply partner’s inventory, production schedule, and production capacity to permit supply chain scheduling and optimization. Demand information sharing and supplier visibility are two essential elements that build trust between supply partners and form the foundation of supplier integration. Our human nature only trusts what we can see. For some reason, we don’t trust what we can’t see. As a result, any blind spots in the supply chain become seedbeds for excess inventory buildups to cover worst case scenarios.
There are a variety of web-based tools available in the marketplace today that permit total supply chain visibility.
Just like there is an optimal production schedule for a factory that minimizes the total production and inventory carrying cost given labor and material availability; manufacturing and storage capacity; and demand requirements, there is an optimal supply chain schedule that minimizes the total cost to consumption including inventory carrying, transportation, warehousing, and lost sales given the supply chain’s production, transportation, and warehousing capacity and inventory requirements at every node in the logistics network. In some supply chains a fourth party (Figure 1) is used to produce the optimal schedule with each major player (supplier, customer, carrier) sharing true demand and capacity information with the fourth party who has the responsibility to produce an optimal supply chain design and operating schedule including retail receiving hours, warehouse shipping and receiving schedules, transportation schedules, and production schedules.
One fallacy in supply chain scheduling is that all scheduling should be pull-based. Study after study has revealed that a mix of pull and push-based scheduling techniques characterize supply chain optimization. Tools such as the IBM supply chain simulator and the growing list of supply chain planning tools are required to identify the appropriate mix and links for pull and push-based scheduling.
We also help make the sourcing and inventory connection with sourcing optimizations that take into consideration the full set of parameters and buying terms that impact the financial, service, operations, and inventory performance of the buy. An example RightBuys™ sourcing optimization is presented
The example is from a recent supply chain strategy project in which the client was considering moving a large portion of their supply base to China and eastern Europe. In fact, the far-sourcing train had a lot of momentum when we were asked to help them consider the full supply chain ramifications of the decision.
As we typically do, we put each of their SKUs through our RightBuys™ Sourcing Optimization System. The optimization revealed that about 1/3 of the SKUs needed to remain domestically sourced, about 1/3 should be sourced in China, and the remaining 1/3 in eastern Europe.
Initial Unit Cost ( First Cost)
Our analysis considers the three main cost elements of sourcing decisions. The first is the initial unit cost (sometimes referred to as the first cost) offered from each supplier. Those costs ranged from $4,101 per unit from the eastern European candidate to $6,906 per unit from the incumbent domestic supplier.
The second group of costs are landing costs. Landing costs include inbound freight, customs brokerage, freight forwarding, export compliance, sourcing organization fees, duties, banking fees, and the cost of poor quality. In this case the unit landing costs ranged from $146 with the incumbent domestic supplier to $998 per unit from the Chinese supplier. The sum of unit landing cost and initial unit cost is the unit landed cost. Unit landed cost ranged from $4,628 to $6,914.
Inventory Carrying Costs
The third set of costs is inventory carrying costs. Some sourcing analyses consider landing cost implications, but few incorporate inventory carrying cost. We include the three buckets of inventory described earlier – safety stock, lot size, and pipeline inventory. As expected, inventory carrying costs from the international suppliers are much higher. The inventory carrying costs for each option range from $11,005 from a candidate domestic supplier to $20,246 from the Romanian supplier.
Total Acquisition Cost
The sum of inventory carrying and landing cost is the total cost of acquisition. The total cost of acquisition ranges from $1,408,646 to $2,085,405. The unit cost of acquisition ranges from $4,695 from the Romanian supplier to $6,951 from the domestic incumbent.
It is rare for one sourcing option to dominate the evaluation criteria, but that was the case here. The eastern European option provided the lowest total acquisition cost, the highest project margin, the highest return on sales, the highest inventory value added, and the shortest payback.