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Supply Chain Optimization – 101
By KEOGH Consulting

Optimizing the supply chain involves satisfying or exceeding customer demands, at the lowest operating cost. While this is generally true, there are organizations that move to a higher cost facility network to provide the best level of customer service. This is seen in the growing trend to have more, smaller distribution centers located closer to an organizations end customers. Wal-mart is an exception to this trend, with many distribution centers, strategically located, but many over a million square feet. And, with a growing number of companies acquiring other businesses with existing distribution centers, another network trend is consolidation. The challenge then is which facilities to close, and where to locate the consolidated facility. With so many factors involved in deciding how many facilities to operate, where to locate them, what customers to serve from each, what inventory to store where, and what size to make each facility, there is a growing need for organizations to understand the basics of supply chain optimization.

The four main logistics cost drivers are information, inventory, facilities and transportation. Information costs become more important with shorter delivery lead-times. If delivery lead-times are short, it is important to monitor shipment information to allow adjustments to transportation modes and carriers. This can increase the cost of information system software and hardware. Most companies hold a minimum safety stock or inventory level for the same products at each distribution center. As a result, inventory costs increase as facilities are added to the network. If products are dedicated to specific facilities, then increases in inventory costs can be minimized. Facility costs increase as the number of distribution centers or space is increased. The objective is to exploit economies of scale to keep facility costs low. However, if your network has only two distribution centers, you may incur higher transportation costs and longer delivery lead-times. This leads to the transportation factor, which is often the key to optimizing the supply chain network. Transportation has many associated costs and options that should be evaluated to satisfy customer demand and control transportation costs.

Transportation Costs

Transportation costs have two factors: outbound to customers and inbound from suppliers. Typically, outbound transportation costs drive the total cost of freight due to a higher number of less-than-truckload (LTL) and small parcel shipments. The industry average for outbound transportation costs is 70% to 80% of the total transportation costs. The inbound shipments are typically truckload (TL) and / or rail shipments at lower rates. As a result, a common strategy is to add distribution centers to get closer to the customers. The addition of facilities leads to an initial reduction in total transportation costs. However, if too many facilities are added to the network, the increase in LTL shipments from inbound suppliers can increase transportation costs.

Transportation Modes

The five primary modes of transportation include air, water, rail, trucking and pipeline. In addition, there are inter-modal combinations that are associated with integrating rail with truck and ocean modes. The two primary modes based on U.S. tonnage shipped are truck carrier and rail. In terms of revenue, truck carriers’ jumps to a higher level above rail. Pipeline is used for moving bulk commodities (i.e. oil), but isn’t part of a typical distribution center network.

Trucking carriers (motor) offer point-to-point service between almost any origin-destination combination and provide the widest market coverage of any mode. The most common trucking options used in distribution centers are small parcel, truckload (TL) and less-than-truckload (LTL). Small parcel is used mainly for small volume outbound shipments and competes with LTL carriers. TL carriers compete with rails for larger volume shipments that are transported more than 500 miles. The average length of haul for trucking carriers is approximately 500 miles. The flexibility and versatility of trucking carriers has enabled them to become the dominant form of transport in the Americas and in many other parts of the world. Trucking rates are expected to increase again this year at a rate of 3% to 4%. The primary reasons for this increase are higher fuel costs and insufficient carrier capacities.

Rail is mainly used to ship large volumes inbound and has an average length of haul of approximately 750 miles. The rail network is not nearly as extensive as the highway network and is limited to fixed track facilities. As a result, rail provides terminal-to-terminal service rather than point-to-point service unless companies have a rail siding at their facility. Rail transport generally costs less (on a weight basis) than air and trucking, but compared to trucking carriers, has disadvantages in terms of transit time and frequency of service. Some of this rail disadvantage is overcome through the use of trailer-on-flatcar (TOFC) or container-on-flatcar (COFC) services. These inter-modal options offer the economy of rail movements with the flexibility of trucking routes. TOFC and COFC are referred to as piggyback service and is a growing trend in the industry for moving goods over 700 miles.

Airfreight offers the quickest time-in-transit of any transport mode. Although increasing numbers of shippers are using airfreight for regular service, most view air transport as premium, emergency service because of its high cost. Shipping competition varies between domestic and international needs. Domestically, airfreight mainly competes with trucking carriers, whereas the major competitor for international airfreight is water carriage. Air carriers usually transport high-value products because it cannot be justified for low-value items. Air transport provides frequent and rapid time-in-transit service, but terminal delays and congestion reduces some of the advantages. Over short distances, trucking transport can often match or out perform the air total transit time. As customers demand higher levels of service and international shipments increase, air may have a greater role in the supply chain plans of many companies. However, increasing security issues must be considered for the impact on transit time and costs.

Water transportation includes several distinct categories: inland waterway, lakes, coastal and inter-coastal ocean, and international deep sea. Water is the dominant mode in international shipping and is the most inexpensive method of shipping high-bulk, low-value commodities. Containers play a big role in domestic and most international water shipments. The shipper places cargo into a container at its facility. The container is then transported by rail or trucking carriage to a water port for loading onto a container ship. After arrival at the port, it is unloaded and loaded onto a rail or trucking carrier and delivered to the customer. The use of containers for inter-modal logistics reduces staffing needs, minimizes in-transit damage and pilferage, and shortens time-in-transit because of reduced port turn around time. Containers are typically 8 feet high by 8 feet wide and of various lengths from 20 feet to 53 feet. The container ships are capable of carrying the equivalent of 6,000 twenty-foot containers. Today, there are many problems at the ports impacting the timeliness of unloading containers from ocean liners. The increase in import volumes, aging port equipment, shortage of rail capacities and limited number of truck drivers and carriers are contributing to this growing problem.

Determining Strategy

The mode of transportation selected impacts customer delivery times, transportation costs, inventory levels, and the size and number of distribution centers. The inventory level and resulting size of the facility is impacted by the frequency of shipments and timeliness of deliveries. Once “physically” optimized, the supply chain management technology must enable the facility network to run efficiently. This technology includes warehouse and transportation management systems which provide data for performance measurements and continuous improvement. In addition, your business processes should support the optimized facility network and ensure that the ultimate business objectives are satisfied.

Given an understanding of modes, there are remaining decisions to be made regarding transportation management strategies. An analysis of using private fleets, carriers, and / or freight forwarders is the next step. The key is to optimize the strategy based on your specific criteria, which may include higher service levels, required capacities, flexibility and low logistics costs.

The transportation industry is being challenged today by ocean containers delayed at the ports, rail and trailer capacity constraints, shortage of drivers, and rising gas prices. If your customer service levels are decreasing and logistics costs are rising, it is time to review and optimize your facility network. The competitive advantage realized can set you apart from the competition.