Supply Chain Vector [Electronic resources] : Methods for Linking the Execution of Global Business Models With Financial Performance نسخه متنی

Logistics and International Materials Management

As was illustrated in the section on the operational role of a 3PL firm in global supply chains, many of the tasks exclusive to the logistics arena have far-reaching consequences for an organization. Based on the quality of 3PL execution, the strategic question becomes: What is the broader effect on supply chains as these activities resonate across the operating model? Returning once again to the heart of manufacturing planning and control, the answer can be found in lead times and inventory accuracy. Digging a bit further into the lexicon of manufacturing planning and control, the role of logistics and its enterprise-wide value can be linked to a trio of terms that have yet to be discussed: order points, safety stock and min/max systems.

Even with the advent of just-in-time (JIT) systems and their emphasis on zero inventory levels, many organizations use either a hybrid of materials requirements planning (MRP)/JIT or have stuck with their battle-tested MRP systems. The reality of working globally is that most organizations, especially manufacturers that deal with suppliers and customers in several countries, still carry a sufficient amount of inventory to cover both forecast and supply chain variances. For this reason, those same companies utilize software that designates order points as well as order quantities. The former is referred to as an order point system, and an example of the latter is the min/max system. Safety stock, on the other hand, is defined as additional inventory that is kept to offset errors in a forecast. If these terms sound familiar, it is because they are the tactical handmaidens to the frequently mentioned and all-important practices of lead time offsetting and gross to net exploding. Based on these discussions, the relevance of logistics and the role of a 3PL provider in this exercise should at this juncture be predictable.

Order points are very important in global operations due to the expansive nature of an international model. With suppliers oftentimes in dozens of countries, each component in a bill of material must be accounted for and its corresponding order point designated in the individual component's software file. Needless to say, order points can vary depending on production volumes, supplier location and mode of transport. Although these factors are important, the technical definition of order points singles out the logistics function as a critical factor to success. The order point formula is

Demand during lead time + Safety stock

As a part of the MRP process, cumulative lead times are estimated for each component that goes into a product; the planning horizon for any end product is as long as the longest cumulative lead time for a specific component. The accuracy of cumulative lead times, defined as the total amount of time that transpires from the moment a need is recognized until that need is fulfilled, [1] is essential to seamless supply chain movements. Because transportation lead time can represent a significant percentage of cumulative lead time, the accuracy and consistency of this variable are equally important to operational success. If lead times are not accurate, variation is introduced to the process, which creates repercussions that invariably result in growing levels of inventory.

Although the logistician's perspective is important to this discussion, to understand the supply chain role of the 3PL firm one must take the position of a production planner or buyer. Based on the information found in the component files of a bill of material, planners or buyers theoretically know exactly when they have to place an order so that it will arrive at the moment needed in production. However, when a product or component does not arrive as scheduled, two very human occurrences take place. In order to avoid the future possibility of lost production time or lost sales, buyers will place their orders sooner and typically buy more than is called for in the gross to net exploding calculation.

Whereas this creates a sense of security for the buyer or planner, the downside is that inventories increase disproportionately to what was designated in the forecast. From this vantage point, the reliability of lead times has a tangible effect on inventory levels and the amount of money committed to them. As lead times become reliable and the trust of planners and buyers is earned, orders can be placed in the quantities and at the times originally set up by the MRP module and in some cases reduced. Ideally, an organization can look to its 3PL provider to assure the reliability and consistency of lead times.

Achieving lead time reliability is the first step in eliminating "nervousness" from supply chain processes. Once this is achieved, efforts can be made to reduce lead times, an exercise that also has an effect on inventory levels. Recall that the order point calculation is the sum of demand during lead time + safety stock and that the planning horizon for a product is equal to the longest cumulative lead time for a given component; therefore, any reduction in lead time will lead to a corresponding reduction in inventory investment. From the 3PL viewpoint, the transportation component of cumulative lead time can be improved in a variety of ways.

One area in which to focus involves the use of ocean transportation for international shipments. It is common knowledge that ocean transportation is less expensive than airfreight, so organizations that plan well are willing to forego lead times for costs savings. Although an argument could be made that the carrying costs of goods on the ocean may offset the savings in transportation, under normal circumstances and depending on the product, ocean transportation is a reliable and cost-effective way to move goods. Within this mode of transport, however, there are tactics that can be used to enhance the slower lead times inherent to it.

For example, some organizations focus on the cost of ocean freight without considering the service levels (i.e., transit times) available for specific routes. Based on the steamship line employed, lead times may vary for the same route (Asia to Europe, for example), based on the number of ports called upon during the journey. Thus, whereas a company may "save" $500 on a 20-foot container with one steamship line, its lead time may increase by as much as 12 days due to multiple ports of call along the way. Other options, although $500 more expensive, will have fewer ports of call and arrive at the destination port sooner.

Depending on the value of the goods, the carrying costs for 12 days in this instance may far outweigh the $500 savings. The company that takes this advanced approach to logistics and SCM would more than likely opt for the shorter lead time with nominal increased costs. The 3PL firm, with its vast knowledge of ocean carriers, ports of call and transit times, takes a lead role in determining the best options available to the client.

In two separate instances, the discussion on logistics has alluded to the benefits of using the same 3PL firm on either end of an international transaction. For reasons already discussed, there are many benefits to using the same service provider at origin and destination, including greater control over the flow of goods and better supply chain visibility. With regard to asset management and cumulative lead times, there are also benefits.

When the customs broker at the destination is related to the forwarder at the origin, documentation and information necessary for customs clearance go directly to the broker. Depending on the country of importation, a pre-clearance can be effected or, at the very least, the customs entry can be prepared for submission in advance of the arrival of the merchandise. When the parties are not related, documents are first sent to the destination office of the forwarder and then transferred to the unrelated customs broker. There are costs inherent to the latter exercise (currency adjustment and/or documentation transfer fees), but perhaps more important is the time lost in completing the additional steps in the process. Under the best of circumstances, at least two business days are lost in the destination port while the transfer of documentation is completed to the assigned customs broker.

Two days may not sound like a lot, but when an organization deals with millions of dollars in merchandise during the course of a year, two days in carrying costs adds up to serious money. Operationally, two days of lost production time or sales opportunities also represents considerable unnecessary inventory investment and revenues that cannot be recovered. Also, if a company is paying a premium for airfreight services, two or three days lost at the destination airport defeats the purpose of moving the goods by air. For all of these reasons and many more, use of a 3PL company that seeks ways to reduce costs while improving lead times is invaluable to any global organization.

Recall that the order point formula is demand during lead time + safety stock; therefore, anything a 3PL firm can do to reduce lead times will result in placement of smaller orders and, hence, less cash committed to inventories. Focus on the demand during lead time component of the formula makes this point abundantly clear. Specifically, if the lead time is reduced, the quantity needed for the shorter period is also reduced. Table 6.2 offers an example. For a component with a cumulative lead time of six weeks, a forecasted weekly consumption of 10,000 units and safety stock of 15,000 units, the order point is at 75,000 units. If cumulative lead time were improved by one week vis--vis 3PL initiatives, the new order point would be hit at 65,000 units.

Table 6.2: Order Points and Lead Time Reduction

The improvement wrought by the 3PL firm has allowed the inventory of this component to be depleted by an additional 10,000 units prior to having to place another order, thus delaying the implications for inventory and accounts payable on the balance sheet by one week. If the component costs $5, that delays $50,000 worth of inventory hitting the books by seven days. For a product that has a hundred different components, the overall effect of 3PL activities on inventory levels adds up to a significant amount of cash.

The preceding discussion considers the effect of 3PL on inventory levels as it relates only to reducing lead times. However, the impact that 3PL can have on safety stock must also be considered. In a domestic model, the definition of safety stock is additional inventory that is carried to cover for errors (variation) in the forecast.

In a global model, many companies carry safety stock to cover not only forecast error but also supply chain unknowns such as transit time variance, customs clearance delays and supplier problems. Although a 3PL firm cannot do a lot about supplier problems (except maybe inform its client about past-due purchase orders), it certainly has an effect when it comes to stabilizing transportation lead times. As was the case with order points, if the 3PL firm can bring predictability to international lead times, organizations are more inclined to reduce or even eliminate safety stocks, with the desired effect of reducing overall inventory levels.

In addition to the impact that 3PL can have on order points and safety stock, it also can figure in the determination of min/max quantities. Basically, min/max systems are used to set a range of quantities that can be ordered for a given component or product. They are designed to minimize the amount of money dedicated to inventories while assuring product availability, and the accuracy of min/max systems weighs heavily on SCM. Specifically, as raw materials are consumed in a production process (or sold as finished goods), the amount kept in inventory cannot fall below the minimum amount specified in the component/product file. Conversely, the maximum figure represents the amount up to which a new order can be placed.

For example, if a given component has a min/max of 1,000 and 6,000, this means that the minimum quantity of inventory cannot fall below 1,000 units and the replenishment amount cannot exceed 6,000. Not unlike the rationale behind the relationship between lead times and safety stock, the reliable lead times managed by 3PL firms can also compel an organization to reduce the minimum amount required in inventory for products and/or components.

[1]APICS Dictionary, The Educational Society for Resource Management, 1996.