ENGR 3210 Fundamentals of Logistics Engineering

1. ENGR 3210 Fundamentals of Logistics Engineering Class 5 September 6, 2002

2. 2 Summary from our last class Products can be classified in a number of different ways The classification schemes can be both qualitative and quantitative The logistics system design can and should vary for different classifications of products

3. 3 Today Product characteristics and logistics design Product pricing and logistics Logistics costs and incentive pricing schemes

4. 4 Product Characteristics as indicators of Logistics Design Components Product Characteristics Weight Volume Value Perishability Flammability Substitutability Logistics Design Warehousing Inventories Transportation Materials Handling Order Processing

5. 5 Product Characteristics and Logistics Planning Combinations of these product characteristics influence the design of the Logistics System. Common examples include: Weight – bulk (volume) ratio (Density) Value - weight ratio Substitutability Risk

6. 6 Storage and Transportation Costs To provide a metric for product impact, consider two classifications of logistics costs. Transportation : the cost of moving the product to the market. Storage: covers costs related to inventory, warehouse size and number, material handling, etc. What are the general effects of Product Characteristics on these Logistics Cost classifications?

7. 7 Weight - bulk ratio (lbs. / ft3) Weight to volume ratio (product density) impacts both transportation and storage planning. Potato chips are shipped in cases that weigh 6 pounds and have a volume of 8 ft3 - - 0.75 lbs/ft3. Paint is shipped in cases that weigh 35 lbs and have a volume of 2 ft3 - - 17.5 lbs/ft3

8. 8 Weight - bulk Ratio Impact Both storage and transportation decrease as the ratio increases- advantageous in most cases. Logistics $ reduction declines faster than price so (logistics $/sales$) ratio shrinks. Low ratios are easy to handle but high transport and storage costs

9. 9 If logistics costs decrease as densities increase how do we design our logistics system? Ship and store forms of the product when it is at its highest density Postponement (assembly postponement) is one strategy which takes advantage of this relationship (IKEA)

10. 10 Value- weight Ratio ($/lb.) Logistics costs are sensitive to the value of the product. Value - weight helps to see these tradeoffs. Low value to weight (bulk materials) are expensive to transport but cheap to store High $/lb. items (electronics) are cheap to transport but expensive to store

11. 11 Implications for Logistics Strategy Transportation makes up the lion’s share of Total Logistics Costs for bulk materials (coal, iron ore, sand) Therefore you focus on reducing transportation costs The opposite is true for high value-weight ratio products (electronics, jewelry, furniture) Focus on reducing inventory

12. 12 Substitutability If a product can be replaced by an alternative, there are serious implications for the logistics system. The cost of lost business is an added term in the total cost equation. Brand loyalty??? - the customer may like the other product and be lost forever. It may make sense to increase spending on transportation or inventory to assure availability.

13. 13 Substitution and Transportation For a fixed inventory investment, improved transportation can reduce lost sales and therefore total cost

14. 14 Substitution and Inventory For a fixed transportation service (and cost) expanded inventory levels can reduce lost sales and therefore total cost

15. 15 Product Risk Characteristics Many products present risk issues that impose restrictions on the logistics system and limit the design options which can be considered: Perishability Fragility Susceptibility to theft Flammability Dealing with these risks add costs: Insurance, Refrigeration, Security, Fire Protection etc.

16. 16 Risk vs. Logistics Costs relationships

17. 17 Product Packaging and Logistics Packaging is added to nearly every product. Why? To facilitate storage and handling (Paint) To enable better utilization of transportation and material handling equipment (palletized wrapping) To protect the product (meat) To promote the sale of the product (cereal) To change product density (potato chips) To facilitate use of the product (quarts of oil) To provide re-use value (souvenir cups)

18. 18 Packaging and Logistics System Design decisions are related as we try to satisfy some of these packaging goals To facilitate storage and handling To enable better utilization of transportation and material handling equipment To protect the product To promote the sale of the product To change product density To facilitate use of the product To provide re-use value Strike a balance between marketing and logistics

19. 19 Product Pricing Along with quality and service, cost is a key discriminator for the customer. The issues associated with pricing are complex and a mixture of art and science. The Logistics Engineer may have some impact on two types of pricing: Geographical pricing Incentive pricing

20. 20 Geographical Pricing Transportation adds cost to the product The longer the haul, the higher the cost of transportation Therefore customers located at different distances from the point of production create different costs (and should be charged different prices) But in most cases we can’t charge customers radically different prices We need to balance the detail used in the pricing structure with the costs to manage a very complicated pricing structure For that reason there are a number of pricing methods for which the Logistics Engineer has some influence

21. 21 Geographic Pricing Structures FOB pricing; location at which the quoted item price is effective (typically at factory or at point of delivery) This pricing method defines who owns the goods during transit and who pays for the transportation (See Figure 3-7) Zone pricing: the UPS and mail method Different zones (distances from point of manufacture) are priced differently Uniform pricing One price fits all

22. 22 More Geographic Pricing Freight equalization Competitive pressures force producers far away from the potential customer to come down to the close competitor’s price Basing point pricing Establishes a point other than origin to price the product (again to meet a competitor’s pricing advantage when he is closer to the customer than you Where the product has high transport cost, customers are indifferent to who produces it and there are few producers (steel industry)

23. 23 Legal concerns with pricing In general it is illegal to offer different prices to customers if it is done to lessen competition and create a monopoly Pricing has to be generally in line with the cost of producing, selling and distributing the product Logistics costs however have well understood volume-cost breaks For that reason differential logistics costs are often used to support various incentive pricing schemes

24. 24 Incentive Pricing Essentially the more you buy the cheaper per unit you will be charged If challenged the “discriminatory” prices have to be justified on the basis of cost Logistics costs are one component of price that can be supportive of that justification process

25. 25 Summary of today The characteristics of the product have sometimes profound impacts on total logistics costs Product density, product value per pound, product substitutability and risk can drive transport and inventory costs in different directions. Minimizing total costs requires finding the best combination of the two. Packaging of products can also affect logistics transport and storage costs. A balance between packaging for marketing purposes and packaging to reduce logistics costs must be sought for each product.

26. 26 Summary part 2 Logistics costs (particularly transportation) affect product cost and therefore affect product prices. Transport costs vary by customer location so pricing structures must be clear as to whether the buyer or the seller is responsible for that portion of the product cost. The variation in Logistics costs is often used as justification for incentive pricing.

27. 27 For our next class Customer Service and Order Cycle Time Don’t forget your paper proposal due next Friday