Many companies state their market-logistics objective as “getting the right goods to the right places at the right time for the least cost" Unfortunately, no system can simultaneously maximize customer service and minimize distribution cost. Maximum customer service implies large inventories, premium transportation, and multiple warehouses, all of which raise market-logistics costs. Given that market-logistics activities require trade-offs, managers must make decisions on a total-system basis. The starting point is to study what customers require and what competitors are offering. Customers want on-time delivery, help meeting emergency needs, careful handling of merchandise, and quick return and replacement of defective goods. The company must also consider competitors’ service standards. It will normally want to match or exceed these, but the objective is to maximize profits, not sales.
The firm must make four major decisions about its market logistics: (1) How should we handle orders (order processing)? (2) Where should we locate our stock (warehousing)? (3) How much stock should we hold (inventory)? and (4) How should we ship goods (transportation)?
Order Processing Most companies try to shorten the order-to-payment cycle—the time between an order’s receipt, delivery, and payment. This cycle has many steps, including order transmission by the salesperson, order entry and customer credit check, inventory and production scheduling, order and invoice shipment, and receipt of payment. The longer this cycle takes, the lower the customer’s satisfaction and the lower the company’s profits.
Warehousing Every company must store finished goods until they are sold because production and consumption cycles rarely match. More stocking locations mean goods can be delivered to customers more quickly but warehousing and inventory costs are higher. To reduce these costs, the company might centralize its inventory in one place and use fast transportation to fill orders. To better manage inventory, many department stores such as Nordstrom and Macy’s now ship online orders from individual stores.20
Inventory Salespeople would like their companies to carry enough stock to fill all customer orders immediately. However, this is not cost effective. Inventory cost increases at an accelerating rate as the customer-service level approaches 100 percent. Management needs to know how much sales and profits would increase as a result of carrying larger inventories and promising faster order fulfillment times and then make a decision.
As inventory draws down, management must know at what stock level to place a new order. This stock level is called the order (or reorder) point. An order point of 20 means reordering when the stock falls to 20 units. The order point should balance the risks of stock-out against the costs of overstock. The other decision is how much to order. The larger the quantity ordered, the less frequently an order needs to be placed. The company needs to balance order-processing costs and inventory-carrying costs. Order-processing costs for a manufacturer consist of setup costs and running costs (operating costs when production is running) for the item. If setup costs are low, the manufacturer can produce the item often; if setup costs are high, the firm can reduce the average cost per unit by producing a long run and carrying more inventory.
Order-processing costs must be compared with inventory-carrying costs, which include storage charges, cost of capital, taxes and insurance, and depreciation and obsolescence. The larger the average stock carried, the higher the inventory-carrying costs. This means marketing managers who want to carry larger inventories need to show that incremental gross profits will exceed incremental carrying costs.
We can determine the optimal order quantity by observing how order-processing costs and inventory-carrying costs add up at different order levels. Figure 13.1 shows that the order-processing cost per unit decreases as the number of units ordered increases because the order costs are spread over more units. Inventory-carrying charges per unit increase with the number of units ordered because each unit remains longer in inventory. We sum the two cost curves vertically into a total-cost curve and project the lowest point of the total-cost curve on the horizontal axis to find the optimal order quantity Q .21
Companies are reducing their inventory costs by keeping slow-moving items in a central location and carrying fast-moving items in warehouses closer to customers. They are also considering inventory strategies that give them flexibility should anything go wrong, whether a dock strike in California, an earthquake in Japan, or political turmoil in North Africa. The ultimate answer to carrying near-zero inventory is to build for order, not for stock.
Transportation Transportation choices affect product pricing, on-time delivery performance, and the condition of the goods when they arrive, all of which affect customer satisfaction. In shipping goods to its warehouses, dealers, and customers, a company can choose rail, air, truck,
FIGURE 13.1 Determining Optimal Order Quantity
waterway, or pipeline. Shippers consider such criteria as speed, frequency, dependability, capability, availability, traceability, and cost. For speed, the prime contenders are air, rail, and truck. If the goal is low cost, then the choice is water or pipeline.
Shippers are increasingly combining two or more transportation modes, thanks to containerization, putting the goods in boxes or trailers that are easy to transfer between two transportation modes. Piggyback describes the use of rail and trucks; fishyback, water and trucks; trainship, water and rail; and airtruck, air and trucks. Each coordinated mode offers specific advantages. For example, piggyback is cheaper than trucking alone yet provides flexibility and convenience.
Shippers can choose private, contract, or common carriers. If the shipper owns its own truck or air fleet, it becomes a private carrier. A contract carrier is an independent organization selling transportation services to others on a contract basis. A common carrier provides services between predetermined points on a scheduled basis and is available to all shippers at standard rates. To reduce costly handing at arrival, some firms are putting items into shelf-ready packaging. To reduce damage in shipping, the size, weight, and fragility of the item must be reflected in the crating technique used and the density of foam cushioning.22 With logistics, every little detail must be reviewed to see how it might be changed to improve productivity and profitability.