BUSINESS LOGISTICS

Business Logistics 562

Photo by: Franck Boston

Business logistics refers to a group of related activities all involved in
the movement and storage of products and information—from the
sources of raw materials through to final consumers and beyond to
recycling and disposal. Business logistics is a relatively new term and
concept in modern business vocabulary; its origins can be traced back to
World War II when the ability to mobilize personnel and material was
critical to the outcome of the war. The first university level courses and
textbooks dealing with business logistics appeared in the United States in
the 1960s.

The relatively recent development of business logistics has led, as it has
evolved, to the use of a variety of terms to refer to it. In the 1960s and
1970s the terms

physical distribution,

distribution, materials management, and physical supply were common.
Physical distribution and distribution refer to the outbound flow of goods
from the end of the production process to the consumer; physical supply
and materials management refer to the inbound flow of material to the
production process. As the importance of coordinating the entire flow of
material from the raw materials to the end consumer became recognized, the
term business logistics became widely used to reflect the broadening of
the concept. Today, the term

supply chain management

is coming into use to reflect the importance of forming alliances and
partnerships to streamline the flow of materials. Business logistics
remains the dominant, all-encompassing term for this important concept at
this time.

The most widely used definition of business logistics is that of the
Council of Logistics Management (CLM) of Oak Brook, Illinois, the largest
and best known of the professional logistics organizations. The CLM
definition states, “Logistics is the process of planning,
implementing and controlling the efficient, effective flow and storage of
raw materials, in-process inventory, finished goods, services, and related
information from point of origin to point of consumption (including
inbound, outbound, internal, and external movements) for the purpose of
conforming to customer requirements.”

For many people, what is often referred to as the “seven
rights” provides a good working definition of logistics. The seven
rights state that the logistician’s job is to ensure the
availability of the right product at the right time in the right quantity
in the right condition at the right place for the right customer at the
right cost.

Although these definitions refer primarily to managing the flow of goods,
business logistics is also important in service organizations. It is
important to recognize that all firms produce both goods and services,
some more of one than the other, that all firms purchase supplies; and
that all must meet or exceed customer expectations. In service
organizations the logistician’s job is to ensure the provision of
all required inputs, including materials and information, at the point of
service delivery.

To the organization, business logistics is important in several ways.
First, business logistics provides an opportunity for the firm to create a
sustainable competitive advantage for itself by designing a system which
fulfills customers’ needs better than the

competition.

For example, the firm could offer faster, more accurate, and more
consistent order filling and delivery than competitors are capable of
providing. Secondly, due to its complexity, a superior logistics system is
a proprietary asset that cannot be easily duplicated. Many firms have
begun to view business logistics as an effective competitive weapon.

The activities that make up business logistics, such as transportation and
storage, are as old as trade itself. The concept of grouping them together
and managing them as a system, however, is quite new.

Traditionally, the responsibility for logistical activities has been
scattered throughout the organization. For example, transportation might
be under manufacturing, with finished goods inventory and warehousing
under

marketing

and sales. Where management of the logistics system is uncoordinated,
diseconomies will be found. For example, manufacturing may choose to
reduce transportation and manufacturing

costs

by producing and shipping in very large quantities—and in so doing
greatly increase the costs of storage and the investment in inventory well
beyond the amount saved in transportation costs. With proper coordination,
transportation, manufacturing, storage, and inventory, investment costs
could be balanced so that the firm’s total cost would be minimized.
The initial development of business logistics began in the 1950s with an
understanding of the potential for cost savings if the management of the
logistical activities was coordinated.

There were a number of factors present in the 1950s that encouraged
attempts to coordinate the management of logistical functions. In general,
these attempts focused on cost savings and on the physical distribution or
outbound part of the system.

An important factor present in many organizations involved managers with
military logistics experience from World War II. Not only did they have an
understanding of the interrelationships found in logistics systems, but
some of them had also used

management

science

techniques developed during the war—such as linear programming and
simulation, which are well suited to analyzing logistics problems.

Another factor that proved to be important in focusing management
attention on logistics was the economic

recession

of 1958. Cost cutting was brought on by the recession, and many firms
targeted logistics because it was believed to have more potential than
manufacturing and marketing. Manufacturing had been studied by industrial
engineers for many years, and it was believed that most of the excess
costs had already been squeezed out. Marketing, although costly, was not
understood well enough to intelligently cut costs. For example, most firms
were probably spending more than was optimal on

advertising,

but the relationship between sales and advertising was not known well
enough to tell which advertising costs to cut. In addition, marketing
costs are often difficult to quantify, whereas logistics costs can be
quantified. Tangible things that are moved and stored can be tracked.

Two other developments in the business environment that began during this
period and persist to the present are the proliferation of products and
the shift of power to retailers from large manufacturers of national
brands. The proliferation of new products and variations on existing
products is the outcome of the application of the marketing concept and

market segmentation.

Marketers, attempting to satisfy their customers’ increasing
interest in fashion and their changing lifestyles, have offered more and
more products to smaller and smaller segments of the market. Examples
abound on retailer shelves. Consider such products as large appliances
originally available only in white, or plastic trash bags, cereals, frozen
prepared foods, athletic shoes, office furniture, cosmetics, and so on.
Not only are more and more products available, but the life cycles of the
products are shortening. To remain competitive manufacturers must offer a
continuous stream of new products.

Product proliferation and shorter product life cycles force logisticians
to deal with growing complexity. Each time a new product or product
variation is offered, it increases the number of products to be
manufactured, stored, transported, and generally kept track of. At the
retail level the problem is compounded. A manufacturer may add a new color
of a product, thereby increasing its product line by one; but if all four
of the manufacturer’s competitors also add the new color, the
retailer will be faced with five new products.

As retailers such as Wal-Mart and Kmart continue to grow in size and as
their knowledge of the market becomes more and more sophisticated, their
power relative to manufacturers also grows. As retailers expand to serve
national and international markets, they control access to larger and
larger segments of the market. In addition, with the use of point-of-sale
computerized information systems, retailers have much better and more
timely information about customers than manufacturers.

Initially retailers used their newfound clout to push inventory back onto
manufacturers. They reduced the storage space in stores and required
smaller and more frequent deliveries to stores, thus increasing both
transportation and inventory costs for manufacturers. More recently
retailers such as Wal-Mart have used their size and information systems to
forge partnerships with manufacturers and to design streamlined logistics
systems that are more economical and result in fewer empty spaces on
retail shelves. For example, sales information may be fed directly from
the point-of-sale to the factory where production schedules are developed
based on actual demand; and the product is then shipped directly to the
retailer, bypassing several previously used storage facilities.

All of these factors caused many organizations to focus on their logistics
systems in a way that was different than any time in the past. The
recession, combined with more products to manufacture, move, and store as
well as retailers forcing inventory back on them, caused manufacturers to
focus on the large potential cost savings available from managing
logistics as a system.

Another factor whose importance to the development of business logistics
cannot be underestimated is the evolution of

computers and computer systems.

To realize its full potential, business logistics management requires the
timely processing and analysis of tremendous amounts of data. It is not
uncommon for a firm to have thousands of customers ordering thousands of
products—resulting in tens of thousands of transactions and
shipments, hundreds of suppliers shipping thousands of parts and
components, and multiple factory and warehouse locations—each with
inventories to be tracked. All of this occurs simultaneously across
several countries and continents.

Needless to say manual analysis and day-to-day control of all these facets
is not possible. It is probably not an overstatement to say that the
computer has allowed the business logistics concept to be implemented. The
computer is essential to process the thousands of transactions and record
changes that occur daily. Computers are needed to analyze the logistics
system. They’re needed to make plans concerning such things as
optimal warehouse location, the amount of inventory to have on hand at the
various
warehouses throughout the system, the efficient scheduling and routing of
trucks, the factories’ production schedules, and many other crucial
decisions.

During the 1950s and 1960s logisticians concentrated on reducing

costs

primarily in the physical distribution or outbound side of the system. In
the 1970s attention shifted to the materials management or inbound side of
the logistics system and to improving customer service along with reducing
costs. The shift in focus to materials management was largely the result
of the

OPEC

oil embargo, which severely limited supplies of petroleum and related
products such as plastics. Many firms began to place emphasis on using the
logistics system to improve customer service as the pace of competition
quickened in the United States, especially from firms located overseas.
The net result was that many firms began to look for ways to integrate
materials management and physical distribution and thus to adopt the
concept of business logistics. In addition, many firms began to view
business logistics as a way to strengthen their relations with customers
through improved customer service.

The 1970s were also a time of relatively high

inflation

and

interest rates.

The high interest rates prompted many firms to reconsider their
investments in inventories and to look for ways to reduce them.

The 1980s began with the federal deregulation of transportation in the
United States. The changes in transportation regulation resulted in a much
more competitive and flexible transportation system. Freight rates fell
and transportation companies were allowed to tailor their service to the
needs of individual customers. Many companies were also able to reduce
inventory levels by using fast, responsive transportation service to
deliver to customers from centrally located inventories, rather than
having products stored close to customers.

The 1980s also saw the full development of truly global companies. These
are companies that source parts and components in different countries for
assembly in another country into products destined for markets in several
others. The scope and complexity of the logistics systems of these firms
far exceed those of a purely domestic company. The success or failure of
such firms is even more dependent on an effective logistics system.

A third development of the 1980s, which has had profound effects upon the
concept of business logistics, was the introduction of just-in-time (JIT)
production from Japan to the rest of the world. The idea of producing only
what is required at the time it is required has revolutionized repetitive
manufacturing. Small quantities are delivered frequently on very stringent
schedules in JIT manufacturing. Such systems are very dependent upon the
logistics system to perform nearly flawlessly—not only in terms of
meeting schedules but also in terms of doing so economically. It is
necessary to combine several small shipments together in order to maintain
transportation economies. Such systems require a great deal of planning
and coordination across organizations to perform properly.

During the 1990s the major factors affecting logistics are the
developments in communications technology, such as

electronic data interchange (EDI)

and global positioning systems, the growth of third-party logistics
organizations and

strategic alliances

and

partnerships,

and the tendency to view logistics as an important component in the
firm’s overall strategy.

Electronic data interchange (EDI), which is simply the passage of business
information electronically between organizations, such as
computer-to-computer ordering and invoicing, allows for the rapid transfer
of information between the various organizations involved in the supply
chain. For example, a manufacturer’s computer calls a
supplier’s computer to place an order to be delivered at a specific
time. The supplier’s computer places the order in the production
schedule and arranges for transportation by placing an order with a
trucking company. The supplier’s computer also keeps the
manufacturer informed of the status of the order and when the trucking
company picked it up. The trucking company’s computer advises the
manufacturer of the shipment’s expected time of arrival at the
manufacturer’s factory. If something goes wrong, such as the truck
being delayed by an accident, all parties will be informed and can
formulate a contingency plan.

Global positioning systems (GPS) make possible the precise tracking and
monitoring of transportation equipment. A truck outfitted with a
transponder can transmit a signal to a satellite, which then signals a
home base with the truck’s location. In this way the truck and its
contents can be followed. The trucking company’s computer would
keep track of the progress of the trip and advise the manufacturer, or the
manufacturer could track its progress by asking the trucking
company’s computer for updates. Some systems now have the
capability to monitor such things as the truck’s engine
temperature, oil pressure, and brake systems. The type of capability made
possible with technology such as EDI and GPS make JIT systems
possible and allow firms to operate with leaner inventories across many
countries and continents.

Third-party or contracts logistics companies began to grow very rapidly in
the 1990s. These companies allow a firm to spin off all or part of the
management and operation of its logistics system to an outside expert,
thus freeing up assets and management attention for the firm’s core
business. Modern communications technology such as EDI allows firms to
spin off important logistics activities to third parties and still closely
monitor and control the logistics system. The relationship of the
manufacturer and the third-party logistics firm is often a long-term
strategic alliance or partnership, where the manufacturer entrusts the
operation of an important part of its business to the third party and the
third party makes a major commitment of its own assets to the
manufacturer. The contract logistics market was estimated at $34.2 billion
in 1997, with about 70 percent of all Fortune 500 companies using
third-party logistics firms.

Another development has been the recognition by a growing number of
organizations of the strategic benefits of a well-run logistics system
that is structured to enhance the overall strategy of the firm. Wal-Mart
is a good example of this. Wal-Mart’s basic strategy is to be the
low-cost/low-priced retailer of general merchandise. Like others who have
this same basic strategy, Wal-Mart manages its stores efficiently and buys
in volume at low prices. Where it excels and beats the competition,
however, is in the management of its logistics system. Through the use of
a very sophisticated communication system and strategically located
distribution centers, Wal-Mart is able to supply its stores with
proportionately fewer assets tied up in inventory and less money spent on
transportation than its competitors. Wal-Mart’s logistics system is
estimated to give it a 2 to 3 percent overall cost advantage over rival
Kmart.

Logistical activities are the basic functions that have to be performed in
any logistics system. It is important to recognize that they are the
components of a true system, in that they are all interrelated. Very often
a change in one will create a ripple effect of change throughout the
entire system.

The basic logistics system can be described very simply. The process
begins with a customer placing an order with the organization. A product
is then either produced or shipped from an inventory to the customer. As
more products are sold, more raw materials must be acquired from suppliers
and more products produced to fill demand or replenish inventories. The
way that the parts of this system are configured will determine how and
when the customer receives the order. Thus, the output of the logistics
system is customer service, and the job of the logistician is to design a
system that delivers a desired level of customer service at the lowest
total cost. Cost-cutting, while important, must be balanced with the need
to provide optimum levels of customer service and satisfaction.

Customer service can be defined and measured in many ways, and in most
firms multiple measures will be used. For example, customer service could
be defined as the percentage of times a customer order can be filled from
inventory (product availability), or the length of time it takes to get
the ordered product to the customer (order-cycle time), or the percentage
of orders for which the correct product is sent to the correct
destination, or the percentage of orders the customer receives undamaged.
The consistency or variability of the length of time it takes to get
orders to customers has been found to be very important to customers, more
important than the average length of time to fill an order. Most
customers, if forced to choose, would take consistency over speed. In
other words, an average order cycle of 10 days with no variability would
be preferable to one which averages 4 days but could take up to 14.

The starting point for the design of a logistics system is the
determination of customer service levels that will give the firm a
strategic advantage over competitors. The logistician must learn which
elements are important to customers, how well competitors perform them,
and how well the logistician’s organization is perceived to perform
them. The logistics system must then be designed to deliver the required
level of service at the least possible cost. Determining customer service
levels is an ongoing, never-ending task, because customer needs are
constantly changing and evolving—presenting challenges and
opportunities to the firm and its competitors alike.

Transportation is a very important element in most logistics systems. It
is often the most expensive element. Transportation is composed of five
modes (air, truck, rail, water, and pipeline) and the individual companies
or carriers within each mode, such as Union Pacific Railroad or Roadway
Express. The logisticians’ job is to select the modes and carriers
that will deliver the desired level of service at the lowest cost.

Each mode is different in terms of its speed, reliability, cost, route
flexibility, and the products it can carry efficiently and effectively.
For example, air transport is often the fastest, but it is also the most
expensive and is not usually practical for transporting large bulky
commodities. Also, for short distances a direct truck delivery is usually
faster than air. Truck deliveries account for at least a portion of most
freight
movements because they have the greatest route flexibility, are
relatively fast, have moderate cost, and can carry a wide range of
products. Railroads are usually used to carry large quantities over long
distances (over 500 miles). Pipeline and water are relatively slow and
inexpensive. Pipeline has the least route and product flexibility, and
water is susceptible to weather problems such as droughts, flooding, and
storms.

Intermodal transportation is when two or more modes are combined to take
advantage of the strengths of each. For example, the most popular form of
intermodal transportation is the combination of truck-route flexibility
with the railroads’ inexpensive long-haul capabilities. In one
version of truck/rail intermodal transportation called piggyback, a truck
trailer is placed on a railroad flatcar. The pickup and delivery is
performed by truck, while the long-haul terminal-to-terminal
transportation is performed by rail, thereby capitalizing on the strengths
of each mode.

Individual transportation companies or carriers also have varying
characteristics. For example, the prices or rates they charge, the
condition and age of their equipment, the points they serve, the length of
time it takes them to get a shipment to a particular place, and the
likelihood of the shipment being damaged may all vary from one carrier to
another. In general, for both modes and carriers, the faster and more
reliable they are, the more expensive they will be.

The logistics manager also has a choice as to whether the carrier to be
used will be a common carrier or a contract carrier, or if the
organization should buy its own trucks and set up its own do-it-yourself
transportation company—called a private carrier. A common carrier
is a transportation company that offers its services to the general public
on a for-hire, as-needed basis. A contract carrier is a carrier with which
the organization establishes a longer contractual arrangement. Often the
contract carrier will dedicate equipment to its customer and tailor its
service to that customer, whereas a common carrier will offer mostly the
same service to everyone on a first-come, first-served basis. Many
organizations set up their own private transportation operation,
especially if they have unique service requirements that cannot be met by
common carriers. The disadvantage of having a private carriage operation
is the investment in equipment, facilities, and people to operate and
manage it. Contract carriage is often a good compromise.

The logistician has many choices to make in designing the transportation
component of the system. Inventory is a very important part of a system
and is found in many places throughout the logistics system. On the
inbound side inventories of raw materials, parts, and components are kept
in anticipation of their use in manufacturing. Within manufacturing,
work-in-process inventory is found between the various stages of
production and in production. Finished goods inventories may be kept in
anticipation of demand by customers and may be found at plants or in
warehouses in the field close to customers.

There are several very good reasons for having inventory in the logistics
system. One of the most obvious is for customer service. Products are
produced in advance of customer orders so customers do not have to wait
for them to be manufactured. Customers are served directly from stock.
Inventories may be held because suppliers offer cheaper prices if
purchases are in large volumes. In addition, the cost of transporting them
is lower if they are moved in large volumes. Inventories may also be held
to achieve manufacturing economies. By producing in large lots that exceed
immediate levels of demand, the costs of manufacturing may be reduced.
Seasonality of products or seasonality of customer demand may also lead to
inventories in the system. For example, tomatoes may be harvested in
August and canned and stored to fill demand in the winter months. Seasonal
products such as lawn furniture may be manufactured year-round but only
sold in the spring and summer. During the fall and winter an inventory is
built to satisfy demand in the warmer months. Finally, some products may
require aging or ripening, such as meat and bananas.

Although there are very good reasons for carrying inventory, there are
always costs associated with it. The largest cost of carrying inventory is
the cost of capital tied up in the inventory. In other words, if the firm
did not have its money invested in inventory, it would be able to use that
money elsewhere to increase its productive capacity, or at the very least
it could put it in an interest-bearing savings account. The capital cost
of carrying inventory is an

opportunity cost.

If the money had not been tied up in inventory, it could have been used
to produce income. The

income

not produced is the opportunity cost. Other costs of carrying inventory
include the danger that the product may become obsolete before it is ever
sold or that it will be damaged or stolen while in storage. In addition,

taxes

may have to be paid on the value of the inventory, insurance may have to
be bought to protect against loss or damage, and the space occupied by the
inventory may have to be paid for. Holding inventory can be a rather
expensive undertaking.

While the costs of carrying inventory may be a deterrent to keeping
inventory, there are several other reasons for not carrying it that may be
even more important than the cost. Inventory can be used to cover up
problems rather than find solutions. For
example, an inventory of parts may be used to cover up quality problems
with a supplier. When a defective part is found, it is just put aside and
a replacement is found in the inventory rather than going to the supplier
and correcting the cause of the defective part. Another example could be
late, inconsistent deliveries from a supplier. An inventory of parts kept
on hand to be used when deliveries are late rather than correcting the
cause of the problem is obviously inefficient and wasteful.

Another problem caused by carrying too much inventory is that it reduces
the firm’s flexibility to meet changing customer preferences. A
company with large stocks of current products and parts on hand must use
up the inventory in the system before a new product can be introduced. In
fast-changing markets competitors with lean inventories are able to adjust
more quickly to changing customer needs.

Logisticians must continuously search for ways to acquire materials and
operate factories efficiently while satisfying customers and carrying as
little inventory as possible. Warehouses and distribution centers (DC) are
where much of the inventory is kept. They are used to improve customer
service by moving goods closer to the market and to reduce transportation
costs by allowing goods to be shipped in large, economical loads to the
DC, rather than from the plant in small, expensive shipments. Customers
can be served more quickly from stock located in a nearby DC than from a
remote stocking location.

Logisticians can choose between renting or leasing space in a public
warehouse or building and operating the company’s own private
warehouse. A private warehouse or DC may be attractive if the
firm’s products require special handling, care or equipment, or if
the facility can be used intensively. Public warehouses are attractive to
firms that have seasonal sales patterns that would prevent them from fully
utilizing the facility, or for firms that value the flexibility of being
able to withdraw on short notice from a particular market. The logistician
must decide how many warehouses and DCs to use, whether they should be
private or public, and where they should be located to provide the desired
level of service at the lowest possible cost.

The materials handling system is the equipment within the warehouse that
consists of such things as cranes, forklift trucks, racks, and shelving
which is used to move and store the inventory. The materials handling
system is designed to handle a certain volume of goods of various
dimensions and weights, and the warehouse is designed to enclose the
materials handling system.

Logisticians are also concerned with protective

packaging

of the firm’s products. The package should be strong enough to
protect the product from all of the threats it is likely to encounter
throughout the logistics system, yet be economical. The package will have
a significant effect on the design of the materials handling system. For
example, the dimensions and weight of the package and its stackability
will influence the type of materials handling equipment that is suitable.

The materials management side of the logistics system is designed to
support the production schedule that determines where the firm’s
products will be produced, the quantities to be produced, and the timing
of that production. The acquisition and procurement of raw materials,
parts, and supplies are designed to feed the production schedule. The
location of the source of inbound materials and their destinations, the
quantities to be shipped and the timing of the deliveries all have serious
implications for transportation, inventory levels, production schedules,
and ultimately customer service. For example, companies using just-in-time
production want small quantities of inbound materials shipped frequently
to arrive on rigid time schedules, preferably from nearby suppliers.

In addition to the major logistical functions discussed above, many
logistics managers are involved with related issues such as demand
forecasting, salvage and scrap disposal, return goods handling, parts and
service support, and plant location.

Looking ahead to a new millennium, business logistics and supply chain
managers will be faced with an accelerating demand to deliver better
products faster and cheaper on a global basis. There will be opportunities
as well as challenges. Logistics managers will be called on to maintain
supply and keep up with deliveries in an electronically linked
international business community. And they will be performing in a rapidly
changing business environment as the pace of business change accelerates
over the next decade. Meeting the demands for faster cycle times will
require close cooperation throughout each business’s supply chain,
as companies come to rely on more partners to achieve their logistics
goals.

Globalization

of business will be enhanced by regional trade agreements and the
reduction of trade barriers as well as through international electronic
networks such as the Internet. Such globalization will result in new
consumer demographics as densely populated nations such as

China

and

India

become part of the global marketplace. As companies are faced with
consumer demands from around the globe, speed and simplicity of delivery
become ever more important.

New technologies will play an increasingly important role in business
logistics, if they aren’t already. New

software

tools will provide managers with better ways to analyze the performance
of logistics networks.

Internet

applications will open up internal information to all participants in the
supply chain. The demand for speed will result in companies taking
inventory out of their systems, with technology providing much of the
ability to meet the demands for speed and simplicity. The ultimate, though
perhaps unattainable, goal of logistics will be zero inventory and
immediate availability.

Outsourcing of logistics will likely increase as the growth of third-party
logistics firms continues. For those companies that handle their own
logistics, the challenge for managers will be to communicate to their
company’s senior management the advantages that logistics can
provide.

[

George

C.

Jackson

,

updated by

David

P.

Bianco

]