Elements of LOGS Compiled by:- Vaibhav K.

THE PERFECT ORDER

The ultimate in logistics service is to do everything right and to do it right the first time. It is not
sufficient to deliver a complete order but to deliver it late. Nor is it sufficient to deliver a complete order on time
but to have an incorrect invoice or product damage incurred during the handling and transportation process. In
the past, most logistics managers evaluated customer service performance in terms of several independent
measures: fill rates were evaluated against a standard for fill; on-time delivery was evaluated in terms of a
percentage of deliveries made on time relative to a standard; damage rates were evaluated relative to a standard
for damage; etc. When each of these separate measures was acceptable relative to standard, overall service
performance was considered acceptable.

Recently, however, logistics and supply chain executives have begun to focus attention on zero-defect
or six-sigma performance. As an extension of Total Quality Management (TQM) efforts within organizations,
logistics processes have been subjected to the same scrutiny as manufacturing and other processes in the firm. It
was realized that if standards are established independently for customer service components, even if
performance met standard on each independent measure, a substantial number of customers may have order-
related failures.

For example, if orders shipped complete, average on-time delivery, average damage-free delivery, and
average correct documentation are each 97 percent, the probability that any order will be delivered with no
defects is approximately 88.5 percent. This is so because the potential occurrence of any one failure combined
with any other failure is .97 x .97 x .97 x .97.

The converse of this, of course, is that some type of problem will exist on as many as 1 1.5 percent of
all orders. The notion of the perfect order is that an order should be delivered complete, delivered on time, at the
right location, in perfect condition, with complete and accurate documentation. Each of these individual
elements must comply with customer specifications. Thus, complete delivery means all products that the
customer originally requested, on time means at the customer's specified date and time, etc. In other words, total
order cycle performance must be executed with zero defects-availability and operational performance must be
perfectly executed and all support activities must be completed exactly as promised to the customer. While it
may not be possible to offer zero defects as a basic service strategy across the board to all customers, such high-
level performance may be an option on a selective basis. It is clear that the resources required to implement a
perfect order platform are substantial.

Extremely high fill rates require high inventory levels to meet all potential order requirements and
variations. However, such complete service cannot be achieved based totally on inventory. One way of
elevating logistics performance to at least near zero defects is to utilize a combination of customer alliances,
information technology, postponement strategies, and inventory stocking strategies, premium transportation,
and selectivity programs to match logistical resources to core customer requirements. Each of these topics is the
subject of detailed discussion in subsequent chapters. Suffice it to say at this time that firms achieving superior
logistical customer service are well aware of the challenge related to achieving zero defects. By having a low
tolerance for errors, coupled with a commitment to resolve whatever discrepancies occur, such firms can
achieve strategic advantage over their competitors.

CUSTOMER EXPECTATIONS RELATED TO LOGISTICAL PERFORMANCE

1. Reliability: Reliability is one of the aspects of the firm's basic service platform. In this context, however,
reliability refers to performance of all activities as promised by the supplier. If the supplier promises next
day delivery and delivery takes 2 days, it is perceived as unreliable. If the supplier accepts an order for
100 cases of a product, it implicitly promises that 100 cases will be delivered. The customer expects and
is only satisfied with the supplier if all I00 arc received. Customers judge reliability in terms of all
aspects of the basic service platform. Thus, customers have expectations concerning damage,
documentation accuracy, etc.

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 Elements of LOGS Compiled by:- Vaibhav K.

2. Responsiveness: Responsiveness refers to customers' expectations of the willingness and ability of

supplier personnel to provide prompt service. This extends beyond mere delivery to include issues
related to quick handling of inquiries and resolution of problems. Responsiveness is clearly a time-
oriented concept and customers have expectations regarding suppliers' timely handling of all interactions.

3. Access: Access involves customer expectations of the ease ~f contact and approachability of the
supplier.
For example, is it easy to place orders, to obtain information regarding inventory or order status?

4. Communication: Communication means proactively keeping customers informed. Rather than waiting
for customer inquiries concerning order status, customers have expectations regarding suppliers'
notification of status, particularly if problems with delivery or availability arise. Customers do not like to
be surprised and advance notice is essential.

5. Credibility: Credibility refers to customer expectations that communications from the supplier are in
fact believable and honest. While it is doubtful that many suppliers intentionally mislead customers,
credibility also includes the notion of completeness in required communications.

6. Security: Security deals with customers' feelings of risk or of doubt in doing business with a supplier.
Customers make plans based on their anticipation of supplier performance. For example, they take risk
when they schedule production and undertake machine and line setups in anticipation of delivery. If
orders are late or incomplete, their plans must be changed. Another aspect of security deals with
customer expectations that their dealings with a supplier will be confidential. This is particularly
important in supply chain arrangements when a customer has a unique operating agreement with a
supplier who also services competitors.

7. Courtesy: Courtesy involves politeness, friendliness, and respect of contact personnel. This can be a
particularly vexing problem considering that customers may have contact with numerous individuals in
the organization ranging from sales representatives to customer service personnel to truck drivers.
Failure by one individual may destroy the best efforts of all the others.

8. Competency: Competence is judged by customers in every interaction with a supplier and, like courtesy,
can be problematic because it is perceived in every interaction. In other words, customers judge the
competence of truck drivers when deliveries are made, warehouse personnel when orders are checked,
customer service personnel when phone calls are made, and so forth. Failure by any individual to
demonstrate competence affects customer perceptions of the entire organization.

9. Tangibles: Customers have expectations regarding the physical appearance of facilities, equipment, and
personnel. Consider, for example, a delivery truck that is old, damaged, or in poor condition. Such
tangible features are additional cues used by customers as indicators of a firm's overall performance.

10. Knowing the Customer: While suppliers may think in terms of groups of customers and market
segments, customers perceive themselves as unique. They have expectations regarding suppliers'
understanding their uniqueness and supplier willingness to adapt to their specific requirements.

LOGISTICAL INTEGRATION OBJECTIVES

To achieve logistical integration, six operational objectives must be simultaneously achieved:

1. Responsiveness
Responsiveness is concerned with a firm's ability to satisfy customer requirements in a timely
manner. As noted repeatedly, information technology is facilitating response based strategies that
permit operational commitment to be postponed to the last possible time, followed by accelerated
delivery. The implementation of response-based strategies serves to reduce inventories committed or

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 Elements of LOGS Compiled by:- Vaibhav K.

deployed in anticipation of customer requirements. Responsiveness, as developed in Chapter 1, serves

to shift operational emphasis from forecasting future requirements to accommodating customers on a
rapid order-to-shipment basis. In a response-based system, inventory is not deployed until a customer
commits. To support such commitment, a firm must have inventory availability and timely delivery
once a customer order is received.

2. Variance Reduction
All operating areas of a logistical system are susceptible to variance. Variance results
from failure to perform any expected facet of logistical operations. For example, delay in customer
order processing, an unexpected disruption in manufacturing, goods arriving damaged at a customer's
location, and/or failure to deliver at the right location on time all create unplanned variance in the
order-to-delivery cycle. A common solution to safeguard against the detrimental variance is to use
inventory safety stocks to buffer operations. It is also common to use premium transportation to
overcome unexpected variance that delays planned delivery. Such practices, given their associated
high cost, can be minimized by using information technology to maintain positive logistics control. To
the extent that variance is minimized, logistical productivity will improve.

Thus, variance reduction, the elimination of system disruptions, is one basic objective
of integrated logistics management.

3. Inventory Reduction
To achieve the objective of inventory reduction, an integrated logistics system must control
asset commitment and turn velocity. Asset commitment is the financial value of deployed inventory.
Turn velocity reflects the rate at which inventory is replenished over time. High turn rates, coupled with
desired inventory availability, mean assets devoted to inventory are being efficiently and effectively
utilized; that is, overall assets committed to support an integrated operation are reduced. It is important
to keep in mind that inventory can and does facilitate desirable benefits. Inventories are critical to
achieving economies of scale in manufacturing and procurement. The objective is to reduce and manage
inventory to the lowest possible level while simultaneously achieving performance objectives.

4. Shipment Consolidation
One of the most significant logistical costs is transportation. Approximately 60 cents of each
logistics dollar is expended for transportation. Transportation cost is directly related to the type of
product, size of shipment, and movement distance. Many logistical systems that feature direct
fulfillment depend on high-speed, small shipment transportation, which is costly. A system objective is
to achieve shipment consolidation in an effort to reduce transportation cost. As a general rule, the
larger a shipment and the longer the distance it is transported, the lower is the cost per unit.
Consolidation requires innovative programs to combine small shipments for timely consolidated
movement. Such programs require multiform coordination because they transcend the supply chain.
Successful e-commerce fulfillment direct-to-consumers require innovative ways to achieve effective
consolidation. Industry Insight 6-2 discusses logistics challenges of e-commerce to illustrate the
importance of effective consolidation.

5. Quality
A fundamental operational objective is continuous quality improvement. Total Quality
Management (TQM) is a major initiative throughout most facets of industry. If a product becomes
defective or if service promises are not kept, little, if any value can be added by the logistics process.
Logistical costs, once expended, cannot be reversed or recovered. In fact, when product quality fails
after customer delivery and replacement is necessary, logistical costs rapidly accumulate. In addition to
the initial distribution cost, products must be returned and replaced. Such unplanned movements
typically cost more than original distribution. For this reason, commitment to zero-defect order to-
delivery performance is a major goal of leading-edge logistics.

Logistics itself is performed under challenging conditions. The difficulty of achieving zero-
defect logistics is magnified by the fact that logistical operations typically are performed across a vast
geographical area during all times of day and night without direct supervision.

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6. Life Cycle Support

The final integration design objective is life cycle support. Few items are sold without some
guarantee that the product will perform as advertised. In some situations, the initial value-added
inventory flow to customers must be reversed. Product return is common as a result of increasingly rigid
quality standards, product expiration dating, and responsibility for hazardous consequences. Reverse
logistics also results from the increasing number of laws encouraging recycling of beverage containers
and packaging materials. The significant point concerning reverse logistics is the need to maintain
maximum control when a potential health liability exists, such as a contaminated product.

The operational requirements for reverse logistics range from lowest total cost, such as returning bottles
for recycling, to maximum control in situations involving defective products. Firms that design efficient
reverse logistics often are able to reclaim value by reducing the quantity of products that might otherwise
be scrapped or sold.

ACTIVITY-BASED COSTING

As a partial solution to the problem of arbitrary allocations, Activity-Based Costing (ABC)

suggests that costs should first be traced to activities performed and then activities should be related to
specific product or customer segments of the business. 'Suppose, for example, the order processing
expense is basically a fixed indirect cost in our hypothetical example, amounting to $5000. Allocating
this expense to the two customers based on sales volume results in a charge of $2000 to the hospital and
$3000 to the retailer. However, it is likely that the hospital places very many orders during the year, each
of a small quantity, while the retailer may place only a few large orders. If the hospital placed 80 orders
and the retailer placed 20 orders, an ABC approach would charge the hospital with 80 percent or $4000
and the retailer with 20 percent or $1000 of the order processing expense. Applying similar logic to
other indirect fixed costs by identifying the activities and drivers of cost could result in further
refinement of customer profitability.

Logistical Implications on ABC

Identifying the activities, related expenses, and the drivers of expense represents the biggest
challenge in an ABC approach. Order processing cost may be related to the number of orders in one
company and to the number of lines on orders in another company. Warehouse picking expense may be
related to the number of items picked in one company and to the number of pounds in another.

Transportation might be related to number of deliveries for one firm and number of miles driven for
another. According to proponents of this activity-based costing method, only two types of costs should
be excluded from allocation to segments. First, excess capacity cost in a firm should not be charged to a
segment. Thus, if an order processing system could process five million orders per year but is only
utilized for four million orders, the excess capacity should not be charged to any segment. Similarly, if a
warehouse and its employees could handle 100,000 shipments but are only used for 80,000, the excess
capacity is a cost of the time period rather than a cost attributable to an existing operating segment.

All other costs, however, can and should be traced through an activity-based system." Much of the
distinction between the contribution margin and net profit approaches to segment cost analysis is
disappearing as analysts are developing better approaches to identify expense behavior. Advocates of
direct costing and contribution margin probably go along with the tracing of costs to segments based on
activities performed, as long as the basis for tracing reflects the real cost of the activity. Historically,
their argument has been based on the fairness and appropriateness of the allocation method. Even the
most avid proponent of full costing, on the other hand, would not argue in favor of arbitrary allocation of
cost. The development of better ARC systems has the potential for ultimately resolving this controversy,
which has existed in marketing and distribution for a number of years.

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REVERSE LOGISTICS

Warehousing plays a key role in performing reverse logistics. Most of the physical work related
to product recall, reclamation, and disposal of overstock and damaged inventory is performed at
warehouse. Many firms are generating significant cash flow from refurbishment, recycling, and disposal
of damaged and defective product. Reverse logistics is concerned with controlled and regular inventory.

Controlled inventory consists of hazardous materials and product recalls that have potential
consumer health or environmental considerations. The reclamation of controlled inventory must be
performed under strict operating scrutiny that prevents possible redistribution or improper disposal. As
one might expect, varied governmental agencies, such as the Consumer Product Safety Commission,
Department of Transportation (DOT), the Environmental Protection Agency (EPA), Food and Drug
Administration (FDA), and the Occupational Safety and Health Administration (OSHA), are directly
involved in disposal of controlled inventory ~ less attention has traditionally focused on reclamation of
regular inventory.
In 1997 the disposition of unsaleable product was estimated to cost companies $4 billion. The
food industry alone was estimated to have unsaleable inventory approaching $2.6 billion and growing at
a rate approaching 20 percent per year. The product involved in such reclamation is typically damaged
or aged beyond the recommended sell-by date. While some unsaleable product results from warehouse
damage, most is returned from retail or even from the consumer. While reclamation is difficult for
regular inventory, it is far more challenging for controlled inventory. In both return situations, product
flow lacks the orderly process characteristic of outbound movement. Reverse movement typically
consists of non uniform individual packages and cartons as contrasted to outbound movement of cases
and pallet loads. Packages are often broken, and product is not packaged correctly. Return products
typically require significant manual sortation and inspection to determine appropriate disposal.1°
However, the opportunity to recover cost by reimbursement and recycling is significant.'' Industry
Insight 13-2 illustrates some challenges of reverse logistics.

STRATEGIC WAREHOUSING

Storage has always been an important aspect of economic development. In the pre-industrial
era, storage was performed by individual households forced to function as self-sufficient economic units.
Consumers performed warehousing and accepted the attendant risks.
As transportation capability developed, it became possible to engage in specialization. Product
storage shifted from households to retailers, wholesalers, and manufacturers. Warehouses stored
inventory in the logistics pipeline, serving to coordinate product supply and consumer demand.' Because
the value of strategic storage was not well understood, warehouses were often considered "necessary
evils" that added cost to the distribution process. The concept that middlemen simply increase cost
follows from that belief. The need to deliver product assortments was limited. Labor productivity,
materials handling efficiency, and inventory turnover were not major concerns during this early era.
Because labor was relatively inexpensive, human resources were used freely. Little consideration was
given to efficiency in space utilization, work methods, or materials handling. Despite such shortcomings,
these initial warehouses provided a necessary bridge between production and marketing. Following
World War 1, managerial attention shifted toward strategic storage. Management began to question the
need for vast warehouse networks. In the distributive industries such as wholesaling and retailing, it was
traditionally considered best practice to dedicate a warehouse containing a full assortment of inventory
to every sales territory. As forecasting and production scheduling techniques improved, management
questioned such risky inventory deployment. Production planning became more dependable as
disruptions and time delays during manufacturing decreased. Seasonal production and consumption still
required warehousing, but overall need for storage to support stable manufacturing and consumption
patterns was reduced. Changing requirements in retailing more than offset any reduction in warehousing
obtained as a result of these manufacturing improvements. Retail stores, faced with the challenge of
providing consumers and increasing assortment of products, found it more difficult to maintain
purchasing and transportation economics when buying from suppliers.

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The cost of transporting small shipments made direct ordering prohibitive. This created an
opportunity to establish strategically located warehouses to provide timely and economical inventory
replenishment for retailers. Progressive wholesalers and integrated retailers developed state-of-the-art
warehouse systems to logistically support retail replenishment. Thus, the focus on warehousing shifted
from passive storage to strategic assortment.

Improvements in retail warehousing efficiency soon were adopted by manufacturing. For

manufacturers, strategic warehousing offered a way to reduce holding or dwell time of materials and
parts. Warehousing became integral to Just-in-Time (JIT) and stockless production strategies. While the
basic notion of JIT is to reduce work-in-process inventory, such manufacturing strategies need
dependable logistics. Achieving such logistical support across the U.S. geography requires strategically
located warehouses. Utilizing centralized parts inventory at a central warehouse reduces the need for
inventory at each assembly plant. Products can be purchased and shipped to the strategically located
central warehouse, taking advantage of consolidated transportation.

At the warehouse, products are sorted, sequenced, and shipped to specific manufacturing plants
as needed. Where fully integrated, sortation and sequencing facilities become a vital extension of
manufacturing. On the outbound side of manufacturing, warehouses can be used to create product
assortments for customer shipment. The capability to receive mixed product shipments offers customers
two specific advantages. First, logistical cost is reduced because an assortment of products can be
delivered while taking advantage of consolidated transportation.

Second, inventory of slow-moving products can be reduced because of the capability to receive
smaller quantities as part of a consolidated shipment. Manufacturers that provide assorted product
shipments can achieve a competitive advantage. An important charge in warehousing is maximum
flexibility. Such flexibility can often be achieved through information technology. Technology-based
applications have influenced almost every area of warehouse operations and created new and better ways
to perform storage and handling. Flexibility is also an essential part of being able to respond to
expanding customer demand in terms of product assortments and the way shipments are delivered and
presented. Information technology facilitates this flexibility by allowing warehouse operators to quickly
react to changing customer requirements.

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